Managerial Accounting 16th Edition Garrison Solutions Manual by Ace Test Banks

Managerial Accounting 16th Edition Garrison Solutions Manual By Ray Garrison, Eric Noreen, Peter Brewer

Prologue Managerial Accounting: An Overview Questions P-1 Financial accounting is concerned with reporting financial information to external parties, such as stockholders, creditors, and regulators. Managerial accounting is concerned with providing information to managers for use within the organization. Financial accounting emphasizes the financial consequences of past transactions, objectivity and verifiability, precision, and companywide performance, whereas managerial accounting emphasizes decisions affecting the future, relevance, timeliness, and segment performance. Financial accounting is mandatory for external reports and it needs to comply with rules, such as generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS), whereas managerial accounting is not mandatory and it does not need to comply with externally imposed rules. P-2 Five examples of planning activities include (1) estimating the advertising revenues for a future period, (2) estimating the total expenses for a future period, including the salaries of all actors, news reporters, and sportscasters, (3) planning how many new television shows to introduce to the market, (4) planning each television show’s designated broadcast time slot, and (5) planning the network’s advertising activities and expenditures. Five examples of controlling activities include (1) comparing the actual number of viewers for each show to its viewership projections, (2) comparing the actual costs of producing a made-for-television movie to its budget, (3) comparing the revenues earned from broadcasting a sporting event to the costs incurred to broadcast that event, (4) comparing the actual costs of running a production studio to the budget, and (5) comparing the actual cost of providing global, on-location news coverage to the budget.

P-3 The quantitative analysis would focus on determining the potential cost savings from buying the part rather than making it. The qualitative analysis would focus on broader issues such as strategy, risks, and corporate social responsibility. For example, if the part is critical to the organization’s strategy, it may continue making the part regardless of any potential cost savings from outsourcing. If the overseas supplier might create quality control problems that could threaten the end consumers’ welfare, then the risks of outsourcing may swamp any cost savings. Finally, from a social responsibility standpoint, a company may decide against outsourcing if it would result in layoffs at its domestic manufacturing facility. P-4 Companies prepare budgets to translate plans into formal quantitative terms. Budgets are used for various purposes, such as forcing managers to plan ahead, allocating resources across departments, coordinating activities across departments, establishing goals that motivate people, and evaluating and rewarding employees. These various purposes often conflict with one another, which makes budgeting one of management’s most challenging activities. P-5 Managerial accounting is relevant to all business students because all managers engage in planning, controlling, and decision making activities. If managers wish to influence coworkers across the organization, they must be able to speak in financial terms to justify their proposed courses of action. P-6 The Institute of Management Accountants estimates that 80% of accountants work in nonpublic accounting environments. Accountants that work in corporate, nonprofit, and governmental organizations are expected to

use their planning, controlling, and decisionmaking skills to help improve performance. P-7 Deere & Company is an example of a company that competes in terms of product leadership. The company’s slogan “nothing runs like a Deere” emphasizes its product leadership customer value proposition. Amazon.com competes in terms of operational excellence. The company focuses on delivering products faster, more conveniently, and at a lower price than competitors. Charles Schwab competes in terms of customer intimacy. It focuses on building personal relationships with clients so that it can tailor investment strategies to individual needs. P-8 Planning, controlling, 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 company’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. P-9 This answer is based on Nike, which has suppliers in over 40 countries. One risk that Nike faces is that its suppliers will fail to manage their employees in a socially responsible manner. Nike conducts Management Audit Verifications at its overseas plants to minimize this risk. Nike faces the risk that unsatisfactory environmental performance will diminish its brand image. The company is investing substantial resources to develop products that minimize adverse impacts on the environment. Nike faces the risk that customers will not like its new products. The company uses focus group research to proactively assess the customers’ reaction to its new products. P-10 Airlines face the risk that large spikes in fuel prices will lower their profitability. Therefore, they may 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. P-11 Barnes & Noble could segment its companywide performance by individual store, by sales channel (i.e., bricks-and-mortar versus on-line), and by product line (e.g. non-fiction books, fiction books, music CDs, toys, etc.). Procter & Gamble could segment its performance by product category (e.g., beauty and grooming, household care, and health and well-being), 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). P-12 Timberland publishes quarterly corporate social responsibility (CSR) metrics (see www.earthkeeper.com/CSR. Three of those metrics include metric tons of carbon emissions, the percentage of total cotton sourced that is organic, and renewable energy use as a percent of total energy usage. Timberland’s corporate slogan of “doing well by doing good” suggests that the company publishes CSR reports because it believes that its financial success (i.e., doing well) is positively influenced by its social and environmental performance (i.e., doing good). P-13 Companies that use Lean Production only make units in response to customer orders. They produce units just in time to satisfy customer demand, which results in minimal inventories. P-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 co-workers’ efforts towards achieving organizational goals.

Managerial Accounting, 16th Edition

P-15 Ethical behavior is the lubricant that keeps the economy running. Without that lubricant, the economy would operate much less efficiently—less would be available to consumers, quality would be lower, and prices would be higher. P-16 Examples of internal controls over cash include maintaining a locked cash register, limiting access to the cash register to one employee at a time, periodically reconciling the cash in the register drawer with the register’s sales records, and segregating the duties of (1) checking out customers, (2) counting the cash in the drawer, (3) reconciling the cash in the drawer with the register’s sales report, and (4) depositing the cash in the bank. P-17 You should review a properly authorized purchase order to verify that the goods were actually ordered by the company for legitimate purposes. You should review the original price quotes from the seller to ensure that they agree with prices contained in the sales invoice. You should also review a receiving report to verify that the goods were received in the proper quantities and in satisfactory condition. P-18 Examples of control activities over credit sales and accounts receivable include verifying the credit rating of customers before selling to them on credit, separating the duties of those responsible for generating sales leads and those responsible for the credit approval process, defining credit limits for each customer, and preparing an aging of accounts receivable to monitor subsequent cash collections. P-19 Companies usually count their inventory on hand once a year, often at the end of their fiscal year. The purpose of this control activity is to reconcile the inventory on hand with the company’s accounting records. If a difference exists between the physical inventory and the accounting records, the reason for the difference should be investigated and, if appropriate, an adjustment should be recorded to align the accounting records with the physical count. P-20 Using pre-numbered documents reduces the likelihood of unauthorized transactions. Prenumbering also makes it easy to ensure that all documents are recorded and to quickly identify a missing document. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Prologue

Exercise P-1 (30 minutes) 1. 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. Third, 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. 2. 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. 3. If the company used the sales budget for the sole purpose of planning to deploy resources in a manner that best serves customers, then it is possible that the boss and the sales manager would both be focused on producing the most accurate forecast possible. 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. 4. If the company used the sales budget for the sole purpose of motivating employees to strive for excellent results, then the boss may be inclined to challenge the sales manager by establishing a budget that intentionally exceeds expected sales. If the sales budget has absolutely no impact on the sales manager’s pay raises, promotions or bonuses, then she may be inclined to embrace the challenge of “aiming high” when establishing the sales forecast.

Managerial Accounting, 16th Edition

Exercise P-1 (30 minutes) 5. If the company used the sales budget for the sole purpose of determining pay raises, promotions, and bonuses, then the sales manager will be inclined to understate the sales budget to maximize her pay raise, bonus, and chance of promotion. The boss would expect the sales manager to understate the sale budget, so he would seek to increase the budget above the sales manager’s proposed forecast. 6. When a budget is used to deploy resources, to motivate employees through the use of stretch goals, and to evaluate and reward employees, it creates inevitable conflicts. As a resource deployment tool, the budget should be as accurate as possible. As a motivational tool, the budget should intentionally seek to stretch employees to perform to their full potential. When budgets are used to evaluate and reward employees, the employees will have a strong inclination to establish easily attainable goals to maximize their chances for large pay raises and bonuses as well as their chance for promotion.

Exercise P-2 (10 minutes) The student would feel unfairly criticized for unloading 150 pieces of luggage in 13 minutes. The student would perceive that, according to the boss’s expectations, he should be able to unload 10 pieces of luggage per minute. Therefore, if an airplane contains 150 pieces of luggage, he should be allowed 15 minutes to unload the airplane’s luggage. By unloading 150 pieces of luggage in 13 minutes, the student would rightly claim that he beat the boss’s expectation by two minutes. When companies design control systems, they compare actual performance to some pre-existing expectation. The pre-existing benchmark needs to make sense so that it can result in meaningful managerial insights and fairminded assessments of employee performance. This is the fundamental underlying principle of flexible budgets, which will be explained in a subsequent chapter.

Managerial Accounting, 16th Edition

Exercise P-3 (30 minutes) Examples of Decisions

Application in a University Setting

What products and services should be the focus of our marketing efforts?

How should we allocate our marketing resources among our undergraduate programs, our graduate programs, our research accomplishments, and our athletic programs? Should we introduce a new major for undergraduate students? What prices should we establish for our travel abroad programs? Should we discontinue our MBA program?

What should we be selling?

What new products and services should we offer? What prices should we charge for our products and services? What products and services should we discontinue?

Who should we be serving?

Who should be the focus of our marketing efforts? Who should we start serving? Who should pay price premiums or receive price discounts? Who should we stop serving?

How should we execute?

How should we supply our parts and services? How should we expand our capacity? How should we reduce our capacity? How should we improve our efficiency and effectiveness?

How much of our marketing budget should we channel towards attracting undergraduate students versus graduate students? Should we introduce on-line programs that enable us to serve customers across the globe? How much should we charge for out-of-state tuition? Which one of our branch campuses should we close? What portion of our faculty should be adjunct faculty? Should we increase our average class size to accommodate more students? Should we cut costs by eliminating administrative jobs or faculty jobs? Should we increase our research expectations for our faculty?

Exercise P-4 (20 minutes) 1. Failure to report the obsolete nature of the inventory would violate the IMA’s Statement of Ethical Professional Practice as follows: Competence • Perform duties in accordance with relevant technical standards. Generally accepted accounting principles (GAAP) require the writedown of obsolete inventory. • Prepare decision support information that is accurate. Integrity • Mitigate actual conflicts of interest and avoid apparent conflicts of interest. • Refrain from engaging in any conduct that would prejudice carrying out duties ethically. • Abstain from activities that would discredit the profession. Credibility • Communicate information fairly and objectively. • Disclose all relevant information. • Hiding the obsolete inventory impairs the objectivity and relevance of financial statements. Members of the management team, of which Perlman is a part, are responsible for both operations and recording the results of operations. Because the team will benefit from a bonus, increasing earnings by ignoring the obsolete inventory is clearly a conflict of interest. Furthermore, such behavior is a discredit to the profession. (Unofficial CMA solution)

Managerial Accounting, 16th Edition

Exercise P-4 (continued) 2. As discussed above, the ethical course of action would be for Perlman to insist on writing down the obsolete inventory. This would not, however, be an easy thing to do. Apart from adversely affecting her own compensation, the ethical action may anger her colleagues and make her very unpopular. Taking the ethical action would require considerable courage and self-assurance.

Exercise P-5 (60 minutes) 1.

Company Deere

FedEx

State Farm Insurance

BMW

Amazon.com

Charles Schwab

Strategy Product leadership: “Nothing runs like a Deere” Operational excellence: “When it absolutely, positively has to be there overnight” Customer intimacy: “Like a good neighbor, State Farm is there” Product leadership: “The Ultimate Driving Machine” Operational excellence: Huge selection of products that are promptly delivered straight to your door Customer intimacy: “Talk to Chuck”

Managerial Accounting, 16th Edition

Exercise P-6 (15 minutes)

Airlines

Industry

Pharmaceutical drugs Package delivery Banking Oil & gas E-commerce Automotive

Example of Business Risk

An airplane might crash.

Example of Control to Reduce the Business Risk

Implement a preventive maintenance program. A customer might be Design tamper-proof harmed by a drug. packaging. A package may get Implement an lost. electronic package tracking system. Customer credit card Implement computer numbers may be system firewalls to foil stolen. computer hackers. An oil spill may Create contingency damage the response plans in the environment. event of an oil spill. The company’s website Develop a backup might crash. system that can be easily activated. Customers may not Use focus groups to like the appearance of assess reactions to a new car model. new model prototypes.

Exercise P-7 (20 minutes) 1. If all automotive service shops routinely tried to sell parts and services to customers that they didn’t really need, most customers would eventually figure this out. They would then be reluctant to accept the word of the service representative that a particular problem needs to be corrected—even when a real problem exists. Either the work would not be done, customers would learn to diagnose and repair problems themselves, or customers would hire an independent expert to verify that the work is really needed. All three of these alternatives impose costs and hassles on customers. 2. As argued above, if customers could not trust their service representatives, they would be reluctant to follow the service representative’s advice. They would be inclined not to authorize work even when it is really necessary. And, more customers would learn to do automotive repairs and maintenance themselves. Moreover, customers would be unwilling to pay as much for work that is done because customers would have reason to believe that the work may be unnecessary. These two effects would reduce demand for automotive repair services. The reduced demand would reduce employment in the industry and would lead to lower overall profits.

Managerial Accounting, 16th Edition

Exercise P-8 (10 minutes) 1. The type of cognitive bias revealed by this data is called selfenhancement bias. This bias occurs when people overstate their strengths and understate their weaknesses relative to others. 2. This bias may cause managers to be overly-optimistic when making plans for the future. This bias might also cause managers to readily blame others if control data indicates unsatisfactory performance. It can also lead managers to make poor decisions because they believe their managerial prowess can overcome any potential obstacles revealed by an objective data analysis. 3. Managers can help reduce the potential adverse consequences of selfenhancement bias by establishing a “devil’s advocate” team of managers that are charged with challenging proposed courses of action.

Exercise P-9 (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 Oregon Coastal University. Other students may argue that it is okay to be untruthful with the professor from Oregon Coastal University because it serves a “greater good” from the standpoint of future Mountain State University students that will be able to avoid Dr. Candler. 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.

Managerial Accounting, 16th Edition

Exercise P-10 (20 minutes) The purpose of this exercise is to create a platform for students to debate the merits of the shareholder-focused and stakeholder-focused philosophies of business management. Student responses are likely to fall in three categories. First, those students who believe that the purpose of a company is shareholder wealth maximization will tend to agree with the quote. Second, those students who believe that companies should serve the needs of a broadly defined group of stakeholders may disagree with the quote. Third, some students may argue that the shareholder-focused and stakeholder-focused philosophies of business management are not mutually exclusive. In other words, these students may assert that effectively or ineffectively serving the needs of various stakeholders can have a major impact on a company’s financial performance.

Exercise P-11 (20 minutes) 1. This question gives students a platform for discussing the merits of extrinsic motivators in organizations. Student responses should differ regarding the effectiveness of extrinsic rewards in creating an enduring commitment to a set of values or a course of action, thereby enabling a lively debate. 2.

This question gives students an opportunity to discuss the roles of intrinsic motivation and extrinsic motivation in organizational management.

This question gives students an opportunity to discuss the implementation of compensation systems within organizations. To enrich this discussion, professors can ask students questions such as: (1) Would your incentives be tied to individual performance or teambased performance? (2) Would your incentives be tied to easily attainable goals or stretch targets? and (3) How would you handle the fact that financial incentive systems are often influenced by factors that are beyond the control of those being evaluated?

Managerial Accounting, 16th Edition

Exercise P-12 (20 minutes) 1. Most students are likely to recommend reinforcing the sections of the plane that were hit most often by enemy fire. Indeed, during World War II, American military personnel drew the same conclusion. 2. Perceptive students may realize that this is a classic case of selection bias. Selection bias arises when decision makers rely on a sample that is not representative of the entire population being studied. In this case, the military was relying on a sample that included only those planes that had returned from combat. The sample did not include planes lost in combat. During World War II, statistician Abraham Ward recommended that the portions of the planes hit least often should be reinforced. “Ward reasoned that a plane would be less likely to return if it were hit in a critical area and, conversely, that a plane that did return even when hit had probably not been hit in a critical location.” Note: The above quote appears on page 118 of Jerker Denrell’s article titled “Selection Bias and the Perils of Benchmarking,” from the Harvard Business Review, Volume 83, Issue 4, pp. 114-119.

Exercise P-13 (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 report all gambling winnings to the Internal Revenue Service even though it will force them to pay additional federal income taxes. Other students may argue that it is okay to evade the additional income tax for various reasons, such as “everybody else does it so it is okay.” 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. Note to instructors: Before beginning a classroom discussion, allow students to anonymously answer the question in writing. Summarize the results of the written responses and ask students to comment on them.

Managerial Accounting, 16th Edition

Chapter 1 Managerial Accounting and Cost Concepts Questions 1-1 The three major types of product costs in a manufacturing company are direct materials, direct labor, and manufacturing overhead. 1-2 a. Direct materials are an integral part of a finished product and their costs can be conveniently traced to it. b. Indirect materials are generally small items of material such as glue and nails. They may be an integral part of a finished product but their costs can be traced to the product only at great cost or inconvenience. c. Direct labor consists of labor costs that can be easily traced to particular products. Direct labor is also called “touch labor.” d. Indirect labor consists of the labor costs of janitors, supervisors, materials handlers, and other factory workers that cannot be conveniently traced to particular products. These labor costs are incurred to support production, but the workers involved do not directly work on the product. e. Manufacturing overhead includes all manufacturing costs except direct materials and direct labor. Consequently, manufacturing overhead includes indirect materials and indirect labor as well as other manufacturing costs. 1-3 A product cost is any cost involved in purchasing or manufacturing goods. In the case of manufactured goods, these costs consist of direct materials, direct labor, and manufacturing overhead. A period cost is a cost that is taken directly to the income statement as an expense in the period in which it is incurred.

1-4 a. Variable cost: The variable cost per unit is constant, but total variable cost changes in direct proportion to changes in volume. b. Fixed cost: The total fixed cost is constant within the relevant range. The average fixed cost per unit varies inversely with changes in volume. c. Mixed cost: A mixed cost contains both variable and fixed cost elements. 1-5 a. Unit fixed costs decrease as the activity level increases. b. Unit variable costs remain constant as the activity level increases. c. Total fixed costs remain constant as the activity level increases. d. Total variable costs increase as the activity level increases. 1-6 a. Cost behavior: Cost behavior refers to the way in which costs change in response to changes in a measure of activity such as sales volume, production volume, or orders processed. b. Relevant range: The relevant range is the range of activity within which assumptions about variable and fixed cost behavior are valid. 1-7 An activity base is a measure of whatever causes the incurrence of a variable cost. Examples of activity bases include units produced, units sold, letters typed, beds in a hospital, meals served in a cafe, service calls made, etc. 1-8 The linear assumption is reasonably valid providing that the cost formula is used only within the relevant range.

1-9 A discretionary fixed cost has a fairly short planning horizon—usually a year. Such costs arise from annual decisions by management to spend on certain fixed cost items, such as advertising, research, and management development. A committed fixed cost has a long planning horizon—generally many years. Such costs relate to a company’s investment in facilities, equipment, and basic organization. Once such costs have been incurred, they are “locked in” for many years. 1-10 Yes. As the anticipated level of activity changes, the level of fixed costs needed to support operations may also change. Most fixed costs are adjusted upward and downward in large steps, rather than being absolutely fixed at one level for all ranges of activity.

1-11 The traditional approach organizes costs by function, such as production, selling, and administration. Within a functional area, fixed and variable costs are intermingled. The contribution approach income statement organizes costs by behavior, first deducting variable expenses to obtain contribution margin, and then deducting fixed expenses to obtain net operating income. 1-12 The contribution margin is total sales revenue less total variable expenses. 1-13 A differential cost is a cost that differs between alternatives in a decision. An opportunity cost is the potential benefit that is given up when one alternative is selected over another. A sunk cost is a cost that has already been incurred and cannot be altered by any decision taken now or in the future. 1-14 No, differential costs can be either variable or fixed. For example, the alternatives might consist of purchasing one machine rather than another to make a product. The difference between the fixed costs of purchasing the two machines is a differential cost.

Managerial Accounting, 16th edition

Chapter 1: Applying Excel The completed worksheet is shown below.

Chapter 1: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

[Note: To display formulas in cells instead of their calculated amounts, consult Excel Help.]

Managerial Accounting, 16th edition

Chapter 1: Applying Excel (continued) 1. When the variable selling cost is changed to $900, the worksheet changes as show below:

The gross margin is $6,000; the same as it was before. It did not change because the variable selling expense is deducted after the gross margin, not before it on the traditional format income statement.

Chapter 1: Applying Excel (continued) 2. The new worksheet appears below:

Managerial Accounting, 16th edition

Chapter 1: Applying Excel (continued) The variable costs increased by 10% when the sales increased by 10%, however the fixed costs did not increase at all. By definition, total variable cost increases in proportion to activity whereas total fixed cost is constant. (In the real world, cost behavior may be messier.) The contribution margin also increased by 10%, from $6,000 to $6,600, because both of its components—sales and variable costs—increased by 10%. The net operating income increased by more than 10%, from $700 to $1,170, because even though sales and variable expenses increased by 10%, the fixed costs did not increase by 10%.

The Foundational 15 1. Direct materials........................................... Direct labor................................................. Variable manufacturing overhead ................. Variable manufacturing cost per unit ............

$ 6.00 3.50 1.50 $11.00

Variable manufacturing cost per unit (a) ....... Number of units produced (b) ...................... Total variable manufacturing cost (a) × (b) ... Average fixed manufacturing overhead per unit (c) .................................................... Number of units produced (d) ...................... Total fixed manufacturing cost (c) × (d) ....... Total product (manufacturing) cost...............

$11.00 10,000 $4.00 10,000

$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 ...................................... Variable administrative expense ................... Variable selling and administrative per unit ...

$1.00 0.50 $1.50

Variable selling and admin. per unit (a) ........ Number of units sold (b).............................. Total variable selling and admin. expense (a) × (b) ............................................... Average fixed selling and administrative expense per unit ($3 fixed selling + $2 fixed admin.) (c) ....................................... Number of units sold (d).............................. Total fixed selling and administrative expense (c) × (d) ..................................... Total period (nonmanufacturing) cost ...........

$1.50 10,000 $15,000 $5.00 10,000 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.

Managerial Accounting, 16th edition

The Foundational 15 (continued) 3. Direct materials ....................................... Direct labor ............................................. Variable manufacturing overhead ............. Sales commissions................................... Variable administrative expense ............... Variable cost per unit sold ........................

$ 6.00 3.50 1.50 1.00 0.50 $12.50

4. Direct materials ....................................... Direct labor ............................................. Variable manufacturing overhead ............. Sales commissions................................... Variable administrative expense ............... Variable cost per unit sold ........................

$ 6.00 3.50 1.50 1.00 0.50 $12.50

5. Variable cost per unit sold (a) .................. Number of units sold (b) .......................... Total variable costs (a) × (b)....................

$12.50 8,000 $100,000

6. Variable cost per unit sold (a) .................. Number of units sold (b) .......................... Total variable costs (a) × (b)....................

$12.50 12,500 $156,250

7. Total fixed manufacturing cost (see requirement 1) (a)......................... Number of units produced (b) .................. Average fixed manufacturing cost per unit produced (a) ÷ (b) ............................... 8. Total fixed manufacturing cost (see requirement 1) (a)......................... Number of units produced (b) .................. Average fixed manufacturing cost per unit produced (a) ÷ (b) ............................... 9. Total fixed manufacturing cost (see requirement 1) ..............................

$40,000 8,000 $5.00 $40,000 12,500 $3.20 $40,000

The Foundational 15 (continued) 10. Total fixed manufacturing cost (see requirement 1) ................................ 11. Variable overhead per unit (a) ..................... Number of units produced (b) ..................... Total variable overhead cost (a) × (b) ......... Total fixed overhead (see requirement 1) ..... Total manufacturing overhead cost ..............

$40,000 $1.50 8,000

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

$52,000 8,000 $6.50 $1.50 12,500

Total manufacturing overhead cost (a)......... Number of units produced (b) ..................... Manufacturing overhead per unit (a) ÷ (b)... 13. Selling price per unit................................... Variable cost per unit sold (see requirement 4) ................................. Contribution margin per unit .......................

$12,000 40,000 $52,000

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

$22.00 12.50 $ 9.50

Managerial Accounting, 16th edition

The Foundational 15 (continued) 14. Direct materials per unit ............................. Direct labor per unit ................................... Direct manufacturing cost per unit ..............

$6.00 3.50 $9.50

Direct manufacturing cost per unit (a) Number of units produced (b) ..................... Total direct manufacturing cost (a) × (b) .....

$9.50 11,000 $104,500

Variable overhead per unit (a) ..................... Number of units produced (b) ..................... Total variable overhead cost (a) × (b) ......... Total fixed overhead (see requirement 1) ..... Total indirect manufacturing cost .................

$1.50 11,000

15. Direct materials per unit ............................. Direct labor per unit ................................... Variable manufacturing overhead per unit .... Incremental cost per unit produced .............

$6.00 3.50 1.50 $11.00

$16,500 40,000 $56,500

Note: Variable selling and administrative expenses are variable with respect to the number of units sold, not the number of units produced.

Exercise 1-1 (15 minutes)

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

Cost

The wages of pediatric nurses Prescription drugs Heating the hospital The salary of the head of pediatrics The salary of the head of pediatrics Hospital chaplain’s salary Lab tests by outside contractor Lab tests by outside contractor

Cost Object

The pediatric department A particular patient The pediatric department The pediatric department A particular pediatric patient A particular patient A particular patient A particular department

Direct Cost

Indirect Cost

X X X X X X X X

Managerial Accounting, 16th edition

Exercise 1-2 (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 1-3 (15 minutes)

1. Depreciation on salespersons’ cars ........................ 2. Rent on equipment used in the factory .................. 3. Lubricants used for machine maintenance ............. 4. Salaries of personnel who work in the finished goods warehouse .............................................. 5. Soap and paper towels used by factory workers at the end of a shift ............................................... 6. Factory supervisors’ salaries.................................. 7. Heat, water, and power consumed in the factory ... 8. Materials used for boxing products for shipment overseas (units are not normally boxed) ............. 9. Advertising costs .................................................. 10. Workers’ compensation insurance for factory employees......................................................... 11. Depreciation on chairs and tables in the factory lunchroom ......................................................... 12. The wages of the receptionist in the administrative offices ............................................................... 13. Cost of leasing the corporate jet used by the company's executives ........................................ 14. The cost of renting rooms at a Florida resort for the annual sales conference ..................................... 15. The cost of packaging the company’s product ........

Product Period Cost Cost X X

X X X X X X X X X X X

Managerial Accounting, 16th edition

Exercise 1-4 (15 minutes) 1. Fixed cost ................................. Variable cost ............................. Total cost ................................. Average cost per cup served * ...

Cups of Coffee Served in a Week 2,000 2,100 2,200

$1,200 440 $1,640 $0.820

$1,200 462 $1,662 $0.791

$1,200 484 $1,684 $0.765

* Total cost ÷ cups of coffee served in a week 2. The average cost of a cup of coffee decreases as the number of cups of coffee served increases because the fixed cost is spread over more cups of coffee.

Exercise 1-5 (15 minutes)

Item

1. Cost of the old X-ray machine .... 2. The salary of the head of the Radiology Department ............. 3. The salary of the head of the Laboratory Department ........... 4. Cost of the new color laser printer .................................... 5. Rent on the space occupied by Radiology ............................... 6. The cost of maintaining the old machine ................................. 7. Benefits from a new DNA analyzer ................................. 8. Cost of electricity to run the Xray machines ..........................

Differential Cost

Sunk Cost X

Opportunity Cost

X X X

Note: The costs of the salaries of the head of the Radiology Department and Laboratory Department and the rent on the space occupied by Radiology are neither differential costs, nor opportunity costs, nor sunk costs. These costs do not differ between the alternatives and therefore are irrelevant in the decision, but they are not sunk costs because they occur in the future.

Managerial Accounting, 16th edition

Exercise 1-6 (15 minutes) 1. Traditional income statement Cherokee Inc. Traditional Income Statement Sales ($30 per unit × 20,000 units) .................... Cost of goods sold ($24,000 + $180,000 – $44,000) ..................... Gross margin .................................................... Selling and administrative expenses: Selling expenses (($4 per unit × 20,000 units) + $40,000) ...... Administrative expenses (($2 per unit × 20,000 units) + $30,000) ...... Net operating income ........................................

$600,000 160,000 440,000 $120,000 70,000

190,000 $250,000

2. Contribution format income statement Cherokee Inc. Contribution Format Income Statement Sales ($30 per unit × 20,000 units) .................... Variable expenses: Cost of goods sold ($24,000 + $180,000 – $44,000) .................. Selling expenses ($4 per unit × 20,000 units)... Administrative expenses ($2 per unit × 20,000 units) ......................... Contribution margin........................................... Fixed expenses: Selling expenses ............................................. Administrative expenses .................................. Net operating income ........................................

$600,000 $160,000 80,000 40,000 40,000 30,000

280,000 320,000 70,000 $250,000

Exercise 1-7 (20 minutes) 1a. The total direct manufacturing cost incurred is computed as follows: Direct materials per unit ............................ Direct labor per unit .................................. Direct manufacturing cost per unit (a) ........ Number of units sold (b)............................ Total direct manufacturing cost (a) × (b) ....

$7.00 4.00

$11.00 20,000 $220,000

1b. The total indirect manufacturing cost incurred is computed as follows: Variable manufacturing overhead per unit ... Fixed manufacturing overhead per unit....... Indirect manufacturing cost per unit (a) ..... Number of units sold (b)............................ Total indirect manufacturing cost (a) × (b) .

$1.50 5.00

$6.50 20,000 $130,000

Note: The average fixed manufacturing overhead cost per unit of $5.00 is valid for only one level of activity—20,000 units produced. 2a. The total manufacturing cost that is directly traceable to the Manufacturing Department is computed as follows: Direct materials per unit ............................ Direct labor per unit .................................. Variable manufacturing overhead per unit ... Fixed manufacturing overhead per unit....... Total manufacturing cost per unit (a).......... Number of units sold (b)............................ Total direct costs (a) × (b) .........................

$7.00 4.00 1.50 5.00

$17.50 20,000 $350,000

2b. None of the manufacturing costs should be treated as indirect costs when the cost object is the Manufacturing Department.

Managerial Accounting, 16th edition

Exercise 1-7 (continued) 3a. The first step in calculating the total direct selling expense is to determine the fixed portion of the sales representatives’ compensation as follows: Fixed selling expense per unit (a) ............... Number of units sold (b)............................ Total fixed selling expense (a) × (b) ...........

$3.50 20,000

Total fixed selling expense (a) .................... Advertising expenditures (b) ...................... Total fixed portion of the sales representatives’ compensation (a) ‒ (b) ...

$70,000 $70,000 $50,000 $20,000

The second step is to calculate the total direct selling expense that is traceable to individual sales representatives as follows: Sales commissions per unit (a)................... Number of units sold (b)............................ Total sales commission (a) × (b) ................ Fixed portion of sales representatives’ compensation ......................................... Total direct selling expense ........................

$1.00 20,000

$20,000 20,000 $40,000

3b. The total indirect selling expense that cannot be traced to individual sales representatives is $50,000. The advertising expenditures cannot be traced to specific sales representatives. 4. No. Kubin’s administrative expenses could be direct or indirect depending on the cost object. For example, the chief financial officer’s salary would be an indirect cost if the cost object is units of production; however, his salary would be a direct cost if the cost object is the Finance Department that he oversees.

Exercise 1-8 (20 minutes) 1. Direct materials........................................... Direct labor................................................. Variable manufacturing overhead ................. Variable manufacturing cost per unit ............

$ 7.00 4.00 1.50 $12.50

$12.50 20,000 $5.00 20,000

$250,000

100,000 $350,000

Note: The average fixed manufacturing overhead cost per unit of $5.00 is valid for only one level of activity—20,000 units produced. 2. Sales commissions ...................................... Variable administrative expense ................... Variable selling and administrative per unit ...

$1.00 0.50 $1.50

Variable selling and admin. per unit (a) ........ Number of units sold (b).............................. Total variable selling and admin. expense (a) × (b) ............................................... Average fixed selling and administrative expense per unit ($3.50 fixed selling + $2.50 fixed administrative) (c) ................... Number of units sold (d).............................. Total fixed selling and administrative expense (c) × (d) ..................................... Total period cost .........................................

$1.50 20,000 $30,000 $6.00 20,000 120,000 $150,000

Note: The average fixed selling and administrative expense per unit of $6.00 is valid for only one level of activity—20,000 units sold.

Managerial Accounting, 16th edition

Exercise 1-8 (continued) 3. Direct materials........................................... Direct labor................................................. Variable manufacturing overhead ................. Variable manufacturing cost per unit ............

$ 7.00 4.00 1.50 $12.50

Variable manufacturing cost per unit (a) ....... Number of units produced (b) ...................... Total variable manufacturing cost (a) × (b) ... Total fixed manufacturing cost (see requirement 1) ......................................... Total product cost .......................................

$12.50 22,000

4. Sales commissions ...................................... Variable administrative expense ................... Variable selling and administrative per unit ...

$1.00 0.50 $1.50

$1.50 18,000

$275,000 100,000 $375,000

$27,000 120,000 $147,000

Exercise 1-9 (20 minutes) 1. Direct materials ....................................... Direct labor ............................................. Variable manufacturing overhead ............. Sales commissions................................... Variable administrative expense ............... Variable cost per unit sold ........................

$ 7.00 4.00 1.50 1.00 0.50 $14.00

2. Direct materials ....................................... Direct labor ............................................. Variable manufacturing overhead ............. Sales commissions................................... Variable administrative expense ............... Variable cost per unit sold ........................

$ 7.00 4.00 1.50 1.00 0.50 $14.00

3. Variable cost per unit sold (a) .................. Number of units sold (b) .......................... Total variable costs (a) × (b)....................

$14.00 18,000 $252,000

4. Variable cost per unit sold (a) .................. Number of units sold (b) .......................... Total variable costs (a) × (b)....................

$14.00 22,000 $308,000

Note: The key to answering questions 5 through 8 is to calculate the total fixed manufacturing overhead costs as follows: Average fixed manufacturing overhead cost per unit (a) .................................... Number of units produced (b) .................. Total fixed manufacturing overhead (a) × (b) .......................................................

$5.00 20,000 $100,000

Note: The average fixed manufacturing overhead cost per unit of $5.00 is valid for only one level of activity—20,000 units produced. Once students understand that total fixed manufacturing overhead is $100,000, questions 5 through 8 are answered as follows: © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 22

Managerial Accounting, 16th edition

Exercise 1-9 (continued) 5. The average fixed manufacturing overhead per unit is: Total fixed manufacturing overhead (a)..... Number of units produced (b) .................. Average fixed manufacturing cost per unit produced (rounded) (a) ÷ (b)................

$100,000 18,000 $5.56

6. The average fixed manufacturing overhead per unit is: Total fixed manufacturing overhead (a)..... Number of units produced (b) .................. Average fixed manufacturing cost per unit produced (rounded) (a) ÷ (b)................

$100,000 22,000 $4.55

7. The total fixed manufacturing overhead remains unchanged at $100,000. 8. The total fixed manufacturing overhead remains unchanged at $100,000.

Exercise 1-10 (10 minutes) 1. Direct materials ....................................... Direct labor ............................................. Variable manufacturing overhead ............. Total incremental cost..............................

$ 7.00 4.00 1.50 $12.50

$ 7.00 4.00 1.50 1.00 0.50 $14.00

3. Because the 200 units to be sold to the new customer have already been produced, the incremental manufacturing cost per unit is zero. The variable manufacturing costs incurred to make these units have already been incurred and, as such, are sunk costs. 4. Sales commission .................................... Variable administrative expense ............... Variable cost per unit sold ........................

$1.00 0.50 $1.50

Managerial Accounting, 16th edition

Exercise 1-11 (20 minutes) 1. The company’s variable cost per unit is: $180,000 =$6 per unit. 30,000 units

The completed schedule is as follows:

Units produced and sold 30,000 40,000 50,000

Total costs: Variable cost............... $180,000 Fixed cost................... 300,000 Total costs .................. $480,000 Cost per unit: Variable cost............... $ 6.00 Fixed cost................... 10.00 Total cost per unit ....... $16.00

$240,000 $300,000 300,000 300,000 $540,000 $600,000 $ 6.00 7.50 $13.50

$ 6.00 6.00 $12.00

2. The company’s contribution format income statement is: Sales (45,000 units × $16 per unit) ........................ Variable expenses (45,000 units × $6 per unit) ....... Contribution margin .............................................. Fixed expense ....................................................... Net operating income ............................................

$720,000 270,000 450,000 300,000 $150,000

Exercise 1-12 (10 minutes) 1. The computations for parts 1a through 1e are as follows: a. The cost of batteries in Raw Materials: Beginning raw materials inventory............. Plus: Battery purchases ............................ Batteries available .................................... Minus: Batteries withdrawn ....................... Ending raw materials inventory (a) ............ Cost per battery (b) ................................. Raw materials on April 30th (a) × (b) .........

0 8,000 8,000 7,600

400 $80 $32,000

b. The cost of batteries in Work in Process: Beginning work in process inventory ......... Plus: Batteries withdrawn for production ... Batteries available .................................... Minus: Batteries transferred to finished goods (7,500 × 90%) ............................ Ending work in process inventory (a)......... Cost per battery (b) ................................. Work in process on April 30th (a) × (b) ......

0 7,500 7,500 6,750

750 $80 $60,000

c. The cost of batteries in Finished Goods: Beginning finished goods inventory ........... Plus: Batteries transferred in from work in process (see requirement b) .................. Batteries available .................................... Minus: Batteries transferred out to cost of goods sold (6,750 × (100% ‒ 30%)) ...... Ending finished goods inventory (a) .......... Cost per battery (b) ................................. Finished goods on April 30th (a) × (b)........

0 6,750 6,750 4,725

2,025 $80 $162,000

Managerial Accounting, 16th edition

Exercise 1-12 (continued) d. The cost of batteries in Cost of Goods Sold: Number of batteries (see requirement c) (a) ........................................................ Cost per battery (b) ................................. Cost of goods sold for April (a) × (b).........

4,725 $80 $378,000

e. The cost of batteries included in selling expense: Number of batteries (a) ............................ Cost per battery (b) ................................. Selling expense for April (a) × (b) .............

100 $80 $8,000

2. Raw Materials, Work in Process and Finished Goods would appear on the balance sheet. Cost of Goods Sold and Selling Expense would appear on the income statement.

Exercise 1-13 (30 minutes) 1.

True. The variable manufacturing cost per unit will remain the same within the relevant range.

False. The total fixed manufacturing cost will remain the same within the relevant range.

True. The total variable manufacturing cost will increase, so the total manufacturing cost will increase too.

True. The average fixed manufacturing cost per unit will decrease as the level of activity increases.

False. The total variable manufacturing cost will increase (rather than decrease) as the activity level increases.

False. The variable manufacturing cost per unit will remain the same, but the average fixed manufacturing cost per unit will decrease as the level of activity increases.

True. The variable manufacturing cost per unit of $28 will stay constant within the relevant range. The $28 figure is computed as follows: Total manufacturing cost per unit (a) .................. Variable manufacturing cost percentage (b) ........ Variable manufacturing cost per unit (a) × (b) ....

$70.00 40% $28.00

False. The total fixed manufacturing cost of $420,000 does not change within the relevant range. The $420,000 figure is computed as follows: Total manufacturing cost per unit (a) ........ Variable manufacturing cost per unit (b) ... Average fixed manufacturing cost per unit (a) ‒ (b) ............................................... Number of units produced........................ Total fixed manufacturing cost..................

$70.00 28.00 $42.00 × 10,000 $420,000

Managerial Accounting, 16th edition

Exercise 1-13 (continued) 9.

True. The underlying computations are as follows: Variable manufacturing cost per unit (see requirement 7) (a) ................................. Number of units produced (b) ................... Total variable manufacturing cost (a) × (b) Total fixed manufacturing cost (see requirement 8) ...................................... Total manufacturing cost ...........................

$28.00 10,050

$281,400 420,000 $701,400

10. True. The underlying computations are as follows: Total fixed manufacturing cost (see requirement 8) (a) ....................................................................... Number of units produced (b) .................................. Average fixed manufacturing cost per unit (a) ÷ (b) ..

$420,000 10,050 $41.79

11. False. The total variable manufacturing cost will equal $281,400, computed as follows: Variable manufacturing cost per unit (see requirement 7) (a) .......................................... Number of units produced (b) ............................ Total variable manufacturing cost (a) × (b) .........

$28.00 10,050 $281,400

12. True. The underlying computations are as follows: Variable manufacturing cost per unit (see requirement 7) ............................................... Average fixed manufacturing cost per unit (see requirement 10).............................................. Total manufacturing cost per unit .......................

$28.00 41.79 $69.79

Exercise 1-14 (30 minutes)

Name of the Cost

Rental revenue forgone, $30,000 per year ..................................... Direct materials cost, $80 per unit .. Rental cost of warehouse, $500 per month .................................. Rental cost of equipment, $4,000 per month .................................. Direct labor cost, $60 per unit ........ Depreciation of the annex space, $8,000 per year .......................... Advertising cost, $50,000 per year . Supervisor's salary, $3,500 per month ........................................ Electricity for machines, $1.20 per unit ............................................ Shipping cost, $9 per unit .............. Return earned on investments, $3,000 per year ..........................

(1) Predicting Cost behavior

Cost Classifications for: (3) Preparing (2) Financial Manufacturers Statements

None Variable

None Direct materials

None Product

Fixed

Period

Variable Variable

None Manufacturing overhead Direct labor Manufacturing overhead None Manufacturing overhead Manufacturing overhead None

None

Fixed Variable Fixed Fixed Fixed

Opportunity cost

Product Product Product Period

Sunk cost

Product Product Period None

(4) Decision Making

Managerial Accounting, 16th edition

Opportunity cost

Exercise 1-15 (20 minutes) 1. Traditional income statement The Alpine House, Inc. Traditional Income Statement Sales ................................................................ Cost of goods sold ($30,000 + $100,000 – $40,000) ..................... Gross margin .................................................... Selling and administrative expenses: Selling expenses (($50 per unit × 200 pairs of skis*) + $20,000)......................................... Administrative expenses (($10 per unit × 200 pairs of skis) + $20,000) .............................. Net operating income ........................................

$150,000 90,000 60,000 $30,000 22,000

52,000 $ 8,000

*$150,000 sales ÷ $750 per pair of skis = 200 pairs of skis. 2. Contribution format income statement The Alpine House, Inc. Contribution Format Income Statement Sales ................................................................ Variable expenses: Cost of goods sold ($30,000 + $100,000 – $40,000) .................. Selling expenses ($50 per unit × 200 pairs of skis) .................. Administrative expenses ($10 per unit × 200 pairs of skis) .................. Contribution margin........................................... Fixed expenses: Selling expenses ............................................. Administrative expenses .................................. Net operating income ........................................

$150,000 $90,000 10,000 2,000 20,000 20,000

102,000 48,000 40,000 $ 8,000

Exercise 1-15 (continued) 3. Since 200 pairs of skis were sold and the contribution margin totaled $48,000 for the quarter, the contribution margin per unit was $240 ($48,000 ÷ 200 pair of skis = $240 per pair of skis).

Managerial Accounting, 16th edition

Exercise 1-16 (10 minutes) 1. The differential cost is computed as follows: Cost of a new model 300 (a) .............................. Cost of a new model 200 (b) .............................. Differential cost (a) ‒ (b) ...................................

$313,000 $275,000 $38,000

2. The sunk cost is the cost of the machine purchased seven years ago for $319,000. 3. The opportunity cost is the $374,000 that could have been earned by pursuing the forgone option.

Exercise 1-17 (15 minutes)

Cost Item

1. Hamburger buns at a Wendy’s restaurant ... 2. Advertising by a dental office........................ 3. Apples processed and canned by Del Monte 4. Shipping canned apples from a Del Monte plant to customers................. 5. Insurance on a Bausch & Lomb factory producing contact lenses ...................... 6. Insurance on IBM’s corporate headquarters ............ 7. Salary of a supervisor overseeing production of printers at Hewlett-Packard .... 8. Commissions paid to automobile salespersons ............. 9. Depreciation of factory lunchroom facilities at a General Electric plant ........................ 10. Steering wheels installed in BMWs ......

Cost Classifications for: (2) (1) Preparing Predicting Cost Financial Behavior Statements Variable

Product

Fixed

Period

Variable

Product

Variable

Period

Fixed

Product

Fixed

Period

Fixed

Product

Variable

Period

Fixed

Product

Variable

Product

Managerial Accounting, 16th edition

Problem 1-18 (10 minutes) 1. The direct costs of the Apparel Department are as follows: Apparel Department cost of sales—Evendale Store Apparel Department sales commission—Evendale Store ................................................................ Apparel Department manager’s salary—Evendale Store ................................................................ Total direct costs for the Apparel Department ........

$ 90,000 7,000 8,000 $105,000

2. The direct costs of the Evendale Store are as follows: Apparel Department cost of sales—Evendale Store Store manager’s salary—Evendale Store ............... Apparel Department sales commission—Evendale Store ................................................................ Store utilities—Evendale Store .............................. Apparel Department manager’s salary—Evendale Store ................................................................ Janitorial costs—Evendale Store ........................... Total direct costs for the Evendale Store ...............

$ 90,000 12,000 7,000 11,000 8,000 9,000 $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

Problem 1-19 (30 minutes) 1. Contribution format income statement Todrick Company Contribution Format Income Statement Sales ................................................................ Variable expenses: Cost of goods sold ($20,000 + $200,000 – $7,000) .................... Selling expense............................................... Administrative expense ................................... Contribution margin ........................................... Fixed expenses: Selling expense............................................... Administrative expense ................................... Net operating income ........................................

$300,000 $213,000 15,000 12,000 30,000 12,000

240,000 60,000 42,000 $ 18,000

The variable administrative expense shown above ($12,000) is computed as follows: Sales (a) ................................................. Contribution margin (b) ........................... Total variable costs (a) ‒ (b) .................... Total variable costs (a) ............................. Cost of goods sold ................................... Variable selling expense ........................... Cost of goods sold plus variable selling expense (b) .......................................... Variable administrative expense (a) ‒ (b) ..

$300,000 $60,000

$213,000 15,000

$240,000 $240,000

$228,000 $12,000

Managerial Accounting, 16th edition

Problem 1-19 (continued) The fixed selling expense shown above ($30,000) is computed as follows: Contribution margin (a) ........................... Net operating income (b) ......................... Total fixed costs (a) ‒ (b) .........................

$60,000 $18,000

Total fixed costs (a) ................................. Fixed administrative expense (b) .............. Fixed selling expense (a) ‒ (b) .................

$42,000 $42,000 $12,000 $30,000

2. Traditional income statement Todrick Company Traditional Income Statement Sales ................................................................ Cost of goods sold ($20,000 + $200,000 – $7,000) ....................... Gross margin .................................................... Selling and administrative expenses: Selling expense ($15,000 + $30,000) .................................... Administrative expense ($12,000 + $12,000) .................................... Net operating income ........................................

$300,000 213,000 87,000 $45,000 24,000

69,000 $ 18,000

3. The selling price per unit is $300,000 ÷ 1,000 units sold = $300. 4. The variable cost per unit is $240,000 ÷ 1,000 units sold = $240. 5. The contribution margin per unit is $300 ‒ $240 = $60. 6. The contribution format is more useful because it organizes costs based on their cost behavior. The contribution format enables managers to quickly calculate how variable costs will change in response to changes in unit sales.

Problem 1-20 (20 minutes)

Item a. b. c. d.

e. f. g. h. i.

Description

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

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

Managerial Accounting, 16th edition

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

Problem 1-21 (45 minutes) 1.

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 1-21 (continued) 2.

Marwick’s Pianos, Inc. Contribution Format Income Statement For the Month of August

Sales (40 pianos × $3,125 per piano) ................. Variable expenses: Cost of goods sold (40 pianos × $2,450 per piano) .................... Sales commissions (8% × $125,000) ............... Delivery of pianos (40 pianos × $30 per piano) Clerical (40 pianos × $20 per piano) ................ Total variable expenses...................................... Contribution margin .......................................... Fixed expenses: Advertising ..................................................... Sales salaries ................................................. Utilities .......................................................... Depreciation of sales facilities .......................... Executive salaries ........................................... Insurance....................................................... Clerical........................................................... Depreciation of office equipment ..................... Total fixed expenses .......................................... Net operating income ........................................

Total

Per Piano

98,000 10,000 1,200 800 110,000 15,000

2,450 250 30 20 2,750 $ 375

$125,000

$3,125

700 950 350 800 2,500 400 1,000 300 7,000 $ 8,000

3. Fixed costs remain constant in total but vary on a per unit basis inversely with changes in the activity level. As the activity level increases, for example, the fixed costs will decrease on a per unit basis. Showing fixed costs on a per unit basis on the income statement might mislead management into thinking that the fixed costs behave in the same way as the variable costs. That is, management might be misled into thinking that the per unit fixed costs would be the same regardless of how many pianos were sold during the month. For this reason, fixed costs generally are shown only in totals on a contribution format income statement. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 40

Managerial Accounting, 16th edition

Problem 1-22 (45 minutes) 1. The total manufacturing overhead cost is computed as follows:

Direct labor cost (a) ........................................... Direct labor as a percentage of total conversion costs (b)......................................................... Total conversion cost (a) ÷ (b) ...........................

$15,000

Total conversion cost (a) ................................... Direct labor cost (b)........................................... Total manufacturing overhead cost (a) ‒ (b) .......

$50,000 $15,000 $35,000

The total direct materials cost is computed as follows: Direct labor cost (a) ........................................... Direct labor as a percentage of total prime costs (b) ................................................................. Total prime cost (a) ÷ (b) ..................................

$15,000

Total prime cost (a) ........................................... Direct labor cost (b)........................................... Total direct materials cost (a) ‒ (b) .....................

$37,500 $15,000 $22,500

40% $37,500

The total amount of manufacturing cost is computed as follows: Direct materials cost .......................................... Direct labor cost ................................................ Manufacturing overhead cost ............................. Total manufacturing cost ....................................

30% $50,000

$22,500 15,000 35,000 $72,500

The total variable selling and administrative cost is computed as follows: Total sales (a) ................................................... Sales commission percentage (b) ....................... Total variable selling and administrative cost (a) × (b)..............................................................

$120,000 5% $6,000

Problem 1-22 (continued) 5.

The total variable cost is computed as follows: Direct materials cost .......................................... Direct labor cost ................................................ Sales commissions ............................................. Total variable cost .............................................

The total fixed cost is computed as follows: Total selling and administrative expenses (a) ........................................................ Sales commissions (b) .............................. Total fixed selling and administrative expense (a) ‒ (b) ................................... Total fixed manufacturing overhead ........... Total fixed cost .........................................

$22,500 15,000 6,000 $43,500

$18,000 $6,000 $12,000 35,000 $47,000

The total contribution margin is calculated as follows: Sales (a) ........................................................... Variable costs (b) .............................................. Contribution margin (a) ‒ (b) .............................

$120,000 $43,500 $76,500

Managerial Accounting, 16th edition

Problem 1-23 (30 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 ...............................

Variable or Selling Fixed Cost F

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

Manufacturing Administrative (Product) Cost Cost Direct Indirect X

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

Problem 1-23 (continued)

Cost Item

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 Selling Fixed Cost V V V F

Manufacturing Administrative (Product) Cost Cost Direct Indirect

Managerial Accounting, 16th edition

X X

Problem 1-24 (30 minutes) 1a. The total product cost is computed as follows: Direct materials ................................................. Direct labor ....................................................... Total manufacturing overhead ............................ Total product cost ..............................................

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

1b. The total period cost is computed as follows: Total selling expense ......................................... Total administrative expense .............................. Total period cost ................................................

$30,000 29,000 $59,000

2a. The total direct manufacturing cost is computed as follows: Direct materials ................................................. Direct labor ....................................................... Total direct manufacturing cost ..........................

$ 69,000 35,000 $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 labor ....................................................... Total manufacturing overhead ............................ Total manufacturing cost ....................................

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

Problem 1-24 (continued) 3b. The total nonmanufacturing cost is computed as follows: Total selling expense ......................................... Total administrative expense .............................. Total nonmanufacturing cost ..............................

$30,000 29,000 $59,000

3c. The total conversion cost is computed as follows: Direct labor ....................................................... Total manufacturing overhead ............................ Total conversion cost .........................................

$35,000 43,000 $78,000

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

$ 69,000 35,000 $104,000

4a. The total variable manufacturing cost is computed as follows: Direct materials ................................................. Direct labor ....................................................... 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

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Problem 1-24 (continued) 4c. The variable cost per unit produced and sold is computed as follows: Direct materials ................................................. Direct labor ....................................................... Total variable manufacturing overhead................ Variable selling expense ..................................... Variable administrative expense.......................... Total variable cost (a) ........................................ Number of units produced and sold (b) ............... Variable cost per unit produced and sold (a) ÷ (b) .................................................................

$ 69,000 35,000 15,000 12,000 4,000 $135,000 1,000 $135

5a. The incremental manufacturing cost is computed as follows: Direct materials ................................................. Direct labor ....................................................... Variable manufacturing overhead ....................... Total incremental cost (a) .................................. Number of units produced and sold (b) ............... Incremental cost per unit produced (a) ÷ (b) ......

$ 69,000 35,000 15,000 $119,000 1,000 $119

Problem 1-25 (30 minutes) 1.

Milden Company Contribution Format Income Statement For the Next Quarter Sales (12,000 units × $100 per unit) ............ $1,200,000 Variable expenses: Cost of goods sold (12,000 units × $35 unit) ....................... $420,000 Sales commission (6% × $1,200,000)........ 72,000 Shipping expense (12,000 units × $9.10 per unit) .............. 109,200 Total variable expenses................................ 601,200 Contribution margin .................................... 598,800 Fixed expenses: Advertising expense .................................. 210,000 Shipping expense ..................................... 28,000 Administrative salaries .............................. 145,000 Insurance expense ................................... 9,000 Depreciation expense................................ 76,000 Total fixed expenses .................................... 468,000 Net operating income .................................. $ 130,800

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Problem 1-25 (continued) 2.

Milden Company Traditional Format Income Statement For the Next Quarter Sales (12,000 units × $100 per unit) ............ Cost of goods sold (12,000 units × $35 per unit) .................... Gross margin .............................................. Selling and administrative expenses: Advertising ............................................. Sales commissions (6% × $1,200,000)] ............................. Shipping expense [$28,000 + (12,000 units × $9.10 per unit)] .................................................. Administrative salaries ............................ Insurance expense ................................. Depreciation expense ............................. Total selling and administrative expenses ...... Net operating income ..................................

$1,200,000 420,000 780,000 $210,000 72,000 137,200 145,000 9,000 76,000

649,200 $ 130,800

Case 1-26 (45 minutes) 1.

Cost Item

Direct labor ................................ 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 ...... Administrative office salaries ....... Direct materials used .................. Utilities, factory .......................... Total costs .................................

Cost Behavior Variable Fixed

$118,000

80,000

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

$50,000 40,000 3,500 2,500 4,000 12,000 10,000 60,000 $182,000

Selling or Administrative Cost $50,000

$118,000

$40,000 3,500

80,000

2,500

4,000

3,000 60,000 $197,000

Product Cost Direct Indirect

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12,000 6,000 10,000 94,000 $212,000

20,000 $94,000

Case 1-26 (continued) 2. The average product cost for one patio set would be: Direct ................................................. Indirect .............................................. Total .................................................. $306,000 ÷ 2,000 sets = $153 per set

$212,000 94,000 $306,000

3. The average product cost per set would increase if the production drops. This is because the fixed costs would be spread over fewer units, causing the average cost per unit to rise. 4. a. Yes, the president may expect a minimum price of $153, which is the average cost to manufacture one set. He might expect a price even higher than this to cover a portion of the administrative costs as well. The brother-in-law probably is thinking of cost as including only direct materials, or, at most, direct materials and direct labor. Direct materials alone would be only $47 per set ($94,000 ÷ 2,000 = $47 per set), and direct materials and direct labor would be only $106 per set (($94,000 + $118,000) ÷ 2,000 = $106 per set). b. The term is opportunity cost. The full, regular price of a set might be appropriate here, because the company is operating at full capacity, and this is the amount that must be given up (benefit forgone) to sell a set to the brother-in-law.

Case 1-27 (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. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 52

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Appendix 1A Cost of Quality Exercise 1A-1 (10 minutes) 1. Quality of conformance 2. Quality costs 3. Quality circles 4. Prevention costs, appraisal costs 5. Internal failure costs, external failure costs 6. External failure costs 7. Appraisal costs 8. Prevention costs 9. Internal failure costs 10. External failure costs 11. Prevention costs, appraisal costs 12. Quality cost report

Exercise 1A-2 (15 minutes) 1.

a. b. c. d. e.

Product testing ................... Product recalls .................... Rework labor and overhead . Quality circles ..................... Downtime caused by defects ............................ f. Cost of field servicing .......... g. Inspection of goods ............ h. Quality engineering ............. i. Warranty repairs ................. j. Statistical process control .... k. Net cost of scrap ................ l. Depreciation of test equipment ....................... m. Returns and allowances arising from poor quality ... n. Disposal of defective products .......................... o. Technical support to suppliers .......................... p. Systems development ......... q. Warranty replacements ....... r. Field testing at customer site.................................. s. Product design.....................

Internal External Prevention Appraisal Failure Failure Cost Cost Cost Cost 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.

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Problem 1A-3 (60 minutes) 1. An analysis of the company’s quality cost report is presented below (dollar amounts are in thousands):

Prevention costs: Machine maintenance .. Training suppliers........ Quality circles ...................... ............................... Total prevention costs ....

Last Year Amount Percent*

This Year Amount Percent*

$ 70 0

1.7 0.0

10.4 0.0

$ 120 10

2.5 0.2

20.3 1.7

0 70

0.0 1.7

0.0 10.4

20 150

0.4 3.1

3.4 25.4

20 80 100

0.5 1.9 2.4

3.0 11.9 14.9

40 90 130

0.8 1.9 2.7

6.8 15.3 22.0

Internal failure costs: Rework....................... Scrap ......................... Total internal failure costs ..........................

50 40

1.2 1.0

7.5 6.0

130 70

2.7 1.5

22.0 11.9

2.1

13.4

200

4.2

33.9

External failure costs: Warranty repairs ......... Customer returns ........ Total external failure costs ..........................

90 320

2.1 7.6

13.4 47.8

30 80

0.6 1.7

5.1 13.6

410

9.8

61.2

110

2.3

18.6

Appraisal costs: Incoming inspection .... Final testing ................ Total appraisal costs ......

Total quality cost ...........

$ 670 16.0 100.0

Total production cost ..... $4,200

$ 590 12.3 100.0 $4,800

* Percentage figures may not add down due to rounding.

Problem 1A-3 (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.

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Problem 1A-4 (60 minutes) 1.

Florex Company Quality Cost Report

Prevention costs: Quality engineering .......... Systems development ...... Statistical process control . Total prevention costs ........

Last Year Amount (in Percent thousands) of Sales

570 750 180 1,500

0.76 1.00 0.24 2.00

1.00 1.08 0.04

900 1,200 60

1.20 1.60 0.08

210 1,800

0.28 2.40

240 2,400

0.32 3.20

630 1,050

0.84 1.40

1,125 1,500

1.50 2.00

720 2,400

0.96 3.20

975 3,600

1.30 4.80

External failure costs: Cost of field servicing ....... Warranty repairs .............. Product recalls ................. Total external failure costs ..

1,200 3,600 2,100 6,900

1.60 4.80 2.80 9.20

900 1,050 750 2,700

1.20 1.40 1.00 3.60

Total quality cost ................

$12,000

16.00

$10,200

13.60

Appraisal costs Inspection ....................... Product testing ................ Supplies used in testing ... Depreciation of testing equipment .................... Total appraisal costs ........ Internal failure costs: Net cost of scrap ............. Rework labor ................... Disposal of defective products ....................... Total internal failure costs ...

420 480 0 900

0.56 0.64 0.00 1.20

750 810 30

This Year Amount (in Percent thousands) of Sales $

Problem 1A-4 (continued) 2. $14,000 Quality Costs (in thousands)

$12,000 $10,000 External Failure

$8,000

Internal Failure

$6,000

Appraisal Prevention

$4,000 $2,000 $0 Last Year

This Year

Quality Costs as a Percentage of Sales

18% 16% 14% 12%

External Failure

10%

Internal Failure

Appraisal Prevention

6% 4% 2% 0%

Last Year

This Year

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Problem 1A-4 (continued) 3. The overall impact of the company’s increased emphasis on quality over the past year has been positive in that total quality costs have decreased from 16% of sales to 13.6% of sales. Despite this improvement, the company still has a poor distribution of quality costs. The bulk of the quality costs in both years is traceable to internal and external failure, rather than to prevention and appraisal. Although the distribution of these costs is poor, the trend this year is toward more prevention and appraisal as the company has given more emphasis on quality. Probably due to the increased spending on prevention and appraisal activities during the past year, internal failure costs have increased by one half, going from $2.4 million to $3.6 million. The reason internal failure costs have gone up is that, through increased appraisal activity, defects are being caught and corrected before products are shipped to customers. Thus, the company is incurring more cost for scrap, rework, and so forth, but it is saving huge amounts in field servicing, warranty repairs, and product recalls. External failure costs have fallen sharply, decreasing from $6.9 million last year to just $2.7 million this year. If the company continues its emphasis on prevention and appraisal— and particularly on prevention—its total quality costs should continue to decrease in future years. Although internal failure costs are increasing for the moment, these costs should decrease in time as better quality is designed into products. Appraisal costs should also decrease as the need for inspection, testing, and so forth decreases as a result of better engineering and tighter process control.

Chapter 2 Job-Order Costing: Calculating Unit Product Costs Questions 2-1 Job-order costing is used in situations where many different products, each with individual and unique features, are produced each period. 2-2 In absorption costing, all manufacturing costs, both fixed and variable, are assigned to units of product—units are said to fully absorb manufacturing costs. Conversely, all nonmanufacturing costs are treated as period costs and they are not assigned to units of product. 2-3 Normal costing systems apply overhead costs to jobs by multiplying a predetermined overhead rate by the actual amount of the allocation incurred by the job. 2-4 Unit product cost is computed by taking the total manufacturing costs assigned to a job and dividing it by the number of units contained in the job. 2-5 The first step is to estimate the total amount of the allocation base (the denominator) that will be required for next period’s estimated level of production. The second step is to estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base. The third step is to use the cost formula Y = a + bX to estimate the total manufacturing overhead cost (the numerator) for the coming period. The fourth step is to compute the predetermined overhead rate. 2-6 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 labor 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. 2-7 Some production costs such as a factory manager’s salary cannot be traced to a particular product or job, but rather are incurred as a result of overall production activities. In addition, some production costs such as indirect materials cannot be easily traced to jobs. If these costs are to be assigned to products, they must be allocated to the products. 2-8 If actual manufacturing overhead cost is applied to jobs, the company must wait until the end of the accounting period to apply overhead and to cost jobs. If the company computes actual overhead rates more frequently to get around this problem, the rates may fluctuate widely due to seasonal factors or variations in output. For this reason, most companies use predetermined overhead rates to apply manufacturing overhead costs to jobs. 2-9 The measure of activity used as the allocation base should drive the overhead cost; that is, the allocation base should cause the overhead cost. If the allocation base does not really cause the overhead, then costs will be incorrectly attributed to products and jobs and product costs will be distorted. 2-10 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.

2-11 No, you would not expect the total applied overhead for a period to equal the actual overhead for that period. This is because the applied overhead relies on a predetermined overhead rate that is based on estimates in the numerator and denominator. 2-12 When a company applied less overhead to production than it actually incurs, it creates what is known as underapplied overhead. When it applies more overhead to production than it actually incurs, it results in overapplied overhead.

2-13 A plantwide overhead rate is a single overhead rate used throughout a plant. In a multiple overhead rate system, each production department may have its own predetermined overhead rate and its own allocation base. 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 labor intensive.

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Chapter 2: Applying Excel The completed worksheet is shown below.

Chapter 2: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Managerial Accounting, 16th edition

Chapter 2: Applying Excel (continued) [Note: To display formulas in Excel 2013, select File > Options > Advanced > Display options for this worksheet > Show formulas in cells instead of their calculated amounts. To display the formulas in other versions of Excel, consult Excel Help.]

Chapter 2: Applying Excel (continued) 1. When the total fixed manufacturing overhead cost for the Milling Department is changed to $300,000, the worksheet changes as show below:

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Chapter 2: Applying Excel (continued) The selling price of Job 407 has dropped from $4,348.75 to $4,112.50 because the fixed manufacturing overhead in the Milling Department decreased from $390,000 to $300,000. This reduced the predetermined overhead rate in the Milling Department from $8.50 per machine-hour to $7.00 per machine-hour and hence the amount of overhead applied to Job 407 in the Milling Department.

Chapter 2: Applying Excel (continued) 2. For the new Job 408, the worksheet should look like the following:

Managerial Accounting, 16th edition

Chapter 2: Applying Excel (continued) 3. When the total number of machine-hours in the Assembly Department increases from 3,000 machine-hours to 6,000 machine-hours, the worksheet looks like the following:

Chapter 2: Applying Excel (continued) The selling price for Job 408 is not affected by this change. The reason for this is that the total number of machine-hours in the Assembly Department has no effect on any cost. There would have been a change in costs and in the selling price if the total machine-hours in the Milling Department would have changed. This is because the predetermined overhead rate in that department is based on machine-hours and any change in the total machine-hours would affect the magnitude of the predetermined overhead rate in that department.

Managerial Accounting, 16th edition

Chapter 2: Applying Excel (continued) 4. When the total number of direct labor-hours in the Assembly Department decreases from 80,000 direct labor-hours to 50,000 direct laborhours, the worksheet looks like the following:

Chapter 2: Applying Excel (continued) The selling price of Job 408 has increased from $2,905.00 to $2,944.38. This occurs because the decrease in the total number of direct laborhours in the Assembly Department increases the predetermined overhead rate in that department from $10.00 per direct labor-hour to $13.75 per direct labor-hour. In effect, the same total fixed manufacturing overhead cost is spread across fewer total direct labor-hours.

Managerial Accounting, 16th edition

The Foundational 15 1. The first step is to calculate the estimated total overhead costs in Molding and Fabrication: Molding: 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

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 second step is to combine the estimated manufacturing overhead costs in Molding and Fabrication ($13,500 + $18,300 = $31,800) to enable calculating the predetermined overhead rate as follows: 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

2. 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

2,300 $7.95 $18,285

Job Q

1,700 $7.95 $13,515

The Foundational 15 3. The total manufacturing cost assigned to Job P is computed as follows:

Job P

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

$13,000 21,000 18,285 $52,285

4. Job P’s unit product cost is computed as follows:

Job P

Total manufacturing cost (a) .......................... $52,285 Number of units (b) ....................................... 20 Unit product cost (rounded) (a) ÷ (b) ............. $2,614

5. The total manufacturing cost assigned to Job Q is computed as follows: Direct materials ........................................... Direct labor ................................................. Manufacturing overhead applied ................... Total manufacturing cost..............................

Job P

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

6. Job Q’s unit product cost is computed as follows:

Job P

Total manufacturing cost (a) .......................... $29,015 Number of units (b) ....................................... 30 Unit product cost (rounded) (a) ÷ (b) ............. $967 7. 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 (rounded) (a) ÷ (b) ......

Job P

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

Job Q

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

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The Foundational 15 8. 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 ..... $52,285 Total manufacturing cost assigned to Job Q .... 29,015 Cost of goods sold ......................................... $81,300 9. Molding: 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

$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

The Foundational 15 10. 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

1,700 $5.40 $9,180

Job Q

800 $5.40 $4,320

11. 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

600 $12.20 $7,320

Job Q

900 $12.20 $10,980

12. The unit product cost for Job P is computed as follows: Direct materials .......................................... Direct labor ................................................ Manufacturing overhead applied: Molding Department ................................. Fabrication Department ............................ Total manufacturing cost (a) ....................... Number of units in the job (b) ..................... Unit product cost (a) ÷ (b)..........................

$13,000 21,000 $9,180 7,320

16,500 $50,500 20 $2,525

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

$8,000 7,500 $4,320 10,980

15,300 $30,800 30 $1,027

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The Foundational 15 14. 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

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

Job Q

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

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 ..... $50,500 Total manufacturing cost assigned to Job Q .... 30,800 Cost of goods sold ......................................... $81,300

Exercise 2-1 (10 minutes) The estimated total manufacturing overhead cost is computed as follows: Y = $94,000 + ($2.00 per DLH)(20,000 DLHs) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead: $2.00 per DLH × 20,000 DLHs ........................................ Estimated total manufacturing overhead cost ............

$ 94,000 40,000 $134,000

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

$134,000 20,000 DLHs $6.70 per DLH

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Exercise 2-2 (10 minutes) Actual direct labor-hours (a) ........................ Predetermined overhead rate (b) ................. Manufacturing overhead applied (a) × (b) ....

10,800 $23.40 $252,720

Exercise 2-3 (10 minutes) 1. Total direct labor-hours required for Job A-500: Direct labor cost (a) ..................................... Direct labor wage rate per hour (b) ............... Total direct labor hours (a) ÷ (b) ..................

$153 $17 9

Total manufacturing cost assigned to Job A-500: Direct materials ....................................................... Direct labor ............................................................. Manufacturing overhead applied ($14 per DLH × 9 DLHs)................................................................... Total manufacturing cost ..........................................

$231 153 126 $510

2. Unit product cost for Job A-500: Total manufacturing cost (a) ......................... Number of units in the job (b)....................... Unit product cost (a) ÷ (b) ...........................

$510 40 $12.75

Managerial Accounting, 16th edition

Exercise 2-4 (10 minutes) 1 and 2. The total direct labor-hours required for Job N-60:

Direct labor cost (a) ..................................... Direct labor wage rate per hour (b) ............... Total direct labor hours (a) ÷ (b) ..................

Assembly $180 $20 9

Testing & Packaging $40 $20 2

The total manufacturing cost and unit product cost for Job N-60 is computed as follows: Direct materials ($340 + $25) ................................ Direct labor ($180 + $40) ...................................... Assembly Department ($16 per DLH × 9 DLHs) ....... Testing & Packaging Department ($12 per DLH × 2 DLHs) ................................................................. Total manufacturing cost ........................................ Total manufacturing cost (a) .................................. Number of units in the job (b) ................................ Unit product cost (a) ÷ (b) .....................................

$144 24

$365 220 168 $753 $753 10 $75.30

Exercise 2-5 (10 minutes) 1 and 2. The total direct labor-hours required in Finishing for Job 700: Direct labor cost (a) ..................................... Direct labor wage rate per hour (b) ............... Total direct labor hours (a) ÷ (b) ..................

Finishing $128 $16 8

The total manufacturing cost and unit product cost for Job 700 is computed as follows: Direct materials ($410 + $60) ................................ Direct labor ($128 + $48) ...................................... Finishing Department ($18 per DLH × 8 DLHs) ........ Fabrication Department (110% × $60) ................... Total manufacturing cost ........................................ Total manufacturing cost (a) .................................. Number of units in the job (b) ................................ Unit product cost (rounded) (a) ÷ (b) .....................

$144 66

$470 176 210 $856 $856 15 $57.07

Managerial Accounting, 16th edition

Exercise 2-6 (10 minutes) 1. The estimated total overhead cost is computed as follows: Y = $680,000 + ($0.50 per DLH)(80,000 DLHs) Estimated fixed overhead cost ................................ Estimated variable overhead cost: $0.50 per DLH × 80,000 DLHs ....................................................... Estimated total overhead cost ................................

$680,000 40,000 $720,000

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

$720,000 80,000 DLHs $9.00 per DLH

2. Total manufacturing cost assigned to Xavier: Direct materials ....................................................... Direct labor ............................................................. Overhead applied ($9.00 per DLH × 280 DLHs) ......... Total manufacturing cost ..........................................

$38,000 21,000 2,520 $61,520

Exercise 2-7 (20 minutes) 1. Step 1: The total direct labor-hours required for Job Omega: Direct labor cost (a) ..................................... Direct labor wage rate per hour (b) ............... Total direct labor hours worked (a) ÷ (b) ......

$345,000 $15 23,000

Step 2: Derive the plantwide predetermined overhead rate: Manufacturing overhead applied to Job Omega (a) ................................................ Direct labor hours worked on Job Omega (b) . Plantwide predetermined overhead rate (a) ÷ (b) ........................................................

$184,000 23,000 $8.00 per DLH

2. The job cost sheet for Job Alpha is derived as follows: (note that direct materials is the plug figure) Direct materials (plug figure) ................................. $ 280,000 Direct labor (54,500 DLHs × $15 per DLH) ............ 817,500 Manufacturing overhead applied ($8 per DLH × 54,500 DLHs) .................................................... 436,000 Total job cost (given) ............................................ $1,533,500

Managerial Accounting, 16th edition

Exercise 2-8 (10 minutes) Direct material................................ Direct labor .................................... Manufacturing overhead applied: $12,000 × 125% ......................... Total manufacturing cost ................

$10,000 12,000

Total manufacturing cost (a) ........... Number of units in job (b) ............... Unit product cost (a) ÷ (b) ..............

$37,000 1,000 $37

15,000 $37,000

Exercise 2-9 (30 minutes) 1. The estimated total overhead cost is computed as follows: Y = $1,980,000 + ($2.00 per MH)(165,000 MHs) Estimated fixed overhead ....................................... $1,980,000 Estimated variable overhead: $2.00 per MH × 165,000 MHs ...................................................... 330,000 Estimated total overhead cost ................................ $2,310,000 The plantwide predetermined overhead rate is computed as follows: Estimated total overhead (a) ...................... Estimated total machine-hours (b) ............. Predetermined overhead rate (a) ÷ (b).......

$2,310,000 165,000 MHs $14.00 per MH

2. Total manufacturing cost assigned to Job P90: Direct materials ....................................................... Direct labor ............................................................. Overhead applied ($14 per MH × 72 MHs) ................ Total manufacturing cost ..........................................

$1,150 830 1,008 $2,988

3a. Given that the company is operating at 50% of its manufacturing capacity, an argument can made that the company should pursue any business opportunities that generate a positive a contribution margin. Based on the information provided, it appears that Job P90 does generate a positive contribution margin as shown below: Sales............................................................... Direct materials ............................................... Direct labor ..................................................... Variable overhead applied ($2.00 per MH × 72 MHs) ............................................................ Contribution margin .........................................

$1,150 830

$2,500

144 2,124 $ 376

Managerial Accounting, 16th edition

Exercise 2-9 (continued) 3b. The CFO’s argument is based on the assertion that Job P90 does not generate enough revenue to cover the cost of the manufacturing resources that it consumes. However, given that the company is operating at 50% of its manufacturing capacity, the overhead costs applied to Job P90 in requirement 2 do not represent the cost of the overhead resources consumed making Job P90. In other words, the overhead applied in requirement 2 includes a charge for used and unused capacity. This reality provides instructors an opportunity to introduce students to the main idea underlying Appendix 2B. If we estimate a capacity-based overhead rate for the company and apply overhead costs to Job P90 using this rate, it reveals that the revenue generated by the job ($2,500) is still insufficient to cover its manufacturing costs of $2,556, as computed below: The estimated total overhead cost (at capacity) is computed as follows (keep in mind that 165,000 MHs ÷ 50% = 330,000 MHs): Y = $1,980,000 + ($2.00 per MH)(330,000 MHs) Estimated fixed overhead ....................................... $1,980,000 Estimated variable overhead: $2.00 per MH × 330,000 MHs ...................................................... 660,000 Estimated total overhead cost ................................ $2,640,000 The predetermined capacity-based overhead rate is computed as follows: Estimated total overhead (a) ...................... Estimated total machine-hours (b) ............. Predetermined overhead rate (a) ÷ (b).......

$2,640,000 330,000 MHs $8.00 per MH

The total manufacturing cost assigned to Job P90 (using a capacity-based overhead rate): Direct materials ....................................................... Direct labor ............................................................. Overhead applied ($8 per MH × 72 MHs) .................. Total manufacturing cost ..........................................

$1,150 830 576 $2,556

Exercise 2-10 (10 minutes) 1. Yes, overhead should be applied to Job W at year-end. Because $6,000 of overhead was applied to Job V on the basis of $8,000 of direct labor cost, the company’s predetermined overhead rate must be 75% of direct labor cost. Job W direct labor cost (a) ............................................ Predetermined overhead rate (b) .................................. Manufacturing overhead applied to Job W (a) × (b) .......

$4,000 0.75 $3,000

2. The direct materials ($2,500), direct labor ($4,000), and applied overhead ($3,000) for Job W will be included in Work in Process on Sigma Corporation’s balance sheet.

Managerial Accounting, 16th edition

Exercise 2-11 (30 minutes) Note to the instructor: This exercise can be used as a launching pad for a discussion of Appendix 2B. 1. The estimated total fixed manufacturing overhead can be computed using the data from any of quarters 1-3. For illustrative purposes, we’ll use the first quarter as follows: Total overhead cost (First quarter) ........................... $300,000 Variable cost element ($2.00 per unit × 80,000 units) 160,000 Fixed cost element .................................................. $140,000 2. The fixed and variable cost estimates from requirement 1 can be used to estimate the total manufacturing overhead cost for the fourth quarter as follows: Y = $140,000 + ($2.00 per unit)(60,000 units) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $2.00 per unit × 60,000 units................................ Estimated total manufacturing overhead cost ............

$140,000 120,000 $260,000

The estimated unit product cost for the fourth quarter is computed as follows: Direct materials .................................................... Direct labor ........................................................ Manufacturing overhead ........................................ Total manufacturing costs (a) .............................. Number of units to be produced (b) ..................... Unit product cost (rounded) (a) ÷ (b) ..................

$180,000 96,000 260,000 $536,000 60,000 $8.93

Exercise 2-11 (continued) 3. The fixed portion of the manufacturing overhead cost is causing the unit product costs to fluctuate. The unit product cost increases as the level of production decreases because the fixed overhead is spread over fewer units. 4. The unit product cost can be stabilized by using a predetermined overhead rate that is based on expected activity for the entire year. The cost formula created in requirement 1 can be adapted to compute the annual predetermined overhead rate. The annual fixed manufacturing overhead is $560,000 ($140,000 per quarter × 4 quarters). The variable manufacturing overhead per unit is $2.00. The cost formula is as follows: Y = $560,000 + ($2.00 per unit × 200,000 units) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $2.00 per unit × 200,000 units .............................. Estimated total manufacturing overhead cost ............

$560,000 400,000 $960,000

The annual predetermined overhead rate is computed as follows: Estimated total manufacturing overhead (a) Estimated total units produced (b) .............. Predetermined overhead rate (a) ÷ (b) .......

$960,000 200,000 $4.80 per unit

Using a predetermined overhead rate of $4.80 per unit, the unit product costs would stabilize as shown below:

Direct materials................. Direct labor....................... Manufacturing overhead: at $4.80 per unit ............ Total cost (a) .................... Number of units produced (b) ................................. Unit product cost (a) ÷ (b)

First

Quarter Second Third

Fourth

$240,000 $120,000 $ 60,000 $180,000 128,000 64,000 32,000 96,000 384,000 192,000 96,000 288,000 $752,000 $376,000 $188,000 $564,000 80,000 $9.40

40,000 $9.40

20,000 $9.40

60,000 $9.40

Managerial Accounting, 16th edition

Exercise 2-12 (20 minutes) 1. The estimated total manufacturing overhead cost is computed as follows: Y = $650,000 + ($3.00 per MH)(100,000 MHs) Estimated fixed manufacturing overhead ................. Estimated variable manufacturing overhead: $3.00 per MH × 100,000 MHs ....................................... Estimated total manufacturing overhead cost ..........

$650,000 300,000 $950,000

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

$950,000 100,000 MHs $9.50 per MH

2. Total manufacturing cost assigned to Job 400: Direct materials ....................................................... Direct labor ............................................................. Manufacturing overhead applied ($9.50 per MH × 40 MHs) .................................................................... Total manufacturing cost ..........................................

$ 450 210 380 $1,040

3. The unit product cost of Job 400 is computed as follows: Total manufacturing cost (a) ...................... Number of units in the job (b).................... Unit product cost (a) ÷ (b) ........................

$1,040 52 $20

4. The selling price per unit is computed as follows: Total manufacturing cost ........................... Markup (120% of manufacturing cost) ....... Selling price for Job 400 (a) ....................... Number of units in Job 400 (b) .................. Selling price per unit (a) ÷ (b) ...................

$1,040 1,248 $2,288 52 $44

Exercise 2-12 (continued) 5. Possible critiques of Moody’s pricing tactics include (1) relying on a plantwide overhead rate to allocate overhead costs to jobs may distort the cost base used for cost-plus pricing, (2) relying on an absorption approach may allocate unused capacity costs to jobs thereby distorting the cost base for cost-plus pricing, and (3) relying on absorption cost-plus pricing ignores the customers’ willingness to pay based on their perceived value of the product or service.

Managerial Accounting, 16th edition

Exercise 2-13 (20 minutes) 1. Cutting Department: The estimated total manufacturing overhead cost in the Cutting Department is computed as follows: Y = $264,000 + ($2.00 per MH)(48,000 MHs) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $2.00 per MH × 48,000 MHs ................................. Estimated total manufacturing overhead cost ............

$264,000 96,000 $360,000

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

$360,000 48,000 MHs $7.50 per MH

Finishing Department: The estimated total manufacturing overhead cost in the Finishing Department is computed as follows: Y = $366,000 + ($4.00 per DLH)(30,000 DLHs) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead $4.00 per DLH × 30,000 DLHs .............................. Estimated total manufacturing overhead cost ............

$366,000 120,000 $486,000

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

$486,000 30,000 DLHs $16.20 per DLH

Exercise 2-13 (continued) 2. Total manufacturing cost assigned to Job 203: Direct materials ($500 + $310) ......................... Direct labor ($108 + $360) ............................... Cutting Department (80 MHs × $7.50 per MH) .. Finishing Department (20 DLH × $16.20 per DLH) ............................................................ Total manufacturing cost ..................................

$600 324

$ 810 468 924 $2,202

3. Yes; if some jobs require a large amount of machine time and a small amount of labor time, they would be charged substantially less overhead cost if a plantwide overhead rate based on direct labor hours were used. It appears, for example, that this would be true of Job 203 which required considerable machine time to complete, but required a relatively small amount of labor hours.

Managerial Accounting, 16th edition

Exercise 2-14 (10 minutes) 1. The estimated total overhead cost is computed as follows: Y = $4,800,000 + ($0.05 per DL$)($8,000,000) Estimated fixed overhead ....................................... $4,800,000 Estimated variable overhead: $0.05 per DL$ × $8,000,000 DL$ .................................................. 400,000 Estimated total overhead cost ................................ $5,200,000 The predetermined overhead rate is computed as follows: Estimated total overhead (a) ...................... Estimated total direct labor-dollars (b) ........ Predetermined overhead rate (a) ÷ (b).......

$5,200,000 8,000,000 DL$ $0.65 per DL$

2. Total cost assigned to You Can Say That Again: Direct materials ....................................................... Direct labor ............................................................. Overhead applied ($0.65 per DL$ × $2,400,000) ....... Total job cost ..........................................................

$1,259,000 2,400,000 1,560,000 $5,219,000

Exercise 2-15 (45 minutes) 1a. The first step is to calculate the estimated total overhead costs in Molding and Fabrication: Molding: Using the equation Y = a + bX, the estimated total manufacturing overhead cost would be calculated as follows: Y = $700,000 + ($3.00 per MH)(20,000 MHs) Estimated fixed manufacturing overhead................... Estimated variable manufacturing overhead: $3.00 per MH × 20,000 MHs ........................................... Estimated total manufacturing overhead cost ............

$700,000 60,000 $760,000

Fabrication: Using the equation Y = a + bX, the estimated total manufacturing overhead cost would be calculated as follows: Y = $210,000 + ($1.00 per MH)(30,000 MHs) Estimated fixed manufacturing overhead................... Estimated variable manufacturing overhead: $1.00 per MH × 30,000 MHs ........................................... Estimated total manufacturing overhead cost ............

$210,000 30,000 $240,000

The second step is to combine the estimated manufacturing overhead costs in Molding and Fabrication ($760,000 + $240,000 = $1,000,000) to enable calculating the predetermined overhead rate as follows: Estimated total manufacturing overhead (a) Estimated total machine-hours (b) ............. Predetermined overhead rate (a) ÷ (b) ......

$1,000,000 50,000 MHs $20.00 per MH

Managerial Accounting, 16th edition

Exercise 2-15 (continued) 1b. Total manufacturing cost assigned to Jobs D-70 and C-200: Direct materials ......................................... Direct labor ............................................... Manufacturing overhead applied ($20.00 per MH × 20,000 MHs; $20.00 per MH × 30,000 MHs) ........................................... Total manufacturing cost ............................ 1c. Bid prices for Jobs D-70 and C-200: Total manufacturing cost (a) ...................... Markup percentage (b) .............................. Bid price (a) × (b) ..................................... 1d.

D-70

C-200

$ 700,000 $ 550,000 360,000 400,000 400,000 600,000 $1,460,000 $1,550,000

D-70

C-200

$1,460,000 $1,550,000 150% 150% $2,190,000 $2,325,000

Because the company has no beginning or ending inventories and only Jobs D-70 and C-200 were started, completed, and sold during the year, the cost of goods sold is equal to the sum of the manufacturing costs assigned to both jobs of $3,010,000 (=$1,460,000 + $1,550,000).

Exercise 2-15 (continued) 2a. Molding Department: Using the equation Y = a + bX, the estimated total manufacturing overhead cost would be depicted as follows: Y = $700,000 + ($3.00 per MH)(20,000 MHs) Estimated fixed manufacturing overhead ................... Estimated variable manufacturing overhead: $3.00 per MH × 20,000 MHs ........................................... Estimated total manufacturing overhead cost ............

$700,000 60,000 $760,000

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

$760,000 20,000 MHs $38.00 per MH

Fabrication Department: Using the equation Y = a + bX, the estimated total manufacturing overhead cost would be depicted as follows: Y = $210,000 + ($1.00 per MH)(30,000 MHs) Estimated fixed manufacturing overhead ................... Estimated variable manufacturing overhead: $1.00 per MH × 30,000 MHs ........................................... Estimated total manufacturing overhead cost ............

$210,000 30,000 $240,000

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

$240,000 30,000 MHs $8.00 per MH

Managerial Accounting, 16th edition

Exercise 2-15 (continued) 2b. Total manufacturing costs assigned to Jobs D-70 and C-200:

D-70

Direct materials ................................................ $ 700,000 Direct labor ...................................................... 360,000 Molding Department (14,000 MHs × $38 per MH; 6,000 MHs × $38 per MH)....................... 532,000 Fabrication Department (6,000 MH × $8 per MH; 24,000 MH × $8 per MH) ........................ 48,000 Total manufacturing cost .................................. $1,640,000 2c. Bid prices for Jobs D-70 and C-200: Total manufacturing cost (a) ....................... Markup percentage (b) ............................... Bid price (a) × (b) ...................................... 2d.

D-70

$1,640,000 150% $2,460,000

C-200

$ 550,000 400,000 228,000 192,000 $1,370,000

C-200

$1,370,000 150% $2,055,000

3. The plantwide and departmental approaches for applying manufacturing overhead costs to products produce identical cost of goods sold figures. However, these two approaches lead to different bid prices for Jobs D70 and C-200. The bid price for Job D-70 using the departmental approach is $270,000 (=$2,460,000 ‒ $2,190,000) higher than the bid price using the plantwide approach. This is because the departmental cost pools reflect the fact that Job D-70 is an intensive user of Molding machine-hours. The overhead rate in Molding ($38) is much higher than the overhead rate in Fabrication ($8). Conversely, Job C-200 is an intensive user of the less-expensive Fabrication machine-hours, so its departmental bid price is $270,000 lower than the plantwide bid price.

Exercise 2-15 (continued) Whether a job-order costing system relies on plantwide overhead cost allocation or departmental overhead cost allocation does not usually have an important impact on the accuracy of the cost of goods sold reported for the company as a whole. However, it can have a huge impact on internal decisions with respect to individual jobs, such as establishing bid prices for those jobs. Job-order costing systems that rely on plantwide overhead cost allocation are commonly used to value ending inventories and cost of goods sold for external reporting purposes, but they can create costing inaccuracies for individual jobs that adversely influence internal decision making.

Managerial Accounting, 16th Edition

Problem 2-16 (30 minutes) 1a. The estimated total overhead cost is computed as follows: Y = $784,000 + ($2.00 per DLH)(140,000 DLHs) Estimated fixed manufacturing overhead ................. $ 784,000 Estimated variable manufacturing overhead: $2.00 per DLH × 140,000 DLH ...................................... 280,000 Estimated total manufacturing overhead cost .......... $1,064,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead (a) Estimated total direct labor-hours (b) ......... Predetermined overhead rate (a) ÷ (b).......

$1,064,000 140,000 DLH $7.60 per DLH

1b. Total manufacturing cost assigned to Job 550: Direct materials ....................................................... Direct labor ............................................................. Manufacturing overhead applied ($7.60 per DLH × 15 DLH) ............................................................... Total manufacturing cost of Job 550 ......................... 1c. The selling price for Job 550 is computed as follows: Total manufacturing cost .......................................... Markup (200%) ....................................................... Selling price ............................................................

$175 225 114 $514

Job 550

$ 514 1,028 $1,542

Problem 2-16 (continued) 2a. The estimated total overhead cost is computed as follows: Y = $784,000 + ($4.00 per MH)(70,000 MHs) Estimated fixed manufacturing overhead ................. $ 784,000 Estimated variable manufacturing overhead: $4.00 per MH × 70,000 MHs ......................................... 280,000 Estimated total manufacturing overhead cost .......... $1,064,000 The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead (a) . Estimated total machine-hours (b)................ Predetermined overhead rate (a) ÷ (b) .........

$1,064,000 70,000 MHs $15.20 per MH

2b. Total manufacturing cost assigned to Job 550: Direct materials ....................................................... Direct labor ............................................................. Manufacturing overhead applied ($15.20 per MH × 5 MH) ..................................................................... Total manufacturing cost of Job 550 ......................... 2c. The selling price for Job 550 is computed as follows: Total manufacturing cost .......................................... Markup (200%) ....................................................... Selling price ............................................................

$175 225 76 $476

Job 550

$ 476 952 $1,428

3. The price for Job 550 using direct labor-hours as the allocation base ($1,542) is $114 higher than the price derived using machine-hours as the allocation base ($1,428). If machine-hours is the better choice for an allocation base, then if Landen continues to use direct labor-hours as its overhead allocation base, it will overprice jobs that are intensive users of direct labor-hours and non-intensive users of machine-hours. In a bidding situation, Landen will tend to lose bids on jobs such as Job 550 if its competitors have more accurate cost accounting systems. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 42

Managerial Accounting, 16th Edition

Problem 2-17 (20 minutes) 1. The predetermined plantwide overhead rate is computed as follows: Estimated manufacturing overhead (a) ....... Estimated total direct labor-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 labor-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 labor-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: Quantity of allocation base used (a) Predetermined overhead rate (b) .... Overhead applied to Bravo (a) × (b)

Assembly Fabrication 11 6 $12.00 $8.00 $132 $48

Total $180

Problem 2-18 (15 minutes) 1. The estimated total overhead cost is computed as follows: Y = $350,000 + ($1.00 per DLH)(20,000 DLHs) 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 labor-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 labor ............................................................. Overhead applied ($18.50 per DLH × 6 DLH) ............ Total cost assigned to Mr. Wilkes .............................. 3. The price charged to Mr. Wilkes is computed as follows: Total manufacturing cost .......................................... Markup (40%) ......................................................... Selling price ............................................................

$590 109 111 $810

Job 550

$ 810 324 $1,134

Managerial Accounting, 16th Edition

Problem 2-19 (20 minutes) 1. Molding Department: The estimated total manufacturing overhead cost in the Molding Department is computed as follows: Y = $497,000 + $1.50 per MH × 70,000 MHs Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead: $1.50 per MH × 70,000 MHs ................................. Estimated total manufacturing overhead cost ............

$497,000 105,000 $602,000

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

$602,000 70,000 MHs $8.60 per MH

Painting Department: The estimated total manufacturing overhead cost in the Painting Department is computed as follows: Y = $615,000 + $2.00 per DLH × 60,000 DLHs Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead: $2.00 per DLH × 60,000 DLHs .............................. Estimated total manufacturing overhead cost ............

$615,000 120,000 $735,000

The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead (a) . Estimated total DLHs (b) ............................. Predetermined overhead rate (a) ÷ (b) ........

$735,000 60,000 DLHs $12.25 per DLH

Problem 2-19 (continued) 2. Molding Department overhead applied: 110 machine-hours × $8.60 per machine-hour Painting Department overhead applied: 84 direct labor-hours × $12.25 per DLH .......... Total overhead cost.............................................

$ 946 1,029 $1,975

3. Total cost of Job 205: Direct materials .......................... Direct labor ................................ Manufacturing overhead applied.. Total manufacturing cost ............

Molding Dept.

$ 770 525 946 $2,241

Unit product cost for Job 205: Total manufacturing cost (a) ...................... Number of units in the job (b).................... Unit product cost (a) ÷ (b) ........................

Painting Dept.

$1,332 1,470 1,029 $3,831

Total

$2,102 1,995 1,975 $6,072

$6,072 50 units $121.44 per unit

Managerial Accounting, 16th Edition

Problem 2-20 (45 minutes) 1a. The first step is to calculate the total estimated overhead costs in ICU and Other: ICU: Using the equation Y = a + bX, the estimated total overhead cost would be calculated as follows: Y = $3,200,000 + ($236 per patient-day)(2,000 patient-days) Estimated fixed overhead.................................... Estimated variable overhead: $236 per patient-day × 2,000 patient-days........ Estimated total overhead cost .............................

$3,200,000 472,000 $3,672,000

Other: Using the equation Y = a + bX, the estimated total overhead cost would be calculated as follows: Y = $14,000,000 + ($96 per patient-day)(18,000 patient-days) Estimated fixed overhead .................................... Estimated variable overhead: $96 per patient-day × 18,000 patient-days ........ Estimated total overhead cost ..............................

$14,000,000 1,728,000 $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) ............... Estimated total patient-days (b) .......... Predetermined overhead rate (a) ÷ (b)

$19,400,000 20,000 patient-days $970 per patient-day

Problem 2-20 (continued) 1b. The total cost assign to Patients A and B is computed as follows: Direct materials ...................................... Direct labor ............................................ Overhead applied ($970 per patient-day × 14 patient days; ($970 per patientday × 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

2a. The overhead rate in ICU is computed as follows: Y = $3,200,000 + ($236 per patient-day)(2,000 patient-days) Estimated fixed overhead.................................... Estimated variable overhead: $236 per patient-day × 2,000 patient-days........ Estimated total overhead cost .............................

$3,200,000 472,000 $3,672,000

The predetermined overhead rate is computed as follows: Estimated total overhead (a) ............... Estimated total patient-days (b) ........... Predetermined overhead rate (a) ÷ (b)

$3,672,000 2,000 patient-days $1,836 per patient-day

The overhead rate in Other is computed as follows: Y = $14,000,000 + ($96 per patient-day)(18,000 patient-days) Estimated fixed overhead .................................... Estimated variable overhead: $96 per patient-day × 18,000 patient-days ........ Estimated total overhead cost ..............................

$14,000,000 1,728,000 $15,728,000

The predetermined overhead rate is computed as follows: Estimated total overhead (a) ............... Estimated total patient-days (b) ........... Predetermined overhead rate (rounded) (a) ÷ (b) ..........................

$15,728,000 18,000 patient-days $873.78 per patient-day

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Problem 2-20 (continued) 2b. The total cost assigned to Patient A: Direct materials ................................................ $ 4,500 Direct labor ...................................................... 25,000 ICU ($1,836 per patient-day × 0 patient-days)... $ 0 Other ($873.78 per patient day × 14 patientdays) (rounded to nearest dollar) ................... 12,233 12,233 Total cost assigned to Patient A ........................ $41,733 The total cost assigned to Patient B: Direct materials ................................................ $ 6,200 Direct labor ...................................................... 36,000 ICU ($1,836 per patient-day × 7 patient-days)... $12,852 Other ($873.78 per patient day × 14 patientdays) (rounded to nearest dollar) ................... 12,233 25,085 Total cost assigned to Patient B ........................ $67,285 3. Relying on just one predetermined overhead rates 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.

Problem 2-21 (30 minutes) 1. The plantwide predetermined overhead rate is computed as follows: Estimated manufacturing overhead (a) ....... Estimated total direct labor-hours (b) ......... Predetermined overhead rate (a) ÷ (b).......

$600,000 60,000 DLHs $10 per DLH

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

15 $10 per DLH $150

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

9 $10 per DLH $90

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

$500,000 50,000 MHs $10 per MH

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

$100,000 50,000 DLHs $2 per DLH

The overhead applied to Job A is computed as follows: Quantity of allocation base used (a) . Predetermined overhead rate (b) ..... Overhead applied to Job A (a) × (b) .

Machining 11 $10 $110

Assembly 10 $2 $20

Total $130

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Problem 2-21 (continued) The overhead applied to Job B is computed as follows: Quantity of allocation base used (a) . Predetermined overhead rate (b) ..... Overhead applied to Job B (a) × (b) .

Machining 12 $10 $120

Assembly 5 $2 $10

Total $130

3. The plantwide approach will overcost jobs that are intensive users of Assembly and minimal users of Machining. Conversely, it will undercost products that are intensive users of Machining and minimal users of Assembly. These cost distortions will adversely impact the company’s pricing process. Jobs that get overcosted will have selling prices that are greater than the prices that would be established using departmental overhead allocation. Jobs that get undercosted will have selling prices that are less than the prices that would be established using departmental overhead allocation.

Case 2-22 (60 minutes) 1. a.

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

$840,000 = 140% of direct labor cost $600,000 direct labor cost

b. The manufacturing overhead cost applied to the Koopers job is computed as follows: $9,500 × 140% = $13,300 2. a.

Estimated manufacturing overhead cost (a) ......... Estimated direct labor cost (b)........................ Predetermined overhead rate (a) ÷ (b) ...............

Fabricating Machining Assembly Department Department Department $350,000

$400,000

$ 90,000

$200,000

$100,000

$300,000

175%

400%

30%

b. Fabricating Department: $2,800 × 175%............................. Machining Department: $500 × 400% ............................... Assembly Department: $6,200 × 30% .............................. Total applied overhead .....................

$4,900 2,000 1,860 $8,760

3. The bulk of the labor cost on the Koopers job is in the Assembly Department, which incurs very little overhead cost. The department has an overhead rate of only 30% of direct labor 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 being charged to the job. Use of a plantwide overhead rate in effect redistributes overhead costs proportionately between the three departments (at 140% of direct labor © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 52

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Case 2-22 (continued) cost) and results in a large amount of overhead cost being charged to the Koopers 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. On jobs that require a large amount of labor in the Fabricating or Machining Departments the opposite will be true, and the company will tend to charge too little overhead cost to the jobs if a plantwide overhead rate is being used. The reason is that the plantwide overhead rate (140%) is much lower than the rates would be if these departments were considered separately. 4. The company’s bid was: Direct materials ........................................... Direct labor ................................................. Manufacturing overhead applied (see requirement 1b) .................................................. Total manufacturing cost ............................. Bidding rate ................................................ Total bid price .............................................

$ 4,600 9,500 13,300 $27,400 × 1.5 $41,100

If departmental overhead rates had been used, the bid would have been: Direct materials ........................................... Direct labor ................................................. Manufacturing overhead applied (see requirement 2b) .................................................. Total manufacturing cost ............................. Bidding rate ................................................ Total bid price .............................................

$ 4,600 9,500 8,760 $22,860 × 1.5 $34,290

Note that if departmental overhead rates had been used, Teledex Company would have been the low bidder on the Koopers job because the competitor underbid Teledex by only $2,000.

Appendix 2A Activity-Based Absorption Costing

Exercise 2A-1 (20 minutes) 1. Activity rates are computed as follows:

Activity Cost Pool

Machine setups ...... Special processing .. General factory ......

(a) Estimated Overhead Cost

(b) Expected Activity

$72,000 400 setups $200,000 5,000 MHs $816,000 24,000 DLHs

(a) ÷ (b) Activity Rate

$180 per setup $40 per MH $34 per DLH

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Exercise 2A-1 (continued) 2. Overhead is assigned to the two products as follows:

Hubs: Activity Cost Pool

Machine setups ..................... Special processing ................. General factory ..................... Total.....................................

(a) Activity Rate

$180 per setup $40 per MH $34 per DLH

(b) Activity

100 setups 5,000 MHs 8,000 DLHs

(a) × (b) ABC Cost

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

$ 18,000 200,000 272,000 $490,000

Sprockets: Activity Cost Pool

Machine setups ..................... Special processing ................. General factory ..................... Total.....................................

$180 per setup 300 setups $40 per MH 0 MHs $34 per DLH 16,000 DLHs

$ 54,000 0 544,000 $598,000

Exercise 2A-1 (continued) 2. Each product’s unit product cost is computed as follows: Direct materials................................... Direct labor: $15 per DLH × 0.80 DLHs per unit .... $15 per DLH × 0.40 DLHs per unit .... Manufacturing overhead: $490,000 ÷ 10,000 units................... $598,000 ÷ 40,000 units................... Unit product cost ................................

Hubs

$32.00 12.00 49.00 $93.00

Sprockets

$18.00 6.00 14.95 $38.95

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Exercise 2A-2 (45 minutes) 1. The unit product costs under the company's traditional costing system would be computed as follows:

Rascon

Number of units produced (a) ...................... 20,000 Direct labor-hours per unit (b)...................... 0.40 Total direct labor-hours (a) × (b) ................. 8,000 Total manufacturing overhead (a) ................ Total direct labor-hours (b) .......................... Predetermined overhead rate (a) ÷ (b) .........

Parcel

80,000 0.20 16,000

Total 24,000

$576,000 24,000 DLHs $24.00 per DLH

Rascon

Direct materials ........................................... $13.00 Direct labor ................................................. 6.00 Manufacturing overhead: 0.40 DLH per unit × $24.00 per DLH.......... 9.60 0.20 DLH per unit × $24.00 per DLH.......... Unit product cost ......................................... $28.60

Parcel

$22.00 3.00 4.80 $29.80

Exercise 2A-2 (continued) 2. The unit product costs using activity-based absorption costing can be computed as follows:

Activity Cost Pool

Labor related ........... Engineering design ...

Estimated Overhead Cost*

$288,000 $288,000 $576,000

(b) Expected Activity

(a) ÷ (b) Activity Rate

24,000 direct labor-hours $12.00 per direct labor-hour 6,000 engineering-hours $48.00 per engineering-hour

*The total estimated manufacturing overhead cost of $576,000 is split evenly between the two activity cost pools. Manufacturing overhead is assigned to the two products as follows: Rascon:

Activity Cost Pool

Labor related ......... Engineering design . Total......................

(a) Activity Rate

$12 per DLH $48 per engineering-hour

(b) Activity

8,000 DLHs 3,000 engineering-hours

(a) × (b) ABC Cost

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

$ 96,000 144,000 $240,000

Parcel:

Activity Cost Pool

Labor related ......... Engineering design . Total......................

$12 per DLH $48 per engineering-hour

16,000 DLHs 3,000 engineering-hours

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$192,000 144,000 $336,000

Exercise 2A-2 (continued) The unit product costs combine direct materials, direct labor, and overhead costs: Direct materials ............................................. Direct labor ................................................... Manufacturing overhead ($240,000 ÷ 20,000 units; $336,000 ÷ 80,000 units) .................. Unit product cost ...........................................

Rascon

Parcel

12.00 $31.00

4.20 $29.20

$13.00 6.00

$22.00 3.00

3. The unit product cost of the high-volume product, Parcel, declines under the activity-based approach, whereas the unit product cost of the lowvolume product, Rascon, increases. This occurs because half of the overhead is applied on the basis of engineering design hours instead of direct labor-hours. When the overhead was applied on the basis of direct labor-hours, most of the overhead was applied to the high-volume product. However, when the overhead is applied on the basis of engineering-hours, more of the overhead cost is shifted over to the low-volume product. Engineering-hours is a product-level activity, so the higher the volume, the lower the unit cost and the lower the volume, the higher the unit cost.

Exercise 2A-3 (45 minutes) 1. The predetermined overhead rate is computed as follows: Predetermined = $325,000 = $6.50 per DLH overhead rate 50,000 DLHs

The unit product costs under the company’s traditional costing system are computed as follows:

Direct materials ....................................................... Direct labor ............................................................. Manufacturing overhead (1.0 DLH × $6.50 per DLH; 0.8 DLH × $6.50 per DLH) .................................... Unit product cost.....................................................

Deluxe Standard

$72.00 $53.00 19.00 15.20 6.50 5.20 $97.50 $73.40

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Exercise 2A-3 (continued) 2. The activity rates are computed as follows:

Activity Cost Pool

Supporting direct labor... Batch setups ................. Safety testing ................

(a) Estimated (b) Overhead Total Cost Expected Activity $200,000 $75,000 $50,000

(a) ÷ (b) Activity Rate

50,000 DLHs $4 per DLH 300 setups $250 per setup 100 tests $500 per test

Manufacturing overhead is assigned to the two products as follows:

Deluxe Product: Activity Cost Pool

Supporting direct labor .......... Batch setups ......................... Safety testing ........................ Total.....................................

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

$4 per DLH 10,000 DLHs $250 per setup 200 setups $500 per test 30 tests

$ 40,000 50,000 15,000 $105,000

Standard Product: Activity Cost Pool

Supporting direct labor .......... Batch setups ......................... Safety testing ........................ Total.....................................

$4 per DLH 40,000 DLHs $250 per setup 100 setups $500 per test 70 tests

$160,000 25,000 35,000 $220,000

Exercise 2A-3 (continued) Activity-based absorption costing unit product costs are computed as follows: Direct materials .................................................. Direct labor ........................................................ Manufacturing overhead ($105,000 ÷ 10,000 units; $220,000 ÷ 50,000 units) ....................... Unit product cost ................................................

Deluxe

Standard

10.50 $101.50

4.40 $72.60

$ 72.00 19.00

$53.00 15.20

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Problem 2A-4 (60 minutes) 1. a. When direct labor-hours are used to apply overhead cost to products, the company’s predetermined overhead rate would be: Predetermined = Manufacturing overhead cost overhead rate Direct labor-hours =

$1,800,000 = $50 per DLH 36,000DLHs

b. Direct materials .......................................... Direct labor: $20 per hour × 1.8 hours and 0.9 hours ... Manufacturing overhead: $50 per hour × 1.8 hours and 0.9 hours ... Total unit product cost ................................

Model X200 X99 $ 72

$ 50

90 45 $198 $113

2. a. Predetermined overhead rates for the activity cost pools:

Activity Cost Pool

(a) Estimated Total Cost

(b) Estimated Total Activity

Machine setups ...... $360,000 150 setups Special processing . $180,000 12,000 MHs General factory ...... $1,260,000 36,000 DLHs

(a) ÷ (b) Activity Rate

$2,400 per setup $15 per MH $35 per DLH

Problem 2A-4 (continued) The overhead applied to each product can be determined as follows:

Model X200 Activity Cost Pool

(a) Activity Rate

Activity Cost Pool

(a) Activity Rate

Machine setups .................................... $2,400 per setup Special processing ................................ $15 per MH General factory .................................. $35 per DLH Total manufacturing overhead cost (a) Number of units produced (b) ............. Overhead cost per unit (a) ÷ (b) .........

(b) Activity

(a) × (b) ABC Cost

(b) Activity

(a) × (b) ABC Cost

50 setups 12,000 MHs 9,000 DLHs

$120,000 180,000 315,000 $615,000 5,000 $123.00

Model X99 Machine setups .................................... $2,400 per setup Special processing ................................ $15 per MH General factory .................................. $35 per DLH Total manufacturing overhead cost (a) Number of units produced (b) ............. Overhead cost per unit (a) ÷ (b) .........

100 setups 0 MHs 27,000 DLHs

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$ 240,000 0 945,000 $1,185,000 30,000 $39.50

Problem 2A-4 (continued) b. The unit product cost of each model under the activity-based approach would be computed as follows:

Direct materials ..................................... Direct labor: $20 per DLH × 1.8 DLHs, 0.9 DLHs ...... Manufacturing overhead (above) ............ Total unit product cost ...........................

Model X200 X99

$ 72.00

$50.00

36.00 18.00 123.00 39.50 $231.00 $107.50

Comparing these unit cost figures with the unit costs in Part 1(b), we find that the unit product cost for Model X200 has increased from $198 to $231, and the unit product cost for Model X99 has decreased from $113 to $107.50. 3. It is especially important to note that, even under activity-based costing, 70% of the company’s overhead costs continue to be applied to products on the basis of direct labor-hours: Machine setups (number of setups) ... $ 360,000 Special processing (machine-hours)... 180,000 General factory (direct labor-hours) ... 1,260,000 Total overhead cost .......................... $1,800,000

20 % 10 70 100 %

Thus, the shift in overhead cost from the high-volume product (Model X99) to the low-volume product (Model X200) occurred as a result of reassigning only 30% (=20% + 10%) of the company’s overhead costs. The increase in unit product cost for Model X200 can be explained as follows: First, where possible, overhead costs have been traced to the products rather than being lumped together and spread uniformly over production. Therefore, the special processing costs, which are traceable to Model X200, have all been assigned to Model X200 and none assigned to Model X99 under the activity-based approach. It is common in industry to have some products that require special handling or special processing of some type. This is especially true in modern factories that produce a variety of products. Activity-based costing provides a vehicle for assigning these costs to the appropriate products.

Problem 2A-4 (continued) Second, the costs associated with the batch-level activity (machine setups) have also been assigned to the specific products to which they relate. These costs have been assigned according to the number of setups completed for each product. However, because a batch-level activity is involved, another factor affecting unit costs comes into play. That factor is batch size. Some products are produced in large batches and some are produced in small batches. The smaller the batch, the higher the per unit cost of the batch activity. In the case at hand, the data can be analyzed as follows: Model X200: Cost to complete one setup (see requirement 2a)........ Number of units processed per setup (5,000 units per setup ÷ 50 setups = 100 units) .......

100 units (b)

Setup cost per unit (a) ÷ (b) ......................................

$24

Model X99: Cost to complete one setup (see requirement 2a)........ Number of units processed per setup (30,000 units per setup ÷ 100 setups = 300 units) ... Setup cost per unit (a) ÷ (b) ......................................

$2,400 (a)

$2,400 (a) 300 units (b) $8

Thus, the cost per unit for setups is three times as great for Model X200, the low-volume product, as it is for Model X99, the high-volume product. Such differences in cost are obscured when direct labor-hours (or any other volume measure) is used as a basis for applying overhead cost to products. In sum, overhead cost has shifted from the high-volume product to the low-volume product as a result of more appropriately assigning some costs to the products on the basis of the activities involved, rather than on the basis of direct labor-hours.

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Problem 2A-5 (60 minutes) 1. The company’s estimated direct labor-hours can be computed as follows: Deluxe model: 5,000 units × 2 DLHs per unit .... Regular model: 40,000 units × 1 DLH per unit ... Total direct labor hours ....................................

10,000 DLHs 40,000 DLHs 50,000 DLHs

Using just direct labor-hours as the base, the predetermined overhead rate would be: Estimated overhead cost $900,000 = = $18 per DLH Estimated direct labor-hours 50,000DLHs

The unit product cost of each model using the company’s traditional costing system would be: Direct materials...................... Direct labor............................ Manufacturing overhead: $18 per DLH × 2 DLHs......... $18 per DLH × 1 DLH .......... Total unit product cost ...........

Deluxe $ 40 38 36 $114

Regular $25 19 18 $62

2. Predetermined overhead rates are computed below:

Activity Cost Pool

Purchasing................ Processing ................ Scrap/rework ............ Shipping ...................

(a) Estimated Overhead Cost

(b) Expected Activity

(a) ÷ (b) Activity Rate

$204,000 600 purchase or- $340 per purchase ders order $182,000 35,000 machine- $5.20 per hours machine-hour $379,000 2,000 orders $189.50 per order $135,000 900 shipments $150 per shipment

Problem 2A-5 (continued) 3. a. The overhead applied to each product can be determined as follows:

The Deluxe Model Activity Cost Pool

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

Purchasing................................. $340 per PO 200 POs Processing ................................. $5.20 per MH 20,000 MHs Scrap/rework ............................. $189.50 per order 1,000 tests Shipping .................................... $150 per shipment 250 shipments Total overhead cost (a) .............. Number of units produced (b) ..... Overhead cost per unit (a) ÷ (b) .

$ 68,000 104,000 189,500 37,500 $399,000 5,000 $79.80

The Regular Model Activity Cost Pool

Purchasing................................. $340 per PO 400 POs Processing ................................. $5.20 per MH 15,000 MHs Scrap/rework ............................. $189.50 per order 1,000 orders Shipping .................................... $150 per shipment 650 shipments Total overhead cost (a) .............. Number of units produced (b) ..... Overhead cost per unit (a) ÷ (b) .

Managerial Accounting, 16th Edition

$136,000 78,000 189,500 97,500 $501,000 40,000 $12.53

Problem 2A-5 (continued) b. Using activity-based absorption costing, the unit product cost of each model would be: Direct materials .......................... Direct labor ................................ Manufacturing overhead (above) . Total unit product cost................

Deluxe

$ 40.00 38.00 79.80 $157.80

Regular

$25.00 19.00 12.53 $56.53

4. Unit costs appear to be distorted as a result of using direct labor-hours as the base for assigning overhead cost to products. Although the deluxe model requires twice as much labor time as the regular model, it still is not being assigned enough overhead cost, as shown in the analysis in part 3(a). When the company’s overhead costs are analyzed on an activities basis, it appears that the deluxe model is more expensive to manufacture than the company realizes. Note that the deluxe model accounts for a majority of the machine-hours worked, even though it accounts for only 20% (= 10,000 DLHs ÷ 50,000 DLHs) of the company’s direct labor-hours. Also, it requires just as many scrap/rework orders as the regular model, and scrap/rework orders are very costly to the company. When activity-based absorption costing is used and the company’s transactions are analyzed by product, the overhead cost increases for the deluxe model from $36.00 per unit to $79.80 per unit. This suggests that less than half the overhead cost is being assigned to the deluxe model that ought to be assigned, and unit costs for the deluxe model are understated. If these costs are being used as a basis for pricing, then the selling price for the deluxe model may be too low. This may be the reason why profits have been steadily declining over the last several years. It may also be the reason why sales of the deluxe model have been increasing rapidly.

Case 2A-6 (90 minutes) 1. a. The predetermined overhead rate would be computed as follows:

Expected manufacturing overhead cost $2,200,000 = Estimated direct labor-hours 50,000 DLHs = $44 per DLH b. The unit product cost per pound, using the company’s present costing system, would be:

Direct materials (given) ......... Direct labor (given) ............... Manufacturing overhead: 0.02 DLH × $44 per DLH..... Total unit product cost...........

Kenya Dark

Viet Select

0.88 $5.72

0.88 $4.12

$4.50 0.34

$2.90 0.34

2. a. Overhead rates for each activity cost pool:

Activity Cost Pools

(a) Estimated Overhead Costs

(b) Expected Activity

Purchasing ........... $560,000 2,000 orders Material handling .. $193,000 1,000 setups Quality control ...... $90,000 500 batches Roasting............... $1,045,000 95,000 hours Blending............... $192,000 32,000 hours Packaging ............ $120,000 24,000 hours

(a) ÷ (b) Activity Rate

$280 per order $193 per setup $180 per batch $11 per hour $6 per hour $5 per hour

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Case 2A-6 (continued) Before we can determine the amount of overhead cost to assign to the products we must first determine the activity for each of the products in the six activity centers. The necessary computations follow: Number of purchase orders: Kenya Dark: 80,000 pounds ÷ 20,000 pounds per order = 4 orders Viet Select: 4,000 pounds ÷ 500 pounds per order = 8 orders Number of setups: Kenya Dark: (80,000 pounds ÷ 5,000 pounds per batch) × 2 setups per batch = 32 setups Viet Select: (4,000 pounds ÷ 500 pounds per batch) × 2 setups per batch = 16 setups Number of batches: Kenya Dark: 80,000 pounds ÷ 5,000 pounds per batch = 16 batches Viet Select: 4,000 pounds ÷ 500 pounds per batch = 8 batches Roasting hours: Kenya Dark: 1.5 hours × (80,000 pounds ÷ 100 pounds) = 1,200 hours Viet Select: 1.5 hours × (4,000 pounds ÷ 100 pounds) = 60 hours Blending hours: Kenya Dark: 0.5 hour × (80,000 pounds ÷ 100 pounds) = 400 hours Viet Select: 0.5 hour × (4,000 pounds ÷ 100 pounds) = 20 hours Packaging hours: Kenya Dark: 0.3 hour × (80,000 pounds ÷ 100 pounds) = 240 hours Viet Select: 0.3 hour × (4,000 pounds ÷ 100 pounds) = 12 hours

Case 2A-6 (continued) The overhead applied to each product can be determined as follows:

Kenya Dark Activity Cost Pool

Purchasing ............... Material handling ...... Quality control .......... Roasting ................... Blending ................... Packaging................. Total ........................

Viet Select Activity Cost Pool

Purchasing ............... Material handling ...... Quality control .......... Roasting ................... Blending ................... Packaging................. Total ........................

Activity Rate

Expected Activity

Amount

Activity Rate

Expected Activity

Amount

$280 per order 4 orders $193 per setup 32 setups $180 per batch 16 batches $11 per roasting hour 1,200 roasting hours $6 per blending hour 400 blending hours $5 per packaging hour 240 packaging hours

$280 per order $193 per setup $180 per batch $11 per roasting hour $6 per blending hour $5 per packaging hour

8 orders 16 setups 8 batches 60 roasting hours 20 blending hours 12 packaging hours

Managerial Accounting, 16th Edition

$ 1,120 6,176 2,880 13,200 2,400 1,200 $26,976

$2,240 3,088 1,440 660 120 60 $7,608

Case 2A-6 (continued) b. According to the activity-based absorption costing system, the manufacturing overhead cost per pound is:

Total overhead cost assigned (above) (a) ... Number of pounds manufactured (b) .......... Cost per pound (a) ÷ (b) ...........................

Kenya Dark

$26,976 80,000 $0.34

Viet Select

$7,608 4,000 $1.90

c. The unit product costs according to the activity-based absorption costing system are: Direct materials (given) ............ Direct labor (given) .................. Manufacturing overhead ........... Total unit product cost..............

Kenya Dark

$4.50 0.34 0.34 $5.18

Viet Select

$2.90 0.34 1.90 $5.14

3. MEMO TO THE PRESIDENT: Analysis of JSI’s data shows that several activities other than direct labor drive the company’s manufacturing overhead costs. These activities include purchase orders issued, number of setups for material processing, and number of batches processed. The company’s present costing system, which relies on direct labor time as the sole basis for assigning overhead cost to products, significantly undercosts low-volume products, such as the Viet Select coffee, and significantly overcosts high-volume products, such as our Kenya Dark coffee. An implication of the activity-based approach is that our low-volume products may not be covering the costs of the manufacturing resources they use. For example, Viet Select coffee is currently priced at $5.15 per pound ($4.12 plus 25% markup), which is only one cent higher than its activity-based cost of $5.14 per pound. Under our present costing and pricing system, our high-volume products, such as our Kenya Dark coffee, may be subsidizing our low-volume products. Some adjustments in prices may be required.

Case 2A-6 (continued) ALTERNATIVE SOLUTION: Most students will compute the manufacturing overhead cost per pound of the two coffees as shown above. However, the per pound cost can also be computed as shown below. This alternative approach provides

additional insight into the data and facilitates emphasis of some points made in the chapter.

Purchasing ........... Material handling.. Quality control ..... Roasting .............. Blending .............. Packaging ............ Total ...................

Kenya Dark Per Pound Total (÷ 80,000)

$ 1,120 6,176 2,880 13,200 2,400 1,200 $26,976

$0.014 0.077 0.036 0.165 0.030 0.015 $0.337

Viet Select Per Pound Total (÷ 4,000)

$2,240 3,088 1,440 660 120 60 $7,608

$0.560 0.772 0.360 0.165 0.030 0.015 $1.902

Note particularly how batch size impacts unit cost data. For example, the cost to the company to process a purchase order is $280, regardless of how many pounds of coffee are contained in the order. Twenty thousand pounds of the Kenya Dark coffee are purchased per order (with four orders per year), and just 500 pounds of the Viet Select coffee are purchased per order (with eight orders per year). Thus, the purchase order cost per pound for the Kenya Dark coffee is just 1.4 cents, whereas the purchase order cost per pound for the Viet Select coffee is 40 times as much, or 56 cents. As stated in the text, this is one reason why unit costs of low-volume products, such as the Viet Select coffee, increase so dramatically when activity-based costing is used.

Managerial Accounting, 16th Edition

Appendix 2B The Predetermined Overhead Rate and Capacity

Exercise 2B-1 (20 minutes) 1. There were no beginning or ending inventories, so all of the jobs were started, finished, and sold during the month. Therefore cost of goods sold equals the total manufacturing cost. We can verify that by computing the cost of goods sold as shown below: Manufacturing costs charged to jobs: Direct materials ........................................... Direct labor (all variable).............................. Manufacturing overhead applied (150 hours × $82 hour) ............................ Total manufacturing cost charged to jobs ........ Add: Beginning work in process inventory ....... Deduct: Ending work in process inventory ....... Cost of goods manufactured ........................... Beginning finished goods inventory ................. Add: Cost of goods manufactured ................... Goods available for sale .................................. Deduct: Ending finished goods inventory ......... Cost of goods sold .........................................

$ 5,350 8,860 12,300 26,510 0 26,510 0 $26,510 $

0 26,510 26,510 0 $26,510

At the end of the month, the cost of unused capacity is computed as shown below: Amount of the allocation base at capacity (a) . Actual amount of the allocation base (b) ........ Unused capacity in hours (a) – (b) .................

180 hours 150 hours 30 hours

Unused capacity in hours (a) ......................... Predetermined overhead rate (b) ................... Cost of unused capacity (a) × (b) ..................

30 hours $82 per hour $2,460

Exercise 2B-1 (continued) Consequently, the income statement, prepared for internal management purposes, would appear as follows: Wixis Cabinets Income Statement Sales .................................................... Cost of goods sold (see above) .............. Gross margin ........................................ Other expenses: Cost of unused capacity ...................... Selling and administrative expenses .... Net operating income ............................

$43,740 26,510 17,230 $2,460 8,180

10,640 $ 6,590

2. When the predetermined overhead rate is based on capacity, unused capacity costs ordinarily arise because manufacturing overhead usually contains significant amounts of fixed costs. Suppose, for example, that manufacturing overhead includes $10,000 of fixed costs and the capacity is 100 hours. Then the portion of the predetermined overhead rate that represents fixed costs is $10,000 divided by 100 hours or $100 per hour. Because the plant is seldom (if ever) operated beyond capacity, less than $10,000 will ordinarily be applied to jobs. In other words, $100 per hour multiplied by something less than 100 hours always yields less than $10,000. Therefore, unused capacity costs will arise.

Managerial Accounting, 16th Edition

Exercise 2B-2 (30 minutes) 1. The overhead applied to Mrs. Brinksi’s account would be computed as follows:

Last Year This Year

Estimated overhead cost (a) ............................. $310,500 $310,500 Estimated professional staff hours (b) ............... 4,600 4,500 Predetermined overhead rate (a) ÷ (b) ............. $67.50 $69.00 Professional staff hours charged to Ms. Brinksi’s account......................................................... × 2.5 × 2.5 Overhead applied to Ms. Brinksi’s account ......... $168.75 $172.50 2. If the actual overhead cost and the actual professional hours charged turn out to be exactly as estimated there would be no cost of unused capacity.

Last Year This Year

Predetermined overhead rate (see above) ......... $67.50 $69.00 Actual professional staff hours charged to clients’ accounts (by assumption) ...................... × 4,600 × 4,500 Overhead applied ............................................. $310,500 $310,500 Actual overhead cost incurred (by assumption) .. 310,500 310,500 Cost of unused capacity.................................... $ 0 $ 0 3. If the predetermined overhead rate is based on the professional staff hours available, the computations would be:

Last Year This Year

Estimated overhead cost (a)............................... $310,500 $310,500 Professional staff hours available (b) .................. 6,000 6,000 Predetermined overhead rate (a) ÷ (b) ............... $51.75 $51.75 Professional staff hours charged to Ms. Brinksi’s account .......................................................... × 2.5 × 2.5 Overhead applied to Ms. Brinksi’s account ........... $129.38 $129.38

Exercise 2B-2 (continued) 4. If the actual overhead cost and the actual professional staff hours charged to clients’ accounts turn out to be exactly as estimated, the cost of unused capacity would be calculated as shown below. Amount of the allocation base at capacity (a) ...... Actual amount of the allocation base (b) ............. Unused capacity in hours (a) – (b)...................... Unused capacity in hours (a) .............................. Predetermined overhead rate (b) ........................ Cost of unused capacity (a) × (b) .......................

Last Year This Year 6,000 4,600 1,400

6,000 4,500 1,500

1,400 $51.75 $72,450

1,500 $51.75 $77,625

Proponents of this method of computing predetermined overhead rates suggest that the cost of unused capacity should be treated as a period expense that is disclosed separately on the income statement.

Managerial Accounting, 16th Edition

Problem 2B-3 (60 minutes) 1. The overhead applied to the Verde Baja job is computed as follows:

Estimated studio overhead cost (a) ................. Estimated hours of studio service (b) .............. Predetermined overhead rate (a) ÷ (b) ........... Verde Baja job’s studio hours ......................... Overhead applied to the Verde Baja job .........

Last Year

This Year

$160,000 $160,000 1,000 800 $160 $200 × 40 × 40 $6,400 $8,000

2. If the predetermined overhead rate is based on the hours of studio service at capacity, the computations would be: Estimated studio overhead cost at capacity (a) Hours of studio service at capacity (b) ............. Predetermined overhead rate (a) ÷ (b) ........... Verde Baja job’s studio hours ......................... Overhead applied to the Verde Baja job .........

Last Year This Year

$160,000 $160,000 1,600 1,600 $100 $100 × 40 × 40 $4,000 $4,000

3. The cost of unused capacity for both years is computed as follows: Amount of the allocation base at capacity (a) ...... Actual amount of the allocation base (b) ............. Unused capacity in hours (a) – (b)...................... Unused capacity in hours (a) .............................. Predetermined overhead rate (b) ........................ Cost of unused capacity (a) × (b) .......................

Last Year This Year 1,600 750 850

1,600 500 1,100

850 1,100 $100 $100 $85,000 $110,000

Proponents of this method suggest that the cost of unused capacity should be treated as a period expense that is disclosed separately on the income statement.

Problem 2B-3 (continued) 4. Platinum Track’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 Verde Baja job has increased between last year and this year. 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. Under this method, Platinum Track’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 Verde Baja job is stable at $4,000 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 Verde Baja 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 $4,000 is reported. It is true that the cost of unused capacity 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 unused 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 is less likely to send managers misleading signals.

Managerial Accounting, 16th Edition

Case 2B-4 (120 minutes) 1a.

Vault Hard Drives, Inc. Income Statement: Traditional Approach

Sales (150,000 units × $60 per unit)............ Cost of goods sold: Variable manufacturing (150,000 units × $15 per unit) ............... Manufacturing overhead applied (150,000 units × $25 per unit) ............... Gross margin .............................................. Selling and administrative expenses ............. Net operating income.................................. 1b.

$9,000,000 $2,250,000 3,750,000

6,000,000 3,000,000 2,700,000 $ 300,000

Vault Hard Drives, Inc. Income Statement: New Approach

Sales (150,000 units × $60 per unit) ................... $9,000,000 Cost of goods sold: Variable manufacturing (150,000 units × $15 per unit) ....................... $2,250,000 Manufacturing overhead applied (150,000 units × $20 per unit) ....................... 3,000,000 5,250,000 Gross margin ..................................................... 3,750,000 Other expenses: Cost of unused capacity [(200,000 units – 160,000 units) × $20 per unit] ....................... 800,000 Selling and administrative expenses .................. 2,700,000 Net operating income ......................................... $ 250,000

Case 2B-4 (continued) 2. Under the traditional approach, all of the company’s fixed manufacturing overhead must be included in either cost of goods sold (in the income statement) or ending inventory (in the balance sheet) at the end of an accounting period. For each additional unit produced but not sold, it enables the company to include an extra $25 of fixed overhead in ending inventory, which in turn lowers the company’s cost of goods sold by $25. Since the company has net operating income of $300,000 when it produces 160,000 units and sells 150,000 units, it needs to produce enough additional units, beyond 160,000 units, to raise net operating by $200,000 to achieve a desired profit of $500,000. The following computations show that the company would need to produce 8,000 more units (or 168,000 units in total) to achieve net operating income of $500,000. Additional net operating income required to attain target net operating income ($500,000 – $300,000) (a) ......... Fixed overhead applied to each unit of additional inventory (b) ..................................................................... Additional output required to attain target net operating income (a) ÷ (b) ........................................................ Estimated number of units produced .............................. Actual number of units to be produced ...........................

$200,000 $25 per unit 8,000 units 160,000 units 168,000 units

* The answer of 168,000 units assumes that the overapplied overhead of $200,000 is closed entirely to Cost of Goods Sold.

Managerial Accounting, 16th Edition

Case 2B-4 (continued) 3.

Under the new approach, all of the company’s fixed manufacturing overhead must be included in either cost of goods sold (in the income statement), ending inventory (in the balance sheet), or cost of unused capacity (in the income statement) at the end of an accounting period. For each additional unit produced but not sold, it enables the company to include an extra $20 of fixed overhead in ending inventory, which in turn lowers the company’s cost of unused capacity by $20. Since the company has net operating income of $250,000 when it produces 160,000 units and sells 150,000 units, it needs to produce enough additional units, beyond 160,000 units, to raise net operating by $250,000 to achieve a desired profit of $500,000. The computations below show that the company would need to produce 12,500 more units (or 172,500 units in total) to achieve net operating income of $500,000.

Additional net operating income required to attain target net operating income ($500,000 – $250,000) (a) ........... Fixed overhead applied to each unit of additional inventory (b) ....................................................................... Additional output required to attain target net operating income (a) ÷ (b).......................................................... Estimated number of units produced ............................... Actual number of units to be produced ............................

$250,000 $20 per unit 12,500 units 160,000 units 172,500 units

4. Net 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.

Case 2B-4 (continued) 5. The “hat trick” is a bit harder to perform under the new method. Under the old method, the target net operating income can be attained by producing an additional 8,000 units. Under the new method, the production would have to be increased by 12,500 units. Again, this is a consequence of the difference in predetermined overhead rates. The drop in sales has had a more dramatic effect on net operating income under the new method as noted above in part (4). In addition, because the predetermined overhead rate is lower under the new method, producing excess inventories has less of an effect per unit on net operating income than under the traditional method and hence more excess production is required. 6. 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 net operating income and are not misled, it can be argued that the hat trick is not unethical. 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 net operating income for the period? And 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 this 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 net 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.

Managerial Accounting, 16th Edition

Chapter 3 Job-Order Costing: Cost Flows and External Reporting Questions 3-1 The link that connects these two schedules is the cost of goods manufactured. It is calculated within a schedule of cost of goods manufactured and then it plugs into the schedule of cost of goods sold to enable calculating the cost of goods available for sale. 3-2 The Manufacturing Overhead clearing account is credited when overhead cost is applied to Work in Process. The applied overhead cost for the period will probably not equal the actual overhead cost because overhead application relies on a predetermined overhead rate that is based on estimates made at the beginning of the period. 3-3 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 or overapplied overhead is disposed of by either closing out the amount to Cost of Goods Sold or by allocating the amount among Cost of Goods Sold and ending Work in Process and Finished Goods inventories in proportion to the applied overhead in each account. The adjustment for underapplied overhead increases Cost of Goods Sold (and the two inventories) whereas the adjustment for overapplied overhead decreases Cost of Goods Sold (and the two inventories). 3-4 Manufacturing overhead may be underapplied for several reasons. Control over overhead spending may be poor. Or, some of the overhead may be fixed and the actual amount of the allocation base may be 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. 3-5 Underapplied overhead implies that not enough overhead was assigned to jobs during the period. Thus, cost of goods sold is understated so we add underapplied overhead to cost of goods sold. On the other hand, overapplied overhead is deducted from cost of goods sold. 3-6 The raw materials used in production is calculated by taking the beginning raw materials inventory plus raw material purchases to derive the raw materials available. From this amount, subtract the ending raw materials inventory to derive the raw materials used in production. 3-7 The total manufacturing costs includes the raw materials used production (less any indirect materials used in production), the direct labor cost added to production, and the manufacturing overhead applied to production. 3-8 The total manufacturing costs added to production (which includes the raw materials used production, the direct labor cost added to production, and the manufacturing overhead applied to production) plus the beginning work in process inventory minus the ending work in process inventory equals the cost of goods manufactured. 3-9 Beginning finished goods inventory plus the cost of goods manufactured equals the cost of goods available for sale. From this amount, subtract the ending finished goods inventory to derive the unadjusted cost of goods sold. 3-10 Direct labor costs are added to Work in Process as goods are being manufactured. Once goods are completed, their manufacturing costs

(including direct labor) are transferred to Finished Goods. Once goods are sold to customers their manufacturing costs (including direct labor) are transferred to Cost of Goods Sold.

Managerial Accounting, 15th edition

Chapter 3: Applying Excel The completed worksheet is shown below.

Chapter 3: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

[Note: To display formulas in cells instead of their calculated amounts, consult Excel Help.]

Managerial Accounting, 16th Edition

Chapter 3: Applying Excel (continued) 1. When the estimated total amount of the allocation base is changed to 60,000 machine-hours, the worksheet changes as show below:

The predetermined overhead rate has increased from $4.00 per machine-hour to $5.00 per machine-hour because the estimated total amount of the allocation base has decreased from 75,000 machinehours to 60,000 machine-hours. The same amount of estimated overhead cost is spread across fewer machine-hours.

Chapter 3: Applying Excel (continued) 2. With all of the changes in the data, the worksheet should look like the following:

Managerial Accounting, 16th Edition

Chapter 3: Applying Excel (continued) 3. When the estimated total amount of the allocation base is changed to 40,000 machine-hours, the worksheet looks like the following:

The manufacturing overhead is now overapplied by $10,000 rather than underapplied by $10,000 as it was when the estimated total amount of the allocation base was 10,000 machine-hours higher. This occurred because the predetermined overhead rate was $2.00 per machine-hour when the estimated total amount of the allocation base was 50,000 machine-hours and is now $2.50 per machine-hour as a consequence of the reduction in the estimated total amount of the allocation base to 40,000 machine-hours. Because the predetermined overhead rate is now larger and everything else is the same, more overhead was applied. In this case, the result is a switch from underapplied to overapplied overhead.

Chapter 3: Applying Excel (continued) 4. When the estimated total amount of the allocation base is changed to back to 50,000 machine-hours and the actual manufacturing overhead cost is changed to $100,000, the worksheet looks like the following:

In part 2 above, manufacturing overhead was underapplied by $10,000. Manufacturing overhead is now underapplied by $20,000. This occurred because the actual manufacturing overhead cost increased by $10,000— from $90,000 to $100,000. Thus, the amount of the underapplied overhead also increased by $10,000.

Managerial Accounting, 16th Edition

The Foundational 15 1. The journal entry to record raw materials used in production is: Work in Process ............... 480,000 Raw Materials ......... 480,000 2. The ending balance in Raw Materials is: Beg. Bal. (a) End. Bal.

Raw Materials 40,000 510,000 (b) 70,000

480,000

3. The journal entry to record the labor costs is: Work in Process .............................. 600,000 Manufacturing Overhead ................. 150,000 Selling and administrative salaries .... 240,000 Wages Payable ....................... 990,000 4. The total manufacturing overhead applied to production is computed as follows: Actual direct labor-hours (a) ............................ Predetermined overhead rate (b) ..................... Manufacturing overhead applied (a) × (b) ........

41,000 $16.25 $666,250

5. The total manufacturing cost added to work in process is: Raw materials used in production................... Direct labor................................................... Manufacturing overhead applied .................... Total manufacturing cost ...............................

$ 480,000 600,000 666,250 $1,746,250

The Foundational 15 (continued) 6. The journal entry is recorded as follows: Finished Goods ................ 1,680,000 Work in Process ...... 1,680,000 7. The ending balance in Work in Process is computed as follows:

Beg. Bal. (b) (c) (f) End. Bal.

Work in Process 18,000 480,000 600,000 666,250 (g) 84,250

1,680,000

8. The total actual manufacturing overhead cost is as follows: Indirect labor .............................................. Depreciation, insurance, utilities, etc............. Total actual manufacturing overhead cost .....

$150,000 500,000 $650,000

9. The overapplied overhead is computed as follows: Actual manufacturing overhead cost (a) ........... Manufacturing overhead applied (b) ................ Overapplied overhead (a) ‒ (b) .......................

$650,000 $666,250 $(16,250)

10. The cost of goods available for sale is computed as follows: Beginning finished goods inventory ................ Add: Cost of goods manufactured .................. Cost of goods available for sale ......................

$ 35,000 1,680,000 $1,715,000

11. The journal entry is recorded as follows: Cost of Goods Sold .................. Finished Goods .....................

1,690,000

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 12. The ending balance in Finished Goods is: Beg. Bal. (g) End. Bal.

Finished Goods 35,000 1,680,000 (h) 25,000

1,690,000

13. The adjusted cost of goods sold is computed as follows: Beginning finished goods inventory ................. $ 35,000 Cost of goods manufactured .......................... 1,680,000 Cost of goods available for sale ...................... 1,715,000 Ending finished goods inventory..................... 25,000 Unadjusted cost of goods sold ....................... 1,690,000 Overapplied overhead ................................... (16,250) Adjusted cost of goods sold ........................... $1,673,750 14. and 15. The gross margin and net operating income are computed as follows: Sales ........................................................ Cost of goods sold ..................................... Gross margin ............................................ Selling and administrative expenses ($240,000 + $367,000) ........................... Net operating income ................................

$2,800,000 1,673,750 1,126,250 607,000 $ 519,250

Note: The selling and administrative expenses ($607,000) include selling and administrative salaries ($240,000) and various other selling and administrative expenses ($367,000).

Exercise 3-1 (10 minutes) a. Raw Materials ......................... Accounts Payable ...............

80,000

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

62,000 9,000

c. Work in Process ...................... Manufacturing Overhead ......... Cash .................................

101,000 11,000

d. Manufacturing Overhead ......... Accumulated Depreciation ..

175,000

80,000

71,000

112,000 175,000

Managerial Accounting, 16th Edition

Exercise 3-2 (20 minutes) Requirement 1 Cash (a) (c) (d) (b) (c) (e) Bal.

94,000 132,000 143,000

Work in Process 78,000 (f) 342,000 112,000 152,000 0

Manufacturing Overhead (b) 11,000 (e) 152,000 (c) 20,000 (h) 22,000 (d) 143,000 Bal. 0

(a) Bal.

Raw Materials 94,000 (b) 5,000

(f) Bal.

Finished Goods 342,000 (g) 342,000 0

(g) (h) Bal.

Cost of Goods Sold 342,000 22,000 364,000

89,000

Requirement 2: The adjusted cost of goods sold is shown above as the ending balance in the Cost of Goods Sold T-account ($364,000).

Exercise 3-3 (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 labor ................................................... 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 ................. $ 35,000 Add: Cost of goods manufactured ................... 155,000 Cost of goods available for sale ...................... 190,000 Deduct: Ending finished goods inventory ......... 42,000 Unadjusted cost of goods sold ........................ 148,000 Add: Underapplied overhead .......................... 4,000 Adjusted cost of goods sold ............................ $152,000

Managerial Accounting, 16th Edition

Exercise 3-4 (10 minutes) 1. Manufacturing overhead incurred (a).......

$215,000

Actual direct labor-hours......................... × Predetermined overhead rate .............. = Manufacturing overhead applied (b) ....

11,500 $18.20 $209,300

Manufacturing overhead underapplied (a) – (b) .............................................

$5,700

2. Because manufacturing overhead is underapplied, the journal entry would increase cost of goods sold by $5,700 and the gross margin would decrease by $5,700.

Exercise 3-5 (30 minutes) 1. a. Raw Materials .......................................... Accounts Payable ..................................

210,000

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

178,000 12,000

c. Work in Process ....................................... Manufacturing Overhead .......................... Salaries and Wages Payable...................

90,000 110,000

d. Manufacturing Overhead .......................... Accumulated Depreciation .....................

40,000

e. Manufacturing Overhead .......................... Accounts Payable ..................................

70,000

Work in Process ....................................... Manufacturing Overhead ....................... 30,000 MH × $8 per MH = $240,000.

240,000

g. Finished Goods ........................................ Work in Process ....................................

520,000

h. Cost of Goods Sold .................................. Finished Goods .....................................

480,000

Accounts Receivable ................................ Sales .................................................... $480,000 × 1.25 = $600,000.

600,000

2. (b) (c) (d) (e)

Manufacturing Overhead 12,000 (f) 240,000 110,000 40,000 70,000 8,000 (Overapplied overhead)

Bal. (b) (c) (f) Bal.

210,000

190,000

200,000 40,000 70,000 240,000

520,000 480,000 600,000

Work in Process 42,000 (g) 520,000 178,000 90,000 240,000 30,000

Managerial Accounting, 16th Edition

Exercise 3-6 (30 minutes) 1. Mason Company’s schedule of cost of goods manufactured is as follows: 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 ................... Direct labor ...................................................... Manufacturing overhead applied to work in process .............................................................. Total manufacturing costs ................................. Add: Beginning work in process inventory ..........

$ 7,000 118,000 125,000 15,000

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

$110,000 70,000 90,000 270,000 10,000 280,000 5,000 $275,000

2. Mason Company’s schedule of cost of goods sold is as follows: 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.................... Deduct: Overapplied overhead* ................. Adjusted cost of goods sold .......................

$ 20,000 275,000 295,000 35,000 260,000 10,000 $250,000

* Actual manufacturing overhead cost of $80,000 ‒ Manufacturing overhead applied of $90,000 = Overapplied overhead of $10,000.

Exercise 3-6 (continued) 3.

Mason Company Income Statement Sales .............................................................. $524,000 Cost of goods sold ($260,000 – $10,000).......... 250,000 Gross margin .................................................. 274,000 Selling and administrative expenses: Selling expenses ......................................... $140,000 Administrative expense ............................... 63,000 203,000 Net operating income ...................................... $ 71,000

Managerial Accounting, 16th Edition

Exercise 3-7 (15 minutes) 1. Actual manufacturing overhead costs (a) ... Manufacturing overhead cost applied: 19,400 MH × $25 per MH (b) ................. Overapplied overhead cost (a) ‒ (b) .......... 2. 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 ........................... Direct labor.............................................. Manufacturing overhead applied to work in process ................................................. Total manufacturing costs......................... Add: Beginning work in process inventory . Deduct: Ending work in process inventory . Cost of goods manufactured .....................

$473,000 485,000 $(12,000) $ 20,000 400,000 420,000 30,000 390,000 15,000 $375,000 60,000 485,000 920,000 40,000 960,000 70,000 $890,000

Exercise 3-8 (15 minutes) 1. Item (a): Item (b): Item (c): Item (d):

Actual manufacturing overhead costs incurred for the year. Overhead cost applied to Work in Process for the year. Cost of goods manufactured for the year. Cost of goods sold for the year.

2. The journal entry to close the balance in the Manufacturing Overhead account to Cost of Goods Sold is: Cost of Goods Sold .......................................... Manufacturing Overhead ............................

70,000

3. The underapplied overhead is allocated to Work in Process, Finished Goods, and Cost of Goods Sold based on the percentage of total overhead applied during the year that resides in each account as of the end of the year: Work in Process ........... Finished Goods ............. Cost of Goods Sold ....... Total cost.....................

$ 19,500 58,500 312,000 $390,000

5% 15 80 100 %

Using these percentages, the journal entry would be as follows: Work in Process (5% × $70,000) ................. Finished Goods (15% × $70,000)................. Cost of Goods Sold (80% × $70,000) ........... Manufacturing Overhead ........................

3,500 10,500 56,000

70,000

Managerial Accounting, 16th Edition

Exercise 3-9 (30 minutes) 1. The overhead applied to work in process is computed as follows: Machine-hours worked (a) ............................... Predetermined overhead rate (b) ..................... Overhead applied to work in process (a) × (b) ..

75,000 $2.40 per MH $180,000

This amount is shown in entry (a) below: Manufacturing Overhead (Maintenance) 21,000 (a) (Indirect materials) 8,000 (Indirect labor) 60,000 (Utilities) 32,000 (Insurance) 7,000 (Depreciation) 56,000 Balance 4,000

180,000

Work in Process (Direct materials) 710,000 (Direct labor) 90,000 (Overhead) (a) 180,000 2. Overhead is underapplied by $4,000 for the year, as shown in the Manufacturing Overhead account above. The entry to close out this balance to Cost of Goods Sold would be: Cost of Goods Sold ...................................... Manufacturing Overhead.........................

4,000

Exercise 3-9 (continued) 3. When overhead is applied using a predetermined rate based on machine-hours, it is assumed that overhead cost is proportional to machine-hours. When the actual machine-hours turn out to be 75,000, the costing system assumes that the overhead will be 75,000 machine-hours × $2.40 per machine-hour, or $180,000. This is a drop of $12,000 from the initial estimated manufacturing overhead cost of $192,000. However, the actual manufacturing overhead cost did not drop by this much. The actual manufacturing overhead cost was $184,000—a drop of $8,000 from the estimate. The manufacturing overhead did not decline by the full $12,000 because of the existence of fixed costs and/or because overhead spending was not under control. These issues will be covered in more detail in later chapters.

Managerial Accounting, 16th Edition

Exercise 3-10 (30 minutes) 1. a. Raw Materials ......................................... Accounts Payable ..............................

325,000

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

232,000 58,000

c. Work in Process ...................................... Manufacturing Overhead ......................... Wages and Salaries Payable ...............

60,000 120,000

d. Manufacturing Overhead ......................... Accumulated Depreciation ..................

75,000

e. Manufacturing Overhead ......................... Accounts Payable ..............................

62,000

f. Work in Process ...................................... Manufacturing Overhead ....................

300,000

325,000

290,000

180,000 75,000 62,000 300,000

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

$4,800,000 = $20 per MH 240,000 MHs

15,000 MH × $20 per MH = $300,000 2.

(b) (c) (d) (e)

Manufacturing Overhead 58,000 (f) 300,000 120,000 75,000 62,000

(b) (c) (f)

Work in Process 232,000 60,000 300,000

3. The cost of the completed job is $592,000 as shown in the Work in Process T-account in requirement 2. The journal entry is: Finished Goods................................. Work in Process ..........................

592,000

Exercise 3-10 (continued) 4. The unit product cost for this job would be: $592,000 ÷ 16,000 units = $37 per unit So, the portion of this job’s costs that would be included in February’s cost of goods sold is: 10,000 units × $37 per unit = $370,000

Managerial Accounting, 16th Edition

Problem 3-11 (45 minutes) 1. The cost of raw materials used in production was: Beginning raw materials inventory ......... Add: Purchases of materials (debits) ..... Total raw materials available ................. Deduct: Ending raw materials inventory. Raw materials used in production ..........

$ 15,000 120,000 135,000 25,000 $110,000

2. Of the $110,000 in materials requisitioned for production, $90,000 was debited to Work in Process as direct materials. Therefore, the difference of $20,000 was debited to Manufacturing Overhead as indirect materials. 3. Total factory wages accrued during the year (credits to the Factory Wages Payable account) ............................ Less direct labor cost (from Work in Process) ................... Indirect labor cost ..........................................................

$180,000 150,000 $ 30,000

4. The cost of goods manufactured was $470,000—the credits to the Work in Process account. 5. The Cost of Goods Sold for the year was: Beginning finished goods inventory ................................... $ 40,000 Add: Cost of goods manufactured (from Work in Process) .. 470,000 Cost of goods available for sale ......................................... 510,000 Deduct: Ending finished goods inventory ........................... 60,000 Cost of goods sold ............................................................ $450,000 6. The predetermined overhead rate was:

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

$240,000 = 160% of direct labor cost $150,000 direct labor cost

Problem 3-11 (continued) 7. Manufacturing overhead was overapplied by $10,000, computed as follows: Actual manufacturing overhead cost for the year (debits to Manufacturing Overhead) ......................................... $230,000 Manufacturing overhead applied (debits to Work in Process) ........................................................................... 240,000 Overapplied overhead ..................................................... $(10,000) 8. The ending balance in Work in Process is $30,000. Direct materials make up $9,200 of this balance, and applied overhead makes up $12,800. The computations are: Balance, Work in Process, 12/31 (a) ................... Less: Direct labor cost (given) ............................ Applied overhead cost ($8,000 × 160%) .... Total conversion cost (b) ........................... Direct materials cost (a) – (b) ............................

8,000 12,800

$30,000 20.800 $ 9,200

Managerial Accounting, 16th Edition

Problem 3-12 (30 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) .........

$900,000 75,000 hours $12.00 per hour

Actual manufacturing overhead cost ....................... Manufacturing overhead applied to Work in Process during the year: 60,000 actual MHs × $12 per MH .............................................................. Underapplied overhead cost................................... 2. Cost of Goods Sold ................................... Manufacturing Overhead .....................

130,000

$850,000 720,000 $130,000 130,000

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

$ 36,000 5% 180,000 25 % 504,000 70 % $720,000 100 %

The entry to record the allocation of the underapplied overhead would be: Work in Process (5% × $130,000) ........... Finished Goods (25% × $130,000) ........... Cost of Goods Sold (70% × $130,000) ..... Manufacturing Overhead .................

6,500 32,500 91,000

130,000

Problem 3-12 (continued) 4. Comparing the two methods: Cost of goods sold if the underapplied overhead is closed to cost of goods sold ($1,400,000 + $130,000) .......................................................... Cost of goods sold if the underapplied overhead is closed to Work in Process, Finished Goods, and Cost of Goods Sold ($1,400,000 + $91,000)......... Difference in cost of goods sold .............................

$1,530,000 1,491,000 $ 39,000

Thus, net operating income will be $39,000 greater if the underapplied overhead is closed to Work in Process, Finished Goods, and Cost of Goods Sold rather than being closed to Cost of Goods Sold.

Managerial Accounting, 16th Edition

Problem 3-13 (30 minutes) 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 ............... Direct labor.................................................. Manufacturing overhead applied to work in process* ................................................... Total manufacturing costs* ........................... Add: Beginning work in process inventory .....

$ 40,000 290,000 330,000 10,000

$320,000 78,000 285,000 683,000 42,000 725,000 35,000 $690,000

Deduct: Ending work in process inventory* ... Cost of goods manufactured ......................... 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*..................... Deduct: Overapplied overhead ($270,000 ‒ $285,000) ................................................. Adjusted cost of goods sold ..........................

$ 50,000 690,000 740,000 80,000 660,000 15,000 $645,000

Income statement: Sales .......................................................... Cost of goods sold ($660,000 – $15,000)...... Gross margin .............................................. Selling and administrative expenses: Selling expenses* ..................................... Administrative expense* ........................... Net operating income* ................................

$915,000 645,000 270,000 $140,000 100,000

240,000 $ 30,000

Problem 3-14 (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 = 2.

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

Before the underapplied or overapplied overhead can be computed, we must determine the amount 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 ........................ 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 ($450,000 × 160%) ................................. Underapplied overhead .......................................

$ 20,000 510,000 530,000 80,000 $450,000 $170,000 48,000 260,000 95,000 7,000 180,000 760,000 720,000 $ 40,000

Managerial Accounting, 16th Edition

Problem 3-14 (continued) 3.

Gitano Products 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 Raw materials used in production .................... $ 450,000 Direct labor .................................................... 90,000 Manufacturing overhead applied to work in process ........................................................ 720,000 Total manufacturing costs ............................... 1,260,000 Add: Beginning work in process inventory ........ 150,000 1,410,000 Deduct: Ending work in process inventory ........ 70,000 Cost of goods manufactured ............................ $1,340,000

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 ...........................

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

The underapplied overhead can either be closed out to Cost of Goods Sold or allocated between Work in Process, Finished Goods, and Cost of Goods Sold based on the overhead applied during the year in the ending balance in each of these accounts.

Problem 3-14 (continued) 5. The amount of overhead cost in Work in Process was: $24,000 direct materials cost × 160% = $38,400 The amount of direct labor cost in Work in Process is: Total ending work in process .............. Deduct: Direct materials .................... Manufacturing overhead........ Direct labor cost .................................

$24,000 38,400

$70,000 62,400 $ 7,600

The completed schedule of costs in Work in Process was: Direct materials .................................. Direct labor ........................................ Manufacturing overhead ..................... Work in process inventory...................

$24,000 7,600 38,400 $70,000

Managerial Accounting, 16th Edition

Problem 3-15 (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 .................... Salaries Expense ............................... Salaries and Wages Payable ..........

230,000 90,000 110,000

e. Manufacturing Overhead .................... Accounts Payable .........................

54,000

f. 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

i. Work in Process................................. Manufacturing Overhead...............

390,000

200,000 185,000

70,000

430,000 54,000 136,000

95,000

120,000 390,000

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

$360,000 = $400 per DLH 900 DLHs

975 actual DLH × $400 per DLH = $390,000

Problem 3-15 (continued) j. Finished Goods .................................. Work in Process ............................

770,000

k. Accounts Receivable........................... Sales ............................................ Cost of Goods Sold ............................. Finished Goods .............................

1,200,000 800,000

770,000 1,200,000 800,000

Managerial Accounting, 16th Edition

Problem 3-15 (continued) 2.

Accounts Receivable 1,200,000

(k) Bal. (a) Bal.

Raw Materials 30,000 185,000 200,000 (b) 45,000

Bal. (b) (d) (i) Bal.

Work in Process 21,000 (j) 770,000 185,000 230,000 390,000 56,000

Bal. (j) Bal.

Finished Goods 60,000 (k) 800,000 770,000 30,000

Accumulated Depreciation (g) 95,000 Accounts Payable (a) 200,000 (c) 70,000 (e) 54,000 (f) 136,000 (h) 120,000 Salaries & Wages Payable (d) 430,000

Sales (k)

Cost of Goods Sold 800,000

(k)

1,200,000

Manufacturing Overhead 63,000 (i) 390,000 90,000 54,000 76,000 102,000 Bal. 5,000

(f)

Advertising Expense 136,000

(c)

Utilities Expense 7,000

(d)

Salaries Expense 110,000

(g)

Depreciation Expense 19,000

(h)

Rent Expense 18,000

Problem 3-15 (continued) 3.

Froya Fabrikker A/S Schedule of Cost of Goods Manufactured Direct materials: Beginning raw materials inventory .......... Purchases of raw materials ..................... Total raw materials available .................. Ending raw materials inventory ............... Materials used in production ................... Direct labor .............................................. Manufacturing overhead applied to work in process ................................................. Total manufacturing costs ......................... Add: Beginning work in process inventory ..

$ 30,000 200,000 230,000 45,000

390,000 805,000 21,000 826,000 56,000 $770,000

Deduct: Ending work in process inventory.. Cost of goods manufactured ..................... 4. Manufacturing Overhead ........................... Cost of Goods Sold .............................. 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 ................ Deduct: Overapplied overhead................ Adjusted cost of goods sold ....................

$185,000 230,000

5,000

5,000 $ 60,000 770,000 830,000 30,000 800,000 5,000 $795,000

Managerial Accounting, 16th Edition

Problem 3-15 (continued) 5.

Froya Fabrikker A/S Income Statement Sales ..................................................... Cost of goods sold.................................. Gross margin ......................................... Selling and administrative expenses: Advertising expense ............................. Utilities expense .................................. Salaries expense .................................. Depreciation expense........................... Rent expense ...................................... Net operating income .............................

$1,200,000 795,000 405,000 $136,000 7,000 110,000 19,000 18,000

290,000 $ 115,000

Problem 3-16 (60 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 .................... Administrative Salaries Expense ............... Salaries and Wages Payable ...............

180,000 72,000 63,000 90,000

d. Manufacturing Overhead ......................... Rent Expense ......................................... Accounts Payable ..............................

13,000 5,000

e. Manufacturing Overhead ......................... Accounts Payable ..............................

57,000

f. Advertising Expense ................................ Accounts Payable ..............................

140,000

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

18,000 57,000 140,000

100,000 297,000

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

$330,000 165% of = direct labor cost $200,000 direct labor cost

$180,000 actual direct labor cost × 165% = $297,000

Managerial Accounting, 16th Edition

Problem 3-16 (continued) i. Finished Goods ....................................... Work in Process .................................

675,000

j. Cash ...................................................... Sales ................................................. Cost of Goods Sold .................................. Finished Goods ..................................

1,250,000

2. Bal. (a) Bal.

Raw Materials 25,000 (b) 280,000 275,000 20,000

Bal. (i) Bal.

Finished Goods 40,000 (j) 700,000 675,000 15,000

(j)

Cost of Goods Sold 700,000

Bal. (b) (c) (h) Bal. (b) (c) (d) (e) (g)

700,000

675,000 1,250,000 700,000

Work in Process 10,000 (i) 675,000 220,000 180,000 297,000 32,000 Manufacturing Overhead 60,000 (h) 297,000 72,000 13,000 57,000 88,000 Bal. 7,000

3. Manufacturing overhead is overapplied by $7,000 for the year. The entry to close this balance to Cost of Goods Sold would be: Manufacturing Overhead..................................... Cost of Goods Sold ........................................

7,000

Problem 3-16 (continued) 4.

Gold Nest Company Income Statement Sales ..................................................... Cost of goods sold ($700,000 - $7,000) ............................. Gross margin ......................................... Selling and administrative expenses: Sales commissions ............................... Administrative salaries expense ............ Rent expense ...................................... Advertising expense ............................. Depreciation expense ........................... Net operating income .............................

$1,250,000 693,000 557,000 $63,000 90,000 5,000 140,000 12,000

310,000 $ 247,000

Managerial Accounting, 16th Edition

Problem 3-17 (60 minutes) 1. and 2. Bal. (l) Bal.

Cash 63,000 (m) 850,000 128,000

Bal. (a) Bal.

Raw Materials 30,000 (b) 185,000 15,000

Bal. (b) (f) (i) Bal.

Videos in Process 45,000 (j) 550,000 170,000 82,000 290,000 37,000

Bal.

Studio and Equipment 730,000

(b) (c) (d) (f) (g) (n)

785,000

200,000

Studio Overhead 30,000 * (i) 290,000 72,000 63,000 110,000 5,600 Bal. 9,400 9,400

Bal. (k) Bal.

Accounts Receivable 102,000 (l) 850,000 925,000 177,000

Bal. Bal.

Prepaid Insurance 9,000 (g) 2,000

Bal. (j) Bal.

Finished Goods 81,000 (k) 600,000 550,000 31,000

7,000

Accumulated Depreciation Bal. 210,000 (d) 84,000 Bal. 294,000 (d)

Depreciation Expense 21,000

(g)

Insurance Expense 1,400

* $280,000 ÷ 7,000 hours = $40 per hour; 7,250 hours × $40 per hour = $290,000 (e)

Advertising Expense 130,000

(h)

Miscellaneous Expense 8,600

Problem 3-17 (continued) Administrative Salaries Expense (f) 95,000 (k)

Cost of Goods Sold 600,000 (n)

Bal.

590,600

9,400

Sales (k) (m)

925,000

Accounts Payable 500,000 Bal. 160,000 (a) 185,000 (c) 72,000 (e) 130,000 (h) 8,600 Bal. 55,600

Salaries & Wages Payable (m) 285,000 (f) 287,000 Bal. 2,000 Capital Stock Bal.

420,000

Retained Earnings Bal. 270,000

3. Overhead is overapplied for the year by $9,400. Entry (n) above records the closing of this overapplied overhead balance to Cost of Goods Sold.

Managerial Accounting, 16th Edition

Problem 3-17 (continued) 4.

Supreme Videos, Inc. Schedule of Cost of Goods Manufactured

Direct materials: Beginning raw materials inventory ........... Purchases of raw materials ..................... Total raw materials available ................... Ending raw materials inventory ............... Raw materials used in production ............ Deduct: Indirect materials ...................... Direct labor .............................................. Manufacturing overhead applied to work in process .................................................. Total manufacturing costs ......................... Add: Beginning videos in process inventory

$ 30,000 185,000 215,000 15,000 200,000 30,000

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

170,000 82,000 290,000 542,000 45,000 587,000 37,000 $550,000

The cost of goods manufactured from this schedule ($550,000) agrees with transaction “j.” 5.

Supreme Videos, Inc. 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 ................ Deduct: Overapplied overhead ............... Adjusted cost of goods sold....................

$ 81,000 550,000 631,000 31,000 600,000 9,400 $590,600

The unadjusted cost of goods sold ($600,000) agrees with transaction “k.”

Problem 3-17 (continued) 6.

Supreme Videos, Inc. Income Statement For the Year Ended December 31 Sales .......................................................... Cost of goods sold ($600,000 – $9,400) ....... Gross margin .............................................. Selling and administrative expenses: Depreciation expense ................................ $ 21,000 Advertising expense .................................. 130,000 Administrative salaries .............................. 95,000 Insurance expense.................................... 1,400 Miscellaneous expense .............................. 8,600 Net operating income ..................................

$925,000 590,600 334,400

256,000 $ 78,400

Managerial Accounting, 16th Edition

Case 3-18 (45 minutes) 1. Shaving 5% off the estimated direct labor-hours in the predetermined overhead rate will result in an artificially high overhead rate. The artificially high predetermined overhead rate is likely to result in overapplied overhead for the year. The cumulative effect of overapplying the overhead throughout the year is all recognized in December when the balance in the Manufacturing Overhead account is closed out to Cost of Goods Sold. If the balance were closed out every month or every quarter, this effect would be dissipated over the course of the year. 2. This question may generate lively debate. Where should Terri Ronsin’s loyalties lie? Is she working for the general manager of the division or for the corporate controller? Is there anything wrong with the “Christmas bonus”? How far should Terri go in bucking her boss on a new job? While individuals can certainly disagree about what Terri should do, some of the facts are indisputable. First, understating direct labor-hours artificially inflates the overhead rate. This has the effect of inflating the Cost of Goods Sold in all months prior to December and overstating the costs of inventories. In December, the huge adjustment for overapplied overhead provides a big boost to net operating income. Therefore, the practice results in distortions in the pattern of net operating income over the year. In addition, because all of the adjustment is taken to Cost of Goods Sold, inventories are still overstated at year-end. This means, of course, that the net operating income for the entire year is also overstated. While Terri is in an extremely difficult position, her responsibilities under the IMA’s Statement of Ethical Professional Practice seem to be clear. The Credibility Standard states that management accountants have a responsibility to “disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses or recommendations.” In our opinion, Terri should discuss this situation with her immediate supervisor in the controller’s office at corporate headquarters. This step may bring her into direct conflict with the general manager of the division, so it would be a very difficult decision for her to make.

Case 3-18 (continued) In the actual situation that this case is based on, the corporate controller’s staff were aware of the general manager’s accounting tricks, but top management of the company supported the general manager because “he comes through with the results” and could be relied on to hit the annual profit targets for his division. Personally, we would be very uncomfortable supporting a manager who will resort to deliberate distortions to achieve “results.” If the manager will pull tricks in this area, what else might he be doing that is questionable or even perhaps illegal?

Managerial Accounting, 16th Edition

Appendix 3A Job-Order Costing: A Microsoft Excel-Based Approach

Exercise 3A-1 (20 minutes) The transactions are recorded as follows:

Transaction a. b. c. d. e. f. g.

Work Raw in Finished Cash Materials Process Goods $(56,000) $56,000 $(40,000) $40,000 $35,000 $(110,000) $110,000 $(90,000) $160,000 $(18,000)

Manufacturing Overhead

= = $(35,000) = = = = =

Retained Earnings

$(90,000) $160,000 $(18,000)

Exercise 3A-2 (20 minutes) The transactions are recorded as follows:

Transaction a. b. c. d. e.

Work in Process

$115,000

Manufacturing Overhead $80,000 $28,000 $1,875 $(115,000) $5,125

Prepaid Expenses

PP&E (net)

= $(35,000) = $(2,500) = = =

Managerial Accounting, 16th Edition

Accounts Payable $80,000

Retained Earnings $(7,000) $(625) $5,125

Exercise 3A-3 (20 minutes) The transactions are recorded as follows: Transaction a. b. c. d. e. f. g. h. i. j. k.

Retained Earnings Yes No √ √ $(45,000) $(21,000) $450,000 √ √ √ √ $(220,000) √

Problem 3A-4 (45 minutes) The transactions are recorded as shown below. The ending balance sheet balances are calculated in row 20 of the spreadsheet.

2. Since Morrison Company does not pay any dividends, its net operating income for the month of January equals the change in the balance of its Retained Earnings account ($255,800 ‒ $247,000 = $8,800).

Managerial Accounting, 16th Edition

Problem 3A-5 (60 minutes) 1.

The transactions are recorded as shown below. The ending balance sheet balances are calculated in row 22 of the spreadsheet.

Problem 3A-5 (continued) 2.

The schedule of cost of goods manufactured is prepared as shown below.

Managerial Accounting, 16th Edition

Problem 3A-5 (continued) 3. The schedule of cost of goods sold is prepared as shown below:

4. The income statement is prepared as shown below:

Problem 3A-6 (60 minutes) 1.

The transactions are recorded as shown below. The ending balance sheet balances are calculated in row 20 of the spreadsheet.

Managerial Accounting, 16th Edition

Problem 3A-6 (continued) The formula for computing the cost of goods manufactured that is included in the spreadsheet for requirement 1 is as follows: Beginning work in process ...................... Total manufacturing costs: ..................... Direct materials .................................... Direct labor .......................................... Manufacturing overhead applied ........... Total costs to account for ....................... Deduct: Ending work in process .............. Cost of goods manufactured ...................

$ 14,000 $67,000 102,000 101,000

270,000 284,000 5,000 $279,000

The formula for computing the unadjusted cost of goods sold that is included in the spreadsheet for requirement 1 is as follows: Beginning finished goods ........................ Cost of goods manufactured ................... Cost of goods available for sale ............... Deduct: Ending finished goods ................ Unadjusted cost of goods sold ................

$ 22,000 279,000 301,000 6,000 $295,000

Problem 3A-6 (continued) 2. The schedule of the cost of goods manufactured is as follows:

Managerial Accounting, 16th Edition

Problem 3A-6 (continued) 3. The schedule of cost of goods sold is as follows:

4. The income statement is as follows:

Chapter 4 Process Costing Solutions to Questions 4-1 A process costing system should be used in situations where a homogeneous product is produced on a continuous basis in large quantities. 4-2 Job-order and processing costing are similar in the following ways: 1. Job-order costing and process costing have the same basic purposes—to assign materials, labor, and overhead cost to products and to provide a mechanism for computing unit product costs. 2. Both systems use the same basic manufacturing accounts. 3. Costs flow through the accounts in basically the same way in both systems. 4-3 Cost accumulation is simpler under process costing because costs only need to be assigned to departments—not individual 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. 4-4 In a process costing system, a Work in Process account is maintained for each processing department.

4-5 The journal entry to record the transfer of work in process from the Mixing Department to the Firing Department is: Work in Process, Firing ........ XXXX Work in Process, Mixing. XXXX 4-6 The costs that might be added in the Firing Department include: (1) costs transferred in from the Mixing Department; (2) materials costs added in the Firing Department; (3) labor costs added in the Firing Department; and (4) overhead costs added in the Firing Department. 4-7 Under the weighted-average method, equivalent units of production consist of units transferred to the next department (or to finished goods) during the period plus the equivalent units in the department’s ending work in process inventory. 4-8 The company will want to distinguish between the costs of the metals used to make the medallions, but the medals are otherwise identical and go through the same production processes. Thus, operation costing is ideally suited for the company’s needs.

Chapter 4: Applying Excel The completed worksheet is shown below.

Managerial Accounting, 16th Edition

Chapter 4: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Chapter 4: Applying Excel (continued) 1. When the units are changed, the worksheet changes as show below:

Managerial Accounting, 16th Edition

Chapter 4: Applying Excel (continued) All of the amounts involving units were cut in half. The units in beginning work in process inventory were reduced from 200 units to 100 units; the units started into production during the period were reduced from 5,000 units to 2,500 units; and the units in ending work in process inventory were reduced from 400 units to 200 units. All of the costs remained the same. The effect was to double the cost per equivalent unit, but the total cost of the units transferred out was unaffected. When a cost per equivalent unit that is twice as much is multiplied by units that are half as much, the result is unaffected.

Chapter 4: Applying Excel (continued) 2. With all of the changes in the data, the worksheet should look like:

Managerial Accounting, 16th Edition

Chapter 4: Applying Excel (continued) 3. Changing the percentage completion with respect to conversion for beginning inventory from 20% to 40% results in:

Chapter 4: Applying Excel (continued) The cost per equivalent unit for conversion is not affected by the increase in the percentage completion of the beginning inventory. In fact, nothing else on the worksheet is affected except this one amount. This is a consequence of using the weighted-average method. If the FIFO method had been used, the change in the percentage completion of beginning inventory would have affected the cost per equivalent unit and many other amounts on the worksheet.

Managerial Accounting, 16th Edition

The Foundational 15 1.

The journal entries would be recorded as follows: Work in Process—Mixing........................... Raw Materials Inventory ......................

120,000

Work in Process—Mixing........................... Salaries and Wages Payable ................

79,500

The journal entry would be recorded as follows: Work in Process—Mixing........................... Manufacturing Overhead .....................

120,000

97,000

The “units completed and transferred to finished goods” is computed as follows: Work in process, June 1 ........................................... Started into production during the month .................. Total units in process ............................................... Deduct work in process, June 30 .............................. Completed and transferred out during the month ......

Pounds

5,000 37,500 42,500 8,000 34,500

4. and 5. The equivalent units of production for materials and conversion are computed as follows:

Units transferred out ............................. Equivalent units in ending work in process inventory: 8,000 units × 100% ............................ 8,000 units × 40% .............................. Equivalent units of production .................

Equivalent Units Materials Conversion 34,500 8,000 42,500

34,500

3,200 37,700

The Foundational 15 (continued) 6. and 7.

Materials

Cost of beginning work in process ................ Cost added during the period ....................... Total cost ....................................................

$ 16,000 120,000 $136,000

Conversion

$ 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)

$136,000 42,500 $3.20

$188,500 37,700 $5.00

10. and 11. The cost of ending work in process inventory is computed as follows: Equivalent units in ending work in process inventory (a) ................ Cost per equivalent unit (b) ........... Cost of ending work in process inventory (a) × (b)....................

Materials Conversion 8,000 $3.20 $25,600

Total

3,200 $5.00 $16,000 $41,600*

* $41,600 is the June 30 balance in the Work in Process—Mixing Department T-account. 12. and 13. The costs transferred to finished goods are computed as follows: Units transferred out (a) ............... Cost per equivalent unit (b) .......... Cost of units transferred to finished goods (a) × (b) ...........

Materials Conversion 34,500 $3.20

$110,400

34,500 $5.00

Total

$172,500 $282,900

Managerial Accounting, 16th Edition

The Foundational 15 (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............................................ Work in Process—Mixing .......................

15.

282,900

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...... Costs added to production during the period ..... Total cost to be accounted for ..........................

$ 28,000 296,500 $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

Exercise 4-1 (20 minutes) a. To record raw materials used in production: Work in Process—Molding Department ......... Work in Process—Firing Department............. Raw Materials .......................................

23,000 8,000

b. To record direct labor costs incurred: Work in Process—Molding Department ......... Work in Process—Firing Department............. Salaries and Wages Payable ..................

12,000 7,000

c. To record applying manufacturing overhead: Work in Process—Molding Department ......... Work in Process—Firing Department............. Manufacturing Overhead .......................

25,000 37,000

d. To record transfer of unfired, molded bricks from the Molding Department to the Firing Department: Work in Process—Firing Department............. 57,000 Work in Process—Molding Department ...

31,000

19,000

62,000

57,000

e. To record transfer of finished bricks from the Firing Department to the finished bricks warehouse: Finished Goods............................................ 103,000 Work in Process—Firing Department ...... 103,000 f. To record cost of goods sold: Cost of Goods Sold ...................................... Finished Goods .....................................

101,000

Managerial Accounting, 16th Edition

Exercise 4-2 (10 minutes) Weighted-Average Method

Units transferred out...................... Equivalent units in ending work in process inventory: 15,000 units × 80% .................... 15,000 units × 40% .................... Equivalent units of production ........

Equivalent Units of Production Materials Conversion 190,000

12,000 202,000

190,000

6,000 196,000

Exercise 4-3 (10 minutes) Weighted-Average Method 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) ..

Materials

Labor

Overhead

$ 18,000 238,900 $256,900

$ 5,500 80,300 $85,800

$ 27,500 401,500 $429,000

35,000 $7.34

33,000 $2.60

33,000 $13.00

Materials...................................................... Labor .......................................................... Overhead .................................................... Total cost per equivalent unit ........................

Total

$ 7.34 2.60 13.00 $22.94

Managerial Accounting, 16th Edition

Exercise 4-4 (10 minutes) 1.

Ending work in process inventory:

Materials Conversion

Equivalent units ........................... Cost per equivalent unit ............... Cost of ending work in process inventory ................................ 2.

Units completed and transferred out: Units transferred to the next department ............................. Cost per equivalent unit ............... Cost of units transferred out.........

2,000 $13.86

800 $4.43

$27,720

$3,544

Materials Conversion

20,100 $13.86 $278,586

Total

$31,264

Total

20,100 $4.43 $89,043 $367,629

Exercise 4-5 (10 minutes) 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

*The cost of units completed and transferred out can be deduced as follows: Cost of beginning Costs added Cost of ending Cost of units work in process + to production = work in process + completed and inventory during the period inventory transferred out Cost of units $3,570 + $43,120 = $2,860 + completed and transferred out Cost of units completed and = $3,570 + $43,120 - $2,860 transferred out Cost of units completed and = $43,830 transferred out

Managerial Accounting, 16th Edition

Exercise 4-6 (10 minutes) Weighted-Average Method 1.

Work in process, June 1 ........................................... Started into production during the month .................. Total tons in process ................................................ Deduct work in process, June 30 .............................. Completed and transferred out during the month ......

2. Units transferred out ................................. Equivalent units in ending work in process inventory: Materials: 30,000 tons × 60% complete .. Labor and overhead: 30,000 tons × 40% complete ............... Equivalent units of production ...................

Tons of Pulp 20,000 190,000 210,000 30,000 180,000

Equivalent Units of Production Labor and Materials Overhead 180,000

180,000

18,000 198,000

12,000 192,000

Exercise 4-7 (10 minutes) Work in Process—Cooking ............ Raw Materials Inventory .........

42,000

Work in Process—Cooking ............ Work in Process—Molding ............ Salaries and Wages Payable ....

50,000 36,000

Work in Process—Cooking ............ Work in Process—Molding ............ Manufacturing Overhead .........

75,000 45,000

Work in Process—Molding ............ Work in Process—Cooking .......

160,000

Finished Goods ............................ Work in Process—Molding .......

240,000

42,000

86,000

120,000 160,000 240,000

Managerial Accounting, 16th Edition

Exercise 4-8 (30 minutes) Weighted-Average Method 1.

Units transferred to the next production department ................................................. Equivalent units in ending work in process inventory: Materials: 10,000 units × 100% complete ..... Conversion: 10,000 units × 30% complete .... Equivalent units of production .........................

2. 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)................... 3. and 4.

Ending work in process inventory: Equivalent units (see above) .... Cost per equivalent unit (see above) ............................... Cost of ending work in process inventory............................

Materials Conversion 175,000 10,000 185,000

175,000

3,000 178,000

Materials Conversion $ 1,500 $ 4,000 54,000 352,000 $55,500 $356,000 185,000 178,000 $0.30 $2.00

Materials Conversion 10,000

3,000

$0.30

$2.00

$3,000

$6,000

Total

$9,000

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

$2.00

$52,500

$350,000

$402,500

Exercise 4-9 (15 minutes) Weighted-Average Method 1. Units transferred to the next department...................................... Equivalent units in ending work in process inventory: Materials: 8,000 units × 75% complete .......... Labor and overhead: 8,000 units × 50% complete .......... Equivalent units of production .............

Materials

Labor

Overhead

42,000

48,000

4,000 46,000

Materials $ 4,320 52,800 $57,120

Labor

$ 1,040 21,500 $22,540

Overhead

48,000 $1.19

46,000 $0.49

46,000 $0.74

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) ....

6,000

$ 1,790 32,250 $34,040

Managerial Accounting, 16th Edition

Exercise 4-10 (10 minutes) Weighted-Average Method

Pounds transferred to the Packing Department during July* ...................................................... Equivalent units in ending work in process inventory: Materials: 25,000 pounds × 100% complete ....... Labor and overhead: 25,000 pounds × 60% complete ..................... Equivalent units of production ..............................

Labor & Materials Overhead 375,000

375,000

25,000 400,000

15,000 390,000

* 20,000 + 380,000 – 25,000 = 375,000

Exercise 4-11 (30 minutes) Weighted-Average Method 1. Equivalent units of production 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 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) .................

Pulping

Conversion

157,000

8,000

2,000 159,000

165,000

Pulping

Conversion

$0.65

$0.20

$ 4,800 102,450 $107,250 165,000

500 31,300 $31,800 159,000

3. and 4. Cost of ending work in process inventory and units transferred out

Pulping

Ending work in process inventory: Equivalent units ....................... 8,000 Cost per equivalent unit ........... $0.65 Cost of ending work in process inventory............................... $5,200 Units completed and transferred out: Units transferred to the next department ........................... 157,000 Cost per equivalent unit ........... $0.65 Cost of units completed and transferred out ...................... $102,050

Conversion

Total

2,000 $0.20 $400

$5,600

157,000 $0.20 $31,400

$133,450

Managerial Accounting, 16th Edition

Exercise 4-11 (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

Exercise 4-12 (20 minutes) Weighted-Average Method 1. Computation of equivalent units in ending inventory: Units in ending work in process inventory .............................. Percent completed ................... Equivalent units .......................

Materials

Labor

Overhead

3,000 80% 2,400

3,000 60% 1,800

2. and 3. Cost of ending work in process inventory and units transferred out:

Materials

Labor

Overhead

1,800 $3.20

1,800 $6.40

$5,760

$11,520

Units completed and transferred out: Units transferred to the next department ........ 25,000 25,000 Cost per equivalent unit $12.50 $3.20 Cost of units completed and transferred out .... $312,500 $80,000

25,000 $6.40

Ending work in process inventory: Equivalent units ........... 2,400 Cost per equivalent unit $12.50 Cost of ending work in process inventory ....... $30,000

$160,000

Total

$47,280

$552,500

4. Cost reconciliation: 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 ...............................

$599,780 $ 47,280 552,500 $599,780

Managerial Accounting, 16th Edition

Problem 4-13 (60 minutes) Weighted-Average Method 1. Computation of equivalent units of production: Units transferred to the next department ........ Equivalent units in ending work in process inventory: Mixing: 1 unit × 100% complete................ Materials: 1 unit × 80% complete.............. Conversion: 1 unit × 70% complete........... Equivalent units of production ........................

Mixing 50.0

1.0

Materials 50.0

Conversion 50.0

0.8

51.0

50.8

0.7 50.7

Mixing

Materials

Conversion

2. Costs per equivalent unit: 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

$ 90 6,006 $6,096 50.8 $120

$ 605 42,490 $43,095 50.7 $850

Problem 4-13 (continued) 3. and 4. Costs of ending work in process inventory and units transferred out: 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 ......................

Mixing

Materials

Conversion

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

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...............................

$ 2,365 129,956 $132,321 $ 2,321 130,000 $132,321

Managerial Accounting, 16th Edition

Total

Problem 4-14 (45 minutes) Weighted-Average Method 1. Equivalent units of production Transferred to next department* ..................... Equivalent units in ending work in process: Materials: 15,000 units x 100% complete ....... Conversion: 15,000 units x 60% complete ...... Equivalent units of production..........................

Materials Conversion 170,000

15,000 185,000

170,000

9,000 179,000

*Units transferred to the next department = Units in beginning work in process + Units started into production − Units in ending work in process = 18,000 + 167,000 − 15,000 = 170,000 2. Cost per equivalent unit

Materials Conversion

Cost of beginning work in process ................. $ 14,600 Cost added during the period ....................... 133,400 Total cost (a) ............................................... $148,000 Equivalent units of production (b) ................. 185,000 Cost per equivalent unit (a) ÷ (b) ................. $0.80

$ 7,200 225,500 $232,700 179,000

$1.30

3. and 4. Cost of ending work in process inventory and units transferred out Ending work in process inventory: Equivalent units ....................... Cost per equivalent unit ...........

Materials Conversion 15,000

9,000

$0.80

$1.30

Cost of ending work in process inventory............................... $12,000 Units completed and transferred out: Units transferred to the next department ........................... 170,000 Cost per equivalent unit ........... $0.80 Cost of units completed and transferred out ...................... $136,000

$11,700

Total

$23,700

170,000 $1.30 $221,000

$357,000

Problem 4-15 (45 minutes) Weighted-Average Method 1. Equivalent units of production: Transferred to next department ....................... Equivalent units in ending work in process inventory: Materials: 40,000 units x 100% complete ....... Conversion: 40,000 units x 25% complete ...... Equivalent units of production.......................... 2. Cost 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) .................

Materials Conversion 160,000

40,000 200,000

160,000

10,000 170,000

Materials Conversion $ 25,200 334,800 $360,000 200,000 $1.80

$ 24,800 238,700 $263,500 170,000 $1.55

3 and 4. Assigning costs to units:

Materials Conversion

Ending work in process inventory: Equivalent units ................... 40,000 Cost per equivalent unit ....... $1.80 Cost of ending work in process inventory........................... $72,000 Units completed and transferred out: Units transferred to the next department ....................... 160,000 Cost per equivalent unit ....... $1.80 Cost of units completed and transferred out .................. $288,000

Total

10,000 $1.55 $15,500

$87,500

160,000 $1.55 $248,000

$536,000

Managerial Accounting, 16th Edition

Problem 4-15 (continued) 5.

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

Problem 4-16 (45 minutes) Weighted-Average Method 1. Equivalent units of production Transferred to next department* ..................... Equivalent units in ending work in process: Materials: 15,000 units x 60% complete ......... Conversion: 15,000 units x 20% complete ...... Equivalent units of production..........................

Materials Conversion 95,000

9,000 104,000

95,000 3,000 98,000

*Units transferred to the next department = Units in beginning work in process + Units started into production − Units in ending work in process = 10,000 + 100,000 − 15,000 = 95,000 2. Cost 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) .................

Materials Conversion $ 1,500 154,500 $156,000 104,000

$ 7,200 90,800 $98,000 98,000

$1.50

$1.00

3. and 4. Cost of ending work in process inventory and units transferred out

Materials Conversion

Ending work in process inventory: Equivalent units ....................... 9,000 Cost per equivalent unit ........... $1.50 Cost of ending work in process inventory............................... $13,500 Units completed and transferred out: Units transferred to the next department ........................... 95,000 Cost per equivalent unit ........... $1.50 Cost of units completed and transferred out ...................... $142,500

Total

3,000 $1.00 $3,000

$16,500

95,000 $1.00 $95,000

$237,500

Managerial Accounting, 16th Edition

Problem 4-16 (continued) 5.

Cost Reconciliation Costs to be accounted for: Cost of beginning work in process inventory ($1,500 + $7,200) ..................................... Costs added to production during the period ($154,500 + $90,800)................................ 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 ...............................

$ 8,700 245,300 $254,000 $ 16,500 237,500 $254,000

Problem 4-17 (45 minutes) Weighted-Average Method 1. a. Work in Process—Refining Department ........ Work in Process—Blending Department ........ Raw Materials ........................................

495,000 115,000

b. Work in Process—Refining Department ........ Work in Process—Blending Department ........ Salaries and Wages Payable ...................

72,000 18,000

c. Manufacturing Overhead ............................. Accounts Payable ...................................

225,000

d. Work in Process—Refining Department ........ Work in Process—Blending Department ........ Manufacturing Overhead ........................

181,000 42,000

e. Work in Process—Blending Department ........ Work in Process—Refining Department ...

740,000

f. Finished Goods ........................................... Work in Process—Blending Department...

950,000

610,000

90,000 225,000

223,000 740,000 950,000

g. Accounts Receivable.................................... 1,500,000 Sales ..................................................... 1,500,000 Cost of Goods Sold...................................... Finished Goods ......................................

900,000

Managerial Accounting, 16th Edition

Problem 4-17 (continued) 2. (g)

Accounts Receivable 1,500,000

Bal. (a) (b) (d) Bal.

Work in Process Refining Department 38,000 (e) 740,000 495,000 72,000 181,000 46,000

Work in Process Blending Department Bal. 65,000 (f) 950,000 (a) 115,000 (b) 18,000 (d) 42,000 (e) 740,000 Bal. 30,000

Bal. (f) Bal.

Finished Goods 20,000 (g) 900,000 950,000 70,000

Manufacturing Overhead (c) 225,000 (d) 223,000 Bal. 2,000

Accounts Payable (c) 225,000

Salaries and Wages Payable (b) 90,000

Sales (g)

1,500,000

Bal. Bal.

(g)

Raw Materials 618,000 (a) 610,000 8,000

Cost of Goods Sold 900,000

Problem 4-18 (30 minutes) Weighted-Average Method 1. Equivalent units of production Transferred to next department ....................... Equivalent units in ending work in process inventory: Materials: 40,000 units x 75% complete ......... Conversion: 40,000 units x 60% complete ...... Equivalent units of production.......................... 2. Cost per equivalent unit

Materials Conversion 190,000

30,000 220,000

190,000

24,000 214,000

Materials Conversion

Cost of beginning work in process ................. $ 67,800 Cost added during the period ....................... 579,000 Total cost (a) ............................................... $646,800 Equivalent units of production (b) ................. 220,000 Cost per equivalent unit (a) ÷ (b) ................. $2.94 3. Total units transferred ................................. Less units in the beginning inventory ........... Units started and completed during April ......

$ 30,200 248,000 $278,200 214,000 $1.30

190,000 30,000 160,000

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.

Managerial Accounting, 16th Edition

Case 4-19 (45 minutes) Weighted-Average Method 1. The revised computations follow: Equivalent units of production: Transferred to finished goods.................................... Equivalent units in ending work in process: Transferred in costs: 600 units x 100% complete ..... Materials: 600 units x 0% complete ........................ Conversion: 600 units x 35% complete ................... Equivalent units of production................................... Cost 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 Costs Materials Conversion 1,800

1,800

600

2,400

1,800

210 2,010

Transferred In Costs

Materials

Conversion

$ 4,068 17,940 $22,008 2,400 $9.17

$1,980 6,210 $8,190 1,800 $4.55

1,800

$ 2,160 13,920 $16,080 2,010 $8.00

Case 4-19 (continued)

Ending work in process inventory: Equivalent units (see above) ................. Cost per equivalent unit ............................. Cost of ending work in process inventory .... Units completed and transferred out: Units transferred to finished goods ........ Cost per equivalent unit ............................. Cost of units completed and transferred out 2.

Transferred In Costs

Materials

Conversion

600 $9.17 $5,502

0 $4.55 $0

210 $8.00 $1,680

$7,182

1,800 $9.17 $16,506

1,800 $4.55 $8,190

1,800 $8.00 $14,400

$39,096

The unit cost computed above is $21.72 (= $9.17 + $4.55 + $8.00) versus $25.71 on the original report for the units completed and transferred to finished goods. The unit cost on the original report is high because none of the cost incurred during the month was assigned to the units in the ending work in process inventory.

Total

Managerial Accounting, 16th Edition

Case 4-20 (90 minutes) • This case is difficult—particularly part 3, which requires analytical skills. • Because there are no beginning inventories, it makes no difference whether the weighted-average or FIFO method is used by the company. You may choose to specify that the FIFO method be used rather than the weighted-average method. 1. Computation of the Cost of Goods Sold: Units completed and sold ...................... Equivalent units in ending work in process inventory: Transferred in: 10,000 units × 100% complete ......... Conversion: 10,000 units × 30% complete ........... Equivalent units of production................ 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 200,000

Conversion 200,000

10,000 210,000

3,000 203,000

Transferred In

Conversion

$187.50

$102.50

$ 0 $ 0 39,375,000 20,807,500 $39,375,000 $20,807,500 210,000 203,000

Cost of goods sold = 200,000 units × ($187.50 per unit + $102.50 per unit) = $58,000,000 2. The estimate of the percentage completion of ending work in process inventories affects the unit costs of finished goods and therefore the cost of goods sold. Gary Stevens would like the estimated percentage completion of the ending work in process to be increased. The higher the percentage of completion of ending work in process, the higher the equivalent units for the period and the lower the unit costs. 3. Increasing the percentage of completion can increase net operating income by reducing the cost of goods sold. To increase net operating income by $200,000, the cost of goods sold would have to be decreased by $200,000 from $58,000,000 down to $57,800,000. See the next page for the necessary calculations. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 4

Case 4-20 (continued) The percentage of completion, X, affects the cost of goods sold by its effect on the unit cost, which can be determined as follows: Unit cost = $187.50 +

$20,807,500 200,000 + 10,000X

And the cost of goods sold can be computed as follows: Cost of goods sold = 200,000 × Unit cost Because the cost of goods sold must be reduced down to $57,800,000, the unit cost must be $289.00 ($57,800,000 ÷ 200,000 units). Thus, the required percentage completion, X, to obtain the $200,000 reduction in cost of goods sold can be found by solving the following equation: $187.50 +

$20,807,500 = $289.00 200,000 + 10,000X

$20,807,500 = $289.00 - $187.50 200,000 + 10,000X $20,807,500 = $101.50 200,000 + 10,000X 200,000 + 10,000X 1 = $20,807,500 $101.50 200,000 + 10,000X =

$20,807,500 $101.50

200,000 + 10,000X = 205,000 10,000X = 205,000 - 200,000 10,000X = 5,000 X=

5,000 = 50% 10,000

Thus, changing the percentage completion to 50% will decrease cost of goods sold and increase net operating income by $200,000 as verified on the next page. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 38

Managerial Accounting, 16th Edition

Case 4-20 (continued) 3. (continued) Computation of the Cost of Goods Sold: Units completed and sold ...................... Equivalent unit in ending work in process inventory: Transferred in: 10,000 units x 100% complete .......... Conversion: 10,000 units x 50% complete ............ Equivalent units of production................ 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 200,000

Conversion 200,000

10,000 210,000

5,000 205,000

Transferred In

Conversion

$187.50

$101.50

$ 0 $ 0 39,375,000 20,807,500 $39,375,000 $20,807,500 210,000 205,000

Cost of goods sold = 200,000 units × ($187.50 per unit + $101.50 per unit) = $57,800,000 4. Mary is in a very difficult position. Collaborating with Gary Stevens in subverting the integrity of the accounting system is unethical by almost any standard. To put the situation in its starkest light, Stevens is suggesting that the production managers lie in order to get their bonus. Having said that, the peer pressure to go along in this situation may be intense. It is difficult on a personal level to ignore such peer pressure. Moreover, Mary probably prefers not to risk alienating people she might need to rely on in the future. On the other hand, Mary should be careful not to accept at face value Gary’s assertion that all of the other managers are “doing as much as they can to pull this bonus out of the hat.” Those who engage in unethical or illegal acts often rationalize their own behavior by exaggerating the extent to which others engage in the same kind of behavior. Other managers may actually be very uncomfortable “pulling strings” to make the target profit for the year. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 4

Case 4-20 (continued) From a broader perspective, if the net profit figures reported by the managers in a division cannot be trusted, then the company would be foolish to base bonuses on the net profit figures. A bonus system based on divisional net profits presupposes the integrity of the accounting system. The company should perhaps reconsider how it determines the bonus. It is quite common for companies to pay an “all or nothing” bonus contingent on making a particular target. This inevitably creates powerful incentives to bend the rules when the target has not quite been attained. It might be better to have a bonus without this “all or nothing” feature. For example, managers could be paid a bonus of x% of profits above target profits rather than a bonus that is a preset percentage of their base salary. Under such a policy, the effect of adding that last dollar of profits that just pushes the divisional net profits over the target profit will add a few pennies to the manager’s compensation rather than thousands of dollars. Therefore, the incentives to misstate the net operating income are reduced. Why tempt people unnecessarily?

Managerial Accounting, 16th Edition

Appendix 4A FIFO Method Exercise 4A-1 (10 minutes) FIFO Method Equivalent units to complete beginning work in process inventory: Materials: 30,000 units × (100% − 65%) ......... Conversion: 30,000 units × (100% − 30%) ...... Units started and completed during October* ...... Equivalent units in ending work in process inventory: Materials: 15,000 units × 80% complete .......... Conversion: 15,000 units × 40% complete ....... Equivalent units of production ............................

Materials Conversion 10,500 160,000 12,000 182,500

21,000 160,000

6,000 187,000

* 175,000 units started – 15,000 units in ending work in process = 160,000 units started and completed

Exercise 4A-2 (10 minutes) FIFO method Cost added during May (a) ............... Equivalent units of production (b) ..... Cost per equivalent unit (a) ÷ (b) .....

Materials

Labor

Overhead

$193,320 $62,000 $310,000 27,000 25,000 25,000 $7.16 $2.48 $12.40

Total

$ 7.16 2.48 12.40 $22.04

Managerial Accounting, 16th Edition

Exercise 4A-3 (15 minutes) 1. and 2.

Ending work in process inventory:

Equivalent units.................................... Cost per equivalent unit ........................ Cost of ending work in process inventory

Units transferred out:

Cost in beginning inventory ...................

Materials Conversion 400 $2.32 $928

200 $0.75 $150

$1,078

$3,200

$650

$3,850

600 $2.32

1,200 $0.75

$1,392

$900

24,000 $2.32

24,000 $0.75

$55,680

$18,000 $73,680 $79,822

Cost to complete the units in beginning inventory: Equivalent units needed 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 (26,000 units completed and transferred to the next department – 2,000 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 .........

Total

$2,292

Exercise 4A-4 (10 minutes) Mixing 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 .......................

$ 1,460 36,540 $38,000

Costs accounted for as follows: Cost of ending work in process inventory....... Cost of units completed and transferred out .. Total cost accounted for ...............................

$ 3,120 34,880 * $38,000

*The cost of units completed and transferred out can be deduced as follows: Cost of beginning Costs added Cost of ending Cost of units work in process + to production = work in process + completed and inventory during the period inventory transferred out Cost of units $1,460 + $36,540 = $3,120 + completed and transferred out Cost of units completed and = $1,460 + $36,540 - $3,120 transferred out Cost of units completed and = $34,880 transferred out

Managerial Accounting, 16th Edition

Exercise 4A-5 (10 minutes) Equivalent units needed to complete beginning work in process inventory: Materials: 500 units x (100% – 80%) .............. Conversion: 500 units x (100% – 40%) ........... Units started and completed during the period (153,600 units started – 400 units in ending inventory) ...................................................... Equivalent units in ending work in process inventory: Materials: 400 units x 75% complete ............... Conversion: 400 units x 20% complete ............ Equivalent units of production .............................

Materials Conversion 100

153,200 300 153,600

300 153,200

80 153,580

Exercise 4A-6 (15 minutes) FIFO Method

Equivalent units needed to complete the beginning work in process inventory: Materials: 20,000 pounds × (100% − 100%) ..... Labor and overhead: 20,000 pounds × (100% − 30%) .................... Pounds started and completed during July*........... Equivalent units in ending work in process inventory: Materials: 25,000 pounds × 100% complete ....... Labor and overhead: 25,000 pounds × 60% complete ..................... Equivalent units of production ..............................

Labor & Materials Overhead 0 355,000

14,000 355,000

25,000 380,000

15,000 384,000

* 380,000 pounds started – 25,000 pounds in ending work in process inventory = 355,000 pounds started and completed this month

Managerial Accounting, 16th Edition

Exercise 4A-7 (20 minutes) FIFO Method 1.

Equivalent units needed to complete beginning work in process inventory: Materials: 5,000 units × (100% − 80%) .............................. Labor: 5,000 units × (100% − 60%) .............................. Overhead: 5,000 units × (100% − 60%) .............................. Units started and completed during the period*............................................. Equivalent units in ending work in process inventory: Materials: 8,000 units × 75% ............ Labor: 8,000 units × 50% ................. Overhead: 8,000 units × 50% ........... Equivalent units of production ..............

Materials

Labor

Overhead

1,000 2,000 2,000 37,000 6,000 44,000

37,000

4,000 43,000

37,000

4,000 43,000

* 45,000 units started into production – 8,000 units in ending work in process = 37,000 started and completed 2. Cost added during the period (a) .......... Equivalent units of production (b) ......... Cost per equivalent unit (a) ÷ (b) .........

Materials

Labor

$52,800 $21,500 44,000 43,000 $1.20 $0.50

Overhead

$32,250 43,000 $0.75

Exercise 4A-8 (15 minutes) FIFO Method 1.

2. Equivalent units needed to complete beginning work in process inventory: Materials: 20,000 tons × (100% − 90%) . Labor and overhead: 20,000 tons × (100% − 80%).................................... Units started and completed during the month*.................................................. Equivalent units in ending work in process inventory: Materials: 30,000 tons × 60% complete .. Labor and overhead: 30,000 tons × 40% complete ............... Equivalent units of production ...................

Tons of Pulp 20,000 190,000 210,000 30,000 180,000

Equivalent Units Labor and Materials Overhead 2,000 4,000 160,000

160,000

18,000 180,000

12,000 176,000

* 190,000 tons started into production – 30,000 tons in ending work in process = 160,000 tons started and completed

Managerial Accounting, 16th Edition

Exercise 4A-9 (45 minutes) FIFO Method 1. Computation of the total cost per equivalent unit: Cost per equivalent unit for material.................................. Cost per equivalent unit for conversion .............................. Total cost per equivalent unit ............................................

$25.40 18.20 $43.60

2. Computation of equivalent units in ending inventory: Units in ending inventory (a)................. Percentage completed (b)..................... Equivalent units (a) × (b) .....................

Materials

Conversion

300 70 % 210

300 60 % 180

3. Computation of equivalent units required to complete the beginning inventory: Units in beginning inventory (a) ............ Percentage needed to complete production of beginning inventory (b) . Equivalent units (a) × (b) .....................

Materials

Conversion

400

20 %* 80

60 %** 240

* 100% – 80% = 20% ** 100% – 40% = 60% 4. Units transferred to the next department ............ Units from the beginning inventory .................... Units started and completed during the period ....

3,100 400 2,700

Exercise 4A-9 (continued) 5. and 6. Ending work in process inventory: Equivalent units .................................. 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 needed 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................................... Total cost of units transferred out ........

Materials Conversion

Total

210 $25.40

180 $18.20

$5,334

$3,276

$8,610

$8,120

$2,920

$11,040

80 $25.40

240 $18.20

$2,032

$4,368

2,700 $25.40

2,700 $18.20

$68,580

$49,140 $117,720 $135,160

$6,400

Managerial Accounting, 16th Edition

Problem 4A-10 (45 minutes) FIFO method 1. Equivalent units of production Equivalent units needed to complete beginning work in process inventory: Materials: 10,000 units x (100% − 100%).. Conversion: 10,000 units x (100% − 30%) Units started and completed during the period (170,000 units started − 20,000 units in ending inventory) ....................................... Equivalent units in ending work in process inventory: Materials: 20,000 units x 100% complete ... Conversion: 20,000 units x 40% complete .. Equivalent units of production ........................ 2. Cost per equivalent unit Cost added during the period (a) .............. Equivalent units of production (b) ............. Cost per equivalent unit (a) ÷ (b) ............. 3. and 4.

Materials Conversion 0

150,000 20,000 170,000

7,000 150,000

8,000 165,000

Materials Conversion $139,400 170,000 $0.82

$244,200 165,000 $1.48

See the next page.

5. Cost Reconciliation Costs to be accounted for: Cost of beginning work in process inventory ($8,500 + $4,900) .............................................. Costs added to production during the period ($139,400 + $244,200) ....................................... 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 .........................................

$ 13,400 383,600 $397,000 $ 28,240 368,760 $397,000

Problem 4A-10 (continued) 3. and 4. Costs of Ending Work in Process Inventory and Units Transferred Out Ending work in process inventory: Equivalent units ..................................................................... Cost per equivalent unit ......................................................... Cost of ending work in process inventory ................................

Materials Conversion

Total

20,000 $0.82 $16,400

8,000 $1.48 $11,840

$28,240

$4,900

$13,400

7,000 $1.48 $10,360

$10,360

Units transferred out: Cost in beginning work in process inventory ............................ $8,500 Cost to complete the units in beginning work in process inventory: Equivalent units required to complete the beginning inventory ....................................................................... 0 Cost per equivalent unit ..................................................... $0.82 Cost to complete the units in beginning inventory ................ $0 Cost of units started and completed this period: Units started and completed this period .............................. 150,000 Cost per equivalent unit ..................................................... $0.82 Cost of units started and completed this period ................... $123,000 Cost of units transferred out ...................................................

Managerial Accounting, 16th Edition

150,000 $1.48 $222,000 $345,000 $368,760

Problem 4A-11 (45 minutes) FIFO method 1. Equivalent units of production Equivalent units needed to complete beginning work in process inventory: 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) ....................................... Equivalent units in ending work in process inventory: Materials: 40,000 units x 100% complete ... Conversion: 40,000 units x 25% complete .. Equivalent units of production ........................ 2. Cost per equivalent unit Cost added during the period (a) .............. Equivalent units of production (b) ............. Cost per equivalent unit (a) ÷ (b) .............

Materials Conversion 0

140,000 40,000 180,000

5,000 140,000

10,000 155,000

Materials Conversion $334,800 180,000 $1.86

$238,700 155,000 $1.54

3. and 4. See the next page. 5. 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 ................ Costs of units transferred out ................................. Total cost accounted for .........................................

$ 50,000 573,500 $623,500 $ 89,800 533,700 $623,500

Problem 4A-11 (continued) 3. and 4. Costs of Ending Work in Process Inventory and Units Transferred Out Ending work in process inventory: Equivalent units ..................................................................... Cost per equivalent unit ......................................................... Cost of ending work in process inventory ................................

Materials Conversion

Total

40,000 $1.86 $74,400

10,000 $1.54 $15,400

$89,800

$24,800

$50,000

5,000 $1.54 $7,700

$7,700

Units transferred out: Cost in beginning work in process inventory ............................ $25,200 Cost to complete the units in beginning work in process inventory: Equivalent units needed to complete the beginning inventory ....................................................................... 0 Cost per equivalent unit ..................................................... $1.86 Cost to complete the units in beginning inventory ................ $0 Cost of units started and completed this period: Units started and completed this period .............................. 140,000 Cost per equivalent unit ..................................................... $1.86 Cost of units started and completed this period ................... $260,400 Cost of units transferred out ...................................................

Managerial Accounting, 16th Edition

140,000 $1.54 $215,600 $476,000 $533,700

Case 4A-12 (60 minutes) 1. Equivalent units needed to complete beginning work in process inventory: Transferred in: 450 units × (100% − 100%) ................. Materials: 450 units × (100% − 100%) ........................ Conversion: 450 units × (100% − 60%) ....................... Units started and completed during the period (1,950 units started − 600 units in ending inventory)......................... Equivalent units in ending work in process inventory: Transferred in: 600 units x 100% complete Materials: 600 units x 0% complete .............................. Conversion: 600 units x 35% complete ......................... Equivalent units of production ........................................... Cost added during the period (a) ...................................... Equivalent units of production (b) ..................................... Cost per equivalent unit (a) ÷ (b) .....................................

Transferred In 0

1,350 600 1,950

Transferred In $17,940 1,950 $9.20

Materials Conversion

0 1,350 0 1,350

180 1,350

210 1,740

Materials Conversion $6,210 1,350 $4.60

$13,920 1,740 $8.00

Case 4A-12 (continued) Ending work in process inventory: Equivalent units .............................................. 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 needed 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 production ............. Cost of units started and completed this period ..................................................... Cost of units transferred out ............................

Transferred In Materials Conversion

Total

600 $9.20 $5,520

0 $4.60 $0

210 $8.00 $1,680

$7,200

$4,068

$1,980

$2,160

$8,208

0 $9.20

0 $4.60

180 $8.00

$1,440

1,350 $9.20

1,350 $4.60

1,350 $8.00

$12,420

$6,210

$10,800

$1,440

$29,430 $39,078

2. The unit cost in the report prepared by the new assistant controller is high because none of the cost incurred during the month was assigned to the units in ending work in process inventory. Because all of the cost was assigned to the units completed and transferred to finished goods, the cost of those units was incorrectly inflated.

Managerial Accounting, 16th Edition

Appendix 4B Service Department Allocations Exercise 4B-1 (15 minutes)

Departmental costs before allocations .......... Allocations: Administration costs (20/25, 5/25) ............ Facility Services costs (70/100, 30/100)* .... Total costs after allocations.....................

Service Departments AdminiFacility stration Services $2,400,000

Operating Departments Undergraduate Graduate Programs Programs

$1,600,000

(2,400,000) (1,600,000) $

$26,800,000 $5,700,000 1,920,000

480,000

1,120,000

480,000

$29,840,000 $6,660,000

Total $36,500,000

$36,500,000

*Based on the space occupied by the two operating departments, which is 100,000 square feet.

Exercise 4B-2 (15 minutes)

Service Departments Administration Janitorial

Departmental costs before allocations ..... $150,000 $40,000 Allocations: Administration costs (160/4,000, 3,100/4,000, 740/4,000)*.................................... (150,000) 6,000 Janitorial costs (4,000/5,000, 1,000/5,000)†............ (46,000) Total costs after allocations .................... $ 0 $ 0

Operating Departments Groceries

Gifts

$2,320,000 $950,000

116,250

Total

$3,460,000

27,750

36,800 9,200 $2,473,050 $986,950

$3,460,000

*Based on employee hours in the other three departments: 160 + 3,100 + 740 = 4,000. †Based on space occupied by the two operating departments: 4,000 + 1,000 = 5,000. Both the Janitorial Department costs of $40,000 and the Administration costs of $6,000 that have been allocated to the Janitorial Department are allocated to the two operating departments.

Managerial Accounting, 16th Edition

Exercise 4B-3 (20 minutes)

Service Departments Departmental costs before allocations Allocations: Administration costs1: (35/700, 140/700, 315/700, 210/700)..................................... Janitorial costs2: (20/160, 40/160, 100/160) .......... Maintenance costs3: (30/90, 60/90) Total costs after allocations ...............

Administration

Operating Departments

Janitorial

Maintenance

7,000

28,000

$140,000 $105,000 $ 48,000

(140,000)

Binding

Printing

63,000

42,000

Total

$275,000 $430,000 $998,000

(112,000) $

0 $

14,000 28,000 70,000 (90,000) 30,000 60,000 0 $ 0 $396,000 $602,000 $998,000

Allocation base: 35 employees + 140 employees + 315 employees + 210 employees = 700 employees Allocation base: 20,000 square feet + 40,000 square feet + 100,000 square feet = 160,000 square feet 3 Allocation base: 30,000 hours + 60,000 hours = 90,000 hours 2

Exercise 4B-4 (20 minutes)

Service Departments Administration

Janitorial

Operating Departments Maintenance

Departmental costs before allocations ................................ $140,000 $105,000 $ 48,000 Allocations: Administration costs1: (315/525, 210/525) ................ (140,000) Janitorial costs2: (40/140, 100/140) .................. (105,000) 3 Maintenance costs : (30/90, 60/90) ....................... (48,000) Total costs after allocations .......... $ 0 $ 0 $ 0

Binding

Printing

$275,000

$430,000 $998,000

84,000

56,000

30,000

75,000

16,000 $405,000

Allocation base: 315 employees + 210 employees = 525 employees Allocation base: 40,000 square feet + 100,000 square feet = 140,000 square feet 3 Allocation base: 30,000 hours + 60,000 hours = 90,000 hours 1 2

Managerial Accounting, 16th Edition

Total

32,000 $593,000 $998,000

Problem 4B-5 (45 minutes)

Housekeeping Services

Food Services

Administrative General Services Laboratory Radiology Hospital

Departmental costs before allocations ................................ $87,000 $301,060 $249,020 Allocations: Housekeeping Services costs (13/145; 6.5/145; 10/145; 7.5/145; 108/145) ...................

(87,000)

Food Services costs (800 ÷ 71,800; 2,000 ÷ 71,800; 1,000 ÷ 71,800; 68,000 ÷ 71,800 ..................

3,900

6,000

4,500

64,800

(308,860)

3,441

8,603

4,302

292,514

(256,361)

78,023

39,011

139,327

$498,526

$520,500 $475,800

7,800

Admin. Services costs: (14/46; 7/46; 25/46) .............. Total costs after allocations .......... $

$405,900

$568,313 $972,441

Problem 4B-6 (60 minutes) 1. Step-down method

Factory Administration

Custodial Services Personnel

Maintenance

Machining Assembly

Departmental costs before allocations ............................... $270,000 $ 68,760 $ 28,840 $ 45,200 $376,300 $175,900 Allocations: Factory Administration costs ($270,000 ÷ 150,000 laborhours = $1.80 per labor-hour) (270,000) 5,400 9,000 39,600 54,000 162,000 Custodial Services costs ($74,160 ÷ 103,000 square feet = $0.72 per square foot) . (74,160) 2,160 7,200 50,400 14,400 Personnel costs ($40,000 ÷ 125 employees = $320 per employee)............................. (40,000) 8,000 12,800 19,200 Maintenance costs ($100,000 ÷ 80,000 MH = $1.25 per MH) .. (100,000) 87,500 12,500 Total costs after allocations ......... $ 0 $ 0 $ 0 $ 0 $581,000 $384,000 Divide by machine-hours ............. ÷ 70,000 Divide by direct labor-hours......... ÷ 80,000 Overhead rate ............................ $8.30 $4.80

Managerial Accounting, 16th Edition

Problem 4B-6 (continued) 2. Direct method

Factory Administration

Departmental costs before allocations ............................. $270,000 Allocations: Factory Administration costs (30/120, 90/120) ................ (270,000) Custodial Services costs (70/90, 20/90) .................... Personnel costs (40/100, 60/100) ................ Maintenance costs (70/80, 10/80) .................... Total costs after allocations ....... $ 0 Divide by machine-hours .......... Divide by direct labor-hours ...... Overhead rate (rounded) ..........

Custodial Services Personnel

Maintenance

Machining Assembly

$68,760

$45,200

$376,300 $175,900

$28,840

(68,760) (28,840) $

202,500

53,480

15,280

11,536

17,304

(45,200) 39,550 5,650 $ 0 $548,366 $416,634 ÷ 70,000 ÷ 80,000 $7.834 $5.208

67,500

Problem 4B-6 (continued) 3. Plantwide rate Overhead rate= =

Total overhead cost Total direct labor-hours $965,000 = $9.65 per DLH 100,000 DLHs

4. The amount of overhead cost assigned to the job would be: Step-down method: Machining Department: $8.30 per machine-hour × 190 machine-hours ................................................. Assembly Department: $4.80 per direct labor-hour × 75 direct labor-hours ............................................... Total overhead cost ...................................................... Direct method: Machining Department: $7.834 per machine-hour × 190 machine-hours ................................................. Assembly department: $5.208 per direct labor-hour × 75 direct labor-hours ............................................... Total overhead cost ...................................................... Plantwide method: $9.65 per direct labor-hour × 100 direct labor-hours....

$1,577 360 $1,937

$1,488 391 $1,879 $965

The plantwide method, which is based on direct labor-hours, assigns very little overhead cost to the job because it requires little labor time. Assuming that Factory Administrative costs really do vary in proportion to labor-hours, Custodial Services with square feet occupied, and so on, the company will tend to undercost such jobs if a plantwide overhead rate is used (and it will tend to overcost jobs requiring large amounts of labor time). The direct method is better than the plantwide method, but the step-down method will generally provide the most accurate overhead rates of the three methods.

Managerial Accounting, 14th Edition

Case 4B-7 (60 minutes) 1. Step-down method:

Custodial Personnel Services

Maintenance

Printing

Binding

Departmental costs before allocations ............... $360,000 $141,000 $201,000 $525,000 $373,500 Allocations: Personnel costs (15/200, 25/200, 40/200, 120/200)1 .................................................. (360,000) 27,000 45,000 72,000 216,000 Custodial services costs (20/140, 80/140, 40/140)2 .......................... (168,000) 24,000 96,000 48,000 3 Maintenance costs (150/180, 30/180) ........... (270,000) 225,000 45,000 Total costs after allocations .............................. $ 0 $ 0 $ 0 $918,000 $682,500 Divide by machine-hours .................................. 150,000 Divide by direct labor-hours ............................. 175,000 Predetermined overhead rate ........................... $6.12 $3.90 Based on 15 + 25 + 40 + 120 = 200 employees Based on 20,000 + 80,000 + 40,000 = 140,000 square feet 3 Based on 150,000 + 30,000 = 180,000 machine-hours 1 2

Case 4B-7 (continued) 2. Direct method:

Custodial Personnel Services

Maintenance

Printing

Binding

Departmental costs before allocations ............... $360,000 $141,000 $201,000 $525,000 $373,500 Allocations: Personnel costs (40/160, 120/160)1 ............... (360,000) 90,000 270,000 2 Custodial Services costs (80/120, 40/120) ..... (141,000) 94,000 47,000 3 Maintenance costs (150/180, 30/180) ........... (201,000) 167,500 33,500 Total costs after allocations .............................. $ 0 $ 0 $ 0 $876,500 $724,000 Divide by machine-hours .................................. 150,000 Divide by direct labor-hours ............................. 175,000 Predetermined overhead rate ........................... $5.84 $4.14 1

Based on 40 + 120 = 160 employees Based on 80,000 + 40,000 = 120,000 square feet 3 Based on 150,000 + 30,000 = 180,000 machine-hours 2

Managerial Accounting, 16th Edition

Case 4B-7 (continued) 3. a. The amount of overhead cost assigned to the job would be:

Step-down method:

Printing department: $6.12 per machine-hour × 15,400 machine-hours ....... $ 94,248 Binding department: $3.90 per direct labor-hour × 2,000 direct labor-hours 7,800 Total overhead cost...................................................... $102,048

Direct method:

Printing department: $5.84 per machine-hour × 15,400 machine-hours ....... $ 89,936 Binding department: $4.14 per direct labor-hour × 2,000 direct labor-hours 8,280 Total overhead cost...................................................... $ 98,216

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. Inaccuracies in the predetermined overhead rate can cause corresponding inaccuracies in bids for jobs. Because the direct method in this case understates the overhead rate in the Printing Department and overstates the overhead rate in the Binding Department, it is not surprising that the company tends to bid low on jobs requiring a lot of printing work and tends to bid too high on jobs that require a lot of binding work.

Chapter 5 Cost-Volume-Profit Relationships Solutions to Questions 5-1 The contribution margin (CM) ratio is the ratio of the total contribution margin to total sales revenue. It can also be expressed as the ratio of the contribution margin per unit to the selling price per unit. It is used in target profit and break-even analysis and can be used to quickly estimate the effect on profits of a change in sales revenue.

higher unit volume. (b) If the fixed cost increased, then both the fixed cost line and the total cost line would shift upward and the breakeven point would occur at a higher unit volume. (c) If the variable cost per unit increased, then the total cost line would rise more steeply and the break-even point would occur at a higher unit volume.

5-2 Incremental analysis focuses on the changes in revenues and costs that will result from a particular action.

5-7 The margin of safety is the excess of budgeted (or actual) sales over the break-even volume of sales. It is the amount by which sales can drop before losses begin to be incurred.

5-3 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 increase in contribution margin and in profits when sales increase. 5-4 Operating leverage measures the impact on net operating income of a given percentage change in sales. The degree of operating leverage at a given level of sales is computed by dividing the contribution margin at that level of sales by the net operating income at that level of sales. 5-5 The break-even point is the level of sales at which profits are zero. 5-6 (a) If the selling price decreased, then the total revenue line would rise less steeply, and the break-even point would occur at a

5-8 The sales mix is the relative proportions in which a company’s products are sold. The usual assumption in cost-volume-profit analysis is that the sales mix will not change. 5-9 A higher break-even point and a lower net operating income could result if the sales mix shifted from high contribution margin products to low contribution margin products. Such a shift would cause the average contribution margin ratio in the company to decline, resulting in less total contribution margin for a given amount of sales. Thus, net operating income would decline. With a lower contribution margin ratio, the break-even point would be higher because more sales would be required to cover the same amount of fixed costs.

Chapter 5: Applying Excel The completed worksheet is shown below.

Managerial Accounting, 16th Edition

Chapter 5: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Chapter 5: Applying Excel (continued) 1. When the fixed expenses are changed to $270,000, the worksheet changes as shown below:

The margin of safety percentage is now 10%, whereas it was 20% before. This change occurred because the increase in fixed expenses increased the break-even point and hence reduced the margin of safety available for the current level of unit sales. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 4

Managerial Accounting, 16th Edition

Chapter 5: Applying Excel (continued) 2. With the changes in the data, the worksheet should look like this:

The margin of safety percentage is 13% and the degree of operating leverage is 8.

Chapter 5: Applying Excel (continued) 3. The degree of operating leverage can be used to estimate the expected percentage increase in net operating income from a 15% increase in unit sales as follows: Percentage change in net operating income = Degree of operating leverage × Percentage change in sales = 8.00 × 15% = 120% An increase of 120% over the current net operating income of $60,000 would result in net operating income of $132,000. This is verified in part (4) that follows.

Managerial Accounting, 16th Edition

Chapter 5: Applying Excel (continued) 4. Increasing the unit sales by 15% results in net operating income of $132,000—an increase of 120% over the previous net operating income of $60,000.

Chapter 5: Applying Excel (continued) 5. a. The initial plan for the Western Hombre motorcycle is summarized below:

Managerial Accounting, 16th Edition

Chapter 5: Applying Excel (continued) 5. b. The modified plan for the Western Hombre motorcycle is summarized below:

Chapter 5: Applying Excel (continued) This does not appear to be a good plan. At best, Thad would only break even—and that assumes that 600 units would still be sold despite the drastic reduction in advertising expenses. The margin of safety is zero which means that any decrease in sales to below 600 units would result in a loss. The degree of operating leverage is displayed in the worksheet as #DIV/0!. This means that Excel is unable to compute the degree of operating leverage because the divisor is 0. The divisor is 0 because the degree of operating leverage is the contribution margin divided by the net operating income and the net operating income is zero. Technically, the degree of operating leverage is undefined when net operating income is zero.

Managerial Accounting, 16th Edition

The Foundational 15 1. The contribution margin per unit is calculated as follows: Total contribution margin (a) .............. Total units sold (b) ....... ........ ............ Contribution margin per unit (a) ÷ (b) .

$8,000 1,000 units $8.00 per unit

The contribution margin per unit ($8) can also be derived by calculating the selling price per unit of $20 (= $20,000 ÷ 1,000 units) and deducting the variable expense per unit of $12 (= $12,000 ÷ 1,000 units). 2. The contribution margin ratio is calculated as follows: Total contribution margin (a) .............. Total sales (b) .............. ........ ............ Contribution margin ratio (a) ÷ (b) ......

$8,000 $20,000 40%

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

$12,000 $20,000 60%

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

$8.00 per unit unit 1 $8.00

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

Total Per Unit

$18,000 10,800 7,200 6,000 $ 1,200

$20.00 12.00 $ 8.00

The Foundational 15 (continued) 6. The new net operating income would be computed as follows: Sales (900 units) .......... Variable expenses ......... Contribution margin ...... Fixed expenses ............. Net operating income ...

Total Per Unit

$19,800 10,800 9,000 6,000 $ 3,000

$22.00 12.00 $10.00

7. The new net operating income would be computed as follows: Sales (1,250 units) ....... Variable expenses ......... Contribution margin ...... Fixed expenses ............. Net operating income ...

Total Per Unit

$25,000 16,250 8,750 7,500 $ 1,250

$20.00 13.00 $ 7.00

8. The equation method yields the break-even point in unit sales, Q, as follows: Profit = Unit CM × Q − Fixed expenses $0 = ($20 − $12) × Q − $6,000 $0 = ($8) × Q − $6,000 $8Q = $6,000 Q = $6,000 ÷ $8 Q = 750 units 9. The equation method yields the dollar sales to break-even as follows: Profit = CM ratio × Sales − Fixed expenses $0 = 0.40 × Sales − $6,000 0.40 × Sales = $6,000 Sales = $6,000 ÷ 0.40 Sales = $15,000 The dollar sales to break-even ($15,000) can also be computed by multiplying the selling price per unit ($20) by the unit sales to breakeven (750 units). © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 12

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 10. The equation method yields the target profit as follows: Profit = Unit CM × Q − Fixed expenses $5,000 = ($20 − $12) × Q − $6,000 $5,000 = ($8) × Q − $6,000 $8Q = $11,000 Q = $11,000 ÷ $8 Q = 1,375 units 11. The margin of safety in dollars is calculated as follows: Sales .............................................................. Break-even sales (at 750 units) ........................ Margin of safety (in dollars) .............................

$20,000 15,000 $ 5,000

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) .......

$5,000 $20,000 25%

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

$8,000 $2,000 4.0

13. A 5% increase in sales should result in a 20% increase in net operating income, computed as follows: Degree of operating leverage (a) ............................. Percent increase in sales (b) .................................... Percent increase in net operating income (a) × (b) ...

4.0 5% 20%

14. The degree of operating leverage is calculated as follows: Contribution margin ($20,000 – $6,000) (a) ......... Net operating income (b) .................................... Degree of operating leverage (a) ÷ (b) ................

$14,000 $2,000 7.0

The Foundational 15 (continued) 15. A 5% increase in sales should result in 35% increase in net operating income, computed as follows: Degree of operating leverage (a) .............................. Percent increase in sales (b) ..................................... Percent increase in net operating income (a) × (b) ....

7.0 5% 35%

Managerial Accounting, 16th Edition

Exercise 5-1 (20 minutes) 1. The revised net operating income would be: Sales (10,100 units) ........ Variable expenses ........... Contribution margin ........ Fixed expenses ............... Net operating income ......

Total

Per Unit

$353,500 202,000 151,500 135,000 $ 16,500

$35.00 20.00 $15.00

You can get the same net operating income using the following approach: Original net operating income .... Change in contribution margin (100 units × $15.00 per unit) .. New net operating income .........

$15,000 1,500 $16,500

2. The revised net operating income would be: Sales (9,900 units) ............ Variable expenses ............. Contribution margin .......... Fixed expenses ................. Net operating income ........

Total

$346,500 198,000 148,500 135,000 $ 13,500

Per Unit

$35.00 20.00 $15.00

You can get the same net operating income using the following approach: Original net operating income ............. Change in contribution margin (-100 units × $15.00 per unit) .......... New net operating income ..................

$15,000 (1,500) $13,500

Exercise 5-1 (continued) 3. The revised net operating income would be: Sales (9,000 units) ........ Variable expenses ......... Contribution margin ...... Fixed expenses ............. Net operating income ....

Total Per Unit

$315,000 180,000 135,000 135,000 $ 0

$35.00 20.00 $15.00

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

Managerial Accounting, 16th Edition

Exercise 5-2 (30 minutes) 1. The CVP graph can be plotted using the three steps outlined in the text. The graph appears on the next page. Step 1. Draw a line parallel to the volume axis to represent the total fixed expense. For this company, the total fixed expense is $24,000. Step 2. Choose some volume of sales and plot the point representing total expenses (fixed and variable) at the activity level you have selected. We’ll use the sales level of 8,000 units. Fixed expenses ................................................... Variable expenses (8,000 units × $18 per unit) .... Total expense .....................................................

$ 24,000 144,000 $168,000

Step 3. Choose some volume of sales and plot the point representing total sales dollars at the activity level you have selected. We’ll use the sales level of 8,000 units again. Total sales revenue (8,000 units × $24 per unit) ..

$192,000

2. The break-even point is the point where the total sales revenue and the total expense lines intersect. This occurs at sales of 4,000 units. This can be verified as follows: Profit = Unit CM × Q − Fixed expenses = ($24 − $18) × 4,000 − $24,000 = $6 × 4,000 − $24,000 = $24,000− $24,000 = $0

Exercise 5-2 (continued)

CVP Graph $200,000

Dollars

$150,000

$100,000

$50,000

$0 0

2,000

4,000

6,000

8,000

Volume in Units Fixed Expense

Total Expense

Total Sales Revenue

Managerial Accounting, 16th Edition

Exercise 5-3 (15 minutes) 1. The profit graph is based on the following simple equation: Profit = Unit CM × Q − Fixed expenses Profit = ($16 − $11) × Q − $16,000 Profit = $5 × Q − $16,000 To plot the graph, select two different levels of sales such as Q=0 and Q=4,000. The profit at these two levels of sales are -$16,000 (=$5 × 0 − $16,000) and $4,000 (= $5 × 4,000 − $16,000).

Profit Graph $5,000

Profit

-$5,000

-$10,000

-$15,000

-$20,000 0

500

1,000 1,500 2,000 2,500 3,000 3,500 4,000 Sales Volume in Units

Exercise 5-3 (continued) 2. Looking at the graph, the break-even point appears to be 3,200 units. This can be verified as follows: Profit = Unit CM × Q − Fixed expenses = $5 × Q − $16,000 = $5 × 3,200 − $16,000 = $16,000 − $16,000 = $0

Managerial Accounting, 16th Edition

Exercise 5-4 (10 minutes) 1. The company’s contribution margin (CM) ratio is: Total sales ............................ Total variable expenses ......... Total contribution margin (a) .

$200,000 120,000 $ 80,000

Total contribution margin (a) . Total sales (b)....................... CM ratio (a) ÷ (b) .................

$80,000 $200,000 40%

2. The change in net operating income from an increase in total sales of $1,000 can be estimated by using the CM ratio as follows: Change in total sales (a) .......................................... CM ratio (b) ............................................................ Estimated change in net operating income (a) × (b) .

$1,000 40% $400

This computation can be verified as follows: Total sales (a) .......................... Total units sold (b) ................... Selling price per unit (a) ÷ (b) ..

$200,000 50,000 units $4.00 per unit

Increase in total sales (a) ......... Selling price per unit (b) ........... Increase in unit sales (a) ÷ (b) .

$1,000 $4.00 per unit 250 units

Increase in unit sales ............... Original total unit sales ............. New total unit sales ..................

250 units 50,000 units 50,250 units

Total unit sales ............... Sales .............................. Variable expenses ........... Contribution margin ........ Fixed expenses ............... Net operating income ......

Original

New

50,000 50,250 $200,000 $201,000 120,000 120,600 80,000 80,400 65,000 65,000 $ 15,000 $ 15,400

Exercise 5-5 (20 minutes) 1. The following table shows the effect of the proposed change in monthly advertising budget:

Sales With Additional Current Advertising Sales Budget Difference

Sales .............................. $180,000 $189,000 Variable expenses ........... 126,000 132,300 Contribution margin ........ 54,000 56,700 Fixed expenses ............... 30,000 35,000 Net operating income ...... $ 24,000 $ 21,700

$ 9,000 6,300 2,700 5,000 $ (2,300)

Assuming no other important factors need to be considered, the increase in the advertising budget should not be approved because it would lead to a decrease in net operating income of $2,300. Alternative Solution 1 Expected total contribution margin: $189,000 × 30% CM ratio .................. Present total contribution margin: $180,000 × 30% CM ratio .................. Incremental contribution margin ........... Change in fixed expenses: Less incremental advertising expense . Change in net operating income ............

$56,700 54,000 2,700 5,000 $ (2,300)

Alternative Solution 2 Incremental contribution margin: $9,000 × 30% CM ratio ..................... Less incremental advertising expense .... Change in net operating income ............

$2,700 5,000 $ (2,300)

Managerial Accounting, 16th Edition

Exercise 5-5 (continued) 2. The $2 increase in variable expense will cause the unit contribution margin to decrease from $27 to $25 with the following impact on net operating income: Expected total contribution margin with the higher-quality components: 2,000 units × 1.1 × $25 per unit ............ Present total contribution margin: 2,000 units × $27 per unit ..................... Change in total contribution margin...........

$55,000 54,000 $ 1,000

Assuming no change in fixed expenses, the net operating income will also increase by $1,000. The higher-quality components should be used.

Exercise 5-6 (20 minutes) 1. The break-even point in unit sales, Q, is computed as follows: Profit = Unit CM × Q − Fixed expenses $0 = ($15 − $12) × Q − $4,200 $0 = ($3) × Q − $4,200 $3Q = $4,200 Q = $4,200 ÷ $3 Q = 1,400 baskets 2. The break-even point in dollar sales is computed as follows: Unit sales to break even (a) ............................ Selling price per unit (b) ................................. Dollar sales to break even (a) × (b) ................

1,400 $15 $21,000

3. The new break-even point in unit sales, Q, is computed as follows: Profit = Unit CM × Q − Fixed expenses $0 = ($15 − $12) × Q − $4,800 $0 = ($3) × Q − $4,800 $3Q = $4,800 Q = $4,800 ÷ $3 Q = 1,600 baskets The break-even point in dollar sales is computed as follows: Unit sales to break even (a) ............................ Selling price per unit (b) ................................. Dollar sales to break even (a) × (b) ................

1,600 $15 $24,000

Managerial Accounting, 16th Edition

Exercise 5-7 (10 minutes) 1. The required unit sales, Q, to attain the target profit is computed as follows: Profit = Unit CM × Q − Fixed expenses $10,000 = ($120 − $80) × Q − $50,000 $10,000 = ($40) × Q − $50,000 $40 × Q = $10,000 + $50,000 Q = $60,000 ÷ $40 Q = 1,500 units 2. One approach to solving this requirement is to compute the unit sales required to attain the target profit and then multiply this quantity by the selling price per unit: Profit = Unit CM × Q − Fixed expenses $15,000 = ($120 − $80) × Q − $50,000 $15,000 = ($40) × Q − $50,000 $40 × Q = $15,000 + $50,000 Q = $65,000 ÷ $40 Q = 1,625 units Unit sales to attain the target profit (a)............ Selling price per unit (b) ................................. Dollar sales to attain target profit (a) × (b) ......

1,625 $120 $195,000

Exercise 5-8 (10 minutes) 1. To compute the margin of safety, we must first compute the break-even unit sales. Profit = Unit CM × Q − Fixed expenses $0 = ($30 − $20) × Q − $7,500 $0 = ($10) × Q − $7,500 $10Q = $7,500 Q = $7,500 ÷ $10 Q = 750 units; or, at $30 per unit, $22,500 Sales (at the budgeted volume of 1,000 units) .. Less break-even sales (at 750 units) ................ Margin of safety (in dollars) .............................

$30,000 22,500 $ 7,500

2. The margin of safety as a percentage of sales is as follows: Margin of safety (in dollars) (a) ................ $7,500 Sales (b)................................................. $30,000 Margin of safety percentage (a) ÷ (b) ...... 25%

Managerial Accounting, 16th Edition

Exercise 5-9 (20 minutes) 1. The company’s degree of operating leverage would be computed as follows: Contribution margin (a) .......................... Net operating income (b)........................ Degree of operating leverage (a) ÷ (b) ...

$48,000 $10,000 4.8

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

4.8 5% 24%

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

Sales ............................ Variable expenses ......... Contribution margin ...... Fixed expenses ............. Net operating income ....

Amount

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

Percent of Sales

100% 40% 60%

Net operating income reflecting change in sales ...... Original net operating income (a) ........................... Change in net operating income (b) ....................... Percent change in net operating income (b) ÷ (a) ...

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

Exercise 5-10 (20 minutes) 1. The overall contribution margin ratio can be computed as follows: Overall CM ratio = =

Total contribution margin Total sales $30,000 =30% $100,000

2. The overall break-even point in dollar sales can be computed as follows: Overall break-even =

Total fixed expenses Overall CM ratio

$24,000 = $80,000 30%

3. To construct the required income statement, we must first determine the relative sales mix for the two products: Original dollar sales ....... Percent of total ............. Sales at break-even ....... Sales ............................ Variable expenses* ....... Contribution margin ...... Fixed expenses ............. Net operating income ....

Claimjumper Makeover $30,000 30% $24,000

$70,000 70% $56,000

Claimjumper Makeover $24,000 16,000 $ 8,000

$56,000 40,000 $16,000

Total

$100,000 100% $80,000

Total

$80,000 56,000 24,000 24,000 $ 0

*Claimjumper variable expenses: ($24,000/$30,000) × $20,000 = $16,000 Makeover variable expenses: ($56,000/$70,000) × $50,000 = $40,000

Managerial Accounting, 16th Edition

Exercise 5-11 (20 minutes) a. Number of units sold .. Sales ......................... Variable expenses....... Contribution margin .... Fixed expenses........... Net operating income . Number of units sold .. Sales ......................... Variable expenses....... Contribution margin .... Fixed expenses........... Net operating income (loss).. b. Sales.......................... Variable expenses ....... Contribution margin .... Fixed expenses ........... Net operating income..

Sales ......................... Variable expenses ...... Contribution margin ... Fixed expenses .......... Net operating income (loss).

Case #1

15,000 * $180,000 * $12 120,000 * 8 60,000 $4 50,000 * $ 10,000

Case #2

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

Case #3

Case #4

10,000 * 6,000 * $200,000 $20 $300,000 * 70,000 * 7 210,000 130,000 $13 * 90,000 118,000 100,000 * $ 12,000 * $ (10,000) *

Case #1

$500,000 * 100% 400,000 80% 100,000 20% * 93,000 $ 7,000 *

Case #3

$25 15 $10 *

$50 35 $15

Case #2

$400,000 * 100% 260,000 * 65% 140,000 35% 100,000 * $ 40,000

Case #4

$250,000 100% $600,000 * 100% 100,000 40% 420,000 * 70% 150,000 60% * 180,000 30% 130,000 * 185,000 $ 20,000 * $ (5,000) *

*Given

Exercise 5-12 (30 minutes) 1.

Flight Dynamic Amount %

Sales ............... $150,000 100 Variable expenses ...... 30,000 20 Contribution margin .......... $120,000 80 Fixed expenses Net operating income .........

Sure Shot Amount %

Total Company Amount %

$250,000 100

$400,000

100.0

160,000

190,000

47.5

$ 90,000

210,000 183,750

52.5*

$ 26,250

*$210,000 ÷ $400,000 = 52.5% 2. The break-even point for the company as a whole is:

Dollar sales to = Fixed expenses break even Overall CM ratio =

$183,750 = $350,000 0.525

3. The additional contribution margin from the additional sales is computed as follows: $100,000 × 52.5% CM ratio = $52,500 Assuming no change in fixed expenses, all of this additional contribution margin of $52,500 should drop to the bottom line as increased net operating income. This answer assumes no change in selling prices, variable costs per unit, fixed expense, or sales mix.

Managerial Accounting, 16th Edition

Exercise 5-13 (20 minutes) 1. Sales (20,000 units × 1.15 = 23,000 units)..... Variable expenses ......................................... Contribution margin ...................................... Fixed expenses ............................................. Net operating income ....................................

Total

Per Unit

$345,000 $ 15.00 207,000 9.00 138,000 $ 6.00 70,000 $ 68,000

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

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

$16.80 9.60 $ 7.20

Exercise 5-14 (30 minutes) 1. Variable expenses: $40 × (100% – 30%) = $28 2. The break-even points in unit sales (Q) and dollar sales are computed as follows: Selling price .......................... Variable expenses ................. Contribution margin ..............

$40 100% 28 70% $12 30%

Profit = Unit CM × Q − Fixed expenses $0 = $12 × Q − $180,000 $12Q = $180,000 Q = $180,000 ÷ $12 Q = 15,000 units In dollar sales: 15,000 units × $40 per unit = $600,000 Alternative solution: Profit = CM ratio × Sales − Fixed expenses $0 = 0.30 × Sales − $180,000 0.30 × Sales = $180,000 Sales = $180,000 ÷ 0.30 Sales = $600,000 In unit sales: $600,000 ÷ $40 per unit = 15,000 units 3. The unit sales and dollar sales needed to attain the target profit are computed as follows: Profit = Unit CM × Q − Fixed expenses $60,000 = $12 × Q − $180,000 $12Q = $60,000 + $180,000 $12Q = $240,000 Q = $240,000 ÷ $12 Q = 20,000 units In dollar sales: 20,000 units × $40 per unit = $800,000

Managerial Accounting, 16th Edition

Exercise 5-14 (continued) Alternative solution: Profit = CM ratio × Sales − Fixed expenses $60,000 = 0.30 × Sales − $180,000 0.30 × Sales = $240,000 Sales = $240,000 ÷ 0.30 Sales = $800,000 In unit sales: $800,000 ÷ $40 per unit = 20,000 units 4. The new break-even points in unit sales and dollar sales are computed as follows: The company’s new cost/revenue relation will be: Selling price .............................. Variable expenses ($28 – $4) ..... Contribution margin ...................

$40 100% 24 60% $16 40%

Profit = Unit CM × Q − Fixed expenses $0 = ($40 − $24) × Q − $180,000 $16Q = $180,000 Q = $180,000 ÷ $16 per unit Q = 11,250 units In dollar sales: 11,250 units × $40 per unit = $450,000 Alternative solution: Profit = CM ratio × Sales − Fixed expenses $0 = 0.40 × Sales − $180,000 0.40 × Sales = $180,000 Sales = $180,000 ÷ 0.40 Sales = $450,000 In unit sales: $450,000 ÷ $40 per unit = 11,250 units

Exercise 5-14 (continued) 4. The dollar sales required to attain the target profit is computed as follows: Profit = CM ratio × Sales − Fixed expenses $60,000 = 0.40 × Sales − $180,000 0.40 × Sales = $240,000 Sales = $240,000 ÷ 0.40 Sales = $600,000

Managerial Accounting, 16th Edition

Exercise 5-15 (15 minutes) 1. Sales (15,000 games) ......... Variable expenses .............. Contribution margin ............ Fixed expenses................... Net operating income .........

Total

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

Per Unit

$20 6 $14

The degree of operating leverage is: Degree of operating = Contribution margin leverage Net 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, net operating income should increase by 7.5 times as much, or by 150% (7.5 × 20%). b. The expected total dollar amount of net operating income for next year would be: Last year’s net operating income ...................... Expected increase in net operating income next year (150% × $28,000) ................................ Total expected net operating income ................

$28,000 42,000 $70,000

Exercise 5-16 (30 minutes) 1. The contribution margin per person would be: Price per ticket ..................................... Variable expenses: Dinner............................................... Favors and 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). The break-even point would be: Profit = Unit CM × Q − Fixed expenses $0 = ($35 − $20) × Q − $6,000 $0 = ($15) × Q − $6,000 $15Q = $6,000 Q = $6,000 ÷ $15 Q = 400 persons; or, at $35 per person, $14,000 Alternative solution: Fixed expenses Unit sales to = break even Unit contribution margin =

$6,000 = 400 persons $15

or, at $35 per person, $14,000. 2. Variable cost per person ($18 + $2) ................. Fixed cost per person ($6,000 ÷ 300 persons) .. Ticket price per person to break even ...............

$20 20 $40

Managerial Accounting, 16th Edition

Exercise 5-16 (continued) 3. Cost-volume-profit graph: $20,000

Total Sales

$18,000

Total Expenses

Break-even point: 400 persons or $14,000 total sales

$16,000

Total Sales

$14,000 $12,000 $10,000 $8,000 Total Fixed Expenses

$6,000 $4,000 $2,000 $0 0

100

200

300

400

500

600

700

Number of Persons

Exercise 5-17 (30 minutes) 1.

Profit = Unit CM × Q − Fixed expenses $0 = ($50 − $32) × Q − $108,000 $0 = ($18) × Q − $108,000 $18Q = $108,000 Q = $108,000 ÷ $18 Q = 6,000 stoves, or at $50 per stove, $300,000 in sales Alternative solution: Fixed expenses Unit sales to = break even Unit contribution margin =

$108,000 = 6,000 stoves $18.00 per stove

or at $50 per stove, $300,000 in sales. 2. An increase in variable expenses as a percentage of the selling price would result in a higher break-even point. If variable expenses increase as a percentage of sales, then the contribution margin will decrease as a percentage of sales. With a lower CM ratio, more stoves would have to be sold to generate enough contribution margin to cover the fixed costs. 3.

Present: 8,000 Stoves Total Per Unit

Sales ............................ $400,000 Variable expenses.......... 256,000 Contribution margin ....... 144,000 Fixed expenses.............. 108,000 Net operating income .... $ 36,000

$50 32 $18

Proposed: 10,000 Stoves* Total Per Unit

$450,000 320,000 130,000 108,000 $ 22,000

$45 32 $13

*8,000 stoves × 1.25 = 10,000 stoves **$50 × 0.9 = $45 As shown above, a 25% increase in volume is not enough to offset a 10% reduction in the selling price; thus, net operating income decreases.

Managerial Accounting, 16th Edition

Exercise 5-17 (continued) 4.

Profit = Unit CM × Q − Fixed expenses $35,000 = ($45 − $32) × Q − $108,000 $35,000 = ($13) × Q − $108,000 $13 × Q = $143,000 Q = $143,000 ÷ $13 Q = 11,000 stoves

Alternative solution: Unit sales to attain = Target profit + Fixed expenses target profit Unit contribution margin =

$35,000 + $108,000 $13

= 11,000 stoves

Exercise 5-18 (30 minutes) 1.

Profit = Unit CM × Q − Fixed expenses $0 = ($30 − $12) × Q − $216,000 $0 = ($18) × Q − $216,000 $18Q = $216,000 Q = $216,000 ÷ $18 Q = 12,000 units, or at $30 per unit, $360,000 Alternative solution: Fixed expenses Unit sales = to break even 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. The unit sales to attain the target profit is computed as follows: 3. Units sold to attain Target profit + Fixed expenses = target profit Unit contribution margin =

$90,000 + $216,000 $18

= 17,000 units

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

Total

Unit

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

12 $18

$510,000

$30

Managerial Accounting, 16th Edition

Exercise 5-18 (continued) 4. Margin of safety in dollar terms:

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

$90,000 = 20% $450,000

5. The CM ratio is 60% [= ($30 – $12) ÷ $30]. 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 net operating income will also increase by $30,000.

Problem 5-19 (45 minutes) 1. Sales (15,000 units × $70 per unit) ...................... Variable expenses (15,000 units × $40 per unit) ... Contribution margin ............................................ Fixed expenses ................................................... Net operating loss ...............................................

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

2. Unit sales to Fixed expenses = break even Unit contribution margin

$540,000 $70 per unit - $40 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: Fixed expenses Unit sales to = break even 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, 16th Edition

Problem 5-19 (continued) 3.

Unit Unit Unit Selling Variable Contribution Price Expense Margin $70 $68 $66 $64 $62 $60 $58 $56

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

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

Volume (Units)

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

Total Contribution Margin $450,000 $560,000 $650,000 $720,000 $770,000 $800,000 $810,000 $800,000

Fixed Expenses

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

Net operating income (loss) $ (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.

Problem 5-20 (75 minutes) 1. a. Selling price ..................... $25 100% Variable expenses ............ 15 60% Contribution margin ......... $10 40% Profit = Unit CM × Q − Fixed expenses $0 = $10 × Q − $210,000 $10Q = $210,000 Q = $210,000 ÷ $10 Q = 21,000 balls Alternative solution: Fixed expenses Unit sales to = break even Unit contribution margin =

$210,000 $10

= 21,000 balls

b. The degree of operating leverage is: Contribution margin Degree of = operating leverage Net operating income =

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

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

$25 100% 18 72% $ 7 28%

The new break-even point will be: Profit = Unit CM × Q − Fixed expenses $0 = $7 × Q − $210,000 $7Q = $210,000 Q = $210,000 ÷ $7 Q = 30,000 balls © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 44

Managerial Accounting, 16th Edition

Problem 5-20 (continued) Alternative solution: Fixed expenses Unit sales to = break even Unit contribution margin =

$210,000 $7

= 30,000 balls

Profit = Unit CM × Q − Fixed expenses $90,000 = $7 × Q − $210,000 $7Q = $90,000 + $210,000 Q = $300,000 ÷ $7 Q = 42,857 balls (rounded) Alternative solution: Unit sales to attain = Target profit + Fixed expenses target profit Unit contribution margin =

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

Thus, sales will have to increase by 12,857 balls (= 42,857 balls – 30,000 balls = 12,857 balls) to earn the same amount of net 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 21,000 30,000

Expected 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.

Problem 5-20 (continued) 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. 5. The new CM ratio would be: Selling price ........................ Variable expenses................ Contribution margin.............

$25 100% 9* 36% $16 64%

*$15 – ($15 × 40%) = $9 The new break-even point would be: Profit = Unit CM × Q − Fixed expenses $0 = $16 × Q – ($210,000 × 2) $16Q = $420,000 Q = $420,000 ÷ $16 Q = 26,250 balls Alternative solution: Fixed expenses Unit sales to = break even Unit contribution margin =

$420,000 = 26,250 balls $16

Although this new break-even point is greater than the company’s present break-even point 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]. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 46

Managerial Accounting, 16th Edition

Problem 5-20 (continued) 6.

Profit = Unit CM × Q − Fixed expenses $90,000 = $16 × Q − $420,000 $16Q = $90,000 + $420,000 Q = $510,000 ÷ $16 Q = 31,875 balls

Alternative solution:

Unit sales to attain = Target profit + Fixed expenses target profit 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]. 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 ................................................. Net operating income .......................................

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

Contribution margin Degree of = operating leverage Net operating income =

$480,000 =8 $60,000

Problem 5-20 (continued) 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.

Managerial Accounting, 16th Edition

Problem 5-21 (30 minutes)

Product Fragrant

Loonzain

Total

24% $180,000 100% 36,000 20% $144,000 80%

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

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

White

Percentage of total sales ..................... 40% Sales ....................... $300,000 100% Variable expenses .... 216,000 72% Contribution margin.. $ 84,000 28% Fixed expenses ........ Net operating income (loss).........

$ (59,280)

*$390,000 ÷ $750,000 = 52% 2. Break-even sales would be:

Dollar sales to = Fixed expenses break even CM ratio =

$449,280 = $864,000 0.52

Problem 5-21 (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 from that budgeted. This is the reason the budgeted net operating income was not met, and the reason the break-even sales were greater than budgeted. The company’s sales mix was planned at 20% White, 52% Fragrant, and 28% Loonzain. The actual sales mix was 40% White, 24% Fragrant, and 36% Loonzain. As shown by these data, sales shifted away from Fragrant Rice, which provides our greatest contribution per dollar of sales, and shifted toward White Rice, which provides our least contribution per dollar of sales. Although the company met its budgeted level of sales, these sales provided considerably less contribution margin than we had planned, with a resulting decrease in net operating income. Notice from the attached statements that the company’s overall CM ratio was only 52%, as compared to a planned CM 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 provide sufficient contribution margin to cover fixed costs.

Managerial Accounting, 16th Edition

Problem 5-22 (60 minutes) 1. The CM ratio is 30%.

Total

Sales (19,500 units) ........ $585,000 Variable expenses ........... 409,500 Contribution margin......... $175,500

Per Unit Percent of Sales $30.00 21.00 $ 9.00

100% 70% 30%

The break-even point is: Profit = Unit CM × Q − Fixed expenses $0 = ($30 − $21) × Q − $180,000 $0 = ($9) × Q − $180,000 $9Q = $180,000 Q = $180,000 ÷ $9 Q = 20,000 units 20,000 units × $30 per unit = $600,000 in sales Alternative solution:

Fixed expenses Unit sales to = break even Unit contribution margin =

$180,000 = 20,000 units $9.00

Dollar sales to = Fixed expenses break even 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 net 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 – $4,500 = $3,500).

Problem 5-22 (continued) 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) ........... Net operating loss .........................................

$1,053,000

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

*$30.00 – ($30.00 × 0.10) = $27.00 4.

Profit = Unit CM × Q − Fixed expenses $9,750 = ($30.00 − $21.75) × Q − $180,000 $9,750 = ($8.25) × Q − $180,000 $8.25Q = $189,750 Q = $189,750 ÷ $8.25 Q = 23,000 units *$21.00 + $0.75 = $21.75 Alternative solution:

Unit sales to attain = Target profit + Fixed expenses target profit CM per unit =

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

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

Per Unit $30.00 18.00 $12.00

Percent of Sales 100% 60% 40%

Managerial Accounting, 16th Edition

Problem 5-22 (continued) The new break-even point would be: Fixed expenses Unit sales to = break even Unit contribution margin =

$180,000 + $72,000 $12.00

= 21,000 units Dollar sales to = Fixed expenses break even CM ratio =

$180,000 + $72,000 0.40

= $630,000

b. Comparative income statements follow:

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

Not Automated Per Total Unit %

Automated Per Total Unit

$780,000 $30.00 100

546,000 21.00

468,000

18.00

234,000 $ 9.00 180,000

312,000 $12.00 252,000

$ 54,000

$ 60,000

Problem 5-22 (continued) c.

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 (= $60,000 – $54,000) 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. Note to the Instructor: Although it is not asked for in the problem, if time permits you may want to compute the point of indifference between the two alternatives in terms of units sold; i.e., the point where profits will be the same under either alternative. At this point, total revenue will be the same; hence, we include only costs in our equation: Let Q = Point of indifference in units sold $21.00Q + $180,000 = $18.00Q + $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).

Managerial Accounting, 16th Edition

Problem 5-23 (60 minutes) 1. The CM ratio is 60%: Sales price ...................... Variable expenses ........... Contribution margin ........

$20.00 100% 8.00 40% $12.00 60%

2. Dollar sales to Fixed expenses = break even CM ratio

$180,000 0.60

= $300,000 3. $75,000 increased sales × 0.60 CM ratio = $45,000 increased contribution margin. Because the fixed costs will not change, net operating income should also increase by $45,000. 4a. The degree of operating leverage is calculated as follows: 4.

Contribution margin Degree of = operating leverage Net operating income =

$240,000 $60,000

=4 4b. 4 × 20% = 80% increase in net operating income. In dollars, this increase would be 80% × $60,000 = $48,000.

Problem 5-23 (continued) 5. This year’s net operating income is computed as follows: Sales (25,000 units × $18 per unit) .................... Variable expenses (25,000 units × $8 per unit) ... Contribution margin .......................................... Fixed expenses ($180,000 + $30,000)................ Net operating income ........................................

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

The sales manager’s suggestions should not be implemented because they will lower net operating income by $20,000 (= $60,000 – $40,000). 6. Expected total contribution margin: 20,000 units × 1.25 × $11.00 per unit* ........................ Present total contribution margin .................................... Incremental contribution margin, and the amount by which advertising can be increased with net operating income remaining unchanged.......................................

$275,000 240,000 $ 35,000

*$20.00 – ($8.00 + $1.00) = $11.00

Managerial Accounting, 16th Edition

Problem 5-24 (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 .................................

$13.50 $8.00 1.50

9.50 $ 4.00

Since there are no fixed costs, the number of unit sales needed to yield the desired $1,200 in profits can be obtained by dividing the target $1,200 profit by the unit contribution margin:

Target profit $1,200 = = 300 sweatshirts Unit CM $4.00 300 sweatshirts × $13.50 per sweatshirt = $4,050 in total sales 2. Since an order has been placed, there is now a “fixed” cost associated with the purchase price of the sweatshirts (i.e., the sweatshirts can’t be returned). For example, an order of 75 sweatshirts requires a “fixed” cost (investment) of $600 (=75 sweatshirts × $8.00 per sweatshirt). The new contribution margin per sweatshirt becomes: Selling price ......................................... Variable expenses (commissions only) ... Contribution margin..............................

$13.50 1.50 $12.00

Since the “fixed” cost of $600 must be recovered before Mr. Hooper shows any profit, the break-even computation would be:

Unit sales to = Fixed expenses break even Unit CM =

$600 = 50 sweatshirts $12.00

50 sweatshirts × $13.50 per sweatshirt = $675 in total sales If a quantity other than 75 sweatshirts were ordered, the answer would change accordingly.

Problem 5-25 (45 minutes) 1. The contribution margin per unit on the first 16,000 units is: Sales price .......................... Variable expenses................ Contribution margin.............

Per Unit $3.00 1.25 $1.75

The contribution margin per unit on anything over 16,000 units is: Sales price .......................... Variable expenses................ Contribution margin.............

Per Unit $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 ....

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

Managerial Accounting, 16th Edition

Problem 5-25 (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 2.

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.

Problem 5-26 (60 minutes) 1.

Profit = Unit CM × Q − Fixed expenses $0 = ($30 − $18) × Q − $150,000 $0 = ($12) × Q − $150,000 $12Q = $150,000 Q = $150,000 ÷ $12 Q = 12,500 pairs 12,500 pairs × $30 per pair = $375,000 in sales Alternative solution:

Unit sales to = Fixed expenses break even Unit CM =

$150,000 = 12,500 pairs $12.00

Dollar sales to = Fixed expenses break even CM ratio =

$150,000 = $375,000 in sales 0.40

2. See the graph on the following page. 3. The simplest approach is: Break-even sales ....................... Actual sales ............................... Sales short of break-even ...........

12,500 pairs 12,000 pairs 500 pairs

500 pairs × $12 contribution margin per pair = $6,000 loss Alternative solution: Sales (12,000 pairs × $30.00 per pair) ..... Variable expenses (12,000 pairs × $18.00 per pair) ........... Contribution margin ................................ Fixed expenses ....................................... Net operating loss...................................

$360,000 216,000 144,000 150,000 $ (6,000)

Managerial Accounting, 16th Edition

Problem 5-26 (continued) 2. Cost-volume-profit graph: $500

Break-even point: 12,500 pairs of shoes or $375,000 total sales

$450 $400

Total Sales Total Expense s

Total Sales (000s)

$350 $300 $250 $200

Total Fixed Expense s

$150 $100 $50 $0 0

2,500

5,000

7,500

10,000 12,500 15,000 17,500 20,000

Number of Pairs of Shoes Sold

Problem 5-26 (continued) 4. The variable expenses will now be $18.75 per pair, and the contribution margin will be $11.25 per pair. Profit = Unit CM × Q − Fixed expenses $0 = ($30.00 − $18.75) × Q − $150,000 $0 = ($11.25) × Q − $150,000 $11.25Q = $150,000 Q = $150,000 ÷ $11.25 Q = 13,333 pairs (rounded) 13,333 pairs × $30.00 per pair = $400,000 in sales Alternative solution:

Unit sales to = Fixed expenses break even CM per unit =

$150,000 = 13,333 pairs $11.25

Dollar sales to = Fixed expenses break even CM ratio =

$150,000 = $400,000 in sales 0.375

5. The simplest approach is: Actual sales ................................ Break-even sales......................... Excess over break-even sales ......

15,000 pairs 12,500 pairs 2,500 pairs

2,500 pairs × $11.50 per pair* = $28,750 profit *$12.00 present contribution margin – $0.50 commission = $11.50

Managerial Accounting, 16th Edition

Problem 5-26 (continued) 6. The new variable expenses will be $13.50 per pair. Profit = Unit CM × Q − Fixed expenses $0 = ($30.00 − $13.50) × Q – ($150,000 + $31,500) $0 = ($16.50) × Q − $181,500 $16.50Q = $181,500 Q = $181,500 ÷ $16.50 Q = 11,000 pairs 11,000 pairs × $30.00 per pair = $330,000 in sales Although the change will lower the break-even point from 12,500 pairs to 11,000 pairs, the company must consider whether this reduction in the break-even point is more than offset by the possible loss in sales arising from having the sales staff on a salaried basis. Under a salary arrangement, the sales staff has less incentive to sell than under the present commission arrangement, resulting in a potential loss of sales and a reduction of profits. Although it is generally desirable to lower the break-even point, management must consider the other effects of a change in the cost structure. The break-even point could be reduced dramatically by doubling the selling price but it does not necessarily follow that this would improve the company’s profit.

Problem 5-27 (45 minutes) 1. a.

Sales .......................... Variable expenses ....... Contribution margin .... Fixed expenses ........... Net operating income .. b.

Hawaiian Fantasy (20,000 units) Amount %

Tahitian Joy (5,000 units) Amount %

Total Amount %

$300,000 100% $500,000 100% $800,000 100% 180,000 60% 100,000 20% 280,000 35% $120,000 40% $400,000 80% 520,000 65% 475,800 $ 44,200

Dollar sales to = Fixed expenses = $475,800 = $732,000 break even CM ratio 0.65

Margin of safety = Actual sales - Break-even sales = $800,000 - $732,000 = $68,000 Margin of safety = Margin of safety in dollars percentage Actual sales =

$68,000 = 8.5% $800,000

Managerial Accounting, 16th Edition

Problem 5-27 (continued)

2. a.

Hawaiian Fantasy (20,000 units) Amount %

Sales ................. $300,000 100% Variable expenses ........ 180,000 60% Contribution margin ............ $120,000 40% Fixed expenses .. Net operating income ...........

Tahitian Joy (5,000 units) Amount %

Samoan Delight (10,000 units) Amount %

Total Amount

100,000

20%

360,000

80%

640,000 51.2%

$400,000

80%

$ 90,000

20%

610,000 48.8% 475,800

$500,000 100% $450,000 100% $1,250,000 100.0%

$ 134,200

Problem 5-27 (continued) b.

Dollar sales to = Fixed expenses = $475,800 = $975,000 break even CM ratio 0.488

Margin of safety = Actual sales - Break-even sales = $1,250,000 - $975,000 = $275,000 Margin of safety = Margin of safety in dollars percentage Actual sales $275,000 = = 22% $1,250,000 3. The reason for the increase in the break-even point can be traced to the decrease in the company’s overall contribution margin ratio when the third product is added. Note from the income statements above that this ratio drops from 65% to 48.8% with the addition of the third product. This product (the Samoan Delight) has a CM ratio of only 20%, which causes the average contribution margin per dollar of sales to shift downward. This problem shows the somewhat tenuous nature of break-even analysis when the company has more than one product. The analyst must be very careful of his or her assumptions regarding sales mix, including the addition (or deletion) of new products. It should be pointed out to the president that even though the breakeven point is higher with the addition of the third product, the company’s margin of safety is also greater. Notice that the margin of safety increases from $68,000 to $275,000 or from 8.5% to 22%. Thus, the addition of the new product shifts the company much further from its break-even point, even though the break-even point is higher.

Managerial Accounting, 16th Edition

Problem 5-28 (60 minutes) 1.

Carbex, Inc. Income Statement For April

Standard Amount %

Deluxe Amount %

Total Amount %

Sales............................ $240,000 100 $150,000 100 $390,000 100.0 Variable expenses: Production ................. 60,000 25 60,000 40 120,000 30.8 Sales commission ....... 36,000 15 22,500 15 58,500 15.0 Total variable expenses . 96,000 40 82,500 55 178,500 45.8 Contribution margin ...... $144,000 60 $ 67,500 45 $211,500 54.2 Fixed expenses: Advertising ................ 105,000 Depreciation .............. 21,700 Administrative ............ 63,000 Total fixed expenses ..... 189,700 Net operating income.... $ 21,800 Carbex, Inc. Income Statement For May

Standard Amount %

Sales............................ $60,000 100 Variable expenses: Production ................. 15,000 25 Sales commission ....... 9,000 15 Total variable expenses . 24,000 40 Contribution margin ...... $36,000 60 Fixed expenses: Advertising ................ Depreciation .............. Administrative ............ Total fixed expenses ..... Net operating income....

Deluxe Amount %

Total Amount %

$375,000 100

$435,000 100.0

150,000 56,250 206,250 $168,750

165,000 65,250 230,250 204,750

40 15 55 45

37.9 15.0 52.9 47.1

105,000 21,700 63,000 189,700 $ 15,050

Problem 5-28 (continued) 2. The sales mix has shifted over the last year from Standard sets to Deluxe sets. This shift has caused a decrease in the company’s overall CM ratio from 54.2% in April to 47.1% in May. For this reason, even though total sales (in dollars) are greater, net operating income is lower. 3. Sales commissions could be based on contribution margin rather than on sales price. A flat rate on total contribution margin, as the text suggests, might encourage the salespersons to emphasize the product with the greatest contribution to the profits. a. The break-even in dollar sales can be computed as follows: Dollar sales to = Fixed expenses = $189,700 = $350,000 break even CM ratio 0.542

b. The break-even point in May would be higher than the break-even point in April. This occurs because the sales mix has shifted from the more profitable to the less profitable units, which in turn decreases the company’s overall CM ratio.

Managerial Accounting, 16th Edition

Problem 5-29 (60 minutes) 1. The income statements would be:

Sales ......................... Variable expenses ...... Contribution margin ... Fixed expenses .......... Net operating income .

Sales ......................... Variable expenses* .... Contribution margin ... Fixed expenses .......... Net operating income .

Present Amount Per Unit

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

$30 21 $ 9

100% 70% 30%

Proposed Amount Per Unit

$450,000 180,000 270,000 225,000 $ 45,000

$30 12 $18

100% 40% 60%

*$21 – $9 = $12 2. a. Degree of operating leverage: Present: Contribution margin Degree of = operating leverage Net operating income =

$135,000 =3 $45,000

Proposed: Contribution margin Degree of = operating leverage Net operating income =

$270,000 =6 $45,000

Problem 5-29 (continued) b. Dollar sales to break even: Present: Dollar sales to = Fixed expenses break even CM ratio =

$90,000 = $300,000 0.30

Proposed: Dollar sales to = Fixed expenses break even CM ratio =

$225,000 = $375,000 0.60

c. Margin of safety: Present:

Margin of safety = Actual sales - Break-even sales = $450,000 - $300,000 = $150,000 Margin of safety = Margin of safety in dollars percentage Actual sales =

$150,000 = 33.33% $450,000

Proposed:

Margin of safety = Actual sales - Break-even sales = $450,000 - $375,000 = $75,000 Margin of safety = Margin of safety in dollars percentage Actual sales =

$75,000 = 16.67% $450,000

Managerial Accounting, 16th Edition

Problem 5-29 (continued) 3. The major factor would be the sensitivity of the company’s operations to cyclical movements in the economy. Because the new equipment will increase the CM ratio, in years of strong economic activity, the company will be better off with the new equipment. However, in economic recession, the company will be worse off with the new equipment. The fixed costs of the new equipment will cause losses to be deeper and sustained more quickly than at present. Thus, management must decide whether the potential for 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: Profit = (Sales − Variable expenses) − Fixed expenses $54,000** = ($585,000* − Variable expenses) − $180,000 Variable expenses = $585,000 − $180,000 − $54,000 = $351,000 *New level of sales: $450,000 × 1.30 = $585,000 **New level of net operating income: $45,000 × 1.2 = $54,000 New CM ratio: Sales ................................ $585,000 Variable expenses.............. 351,000 Contribution margin........... $234,000

100% 60% 40%

With the above data, the new break-even point can be computed: Dollar sales to = Fixed expenses = $180,000 = $450,000 break even CM ratio 0.40

Problem 5-29 (continued) The greatest risk is that the increases in sales and net operating income predicted by the marketing manager will not happen and that sales will remain at their present level. Note that the present level of sales is $450,000, which is equal to the break-even level of sales under the new marketing method. Thus, if the new marketing strategy is adopted and sales remain unchanged, profits will drop from the current level of $45,000 per month to zero. It would be a good idea to compare the new marketing strategy to the current situation more directly. What level of sales would be needed under the new method to generate at least the $45,000 in profits the company is currently earning each month? The computations are: Dollar sales to = Target profit + Fixed expenses attain target profit CM ratio =

$45,000 + $180,000 0.40

= $562,500 in sales each month

Thus, sales would have to increase by at least 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.

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Problem 5-30 (60 minutes) 1.

Profit = Unit CM × Q − Fixed expenses $0 = ($40 − $16) × Q − $60,000 $0 = ($24) × Q − $60,000 $24Q = $60,000 Q = $60,000 ÷ $24 Q = 2,500 pairs, or at $40 per pair, $100,000 in sales Alternative solution: Unit sales to = Fixed expenses = $60,000 = 2,500 pairs break even CM per unit $24.00

Dollar sales to = Fixed expenses = $60,000 = $100,000 break even CM ratio 0.60 2. See the graphs 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 pairs Alternative solution: Unit sales to attain = Target profit + Fixed expenses target profit Unit contribution margin =

$18,000 + $60,000 = 3,250 pairs $24.00

4. Incremental contribution margin: $25,000 increased sales × 60% CM ratio ..... Incremental fixed salary cost ......................... Increased net income ....................................

$15,000 8,000 $ 7,000

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

Problem 5-30 (continued) 5. a.

Contribution margin $72,000 Degree of = = =6 operating leverage Net operating income $12,000

b. 6 × 50% sales increase = 300% increase in net operating income. Thus, net operating income next year would be: $12,000 + ($12,000 × 300%) = $48,000. 2. Cost-volume-profit graph: $200

Total Sales

$180 $160

Total Sales (000s)

$140

Break-even point: 2,500 pairs of sandals or $100,000 total sales

$120

Total Expense s

$100 $80

Total Fixed Expense s

$60 $40 $20 $0 0

500

1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000

Number of Pairs of Sandals Sold

Managerial Accounting, 16th Edition

Problem 5-30 (continued) Profit graph:

Profit Graph $35,000 $30,000 $25,000 $20,000 $15,000

Break-even point: 2,500 sandals

$10,000 $5,000 $0

Profit

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

-$20,000 -$25,000 -$30,000 -$35,000 -$40,000 -$45,000 -$50,000 -$55,000 -$60,000 0

500

1,000 1,500 2,000 2,500 3,000 3,500 4,000

Sales Volume in Units

Problem 5-31 (30 minutes) 1. (1) (2) (3) (4) (5) (6) (7) (8) (9)

Dollars Volume of output, expressed in units, % of capacity, sales, or some other measure Total expense line Variable expense area Fixed expense area Break-even point Loss area Profit area Sales line

Managerial Accounting, 16th Edition

Problem 5-31 (continued) 2. a. Line 3: Line 9: Break-even point:

Remain unchanged. Have a steeper slope. Decrease.

b. Line 3: Line 9: Break-even point:

Have a flatter slope. Remain unchanged. Decrease.

c. Line 3: Line 9: Break-even point:

Shift upward. Remain unchanged. Increase.

d. Line 3: Line 9: Break-even point:

Remain unchanged. Remain unchanged. Remain unchanged.

e. Line 3: Line 9: Break-even point:

Shift downward and have a steeper slope. Remain unchanged. Probably change, but the direction is uncertain.

f. Line 3: Line 9: Break-even point:

Have a steeper slope. Have a steeper slope. Remain unchanged in terms of units; increase in terms of total dollars of sales.

g. Line 3: Line 9: Break-even point:

Shift upward. Remain unchanged. Increase.

h. Line 3: Line 9: Break-even point:

Shift upward and have a flatter slope. Remain unchanged. Probably change, but the direction is uncertain.

Case 5-32 (60 minutes) Note: This is a problem that will challenge the very best students’ conceptual and analytical skills. However, working through this case will yield substantial dividends in terms of a much deeper understanding of critical management accounting concepts. 1. The overall break-even sales can be determined using the CM ratio.

Velcro

Sales ............................. $165,000 Variable expenses .......... 125,000 Contribution margin ....... $ 40,000 Fixed expenses .............. Net operating income ..... CM ratio =

Metal

Nylon

Total

$300,000 $340,000 $805,000 140,000 100,000 365,000 $160,000 $240,000 440,000 400,000 $ 40,000

Contribution margin $440,000 = = 0.5466 Sales $805,000

Dollar sales to = Fixed expenses = $400,000 = $731,797 (rounded) break even CM ratio 0.5466 2. The issue is what to do with the common fixed cost when computing the break-evens for the individual products. The correct approach is to ignore the common fixed costs. If the common fixed costs are included in the computations, the break-even points will be overstated for individual products and managers may drop products that in fact are profitable. a. The break-even points for each product can be computed using the contribution margin approach as follows:

Velcro

Metal

Nylon

Unit selling price .................................. $1.65 $1.50 $0.85 Variable cost per unit ........................... 1.25 0.70 0.25 Unit contribution margin (a) .................. $0.40 $0.80 $0.60 Product fixed expenses (b) ................... $20,000 $80,000 $60,000 Unit sales to break even (b) ÷ (a) ......... 50,000 100,000 100,000

Managerial Accounting, 16th Edition

Case 5-32 (continued) b. If the company were to sell exactly the break-even quantities computed above, the company would lose $240,000—the amount of the common fixed cost. This can be verified as follows: Unit sales ................... Sales .......................... Variable expenses ....... Contribution margin .... Fixed expenses ........... Net operating loss .......

Velcro

Metal

Nylon

50,000 100,000 100,000 $82,500 $150,000 $85,000 62,500 70,000 25,000 $20,000 $ 80,000 $60,000

Total $317,500 157,500 160,000 400,000 $(240,000)

At this point, many students conclude that something is wrong with their answer to part (a) because a result in which the company loses money operating at the break-evens for the individual products does not seem to make sense. They also worry that managers may be lulled into a false sense of security if they are given the break-evens computed in part (a). Total sales at the individual product break-evens is only $317,500, whereas the total sales at the overall break-even computed in part (1) is $731,797. Many students (and managers, for that matter) attempt to resolve this apparent paradox by allocating the common fixed costs among the products prior to computing the break-evens for individual products. Any of a number of allocation bases could be used for this purpose—sales, variable expenses, product-specific fixed expenses, contribution margins, etc. (We usually take a tally of how many students allocated the common fixed costs using each possible allocation base before proceeding.) For example, the common fixed costs are allocated on the next page based on sales.

Case 5-32 (continued) Allocation of common fixed expenses on the basis of sales revenue: Sales................................... Percentage of total sales ...... Allocated common fixed expense* .......................... Product fixed expenses ........ Allocated common and product fixed expenses (a) Unit contribution margin (b) . “Break-even” point in units sold (a) ÷ (b) ...................

Velcro

Metal

Nylon

Total

$165,000 20.497%

$300,000 $340,000 $805,000 37.267% 42.236% 100.0%

$49,193 20,000

$ 89,441 $101,366 $240,000 80,000 60,000 160,000

$69,193 $0.40

$169,441 $161,366 $400,000 $0.80 $0.60

172,983

211,801

268,943

*Total common fixed expense × percentage of total sales If the company sells 172,983 units of the Velcro product, 211,801 units of the Metal product, and 268,943 units of the Nylon product, the company will indeed break even overall. However, the apparent break-evens for two of the products are higher than their normal annual sales. Normal annual sales volume .... “Break-even” annual sales ....... “Strategic” decision .................

Velcro

100,000 172,983 drop

Metal

200,000 211,801 drop

Nylon

400,000 268,943 retain

It would be natural for managers to interpret a break-even for a product as the level of sales below which the company would be financially better off dropping the product. Therefore, we should not be surprised if managers, based on the above erroneous break-even calculation, would decide to drop the Velcro and Metal products and concentrate on the company’s “core competency,” which appears to be the Nylon product.

Managerial Accounting, 16th Edition

Case 5-32 (continued) If the managers drop the Velcro and Metal products, the company would face a loss of $60,000 computed as follows: Sales............................ Variable expenses ......... Contribution margin ...... Fixed expenses* ........... Net operating loss.........

Velcro

dropped

Metal

Nylon

dropped $340,000 100,000 $240,000

Total

$340,000 100,000 240,000 300,000 $ (60,000)

* By dropping the two products, the company reduces its fixed expenses by only $100,000 ($20,000 + $80,000). Therefore, the total fixed expenses are $300,000 rather than $400,000. By dropping the two products, the company would go from making a profit of $40,000 to suffering a loss of $60,000. The reason is that the two dropped products were contributing $100,000 toward covering common fixed expenses and toward profits. This can be verified by looking at a segmented income statement like the one that will be introduced in a later chapter.

Velcro

Metal

Nylon

Total

Sales................................... $165,000 $300,000 $340,000 $805,000 Variable expenses ................ 125,000 140,000 100,000 365,000 Contribution margin ............. 40,000 160,000 240,000 440,000 Product fixed expenses ........ 20,000 80,000 60,000 160,000 Product segment margin ...... $ 20,000 $ 80,000 $180,000 280,000 Common fixed expenses ...... 240,000 Net operating income ........... $ 40,000 $100,000

Case 5-33 (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 $16,000

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

100%

60% 40%

20% Commission $16,000

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

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

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

Own Sales Force

Managerial Accounting, 16th Edition

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

Case 5-33 (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 = Fixed expenses = $4,800,000 = $12,000,000 break even CM ratio 0.40

b. Break-even point in dollar sales if the commission increases to 20%: Dollar sales to = Fixed expenses = $4,800,000 = $13,714,286 break even CM ratio 0.35

c. Break-even point in dollar sales if the company employs its own sales force: Dollar sales to = Fixed expenses = $7,125,000 = $15,000,000 break even 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 = Target income before taxes + Fixed expenses attain target 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.

Case 5-33 (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.

15% 20% Own Commission Commission Sales Force

Contribution margin (Part 1) (a) ..... $6,400,000 Income before taxes (Part 1) (b) .... $1,600,000 Degree of operating leverage: (a) ÷ (b) .................................... 4

$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. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 84

Managerial Accounting, 16th Edition

Appendix 5A Analyzing Mixed Costs Exercise 5A-1 (20 minutes) 1. High activity level (August) .. Low activity level (October) . Change...............................

OccupancyDays 2,406 124 2,282

Electrical Costs $5,148 1,588 $3,560

Variable cost = Change in cost ÷ Change in activity = $3,560 ÷ 2,282 occupancy-days = $1.56 per occupancy-day Total cost (August)..................................................... Variable cost element ($1.56 per occupancy-day × 2,406 occupancy-days) . Fixed cost element .....................................................

$5,148 3,753 $1,395

2. Electrical costs may reflect seasonal factors other than just the variation in occupancy days. For example, common areas such as the reception area must be lighted for longer periods during the winter than in the summer. This will result in seasonal fluctuations in the fixed electrical costs. Additionally, fixed costs will be affected by the number of days in a month. In other words, costs like the costs of lighting common areas are variable with respect to the number of days in the month, but are fixed with respect to how many rooms are occupied during the month. Other, less systematic, factors may also affect electrical costs such as the frugality of individual guests. Some guests will turn off lights when they leave a room. Others will not.

Exercise 5A-2 (20 minutes) 1. and 2. The scattergraph plot and least-squares regression estimates of fixed and variable costs using Microsoft Excel are shown below:

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. Note that 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, 16th Edition

Exercise 5A-3 (20 minutes) 1. High level of activity ......................... Low level of activity .......................... Change............................................

Kilometers Total Annual Driven Cost* 105,000 70,000 35,000

$11,970 9,380 $ 2,590

* 105,000 kilometers × $0.114 per kilometer = $11,970 70,000 kilometers × $0.134 per kilometer = $9,380 Variable cost per kilometer: Change in cost $2,590 = =$0.074 per kilometer Change in activity 35,000 kilometers

Fixed cost per year: Total cost at 105,000 kilometers ..................... Less variable portion: 105,000 kilometers × $0.074 per kilometer .. Fixed cost per year ........................................

$11,970 7,770 $ 4,200

2. Y = $4,200 + $0.074X 3. Fixed cost ......................................................... Variable cost: 80,000 kilometers × $0.074 per kilometer ........ Total annual cost ...............................................

$ 4,200 5,920 $10,120

Exercise 5A-4 (45 minutes) 1. The scattergraph appears below:

$3,000

Shipping Expense

$2,500 $2,000 $1,500

$1,000 $500 $0 0

Units Shipped Yes, there is an approximately linear relationship between the number of units shipped and the total shipping expense.

Managerial Accounting, 16th Edition

Exercise 5A-4 (continued) 2. The high-low estimates and cost formula are computed as follows:

Units Shipped Shipping Expense High activity level (June) ..... Low activity level (July) ....... Change...............................

8 2 6

$2,700 1,200 $1,500

Variable cost element:

Change in expense $1,500 = =$250 per unit. Change in activity 6 units Fixed cost element: Shipping expense at high activity level ....................... Less variable cost element ($250 per unit × 8 units) .. Total fixed cost .........................................................

$2,700 2,000 $ 700

The cost formula is $700 per month plus $250 per unit shipped or Y = $700 + $250X, where X is the number of units shipped. The scattergraph on the following page shows the straight line drawn through the high and low data points.

Exercise 5A-4 (continued)

$3,000

Shipping Expense

$2,500 $2,000

$1,500 $1,000 $500 $0 0

Units Shipped 3. The high-low estimate of fixed costs is $210.71 (= $910.71 – $700.00) lower than the estimate provided by least-squares regression. The highlow estimate of the variable cost per unit is $32.14 (= $250.00 – $217.86) higher than the estimate provided by least-squares regression. A straight line that minimized the sum of the squared errors would intersect the Y-axis at $910.71 instead of $700. It would also have a flatter slope because the estimated variable cost per unit is lower than the high-low method. 4. The cost of shipping units is likely to depend on the weight and volume of the units shipped and the distance traveled as well as on the number of units shipped. In addition, higher cost shipping might be necessary to meet a deadline. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 90

Managerial Accounting, 16th Edition

Exercise 5A-5 (20 minutes) 1. and 2. The scattergraph plot and regression estimates of fixed and variable costs using Microsoft Excel are shown below:

Note that the R2 is approximately 0.94, which means that 94% of the variation in etching costs is explained by the number of units etched. This is a very high R2 which indicates a very good fit. The regression equation, in the form Y = a + bX, is as follows (where a is rounded to nearest dollar and b is rounded to the nearest cent): Y = $12.32 + $1.54X 3. Total expected etching cost if 5 units are processed: Variable cost: 5 units × $1.54 per unit ...... Fixed cost ............................................... Total expected cost .................................

$ 7.70 12.32 $20.02

Problem 5A-6 (30 minutes) 1. The scattergraph plot and regression estimates of fixed and variable costs using Microsoft Excel are shown below:

The cost formula, in the form Y = a + bX, using tons mined as the activity base is $28,352 per quarter plus $2.58 per ton mined, or Y = $28,352 + $2.58X. Note that the R2 is approximately 0.47, which means that only 47% of the variation in utility costs is explained by the number of tons mined.

Managerial Accounting, 16th Edition

Problem 5A-6 (continued) 2. The scattergraph plot and regression estimates of fixed and variable costs using Microsoft Excel are shown below:

The cost formula, in the form Y = a + bX, using direct labor-hours as the activity base is $17,000 per quarter plus $9.00 per direct labor-hour, or: Y = $17,000 + $9.00X. Note that the R2 is approximately 0.93, which means that 93% of the variation in utility costs is explained by direct labor-hours. This is a very high R2 which is an indication of a very good fit. 3. The company should probably use direct labor-hours as the activity base, since the fit of the regression line to the data is much tighter than it is with tons mined. The R2 for the regression using direct labor-hours as the activity base is twice as large as for the regression using tons mined as the activity base. However, managers should look more closely at the costs and try to determine why utilities costs are more closely tied to direct labor-hours than to the number of tons mined.

Problem 5A-7 (45 minutes) 1. Cost of goods sold................... Variable Advertising expense ................ Fixed Shipping expense .................... Mixed Salaries and commissions ........ Mixed Insurance expense .................. Fixed Depreciation expense .............. Fixed 2. Analysis of the mixed expenses:

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

Shipping Expense

Units

5,000 4,000 1,000

$38,000 34,000 $ 4,000

Salaries and Commissions Expense $90,000 78,000 $12,000

Variable cost element:

Variable rate =

Change in cost Change in activity

Shipping expense:

$4,000 = $4 per unit 1,000 units

Salaries and commissions expense:

$12,000 = $12 per unit 1,000 units

Fixed cost element:

Cost at high level of activity ... Less variable cost element: 5,000 units × $4 per unit .... 5,000 units × $12 per unit ... Fixed cost element.................

Shipping Expense

$38,000 20,000 $18,000

Salaries and Commissions Expense

$90,000 60,000 $30,000

Managerial Accounting, 16th Edition

Problem 5A-7 (continued) The cost formulas are: Shipping expense: $18,000 per month plus $4 per unit or Y = $18,000 + $4X Salaries and commissions expense: $30,000 per month plus $12 per unit or Y = $30,000 + $12X 3. Morrisey & Brown, Ltd. Income Statement For the Month Ended September 30 Sales (5,000 units × $100 per unit) ........... Variable expenses: Cost of goods sold (5,000 units × $60 per unit) ............... Shipping expense (5,000 units × $4 per unit) .................. Salaries and commissions expense (5,000 units × $12 per unit) ................ Contribution margin ................................. Fixed expenses: Advertising expense ............................... Shipping expense .................................. Salaries and commissions expense ......... Insurance expense ................................ Depreciation expense............................. Net operating income ...............................

$500,000 $300,000 20,000 60,000 21,000 18,000 30,000 6,000 15,000

380,000 120,000

90,000 $ 30,000

Problem 5A-8 (20 minutes) 1. Maintenance cost at the 90,000 machine-hour level of activity can be isolated as follows:

Total factory overhead cost ........ Deduct: Utilities cost @ $0.80 per MH*. Supervisory salaries ................ Maintenance cost ......................

Level of Activity 60,000 MHs 90,000 MHs $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 ...................................

Machine- Maintenance Hours 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, 16th Edition

Problem 5A-8 (continued) 3. Utilities cost .................... Supervisory salaries cost.. Maintenance cost ............ Total overhead cost .........

Variable Cost per Machine-Hour

Fixed Cost

1.60 $2.40

$21,000 9,000 $30,000

$0.80

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 5A-9 (30 minutes) 1. High-low method:

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

Variable cost per unit = =

Units Sold

20,000 10,000 10,000

Shipping Expense

$210,000 119,000 $91,000

Change in cost Change in activity $91,000 = $9.10 per unit 10,000 units

Fixed cost element: Total shipping expense at high activity level .................................................... Less variable element: 20,000 units × $9.10 per unit................ Fixed cost element ..................................

$210,000 182,000 $ 28,000

Therefore, the cost formula is: Y = $28,000 + $9.10X.

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Problem 5A-9 (continued) 2.

Milden Company Budgeted Contribution Format Income Statement For the First Quarter, Year 3 Sales (12,000 units × $100 per unit) ............ $1,200,000 Variable expenses: Cost of goods sold (12,000 units × $35 unit) ....................... $420,000 Sales commission (6% × $1,200,000)........ 72,000 Shipping expense (12,000 units × $9.10 per unit) .............. 109,200 Total variable expenses................................ 601,200 Contribution margin .................................... 598,800 Fixed expenses: Advertising expense .................................. 210,000 Shipping expense ..................................... 28,000 Administrative salaries .............................. 145,000 Insurance expense ................................... 9,000 Depreciation expense................................ 76,000 Total fixed expenses .................................... 468,000 Net operating income .................................. $ 130,800

Problem 5A-10 (30 minutes) 1. and 2. The scattergraph plot and regression estimates of fixed and variable costs using Microsoft Excel are shown below:

The cost formula, in the form Y = a + bX, using number of sections offered as the activity base is $3,700 per quarter plus $1,750 per section offered, or: Y = $3,700 + $1,750X Note that the R2 is approximately 0.96, which means that 96% of the variation in cost is explained by the number of sections. This is a very high R2 which indicates a very good fit.

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Problem 5A-10 (continued) 3. Expected total cost would be: Fixed cost ....................................................... $ 3,700 Variable cost (8 sections × $1,750 per section) . 14,000 Total cost ........................................................ $17,700 The problem with using the cost formula from (2) to derive total cost is that an activity level of 8 sections may lie outside the relevant range— the range of activity within which the fixed cost is approximately $3,700 per term and the variable cost is approximately $1,750 per section offered. These approximations appear to be reasonably accurate within the range of 2 to 6 sections, but they may be invalid outside this range.

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Case 5A-11 (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 MH Fixed element: Total cost—25,000 MH .......................... Less variable element: 25,000 MH × $2.30 per MH ................ 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

Machine-Hours

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Case 5A-11 (continued) 2. The scattergraph shows that there are two relevant ranges—one below 19,500 MH and one above 19,500 MH. 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 MH, and to be discontinuous between the fixed fee and hourly rate points. 3. The cost formulas computed with the high-low and regression methods are faulty since they are 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

25,000 20,000 5,000

Cost

$99,000 80,000 $19,000

Variable element: $19,000 ÷ 5,000 MH = $3.80 per MH Fixed element: Total cost—25,000 MH .......................... Less variable element: 25,000 MH × $3.80 per MH ................ 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

5. The high-low estimate of fixed costs is $6,090 (= $10,090 – $4,000) lower than the estimate provided by least-squares regression. The highlow estimate of the variable cost per machine hour is $0.27 (= $3.80 – $3.53) higher than the estimate provided by least-squares regression. A straight line that minimized the sum of the squared errors would intersect the Y-axis at $10,090 instead of $4,000. It would also have a flatter slope because the estimated variable cost per unit is lower than the high-low method. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Appendix 5A

103

Case 5A-12 (45 minutes) 1. and 2. The scattergraph plot and regression estimates of fixed and variable costs using Microsoft Excel are shown below:

The scattergraph reveals three interesting findings. First, it indicates the relation between overhead expense and labor hours is approximated reasonably well by a straight line. (However, there appears to be a slight downward bend in the plot as the labor-hours increase—evidence of increasing returns to scale. This is a common occurrence in practice. See Noreen & Soderstrom, “Are overhead costs strictly proportional to activity?” Journal of Accounting and Economics, vol. 17, 1994, pp. 255278.) Second, the data points are all fairly close to the straight line. This indicates that most of the variation in overhead expenses is explained by labor hours. As a consequence, there probably wouldn’t be much benefit to investigating other possible cost drivers for the overhead expenses. Third, most of the overhead expense appears to be fixed. Maria should ask herself if this is reasonable. Does the company have large fixed expenses such as rent, depreciation, and salaries? © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 104

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CASE 5A-12 (continued) The cost formula, in the form Y = a + bX, using labor-hours as the activity base is $48,126 per month plus $3.95 per labor-hour, or: Y = $48,126 + $3.95X Note that the R2 is approximately 0.96, which means that 96% of the variation in cost is explained by labor-hours. This is a very high R2 which indicates a very good fit. 3. Using the least-squares regression estimate of the variable overhead cost, the total variable cost per guest is computed as follows: Food and beverages.............................. Labor (0.5 hour @ $10 per hour) ........... Overhead (0.5 hour @ $3.95 per hour) .. Total variable cost per guest ..................

$15.00 5.00 1.98 $21.98

The total contribution from 180 guests paying $31 each is computed as follows: Sales (180 guests @ $31.00 per guest) .............. Variable cost (180 guests @ $21.98 per guest) ... Contribution to profit ........................................

$5,580.00 3,956.40 $1,623.60

Fixed costs are not included in the above computation because there is no indication that any additional fixed costs would be incurred as a consequence of catering the cocktail party. If additional fixed costs were incurred, they should also be subtracted from revenue. 4. Assuming that no additional fixed costs are incurred as a result of catering the charity event, any price greater than the variable cost per guest of roughly $22 would contribute to profits.

105

CASE 5A-12 (continued) 5. We would favor bidding slightly less than $30 to get the contract. Any bid above $22 would contribute to profits and a bid at the normal price of $31 is unlikely to land the contract. And apart from the contribution to profit, catering the event would show off the company’s capabilities to potential clients. The danger is that a price that is lower than the normal bid of $31 might set a precedent for the future or it might initiate a price war among caterers. However, the price need not be publicized and the lower price could be justified to future clients because this is a charity event. Another possibility would be for Maria to maintain her normal price but throw in additional services at no cost to the customer. Whether to compete on price or service is a delicate issue that Maria will have to decide after getting to know the personality and preferences of the customer.

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Chapter 6 Variable Costing and Segment Reporting: Tools for Management Solutions to Questions 6-1 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 immediately expensed on the income statement. 6-2 Selling and administrative expenses are treated as period costs under both variable costing and absorption costing. 6-3 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. 6-4 Absorption costing advocates argue that absorption costing does a better job of matching costs with revenues than variable costing. They argue that all manufacturing costs must be assigned to products to properly match the costs of producing units of product with the revenues from the units when they are sold. They believe that no distinction should be made between variable and fixed manufacturing costs for the purposes of matching costs and revenues. 6-5 Advocates of variable costing argue that fixed manufacturing costs are not really the cost of any particular unit of product. If a unit is made or not, the total fixed manufacturing costs will be exactly the same. Therefore, how can one say that these costs are part of the costs of

the products? These costs are incurred to have the capacity to make products during a particular period and should be charged against that period as period costs according to the matching principle. 6-6 If production and sales are equal, net 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. 6-7 If production exceeds sales, absorption costing will usually show higher net 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 contrast, all of the fixed manufacturing overhead cost of the current period is immediately expensed under variable costing. 6-8 If fixed manufacturing overhead cost is released from inventory, then inventory levels must have decreased and therefore production must have been less than sales. 6-9 Under absorption costing net 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 net operating income to increase.

depreciation of machines shared by several departments.

6-10 Differences in reported net 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 tied 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 net operating income.

6-14 The contribution margin is the difference between sales revenue and variable expenses. The segment margin is the amount remaining after deducting traceable fixed expenses from the contribution margin. The contribution margin is useful as a planning tool for many decisions, particularly those in which fixed costs don’t change. The segment margin is useful in assessing the overall profitability of a segment.

6-11 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, and product lines. 6-12 Under the contribution approach, costs are assigned to a segment if and only if the costs are traceable to the segment (i.e., could be avoided if the segment were eliminated). Common costs are not allocated to segments under the contribution approach. 6-13 A traceable fixed cost of a segment is a cost that arises specifically because of the existence of that segment. If the segment were eliminated, the cost would disappear. A common fixed cost, by contrast, is a cost that supports more than one segment, but is not traceable in whole or in part to any one of the segments. If the departments of a company are treated as segments, then examples of the traceable fixed costs of a department would include the salary of the department’s supervisor and depreciation of machines used exclusively by the department. Examples of common fixed costs would include the salary of the general counsel of the entire company, the lease cost of the headquarters building, corporate image advertising, and

6-15 If common fixed costs were allocated to segments, then the costs of segments would be overstated and their margins would be understated. As a consequence, some segments may 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 fixed costs, the overall profit of the company would decline and the common fixed cost that had been allocated to the segment would be reallocated to the remaining segments—making them appear less profitable. 6-16 There are often limits to how far down an organization a cost can be traced. Therefore, fixed costs that are traceable to a segment may become common as that segment is divided into smaller segment units. For example, the costs of national TV and print advertising might be traceable to a specific product line, but be a common fixed cost of the geographic sales territories in which that product line is sold. 6-17 No, a company should not allocate its common fixed costs to business segments. These costs are not traceable to individual segments and will not be affected by segmentlevel decisions.

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Chapter 6: Applying Excel The completed worksheet is shown below.

Chapter 6: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Note: This worksheet assumes that the beginning inventory in Year 1 is zero. If this were not true, the worksheet would have to be modified. Also note that the formula in Cell C41 contains an IF statement because of the LIFO inventory flow assumption that is used throughout the chapter. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 4

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Chapter 6: Applying Excel (continued) 1. When the units sold in Year 2 are changed to 6,000, the result is:

Chapter 6: Applying Excel (continued) If the units produced equals the units sold, under the LIFO assumption, all of the fixed manufacturing overhead from Year 2 flows to the income statement under absorption costing. No fixed manufacturing overhead is released from or deferred in inventories. Therefore, absorption costing net operating income equals variable costing net operating income.

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Chapter 6: Applying Excel (continued) 2. With the changes in the data, the worksheet should look like this:

Chapter 6: Applying Excel (continued) The variable costing net operating income is the same in Year 1 and Year 2 because the sales are the same in the two years—12,000 units. Absorption costing net operating income exceeds variable costing net operating income in Year 1 because production exceeded sales and fixed manufacturing overhead was deferred in inventories under absorption costing. Absorption costing net operating income is less than variable costing net operating income in Year 2 because sales exceeded production and fixed manufacturing overhead was released from inventories under absorption costing.

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Chapter 6: Applying Excel (continued) 3. With the increase in units produced in Year 2, the result is:

Chapter 6: Applying Excel (continued) Increasing the production in Year 2 to 50,000 units while keeping everything else the same—including the unit sales—would result in absorption costing net operating income of $504,000 and payment of the bonus. However, it would also result in huge ending inventories that exceed the normal sales by several times. These huge inventories are likely to increase storage and other costs. Furthermore, if sales remain constant and management attempts to reduce inventories in the next year, the result will be a precipitous decline in the absorption costing net operating income in Year 3. To reduce inventories, management would have to produce less than it sells. This would result in absorption costing net operating income falling below $390,000—the net operating income that would be realized under variable costing.

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The Foundational 15 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 ($800,000 ÷ 40,000 units) ........... Unit product cost ............................

Variable Costing

Absorption Costing

— $40

20 $60

$24 14 2

3. and 4. The total contribution margin and net operating income (loss) under variable costing are computed as follows: Sales (35,000 units × $80 per unit) ..... Variable expenses: Variable cost of goods sold (35,000 units × $40 per unit)......... Variable selling and administrative (35,000 units × $4 per unit) .......... Contribution margin ............................ Fixed expenses: Fixed manufacturing overhead .......... Fixed selling and administrative ........ Net operating loss ..............................

$2,800,000 $1,400,000 140,000 1,540,000 1,260,000 800,000 496,000 1,296,000 $ (36,000)

The Foundational 15 (continued) 5. and 6. The total gross margin and net operating income under absorption costing are computed as follows: Sales (35,000 units × $80 per unit) ........................... $2,800,000 Cost of goods sold (35,000 units × $60 per unit)........ 2,100,000 Gross margin ........................................................... 700,000 Selling and administrative expenses [(35,000 units × $4 per unit) + $496,000] .............. 636,000 Net operating income ............................................... $ 64,000 7. The difference between the absorption and variable costing net 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 = ($20 per unit × 5,000 units) − $0 = $100,000 Variable costing net operating loss (see requirement 4) ....................................................................... Add fixed manufacturing overhead cost deferred in inventory under absorption costing ....................... Absorption costing net operating income (see requirement 6) ....................................................

$(36,000) 100,000 $ 64,000

8. The break-even point in units is computed as follows: Profit = Unit CM × Q − Fixed expenses $0 = ($80 − $44) × Q − $1,296,000 $0 = ($36) × Q − $1,296,000 $36Q = $1,296,000 Q = $1,296,000 ÷ $36 Q = 36,000 units The break-even point is above the actual sales volume; however, in question 6, the absorption costing net operating income is $64,000. This counter-intuitive result emerges because $100,000 of fixed manufacturing overhead is deferred in inventory under absorption costing. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 12

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The Foundational 15 (continued) 9. The break-even point of 36,000 units would remain the same. This occurs because the contribution margin per unit is the same regardless of whether a unit is sold in the East or West region. The total fixed cost also remains unchanged so the break-even point stays at 36,000 units. 10. and 11. The variable costing net 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 × $40 per unit)......... Variable selling and administrative (35,000 units × $4 per unit) .......... Contribution margin ............................ Fixed expenses: Fixed manufacturing overhead .......... Fixed selling and administrative ........ Net operating loss ..............................

$2,800,000 $1,400,000 140,000 1,540,000 1,260,000 800,000 496,000 1,296,000 $ (36,000)

When the number of units produced equals the number of units sold, absorption costing net operating income equals the variable costing net operating income. Therefore, the answer to question 11 is that the absorption costing net operating loss would be $36,000. 12.

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.

The Foundational 15 (continued) 13. The segment margins for the East and West regions are computed as follows:

Total Company

East

West

Sales* ......................................... $2,800,000 $2,000,000 $800,000 Variable expenses** .....................1,540,000 1,100,000 440,000 Contribution margin......................1,260,000 900,000 360,000 Traceable fixed expenses .............. 400,000 150,000 250,000 Region segment margin ................ 860,000 $ 750,000 $110,000 Common fixed expenses not traceable to regions ($800,000 + $96,000) ............... 896,000 Net operating loss ........................$ (36,000) * East: 25,000 units × $80 per unit = $2,000,000; West: 10,000 units × $80 per unit = $800,000. ** East: 25,000 units × $44 per unit = $1,100,000; West: 10,000 units × $44 per unit = $440,000. 14. Diego has apparently determined that the total gross margin in the West region equals $200,000. As computed in requirement 1, the unit product cost under absorption costing is $60; therefore, the gross margin per unit is $20 ($80 – $60). The West region’s total gross margin of $200,000 (10,000 units × $20 per unit) is less than its traceable fixed expenses of $250,000. This mode of analysis creates the illusion that the West region should be discontinued. The correct way to answer this question is to focus on the information in the contribution format segmented income statements as follows: Forgone segment margin in the West region ............. $(110,000) Additional contribution margin in East region* .......... 45,000 Decrease in profits if the West region is dropped .......$ (65,000) *$900,000 × 5% = $45,000.

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The Foundational 15 (continued) 15.

The profit impact is computed as follows: Additional advertising .............................................. $(30,000) Additional contribution margin in the West region*.... 72,000 Increase in profits ................................................... $ 42,000 * $360,000 × 20% = $72,000.

Exercise 6-1 (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 ($60,000 ÷ 250 units) ..... Absorption costing unit product cost ..............................

$100 320 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 ..................................

$100 320 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.

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Exercise 6-2 (20 minutes) 1. Fixed manufacturing overhead cost deferred in inventory = 25 units in ending inventory × $240 per unit* = $6,000 * $60,000 ÷ 250 units = $240 per unit 2. The variable costing income statement appears below: Sales ............................................................ Variable expenses: Variable cost of goods sold (225 units sold × $460* per unit).............. Variable selling and administrative expenses (225 units × $20 per unit) ........................ Contribution margin....................................... Fixed expenses: Fixed manufacturing overhead ..................... Fixed selling and administrative expenses..... Net operating income ....................................

$191,250 $103,500 4,500 60,000 20,000

108,000 83,250 80,000 $ 3,250

* Variable cost of goods sold per unit: Direct materials ....................................................... $100 Direct labor ............................................................. 320 Variable manufacturing overhead.............................. 40 Variable costing unit product cost ............................. $460 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 $6,000 of fixed manufacturing overhead cost has been deferred in inventory to the next period. Thus, net operating income under the absorption costing approach is $6,000 higher than it is under variable costing.

Exercise 6-3 (20 minutes) 1.

Beginning inventories .......... Ending inventories ............... Change in inventories .......... Fixed manufacturing overhead in ending inventories (@$560 per unit)................................. Fixed manufacturing overhead in beginning inventories (@$560 per unit)................................. Fixed manufacturing overhead deferred in (released from) inventories (@$560 per unit).................................

Year 1

Year 2

Year 3

$ 95,200

$100,800

$123,200

112,000

95,200

100,800

$(16,800)

$ 5,600

$ 22,400

200 170 (30)

170 180 10

180 220 40

Variable costing net operating income .............. $1,080,400 $1,032,400 $ 996,400 Add (deduct) fixed manufacturing overhead cost deferred in (released from) inventory under absorption costing ............ (16,800) 5,600 22,400 Absorption costing net operating income .............. $1,063,600 $1,038,000 $1,018,800 2a. and 2b. Because absorption costing net operating income was greater than variable costing net 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 net operating incomes, or $28,000 = $1,012,400 – $984,400. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 18

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Exercise 6-4 (10 minutes) Sales* ................................... Variable expenses** .............. Contribution margin ............... Traceable fixed expenses ........ Product line segment margin .. Common fixed expenses not traceable to products ........... Net operating income .............

Total Company Weedban $300,000 183,000 117,000 66,000 51,000

$90,000 36,000 54,000 45,000 $ 9,000

Greengrow $210,000 147,000 63,000 21,000 $ 42,000

33,000 $ 18,000

Weedban: 15,000 units × $6.00 per unit = $90,000. Greengrow: 28,000 units × $7.50 per unit = $210,000. ** Weedban: 15,000 units × $2.40 per unit = $36,000. Greengrow: 28,000 units × $5.25 per unit = $147,000.

Exercise 6-5 (10 minutes) 1. The companywide break-even point is computed as follows: Dollar sales for company to break even

Traceable fixed expenses + Common fixed expenses Overall CM ratio

$120,000 + $50,000 $240,000 ÷ $600,000

$170,000 0.40

$425,000

2. The break-even point for the North region is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

60,000 $120,000 ÷ $400,000

$60,000 0.30

= $200,000

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Exercise 6-5 (continued) 3. The break-even point for the South region is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$60,000 $120,000 ÷ $200,000

$60,000 0.60

= $100,000

Exercise 6-6 (30 minutes) 1. a. The unit product cost under absorption costing would be: Direct materials.............................................................. Direct labor.................................................................... 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) ........................... $1,000,000 Cost of goods sold (20,000 units × $30 per unit) ....... 600,000 Gross margin ........................................................... 400,000 Selling and administrative expenses [(20,000 units × $4 per unit) + $190,000] .............. 270,000 Net operating income ............................................... $ 130,000 2. a. The unit product cost under variable costing would be: Direct materials............................ Direct labor.................................. 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) ............ $1,000,000 Variable expenses: Variable cost of goods sold (20,000 units × $18 per unit) ............... $360,000 Variable selling expense (20,000 units × $4 per unit) ................. 80,000 440,000 Contribution margin .................................. 560,000 Fixed expenses: Fixed manufacturing overhead ................ 300,000 Fixed selling and administrative expense .. 190,000 490,000 Net operating income ................................ $ 70,000

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Exercise 6-7 (10 minutes) The completed segmented income statement should appear as follows:

Divisions Total Company Amount %

Sales ............................................... $500,000 100.0 Variable expenses ............................ 270,000 54.0 Contribution margin ......................... 230,000 46.0 Traceable fixed expenses .................. 130,000 26.0 Territorial segment margin ............... 100,000 20.0 Common fixed expenses .................. 90,000 18.0 Net operating income ....................... $ 10,000 2.0

North Amount %

South Amount %

$300,000 100.0 $200,000 100.0 150,000 50.0 120,000 60.0 150,000 50.0 80,000 40.0 80,000 26.7 50,000 25.0 $ 70,000 23.3 $30,000 15.0

Exercise 6-8 (10 minutes) Sales were above the company’s break-even sales and yet the company sustained a loss. 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 above the break-even point, the variable costing net operating income would have been positive. However, the absorption costing net operating income was negative. Ordinarily, this would only happen if inventories decreased and fixed manufacturing overhead deferred in inventories was released to the income statement on the absorption costing income statement. This added fixed manufacturing overhead cost resulted in a loss on an absorption costing basis even though the company operated at its break-even point on a variable costing basis.

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Exercise 6-9 (30 minutes) 1. 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 $25 15 5 $45

$25 15 5 $45

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. 1. b. Sales ......................................................... Variable expenses: Variable cost of goods sold @ $45 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 ................................... Net operating income (loss) ........................

Year 1

Year 2

1,800,000

2,250,000

80,000 1,880,000 520,000

100,000 2,350,000 650,000

$2,400,000 $3,000,000

250,000 250,000 80,000 80,000 330,000 330,000 $ 190,000 $ 320,000

2. a. The unit product costs under absorption costing: Direct materials .................................... Direct labor .......................................... Variable manufacturing overhead .......... Fixed manufacturing overhead .............. Absorption costing unit product cost ......

Year 1 Year 2

$25 $25.00 15 15.00 5 5.00 *5 **6.25 $50 $51.25

Exercise 6-9 (continued) 2. b. The absorption costing income statements appears below:

Year 1

Year 2

Sales (see requirement 1(b)) .................. $2,400,000 $3,000,000 Cost of goods sold.................................. *2,000,000 **2,550,000 Gross margin ......................................... 400,000 450,000 Selling and administrative expenses ........ 160,000 180,000 Net operating income ............................. $ 240,000 $ 270,000 * 40,000 units × $50 per unit = $2,000,000 ** (40,000 units × $51.25 per unit) + (10,000 units × $50 per unit) = $2,550,000 3. The net operating incomes are reconciled as follows: Units in beginning inventory ........................ + Units produced ....................................... − Units sold ............................................... = Units in ending inventory ......................... Fixed manufacturing overhead in ending inventory (10,000 units × $5 per unit) ...... Deduct: Fixed manufacturing overhead in beginning inventory (10,000 units × $5 per unit).................................................. Manufacturing overhead deferred in (released from) inventory ......................... Variable costing net operating income ........ Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing .................................................... Deduct: Fixed manufacturing overhead cost released from inventory under absorption costing .................................................... Absorption costing net operating income .....

Year 1

Year 2

Year 1

Year 2

$50,000

0 50,000 40,000 10,000

10,000 40,000 50,000 0

0 50,000

$50,000

$(50,000)

Year 1

Year 2

$190,000

$320,000

50,000

$240,000

(50,000) $270,000

Managerial Accounting, 16th Edition

Exercise 6-10 (20 minutes) 1. The companywide break-even point is computed as follows: Dollar sales for company to break even

Traceable fixed expenses + Common fixed expenses Overall CM ratio

$141,000 + $59,000 $225,000 ÷ $900,000

$200,000 0.25

$800,000

2. The break-even point for the East region is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$50,000 $120,000 ÷ $600,000

$50,000 0.20

= $250,000

Exercise 6-10 (continued) 3. The break-even point for the West region is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$91,000 $105,000 ÷ $300,000

$91,000 0.35

= $260,000 4. The new segmented income statement is computed as follows:

Total Company

East

Sales ..................................... $510,000 $250,000 Variable expenses* ................ 369,000 200,000 Contribution margin** ........... 141,000 50,000 Traceable fixed expenses ........ 141,000 50,000 Product line segment margin .. 0 $ 0 Common fixed expenses not traceable to products ........... 59,000 Net operating loss .................. $(59,000)

West

$260,000 169,000 91,000 91,000 $ 0

East: $250,000 × 0.80 variable expense ratio = $200,000. West: $260,000 × 0.65 variable expense ratio = $169,000. ** East: $250,000 × 0.20 CM ratio = $50,000. West: $260,000 × 0.35 CM ratio = $91,000. 5. No, a company should not allocate its common fixed expenses to business segments. These costs are not traceable to individual segments and will not be affected by segment-level decisions.

Managerial Accounting, 16th Edition

Exercise 6-11 (20 minutes) 1. Sales .............................. Variable expenses ........... Contribution margin ........ Traceable fixed expenses . Divisional segment margin......................... Common fixed expenses not traceable to divisions* .................... Net operating loss ...........

Total Company

Division East

Central

West

$1,000,000 390,000 610,000 535,000

$250,000 $400,000 $350,000 130,000 120,000 140,000 120,000 280,000 210,000 160,000 200,000 175,000

75,000

$(40,000) $ 80,000 $ 35,000

90,000 $ (15,000)

*$625,000 – $535,000 = $90,000. 2. The incremental net operating income is computed as follows: Incremental West Division sales ($350,000 × 20%)................................................ Contribution margin ratio ($210,000 ÷ $350,000)......................... Incremental contribution margin .............. Less incremental advertising expense ....... Incremental net operating income ............

$70,000 × 60% $42,000 15,000 $27,000

Yes, the advertising program should be initiated.

Exercise 6-12 (20 minutes) 1. Sales (35,000 units × $25 per unit) ................ Variable expenses: Variable cost of goods sold (35,000 units × $12 per unit*) .................. Variable selling and administrative expenses (35,000 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....

$875,000 $420,000 70,000 160,000 210,000

490,000 385,000 370,000 $ 15,000

$5 6 1 $12

2. The difference in net operating income can be explained by the $20,000 in fixed manufacturing overhead deferred in inventory under the absorption costing method: Units in ending inventory = Units in beginning inventory + Units produced – Units sold = 0 units + 40,000 units – 35,000 units = 5,000 units Manufacturing overhead deferred in (released from) inventory = Fixed manufacturing overhead in ending inventory – Fixed manufacturing overhead in beginning inventory = (5,000 units × $4 per unit) – $0 = $20,000 Variable costing net operating income ...................... Add fixed manufacturing overhead cost deferred in inventory under absorption costing ........................ Absorption costing net operating income ..................

$15,000 20,000 $35,000

Managerial Accounting, 16th Edition

Exercise 6-13 (20 minutes) 1. The company is using variable costing. The computations are:

Direct materials ........................... Direct labor ................................. Variable manufacturing overhead . Fixed manufacturing overhead ($150,000 ÷ 25,000 units) ........ Unit product cost ......................... Total cost for 3,000 units .............

Variable Costing

Absorption Costing

— $24 $72,000

6 $30 $90,000

$ 9 10 5

2. a. No, $72,000 is not the correct figure to use because variable costing is not generally accepted for external reporting purposes or for tax purposes. b. The Finished Goods inventory account should be stated at $90,000, which represents the absorption cost of the 3,000 unsold units. Thus, the account should be increased by $18,000 for external reporting purposes. This $18,000 consists of the amount of fixed manufacturing overhead cost that is allocated to the 3,000 unsold units under absorption costing (3,000 units × $6 per unit fixed manufacturing overhead cost = $18,000).

Exercise 6-14 (30 minutes) 1. 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..

$ 50 80 20 $150

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. 2. The variable costing income statement appears below: Sales (19,000 units × $210 per unit) ............. Variable expenses: Variable cost of goods sold (19,000 units × $150 per unit) ......................................... Variable selling and administrative expenses (19,000 units × $10 per unit) ................... Contribution margin ...................................... Fixed expenses: Fixed manufacturing overhead .................... Fixed selling and administrative expenses .... Net operating loss ........................................

$3,990,000 $2,850,000 190,000 700,000 285,000

3,040,000 950,000 985,000 $ (35,000)

3. 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 .. Unit sales to break even = =

$210 160 $ 50

Fixed expenses Unit contribution margin $985,000 = 19,700 units $50 per unit

Managerial Accounting, 16th Edition

Exercise 6-15 (20 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 ($700,000 ÷ 20,000 units) .......................... Absorption costing unit product cost ...............

$ 50 80 20 35 $185

2. The absorption costing income statement appears below: Sales (19,000 units × $210 per unit) ...................... $3,990,000 Cost of goods sold (19,000 units × $185 per unit) ... 3,515,000 Gross margin ........................................................ 475,000 Selling and administrative expenses ($285,000 + 19,000 units × $10 per unit) ............ 475,000 Net operating income ............................................ $ 0 Note: The company has a zero net operating income even though its sales are below the break-even point computed in Exercise 6-14. This occurs because $35,000 [= $35 per unit × (20,000 units produced – 19,000 units sold)] of fixed manufacturing overhead has been deferred in inventory and does not appear on the income statement prepared using absorption costing.

Exercise 6-16 (20 minutes) 1. The companywide break-even point is computed as follows: Dollar sales for company to break even

Traceable fixed expenses + Common fixed expenses Overall CM ratio

$126,000 + $63,000 0.50

$189,000 0.50

$378,000

The break-even point for the Chicago office is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$78,000 0.70

= $111,429 (rounded)

Managerial Accounting, 16th Edition

Exercise 6-16 (continued) The break-even point for the Minneapolis office is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$48,000 0.40

= $120,000 The sum of the segment break-even points is less than the companywide break-even point because the companywide break-even point takes into account common fixed expenses that do not affect the segment break-even calculations. 2. $75,000 × 40% CM ratio = $30,000 increased contribution margin in Minneapolis. Because the fixed costs in the office and in the company as a whole will not change, the entire $30,000 would result in increased net operating income for the company. It is not correct to multiply the $75,000 increase in sales by Minneapolis’ 24% 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.

Exercise 6-16 (continued) 3. a. The segmented income statement follows:

Total Company Amount %

Sales .......................... $500,000 100.0 Variable expenses ....... 240,000 48.0 Contribution margin .... 260,000 52.0 Traceable fixed expenses ................. 126,000 25.2 Office segment margin..................... 134,000 26.8 Common fixed expenses not traceable to segments................. 63,000 12.6 Net operating income .. $ 71,000 14.2

Segments Chicago Minneapolis Amount % Amount %

$200,000 100 60,000 30 140,000 70

$300,000 100 180,000 60 120,000 40

78,000

48,000

31 $ 72,000

$ 62,000

b. The segment margin ratio rises and falls as sales rise and fall due to the presence of fixed costs. The fixed costs are spread over a larger base as sales increase. In contrast to the segment ratio, the contribution margin ratio for a given segment is stable so long as there is no change in either the variable expenses or the selling price per unit of service.

Managerial Accounting, 16th Edition

Exercise 6-17 (15 minutes) 1. and 2. The profit impacts in both markets are as follows:

Medical

Dental

Increased sales ............................................. $40,000 $35,000 Market CM ratio ............................................. × 36% × 48% Incremental contribution margin..................... $14,400 $16,800 Less cost of the campaign .............................. 5,000 5,000 Increased segment margin and net operating income for the company as a whole ............. $ 9,400 $11,800 3. The company should focus its advertising campaign on the Dental market. 4. The $48,000 in traceable fixed expenses for Minneapolis in the previous exercise is now partly traceable and partly common. When we segment Minneapolis by market, only $33,000 remains a traceable fixed expense. This amount represents costs such as advertising and salaries of individuals that arise because of the existence of the Medical and Dental markets. The remaining $15,000 ($48,000 – $33,000) is a common cost when Minneapolis is segmented by market. This amount would include costs such as the salary of the manager of the Minneapolis office that could not be avoided by eliminating either of the two market segments.

Problem 6-18 (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 ($20 + $12 + $4 + $2).... Contribution margin per unit ............................

$58 38 $20

Break-even unit sales = Fixed expenses ÷ Unit contribution margin = ($960,000 + $240,000) ÷ $20 per unit = $1,200,000 ÷ $20 per unit = 60,000 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 $20 12 4 $36

$20 12 4 $36

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, 16th Edition

Problem 6-18 (continued) 2. b. The variable costing income statements appear below: Sales (@ $58 per unit) .............................................. Variable expenses: Variable cost of goods sold @ $36 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 ................................................. Net operating income (loss) ......................................

Year 1

$3,480,000

Year 2

Year 3

$2,900,000 $3,770,000

2,160,000 120,000 2,280,000 1,200,000

1,800,000 100,000 1,900,000 1,000,000

2,340,000 130,000 2,470,000 1,300,000

960,000 960,000 960,000 240,000 240,000 240,000 1,200,000 1,200,000 1,200,000 $ 0 $ (200,000) $ 100,000

3. a. The unit product costs under absorption costing:

Year 1

Year 2 Year 3

Direct materials .................................... $20 $20.00 Direct labor .......................................... 12 12.00 Variable manufacturing overhead .......... 4 4.00 Fixed manufacturing overhead .............. *16 **12.80 Absorption costing unit product cost ...... $52 $48.80 * $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.

$20 12 4 ***24 $60

Problem 6-18 (continued) 3. b. The absorption costing income statements appears below:

Year 1

Year 2

Year 3

Sales ..................................................... $3,480,000 $2,900,000 $3,770,000 Cost of goods sold.................................. 3,120,000 2,440,000 3,620,000 Gross margin ......................................... 360,000 460,000 150,000 Selling and administrative expenses ($2 per unit + $240,000) ..................... 360,000 340,000 370,000 Net operating income (loss) .................... $ 0 $ 120,000 $ (220,000) Cost of goods sold computations: Year 1: 60,000 units × $52 per unit = $3,120,000 Year 2: 50,000 units × $48.80 per unit = $2,440,000 Year 3: (25,000 × $48.80 per unit) + (40,000 × $60 per unit) = $3,620,000 4. Units sold ........................................................... Break-even point in units ..................................... Units above (below) break-even point .................. Variable costing net operating income (loss) ......... Absorption costing net operating income (loss) .....

Year 1

60,000 60,000 0

Year 2

50,000 60,000 (10,000)

Year 3

65,000 60,000 5,000

$0 $(200,000) $ 100,000 $0 $ 120,000 $(220,000)

The absorption costing net operating incomes in years 2 and 3 are counterintuitive. In year 2, the number of units sold is below the break-even point; however, absorption costing reports a net operating income greater than zero. In year 3, the number of units sold is above the break-even point; however, absorption costing reports a net operating income less than zero. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 40

Managerial Accounting, 16th Edition

Problem 6-19 (30 minutes) 1. The unit product cost under variable costing is computed as follows: Direct materials .......................... Direct labor ................................ 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 ................................... Net 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

Problem 6-19 (continued) 3. The reconciliation of absorption and variable costing follows: Units in beginning inventory ........................ + Units produced ....................................... − Units sold ............................................... = Units in ending inventory ......................... 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 ......................... 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 net operating income .....

Year 1

Year 2

Year 1

Year 2

$30,000

0 45,000 40,000 5,000

5,000 45,000 50,000 0

0 30,000

$30,000

$(30,000)

Year 1

Year 2

$40,000

$150,000

30,000

$70,000

(30,000) $120,000

Managerial Accounting, 16th Edition

Problem 6-20 (45 minutes) 1. a. The unit product cost under absorption costing is: Direct materials ................................... Direct labor ......................................... Variable manufacturing overhead .......... Fixed manufacturing overhead ($100,000 ÷ 10,000 units) ................ Absorption costing unit product cost .....

$20 8 2 10 $40

b. The absorption costing income statement is: Sales (8,000 units × $75 per unit).......................... $600,000 Cost of goods sold (8,000 units × $40 per unit) ...... 320,000 Gross margin ........................................................ 280,000 Selling and administrative expenses [$200,000 + (8,000 units × $6 per unit)] ............. 248,000 Net operating income ............................................ $ 32,000 2. a. The unit product cost under variable costing is: Direct materials ............................ $20 Direct labor .................................. 8 Variable manufacturing overhead ... 2 Variable costing unit product cost... $30 b. The variable costing income statement is: Sales (8,000 units × $75 per unit) .................. $600,000 Variable expenses: Variable cost of goods sold (8,000 units × $30 per unit) ...................... $240,000 Variable selling expenses (8,000 units × $6 per unit) ........................ 48,000 288,000 Contribution margin ....................................... 312,000 Fixed expenses: Fixed manufacturing overhead ..................... 100,000 Fixed selling and administrative expenses ..... 200,000 300,000 Net operating income ..................................... $ 12,000

Problem 6-20 (continued) 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 $10 per unit ($100,000 ÷ 10,000 units produced = $10 per unit). Thus, under absorption costing a portion of the $100,000 fixed manufacturing overhead cost for the month has been added to the inventory account rather than expensed on the income statement: Added to the ending inventory (2,000 units × $10 per unit) ....................................... Expensed as part of cost of goods sold (8,000 units × $10 per unit) ....................................... Total fixed manufacturing overhead cost for the month ..

$ 20,000 80,000 $100,000

Because $20,000 of fixed manufacturing overhead cost has been deferred in inventory under absorption costing, the net operating income reported under that costing method is $20,000 (= $32,000 – $12,000) higher than the net operating income under variable costing, as shown in parts (1) and (2) above.

Managerial Accounting, 16th Edition

Problem 6-21 (30 minutes) 1.

Total Company Amount %

Sales ............................................... $750,000 100.0 Variable expenses............................. 336,000 44.8 Contribution margin.......................... 414,000 55.2 Traceable fixed expenses .................. 228,000 30.4 Territorial segment margin ................ 186,000 24.8 Common fixed expenses* ................. 150,000 20.0 Net operating income ....................... $ 36,000 4.8

Sales Territory Northern Southern Amount % Amount %

$300,000 100 156,000 52 144,000 48 120,000 40 $ 24,000 8

$450,000 100 180,000 40 270,000 60 108,000 24 $162,000 36

*378,000 – $228,000 = $150,000

Product Line Sales .............................................. Variable expenses............................ Contribution margin......................... Traceable fixed expenses ................. Product line segment margin............ Common fixed expenses* ................ Sales territory segment margin ........

Northern Territory Amount %

$300,000 100.0 156,000 52.0 144,000 48.0 70,000 23.3 74,000 24.7 50,000 16.7 $ 24,000 8.0

Paks Amount %

$50,000 100 11,000 22 39,000 78 30,000 60 $ 9,000 18

*$120,000 – $70,000 = $50,000

Tibs Amount %

$250,000 100 145,000 58 105,000 42 40,000 16 $ 65,000 26

Problem 6-21 (continued) 2. Two insights should be brought to the attention of management. First, compared to the Southern territory, the Northern territory has a low contribution margin ratio. Second, the Northern territory has high traceable fixed expenses. Overall, compared to the Southern territory, the Northern territory is very weak. 3. Again, two insights should be brought to the attention of management. First, the Northern territory has a poor sales mix. Note that the territory sells very little of the Paks product, which has a high contribution margin ratio. This poor sales mix accounts for the low overall contribution margin ratio in the Northern territory mentioned in part (2) above. Second, the traceable fixed expenses of the Paks product seem very high in relation to sales. These high fixed expenses may simply mean that the Paks product is highly leveraged; if so, then an increase in sales of this product line would greatly enhance profits in the Northern territory and in the company as a whole.

Managerial Accounting, 16th Edition

Problem 6-22 (45 minutes) 1. a. and b. Direct materials .................................... Direct labor .......................................... Variable manufacturing overhead .......... Fixed manufacturing overhead ($315,000 ÷ 17,500 units) ................. Unit product cost ..................................

Absorption Costing

Variable Costing

18 $40

— $22

$ 7 10 5

July

August

Sales ............................................................ $900,000 $1,200,000 Variable expenses: Variable cost of goods sold @ $22 per unit ... 330,000 440,000 Variable selling and administrative expenses @ $3 per unit ............................ 45,000 60,000 Total variable expenses.................................. 375,000 500,000 Contribution margin....................................... 525,000 700,000 Fixed expenses: Fixed manufacturing overhead..................... 315,000 315,000 Fixed selling and administrative expenses .... 245,000 245,000 Total fixed expenses ...................................... 560,000 560,000 Net operating income (loss) ........................... $ (35,000) $ 140,000 3. Units in beginning inventory ........................ + Units produced ........................................ − Units sold................................................ = Units in ending inventory ......................... Fixed manufacturing overhead in ending inventory (2,500 units × $18 per unit) ..... − Fixed manufacturing overhead in beginning inventory (2,500 units × $18 per unit) .................................................. = Manufacturing overhead deferred in (released from) inventory ........................

July

August

$45,000

0 17,500 15,000 2,500

2,500 17,500 20,000 0 0

45,000

$45,000

$(45,000)

Problem 6-22 (continued) 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 net operating income ......

July

August

$ (35,000) $ 140,000 45,000

$ 10,000

(45,000) $ 95,000

4. As shown in the reconciliation in part (3) above, $45,000 of fixed manufacturing overhead cost was deferred in inventory under absorption costing at the end of July because $18 of fixed manufacturing overhead cost “attached” to each of the 2,500 unsold units that went into inventory at the end of that month. This $45,000 was part of the $560,000 total fixed cost that has to be covered each month in order for the company to break even. Because the $45,000 was added to the inventory account, and thus did not appear on the income statement for July as an expense, the company was able to report a small profit for the month even though it sold less than the break-even volume of sales. In short, only $515,000 of fixed cost ($560,000 – $45,000) was expensed for July, rather than the full $560,000 as presented in the break-even analysis. As stated in the text, this is a major problem with the use of absorption costing internally for management purposes. The method does not harmonize well with the principles of cost-volume-profit analysis, and can result in data that are unclear or confusing.

Managerial Accounting, 16th Edition

Problem 6-23 (60 minutes) 1. a. Absorption costing unit product cost is: Direct materials .................................. Direct labor ........................................ Variable manufacturing overhead ........ Fixed manufacturing overhead ($300,000 ÷ 30,000 units) ............... Absorption costing unit product cost ....

$ 3.50 12.00 1.00 10.00 $26.50

b. The absorption costing income statement is: Sales (28,000 units × $40 per unit) ........................ Cost of goods sold (28,000 units × $26.50 per unit) Gross margin ........................................................ Selling and administrative expenses ($200,000 + 28,000 units × $6.00 per unit) ......... Net operating income ............................................

$1,120,000 742,000 378,000 368,000 $ 10,000

c. The reconciliation is as follows: Units in ending inventory = Units in beginning inventory + Units produced – Units sold = 0 units +30,000 units – 28,000 units = 2,000 units Manufacturing overhead deferred in (released from) inventory = Fixed manufacturing overhead in ending inventory – Fixed manufacturing overhead in beginning inventory = (2,000 units × $10 per unit) – $0 = $20,000 Variable costing net loss ........................................ Add fixed manufacturing overhead cost deferred in inventory under absorption costing ...................... Absorption costing net operating income ................

$(10,000) 20,000 $ 10,000

Problem 6-23 (continued) 2. Under absorption costing, the company did earn a profit for the quarter. 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 release of fixed manufacturing overhead costs to expense. Advocates of variable costing 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, no profit was earned during the quarter 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 an expense until the units are sold. Therefore, if the selling price of a unit is greater than the unit product 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. 3. a. The variable costing income statement is: Sales (32,000 units × $40 per unit) ............ Variable expenses: Variable cost of goods sold [32,000 units × ($3.50 + $12.00 + $1.00) per unit] ................................... Variable selling and administrative expenses (32,000 units × $6 per unit) .. Contribution margin .................................. Fixed expenses: Fixed manufacturing overhead................. Fixed selling and administrative expense .. Net operating income ................................

$1,280,000

$528,000 192,000 300,000 200,000

720,000 560,000 500,000 $ 60,000

Managerial Accounting, 16th Edition

Problem 6-23 (continued) b. The absorption costing income statement would be constructed as follows: The absorption costing unit product cost will remain at $26.50, the same as in part (1). Sales (32,000 units × $40 per unit) ........................... $1,280,000 Cost of goods sold (32,000 units × $26.50 per unit) ... 848,000 Gross margin ........................................................... 432,000 Selling and administrative expenses ($200,000 + 32,000 units × $6.00 per unit) ............ 392,000 Net operating income ............................................... $ 40,000 c. The reconciliation of variable costing and absorption costing income is: Units in ending inventory = Units in beginning inventory + Units produced – Units sold = 2,000 units +30,000 units – 32,000 units = 0 units Manufacturing overhead deferred in (released from) inventory = Fixed manufacturing overhead in ending inventory – Fixed manufacturing overhead in beginning inventory = (0 units × $10 per unit) – (2,000 units × $10 per unit) = $(20,000) Variable costing net operating income .................... Deduct fixed manufacturing overhead cost released from inventory under absorption costing .............. Absorption costing net operating income ................

$ 60,000 (20,000) $ 40,000

Problem 6-24 (45 minutes) 1.

The intern’s decision to use the absorption format for her segmented income statements is a bad idea because it does not focus on cost behavior. To make decisions and perform break-even analysis, the contribution format is superior to the absorption format because it separates costs into variable cost and fixed cost categories.

2.a. To answer this question, students must understand that cost of goods sold for a merchandiser is a variable cost. Thus, all of the company’s fixed costs plus its sales commissions are reported as part of selling and administrative expenses. The amount of common fixed expenses allocated to each segment is computed as follows:

Total

Total selling and administrative expense (a) ............................ $240,000 Traceable fixed expenses ............ $ 93,000 Sales commissions (10% of sales) ........................ 75,000 Selling and administrative expenses accounted for (b) ...... $168,000 Common fixed expenses (a) – (b) $72,000

Commercial Residential $104,000 $55,000

$136,000 $38,000

25,000

50,000

$80,000 $24,000

$88,000 $48,000

2.b. The amount of common fixed expenses allocated to Residential ($48,000) is twice as much as the amount of common fixed expenses allocated to Commercial ($24,000). Because the Residential sales ($500,000) are twice as much as the Commercial sales ($250,000), it appears that the common fixed expenses were allocated to segments based on sales dollars. 3.

No. Allocating common fixed expenses is a bad idea because these costs are not traceable to segments and they are not affected by segment-level decisions.

Managerial Accounting, 16th Edition

Problem 6-24 (continued) 4. The contribution format segmented income statements would appear as follows:

Sales .................................... Variable expenses: Cost of goods sold .............. Sales commissions (10%) ... Total variable expenses .......... Contribution margin............... Traceable fixed expenses ....... Segment margin.................... Common fixed expenses ........ Net operating income ............

Total Company Commercial Residential $750,000 $250,000

$500,000

500,000 140,000 75,000 25,000 575,000 165,000 175,000 85,000 93,000 55,000 82,000 $ 30,000 72,000 $ 10,000

360,000 50,000 410,000 90,000 38,000 $ 52,000

Problem 6-24 (continued) 5. The companywide break-even point is computed as follows: Dollar sales for company to break even

Traceable fixed expenses + Common fixed expenses Overall CM ratio

$93,000 + $72,000 $175,000 ÷ $750,000

$165,000 0.233 (rounded)

$708,155 (rounded)

6. The break-even point for the Commercial Division is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$55,000 $85,000 ÷ $250,000

$55,000 0.34

= $161,765 (rounded)

Managerial Accounting, 16th Edition

Problem 6-24 (continued) The break-even point for the Residential Division is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$38,000 $90,000 ÷ $500,000

$38,000 0.18

= $211,111 (rounded) 7. The new break-even point for the Commercial Division is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$70,000 0.39

= $179,487 (rounded) The new break-even point for the Residential Division is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$68,000 0.23

= $295,652 (rounded)

Problem 6-25 (75 minutes) 1. Sales .......................................... Variable expenses: Variable cost of goods sold @ $2 per unit ........................ Variable selling and administrative expenses @ $1 per unit ........................ Total variable expenses ................ Contribution margin..................... Fixed expenses: Fixed manufacturing overhead ... Fixed selling and administrative expenses ............................... Total fixed expenses .................... Net operating income (loss) .........

Year 1

Year 2

Year 3

$800,000

$ 640,000 $800,000

100,000

80,000

100,000

50,000 150,000 650,000

40,000 120,000 520,000

50,000 150,000 650,000

480,000

140,000 620,000 $ 30,000

140,000 140,000 620,000 620,000 $(100,000) $ 30,000

Managerial Accounting, 16th Edition

Problem 6-25 (continued) 2. a.

Year 1

Variable manufacturing cost ................ $ 2.00 Fixed manufacturing cost: $480,000 ÷ 50,000 units .................. 9.60 $480,000 ÷ 60,000 units .................. $480,000 ÷ 40,000 units .................. Absorption costing unit product cost .... $11.60

b. Units in beginning inventory ................ 0 + Units produced ................................ 50,000 − Units sold ....................................... 50,000 = Units in ending inventory ................. 0 Fixed manufacturing overhead in ending inventory .............................. $ − Fixed manufacturing overhead in beginning inventory .......................... = Manufacturing overhead deferred in (released from) inventory ................. $

Year 2

$ 2.00 8.00

Year 3

$ 2.00

$10.00

12.00 $14.00

0 60,000 40,000 20,000

20,000 40,000 50,000 10,000

0 $160,000 $120,000 0

160,000

0 $160,000 $(40,000)

Variable costing net operating income (loss)............................................... $30,000 $(100,000) $ 30,000 Add fixed manufacturing overhead deferred in inventory ........................ 0 160,000 0 Deduct fixed manufacturing overhead cost released from inventory ............. 0 0 (40,000) Absorption costing net operating income (loss) ................................... $30,000 $ 60,000 $(10,000) 3. Production went up sharply in Year 2, thereby reducing the unit product cost, as shown in (2a) above. This reduction in cost per unit, combined with the large amount of fixed manufacturing overhead deferred in inventory for the year, more than offset the loss of revenue. The net result is that the company’s net operating income increased. 4. The fixed manufacturing overhead deferred in inventory from Year 2 was charged against Year 3 operations. This added charge against Year 3 operations was offset somewhat by the fact that part of Year 3’s fixed © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 6

Problem 6-25 (continued) manufacturing overhead costs were deferred in inventory to future years. Overall, the added costs charged against Year 3 were greater than the costs deferred to future years, 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 tied 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 net operating income under absorption costing would have been the same as under variable costing in all three years. With production tied to sales, there would have been no ending inventory, and therefore there would have been no fixed manufacturing overhead costs deferred in inventory to other years.

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Problem 6-26 (60 minutes) 1. The 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 regions taken together. b. The regional expenses should be segregated into variable and fixed categories to permit the computation of both a contribution margin and a regional segment margin. c. The corporate expenses are probably common to the regions and should not be arbitrarily allocated. 2. Corporate advertising expenses have been allocated on the basis of sales dollars; the general administrative expenses have been allocated evenly among the three regions. 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. The “net operating income” or “net loss” after allocating common expenses should not be used to judge the performance of a segment.

Problem 6-26 (continued) 3.

Total Company

Sales ..................................... $2,000,000 Variable expenses: Cost of goods sold ............... 819,400 Shipping expense ................. 77,600 Total variable expenses ........... 897,000 Contribution margin ................ 1,103,000 Traceable fixed expenses: Salaries ............................... 313,000 Utilities ................................ 40,500 Advertising .......................... 518,000 Depreciation ........................ 85,000 Total traceable fixed expenses . 956,500 Regional segment margin........ 146,500 Common fixed expenses: Advertising (general)* .......... 80,000 General administration** ...... 150,000 Total common fixed expense ... 230,000 Net operating loss .................. $ (83,500)

West

Central

100.0

$450,000

100 $800,000

100 $750,000

100

41.0 3.9 44.9 55.1

162,900 17,100 180,000 270,000

36 4 40 60

35 4 39 61

376,500 28,500 405,000 345,000

50 4 54 46

15.6 2.0 25.9 4.3 47.8 7.3

90,000 13,500 108,000 27,000 238,500 $ 31,500

20 88,000 3 12,000 24 200,000 6 28,000 53 328,000 7 $160,000

11 135,000 2 15,000 25 210,000 4 30,000 42 390,000 19 $ (45,000)

18 2 28 4 52 (6)

4.0 7.5 11.5 ( 4.2)

Note: Percentage figures may not total due to rounding. * $18,000 + $32,000 + $30,000 = $80,000 ** $50,000 + $50,000 +$50,000 = $150,000

East

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280,000 32,000 312,000 488,000

Problem 6-26 (continued) 4. The following points should be brought to management’s attention: a. Sales in the West are much lower than in the other two regions. This is not due to lack of salespeople—salaries in the West are about the same as in the Central Region, which has the highest sales of the three regions. b. The West is spending about half as much for advertising as the Central Region. Perhaps this is the reason for the West’s lower sales. c. The East apparently is selling a large amount of low-margin items. Note that it has a contribution margin ratio of only 46%, compared to 60% or more for the other two regions. d. The East appears to be overstaffed. Its salaries are about 50% greater than in either of the other two regions. e. The East is not covering its own traceable costs. Attention should be given to improving the sales mix and reducing expenses in this region. f. Apparently, the salespeople in all three regions are on a salary basis. Perhaps a change to a commission basis would encourage the sales staff to be more aggressive and improve sales throughout the company.

Problem 6-27 (30 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 net 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

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Problem 6-27 (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 net 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 would 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. In sum, producing as much as possible so as to maximize the division’s net operating income and the manager’s bonus would be unethical because it subverts the goals of the overall organization.

Problem 6-28 (45 minutes) 1.

Total Company

Cookbook

Sales ...................................... $300,000 $90,000 Variable expenses: Printing cost......................... 102,000 27,000 Sales commissions................ 30,000 9,000 Total variable expenses ........... 132,000 36,000 Contribution margin ................ 168,000 54,000 Traceable fixed expenses: Advertising........................... 36,000 13,500 Salaries ............................... 33,000 18,000 Equipment depreciation* 9,000 2,700 Warehouse rent** ................ 12,000 1,800 Total traceable fixed expenses . 90,000 36,000 Product line segment margin ... 78,000 $18,000 Common fixed expenses: General sales ....................... 18,000 General administration .......... 42,000 Depreciation—office facilities . 3,000 Total common fixed expenses .. 63,000 Net operating income .............. $ 15,000

Travel Guide

Handy Speller

63,000 15,000 78,000 72,000

12,000 6,000 18,000 42,000

$150,000 $60,000

19,500 3,000 9,000 6,000 4,500 1,800 6,000 4,200 39,000 15,000 $ 33,000 $27,000

* $9,000 × 30%, 50%, and 20%, respectively. ** 48,000 square feet × $3 per square foot = $144,000; $144,000 ÷ 12 months = $12,000 per month. $12,000 ÷ 48,000 square feet = $0.25 per square foot per month. $0.25 per square foot × 7,200 square feet = $1,800; $0.25 per square foot × 24,000 square feet = $6,000; and $0.25 per square foot × 16,800 square feet = $4,200.

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Problem 6-28 (continued) 2. a. No, the cookbook line should not be eliminated. The cookbook is covering all of its own costs and is generating an $18,000 segment margin toward covering the company’s common costs and toward profits. (Note: Problems relating to the elimination of a product line are covered in more depth in a later chapter.) b. Contribution margin (a) .................. Sales (b)........................................ Contribution margin ratio (a) ÷ (b)..

Cookbook

Travel Guide

$54,000 $72,000 $90,000 $150,000 60% 48%

Handy Speller

$42,000 $60,000 70%

It is probably unwise to focus all available resources on promoting the travel guide. The company is already spending more on the promotion of this product than on the other two products combined. Furthermore, the travel guide has the lowest contribution margin ratio of the three products. Therefore, a dollar of sales of the travel guide generates less profit than a dollar of sales of either of the two other products. Nevertheless, we cannot say for sure which product should be emphasized in this situation without more information. The problem states that there is ample demand for all three products, which suggests that there is no idle capacity. If the equipment is being fully utilized, increasing the production of any one product would require cutting back production of the other products. In a later chapter we will discuss how to choose the most profitable product when a production constraint forces such a trade-off among products.

Case 6-29 (45 minutes) 1. 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 $32 20 4 $56

$32 20 4 $56

1. b. The variable costing income statements appear below: Year 1 Year 2 Year 3 Sales (@ $75 per unit) ................................................. $6,000,000 $6,750,000 $5,625,000 Variable expenses: Variable cost of goods sold @ $56 per unit .................. 4,480,000 5,040,000 4,200,000 Variable selling and administrative @ $3 per unit ......... 240,000 270,000 225,000 Total variable expenses ................................................ 4,720,000 5,310,000 4,425,000 Contribution margin ..................................................... 1,280,000 1,440,000 1,200,000 Fixed expenses: Fixed manufacturing overhead ................................... 660,000 660,000 660,000 Fixed selling and administrative .................................. 120,000 120,000 120,000 Total fixed expenses ..................................................... 780,000 780,000 780,000 Net operating income ................................................... $ 500,000 $ 660,000 $ 420,000 2.a. and 2.b. The answers to 2a and 2b are the same as 1a and 1b because the unit product costs are the same for all three years. The inventory flow assumption is irrelevant when the unit product cost stays constant. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 66

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Case 6-29 (continued) 3. a. The unit product costs under absorption costing:

Year 1

Direct materials .................................... $32.00 Direct labor .......................................... 20.00 Variable manufacturing overhead .......... 4.00 Fixed manufacturing overhead .............. *6.60 Absorption costing unit product cost ...... $62.60

Year 2

$32.00 20.00 4.00 **8.80 $64.80

Year 3

$32.00 20.00 4.00 ***8.25 $64.25

* $660,000 ÷ 100,000 units = $6.60 per unit. ** $660,000 ÷ 75,000 units = $8.80 per unit. *** $660,000 ÷ 80,000 units = $8.25 per unit. 3. b. The absorption costing income statements appear below (FIFO):

Year 1

Year 2

Year 3

Sales (@ $75 per unit) ........................... $6,000,000 $6,750,000 $5,625,000 Cost of goods sold.................................. 5,008,000 5,788,000 4,821,500 Gross margin ......................................... 992,000 962,000 803,500 Selling and administrative expenses ($3 per unit + $120,000) ..................... 360,000 390,000 345,000 Net operating income ............................. $ 632,000 $ 572,000 $ 458,500 Cost of goods sold computations: Year 1: 80,000 units × $62.60 per unit = $5,008,000 Year 2: (20,000 units × $62.60 per unit) + (70,000 units × $64.80 per unit) = $5,788,000 Year 3: (5,000 × $64.80 per unit) + (70,000 × $64.25 per unit) = $4,821,500

Case 6-29 (continued) 4. a. The unit product costs under absorption costing:

Year 1

Year 2

Direct materials .................................... $32.00 $32.00 Direct labor .......................................... 20.00 20.00 Variable manufacturing overhead .......... 4.00 4.00 Fixed manufacturing overhead .............. *6.60 **8.80 Absorption costing unit product cost ...... $62.60 $64.80

Year 3

$32.00 20.00 4.00 ***8.25 $64.25

* $660,000 ÷ 100,000 units = $6.60 per unit. ** $660,000 ÷ 75,000 units = $8.80 per unit. *** $660,000 ÷ 80,000 units = $8.25 per unit. 4. b. The absorption costing income statements appears below (LIFO):

Year 1

Year 2

Year 3

Sales ..................................................... $6,000,000 $6,750,000 $5,625,000 Cost of goods sold.................................. 5,008,000 5,799,000 4,818,750 Gross margin ......................................... 992,000 951,000 806,250 Selling and administrative expenses ........ 360,000 390,000 345,000 Net operating income ............................. $ 632,000 $ 561,000 $ 461,250 Cost of goods sold computations: Year 1: 80,000 units × $62.60 per unit = $5,008,000 Year 2: (75,000 units × $64.80 per unit) + (15,000 units × $62.60 per unit) = $5,799,000 Year 3: 75,000 × $64.25 per unit = $4,818,750

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Case 6-30 (75 minutes) 1. See the segmented statement on the second following page. Supporting computations for the statement are given below: Sales: Membership dues (20,000 × $100) .......................... Assigned to Magazine Subscriptions Division (20,000 × $20) .................................................... Assigned to Membership Division ............................. Non-member magazine subscriptions (2,500 × $30) . Reports and texts (28,000 × $25) ............................ Continuing education courses: One-day (2,400 × $75)......................................... Two-day (1,760 × $125) ....................................... Total revenue..........................................................

$2,000,000 400,000 $1,600,000 $ 75,000 $ 700,000 $ 180,000 220,000 $ 400,000

Salary and personnel costs: Membership Division ..................... Magazine Subscriptions Division ..... Books and Reports Division ............ Continuing Education Division ........ Total assigned to divisions ............. Corporate staff .............................. Total .............................................

Salaries

$210,000 150,000 300,000 180,000 840,000 80,000 $920,000

Personnel Costs (25% of Salaries) $ 52,500 37,500 75,000 45,000 210,000 20,000 $230,000

Case 6-30 (continued) Some may argue that, except for the $50,000 in rental cost directly attributed to the Books and Reports Division, occupancy costs are common costs that should not be allocated. The correct treatment of the occupancy costs depends on whether they could be avoided in part by eliminating a division. In the solution below, we have assumed they could be avoided. Occupancy costs ($230,000 allocated + $50,000 direct to the Books and Reports Division = $280,000): Allocated to: Membership Division ($230,000 × 0.2) ........................................... $ 46,000 Magazine Subscriptions Division ($230,000 × 0.2) ........................................... 46,000 Books and Reports Division ($230,000 × 0.3 + $50,000)........................... 119,000 Continuing Education Division ($230,000 × 0.2) ........................................... 46,000 Corporate staff ($230,000 × 0.1) ........................................... 23,000 Total occupancy costs ....................................... $280,000 Printing and paper costs ...................................... $320,000 Assigned to: Magazine Subscriptions Division (22,500 × $7) ............................................. $157,500 Books and Reports Division (28,000 × $4) ............................................. 112,000 269,500 Remainder—Continuing Education Division ...... $ 50,500 Postage and shipping costs .................................. $176,000 Assigned to: Magazine Subscriptions Division (22,500 × $4) ............................................. $ 90,000 Books and Reports Division (28,000 × $2) ............................................. 56,000 146,000 Remainder—corporate staff ............................ $ 30,000

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Case 6-30 (continued)

Division Association Magazine Books & Continuing Total Membership Subscriptions Reports Education

Sales: Membership dues ........................... $2,000,000 Non-member magazine subscriptions ............................... 75,000 Advertising .................................... 100,000 Reports and texts........................... 700,000 Continuing education courses ......... 400,000 Total revenues ............................... 3,275,000 Expenses traceable to segments: Salaries ......................................... 840,000 Personnel costs .............................. 210,000 Occupancy costs ............................ 257,000 Reimbursement of member costs to local chapters .......................... 600,000 Other membership services ............ 500,000 Printing and paper ......................... 320,000 Postage and shipping ..................... 146,000 Instructors’ fees ............................. 80,000 Total traceable expenses ................ 2,953,000 Division segment margin ................... 322,000 [The statement is continued on the next page.]

$1,600,000

$400,000 75,000 100,000

1,600,000

575,000

700,000

$400,000 400,000

210,000 52,500 46,000

150,000 37,500 46,000

300,000 75,000 119,000

180,000 45,000 46,000

157,500 90,000

112,000 56,000

50,500

481,000 $ 94,000

662,000 $ 38,000

600,000 500,000

1,408,500 $ 191,500

$700,000

80,000 401,500 $ (1,500)

Case 6-30 (continued) [Continuation of the segmented income statement.]

Division Association Magazine Books & Continuing Total Membership Subscriptions Reports Education

Division segment margin ................... 322,000 Common expenses not traceable to divisions: Salaries—corporate staff ................. 80,000 Personnel costs .............................. 20,000 Occupancy costs ............................ 23,000 Postage and shipping ..................... 30,000 General and administrative ............. 38,000 Total common expenses .................... 191,000 Excess of revenues over expenses ..... $ 131,000

$ 191,500

$ 94,000

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$ 38,000

$ (1,500)

Case 6-30 (continued) 2. While we do not favor the allocation of common costs to segments, the most common reason given for this practice is that segment managers need to be aware of the fact that common costs do exist and that they must be covered. Arguments against allocation of all costs: • Allocation bases will need to be chosen arbitrarily because no causeand-effect relationship exists between common costs and the segments to which they are allocated. • Management may be misled into eliminating a profitable segment that appears to be unprofitable because of allocated common costs. • Segment managers usually have little control over common costs. They should not be held accountable for costs over which they have no control. • Allocations of common costs undermine the credibility of performance reports. Segment managers may resent such allocations and ignore the entire performance report as arbitrary and unfair.

Appendix 6A Super-Variable Costing Exercise 6A-1 (10 minutes) 1. a. The unit product cost under super-variable costing would include direct materials of $18. b. The super-variable costing income statement would be: Sales (20,000 units × $50 per unit) ............ $1,000,000 Variable cost of goods sold (20,000 units × $18 per unit) ............... 360,000 Contribution margin .................................. 640,000 Fixed expenses: Direct labor ............................................ $200,000 Fixed manufacturing overhead ................ 250,000 Fixed selling and administrative expense .. 80,000 530,000 Net operating income ................................ $ 110,000

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Exercise 6A-2 (20 minutes) 1. a. The unit product cost under super-variable costing would include direct materials of $13. b. The super-variable costing income statement would be: Sales (52,000 units × $40 per unit) ............ $2,080,000 Variable cost of goods sold (52,000 units × $13 per unit) ............... 676,000 Contribution margin .................................. 1,404,000 Fixed expenses: Direct labor ............................................ $750,000 Fixed manufacturing overhead ................ 420,000 Fixed selling and administrative expense .. 110,000 1,280,000 Net operating income ................................ $ 124,000 2. a. The unit product cost under variable costing would be: Direct materials.............................................................. Direct labor ($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 ............... $420,000 Fixed selling and administrative expense ............................................. 110,000 Net operating income ...............................

$2,080,000 1,326,000 754,000

530,000 $ 224,000

Exercise 6A-2 (continued) 3. The difference between the super-variable costing and variable costing net 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 labor cost deferred in (released from) inventory = Direct labor cost ending inventory – Direct labor cost in beginning inventory = (8,000 units × $12.50 per unit) − $0 = $100,000 Super-variable costing net operating income .................. Add direct labor cost deferred in inventory under variable costing ......................................................... Variable costing net operating income ...........................

$124,000 100,000 $224,000

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Exercise 6A-3 (20 minutes) 1. a. Under super-variable costing, the unit product cost for both years includes direct materials of $12. 1. b.

Year 1

Sales (@ $50 per unit) ................................ Variable cost of goods sold (@ $12 per unit) Contribution margin .................................... Fixed expenses: Direct labor ............................................. Fixed manufacturing overhead .................. Fixed selling and administrative ................ Total fixed expenses ................................... Net operating income .................................

Year 2

$2,000,000 $3,000,000 480,000 720,000 1,520,000 2,280,000 500,000 500,000 450,000 450,000 180,000 180,000 1,130,000 1,130,000 $ 390,000 $1,150,000

2. a. The unit product costs under variable costing: Direct materials .................................... Direct labor .......................................... Variable costing unit product cost ..........

Year 1

$12 *10 $22

Year 2

$12 *10 $22

* $500,000 ÷ 50,000 units = $10 per unit.

Exercise 6A-3 (continued) 2. b. The variable costing income statements would be: Sales ......................................................... Variable cost of goods sold (@ $22 per unit) Contribution margin .................................... Fixed expenses: Fixed manufacturing overhead .................. Fixed selling and administrative ................ Total fixed expenses ................................... Net operating income .................................

Year 1

Year 2

$2,000,000 $3,000,000 880,000 1,320,000 1,120,000 1,680,000 450,000 450,000 180,000 180,000 630,000 630,000 $ 490,000 $1,050,000

3. The net operating incomes are reconciled as follows: Units in beginning inventory ........................ + Units produced ....................................... − Units sold ............................................... = Units in ending inventory ......................... Direct labor cost in ending inventory (10,000 units × $10 per unit) ................... Deduct: Direct labor cost in beginning inventory (10,000 units × $10 per unit) .... Direct labor cost deferred in (released from) inventory ................................................. Super-variable costing net operating income Add: Direct labor deferred in inventory under variable costing .............................. Deduct: Direct labor released from inventory under variable costing ............... Variable costing net operating income .........

Year 1

Year 2

Year 1

Year 2

$100,000

0 50,000 40,000 10,000

10,000 50,000 60,000 0

100,000

$100,000

$(100,000)

Year 1

Year 2

$390,000 $1,150,000 100,000

(100,000) $490,000 $1,050,000

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Problem 6A-4 (30 minutes) 1. a. and b.

The unit product cost for all three years under super-variable costing would include direct materials of $16 per unit. The super-variable costing income statements appear below:

Year 1

Sales (@ $45 per unit) .............................................. $2,700,000 Variable cost of goods sold (@ $16 per unit) .............. 960,000 Contribution margin .................................................. 1,740,000 Fixed expenses: Direct labor............................................................ 540,000 Fixed manufacturing overhead ................................ 822,000 Fixed selling and administrative............................... 370,000 Total fixed expenses ................................................. 1,732,000 Net operating income (loss) ...................................... $ 8,000

Year 2

$2,475,000 $2,925,000 880,000 1,040,000 1,595,000 1,885,000 540,000 540,000 822,000 822,000 370,000 370,000 1,732,000 1,732,000 $ (137,000) $ 153,000

Year 3

Problem 6A-4 (continued) 2. a. The unit product costs under variable costing: Direct materials ........................................... Direct labor* ............................................... Variable costing unit product cost .................

Year 1

$16 9 $25

Year 2 Year 3 $16 9 $25

$16 9 $25

*Direct labor cost per unit for each year: $540,000 ÷ 60,000 units = $9. 2. b. The variable costing income statements appears below:

Year 1

Sales........................................................................ $2,700,000 Variable cost of goods sold (@ $25 per unit) .............. 1,500,000 Contribution margin .................................................. 1,200,000 Fixed expenses: Fixed manufacturing overhead ................................ 822,000 Fixed selling and administrative............................... 370,000 Total fixed expenses ................................................. 1,192,000 Net operating income (loss) ...................................... $ 8,000

Year 2

$2,475,000 $2,925,000 1,375,000 1,625,000 1,100,000 1,300,000 822,000 822,000 370,000 370,000 1,192,000 1,192,000 $ (92,000) $ 108,000

Year 3

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Problem 6A-4 (continued) 3. The net operating incomes are reconciled as follows: Units in beginning inventory ........................ + Units produced ....................................... − Units sold ............................................... = Units in ending inventory ......................... Direct labor cost in ending inventory (5,000 units × $9 per unit) ................................. Deduct: Direct labor cost in beginning inventory (5,000 units × $9 per unit) ........ Direct labor cost deferred in (released from) inventory .................................................

Super-variable costing net operating income (loss) ...................................................... Add: Direct labor deferred in inventory under variable costing .............................. Deduct: Direct labor released from inventory under variable costing ............... Variable costing net operating income (loss)

Year 1

Year 2

Year 3

Year 1

Year 2

Year 3

$45,000

45,000

$45,000

$(45,000)

Year 2

Year 3

0 60,000 60,000 0

Year 1

0 60,000 55,000 5,000

5,000 60,000 65,000 0

$8,000 $(137,000)

$153,000

45,000 $8,000

(45,000) $108,000

$ (92,000)

Problem 6A-5 (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 labor ............................................ $250,000 Fixed manufacturing overhead ................ 300,000 Fixed selling and administrative expense .. 90,000 Net operating income ................................

$990,000 342,000 648,000

640,000 $ 8,000

2. a. The unit product cost under variable costing would be: Direct materials.............................................................. Direct labor ($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 ................ $300,000 Fixed selling and administrative expense .. 90,000 Net operating income ................................

$990,000 567,000 423,000 390,000 $ 33,000

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Problem 6A-5 (continued) 3. a. The unit product cost under absorption costing would be: Direct materials.............................................................. Direct labor ($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 .......................... Net operating income ...............................................

$990,000 837,000 153,000 90,000 $ 63,000

4. The difference between the super-variable costing and variable costing net operating incomes is the direct labor 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 labor cost deferred in (released from) inventory = Direct labor cost in ending inventory – Direct labor cost in beginning inventory = (2,000 units × $12.50 per unit) – $0 = $25,000 Super-variable costing net operating income ............ Add direct labor cost deferred in inventory under variable costing ................................................... Variable costing net operating income......................

$ 8,000 25,000 $33,000

Problem 6A-5 (continued) 4. The difference between the super-variable costing and absorption costing net operating incomes is explained as follows: Direct labor and fixed manufacturing overhead cost deferred in (released from) inventory = Direct labor and fixed manufacturing overhead cost in ending inventory – Direct labor 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 net operating income ............ Add direct labor and fixed manufacturing overhead cost deferred in inventory under absorption costing ................................................................ Absorption costing net operating income .................

$ 8,000 55,000 $63,000

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Chapter 7 Activity-Based Costing: A Tool to Aid Decision Making Solutions to Questions 7-1 Activity-based costing differs from traditional costing systems in a number of ways. In activity-based costing, nonmanufacturing as well as manufacturing costs may be assigned to products. And, some manufacturing costs— including the costs of idle capacity—may be excluded from product costs. An activity-based costing system typically includes a number of activity cost pools, each of which has its unique measure of activity. These measures of activity often differ from the allocation bases used in traditional costing systems. 7-2 When direct labor is used as an allocation base for overhead, it is implicitly assumed that overhead cost is directly proportional to direct labor. When cost systems were originally developed in the 1800s, this assumption may have been reasonably accurate. However, direct labor has declined in importance over the years while overhead has been increasing. This suggests that there is no longer a direct link between the level of direct labor and overhead. Indeed, when a company automates, direct labor is replaced by machines; a decrease in direct labor is accompanied by an increase in overhead. This violates the assumption that overhead cost is directly proportional to direct labor. Overhead cost appears to be driven by factors such as product diversity and complexity as well as by volume, for which direct labor has served as a convenient measure. 7-3 Top managers provide leadership that is needed to properly motivate all employees to embrace the need to implement ABC. Top managers also have the authority to link ABC data to the employee evaluation and reward system. Cross-functional employees are also important because they possess intimate knowledge of operations that is needed to design an effective

ABC system. Tapping the knowledge of crossfunctional employees also lessens their resistance to ABC because they feel included in the implementation process. 7-4 Unit-level activities are performed for each unit that is produced. Batch-level activities are performed for each batch regardless of how many units are in the batch. Product-level activities must be carried out to support a product regardless of how many batches are run or units produced. Customer-level activities must be carried out to support customers regardless of what products or services they buy. Organizationsustaining activities are carried out regardless of the company’s precise product mix or mix of customers. 7-5 Organization-sustaining costs, customerlevel costs, and the costs of idle capacity should not be assigned to products. These costs represent resources that are not consumed by the products. 7-6 In activity-based costing, costs must first be allocated to activity cost pools and then they are allocated from the activity cost pools to products, customers, and other cost objects. 7-7 Because people are often involved in more than one activity, some way must be found to estimate how much time they spend in each activity. The most practical approach is often to ask employees how they spend their time. It is also possible to ask people to keep records of how they spend their time or observe them as they perform their tasks, but both of these alternatives are costly and it is not obvious that the data would be any better. People who know they are being observed may change how they behave.

7-8 In traditional cost systems, product-level costs are indiscriminately spread across all products using direct labor-hours or some other allocation base related to volume. As a consequence, high-volume products are assigned the bulk of such costs. If a product is responsible for 40% of the direct labor in a factory, it will be assigned 40% of the manufacturing overhead cost in the factory—including 40% of the productlevel costs of low-volume products. In an activitybased costing system, batch-level and productlevel costs are assigned more appropriately. This results in shifting product-level costs back to the products that cause them and away from the high-volume products. (A similar effect will be observed with batch-level costs if high-volume products are produced in larger batches than lowvolume products.)

7-9 Activity rates tell managers the average cost of resources consumed to carry out a particular activity such as processing purchase orders. An activity whose average cost is high may be a good candidate for process improvements. Benchmarking can be used to identify which activities have unusually large costs. If some other organization is able to carry out the activity at a significantly lower cost, it is reasonable to suppose that improvement may be possible. 7-10 The activity-based costing approach described in the chapter is probably unacceptable for external financial reports for two reasons. First, activity-based product costs, as described in this chapter, exclude some manufacturing costs and include some nonmanufacturing costs. Second, the first-stage allocations are based on interviews rather than verifiable, objective data.

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Chapter 7: Applying Excel The completed worksheet is shown below.

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Chapter 7: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Chapter 7: Applying Excel (continued) 1. When the number of units ordered by OfficeMart is doubled to 160 units, the result is:

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Chapter 7: Applying Excel (continued) a. The customer margin under activity-based costing at 80 units was only $840, whereas the customer margin at 160 units is $7,640. The number of units ordered has doubled, but the customer margin is almost ten times what it was. The customer margin would have doubled only if all of the costs were strictly variable with respect to the number of units ordered. This is not the case under activity-based costing. Under activity-based costing, the substantial order-related and customer-related overhead costs have not changed at all even though the number of units ordered doubled. b. The product margin under traditional costing has exactly doubled, going from a loss of $10,800 to a loss of $21,600, because all of the costs included in the product margin under traditional costing are assumed to be strictly variable with respect to the number of units ordered. c. Assuming that the activity-based costing system was carefully designed and implemented, it will provide a more accurate picture of what happens to profits as the number of units ordered increases. If some of the fixed manufacturing overhead costs are order-related and customer-related costs and some are not attributable to particular orders or customers at all, then allocating all of the manufacturing overhead costs based on the number of units as in traditional costing will seriously distort costs. Moreover, if some of the selling and administrative costs are caused by the number of units ordered, the number of orders, and the number of customers, the activity-based costing system will more accurately assign these costs than the traditional costing system, which does not assign them to units, orders, or customers at all.

Chapter 7: Applying Excel (continued) 2. With the changes in the data, the worksheet should look like this:

Managerial Accounting, 16th Edition

Chapter 7: Applying Excel (continued) a. The customer margin under activity-based costing is now $(6,600). b. The product margin under traditional costing is now $1,600. c. Even though the number of units ordered is exactly the same, the profitability picture has shifted radically and is summarized below:

Customer margin, activity-based costing ................. Product margin, traditional costing .

Lower-end, Fewer orders, More units per order

Higher-end, More orders, Fewer units per order

$840

$(6,600)

$(10,800)

$1,600

The reasons for these changes are complex. One reason is that the difference between the selling price and the direct materials and direct labor costs has increased.

Selling price ............. Direct materials ........ Direct labor .............. Excess of selling price over direct material and direct labor..........

Lower-end, Fewer orders, More units per order $595 180 50

Higher-end, More orders, Fewer units per order $795 185 90

$365

$520

Under the traditional costing method, $500 of manufacturing overhead is allocated to each. Consequently, the product margin is $20 per unit. When 80 units are ordered, the result is a total product margin of $1,600 (= $20 per unit × 80 units). Under activity-based costing, the additional costs of processing 20 orders rather than 4 orders increases the order-related overhead from $4,960 to $24,800. This swamps the fact that the selling price has gone up a lot more than the direct materials and direct labor costs. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 7

Managerial Accounting, 16th Edition

Chapter 7: Applying Excel (continued) 3. With the change in the selling and administrative percentages, the result is:

Chapter 7: Applying Excel (continued) a. The customer margin under activity-based costing has improved from $(6,600) to $(3,450) because costs have shifted from the orderrelated activity cost pool to the customer-related activity cost pool. The average number of orders per customer is 2.5 (= 250 orders ÷ 100 customers). Since in this part we assume that this customer had 20 orders, this customer would be assigned much more order-related cost than most customers. Consequently, when the percentages change and result in costs being shifted from the order-related cost pool to the customer-related cost pool, this particular customer margin will improve. The customer margins for customers who place few orders will look worse. b. Shifting selling and administrative costs from the order-related cost pool to the customer-related cost pool has no effect on product margins under traditional costing for two reasons. First, selling and administrative costs are not assigned to products under traditional costing. Second, the order-related and customer-related cost pools do not exist under traditional costing.

Managerial Accounting, 16th Edition

The Foundational 15 1. The plantwide overhead rate is computed as follows: Total estimated overhead cost (a) ............ Total expected direct labor-hours (b) ....... Predetermined overhead rate (a) ÷ (b) ....

$684,000 12,000 DLHs $57.00 per DLH

2. The overhead cost assignments to Products Y and Z are as follows:

Product Y Total direct labor hours (a) ...................... Plantwide overhead rate per DLH (b) ........ Manufacturing overhead assigned (a) × (b)

8,000 $57.00 $456,000

Product Z 4,000 $57.00 $228,000

3-6. The activity rates are computed as follows:

Activity Cost Pool

Machining ............... Machine setups ....... Product design ........ General factory .......

(a) Estimated Overhead Cost

(b) Expected Activity

(a) ÷ (b) Activity Rate

$200,000 10,000 MH $20 per MH $100,000 200 setups $500 per setup $84,000 2 products $42,000 per product $300,000 12,000 DLHs $25 Per DLH

7. Machine setups is a batch-level activity. A setup is performed to run a batch of units. The cost of the setup is determined by the resources consumed performing the setup and it is not influenced by the number of units processed once the setup is complete. 8. The product design activity is a product-level activity. The product design cost is determined by the number of products supported and it is not influenced by the number of batches or units processed.

The Foundational 15 (continued) 9-10. Using the ABC system, the total overhead assigned to Products Y and Z is computed as follows:

Machining, at $20.00 per machine-hour ............... Machine setups, at $500.00 per setup ................. Product design, at $42,000 per product ............... General factory, at $25.00 per direct labor-hour ... Total overhead cost assigned ..............................

Product Y Expected Activity Amount 7,000 50 1 8,000

$140,000 25,000 42,000 200,000 $407,000

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Product Z Expected Activity Amount 3,000 150 1 4,000

$ 60,000 75,000 42,000 100,000 $277,000

The Foundational 15 (continued) 11-15. The percentages of overhead assigned using the plantwide and ABC approaches are computed as follows:

Product Y

Plantwide Approach

Manufacturing overhead ........

Product Z

(a) (a) ÷ (c) (b) (b) ÷ (c) Amount % Amount % $456,000 66.7% $228,000 33.3%

Activity-Based Costing System

Machining ............................. $140,000 Machine setups ..................... 25,000 Product design ...................... 42,000 General factory ..................... 200,000 Total cost assigned to products $407,000

70.0% 25.0% 50.0% 66.7%

$ 60,000 75,000 42,000 100,000 $277,000

30.0% 75.0% 50.0% 33.3%

Total

The Machining allocation percentages used in the ABC system are similar to the plantwide allocation percentages because the Machining cost pool uses a unit-level activity measure (machine-hours). Since the plantwide cost pool also uses a unit-level allocation base (direct labor-hours), it is reasonable to expect these cost allocations percentages to be comparable. Under the ABC system, 25% and 75% of the Machine Setups cost is allocated to Products Y and Z, respectively, whereas the plantwide approach allocates 67% and 33% of all overhead costs to the two products. These allocation percentages are different because Machine Setups is a batch-level cost pool. Although Product Y is the high-volume product (14,000 units) and Product Z is the lowvolume product (6,000 units), Product Y only consumes 25% of the total machine setups and Product Z consumes 75% of the total machine setups. The conventional system is allocating too much of the machine setup costs to Product Y and too little of these costs to Product Z. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 7

The Foundational 15 (continued) Under the ABC system, 50% of the Product Design cost is allocated to each product, whereas the plantwide approach allocates 67% and 33% of all overhead costs to Products Y and Z, respectively. These percentages are different because Product Design is a product-level cost pool. Although Product Y is the high volume product (14,000 units) and Product Z is the low-volume product (6,000 units), both products consume 50% of the product design resources. The conventional system is allocating too much of the product design costs to Product Y and too little of these costs to Product Z. Under the ABC system, the General Factory allocation percentages are the same as the plantwide allocation percentages because the General Factory cost pool is allocated to products using the same unit-level activity measure (direct labor-hours) as the plantwide approach.

Managerial Accounting, 16th Edition

Exercise 7-1 (10 minutes) a. Receive raw materials from suppliers. b. Manage parts inventories. c. Do rough milling work on products. Interview and process new employees in the d. personnel department. e. Design new products. Perform periodic preventive maintenance on generalf. use equipment. g. Use the general factory building. h. Issue purchase orders for a job.

Batch-level Product-level Unit-level Organizationsustaining Product-level Organizationsustaining Organizationsustaining Batch-level

Some of these classifications are debatable and depend on the specific circumstances found in particular companies.

Exercise 7-2 (15 minutes)

Travel

Driver and guard wages......................... $360,000 Vehicle operating expense ..................... 196,000 Vehicle depreciation .............................. 72,000 Customer representative salaries and expenses............................................ 0 Office expenses..................................... 0 Administrative expenses ........................ 0 Total cost ............................................. $628,000

Pickup and Delivery

Customer Service $ 72,000 0 0

$ 36,000 70,000 30,000

$ 720,000 280,000 120,000

0 6,000 16,000 $306,000

144,000 9,000 192,000 $417,000

16,000 15,000 112,000 $279,000

160,000 30,000 320,000 $1,630,000

$252,000 14,000 18,000

Other

Totals

Each entry in the table is derived by multiplying the total cost for the cost category by the percentage taken from the table below that shows the distribution of resource consumption:

Driver and guard wages......................... Vehicle operating expense ..................... Vehicle depreciation .............................. Customer representative salaries and expenses............................................ Office expenses..................................... Administrative expenses ........................

Travel

Pickup and Delivery

Customer Service

Other

0% 0% 0%

0% 20% 5%

90% 30% 60%

10% 50% 35%

50% 70% 60%

35% 5% 15%

10% 0% 0%

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5% 25% 25%

Totals

100% 100% 100% 100% 100% 100%

Exercise 7-3 (10 minutes)

Activity Cost Pool

Caring for lawn .................... Caring for garden beds– low maintenance ............... Caring for garden beds–high maintenance ..................... Travel to jobs ....................... Customer billing and service .

Estimated Overhead Cost $72,000 $26,400 $41,400 $3,250 $8,750

Expected Activity

150,000 square ft. of lawn 20,000 square ft. of low maintenance beds 15,000 square ft. of high maintenance beds 12,500 miles 25 customers

Activity Rate

$0.48 per square ft. of lawn $1.32 per square ft. of low maintenance beds $2.76 per square ft. of high maintenance beds $0.26 per mile $350 per customer

The activity rate for each activity cost pool is computed by dividing its estimated overhead cost by its expected activity.

Exercise 7-4 (10 minutes)

K425

Activity Cost Pool

Supporting direct labor ......... Machine processing .............. Machine setups .................... Production orders ................. Shipments ........................... Product sustaining ................ Total ...................................

M67

Activity Cost Pool

$6 $4 $50 $90 $14 $840

Activity Rate

per direct labor-hour per machine-hour per setup per order per shipment per product

Activity Rate

80 100 1 1 1 1

per direct labor-hour 500 per machine-hour 1,500 per setup 4 per order 4 per shipment 10 per product 1

Activity

ABC Cost

Activity

ABC Cost

direct labor-hours machine-hours setups order shipment product

direct labor-hours machine-hours setups orders shipments product

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$ 480 400 50 90 14 840 $1,874

$ 3,000 6,000 200 360 140 840 $10,540

Exercise 7-5 (15 minutes) Sales ($1,850 per standard model glider × 20 standard model gliders + $2,400 per custom designed glider × 3 custom designed gliders) ..... Costs: Direct materials ($564 per standard model glider × 20 standard model gliders + $634 per custom designed glider × 3 custom designed gliders) .. Direct labor ($19.50 per direct labor-hour × 26.35 direct labor-hours per standard model glider × 20 standard model gliders + $19.50 per direct labor-hour × 28 direct labor-hours per custom designed glider × 3 custom designed gliders)............................................ Supporting direct labor ($26 per direct laborhour × 26.35 direct labor-hours per standard model glider × 20 standard model gliders + $26 per direct labor-hour × 28 direct laborhours per custom designed glider × 3 custom designed gliders)............................................ Order processing ($284 per order × 4 orders) .... Custom designing ($186 per custom design × 3 custom designs) ............................................. Customer service ($379 per customer × 1 customer) ................................................... Customer margin.................................................

$44,200

$13,182

11,915

15,886 1,136 558 379

43,056 $ 1,144

Exercise 7-6 (10 minutes)

Activity a. Sales representatives’ periodic visits to customers to keep them informed about the services provided by CD Express. b. Ordering labels from the printer for a particular CD*. c. Setting up the CD duplicating machine to make copies from a particular master CD. d. Loading the automatic labeling machine with labels for a particular CD*. e. Visually inspecting CDs and placing them by hand into protective plastic cases prior to shipping. f. Preparation of the shipping documents for the order. g. Periodic maintenance of equipment. h. Lighting and heating the company’s production facility. i. Preparation of quarterly financial reports.

Level Customer-level Product-level Batch-level Batch-level Unit-level Product-level Organization-sustaining Organization-sustaining Organization-sustaining

*The cost of the labels themselves would be part of direct materials.

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Exercise 7-7 (10 minutes) Teller wages ............................... Assistant branch manager salary .. Branch manager salary ................

Teller wages ............................... Assistant branch manager salary .. Branch manager salary ................

Teller wages ................................ Assistant branch manager salary .. Branch manager salary ................ Total cost ....................................

$160,000 $75,000 $80,000

Distribution of Resource Consumption Across Activities Processing Processing Other Opening Deposits and Customer Other Accounts Withdrawals Transactions Activities Totals 5% 15% 5%

Opening Accounts $ 8,000 11,250 4,000 $23,250

65% 5% 0%

20% 30% 10%

10% 50% 85%

100% 100% 100%

Processing Deposits and Withdrawals

Processing Other Customer Transactions

Other Activities

Totals

$104,000 3,750 0 $107,750

$32,000 22,500 8,000 $62,500

$ 16,000 37,500 68,000 $121,500

$160,000 75,000 80,000 $315,000

Teller wages are $160,000 and 65% of the tellers’ time is spent processing deposits and withdrawals: $160,000 × 65% = $104,000. Other entries in the table are determined similarly. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 7

Exercise 7-8 (20 minutes) 1. Computation of activity rates:

Activity Cost Pools

Opening accounts ............................... Processing deposits and withdrawals ... Processing other customer transactions

(a) Total Cost

$23,250

(b) Total Activity

(a) ÷ (b) Activity Rate

500 accounts $46.50 per account opened opened $107,750 100,000 deposits and $1.08 per deposit or withdrawals withdrawal $62,500 5,000 other customer $12.50 per other customer transactions transaction

2. The cost of opening an account at the Westfield branch is much higher than at the lowest cost branch ($46.50 versus $26.75). On the other hand, the cost of processing deposits and withdrawals is lower than at the lowest cost branch ($1.08 versus $1.24). And the cost of processing other customer transactions is higher at the Westfield branch ($12.50 versus $11.86). The other branches may have something to learn from Westfield concerning processing deposits and withdrawals and Westfield may benefit from learning about how some of the other branches open accounts and process other transactions. It may be particularly instructive to compare the details of the activity rates. For example, is the cost of opening accounts at Westfield high because of the involvement of the assistant branch manager in this activity? Perhaps tellers open new accounts at other branches. The apparent differences in the costs of the activities at the various branches may be due to inaccuracies in employees’ reports of the amount of time they devote to the activities. The differences in costs may also reflect different strategies. For example, the Westfield branch may purposely spend more time with new customers in order to win their loyalty. The higher cost of opening new accounts at the Westfield branch may be justified by future benefits of having more satisfied customers. Nevertheless, comparative studies of the costs of activities may provide a useful starting point for identifying best practices within a company and where improvements can be made. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 24

Managerial Accounting, 16th Edition

Exercise 7-9 (10 minutes)

Activity Cost Pool

Order size .......... Customer orders . Product testing ... Selling................ Total ..................

(a) Activity Rate

$16.85 per direct labor-hour $320.00 per customer order $89.00 per product testing hour $1,090.00 per sales call

(b) Activity

200 direct labor-hours 1 customer order 4 product testing hours 2 sales calls

According to these calculations, the total overhead cost of the order was $6,226.

(a) × (b) ABC Cost $3,370 320 356 2,180 $6,226

Exercise 7-10 (30 minutes) 1. Total revenue received: Cost of goods sold to the hospital (a) ............... Markup percentage ......................................... Markup in dollars (b) ....................................... Revenue received from hospitals (a) + (b)........ 2. Activity Rates:

Activity Cost Pool

Customer deliveries ............. Manual order processing ...... Electronic order processing .. Line item picking .................

(a) Estimated Overhead Cost

University

$30,000 × 5% $1,500 $31,500

(b) Expected Activity

$500,000 5,000 $248,000 4,000 $200,000 12,500 $450,000 450,000

deliveries orders orders line items

Memorial

$30,000 × 5% $1,500 $31,500

$100.00 $62.00 $16.00 $1.00

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(a) ÷ (b) Activity rate

per delivery per manual order per electronic order per line item picked

Exercise 7-10 (continued) 3. Activity costs are assigned to the two hospitals as follows:

University: Activity Cost Pool

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

Customer deliveries ........... $100.00 per delivery 10 deliveries Manual order processing .... $62.00 per order 0 orders Electronic order processing $16.00 per order 15 orders Line item picking ............... $1.00 per line item 120 line items Total activity costs .............

$1,000 0 240 120 $1,360

Memorial: Activity Cost Pool

Customer deliveries ........... $100.00 per delivery Manual order processing .... $62.00 per order Electronic order processing $16.00 per order Line item picking ............... $1.00 per line item Total activity costs .............

25 deliveries 30 orders 0 orders 250 line items

$2,500 1,860 0 250 $4,610

Exercise 7-10 (continued) 4. Customer margins for the two hospitals: Sales .................................................... Cost of goods sold ................................. Gross margin ........................................ Customer deliveries ............................... Manual order processing ........................ Electronic order processing .................... Line item picking ................................... Total activity costs................................. Customer margin...................................

University

$31,500 30,000 1,500 1,000 0 240 120 1,360 $ 140

Memorial

$31,500 30,000 1,500 2,500 1,860 0 250 4,610 $(3,110)

5. Hospitals that require frequent deliveries, place a high volume of manual orders, and order many line items are likely to be unprofitable.

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Exercise 7-11 (15 minutes)

Customer Margin—ABC Analysis

Sales (1,000 seats × $20 per unit) .................... Costs: Direct materials ($8.50 per unit × 1,000 units) .. Direct labor ($6.00 per unit × 1,000 units) ........ Supporting direct labor ($5.55 per DLH × 0.25 DLH per unit × 1,000 units) ........................... Batch processing ($107 per batch × 2 batches). Order processing ($275 per order × 1 order) .... Customer service overhead ($2,463 per customer × 1 customer) ................................ Customer margin ...............................................

$20,000.00 $8,500.00 6,000.00 1,387.50 214.00 275.00 2,463.00

18,839.50 $ 1,160.50

Exercise 7-12 (10 minutes)

Activity a.

Direct labor workers assemble a product.

Activity Classification Unit

Products are designed by b. engineers.

Product

c. Equipment is set up.

Batch

Machines are used to shape and cut materials. Monthly bills are sent out e. to regular customers. Materials are moved from f. the receiving dock to production lines. All completed units are g. inspected for defects. d.

Unit Customer Batch Unit

Examples of Activity Measures Direct labor-hours Number of new products designed; hours of design time Number of setups; setup hours Number of units processed; machine-hours Number of bills sent; time spent preparing bills Number of loads transferred; time spent moving materials Number of units inspected; Inspection hours

Notes: In all cases except for direct labor in part (a), two activity measures are listed. The first is a “transaction driver” and the second is a “duration driver.” Transaction drivers are simple counts of the number of times an activity occurs such as the number of times materials are moved. Duration drivers are measures of the amount of time required to perform an activity such as the time spent moving materials. In general, duration drivers are more accurate measures of the consumption of resources than transaction drivers, but they take more effort to record.

Managerial Accounting, 16th Edition

Exercise 7-13 (30 minutes) 1. Activity rates are computed as follows:

Activity Cost Pool

Machine setups ...... Special processing ..

(a) Estimated Overhead Cost

$72,000 $200,000

(b) Expected Activity

400 setups 5,000 MHs

(a) ÷ (b) Activity Rate

$180 per setup $40 per MH

There is no activity rate for the General Factory activity because it is an organization-sustaining activity. Organization-sustaining costs should not be allocated to products. 2. Overhead is assigned to the two products as follows:

Hubs: Activity Cost Pool

Machine setups ..................... Special processing ................. Total.....................................

(a) Activity Rate

$180 per setup $40 per MH

(b) Activity

100 setups 5,000 MHs

(a) × (b) ABC Cost

(a) Activity Rate

(b) Activity

(a) × (b) ABC Cost

$ 18,000 200,000 $218,000

Sprockets: Activity Cost Pool

Machine setups ..................... Special processing ................. Total.....................................

$180 per setup $40 per MH

300 setups 0 MHs

$54,000 0 $54,000

Exercise 7-13 (continued) Direct materials................................... Direct labor: $15 per DLH × 0.80 DLHs per unit .... $15 per DLH × 0.40 DLHs per unit .... Overhead: $218,000 ÷ 10,000 units................... $54,000 ÷ 40,000 units .................... Unit cost .............................................

Hubs

$32.00 12.00 21.80 $65.80

Sprockets

$18.00 6.00 1.35 $25.35

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Exercise 7-14 (30 minutes) 1. The first step is to determine the activity rates:

(a) Activity Cost Pools Total Cost

Serving parties ....... Serving diners ........ Serving drinks ........

(b) Total Activity

$33,000 6,000 parties $138,000 15,000 diners $24,000 10,000 drinks

(a) ÷ (b) Activity Rate

$5.50 per party $9.20 per diner $2.40 per drink

According to the activity-based costing system, the cost of serving each of the parties can be computed as follows: a. Party of 4 persons who order a total of 3 drinks:

Activity Cost Pool

(a) Activity Rate

Serving parties ....... $5.50 per party Serving diners ........ $9.20 per diner Serving drinks ........ $2.40 per drink Total .....................

(b) Activity

(a) × (b) ABC Cost

(b) Activity

(a) × (b) ABC Cost

(b) Activity

(a) × (b) ABC Cost

1 party 4 diners 3 drinks

$ 5.50 36.80 7.20 $49.50

b. Party of 2 persons who order no drinks:

Activity Cost Pool

(a) Activity Rate

Serving parties ....... $5.50 per party Serving diners ........ $9.20 per diner Serving drinks ........ $2.40 per drink Total .....................

1 party 2 diners 0 drinks

$ 5.50 18.40 0 $23.90

c. Party of 1 person who orders 2 drinks:

Activity Cost Pool

(a) Activity Rate

Serving parties ....... $5.50 per party Serving diners ........ $9.20 per diner Serving drinks ........ $2.40 per drink Total .....................

1 party 1 diner 2 drinks

$ 5.50 9.20 4.80 $19.50

Exercise 7-14 (continued) 2. The average cost per diner for each party can be computed by dividing the total cost of the party by the number of diners in the party as follows: a. $49.50 ÷ 4 diners = $12.375 per diner b. $23.90 ÷ 2 diners = $11.95 per diner c. $19.50 ÷ 1 diner = $19.50 per diner 3. The average cost per diner differs from party to party under the activitybased costing system for two reasons. First, the cost of serving a party ($5.50) does not depend on the number of diners in the party. Therefore, the average cost per diner of this activity decreases as the number of diners in the party increases. With only one diner, the cost is $5.50. With two diners, the average cost per diner is cut in half to $2.75. With five diners, the average cost per diner would be only $1.10, and so on. Second, the average cost per diner differs also because of the differences in the number of drinks ordered by the diners. If a party does not order any drinks, as was the case with the party of two, no costs of serving drinks are assigned to the party. The average cost per diner differs from the overall average cost of $16 per diner for several reasons. First, the average cost of $16 per diner includes organization-sustaining costs that are excluded from the computations in the activity-based costing system. Second, the $16 per diner figure does not recognize differences in the diners’ demands on resources. It does not recognize that some diners order more drinks than others nor does it recognize the economies of scale in serving larger parties. (The batch-level costs of serving a party can be spread over more diners if the party is larger.) We should note that the activity-based costing system itself does not recognize all of the differences in diners’ demands on resources. For example, there are undoubtedly differences in the costs of preparing the various meals on the menu. It may or may not be worth the effort to build a more detailed activity-based costing system that would take such nuances into account.

Managerial Accounting, 16th Edition

Exercise 7-15 (30 minutes) 1. First-stage allocations of overhead costs to the activity cost pools:

Wages and salaries ......... Other overhead costs ......

Wages and salaries ......... Other overhead costs ...... Total cost .......................

Distribution of Resource Consumption Across Activity Cost Pools Supporting Order Customer Direct Labor Processing Support Other 30% 10%

20% 20%

10% 40%

Totals

Direct Labor Order Support Processing

Customer Support

Other

Totals

40% 30%

$120,000 30,000 $150,000

$ 90,000 10,000 $100,000

$ 60,000 20,000 $ 80,000

$ 30,000 40,000 $ 70,000

Example: 40% of $300,000 is $120,000. 2. Computation of activity rates:

Activity Cost Pools

Supporting direct labor ..................... Order processing ...... Customer support ....

(a) Total Cost

(b) Total Activity

$150,000 20,000 DLHs $100,000 400 orders $80,000 200 customers

(a) ÷ (b) Activity Rate $7.50 per DLH $250 per order $400 per customer

100% 100%

$300,000 100,000 $400,000

Exercise 7-15 (continued) 3. Computation of the overhead costs for the Shenzhen Enterprises order:

Activity Cost Pool

(a) Activity Rate

Supporting direct labor .................. $7.50 per DLH Order processing ... $250 per order Customer support . $400 per customer Total ....................

(b) Activity

(a) × (b) ABC Cost

20 DLHs* 1 order 1 customer

$150 250 400 $800

*2 DLHs per unit × 10 units = 20 DLHs. 4. The customer margin for Shenzhen Enterprises is computed as follows:

Customer Margin—ABC Analysis

Sales (10 units × $300 per unit) .................... Costs: Direct materials ($180 per unit × 10 units) ... Direct labor ($50 per unit × 10 units) ........... Support direct labor overhead (see part 3 above) ..................................................... Order processing overhead (see part 3 above) ..................................................... Customer support overhead (see part 3 above) ..................................................... Customer margin ..........................................

$3,000 $1,800 500 150 250 400

3,100 $ (100)

Managerial Accounting, 16th Edition

Problem 7-16 (45 minutes) 1. Under the traditional direct labor-dollar based costing system, manufacturing overhead is applied to products using the predetermined overhead rate computed as follows:

Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total direct labor dollars =

$608,000 = $2.00 per DL$ $304,000

The product margins using the traditional approach would be computed as follows: Sales ................................... Direct materials ................... Direct labor ......................... Manufacturing overhead applied @ $2.00 per direct labor-dollar ....................... Total manufacturing cost ...... Product margin ....................

B300

T500

Total

$1,400,000 436,300 200,000

$700,000 251,700 104,000

$2,100,000 688,000 304,000

400,000 1,036,300 $ 363,700

208,000 563,700 $136,300

608,000 1,600,000 $ 500,000

Note that all of the manufacturing overhead cost is applied to the products under the company’s traditional costing system.

Problem 7-16 (continued) 2. The first step is to determine the activity rates:

Activity Cost Pools

(a) Total Cost

(b) Total Activity

Machining .............. $213,500 152,500 MH Setups ................... $157,500 375 setup hrs Product sustaining .. $120,000 2 products

(a) ÷ (b) Activity Rate

$1.40 per MH $420 per setup hr $60,000 per product

*The Other activity cost pool is not shown above because it includes organization-sustaining and idle capacity costs that should not be assigned to products. Under the activity-based costing system, the product margins would be computed as follows: Sales .................................. Direct materials ................... Direct labor ......................... Advertising expense ............ Machining ........................... Setups ................................ Product sustaining ............... Total cost ........................... Product margin ...................

B300

$1,400,000 436,300 200,000 50,000 126,000 31,500 60,000 903,800 $ 496,200

T500

$700,000 251,700 104,000 100,000 87,500 126,000 60,000 729,200 $(29,200)

Total

$2,100,000 688,000 304,000 150,000 213,500 157,500 120,000 1,633,000 $ 467,000

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Problem 7-16 (continued) 3. The quantitative comparison is as follows:

Traditional Cost System Direct materials ......................... Direct labor ............................... Manufacturing overhead ............ Total cost assigned to products .. Selling and administrative .......... Total cost .................................

B300 (a) (a) ÷ (c) Amount % $436,300 63.4% 200,000 65.8% 400,000 65.8% $1,036,300

T500 Total (b) (b) ÷ (c) (c) Amount % Amount $251,700 36.6% $ 688,000 104,000 34.2% 304,000 208,000 34.2% 608,000 $563,700 $1,600,000 550,000 $2,150,000

Activity-Based Costing System

Direct costs: Direct materials ......................... Direct labor ............................... Advertising expense .................. Indirect costs: Machining ................................. Setups ...................................... Product sustaining ..................... Total cost assigned to products .. Costs not assigned to products: Selling and administrative .......... Other .................................... Total cost .................................

$436,300 200,000 50,000

63.4% 65.8% 33.3%

$251,700 104,000 100,000

36.6% 34.2% 66.7%

$ 688,000 304,000 150,000

126,000 31,500 60,000 $903,800

59.0% 20.0% 50.0%

87,500 126,000 60,000 $729,200

41.0% 80.0% 50.0%

213,500 157,500 120,000 1,633,000 400,000 117,000 $2,150,000

Problem 7-16 (continued) The traditional and activity-based cost assignments differ for three reasons. First, the traditional system assigns all $608,000 of manufacturing overhead to products. The ABC system assigns only $491,000 (= $213,500 + $157,500 + $120,000) of manufacturing overhead to products. The ABC system does not assign the $117,000 of Other activity costs to products because they represent organizationsustaining costs. Second, the traditional system uses one unit-level activity measure, direct labor dollars, to assign 65.8% of all overhead to the B300 product line and 34.2% of all overhead to the T500 product line. The ABC system assigns 59.0% of Machining costs to the B300 product line and 41.0% to the T500 product line. The ABC system assigns 20.0% of Setup costs (a batch-level activity) to the B300 product line and 80.0% to the T500 product line. The ABC system assigns 50% of Product sustaining costs (a product-level activity) to each product line. Third, the traditional system does not trace any advertising expenses to the two products. The ABC system traces $50,000 of advertising to the B300 and $100,000 of advertising to the T500 product line.

Managerial Accounting, 16th Edition

Problem 7-17 (45 minutes) 1. Under the traditional direct labor-hour based costing system, manufacturing overhead is applied to products using the predetermined overhead rate computed as follows:

Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total direct labor -hours =

$1,980,000 = $16.50 per DLH 120,000 DLHs *

*20,000 units of Xtreme @ 2.00 DLH per unit + 80,000 units of the Pathfinder@ 1.0 DLH per unit = 40,000 DLHs + 80,000 DLHs = 120,000 DLHs. Consequently, the product margins using the traditional approach would be computed as follows: Sales ................................... Direct materials ................... Direct labor ......................... Manufacturing overhead applied @ $16.50 per direct labor-hour ............... Total manufacturing cost ...... Product margin ....................

Xtreme

Pathfinder

Total

$2,800,000 1,440,000 480,000

$7,920,000 4,240,000 960,000

$10,720,000 5,680,000 1,440,000

660,000 2,580,000 $ 220,000

1,320,000 6,520,000 $1,400,000

1,980,000 9,100,000 $ 1,620,000

Note that all of the manufacturing overhead cost is applied to the products under the company’s traditional costing system.

Problem 7-17 (continued) 2. The first step is to determine the activity rates:

Activity Cost Pools

(a) Total Cost

(b) Total Activity

Supporting direct labor ................... $783,600 120,000 DLH Batch setups .......... $495,000 300 setups Product sustaining .. $602,400 2 products

(a) ÷ (b) Activity Rate $6.53 per DLH $1,650 per setup $301,200 per product

*The Other activity cost pool is not shown above because it includes organization-sustaining and idle capacity costs that should not be assigned to products. Under the activity-based costing system, the product margins would be computed as follows: Sales ................................. Direct materials ................. Direct labor ....................... Supporting direct labor ....... Batch setups...................... Product sustaining ............. Total cost .......................... Product margin ..................

Xtreme

$2,800,000 1,440,000 480,000 261,200 330,000 301,200 2,812,400 $ (12,400)

Pathfinder

$7,920,000 4,240,000 960,000 522,400 165,000 301,200 6,188,600 $1,731,400

Total

$10,720,000 5,680,000 1,440,000 783,600 495,000 602,400 9,001,000 $ 1,719,000

Managerial Accounting, 16th Edition

Problem 7-17 (continued) 3. The quantitative comparison is as follows:

Traditional Cost System Direct materials ........................ Direct labor .............................. Manufacturing overhead ........... Total cost assigned to products .

Xtreme Pathfinder Total (a) (a) ÷ (c) (b) (b) ÷ (c) (c) Amount % Amount % Amount $1,440,000 25.4% $4,240,000 74.6% $5,680,000 480,000 33.3% 960,000 66.7% 1,440,000 660,000 33.3% 1,320,000 66.7% 1,980,000 $2,580,000 $6,520,000 $9,100,000

Activity-Based Costing System

Direct costs: Direct materials ........................ $1,440,000 Direct labor .............................. 480,000 Indirect costs: Supporting direct labor ............. 261,200 Batch setups ............................ 330,000 Product sustaining .................... 301,200 Total cost assigned to products . $2,812,400 Costs not assigned to products: Other....................................... Total cost ................................

25.4% $4,240,000 33.3% 960,000

74.6% $5,680,000 66.7% 1,440,000

33.3% 66.7% 50.0%

66.7% 33.3% 50.0%

522,400 165,000 301,200 $6,188,600

99,000 $9,100,000

783,600 495,000 602,400 9,001,000

Problem 7-17 (continued) The traditional and activity-based cost assignments differ for two reasons. First, the traditional system assigns all $1,980,000 of manufacturing overhead to products. The ABC system assigns only $1,881,000 (= $783,600 + $495,000 + $602,400) of manufacturing overhead to products. The ABC system does not assign the $99,000 of Other activity costs to products because they represent organizationsustaining and idle capacity costs. Second, the traditional system uses one unit-level activity measure, direct labor hours, to assign 33.3% of all overhead to the Xtreme product line and 66.7% of all overhead to the Pathfinder product line. The ABC system assigns 66.7% of Batch setup costs (a batch-level activity) to the Xtreme product line and 33.3% to the Pathfinder product line. The ABC system assigns 50% of Product sustaining costs (a product-level activity) to each product line.

Managerial Accounting, 16th Edition

Problem 7-18 (45 minutes) 1. The results of the first-stage allocation appear below:

Job Size

Wages and salaries ......... $150,000 Disposal fees .................. 420,000 Equipment depreciation ... 36,000 On-site supplies .............. 30,000 Office expenses .............. 20,000 Licensing and insurance... 120,000 Total cost ....................... $776,000

Estimating and Job Setup $ 30,000 0 4,500 15,000 70,000 0 $119,500

Working on Nonroutine Jobs $ 90,000 280,000 18,000 5,000 50,000 200,000 $643,000

Other

$ 30,000 0 31,500 0 60,000 80,000 $201,500

Totals

$ 300,000 700,000 90,000 50,000 200,000 400,000 $1,740,000

According to the data in the problem, 50% of the wages and salaries cost of $300,000 is attributable to activities related to job size. $300,000 × 50% = $150,000. Other entries in the table are determined in a similar manner. 2.

Activity Cost Pool

Job size ................. Estimating and job setup .................. Working on nonroutine jobs ...

(a) Total Cost

(b) Total Activity

$776,000

800 thousand square feet

$970 per thousand square feet

$119,500

500 jobs

$239 per job

$643,000

100 nonroutine jobs

$6,430 per nonroutine job

(a) ÷ (b) Activity Rate

Problem 7-18 (continued) 3. The costs of each of the jobs can be computed as follows using the activity rates computed above: a. Routine one thousand square foot job: Job size (1 thousand square feet @ $970 per thousand square feet).... Estimating and job setup (1 job @ $239 per job) ................................ Nonroutine job (not applicable) ......................................................... Total cost of the job .......................................................................... Cost per thousand square feet ($1,209 ÷ 1 thousand square feet) ......

$ 970.00 239.00 0 $1,209.00 $1,209.00

b. Routine two thousand square foot job: Job size (2 thousand square feet @ $970 per thousand square feet) .... Estimating and job setup (1 job @ $239 per job) ................................ Nonroutine job (not applicable) ......................................................... Total cost of the job .......................................................................... Cost per thousand square feet ($2,179 ÷ 2 thousand square feet) ......

$1,940.00 239.00 0 $2,179.00 $1,089.50

c. Nonroutine two thousand square foot job: Job size (2 thousand square feet @ $970 per thousand square feet) .... Estimating and job setup (1 job @ $239 per job) ................................ Nonroutine job ................................................................................. Total cost of the job .......................................................................... Cost per thousand square feet ($8,609 ÷ 2 thousand square feet) ......

$1,940.00 239.00 6,430.00 $8,609.00 $4,304.50

Managerial Accounting, 16th Edition

Problem 7-18 (continued) 4. The objectivity of the interview data can be questioned because the onsite work supervisors were undoubtedly trying to prove their case about the cost of nonroutine jobs. Nevertheless, the activity-based costing data certainly suggest that dramatic differences exist in the costs of jobs. While some of the costs may be difficult to adjust in response to changes in activity, it does appear that the standard bid of $2,500 per thousand square feet (= 1,000 square feet × $2.50 per square foot) may be substantially under the company’s cost for nonroutine jobs. Even though it may be difficult to detect nonroutine situations before work begins, the average additional cost of $6,430 for nonroutine work suggests that the estimator should try. And if a nonroutine situation is spotted, this should be reflected in the bid price. Savvy competitors are likely to bid less than $2,500 per thousand square feet on routine work and substantially more than $2,500 per thousand square feet on nonroutine work. Consequently, Mercer Asbestos Removal may find that its product mix shifts toward nonroutine work and away from routine work as customers accept bids on nonroutine work from the company and go to competitors for routine work. This may have a negative effect on the company’s profits.

Problem 7-19 (20 minutes) 1. The cost of serving the local commercial market according to the ABC model can be determined as follows:

Activity Cost Pool

(a) Activity Rate

(b) Activity

Animation concept ........ Animation production.... Contract administration.

$6,040 per proposal $7,725 per minute of animation $6,800 per contract

25 proposals 5 minutes 10 contracts

(a) × (b) ABC Cost $151,000 38,625 68,000 $257,625

2. The margin earned serving the local commercial market is negative, as shown below:

Profitability Analysis

Sales ................................................... $180,000 Costs: Animation concept .............................. $151,000 Animation production.......................... 38,625 Contract administration....................... 68,000 257,625 Margin ................................................. $(77,625) 3. It appears that the local commercial market is losing money and the company would be better off dropping this market segment. However, as discussed in the previous problem, not all of the costs included above may be avoidable. If more than $77,625 of the total costs of $257,625 is not avoidable, then the company really isn’t losing money on the local commercial market and the segment should not be dropped. These issues will be discussed in more depth in Chapters 12 and 13.

Managerial Accounting, 16th Edition

Problem 7-20 (45 minutes) 1. The first-stage allocation of costs to activity cost pools appears below:

Wages ........................................ Cleaning supplies ........................ Cleaning equipment depreciation . Vehicle expenses ........................ Office expenses .......................... President’s compensation ............

Distribution of Resource Consumption Across Activity Cost Pools Cleaning Travel Job Carpets to Jobs Support Other 70% 100% 80% 0% 0% 0%

20% 0% 0% 60% 0% 0%

0% 0% 0% 0% 45% 40%

10% 0% 20% 40% 55% 60%

100% 100% 100% 100% 100% 100%

Cleaning Carpets

Travel to Jobs

Job Support

Other

Total

Wages ......................................... $105,000 Cleaning supplies ......................... 40,000 Cleaning equipment depreciation .. 16,000 Vehicle expenses.......................... 0 Office expenses ........................... 0 President’s compensation ............. 0 Total cost .................................... $161,000

$30,000 0 0 48,000 0 0 $78,000

0 0 0 0 27,000 32,000 $59,000

$ 15,000 0 4,000 32,000 33,000 48,000 $132,000

Example: 70% of $150,000 = $105,000 Other entries in the table are determined in a similar manner.

Total

$150,000 40,000 20,000 80,000 60,000 80,000 $430,000

Problem 7-20 (continued) 2. The activity rates are computed as follows:

(a) Activity Cost Pool Total Cost

(b) Total Activity

(a) ÷ (b) Activity Rate

Cleaning carpets .. $161,000 20,000 hundred $8.05 per hundred square feet square feet Travel to jobs ...... $78,000 60,000 miles $1.30 per mile Job support ......... $59,000 2,000 jobs $29.50 per job 3. The cost for the Flying N Ranch job is computed as follows:

Activity Cost Pool

(a) Activity Rate

(b) Activity

Cleaning carpets... $8.05 per hundred 5 hundred square feet square feet Travel to jobs ....... $1.30 per mile 75 miles Job support .......... $29.50 per job 1 job Total....................

(a) × (b) ABC Cost $ 40.25

97.50 29.50 $167.25

4. The margin earned on the job can be easily computed by using the costs calculated in part (3) above. Sales ........................ $140.00 Costs: Cleaning carpets ..... $40.25 Travel to jobs ......... 97.50 Job support ............ 29.50 167.25 Margin ...................... $(27.25)

Managerial Accounting, 16th Edition

Problem 7-20 (continued) 5. Gallatin Carpet Cleaning appears to be losing money on the Flying N Ranch job. However, caution is advised. Some of the costs may not be avoidable and hence would have been incurred even if the Flying N Ranch job had not been accepted. An action analysis (discussed in Appendix 7A) is a more appropriate starting point for analysis than the simple report in part (4) above. Nevertheless, there is a point at which travel costs eat up all of the profit from a job. With the company’s current policy of charging a flat fee for carpet cleaning irrespective of how far away the client is from the office, there clearly is some point at which jobs should be turned down. (What if a potential customer is located in Florida?) 6. The company should consider charging a fee for travel to outlying customers based on the distance traveled and a flat fee per job. At present, close-in customers are in essence subsidizing service to outlying customers and large-volume customers are subsidizing service to low-volume customers. With fees for travel and for job support, the fee per hundred square feet can be dropped substantially. This may result in losing some low-volume jobs in outlying areas, but the lower fee per hundred square feet may result in substantially more business close to Bozeman. (If the fee is low enough, the added business may not even have to come at the expense of competitors. Some customers may choose to clean their carpets more frequently if the price were more attractive.)

Appendix 7A ABC Action Analysis Exercise 7A-1 (30 minutes)

Note: All Microsoft Excel calculations in this solution use unrounded numbers; however, the depiction of the numbers contained in each cell of this solution have been restricted to two decimal places. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 52

Managerial Accounting, 16th Edition

Exercise 7A-2 (30 minutes)

Exercise 7A-3 (30 minutes) 1. There will be no change to the labor costs assigned to the three jobs. Only the total used and unused capacity will change. Requirements 2 through 5:

Managerial Accounting, 16th Edition

Problem 7A-4 (45 minutes) Requirements 1a through 1c:

Problem 7A-4 (continued) Requirements 2a through 2d:

Managerial Accounting, 16th Edition

Problem 7A-5 (60 minutes) Requirements 1a through 1c:

Problem 7A-5 (continued) Requirements 2a through 2d:

Managerial Accounting, 16th Edition

Problem 7A-5 (continued) Requirements 3a through 3d:

Chapter 8 Master Budgeting Solutions to Questions 8-1 A budget is a detailed quantitative plan for the acquisition and use of financial and other resources over a given time period. Budgetary control involves using budgets to increase the likelihood that all parts of an organization are working together to achieve the goals set down in the planning stage. 8-2 1. Budgets communicate management’s plans throughout the organization. 2. Budgets force managers to think about and plan for the future. In the absence of the necessity to prepare a budget, many managers would spend all of their time dealing with dayto-day emergencies. 3. The budgeting process provides a means of allocating resources to those parts of the organization where they can be used most effectively. 4. The budgeting process can uncover potential bottlenecks before they occur. 5. Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. Budgeting helps to ensure that everyone in the organization is pulling in the same direction. 6. Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent performance. 8-3 Responsibility accounting is a system in which a manager is held responsible for those items of revenues and costs—and only those items—that the manager can control to a significant extent. Each line item in the budget is made the responsibility of a manager who is then held responsible for differences between budgeted and actual results. 8-4 A master budget represents a summary of all of management’s plans and goals for the

future, and outlines the way in which these plans are to be accomplished. The master budget is composed of a number of smaller, specific budgets encompassing sales, production, raw materials, direct labor, manufacturing overhead, selling and administrative expenses, and inventories. The master budget usually also contains a budgeted income statement, budgeted balance sheet, and cash budget. 8-5 The level of sales impacts virtually every other aspect of the firm’s activities. It determines the production budget, cash collections, cash disbursements, and selling and administrative budget that in turn determine the cash budget and budgeted income statement and balance sheet. 8-6 No. Planning and control are different, although related, concepts. Planning involves developing goals and developing budgets to achieve those goals. Control, by contrast, involves the means by which management attempts to ensure that the goals set down at the planning stage are attained. 8-7 Creating a “budgeting assumptions” tab simplifies the process of determining how changes to a master budget’s underlying assumptions impact all supporting schedules and the projected financial statements. 8-8 A self-imposed budget is one in which persons with responsibility over cost control prepare their own budgets. This is in contrast to a budget that is imposed from above. The major advantages of a self-imposed budget are: (1) Individuals at all levels of the organization are recognized as members of the team whose views and judgments are valued. (2) Budget estimates prepared by front-line managers are

often more accurate and reliable than estimates prepared by top managers who have less intimate knowledge of markets and day-to-day operations. (3) Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. Self-imposed budgets create commitment. (4) A manager who is not able to meet a budget that has been imposed from above can always say that the budget was unrealistic and impossible to meet. With a selfimposed budget, this excuse is not available. Self-imposed budgets do carry with them the risk of budgetary slack. The budgets prepared by lower-level managers should be carefully reviewed to prevent too much slack.

8-9 The direct labor budget and other budgets can be used to forecast workforce staffing needs. Careful planning can help a company avoid erratic hiring and laying off of employees. 8-10 The principal purpose of the cash budget is NOT to see how much cash the company will have in the bank at the end of the year. Although this is one of the purposes of the cash budget, the principal purpose is to provide information on probable cash needs during the budget period, so that bank loans and other sources of financing can be anticipated and arranged well in advance.

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Chapter 8: Applying Excel The completed worksheet is shown below.

Chapter 8: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Managerial Accounting, 16th Edition

Chapter 8: Applying Excel (continued) 1. When the budgeted unit sales in the second quarter are increased from 60,000 units to 75,000 units, the result is:

Chapter 8: Applying Excel (continued) The cash disbursements for raw materials have increased from $1,035,980 to $1,095,980 because the increased unit sales in the second quarter require additional purchases of raw materials.

Managerial Accounting, 16th Edition

Chapter 8: Applying Excel (continued) 2. With the revised sales budget, the worksheet should look like this:

Chapter 8: Applying Excel (continued) a. The total expected cash collections for the year under this revised budget are $2,165,000. b. The total required production for the year under this revised budget is 335,000 units. c. The total cost of raw materials to be purchased for the year under this revised budget is $1,358,800. d. The total expected cash disbursements for raw materials for the year under this revised budget are $1,305,900. e. The production constraint of 90,000 units per quarter is a problem in the third quarter of Year 2 and may be a problem later in Year 3. This problem can be approached in a variety of ways. First, the excess capacity in the first and second quarters could be used to build up finished goods inventories beyond the usual levels. Second, management could investigate acquiring another of the milling machines. Third, improvement efforts can be focused on the milling machine; if these efforts are successful, the capacity of the milling machine can be increased and consequently the capacity of the entire plant can be increased. Fourth, management could investigate hiring another company with such a milling machine to do some of the work.

Managerial Accounting, 16th Edition

The Foundational 15 1.

The budgeted sales for July are computed as follows: Unit sales (a) .............................. 10,000 Selling price per unit (b) .............. $70 Total sales (a) × (b) .................... $700,000

The expected cash collections for July are computed as follows: June sales: $588,000 × 60% ................... July sales: $700,000 × 40% ................... Total cash collections ................

July $352,800 280,000 $632,800

The accounts receivable balance at the end of July is: July sales (a) .............................. $700,000 Percent uncollected (b)................ 60% Accounts receivable (a) × (b) ...... $420,000

The required production for July is computed as follows: Budgeted sales in units.................. Add desired ending inventory* ....... Total needs ................................... Less beginning inventory** ........... Required production ......................

July

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.

The Foundational 15 (continued) 5.

The raw material purchases for July are computed as follows: 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 ..........................

July

10,400 5 52,000 6,100 58,100 5,200 52,900

*61,000 pounds × 10% = 6,100 pounds. **52,000 pounds × 10% = 5,200 pounds. 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)

The estimated cash disbursements for materials purchases in July is computed as follows: June purchases: $88,880 × 70% ....................... July purchases: $105,800 × 30% ..................... Total cash disbursements............

52,900 $2.00 $105,800

July $62,216 31,740 $93,956

The accounts payable balance at the end of July is: July purchases (a) ....................... $105,800 Percent unpaid (b) ...................... 70% Accounts payable (a) × (b) .......... $74,060

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 9.

The estimated raw materials inventory balance at the end of July is computed as follows: Ending raw materials inventory (pounds) (a) ..... Cost per pound (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: Direct materials................... Direct labor......................... Manufacturing overhead ...... Unit product cost ................

Quantity

5 pounds 2 hours 2 hours

Cost

$2 per pound $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) ...... 2,400 Unit product cost (b) ........................................ $60.00 Ending finished goods inventory (a) × (b) ......... $144,000

The Foundational 15 (continued) 13. The estimated cost of goods sold for July is computed as follows: Unit sales (a) ................................................... 10,000 Unit product cost (b) ........................................ $60.00 Estimated cost of goods sold (a) × (b) .............. $600,000 The estimated gross margin for July is computed as follows: Total sales (a) .................................................. $700,000 Cost of goods sold (b) ...................................... 600,000 Estimated gross margin (a) – (b) ...................... $100,000 14. The estimated selling and administrative expense for July is computed as follows: Budgeted unit sales ................................... Variable selling and administrative ............. expense per unit .................................... Total variable expense............................... Fixed selling and administrative expenses ... Total selling and administrative expenses ...

July

10,000 × $1.80 $18,000 60,000 $78,000

15. The estimated net operating income for July is computed as follows: Gross margin (a) .............................................. $100,000 Selling and administrative expenses (b) ............. 78,000 Net operating income (a) – (b) ......................... $ 22,000

Managerial Accounting, 16th Edition

Exercise 8-1 (20 minutes)

April

1. February sales: $230,000 × 10% ........ March sales: $260,000 × 70%, 10% .............. April sales: $300,000 × 20%, 70%, 10% ........ May sales: $500,000 × 20%, 70% ................. June sales: $200,000 × 20% .......................... Total cash collections .....

May

June

$ 23,000

Total $

23,000

182,000

$ 26,000

208,000

60,000

210,000 $ 30,000

300,000

100,000

450,000

350,000

40,000 40,000 $265,000 $336,000 $420,000 $1,021,000

Notice that even though sales peak in May, cash collections peak in June. This occurs because the bulk of the company’s customers pay in the month following sale. The lag in collections that this creates is even more pronounced in some companies. Indeed, it is not unusual for a company to have the least cash available in the months when sales are greatest. 2. Accounts receivable at June 30: From May sales: $500,000 × 10% ........................ From June sales: $200,000 × (70% + 10%) ......... Total accounts receivable at June 30.....................

$ 50,000 160,000 $210,000

Exercise 8-2 (10 minutes) Budgeted unit sales ................. Add desired units of ending finished goods inventory*...... Total needs ............................. Less units of beginning finished goods inventory .................... Required production in units ....

April

May

June

Quarter

50,000

75,000

90,000 215,000

7,500 57,500

9,000 84,000

8,000 8,000 98,000 223,000

5,000 52,500

7,500 76,500

9,000 5,000 89,000 218,000

*10% of the following month’s sales in units.

Managerial Accounting, 16th Edition

Exercise 8-3 (15 minutes)

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 purchased ..............

First

Quarter—Year 2 Second Third Fourth

Year

60,000

90,000

150,000

100,000

400,000

× 3

180,000

270,000

450,000

300,000 1,200,000

54,000 234,000

90,000 360,000

60,000 510,000

42,000 42,000 342,000 1,242,000

36,000 54,000 90,000 60,000 36,000 198,000 306,000 420,000 282,000 1,206,000 × $1.50 × $1.50 × $1.50 × $1.50 × $1.50 $297,000 $459,000 $630,000 $423,000 $1,809,000

* Fourth quarter: 70,000 units × 3 grams per unit × 20% = 42,000 grams.

Exercise 8-4 (20 minutes) 1. Assuming that the direct labor workforce is adjusted each quarter, the direct labor budget is:

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

Year

Required production in units ............................ 8,000 6,500 7,000 7,500 29,000 Direct labor time per unit (hours) ..................... × 0.35 × 0.35 × 0.35 × 0.35 × 0.35 Total direct labor-hours needed ....................... 2,800 2,275 2,450 2,625 10,150 Direct labor cost per hour ................................ × $12.00 × $12.00 × $12.00 × $12.00 × $12.00 Total direct labor cost...................................... $ 33,600 $ 27,300 $ 29,400 $ 31,500 $121,800 2. Assuming that the direct labor workforce is not adjusted each quarter and that overtime wages are paid, the direct labor budget is:

Required production in units ........................... Direct labor time per unit (hours) .................... Total direct labor-hours needed ...................... Regular hours paid ......................................... Overtime hours paid....................................... Wages for regular hours (@ $12.00 per hour) . Overtime wages (@ 1.5 × $12.00 per hour) .... Total direct labor cost ....................................

1st Quarter

2nd Quarter

$31,200 3,600 $34,800

$31,200 $31,200 $31,200 $124,800 0 0 450 4,050 $31,200 $31,200 $31,650 $128,850

8,000 × 0.35 2,800 2,600 200

6,500 × 0.35 2,275 2,600 0

3rd Quarter

Managerial Accounting, 16th Edition

7,000 × 0.35 2,450 2,600 0

4th Quarter

7,500 × 0.35 2,625 2,600 25

Year

Exercise 8-5 (15 minutes) 1.

Yuvwell Corporation

Manufacturing Overhead Budget

Budgeted direct labor-hours................................ Variable manufacturing overhead rate ................. Variable manufacturing overhead ........................ Fixed manufacturing overhead ............................ Total manufacturing overhead ............................ Less depreciation ............................................... Cash disbursements for manufacturing overhead .

1st 2nd 3rd 4th Quarter Quarter Quarter Quarter

8,000 8,200 8,500 7,800 32,500 × $3.25 × $3.25 × $3.25 × $3.25 × $3.25 $26,000 $26,650 $27,625 $25,350 $105,625 48,000 48,000 48,000 48,000 192,000 74,000 74,650 75,625 73,350 297,625 16,000 16,000 16,000 16,000 64,000 $58,000 $58,650 $59,625 $57,350 $233,625

2. Total budgeted manufacturing overhead for the year (a) ... Budgeted direct labor-hours for the year (b) ..................... Predetermined overhead rate for the year (a) ÷ (b) ..........

$297,625 32,500 $9.16

Year

Exercise 8-6 (15 minutes) Weller Company Selling and Administrative Expense Budget

Budgeted unit sales ........................................... Variable selling and administrative expense per unit ................................................................ Variable selling and administrative expense ......... Fixed selling and administrative expenses: Advertising ..................................................... Executive salaries ............................................ Insurance ....................................................... Property taxes ................................................ Depreciation ................................................... Total fixed selling and administrative expenses.... Total selling and administrative expenses ............ Less depreciation ............................................... Cash disbursements for selling and administrative expenses ..................................

1st Quarter

15,000

2nd Quarter

16,000

3rd Quarter

14,000

13,000

Year

58,000

× $2.50 × $2.50 × $2.50 × $2.50 × $2.50 $ 37,500 $ 40,000 $ 35,000 $ 32,500 $145,000 8,000 35,000 5,000 20,000 68,000 105,500 20,000

8,000 35,000

8,000 35,000 5,000

8,000 20,000 20,000 71,000 68,000 111,000 103,000 20,000 20,000

8,000 35,000 20,000 63,000 95,500 20,000

32,000 140,000 10,000 8,000 80,000 270,000 415,000 80,000

$ 85,500 $ 91,000 $ 83,000 $ 75,500 $335,000

4th Quarter

Managerial Accounting, 16th Edition

Exercise 8-7 (15 minutes) Garden Depot Cash Budget

1st 2nd Quarter Quarter

3rd Quarter

4th Quarter

Year

Beginning cash balance . $ 20,000 $ 10,000 $ 35,800 $ 25,800 $ 20,000 Total cash receipts ........ 180,000 330,000 210,000 230,000 950,000 Total cash available ...... 200,000 340,000 245,800 255,800 970,000 Less total cash disbursements ........... 260,000 230,000 220,000 240,000 950,000 Excess (deficiency) of cash available over disbursements ........... (60,000) 110,000 25,800 15,800 20,000 Financing: Borrowings (at beginnings of quarters)* ............... 70,000 70,000 Repayments (at ends of quarters) ............. (70,000) (70,000) § Interest .................... (4,200) (4,200) Total financing ............. 70,000 (74,200) (4,200) Ending cash balance ..... $ 10,000 $ 35,800 $ 25,800 $ 15,800 $ 15,800 * Since the deficiency of cash available over disbursements is $60,000, the company must borrow $70,000 to maintain the desired ending cash balance of $10,000. §

$70,000 × 3% × 2 = $4,200.

Exercise 8-8 (10 minutes) Gig Harbor Boating Budgeted Income Statement Sales (460 units × $1,950 per unit) ...................... Cost of goods sold (460 units × $1,575 per unit) ... Gross margin ....................................................... Selling and administrative expenses* .................... Net operating income........................................... Interest expense.................................................. Net income..........................................................

$897,000 724,500 172,500 139,500 33,000 14,000 $ 19,000

*(460 units × $75 per unit) + $105,000 = $139,500.

Managerial Accounting, 16th Edition

Exercise 8-9 (15 minutes) Mecca Copy Budgeted Balance Sheet

Assets

Current assets: Cash* ................................................ Accounts receivable............................ Supplies inventory .............................. Total current assets .............................. Plant and equipment: Equipment ......................................... Accumulated depreciation ................... Plant and equipment, net ...................... Total assets ..........................................

$12,200 8,100 3,200 34,000 (16,000)

$23,500

18,000 $41,500

Liabilities and Stockholders' Equity

Current liabilities: Accounts payable ............................... Stockholders' equity: Common stock ................................... Retained earnings# ............................ Total stockholders' equity ...................... Total liabilities and stockholders' equity ..

$ 1,800 $ 5,000 34,700

39,700 $41,500

*Plug figure. # Retained earnings, beginning balance . Add net income .................................. Deduct dividends ............................... Retained earnings, ending balance ......

$28,000 11,500 39,500 4,800 $34,700

Exercise 8-10 (45 minutes) 1. Production budget: Budgeted unit sales ............... Add desired units of ending finished goods inventory* ... Total needs ........................... Less units of beginning finished goods inventory ..... Required production in units ..

July

August

September October 50,000

30,000

11,000 46,000

13,000 53,000

9,000 59,000

7,000 37,000

10,000 36,000

11,000 42,000

13,000 46,000

9,000 28,000

35,000

40,000

* October: 3,000 units + (20,000 units × 20%) = 7,000 units. 2. During July and August, the company is building inventories in anticipation of peak sales in September. Therefore, production exceeds sales during these months. In September and October, inventories are being reduced in anticipation of a forthcoming decrease in sales. Therefore, production is less than sales during these months.

Managerial Accounting, 16th Edition

Exercise 8-10 (continued) 3. Direct materials budget: 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 ................

July

August

September

× 3 cc 108,000

× 3 cc 126,000

× 3 cc 138,000

63,000 171,000 54,000 117,000

69,000 195,000 63,000 132,000

42,000 * 42,000 180,000 414,000 69,000 54,000 111,000 360,000

36,000

42,000

46,000

Third Quarter

× 3 cc 372,000

124,000

* 28,000 units (October production) × 3 cc per unit = 84,000 cc; 84,000 cc × 1/2 = 42,000 cc. As shown in part (1), production is greatest in September; however, as shown in the raw material purchases budget, purchases of materials are greatest a month earlier—in August. The reason for the large purchases of materials in August is that the materials must be on hand to support the heavy production scheduled for September.

Exercise 8-11 (20 minutes)

Beginning cash balance ............................... Add collections from customers ................... Total cash available ..................................... Less cash disbursements: Purchase of inventory ............................... Selling and administrative expenses .......... Equipment purchases ............................... Dividends ................................................ Total cash disbursements ............................ Excess (deficiency) of cash available over disbursements ......................................... Financing: Borrowings .............................................. Repayments (including interest) ................ Total financing ............................................ Ending cash balance ...................................

Quarter (000 omitted) 1 2 3 4 $

5 $ 5 96 * 92 101 97

$ 6 * 65 71 *

$ 5 70 75

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

6 323 * 329

0 22 (17) * (23) (17) (1) $ 8 $ 8

* Given.

Year

Managerial Accounting, 16th Edition

Exercise 8-12 (30 minutes) 1. Schedule of expected cash collections:

From accounts receivable From July sales: 35% × 210,000 ............ 65% × 210,000 ............ From August sales: 35% × 230,000 ............ 65% × 230,000 ............ From September sales: 35% × 220,000 ............ Total cash collections .......

July

$136,000 73,500

Month August

Sept.

$209,500 $217,000

$136,000 73,500 136,500

$136,500 80,500

Quarter

$149,500

80,500 149,500

77,000 77,000 $226,500 $653,000

2. a. Merchandise purchases budget:

July

August

Sept.

Total

Budgeted cost of goods sold (60% of sales) ..................... $126,000 $138,000 $132,000 $396,000 Add desired ending merchandise inventory* ........ 41,400 39,600 43,200 43,200 Total needs ............................. 167,400 177,600 175,200 439,200 Less beginning merchandise inventory ............................. 62,000 41,400 39,600 62,000 Required purchases ................. $105,400 $136,200 $135,600 $377,200 *

At July 31: $138,000 × 30% = $41,400. At September 30: $144,000 × 30% = $43,200. b. Schedule of cash disbursements for purchases:

July

August

Sept.

Total

From accounts payable .......... $ 71,100 $ 71,100 For July purchases ................ 42,160 $ 63,240 105,400 For August purchases ............ 54,480 $ 81,720 136,200 For September purchases ...... 54,240 54,240 Total cash disbursements....... $113,260 $117,720 $135,960 $366,940 © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 8

Exercise 8-12 (continued) 3.

Beech Corporation Income Statement For the Quarter Ended September 30 Sales ($210,000 + $230,000 + $220,000) . Cost of goods sold (Part 2a) ..................... Gross margin............................................ Selling and administrative expenses ($60,000 × 3 months) ........................... Net operating income ............................... Interest expense ...................................... Net income ..............................................

$660,000 396,000 264,000 180,000 84,000 0 $ 84,000

Beech Corporation Balance Sheet September 30

Assets Cash ($90,000 + $653,000 – $366,940 – ($55,000 × 3)) ..................................................................... $211,060 Accounts receivable ($220,000 × 65%) ..................... 143,000 Inventory (Part 2a) ................................................... 43,200 Plant and equipment, net ($210,000 – ($5,000 ×3)) .. 195,000 Total assets .............................................................. $592,260

Liabilities and Stockholders’ Equity Accounts payable ($135,600 × 60%)......................... $ 81,360 Common stock (Given) ............................................. 327,000 Retained earnings ($99,900 + $84,000) .................... 183,900 Total liabilities and stockholders’ equity ...................... $592,260

Managerial Accounting, 16th Edition

Exercise 8-13 (30 minutes) 1. Schedule of expected cash collections:

From accounts receivable From July sales: 45% × 210,000 ............ 55% × 210,000 ............ From August sales: 45% × 230,000 ............ 55% × 230,000 ............ From September sales: 45% × 220,000 ............ Total cash collections .......

July

$136,000 94,500

Month August

September

$230,500 $219,000

$136,000 94,500 115,500

$115,500 103,500

Quarter

$126,500

103,500 126,500

99,000 99,000 $225,500 $675,000

2. a. Merchandise purchases budget:

July

August

Sept.

Total

Budgeted cost of goods sold .... $126,000 $138,000 $132,000 $396,000 Add desired ending merchandise inventory* ........ 27,600 26,400 28,800 28,800 Total needs ............................. 153,600 164,400 160,800 424,800 Less beginning merchandise inventory ............................. 62,000 27,600 26,400 62,000 Required purchases ................. $ 91,600 $136,800 $134,400 $362,800 At July 31: $138,000 × 20% = $27,600. At September 30: $144,000 ×20% = $28,800. *

b. Schedule of cash disbursements for purchases:

July

August

Sept.

Total

From accounts payable .......... $ 71,100 $ 71,100 For July purchases ................ 27,480 $ 64,120 91,600 For August purchases ............ 41,040 $ 95,760 136,800 For September purchases ...... 40,320 40,320 Total cash disbursements....... $ 98,580 $105,160 $136,080 $339,820

Exercise 8-13 (continued) 3.

$660,000 396,000 264,000 180,000 84,000 0 $ 84,000

Beech Corporation Balance Sheet September 30

Assets Cash ($90,000 + $675,000 – $339,820 – ($55,000 × 3)) ..................................................................... $260,180 Accounts receivable ($220,000 × 55%) ..................... 121,000 Inventory (Part 2a) ................................................... 28,800 Plant and equipment, net ($210,000 – ($5,000 ×3)) .. 195,000 Total assets .............................................................. $604,980

Liabilities and Stockholders’ Equity Accounts payable ($134,400 × 70%)......................... $ 94,080 Common stock (Given) ............................................. 327,000 Retained earnings ($99,900 + $84,000) .................... 183,900 Total liabilities and stockholders’ equity ...................... $604,980

Managerial Accounting, 16th Edition

Exercise 8-14 (30 minutes) 1.

Jessi Corporation Sales Budget

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

Year

Budgeted unit sales ................. 11,000 12,000 14,000 13,000 50,000 Selling price per unit ............... × $18.00 × $18.00 × $18.00 × $18.00 × $18.00 Total sales .............................. $198,000 $216,000 $252,000 $234,000 $900,000 2. Schedule of Expected Cash Collections Beginning accounts receivable . $ 70,200 $ 70,200 st 1 Quarter sales (65%, 30%) .. 128,700 $ 59,400 188,100 nd 2 Quarter sales (65%, 30%) . 140,400 $ 64,800 205,200 rd 3 Quarter sales (65%, 30%) .. 163,800 $ 75,600 239,400 th 4 Quarter sales (65%) ........... 152,100 152,100 Total cash collections .............. $198,900 $199,800 $228,600 $227,700 $855,000

Exercise 8-14 (continued) 3.

Jessi Corporation Production Budget

Budgeted unit sales ................. Add desired units of ending finished goods inventory* ..... Total needs............................. Less units of beginning finished goods inventory**.... Required production in units ....

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter 13,000

50,000

1,800 12,800

2,100 14,100

1,950 15,950

1,850 14,850

1,850 51,850

1,650 11,150

1,800 12,300

2,100 13,850

1,950 12,900

1,650 50,200

11,000

12,000

14,000

* For end of first quarter: 12,000 units × 15% = 1,800 units. ** For beginning of first quarter: 11,000 units × 15% = 1,650 units.

Managerial Accounting, 16th Edition

Year

Exercise 8-15 (30 minutes) 1.

Hruska Corporation Direct Labor Budget Required production in units ......... Direct labor time per unit (hours) .. Total direct labor-hours needed .... Direct labor cost per hour ............. Total direct labor cost...................

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 12,000 0.2 2,400 $12.00 $28,800

10,000 0.2 2,000 $12.00 $24,000

13,000 0.2 2,600 $12.00 $31,200

14,000 0.2 2,800 $12.00 $33,600

Year

49,000 0.2 9,800 $12.00 $117,600

2 and 3.

Hruska Corporation Manufacturing Overhead Budget Budgeted direct labor-hours.......... Variable manufacturing overhead rate .......................................... Variable manufacturing overhead .. Fixed manufacturing overhead ...... Total manufacturing overhead ...... Less depreciation ......................... Cash disbursements for manufacturing overhead ............

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 2,400

2,000

2,600

2,800

$1.75 $ 4,200 86,000 90,200 23,000

$1.75 $ 3,500 86,000 89,500 23,000

$1.75 $ 4,550 86,000 90,550 23,000

$1.75 $ 4,900 86,000 90,900 23,000

$1.75 $ 17,150 344,000 361,150 92,000

$67,200

$66,500

$67,550

$67,900

$269,150

Year

9,800

Exercise 8-16 (30 minutes) 1 and 2. 1 .

Zan Corporation Direct Materials Budget

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 ......................................

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

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

16,000

14,000

12,000

6,000

50,000 × $1.20

62,000 × $1.20

54,000 × $1.20

44,000 × $1.20

210,000 × $1.20

$60,000

$74,400

$64,800

$52,800

$252,000

Managerial Accounting, 16th Edition

Exercise 8-16 (continued) 3.

Zan Corporation 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 ...................................

$38,880

4. 1 .

Zan Corporation Direct Labor Budget

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

$24,000 44,640

$68,640

$29,760 38,880 $68,640

$57,600

$233,760

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 5,000 × 0.20 1,000 × $11.50 $ 11,500

8,000 × 0.20 1,600 × $11.50 $ 18,400

7,000 × 0.20 1,400 × $11.50 $ 16,100

$25,920 31,680

$ 2,880 60,000 74,400 64,800 31,680

6,000 × 0.20 1,200 × $11.50 $ 13,800

Year

26,000 × 0.20 5,200 × $11.50 $ 59,800

Exercise 8-17 (60 minutes) 1a. The budgeted cash collections are computed as follows: Cash sales ($240,000 × 35%) ................................... September credit sales collected in October ............... October credit sales collected in October ($240,000 × 65% × 40%) ...................................................... Total cash collections ................................................

$ 84,000 90,000 62,400 $236,400

1b. The budgeted merchandise purchases are computed as follows: Budgeted cost of goods sold ($240,000 × 45%) ........ Add: desired ending merchandise inventory ($250,000 × 45% × 30%) ................................................... Total needs .............................................................. Less: beginning merchandise inventory...................... Required purchases ..................................................

$108,000 33,750 141,750 32,400 $109,350

1c. The budgeted cash disbursements for merchandise purchases are computed as follows: September credit purchases paid in October .............. October credit purchases paid in October ($109,350 × 30%).................................................................. Total cash disbursements for merchandise purchases .

$ 73,000 32,805 $105,805

1d. The net operating income is computed as follows: Sales ....................................................................... Cost of goods sold ($240,000 × 45%) ....................... Gross margin ........................................................... Selling and administrative expenses ($78,000 + $2,000) ................................................................. Net operating income ...............................................

$240,000 108,000 132,000 80,000 $ 52,000

Managerial Accounting, 16th Edition

Exercise 8-17 (continued) 1e. The budgeted balance sheet is computed as follows: Wheeling Company Balance Sheet October 31 Assets Cash ($59,000 + $236,400 – $105,805 – $78,000) .......... Accounts receivable ($240,000 × 65% × 60%) ................ Inventory ($250,000 × 45% × 30%)............................... Buildings and equipment, (net) ($214,000 – $2,000) ........ Total assets ................................................................... Liabilities and Stockholders’ Equity Accounts payable ($109,350 × 70%) .............................. Common stock ............................................................... Retained earnings ($106,400 + $52,000)......................... Total liabilities and stockholders’ equity ...........................

$111,595 93,600 33,750 212,000 $450,945 $ 76,545 216,000 158,400 $450,945

2a. The budgeted cash collections are computed as follows: Cash sales ($240,000 × 35%) ................................... September credit sales collected in October ............... October credit sales collected in October ($240,000 × 65% × 50%) ...................................................... Total cash collections ................................................

$ 84,000 90,000 78,000 $252,000

2b. The budgeted merchandise purchases are computed as follows: Budgeted cost of goods sold ($240,000 × 45%) ........ Add: desired ending merchandise inventory ($250,000 × 45% × 10%) ................................................... Total needs .............................................................. Less: beginning merchandise inventory...................... Required purchases ..................................................

$108,000 11,250 119,250 32,400 $ 86,850

Exercise 8-17 (continued) 2c. The budgeted cash disbursements for merchandise purchases are computed as follows: September credit purchases paid in October .............. October credit purchases paid in October ($86,850 × 20%).................................................................. Total cash disbursements for merchandise purchases .

$73,000 17,370 $90,370

2d. The net operating income is computed as follows: Sales ....................................................................... Cost of goods sold ($240,000 × 45%) ....................... Gross margin ........................................................... Selling and administrative expenses ($78,000 + $2,000) ................................................................. Net operating income ...............................................

$240,000 108,000 132,000 80,000 $ 52,000

2e. The budgeted balance sheet is computed as follows: Wheeling Company Balance Sheet October 31 Assets Cash ($59,000 + $252,000 – $90,370 – $78,000) ............ Accounts receivable ($240,000 × 65% × 50%) ................ Inventory ($250,000 × 45% × 10%)............................... Buildings and equipment, (net) ($214,000 – $2,000) ........ Total assets ................................................................... Liabilities and Stockholders’ Equity Accounts payable ($86,850 × 80%) ................................ Common stock ............................................................... Retained earnings ($106,400 + $52,000)......................... Total liabilities and stockholders’ equity ...........................

$142,630 78,000 11,250 212,000 $443,880 $ 69,480 216,000 158,400 $443,880

Managerial Accounting, 16th Edition

Exercise 8-17 (continued) 3.

Students may be inclined to conclude that the financial projections in requirement 2 indicate a decline in performance for two reasons. First, the net operating income in the two scenarios is the same. Second, the total assets dropped by $7,065. This interpretation overlooks the importance of cash flows and working capital management. For professors wishing to explore this discussion further, we recommend computing and comparing the operating cycle (as discussed in the chapter titled Financial Statement Analysis) for requirements 1 and 2. The accounts receivable turnover in requirement 1 is 1.70 ($156,000 ÷ $91,800). The average collection period is 17.65 days (30 days ÷ 1.70). The inventory turnover is 3.27 ($108,000 ÷ $33,075). The average sale period is 9.17 days (30 ÷ 3.27). The operating cycle is 26.82 days (17.65 days + 9.17 days). The accounts receivable turnover in requirement 2 is 1.86 ($156,000 ÷ $84,000). The average collection period is 16.13 days (30 days ÷ 1.86). The inventory turnover is 4.95 ($108,000 ÷ $21,825). The average sale period is 6.06 days (30 ÷ 4.95). The operating cycle is 22.19 days (16.13 days + 6.06 days). The operating cycle drops by 4.63 days in requirement 2.

Exercise 8-18 (30 minutes) 1a. The company’s budgeted sales are computed as follows: Cash collections in July (a) ........................................ June sales collected in July (b) .................................. July sales collected in July (a) – (b) ...........................

$77,000 $50,000 $27,000

July sales collected in July (a) ................................... Percentage of sales collected in month of sale (b) ...... July sales (a) ÷ (b) ...................................................

$27,000 30% $90,000

1b. The company’s budgeted merchandise purchases are computed as follows: Cash paid for merchandise purchases in July (a) ........ June purchases paid in July (b) ................................. July purchases paid in July (a) – (b) ..........................

$44,500 $35,300 $9,200

July purchases paid in July (a) .................................. Percentage of purchases paid in month of purchase (b) ........................................................................ July merchandise purchases (a) ÷ (b) .......................

$9,200 20% $46,000

1c. The company’s budgeted cost of goods sold is computed as follows: Merchandise purchases in July .................................. Beginning merchandise inventory in July .................... Total needs in July ....................................................

$46,000 30,000 $76,000

Total needs in July (a) .............................................. Ending inventory in July (b) ...................................... Cost of goods sold in July (a) – (b) ............................

$76,000 $22,000 $54,000

Managerial Accounting, 16th Edition

Exercise 8-18 (continued) 1d. The company’s budgeted net operating income is computed as follows: Sales ...................................................... Cost of goods sold ................................... Gross margin .......................................... Selling and administrative expenses ($15,000 + $3,000) .............................. Net operating income ..............................

$90,000 54,000 36,000 18,000 $18,000

2. The budgeted balance sheet is computed as follows: Wolfpack Company Balance Sheet July 31 Assets Cash ($75,000 + $77,000 – $44,500 – $15,000) .............. Accounts receivable ($90,000 × 70%) ............................. Inventory ....................................................................... Buildings and equipment, (net) ($150,000 – $3,000) ........ Total assets ................................................................... Liabilities and Stockholders’ Equity Accounts payable ($46,000 × 80%) ................................ Retained earnings ($269,700 + $18,000)......................... Total liabilities and stockholders’ equity ...........................

$ 92,500 63,000 22,000 147,000 $324,500 $ 36,800 287,700 $324,500

Problem 8-19 (45 minutes) 1. Schedule of cash collections: Cash sales—May ............................................... Collections on account receivable: April 30 balance .............................................. May sales (50% × ($200,000 – $60,000)) ........ Total cash collections .........................................

$ 60,000 54,000 70,000 $184,000

2. 2. Schedule of expected cash disbursements: Schedule of cash disbursements for purchases: April 30 accounts payable balance ...................... May purchases (40% × $120,000) ..................... Total cash disbursements ................................... 3.

$ 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, 16th Edition

Problem 8-19 (continued) 4.

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

Minden Company Budgeted Balance Sheet May 31 Assets Cash (see requirement 3) ........................................... Accounts receivable (50% × $140,000) ....................... Inventory ................................................................... Buildings and equipment, net of depreciation ($207,000 + $6,500 – $2,000).................................. Total assets ................................................................

211,500 $330,400

Liabilities and Stockholders’ 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

$ 8,900 70,000 40,000

Problem 8-20 (45 minutes) 1. Schedule of cash collections: Cash sales—May ............................................... Collections on account receivable: April 30 balance .............................................. May sales (60% × ($220,000 – $60,000)) ........ Total cash collections .........................................

$ 60,000 54,000 96,000 $210,000

2. Schedule of expected cash disbursements: Schedule of cash payments for purchases: April 30 accounts payable balance ...................... May purchases (50% × $120,000) ..................... Total cash disbursements ................................... 3.

$ 63,000 60,000 $123,000

Minden Company Cash Budget For the Month of May

Beginning cash balance ..................................... $ 9,000 Add collections from customers (above).............. 210,000 Total cash available ........................................... 219,000 Less cash disbursements: Purchase of inventory (above) ......................... 123,000 Selling and administrative expenses ................. 72,000 Purchases of equipment .................................. 6,500 Total cash disbursements ................................... 201,500 Excess of cash available over disbursements ....... 17,500 Financing: Borrowing—note ............................................. 20,000 Repayments—note .......................................... (14,500) Interest .......................................................... (100) Total financing .................................................. 5,400 Ending cash balance .......................................... $ 22,900

Managerial Accounting, 16th Edition

Problem 8-20 (continued) 4.

$220,000 $ 30,000 120,000 150,000 40,000

110,000 110,000 74,000 36,000 100 $ 35,900

Minden Company Budgeted Balance Sheet May 31 Assets Cash (see requirement 3) ........................................... $ 22,900 Accounts receivable (40% × $160,000) ....................... 64,000 Inventory ................................................................... 40,000 Buildings and equipment, net of depreciation ($207,000 + $6,500 – $2,000).................................. 211,500 Total assets ................................................................ $338,400 Liabilities and Stockholders’ Equity Accounts payable (50% × 120,000) ............................ Note payable.............................................................. Capital stock .............................................................. Retained earnings ($42,500 + $35,900) ...................... Total liabilities and stockholders’ equity ........................

$ 60,000 20,000 180,000 78,400 $338,400

Problem 8-21 (30 minutes) 1. December cash sales ................................... Collections on account: October sales: $400,000 × 18% ................ November sales: $525,000 × 60% ............ December sales: $600,000 × 20%............. Total cash collections ................................ 2. Payments to suppliers: November purchases (accounts payable) ... December purchases: $280,000 × 30% ..... Total cash disbursements .......................... 3.

$ 83,000 72,000 315,000 120,000 $590,000 $161,000 84,000 $245,000

Ashton Company Cash Budget For the Month of December Beginning cash balance ................................... Add collections from customers ........................ Total cash available ......................................... Less cash disbursements: Payments to suppliers for inventory ............... $245,000 Selling and administrative expenses* ............. 380,000 New web server ............................................ 76,000 Dividends paid .............................................. 9,000 Total cash disbursements ................................. Excess (deficiency) of cash available over disbursements .............................................. Financing: Borrowings ................................................... Repayments ................................................. Interest ........................................................ Total financing ................................................ Ending cash balance ........................................

$ 40,000 590,000 630,000

710,000 (80,000) 100,000 0 0 100,000 $ 20,000

*$430,000 – $50,000 = $380,000.

Managerial Accounting, 16th Edition

Problem 8-22 (30 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 salesforecasts as well as external factors. Costs within departments should be divided into fixed and variable, controllable and noncontrollable, discretionary and nondiscretionary. Flexible budgeting techniques could then allow departments to identify costs that can be modified in the planning process.

Problem 8-22 (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 CMA Solution)

Managerial Accounting, 16th Edition

Problem 8-23 (45 minutes) 1. Schedule of expected cash collections:

From accounts receivable From April sales: 30% × $300,000 .......... 60% × $300,000 .......... 8% × $300,000 ............ From May sales: 30% × $400,000 .......... 60% × $400,000 .......... From June sales: 30% × $250,000 .......... Total cash collections .......

April

Month May

$120,000 $ 16,000 90,000

June

Quarter

$136,000

$ 24,000

90,000 180,000 24,000

240,000

120,000 240,000

75,000 $210,000 $316,000 $339,000

75,000 $865,000

180,000 120,000

Problem 8-23 (continued) 2. Cash budget:

Beginning cash balance . Add receipts: Collections from customers ............... Total cash available ....... Less cash disbursements: Merchandise purchases ................ Payroll ....................... Lease payments ......... Advertising ................. Equipment purchases.. Total cash disbursements ............ Excess (deficiency) of cash available over disbursements ............ Financing: Borrowings ................. Repayments ............... Interest...................... Total financing .............. Ending cash balance ......

April

Month May

$ 24,000 $ 22,000

$ 26,000

$ 24,000

210,000 234,000

316,000 338,000

339,000 365,000

865,000 889,000

140,000 20,000 22,000 60,000 —

210,000 20,000 22,000 60,000 —

160,000 18,000 22,000 50,000 65,000

510,000 58,000 66,000 170,000 65,000

242,000

312,000

315,000

869,000

(8,000)

26,000

50,000

20,000

30,000 — — — — — 30,000 — $ 22,000 $ 26,000

— (30,000) (1,200) (31,200) $ 18,800

30,000 (30,000) (1,200) (1,200) $ 18,800

June

Quarter

3. If the company needs a minimum cash balance of $20,000 to start each month, the loan cannot be repaid in full by June 30. Some portion of the loan balance will have to be carried over to July.

Managerial Accounting, 16th Edition

Problem 8-24 (60 minutes) 1. Collections on sales:

April

May

June

Quarter

Cash sales (@ 20%) ........ $120,000 $180,000 $100,000 $ 400,000 Sales on account: February: $200,000 × 80% × 20% ............... 32,000 32,000 March: $300,000 × 80% × 70%, 20% ...... 168,000 48,000 216,000 April: $600,000 × 80% × 10%, 70%, 20% ..... 48,000 336,000 96,000 480,000 May: $900,000 × 80% × 10%, 70% .............. 72,000 504,000 576,000 June: $500,000 × 80% × 10% ....................... 40,000 40,000 Total cash collections ....... $368,000 $636,000 $740,000 $1,744,000 2. a. Merchandise purchases budget:

April

May

June

July

Budgeted cost of goods sold .. $420,000 $630,000 $350,000 $280,000 Add desired ending merchandise inventory* ...... 126,000 70,000 56,000 Total needs ........................... 546,000 700,000 406,000 Less beginning merchandise inventory............................ 84,000 126,000 70,000 Required inventory purchases $462,000 $574,000 $336,000 *20% of the next month’s budgeted cost of goods sold. b. Schedule of expected cash disbursements for merchandise purchases: Beginning accounts payable ............... April purchases ...... May purchases ....... June purchases ...... Total cash disbursements .....

April $126,000 231,000

$357,000

May

June

Quarter

$231,000 287,000

$ 126,000 462,000 $287,000 574,000 168,000 168,000

$518,000

$455,000 $1,330,000

Problem 8-24 (continued) 3. Garden Sales, Inc. Cash Budget For the Quarter Ended June 30 Beginning cash balance ...... Add collections from customers ...................... Total cash available ............ Less cash disbursements: Purchases for inventory ... Selling expenses ............. Administrative expenses .. Land purchases............... Dividends paid ................ Total cash disbursements. Excess (deficiency) of cash available over disbursements ................ Financing: Borrowings ..................... Repayments.................... Interest ($130,000 × 1% × 3 + $50,000 × 1% × 2) ...... Total financing ................... Ending cash balance ..........

April

$ 52,000

May

June

$ 40,000 $ 40,000 $

Quarter

368,000 420,000

636,000 676,000

740,000 780,000

1,744,000 1,796,000

357,000 79,000 25,000 — 49,000 510,000

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

(90,000)

(10,000) 242,000

62,000

130,000 0

50,000 0 0 (180,000)

180,000 (180,000)

0 130,000 $ 40,000

0 (4,900) 50,000 (184,900) $ 40,000 $ 57,100 $

(4,900) (4,900) 57,100

52,000

Managerial Accounting, 16th Edition

Problem 8-25 (60 minutes) 1. Collections on sales:

April

May

June

Quarter

Cash sales ....................... $120,000 $180,000 $100,000 $ 400,000 Sales on account: February: $200,000 × 80% × 20% ............... 32,000 32,000 March: $300,000 × 80% × 70%, 20% ...... 168,000 48,000 216,000 April: $600,000 × 80% × 25%, 65%, 10% ..... 120,000 312,000 48,000 480,000 May: $900,000 × 80% × 25%, 65% .............. 180,000 468,000 648,000 June: $500,000 × 80% × 25% ....................... 100,000 100,000 Total cash collections ....... $440,000 $720,000 $716,000 $1,876,000 2. a. Merchandise purchases budget:

April

May

June

July

Budgeted cost of goods sold .. $420,000 $630,000 $350,000 $280,000 Add desired ending merchandise inventory* ...... 94,500 52,500 42,000 Total needs ........................... 514,500 682,500 392,000 Less beginning merchandise inventory............................ 84,000 94,500 52,500 Required inventory purchases $430,500 $588,000 $339,500 *15% of the next month’s budgeted cost of goods sold. b. Schedule of expected cash disbursements for merchandise purchases: Beginning accounts payable ............... April purchases ...... May purchases ....... June purchases ...... Total cash disbursements .....

April $126,000 215,250

$341,250

May

June

Quarter

$215,250 294,000

$ 126,000 430,500 $294,000 588,000 169,750 169,750

$509,250

$463,750 $1,314,250

Problem 8-25 (continued) 3. Garden Sales, Inc. Cash Budget For the Quarter Ended June 30 Beginning cash balance ...... Add collections from customers ...................... Total cash available ............ Less cash disbursements: Purchases for inventory ... Selling expenses ............. Administrative expenses .. Land purchases............... Dividends paid ................ Total cash disbursements. Excess (deficiency) of cash available over disbursements ................ Financing: Borrowings ..................... Repayments.................... Interest ($43,000 × 1% × 3)..... Total financing ................... Ending cash balance ..........

April

$ 52,000

May

June

$ 40,750 $ 83,500 $

Quarter

440,000 492,000

720,000 760,750

716,000 799,500

1,876,000 1,928,000

341,250 79,000 25,000 — 49,000 494,250

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

(2,250)

83,500

252,750

209,750

43,000 0

0 0

0 (43,000)

43,000 (43,000)

0 43,000 $ 40,750

52,000

0 (1,290) (1,290) 0 (44,290) (1,290) $ 83,500 $ 208,460 $ 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.

Managerial Accounting, 16th Edition

Problem 8-26 (45 minutes) 1. a. The reasons that Marge Atkins and Pete Granger use budgetary slack include the following: • These employees are hedging against the unexpected (reducing uncertainty/risk). • The use of budgetary slack allows employees to exceed expectations and/or show consistent performance. This is particularly important when performance is evaluated on the basis of actual results versus budget. • Employees are able to blend personal and organizational goals through the use of budgetary slack as good performance generally leads to higher salaries, promotions, and bonuses. 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. • affecting their ability to identify trouble spots and take appropriate corrective action. • reducing their credibility in the eyes of management. Also, the use of budgetary slack may affect management decisionmaking as the budgets will show lower contribution margins (lower sales, higher expenses). Decisions regarding the profitability of product lines, staffing levels, incentives, etc., could have an adverse effect on Atkins’ and Granger’s departments.

Problem 8-26 (continued) 2. The use of budgetary slack, particularly if it has a detrimental effect on the company, may be unethical. In assessing the situation, the specific standards contained in “Standards of Ethical Conduct for Management Accountants” that should be considered are listed below. Competence Clear reports using relevant and reliable information should be prepared. Confidentiality The standards of confidentiality do not apply in this situation. Integrity • Any activity that subverts the legitimate goals of the company should be avoided. • Favorable as well as unfavorable information should be communicated. Objectivity • Information should be fairly and objectively communicated. • All relevant information should be disclosed. (Unofficial CMA Solution)

Managerial Accounting, 16th Edition

Problem 8-27 (45 minutes) 1. The expected cash collections are calculated as follows:

April 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 ....

$ 60,000

May

June

$ 66,000 $ 78,000

36,000 8,000

Total $204,000 36,000

32,000 8,800

40,000 35,200

44,000

10,400 $104,000 $106,800 $123,600

10,400 $334,400

2. The budgeted merchandise purchases are calculated as follows:

April Cost of goods sold ........ Add: desired ending merchandise inventory* ................. Total needs .................. Less: beginning merchandise inventory Required purchases ......

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 49,000 $ 72,000 $ 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

Problem 8-27 (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) .............................. Retained earnings ($179,700 + $25,000 + $27,500 + $32,500)........................................................................ Total liabilities and stockholders’ equity ...........................

$147,000 41,600 52,000 97,000 $337,600 $ 72,900 264,700 $337,600

Managerial Accounting, 16th Edition

Problem 8-28 (60 minutes) 1. a. Schedule of expected cash collections:

Current year—Fourth quarter sales: $200,000 × 33% ......................... Next year—First quarter sales: $300,000 × 65% ......................... $300,000 × 33% ......................... Next year—Second quarter sales: $400,000 × 65% ......................... $400,000 × 33% ......................... Next year—Third quarter sales: $500,000 × 65% ......................... $500,000 × 33% ......................... Next year—Fourth quarter sales: $200,000 × 65% ......................... Total cash collections ......................

First

Next Year’s Quarter Second Third

Total

$ 66,000

195,000

195,000 99,000

$ 99,000 260,000

260,000 132,000

$132,000 325,000

$165,000

325,000 165,000

130,000 130,000 $261,000 $359,000 $457,000 $295,000 $1,372,000

Fourth

Problem 8-28 (continued) 2. Schedule of expected cash disbursements for merchandise purchases for next year:

Current year—Fourth quarter purchases: $126,000 × 20% ............................... Next year—First quarter purchases: $186,000 × 80% ............................... $186,000 × 20% ............................... Next year—Second quarter purchases: $246,000 × 80% ............................... $246,000 × 20% ............................... Next year—Third quarter purchases: $305,000 × 80% ............................... $305,000 × 20% ............................... Next year—Fourth quarter purchases: $126,000 × 80% ............................... Total cash disbursements ......................

First

Quarter Second Third

Total

$ 25,200

148,800

148,800 37,200

$ 37,200 196,800

196,800 49,200

$ 49,200 244,000

$ 61,000

244,000 61,000

100,800 100,800 $174,000 $234,000 $293,200 $161,800 $863,000

Fourth

Managerial Accounting, 16th Edition

Problem 8-28 (continued) 3. Budgeted cash disbursements for selling and administrative expenses for next year:

Budgeted sales in dollars ................... Variable selling and administrative expense rate .................................. Variable selling and administrative expense ......................................... Fixed selling and administrative expenses ....................................... Total selling and administrative expenses ....................................... Less depreciation .............................. Cash disbursements for selling and administrative expenses ..................

First

Quarter Second Third

Fourth

Year

× 15%

$45,000 $ 60,000 $ 75,000

$30,000

$210,000

50,000

200,000

95,000 20,000

110,000 20,000

125,000 20,000

80,000 20,000

410,000 80,000

$75,000 $ 90,000 $105,000

$60,000

$330,000

$300,000 $400,000 $500,000 $200,000 $1,400,000

Problem 8-28 (continued) 4. Cash budget for next year:

Beginning cash balance ............ Add collections from customers . Total cash available................... Less cash disbursements: Merchandise purchases .......... Selling and administrative expenses (above) ................ Dividends .............................. Land ..................................... Total cash disbursements .......... Excess (deficiency) of cash available over disbursements .. Financing: Borrowings ............................ Repayments .......................... Interest ($48,000 × 2.5% × 3) ........ Total financing .......................... Ending cash balance .................

$ 10,000 261,000 271,000

Quarter Second Third

Fourth

Year

$ 12,000 $ 10,000 $ 10,800 $ 10,000 359,000 457,000 295,000 1,372,000 371,000 467,000 305,800 1,382,000

174,000

234,000

293,200

161,800

863,000

75,000 10,000 –– 259,000

90,000 10,000 75,000 409,000

105,000 10,000 48,000 456,200

60,000 10,000 –– 231,800

330,000 40,000 123,000 1,356,000

12,000

(38,000)

10,800

74,000

26,000

0 0

48,000 0

0 0

0 (48,000)

48,000 (48,000)

First

0 0 $ 12,000

0 0 (3,600) 48,000 0 (51,600) $ 10,000 $ 10,800 $ 22,400 $

Managerial Accounting, 16th Edition

(3,600) (3,600) 22,400

Problem 8-29 (120 minutes) 1. Schedule of expected cash collections: Cash sales .................... Credit sales1 .................. Total collections.............

April

May

$36,000 * $43,200 20,000 * 24,000 $56,000 * $67,200

June

Quarter

$54,000 28,800 $82,800

$133,200 72,800 $206,000

June

Quarter

40% of the preceding month’s sales. * Given. 2. Merchandise purchases budget:

April

May

Budgeted cost of goods sold1 ............................ $45,000 * $ 54,000 * $67,500 $166,500 Add desired ending merchandise inventory2 .................... 43,200 * 54,000 28,800 * 28,800 Total needs ..................... 88,200 * 108,000 96,300 195,300 Less beginning merchandise inventory .. 36,000 * 43,200 54,000 36,000 Required purchases ......... $52,200 * $ 64,800 $42,300 $159,300 1

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

May

June

March purchases ............. $21,750 * April purchases ............... 26,100 * $26,100 * May purchases ................ 32,400 $32,400 June purchases ............... 21,150 Total disbursements ........ $47,850 * $58,500 $53,550

Quarter

$ 21,750 * 52,200 * 64,800 21,150 $159,900

* Given.

Problem 8-29 (continued) 3. Cash budget:

April

Beginning cash balance . $ 8,000 * Add collections from customers .................. 56,000 * Total cash available ....... 64,000 * Less cash disbursements: For inventory .............. 47,850 * For expenses .............. 13,300 * For equipment ............ 1,500 * Total cash disbursements ............ 62,650 * Excess (deficiency) of cash available over disbursements ............ 1,350 * Financing: Borrowings................. 3,000 Repayments ............... 0 Interest ($3,000 × 1% × 3 + $7,000 × 1% × 2) .................. 0 Total financing .............. 3,000 Ending cash balance...... $ 4,350

May

$ 4,350

June

Quarter

$ 4,590 $ 8,000

67,200 71,550

82,800 87,390

206,000 214,000

58,500 15,460 0

53,550 18,700 0

159,900 47,460 1,500

73,960

72,250

208,860

(2,410)

15,140

5,140

7,000 0

0 10,000 (10,000) (10,000)

0 7,000 $ 4,590

(230) (230) (10,230) (230) $ 4,910 $ 4,910

* Given.

Managerial Accounting, 16th Edition

Problem 8-29 (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.

Problem 8-29 (continued) 5.

Shilow Company Balance Sheet June 30 Assets Current assets: Cash (see requirement 3) ............................................. $ 4,910 Accounts receivable ($90,000 × 40%) .......................... 36,000 Inventory (see requirement 2) ...................................... 28,800 Total current assets ........................................................ 69,710 Building and equipment—net ($120,000 + $1,500 – $2,700) ..................................... 118,800 Total assets .................................................................... $188,510 Liabilities and Stockholders’ Equity Accounts payable (Part 2: $42,300 × 50%) .. Stockholders’ equity: Common stock (Given) .............................. $150,000 Retained earnings* ................................... 17,360 Total liabilities and stockholders’ equity .........

$ 21,150 167,360 $188,510

* Beginning retained earnings ..................... $12,250 Add net income (see requirement 4) ......... 5,110 Ending retained earnings .......................... $17,360

Managerial Accounting, 16th Edition

Problem 8-30 (60 minutes) 1. The estimated sales for the third quarter:

Budgeted unit sales .... Selling price per unit... Budgeted sales...........

Month August September

July

30,000 70,000 × $12 × $12 $360,000 $840,000

50,000 × $12 $600,000

Quarter

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

$ 195,000

108,000 $234,000 252,000 $303,000 $486,000

342,000 $546,000

798,000

180,000 180,000 $726,000 $1,515,000

3. The production budget (quantity of beach umbrellas) for July-October: Budgeted unit sales ............... Add desired units of ending finished goods inventory ..... Total needs ........................... Less units of beginning finished goods inventory ..... Required production in units ..

July

August

10,500 40,500 4,500 36,000

30,000

70,000

September October 50,000

20,000

7,500 77,500

3,000 53,000

1,500 21,500

10,500 67,000

7,500 45,500

3,000 18,500

Problem 8-30 (continued) 4 and 5. The direct materials budget for the third 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 .................................

July

August

September

36,000

67,000

45,500

148,500

×4

144,000

268,000

182,000

594,000

134,000

91,000

37,000

278,000

359,000

219,000

631,000

72,000

134,000

91,000

72,000

206,000 × $0.80

225,000 × $0.80

128,000 × $0.80

559,000 × $0.80

$164,800 $180,000

$102,400

$447,200

* September 30: 18,500 units (October) × 4 feet per unit = 74,000 feet 74,000 feet × ½ = 37,000 feet

Quarter

Managerial Accounting, 16th Edition

Problem 8-30 (continued) 6. The expected cash disbursements for materials purchases for the third quarter: Accounts payable, June 30 ........................ July purchases: $164,800 × 50%, 50% . August purchases: $180,000 × 50%, 50% . September purchases: $102,400 × 50% .......... Total cash disbursements .

July

August

September Quarter

$ 76,000

82,400 $ 82,400 90,000 $158,400 $172,400

164,800 $ 90,000

180,000

51,200 51,200 $141,200 $472,000

Problem 8-31 (120 minutes) 1. Schedule of expected cash collections:

January

February

Cash sales .................... $ 80,000 * $120,000 Credit sales ................... 224,000 * 320,000 Total cash collections ..... $304,000 * $440,000

March

Quarter

March

Quarter

$ 60,000 $ 260,000 480,000 1,024,000 $540,000 $1,284,000

* Given. 2. a. Merchandise purchases budget:

January

February

Budgeted cost of goods sold1 ........................... $240,000 * $360,000 * $180,000 Add desired ending merchandise inventory2 ................... 90,000 * 45,000 30,000 Total needs ................. 330,000 * 405,000 210,000 Less beginning merchandise inventory..................... 60,000 * 90,000 45,000 Required purchases ........ $270,000 * $315,000 $165,000

$780,000 30,000 810,000 60,000 $750,000

For January sales: $400,000 × 60% cost ratio = $240,000. At January 31: $360,000 × 25% = $90,000. At March 31: $200,000 April sales × 60% cost ratio × 25% = $30,000. * Given. 2

b. Schedule of expected cash disbursements for merchandise purchases: December purchases ............ January purchases .. February purchases . March purchases ..... Total cash disbursements for purchases ............ * Given.

January

February

March

Quarter

$ 93,000 * 135,000 * $135,000 * 157,500 $157,500 82,500

$ 93,000 * 270,000 * 315,000 82,500

$228,000 * $292,500

$760,500

$240,000

Managerial Accounting, 16th Edition

Problem 8-31 (continued) 3. Cash budget:

January

February

March

Quarter

Beginning cash balance ...... $ 48,000 * $ 30,000 $ 30,800 $ 48,000 Add collections from customers ...................... 304,000 * 440,000 540,000 1,284,000 Total cash available ............ 352,000 * 470,000 570,800 1,332,000 Less cash disbursements: Inventory purchases ........ 228,000 * 292,500 240,000 760,500 Selling and administrative expenses** .................. 129,000 * 145,000 121,000 395,000 Equipment purchases ...... 0 1,700 84,500 86,200 Cash dividends................ 45,000 * 0 0 45,000 Total cash disbursements ... 402,000 * 439,200 445,500 1,286,700 Excess (deficiency) of cash available over disbursements ................ (50,000) * 30,800 125,300 45,300 Financing: Borrowings ..................... 80,000 0 0 80,000 Repayments.................... 0 0 (80,000) (80,000) Interest ($80,000 × 1% × 3)..... 0 0 (2,400) (2,400) Total financing ................... 80,000 0 (82,400) (2,400) Ending cash balance .......... $ 30,000 $ 30,800 $ 42,900 $ 42,900 * Given. ** February: $27,000 + $70,000 + [$600,000 × (5% + 3%)] = $145,000.

Problem 8-31 (continued) 4. Income statement:

Hillyard Company Income Statement For the Quarter Ended March 31

Sales .......................................................... 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: Salaries and wages ($27,000 × 3).............. Advertising ($70,000 × 3) ......................... Shipping (5% of sales) .............................. Depreciation (given) ................................. Other expenses (3% of sales) ................... Net operating income .................................. Interest expense (see requirement 3) ........... Net income .................................................

$1,300,000 $ 60,000 750,000 810,000 30,000 81,000 210,000 65,000 42,000 39,000

780,000 * 520,000

437,000 83,000 2,400 $ 80,600

* A simpler computation would be: $1,300,000 x 60% = $780,000.

Managerial Accounting, 16th Edition

Problem 8-31 (continued) 5. Balance sheet:

Hillyard Company Balance Sheet March 31

Assets Current assets: Cash (see requirement 3) ............................................. Accounts receivable (80% × $300,000)......................... Inventory (see requirement 2a) .................................... Total current assets ........................................................ Buildings and equipment, net ($370,000 + $86,200 – $42,000) .................................. Total assets .................................................................... Liabilities and Stockholders’ Equity Current liabilities: Accounts payable (50% × $165,000) ............. Stockholders’ equity: Common stock.............................................. Retained earnings* ....................................... Total liabilities and stockholders’ equity ............. * Beginning retained earnings .................. Add net income .................................... Total .................................................... Deduct cash dividends .......................... Ending retained earnings .......................

$ 42,900 240,000 30,000 312,900 414,200 $727,100

$ 82,500 $500,000 144,600

644,600 $727,100

$109,000 80,600 189,600 45,000 $144,600

Case 8-32 (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 highquality 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. (Unofficial CMA Solution, adapted) © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 72

Managerial Accounting, 16th Edition

Case 8-33 (120 minutes) 1. a. Sales budget:

April

May

June

Quarter

Budgeted unit sales.... 65,000 100,000 50,000 215,000 Selling price per unit .. × $10 × $10 × $10 × $10 Total sales ................. $650,000 $1,000,000 $500,000 $2,150,000 b. Schedule of expected cash collections: February sales (10%) . $ 26,000 $ 26,000 March sales (70%, 10%) ........... 280,000 $ 40,000 320,000 April sales (20%, 70%, 10%)... 130,000 455,000 $ 65,000 650,000 May sales (20%, 70%) ........... 200,000 700,000 900,000 June sales (20%) ....... 100,000 100,000 Total cash collections . $436,000 $695,000 $865,000 $1,996,000 c. Merchandise purchases budget: Budgeted unit sales.... 65,000 Add desired ending merchandise inventory ................ 40,000 Total needs ................ 105,000 Less beginning merchandise inventory ................ 26,000 Required purchases.... 79,000 Cost of purchases at $4 per unit .............. $316,000

100,000

50,000

215,000

20,000 120,000

12,000 62,000

12,000 227,000

40,000 80,000

20,000 42,000

26,000 201,000

$320,000 $168,000 $ 804,000

d. Budgeted cash disbursements for merchandise purchases: Accounts payable ........ $100,000 April purchases ........... 158,000 May purchases ............ June purchases ........... Total cash payments.... $258,000

$ 100,000 $158,000 316,000 160,000 $160,000 320,000 84,000 84,000 $318,000 $244,000 $ 820,000

Case 8-33 (continued) 2.

Earrings Unlimited Cash Budget For the Three Months Ending June 30

Beginning cash balance ...... Add collections from customers ...................... Total cash available ............ Less cash disbursements: Merchandise purchases ... Advertising ..................... Rent ............................... Salaries .......................... Commissions (4% of sales) .......................... Utilities ........................... Equipment purchases ...... Dividends paid ................ Total cash disbursements ... Excess (deficiency) of cash available over disbursements ................ Financing: Borrowings ..................... Repayments.................... Interest ($170,000 × 1% × 3 + $10,000 × 1% × 2) ...... Total financing ................... Ending cash balance ..........

April

$ 74,000

May

June

$ 50,000 $ 50,000 $

Quarter

436,000 510,000

695,000 745,000

865,000 915,000

1,996,000 2,070,000

258,000 200,000 18,000 106,000

318,000 200,000 18,000 106,000

244,000 200,000 18,000 106,000

820,000 600,000 54,000 318,000

26,000 7,000 0 15,000 630,000

40,000 7,000 16,000 0 705,000

20,000 7,000 40,000 0 635,000

86,000 21,000 56,000 15,000 1,970,000

(120,000)

40,000

280,000

100,000

170,000 0

10,000 0

0 (180,000)

180,000 (180,000)

0 170,000 $ 50,000

0 10,000 $ 50,000

(5,300) (185,300) $ 94,700 $

(5,300) (5,300) 94,700

74,000

Managerial Accounting, 16th Edition

Case 8-33 (continued) 3.

Earrings Unlimited Budgeted Income Statement For the Three Months Ended June 30 Sales (see requirement 1a.) ...................... Variable expenses: Cost of goods sold (@ $4 per unit) ......... Commissions @ 4% of sales ................... Contribution margin ................................. Fixed expenses: Advertising ($200,000 × 3) .................... Rent ($18,000 × 3) ............................... Salaries ($106,000 × 3) ......................... Utilities ($7,000 × 3).............................. Insurance ($3,000 × 3).......................... Depreciation ($14,000 × 3) .................... Net operating income ............................... Interest expense (see requirement 2)........ Net income ..............................................

$2,150,000 $860,000 86,000 600,000 54,000 318,000 21,000 9,000 42,000

946,000 1,204,000

1,044,000 160,000 5,300 $ 154,700

Case 8-33 (continued) 4.

Earrings Unlimited Budgeted Balance Sheet June 30

Assets

Cash (see requirement 2) ............................................... Accounts receivable (see below) ..................................... Inventory (12,000 units @ $4 per unit) ........................... Prepaid insurance ($21,000 – $9,000) ............................. Property and equipment, net ($950,000 + $56,000 – $42,000) ................................. Total assets ...................................................................

Liabilities and Stockholders’ Equity

Accounts payable, purchases (50% × $168,000).............. Dividends payable .......................................................... Common stock ............................................................... Retained earnings (see below) ........................................ Total liabilities and stockholders’ equity ...........................

94,700 500,000 48,000 12,000

964,000 $1,618,700 $

84,000 15,000 800,000 719,700 $1,618,700

Accounts receivable at June 30: 10% × May sales of $1,000,000 ........... $100,000 80% × June sales of $500,000 ............. 400,000 Total.................................................... $500,000 Retained earnings at June 30: Balance, March 31................................ $580,000 Add net income (see requirement 3) ..... 154,700 Total.................................................... 734,700 Less dividends declared ........................ 15,000 Balance, June 30 .................................. $719,700

Managerial Accounting, 16th Edition

Chapter 9 Flexible Budgets and Performance Analysis Solutions to Questions 9-1 A planning budget is prepared before the period begins and is valid for only the planned level of activity. It is sometimes referred to as a static planning budget because it is not adjusted even if the level of activity subsequently changes. 9-2 A flexible budget can be adjusted to reflect any level of activity—including the actual level of activity. By contrast, a static planning budget is prepared for a single level of activity and is not subsequently adjusted. 9-3 Actual results can differ from the budget for many reasons. Very broadly speaking, the differences are usually due to a change in the level of activity, changes in prices, and changes in how effectively resources are managed. 9-4 As noted above, a difference between the budget and actual results can be due to many factors. Most importantly, the level of activity can have a very big impact on costs. From a manager’s perspective, a variance that is due to a change in activity is very different from a variance that is due to changes in prices and changes in how effectively resources are managed. A variance of the first kind requires very different actions from a variance of the second kind. Consequently, these two kinds of variances should be clearly separated from each other. When the budget is directly compared to the actual results, these two kinds of variances are lumped together. 9-5 An activity variance is the difference between a revenue or cost item in the flexible budget and the same item in the static planning budget. An activity variance is due solely to the difference in the actual level of activity used in the flexible budget and the level of activity assumed in the planning budget. Caution should

be exercised in interpreting an activity variance. The “favorable” and “unfavorable” labels are perhaps misleading for activity variances that involve costs. A “favorable” activity variance for a cost occurs because the cost has some variable component and the actual level of activity is less than the planned level of activity. An “unfavorable” activity variance for a cost occurs because the cost has some variable component and the actual level of activity is greater than the planned level of activity. 9-6 A revenue variance is the difference between the actual revenue for the period and how much the revenue should have been, given the actual level of activity. A revenue variance is easy to interpret. A favorable revenue variance occurs because the revenue is greater than expected for the actual level of activity. An unfavorable revenue variance occurs because the revenue is less than expected for the actual level of activity. 9-7 A spending variance is the difference between the actual amount of the cost and how much a cost should have been, given the actual level of activity. Like the revenue variance, the interpretation of a spending variance is straightforward. A favorable spending variance occurs because the cost is lower than expected for the actual level of activity. An unfavorable spending variance occurs because the cost is higher than expected for the actual level of activity. 9-8 In a flexible budget performance report, the actual results are not directly compared to the static planning budget. The flexible budget is interposed between the actual results and the static planning budget. The differences between the flexible budget and the static planning budget are activity variances. The differences between the actual results and the flexible

budget are the revenue and spending variances. The flexible budget performance report cleanly separates the differences between the actual results and the static planning budget that are due to changes in activity (the activity variances) from the differences that are due to changes in prices and the effectiveness with which resources are managed (the revenue and spending variances). 9-9 The only difference between a flexible budget based on a single cost driver and one based on two cost drivers is the cost formulas. When there are two cost drivers, some costs may be a function of the first cost driver, some costs may be a function of the second cost driver, and some costs may be a function of both cost drivers.

9-10 When actual results are directly compared to the static planning budget, it is implicitly assumed that costs (and revenues) should not change with a change in the level of activity. This assumption is valid only for fixed costs. However, it is unlikely that all costs are fixed. Some are likely to be variable or mixed. 9-11 When the static planning budget is adjusted proportionately for a change in activity and then directly compared to actual results, it is implicitly assumed that costs should change in proportion to a change in the level of activity. This assumption is valid only for strictly variable costs. However, it is unlikely that all costs are strictly variable. Some are likely to be fixed or mixed.

Managerial Accounting, 16th Edition

Chapter 9: Applying Excel The completed worksheet is shown below.

Chapter 9: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Note: The formulas to compute whether a variance is Favorable or Unfavorable use the IF() function. For example, in cell D31, the formula is =IF(E31>B31,"U",IF(E31<B31,"F","")). This formula first checks whether the actual revenue (cell B31) exceeds the revenue under the flexible budget (cell E31). If it does, the function returns the value F, which is displayed in cell D31. Otherwise, the function returns the value U, which is displayed in cell D31.When actual revenue is the same as under the flexible budget, nothing is displayed in cell D31.

Managerial Accounting, 16th Edition

Chapter 9: Applying Excel (continued) 1. With the changes in data, the result is:

Chapter 9: Applying Excel (continued) a. The activity variance for revenue is $1,600 U. This variance is the difference between the revenue under the planning budget and under the flexible budget. It is unfavorable because the actual activity exceeds the budgeted activity and consequently revenue should be larger than planned under the budget. b. The spending variance for the cost of ingredients is $60 U. This variance is the difference between what the cost should have been according to the flexible budget and what it actually was for the period. It is unfavorable because the actual cost exceeded what the cost should have been.

Managerial Accounting, 16th Edition

Chapter 9: Applying Excel (continued) 2. With the revised data, the worksheet should look like this:

Actual activity exceeded planned activity by 100 meals served, which should have boosted net operating income by $925. However, actual results were not this favorable. Given the actual number of meals served, the company should have realized net operating income of $2,650, but the actual net operating income was only $1,860, resulting in an unfavorable overall spending and revenue variance of $790. Attention should be focused on the lower than expected revenue. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 9

The Foundational 15 1. The amount of revenue in the flexible budget for May is: Revenue: Variable element per customer served (a)....... Actual activity (b) .......................................... Amount in flexible budget (a) × (b) ................

$5,000 35 $175,000

2. The amount of employee salaries and wages in the flexible budget for May is: Employee salaries and wages: Variable element per customer served (a)....... Actual activity (b) .......................................... Variable portion of the amount (a) × (b) ........

$1,100 35 $38,500

Variable portion of the amount ....................... Fixed element per month ............................... Amount in flexible budget ..............................

$38,500 50,000 $88,500

3. The amount of travel expenses in the flexible budget for May is: Travel expenses: Variable element per customer served (a)....... Actual activity (b) .......................................... Amount in flexible budget (a) × (b) ................

$600 35 $21,000

4. The amount of Other Expenses included in the flexible budget for May would be the fixed element per month of $36,000. 5. The net income reported in the flexible budget can be derived by combining the answers to questions 1-4 as follows: Revenue .............................................. Employee salaries and wages ................ Travel expenses ................................... Other expenses .................................... Net operating income ...........................

$88,500 21,000 36,000

$175,000 145,500 $ 29,500

Managerial Accounting, 16th Edition

The Foundational 15 6. The revenue variance for May is: Actual results $160,000

Revenue Variance $15,000 U

Flexible Budget $175,000

7. The employee salaries and wages spending variance for May is: Actual results $88,000

Spending Variance $500 F

Flexible Budget $88,500

8. The travel expenses spending variance for May is: Actual results $19,000

Spending Variance $2,000 F

Flexible Budget $21,000

9. The other expenses spending variance for May is: Actual results $34,500

Spending Variance $1,500 F

Flexible Budget $36,000

10. The amount of revenue in the planning budget for May is: Revenue: Variable element per customer served (a)....... Planned level of activity (b) ............................ Amount in planning budget (a) × (b)..............

$5,000 30 $150,000

11. The amount of employee salaries and wages in the planning budget for May is: Employee salaries and wages: Variable element per customer served (a)....... Actual activity (b) .......................................... Variable portion of the amount (a) × (b) ........

$1,100 30 $33,000

Variable portion of the amount ....................... Fixed element per month ............................... Amount in planning budget ............................

$33,000 50,000 $83,000

The Foundational 15 12. The amount of travel expenses in the planning budget for May is: Travel expenses: Variable element per customer served (a)....... Actual activity (b) .......................................... Amount in planning budget (a) × (b)..............

$600 30 $18,000

13. The amount of Other Expenses included in the planning budget for May would be the fixed element per month of $36,000. 14. The activity variance for revenue for May is: Flexible Budget $175,000

Activity Variance $25,000 F

Planning Budget $150,000

15. The activity variances for the expenses for May are as follows:

Employee salaries and wages ... Travel expenses ...................... Other expenses .......................

Flexible Budget $88,500 $21,000 $36,000

Activity Variance $5,500 U $3,000 U $0

Planning Budget $83,000 $18,000 $36,000

Managerial Accounting, 16th Edition

Exercise 9-1 (10 minutes) Puget Sound 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) ..................................... Equipment rental ($1,800 + $32.00q) ....... Insurance ($3,400) .................................. Miscellaneous ($630 + $1.80q) ................. Total expense ............................................. Net operating income..................................

$38,325 21,125 315 5,160 3,400 819 30,819 $ 7,506

Exercise 9-2 (15 minutes) 1. The activity variances are shown below: Flight Café Activity Variances For the Month Ended July 31

Meals ......................................... Revenue ($4.50q) ....................... Expenses: Raw materials ($2.40q) ............. Wages and salaries ($5,200 + $0.30q) ................................. Utilities ($2,400 + $0.05q) ........ Facility rent ($4,300) ................ Insurance ($2,300) ................... Miscellaneous ($680 + $0.10q).. Total expense ............................. Net operating income ..................

Flexible Budget

Planning Budget

Activity Variances

$80,100

$81,000

$900

42,720

43,200

480

10,540 3,290 4,300 2,300 2,460 65,610 $14,490

10,600 3,300 4,300 2,300 2,480 66,180 $14,820

60 10 0 0 20 570 $330

F F

17,800

18,000

F F U

2. Management should be concerned that the level of activity fell below what had been planned for the month. This led to an expected decline in profits of $330. However, the individual items on the report should not receive much management attention. The unfavorable variance for revenue and the favorable variances for expenses are entirely caused by the drop in activity.

Managerial Accounting, 16th Edition

Exercise 9-3 (15 minutes) Quilcene Oysteria Revenue and Spending Variances For the Month Ended August 31

Pounds ....................................... 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 expense ............................. Net operating income ..................

Actual Results

Flexible Budget

Revenue and Spending Variances

$35,200

$32,000

$3,200

4,200 3,100

4,000 3,200

200 100

U F

5,640

5,300

340

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

8,000

Exercise 9-4 (20 minutes) 1.

Vulcan Flyovers Flexible Budget Performance Report For the Month Ended July 31

Flights (q) ...................................... Revenue ($320.00q) ....................... Expenses: Wages and salaries ($4,000 + $82.00q) .................................. Fuel ($23.00q)............................. Airport fees ($650 + $38.00q) ...... Aircraft depreciation ($7.00q) ....... Office expenses ($190 + $2.00q).. Total expense ................................ Net operating income .....................

Actual Results

Revenue and Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$13,650

$1,710

$15,360

$640

$16,000

8,430 1,260 2,350 336 460 12,836 $ 814

494 156 124 0 174 700 $2,410

U U F

7,936 1,104 2,474 336 286 12,136 $ 3,224

164 46 76 14 4 304 $336

F F F F F F U

8,100 1,150 2,550 350 290 12,440 $ 3,560

U U U

2. The overall $336 unfavorable activity variance is due to activity falling below what had been planned for the month. The $1,710 unfavorable revenue variance is very large relative to the company’s net operating income and should be investigated. Was this due to discounts given or perhaps a lower average number of passengers per flight than usual? The $494 unfavorable spending variance for wages and salaries is also large and should be investigated. The other spending variances are relatively small, but are worth some management attention—particularly if they recur next month. © The McGraw-Hill Companies, Inc., 2010. All rights reserved. 14

Managerial Accounting, 13th Edition

Exercise 9-5 (15 minutes) Alyeski Tours Flexible Budget For the Month Ended July 31 Budgeted Actual cruises (q1) ............................................... Budgeted Actual passengers (q2) .........................................

24 1,400

Revenue ($25.00q2) ............................................................ Expenses: Vessel operating costs ($5,200 + $480.00q1 + $2.00q2) ..... Advertising ($1,700)......................................................... Administrative costs ($4,300 + $24.00q1 + $1.00q2) .......... Insurance ($2,900) .......................................................... Total expense..................................................................... Net operating income .........................................................

$35,000 19,520 1,700 6,276 2,900 30,396 $ 4,604

Exercise 9-6 (10 minutes) The variance report compares actual results to the planning budget and should not be used to evaluate how well costs were controlled during April. The planning budget is based on 100 jobs, but the actual results are for 105 jobs. Consequently, the actual revenues and many of the actual costs should have been different from what was budgeted at the beginning of the period. Direct comparisons of budgeted to actual costs are valid only if the costs are fixed. To evaluate how well revenues and costs were controlled, it is necessary to estimate what the revenues and costs should have been for the actual level of activity using a flexible budget. The flexible budget amounts can then be compared to the actual results to evaluate how well revenues and costs were controlled.

Managerial Accounting, 16th Edition

Exercise 9-7 (15 minutes) The adjusted budget was created by multiplying each item in the budget by the ratio 105/100; in other words, each item was adjusted upward by 5%. This procedure provides valid benchmarks for revenues and for costs that are strictly variable, but overstates what fixed and mixed costs should be. Fixed costs, for example, should not increase at all if the activity level increases by 5%—providing, of course, that this level of activity is within the relevant range. Mixed costs should increase less than 5%. To evaluate how well revenues and costs were controlled, it is necessary to estimate what the revenues and costs should have been for the actual level of activity using a flexible budget that explicitly recognizes fixed and mixed costs. The flexible budget amounts can then be compared to the actual results to evaluate how well revenues and costs were controlled.

Exercise 9-8 (20 minutes) Jake’s Roof Repair Activity Variances For the Month Ended May 31

Repair-hours (q) .......................... Revenue ($44.50q) ...................... Expenses: Wages and salaries ($23,200 + $16.30q) .............. Parts and supplies ($8.60q) ....... Equipment depreciation ($1,600 + $0.40q) .................. Truck operating expenses ($6,400 + $1.70q) .................. Rent ($3,480) ........................... Administrative expenses ($4,500 + $0.80q) .................. Total expense.............................. Net operating income ..................

Flexible Budget

Planning Budget

Activity Variances

$129,050

$124,600

$4,450

70,470 24,940

68,840 24,080

1,630 860

U U

2,760

2,720

11,330 3,480

11,160 3,480

170 0

6,820 119,800 $ 9,250

6,740 117,020 $ 7,580

80 2,780 $1,670

U U F

2,900

2,800

Managerial Accounting, 16th Edition

Exercise 9-9 (10 minutes) Wyckam Manufacturing Inc. Planning Budget for Manufacturing Costs For the Month Ended June 30 Budgeted machine-hours (q) ........

5,000

Direct materials ($4.25q) ............. Direct labor ($36,800).................. Supplies ($0.30q) ........................ Utilities ($1,400 + $0.05q) ........... Depreciation ($16,700) ................ Insurance ($12,700) .................... Total manufacturing cost .............

$21,250 36,800 1,500 1,650 16,700 12,700 $90,600

Exercise 9-10 (15 minutes) Lavage Rapide Planning Budget For the Month Ended August 31 Budgeted cars washed (q) .............................

9,000

Revenue ($4.90q) .......................................... Expenses: Cleaning supplies ($0.80q) .......................... Electricity ($1,200 + $0.15q) ....................... Maintenance ($0.20q) ................................. Wages and salaries ($5,000 + $0.30q) ......... Depreciation ($6,000) ................................. Rent ($8,000) ............................................. Administrative expenses ($4,000 + $0.10q) .. Total expense................................................ Net operating income ....................................

$44,100 7,200 2,550 1,800 7,700 6,000 8,000 4,900 38,150 $ 5,950

Managerial Accounting, 16th Edition

Exercise 9-11 (15 minutes) Lavage Rapide Flexible Budget For the Month Ended August 31 Actual cars washed (q) ..................................

8,800

$43,120 7,040 2,520 1,760 7,640 6,000 8,000 4,880 37,840 $ 5,280

Exercise 9-12 (20 minutes) Lavage Rapide Activity Variances For the Month Ended August 31

Cars washed (q) ............................... Revenue ($4.90q) ............................. Expenses: Cleaning supplies ($0.80q) ............. Electricity ($1,200 + $0.15q) .......... Maintenance ($0.20q) .................... Wages and salaries ($5,000 + $0.30q) .................... Depreciation ($6,000) .................... Rent ($8,000) ................................ Administrative expenses ($4,000 + $0.10q) ....................... Total expense................................... Net operating income .......................

Flexible Budget

Planning Budget

Activity Variances

$43,120

$44,100

$980

7,040 2,520 1,760

7,200 2,550 1,800

160 30 40

F F F

7,640 6,000 8,000

7,700 6,000 8,000

60 0 0

4,880 37,840 $ 5,280

4,900 38,150 $ 5,950

20 310 $670

F F U

8,800

9,000

Managerial Accounting, 16th Edition

Exercise 9-13 (20 minutes) Lavage Rapide Revenue and Spending Variances For the Month Ended August 31

Cars washed (q) .......................... Revenue ($4.90q) ........................ Expenses: Cleaning supplies ($0.80q) ........ Electricity ($1,200 + $0.15q) ..... Maintenance ($0.20q) ............... Wages and salaries ($5,000 + $0.30q) ............... Depreciation ($6,000) ............... Rent ($8,000) ........................... Administrative expenses ($4,000 + $0.10q) .................. Total expense.............................. Net operating income ..................

Actual Results

Flexible Budget

Revenue and Spending Variances

$43,080

$43,120

$ 40

7,560 2,670 2,260

7,040 2,520 1,760

520 150 500

U U U

8,500 6,000 8,000

7,640 6,000 8,000

860 0 0

4,950 39,940 $ 3,140

4,880 37,840 $ 5,280

70 2,100 $2,140

U U U

8,800

Exercise 9-14 (30 minutes) Lavage Rapide Flexible Budget Performance Report For the Month Ended August 31

Cars washed (q) ................................... Revenue ($4.90q) ................................. Expenses: Cleaning supplies ($0.80q) ................. Electricity ($1,200 + $0.15q) .............. Maintenance ($0.20q) ........................ Wages and salaries ($5,000 + $0.30q) ........................... Depreciation ($6,000) ........................ Rent ($8,000) .................................... Administrative expenses ($4,000 + $0.10q) ........................... Total expense....................................... Net operating income ...........................

Actual Results

Revenue and Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$43,080

8,800

$43,120

$980

$44,100

7,560 2,670 2,260

520 150 500

U U U

7,040 2,520 1,760

160 30 40

F F F

7,200 2,550 1,800

8,500 6,000 8,000

860 0 0

7,640 6,000 8,000

60 0 0

7,700 6,000 8,000

4,950 39,940 $ 3,140

70 2,100 $2,140

U U U

4,880 37,840 $ 5,280

20 310 $670

F F U

4,900 38,150 $ 5,950

9,000

Managerial Accounting, 16th Edition

Exercise 9-15 (45 minutes) 1. The planning budget appears below. Note that the report does not include revenue or net operating income because the production department is a cost center that does not have any revenue. Packaging Solutions Corporation Production Department Planning Budget For the Month Ended March 31 Budgeted labor-hours (q) .............................

8,000

Direct labor ($15.80q) .................................. Indirect labor ($8,200 + $1.60q) .................. Utilities ($6,400 + $0.80q) ........................... Supplies ($1,100 + $0.40q) .......................... Equipment depreciation ($23,000 + $3.70q) . Factory rent ($8,400) ................................... Property taxes ($2,100) ............................... Factory administration ($11,700 + $1.90q) ... Total expense ..............................................

$126,400 21,000 12,800 4,300 52,600 8,400 2,100 26,900 $254,500

2. The flexible budget appears below. Like the planning budget, this report does not include revenue or net operating income because the production department is a cost center that does not have any revenue. Packaging Solutions Corporation Production Department Flexible Budget For the Month Ended March 31 Actual labor-hours (q) ..................................

8,400

$132,720 21,640 13,120 4,460 54,080 8,400 2,100 27,660 $264,180

Exercise 9-15 (continued) 3. The flexible budget performance report appears below. This report does not include revenue or net operating income because the production department is a cost center that does not have any revenue. Packaging Solutions Corporation Production Department Flexible Budget Performance Report For the Month Ended March 31

Labor-hours (q) ............................... Direct labor ($15.80q) ...................... Indirect labor ($8,200 + $1.60q) ...... Utilities ($6,400 + $0.80q) ............... Supplies ($1,100 + $0.40q) .............. Equipment depreciation ($23,000 + $3.70q)....................... Factory rent ($8,400) ....................... Property taxes ($2,100) ................... Factory administration ($11,700 + $1.90q)....................... Total expense ..................................

Actual Results

Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$134,730 19,860 14,570 4,980

$2,010 1,780 1,450 520

U F U U

$132,720 21,640 13,120 4,460

$6,320 640 320 160

U U U U

$126,400 21,000 12,800 4,300

54,080 8,700 2,100

0 300 0

54,080 8,400 2,100

1,480 0 0

52,600 8,400 2,100

26,470 $265,490

1,190 $1,310

F U

27,660 $264,180

760 $9,680

U U

26,900 $254,500

8,400

8,000

Managerial Accounting, 13th Edition

Exercise 9-15 (continued) 4. The overall unfavorable activity variance of $9,680 occurred because the actual level of activity exceeded the budgeted level of activity. The production manager certainly should not be held responsible for this unfavorable variance if this increased activity was due to more orders or more sales. On the other hand, the overall unfavorable spending variance of $1,310 may be of concern to management. Why did the unfavorable—and favorable—variances occur? Even the relatively small unfavorable spending variance for supplies of $520 should probably be investigated because, as a percentage of what the cost should have been ($520/$4,460 = 11.7%), this variance is fairly large.

Exercise 9-16 (20 minutes) Via Gelato Revenue and Spending Variances For the Month Ended June 30

Liters (q) ..................................... Revenue ($12.00q) ....................... Expenses: Raw materials ($4.65q) .............. Wages ($5,600 + $1.40q) .......... Utilities ($1,630 + $0.20q) ......... Rent ($2,600) ............................ Insurance ($1,350) .................... Miscellaneous ($650 + $0.35q) ... Total expense .............................. Net operating income ...................

Actual Results

Flexible Budget

Revenue and Spending Variances

$71,540

$74,400

$2,860

29,230 13,860 3,270 2,600 1,350 2,590 52,900 $18,640

28,830 14,280 2,870 2,600 1,350 2,820 52,750 $21,650

400 420 400 0 0 230 150 $3,010

U F U

6,200

F U U

Managerial Accounting, 16th Edition

Exercise 9-17 (30 minutes) AirQual Test Corporation Flexible Budget Performance Report For the Month Ended February 28

Jobs (q) ............................................... Revenue ($360.00q) ............................. Expenses: Technician wages ($6,400) ................. Mobile lab operating expenses ($2,900 + $35.00q) ......................... Office expenses ($2,600 + $2.00q) ..... Advertising expenses ($970) ............... Insurance ($1,680) ............................ Miscellaneous expenses ($500 + $3.00q) ............................. Total expense....................................... Net operating income ...........................

Actual Results

Revenue and Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$18,950

$230

$18,720

$720

$18,000

6,450

6,400

4,530 3,050 995 1,680

190 346 25 0

F U U

4,720 2,704 970 1,680

70 4 0 0

U U

4,650 2,700 970 1,680

465 17,170 $ 1,780

191 40 $190

F U F

656 17,130 $ 1,590

6 80 $640

U U F

650 17,050 $ 950

6,400

Exercise 9-18 (30 minutes) The flexible budget performance report for September appears below: Gourmand Cooking School Flexible Budget Performance Report For the Month Ended September 30

Actual Results

Revenue and Spending Variances

Flexible Budget

Courses (q1) .................................. Students (q2) .................................

3 42

Revenue ($800q2) .......................... Expenses: Instructor wages ($3,080q1) ........ Classroom supplies ($260q2) ........ Utilities ($870 + $130q1).............. Campus rent ($4,200).................. Insurance ($1,890) ...................... Administrative expenses ($3,270 + $15q1 + $4q2)........... Total expense ................................ Net operating income .....................

$32,400

$1,200

$33,600

$2,400

9,080 8,540 1,530 4,200 1,890

160 2,380 270 0 0

F F U

9,240 10,920 1,260 4,200 1,890

0 780 0 0 0

3,790 29,030 $ 3,370

307 1,963 $ 763

U F F

3,483 30,993 $ 2,607

12 792 $ 1,608

Activity Variances

Managerial Accounting, 16th Edition

Planning Budget 3 45

U F

F F U

$36,000 9,240 11,700 1,260 4,200 1,890 3,495 31,785 $ 4,215

Problem 9-19 (45 minutes) The completed flexible budget performance report is as follows: Ray Company Production Department Flexible Budget Performance Report For the Month Ended August 31

Labor-hours (q) ............................... Direct labor ($14q) .......................... Indirect labor ($7,420 + $1.50q) ...... Utilities ($6,500 + $0.70q) ............... Supplies ($1,600 + $0.30q).............. Equipment depreciation ($78,400) .... Factory administration ($18,700 + $1.90q) ...................... Total expense..................................

Actual Results

Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$134,730 19,860 14,586 4,940 78,400

$2,010 1,780 1,450 496 0

U F U U

$132,720 21,640 13,136 4,444 78,400

$6,720 720 336 144 0

U U U U

$126,000 $20,920 12,800 4,300 78,400

35,572 $288,088

1,140 $1,036

F U

36,712 $287,052

912 $8,832

U U

35,800 $278,220

9,480

Supplemental computations are included on the next two pages.

9,000

Problem 9-19 (continued)

Direct labor:

Cost formula: $132,720 ÷ 9,480 labor-hours = $14 Spending variance: $134,730 ‒ $132,720 = $2,010 U Planning budget: 9,000 labor-hours × $14 per labor-hour = $126,000 Activity variance: $132,720 ‒ $126,000 = $6,720 U

Indirect labor:

Fixed portion of cost formula: $21,640 ‒ (9,480 labor-hours × $1.50) = $7,420 Actual results: $21,640 ‒ $1,780 = $19,860 Planning budget: $7,420 + (9,000 labor-hours × $1.50) = $20,920 Activity variance: $21,640 ‒ $20,920 = $720 U

Utilities:

Variable portion of cost formula: $12,800 ‒ $6,500 = $6,300; $6,300 ÷ 9,000 labor-hours = $0.70 Flexible budget: $6,500 + (9,480 labor-hours × $0.70) = $13,136 Actual results: $13,136 + $1,450 = $14,586

Supplies:

Variable portion of cost formula: $4,444 ‒ $4,300 = $144; $144 ÷ (9,480 ‒ 9,000) = $0.30 Fixed portion of cost formula: $4,300 ‒ (9,000 labor-hours × $0.30) = $1,600 Spending variance: $4,940 ‒ $4,444 = $496 U Activity variance: $4,444 ‒ $4,300 = $144 U

Equipment depreciation:

Planning budget: $78,400 Flexible budget: $78,400 Activity variance: $78,400 ‒ $78,400 = $0 Actual results: $78,400 ‒ $0 = $78,400

Factory administration:

Planning budget: $18,700 + (9,000 labor-hours × $1.90) = $35,800 Flexible budget: $18,700 + (9,480 labor-hours × $1.90) = $36,712 Activity variance: $36,712 ‒ $35,800 = $912 U © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 32

Managerial Accounting, 16th Edition

Problem 9-19 (continued)

Factory administration:

Actual results: $288,088 ‒ ($134,730 + $19,860 + $14,586 + $4,940 + $78,400) = $35,572 Spending variance: $35,572 ‒ $36,712 = $1,140 F

Problem 9-20 (30 minutes) 1. The activity variances are shown below: FAB Corporation Activity Variances For the Month Ended March 31

Machine-hours (q) .......................... Utilities ($20,600 + $0.10q) ............ Maintenance ($40,000 + $1.60q) .... Supplies ($0.30q) ........................... Indirect labor ($130,000 + $0.70q) . Depreciation ($70,000) ................... Total .............................................

Flexible Budget

Planning Budget

Activity Variances

$ 23,200 81,600 7,800 148,200 70,000 $330,800

$ 23,600 88,000 9,000 151,000 70,000 $341,600

$ 400 6,400 1,200 2,800 0 $10,800

26,000

30,000

The activity variances are all favorable because the actual activity was less than the planned activity and therefore all of the variable costs should be lower than planned in the original budget.

Managerial Accounting, 16th Edition

F F F F F

Problem 9-20 (continued) 2. The spending variances are computed below: FAB Corporation Spending Variances For the Month Ended March 31

Actual Results

Flexible Budget

Spending Variances

$ 24,200 78,100 8,400 149,600 71,500 $331,800

$ 23,200 81,600 7,800 148,200 70,000 $330,800

$1,000 3,500 600 1,400 1,500 $1,000

26,000

An unfavorable spending variance means that the actual cost was greater than what the cost should have been for the actual level of activity. A favorable spending variance means that the actual cost was less than what the cost should have been for the actual level of activity. While this makes intuitive sense, sometimes a favorable variance may not be good. For example, the rather large favorable variance for maintenance might have resulted from performing less maintenance. Since these variances are all fairly large, they should all probably be investigated.

U F U U U U

Problem 9-21 (30 minutes) 1.

Milano Pizza Flexible Budget Performance Report For the Month Ended November 30

Pizzas (q1) ...................................... Deliveries (q2) ................................. Revenue ($13.50q1) ........................ Expenses: Pizza ingredients ($3.80q1) ........... Kitchen staff ($5,220) ................... Utilities ($630 + $0.05q1).............. Delivery person ($3.50q2) ............. Delivery vehicle ($540 + $1.50q2) . Equipment depreciation ($275) ..... Rent ($1,830) .............................. Miscellaneous ($820 + $0.15q1) .... Total expense ................................. Net operating income ......................

Actual Results

Revenue and Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$17,420

$680

$16,740

$540

$16,200

4,985 5,281 984 609 655 275 1,830 954 15,573 $ 1,847

273 61 292 0 146 0 0 52 428 $252

U U U

4,712 5,220 692 609 801 275 1,830 1,006 15,145 $ 1,595

152 0 2 21 9 0 0 6 130 $410

4,560 5,220 690 630 810 275 1,830 1,000 15,015 $ 1,185

1,240 174

F F U F

1,240 174

Managerial Accounting, 16th Edition

U F F U U F

1,200 180

Problem 9-21 (continued) 2. Some of the activity variances are favorable and some are unfavorable. This occurs because there are two cost drivers (i.e., measures of activity) and one is up while the other is down. The actual number of pizzas delivered is greater than budgeted, so the activity variance for revenue is favorable, but the activity variances for pizza ingredients, utilities, and miscellaneous are unfavorable. In contrast, the actual number of deliveries is less than budgeted, so the activity variances for the delivery person and the delivery vehicle are favorable.

Problem 9-22 (45 minutes) 1. The variance report should not be used to evaluate how well costs were controlled. In July, the planning 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 activity variance for net operating income was $435 F (favorable). That means that as a consequence of the increase in activity from 150 lessons to 155 lessons, the net operating income should have been up $435 over budget. However, it wasn’t. The budgeted net operating income was $8,030 and the actual net 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 revenue and spending variances. Perhaps most importantly, fuel costs were much higher than expected. The spending variance for fuel was $425 U (unfavorable) 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 spending variances were favorable, so with the exception of this item, costs seem to have been adequately controlled. In addition, the unfavorable 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.

Managerial Accounting, 16th Edition

Problem 9-22 (continued) TipTop Flight School Flexible Budget Performance Report For the Month Ended July 31

Lessons (q) ...................................... 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................................... Net operating income .......................

Actual Results

Revenue and Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$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

155

150

Problem 9-23 (30 minutes) 1. Performance should be evaluated using a flexible budget performance report. In this case, the report will not include revenues. St. Lucia Blood Bank Flexible Budget Performance Report For the Month Ended September 30

Liters of blood collected (q) ................ Medical supplies ($15.00q) ................. Lab tests ($12.00q) ............................ Equipment depreciation ($2,500) ........ Rent ($1,000) .................................... Utilities ($500) ................................... Administration ($10,000 + $2.50q) ..... Total expense ....................................

Actual Results

Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$ 9,250 6,180 2,800 1,000 570 11,740 $31,540

$ 50 1,260 300 0 70 190 $ 750

$ 9,300 7,440 2,500 1,000 500 11,550 $32,290

$1,800 1,440 0 0 0 300 $3,540

$ 7,500 6,000 2,500 1,000 500 11,250 $28,750

620

F F U U U F

620

U U

500

2. The overall unfavorable activity variance of $3,540 was caused by the 24% increase [= (620 – 500) ÷ 500] in activity. There is no reason to investigate this particular variance. The overall spending variance is $750 F, which would seem to indicate that costs were well-controlled. However, the favorable $1,260 spending variance for lab tests is curious. The fact that this variance is favorable indicates that less was spent on lab tests than should have been spent according to the cost formula. Why? Did the blood bank get a substantial discount on the lab tests? Did the blood bank fail to perform required lab tests? If so, was this wise? In addition, the unfavorable spending variance of $300 for equipment depreciation requires some explanation. Was more equipment obtained to collect the additional blood? © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 40

Managerial Accounting, 16th Edition

Problem 9-24 (45 minutes) 1. The report prepared by the bookkeeper compares average budgeted per unit revenues and costs to average actual per unit revenues and costs. This approach implicitly assumes that all costs are strictly variable; only variable costs should be constant on a per unit basis. The average fixed cost should decrease as the level of activity increases and should increase as the level of activity decreases. In this case, the actual level of activity was greater than the budgeted level of activity. As a consequence, the average cost per unit for any cost that is fixed or mixed (such as office expenses, equipment depreciation, rent, and insurance) should decline and show a favorable variance. This makes it difficult to interpret the variance for a mixed or fixed cost. For example, was the favorable $9 variance per exchange for rent due simply to the increased volume or did the company actually save any money on its rent? Because of this ambiguity, the report prepared by the bookkeeper is not as useful as a performance report prepared using a flexible budget. 2. A flexible budget performance report would be much more helpful in assessing the performance of the company than the report prepared by the bookkeeper. To construct such a report, we first need to determine the cost formulas as follows, where q is the number of exchanges completed: Revenue ..........................

$395q

Legal and search fees ...... Office expenses ...............

$165q $5,200 + $5q

Equipment depreciation .... Rent................................ Insurance ........................

$400 $1,800 $200

The revenue all comes from fees. Variable cost $5,200 is fixed; $5 = ($135 × 40 − $5,200)/40 $400 = $10 × 40 $1,800 = $45 × 40 $200 = $5 × 40

Problem 9-24 (continued) Exchange Corp. Flexible Budget Performance Report For the Month Ended May 31

Exchanges completed (q) ............. Revenue ($395q) ......................... Expenses: Legal and search fees ($165q) ... Office expenses ($5,200 + $5q) ....................... Equipment depreciation ($400) .. Rent ($1,800) ........................... Insurance ($200)....................... Total expense .............................. Net operating income ...................

Actual Results

Revenue and Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$19,250

$500

$19,750

$3,950

$15,800

9,200

950

8,250

1,650

6,600

5,600 400 1,800 200 17,200 $ 2,050

150 0 0 0 1,100 $1,600

5,450 400 1,800 200 16,100 $ 3,650

50 0 0 0 1,700 $2,250

5,400 400 1,800 200 14,400 $ 1,400

U U

U F

3. On the one hand, the increase in the number of exchanges completed was positive. The overall favorable activity of $2,250 indicates that the net operating income should have increased by that amount because of the increase in activity. However, the net operating income did not actually increase by nearly that much. This was due to the unfavorable revenue variance and a number of unfavorable spending variances, all of which should be investigated by the owner.

Managerial Accounting, 16th Edition

Problem 9-25 (45 minutes) 1. The cost reports are of little use for assessing how well costs were controlled. The problem is that the company is comparing budgeted costs at one level of activity to actual costs at another level of activity. Costs that are variable will naturally be different at these two different levels of activity. Although the cost reports do a good job of showing whether fixed costs were controlled, they do not do a good job of showing whether variable costs were controlled. Since sales have chronically failed to meet budget, the level of activity in the factory is also likely to have chronically been below budget. Consequently, the variances for variable costs have likely been favorable simply because activity has been less than budgeted in the production departments. No wonder the production supervisors have been pleased with the reports. 2. The company should use a flexible budget approach to evaluate cost control. Under the flexible budget approach, the actual costs incurred in working 35,000 machine-hours are compared to what the costs should have been for that level of activity. 3. See the following page. 4. The flexible budget performance report provides a much clearer picture of the performance of the Assembly Department than the original cost control report prepared by the company. The overall activity variance is $13,500 F (favorable) which simply reflects the fact that the actual level of activity was significantly less than the budgeted level of activity. The variable costs would naturally be less than budgeted. The spending variances indicate that costs were not controlled by the Assembly Department. All three of the variable costs have large unfavorable spending variances and those variances are significantly larger than the one favorable spending variance on the report.

Problem 9-25 (continued) 3.

Westmont Corporation Assembly Department Flexible Budget Performance Report For the Month Ended March 31

Actual Results

Spending Variances

$ 29,700 19,500 51,800 79,200 60,000 $240,200

$ 1,700 2,000 2,800 800 0 $ 5,700

Machine-hours (q)........................... Supplies ($0.80q)* .......................... Scrap ($0.50q)* .............................. Indirect materials ($1.40q)* ............ Wages and salaries ($80,000) .......... Equipment depreciation ($60,000) ... Total ..............................................

35,000

Flexible Budget

Activity Variances

Planning Budget

$ 28,000 17,500 49,000 80,000 60,000 $234,500

$4,000 2,500 7,000 0 0 $13,500

$ 32,000 20,000 56,000 80,000 60,000 $248,000

35,000

U U U F U

F F F F

40,000

*The variable cost per machine-hour is obtained by dividing the total variable cost from the planning budget by 40,000 machine-hours.

Managerial Accounting, 13th Edition

Problem 9-26 (45 minutes) 1. The cost control report compares the planning 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.

Problem 9-26 (continued) 2. A report that would be helpful in assessing how well costs were controlled appears below: Freemont Corporation—Machining Department Flexible Budget Performance Report For the Month Ended June 30

Machine-hours (q)........................ Direct labor wages* ($2.30q)........ Supplies* ($0.60q) ....................... Maintenance** ($92,000 + $1.20q)..................................... Utilities** ($11,700 + $0.10q) ...... Supervision ($38,000) .................. Depreciation ($80,000)................. Total ...........................................

Actual Results

Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$ 86,100 23,100

$ 1,300 300

F U

$ 87,400 22,800

$6,900 1,800

U U

$ 80,500 21,000

137,300 15,700 38,000 80,000 $380,200

300 200 0 0 $ 1,100

F U

137,600 15,500 38,000 80,000 $381,300

3,600 300 0 0 $12,600

U U

38,000

35,000

134,000 15,200 38,000 80,000 U $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 favorable—indicating that costs were most likely under control.

Managerial Accounting, 13th Edition

Case 9-27 (30 minutes) It is difficult to imagine how Tom Kemper could ethically agree to go along with reporting the favorable $21,000 variance for industrial engineering on the final report, even if the bill were not actually received by the end of the year. It would be misleading to exclude part of the final cost of the contract. Collaborating in this attempt to mislead corporate headquarters violates the credibility standard in the Statement of Ethical Professional Practice promulgated by the Institute of Management Accountants. The credibility standard requires that management accountants “disclose all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, analyses, or recommendations.” Failing to disclose the entire amount owed on the industrial engineering contract violates this standard. Individuals will differ in how they think Kemper should handle this situation. In our opinion, he should firmly state that he is willing to call Laura, but even if the bill does not arrive, he is ethically bound to properly accrue the expenses on the report—which will mean an unfavorable variance for industrial engineering and an overall unfavorable variance. This would require a great deal of personal courage. If the general manager insists on keeping the misleading $21,000 favorable variance on the report, Kemper would have little choice except to take the dispute to the next higher managerial level in the company. It is important to note that the problem may be a consequence of inappropriate use of performance reports by corporate headquarters. If the performance report is being used as a way of “beating up” managers, corporate headquarters may be creating a climate in which managers such as the general manager at the Wichita plant will feel like they must always turn in positive reports. This creates pressure to bend the truth since reality isn’t always positive.

Case 9-28 (45 minutes) 1. The flexible budget and spending variances would be computed as follows: Boyne University Motor Pool Spending Variances For the Month Ended March 31

Miles (q1) ........................................ Autos (q2) ....................................... Gasoline ($0.15q1) ........................... Oil, minor repairs, parts ($0.04q1)..... Outside repairs ($75q2) .................... Insurance ($100q2) .......................... Salaries and benefits ($7,540) .......... Vehicle depreciation ($250q2) ........... Total ...............................................

Actual Results

Flexible Budget

Spending Variances

$ 9,350 2,360 1,420 2,120 7,540 5,250 $28,040

$ 9,450 2,520 1,575 2,100 7,540 5,250 $28,435

$100 160 155 20 0 0 $395

63,000 21

F F F U F

2. The original report is based on a static budget approach that does not allow for variations in the number of miles 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 planning budget is based on only 50,000 miles rather than the 63,000 miles 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 miles driven and on the actual number of automobiles used during the month.

Managerial Accounting, 16th Edition

Case 9-29 (75 minutes) 1. The cost formulas for The Little Theatre appear below, where q1 is the number of productions and q2 is the number of performances: o Actors’ and directors’ wages: $2,000q2. Variable with respect to the number of performances. $2,000 = $216,000 ÷ 108. o Stagehands’ wages: $300q2. Variable with respect to the number of performances. $300 = $32,400 ÷ 108. o Ticket booth personnel and ushers’ wages: $150q2. Variable with respect to the number of performances. $150 = $16,200 ÷ 108. o Scenery, costumes, and props: $18,000q1. Variable with respect to the number of productions. $18,000 = $108,000 ÷ 6. o Theater hall rent: $500q2. Variable with respect to the number of performances. $500 = $54,000 ÷ 108. o Printed programs: $250q2. Variable with respect to the number of performances. $250 = $27,000 ÷ 108. o Publicity: $2,000q1. Variable with respect to the number of productions. $2,000 = $12,000 ÷ 6. o Administrative expenses: $32,400 + $1,080q1 +$40q2. o $32,400 = 0.75 × $43,200 o $1,080 = (0.15 × $43,200) ÷ 6 o $40 = (0.10 × $43,200) ÷ 108

Case 9-29 (continued) The flexible budget performance report follows: The Little Theatre Flexible Budget Performance Report For the Year Ended December 31

Number of productions (q1) ....... Number of performances (q2) .... Actors' and directors' wages ($2,000q2) ............................. Stagehands' wages ($300q2) ..... Ticket booth personnel and ushers' wages ($150q2) .......... Scenery, costumes, and props ($18,000q1) ........................... Theater hall rent ($500q2) ......... Printed programs ($250q2) ........ Publicity ($2,000q1) ................... Administrative expenses ($32,400 + $1,080q1 +$40q2) . Total expense ...........................

Actual Results

Spending Variances

Flexible Budget

Activity Variances

Planning Budget

$341,800 49,700

$5,800 700

U F

$336,000 50,400

$120,000 18,000

U $216,000 U 32,400

25,900

700

25,200

9,000

16,200

130,600 78,000 38,300 15,100

4,600 6,000 3,700 1,100

U F F U

126,000 84,000 42,000 14,000

18,000 30,000 15,000 2,000

U U U U

108,000 54,000 27,000 12,000

47,500 $726,900

820 $2,620

U U

46,680 $724,280

3,480 $215,480

7 168

6 108

U 43,200 U $508,800

Managerial Accounting, 13th Edition

Case 9-29 (continued) 2. The overall unfavorable spending variance of $2,620 is a very small percentage of the total cost, less than 0.4% (= $2,620 ÷ $724,280). This suggests that costs are under control. In addition, the pattern of the variances may reflect good management. The largest unfavorable spending variances are for value-added activities (actors’ and directors’ wages and scenery, costumes, and props) that may warrant additional spending. These unfavorable variances are offset by favorable variances for theater hall rent and the printed programs. Assuming that the quality of the printed programs has not noticeably declined and that the favorable variance for the rent reflects a lower negotiated rental fee, management should be congratulated. They have saved in some areas and have apparently transferred the funds to other areas that may favorably impact the quality of the theater’s productions. 3. Average costs may not be very good indicators of the additional costs of any particular production or performance. The averages gloss over considerable variations in costs. For example, a production of Peter Rabbit may require only half a dozen actors and actresses and fairly simple costumes and props. On the other hand, a production of Cinderella may require dozens of actors and actresses and very elaborate and costly costumes and props. Consequently, both the production costs and the cost per performance will be much higher for Cinderella than for Peter Rabbit. Managers of theater companies know that they must estimate the costs of each new production individually— the average costs are of little use for this purpose.

Chapter 10 Standard Costs and Variances 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 Separating an overall variance into a price variance and a quantity variance provides more information. Moreover, price and quantity variances are usually the responsibilities of different managers. 10-3 The materials price variance is usually the responsibility of the purchasing manager. The materials quantity and labor efficiency variances are usually the responsibility of production managers and supervisors. 10-4 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. 10-5 This combination of variances may indicate that inferior quality materials were purchased at a discounted price, but the lowquality materials created production problems. 10-6 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. 10-7 Several factors other than the contractual rate paid to workers can cause a labor rate variance. For example, skilled workers

with high hourly rates of pay can be given duties that require little skill and that call for low hourly rates of pay, resulting in an unfavorable rate variance. Or unskilled or untrained workers can be assigned to tasks that should be filled by more skilled workers with higher rates of pay, resulting in a favorable rate variance. Unfavorable rate variances can also arise from overtime work at premium rates. 10-8 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. 10-9 If overhead is applied using direct laborhours, then the variable overhead efficiency variance and the direct labor efficiency variance will always be favorable or unfavorable together. Both variances are computed by comparing the number of direct labor-hours actually worked to the standard hours allowed. That is, in each case the formula is: Efficiency variance = SR(AH – SH) Only the “SR” part of the formula, the standard rate, differs between the two variances. 10-10 If labor is a fixed cost and standards are tight, then the only way to generate favorable labor 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.

Chapter 10: Applying Excel The completed worksheet is shown below.

Chapter 10: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Note: The formulas to compute whether a variance is Favorable or Unfavorable use the IF() function. For example, in cell C26, the formula is =IF(F22>F23,"U",IF(F22<F23,"F","")). This formula first checks whether the actual quantity of input at the standard price (cell F22) exceeds the standard quantity allowed for the actual output at the standard price (cell F23). If it does, the function returns the value U, which is displayed in cell C26. Otherwise, the formula checks whether the standard quantity allowed for the actual output at the standard price (cell F23) exceeds the actual quantity of input at the standard price (cell F22). If it does, the function returns the value F, which is displayed in cell C26. Otherwise, nothing is displayed in cell C26.

Managerial Accounting, 16th Edition

Chapter 10: Applying Excel (continued) 1. With the changes in data, the result is:

a. The materials quantity variance is $2,800 U. This variance is the difference between the amount of materials that should have been used to make the actual output and the actual amount of materials used, all evaluated at the standard price. This variance is unfavorable because 6,500 pounds were used, but 5,800 pounds should have been used. b. The labor rate variance is $420 F. This variance is the difference between the standard labor rate and the actual labor rate, multiplied by the actual labor hours. It is favorable because the actual labor rate was $21.60 per hour, whereas the standard labor rate was $22.00 per hour.

Managerial Accounting, 16th Edition

Chapter 10: Applying Excel (continued) 2. With the revised data, the worksheet should look like this:

Parts a, b, and c: Materials price variance ...................... Materials quantity variance ................. Labor rate variance ............................ Labor efficiency variance .................... Variable overhead rate variance .......... Variable overhead efficiency variance ..

$635 $200 $102 $660 $1,020 $180

U U U F F F

The Foundational 15 1.

The raw materials cost included in the planning budget is $1,000,000 (= 25,000 pounds × 5 pounds per unit × $8.00 per pound = $1,000,000).

2, 3, and 4. The raw materials cost included in the flexible budget (SQ × SP = $1,200,000), the materials price variance ($80,000 F), and the materials quantity variance ($80,000 U), can be computed using the general model for cost variances as follows: Actual Quantity of Input, at Actual Price (AQ × AP) 160,000 pounds × $7.50 per pound = $1,200,000

Actual Quantity of Input, at Standard Price (AQ × SP) 160,000 pounds × $8.00 per pound = $1,280,000

Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) 150,000 pounds* × $8.00 per pound = $1,200,000

Materials price Materials quantity variance = $80,000 F variance = $80,000 U Spending variance = $0 *30,000 units × 5 pounds per unit = 150,000 pounds Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) = 160,000 pounds ($7.50 per pound – $8.00 per pound) = $80,000 F Materials quantity variance = SP (AQ – SQ) = $8.00 per pound (160,000 pounds – 150,000 pounds) = $80,000 U

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 5. and 6. The materials price variance ($85,000 F) and the materials quantity variance ($80,000 U) can be computed as follows: Actual Quantity of Input, at Actual Price (AQ × AP) 170,000 pounds × $7.50 per pound = $1,275,000

Actual Quantity of Input, at Standard Price (AQ × SP) 170,000 pounds × $8.00 per pound = $1,360,000

Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) 150,000 pounds* × $8.00 per pound = $1,200,000

Materials price variance = $85,000 F 160,000 pounds × $8.00 per pound = $1,280,000 Materials quantity variance = $80,000 U *30,000 units × 5 pounds per unit = 150,000 units Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) = 170,000 pounds ($7.50 per pound – $8.00 per pound) = $85,000 F Materials quantity variance = SP (AQ – SQ) = $8.00 per pound (160,000 pounds – 150,000 pounds) = $80,000 U

The Foundational 15 (continued) 7.

The direct labor cost included in the planning budget is $700,000 (= 25,000 units × 2 hours per unit × $14.00 per hour = $700,000).

8, 9, 10, and 11. The direct labor cost included in the flexible budget (SH × SR = $840,000), the labor rate variance ($55,000 U), the labor efficiency variance ($70,000 F), and the labor spending variance ($15,000 F) can be computed using the general model for cost variances as follows: Actual Hours of Input, at Actual Rate (AH × AR) 55,000 hours × $15 per hour = $825,000

Standard Hours Allowed Actual Hours of Input, for Actual Output, at Standard Rate at Standard Rate (AH × SR) (SH × SR) 55,000 hours × 60,000 hours* × $14.00 per hour $14.00 per hour = $770,000 = $840,000

Labor efficiency Labor rate variance variance = $55,000 U = $70,000 F Spending variance = $15,000 F *30,000 units × 2.0 hours per unit = 60,000 hours Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) = 55,000 hours ($15.00 per hour – $14.00 per hour) = $55,000 U Labor efficiency variance = SR (AH – SH) = $14.00 per hour (55,000 hours – 60,000 hours) = $70,000 F

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 12.

The variable manufacturing overhead cost included in the planning budget is $250,000 (= 50,000 hours × $5.00 per hour = $250,000).

13, 14, and 15. The variable overhead cost included in the flexible budget (SH × SR = $300,000), the variable overhead rate variance ($5,500 U), and the variable overhead efficiency variance ($25,000 F) can be computed using the general model for cost variances as follows: Actual Hours of Input, at Actual Rate (AH × AR) 55,000 hours × $5.10 per hour** = $280,500

Standard Hours Allowed Actual Hours of Input, for Actual Output, at Standard Rate at Standard Rate (AH × SR) (SH × SR) 55,000 hours × 60,000 hours* × $5.00 per hour $5.00 per hour = $275,000 = $300,000

Variable overhead Variable overhead rate efficiency variance variance = $5,500 U = $25,000 F Spending variance = $19,500 F *30,000 units × 2.0 hours per unit = 60,000 hours ** $280,500 ÷ 55,000 hours = $5.10 per hour Alternatively, the variances can be computed using the formulas: Variable overhead rate variance = AH (AR* – SR) = 55,000 hours ($5.10 per hour – $5.00 per hour) = $5,500 U *$280,500 ÷ 55,000 hours = $5.10 per hour Variable overhead efficiency variance = SR (AH – SH) = $5.00 per hour (55,000 hours – 60,000 hours) = $25,000 F

Exercise 10-1 (20 minutes) 1.

Number of helmets produced (a) ........................... Standard kilograms of plastic per helmet (b) .......... Standard quantity of kilograms allowed (a) × (b) ....

35,000 0.6 21,000

Standard quantity of kilograms allowed (a)............. Standard cost per kilogram (b) .............................. Standard cost allowed for actual output (a) × (b) ...

21,000 $8 $168,000

Actual cost incurred (given) (a) ............................. Total standard cost allowed (b).............................. Materials spending variance (a) – (b) ....................

$171,000 $168,000 $3,000 U

4. Actual Quantity of Input, at Actual Price (AQ × AP)

Standard Quantity Actual Quantity of Input, Allowed for Output, at at Standard Price Standard Price (AQ × SP) (SQ × SP) 22,500 kilograms × 21,000 kilograms* × $8 per kilogram $8 per kilogram $171,000 = $180,000 = $168,000    Materials quantity Materials price variance, variance, $9,000 F $12,000 U Spending variance, $3,000 U

*35,000 helmets × 0.6 kilograms per helmet = 21,000 kilograms Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) 22,500 kilograms ($7.60 per kilogram* – $8.00 per kilogram) = $9,000 F * $171,000 ÷ 22,500 kilograms = $7.60 per kilogram Materials quantity variance = SP (AQ – SQ) $8 per kilogram (22,500 kilograms – 21,000 kilograms) = $12,000 U

Managerial Accounting, 16th Edition

Exercise 10-2 (20 minutes) 1. Number of meals prepared (a) ................ Standard direct labor-hours per meal (b) . Standard labor-hours allowed (a) × (b) ...

4,000 0.25 1,000

2. Standard labor-hours allowed (a) ........... 1,000 Standard direct labor cost per hour (b).... $19.75 Standard labor cost allowed (a) × (b) ..... $19,750 3. Actual cost incurred (a) ........................ Standard labor cost allowed (b) ............ Labor spending variance (a) – (b) ......... 4.

$19,200 $19,750 $550 F

Actual Hours of Input, at the Actual Rate (AH × AR) 960 hours × $20.00 per hour = $19,200

Actual Hours of Input, at the Standard Rate (AH × SR) 960 hours × $19.75 per hour = $18,960

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 1,000 hours × $19.75 per hour = $19,750



Labor efficiency Labor rate variance, variance, $240 U $790 F Spending variance, $550 F

Alternatively, the variances can be computed using the formulas: Labor rate variance = AH(AR – SR) = 960 hours ($20.00 per hour – $19.75 per hour) = $240 U Labor efficiency variance = SR(AH – SH) = $19.75 per hour (960 hours – 1,000 hours) = $790 F

Exercise 10-3 (20 minutes) 1. Number of items shipped (a) ............................... 120,000 Standard labor-hours per item (b) ........................ 0.02 Standard quantity of labor-hours allowed (a) × (b) 2,400 2. Standard quantity of labor-hours allowed (a) ........ Standard variable overhead cost per hour (b) ....... Standard variable overhead cost allowed (a) × (b)

2,400 $3.25 $7,800

3. Actual variable overhead cost incurred (a) ............ Standard variable overhead cost allowed (b) ........ Variable overhead spending variance (a) – (b) ......

$7,360 $7,800 $440 F

Actual Hours of Input, at the Actual Rate (AH × AR) 2,300 hours × $3.20 per hour* = $7,360

Actual Hours of Input, at the Standard Rate (AH × SR) 2,300 hours × $3.25 per hour = $7,475

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 2,400 hours** × $3.25 per hour = $7,800



Variable overhead Variable overhead rate efficiency variance, variance, $115 F $325 F Spending variance, $440 F

*$7,360 ÷ 2,300 hours = $3.20 per hour ** 120,000 items × 0.02 hours per unit = 2,400 hours Alternatively, the variances can be computed using the formulas: Variable overhead rate 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, 16th Edition

Exercise 10-4 (30 minutes) 1. Number of units manufactured (a) ....................... Standard labor time per unit (18 minutes ÷ 60 minutes per hour) (b) ............ Standard labor-hours allowed (a) × (b) ................

20,000

2. Standard labor-hours allowed (a) Standard direct labor rate per hour (b) ................. Standard labor cost allowed (a) × (b)...................

6,000 $17 $102,000

3. Actual direct labor cost (a) ................................... Standard labor cost allowed (b) ........................... Labor spending variance (a) – (b) ........................

$102,350 $102,000 $350 U

0.3 6,000

Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Allowed Actual Hours of Input, for Output, at the at the Standard Rate Standard Rate (AH × SR) (SH × SR) 5,750 hours × 6,000 hours* × $17.00 per hour $17.00 per hour = $97,750 = $102,000 $102,350    Labor efficiency Labor rate variance, variance, $4,600 U $4,250 F Spending variance, $350 U

*20,000 units × 0.3 hours per unit = 6,000 hours Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) 5,750 hours ($17.80 per hour* – $17.00 per hour) = $4,600 U *$102,350 ÷ 5,750 hours = $17.80 per hour Labor efficiency variance = SR (AH – SH) $17.00 per hour (5,750 hours – 6,000 hours) = $4,250 F

Exercise 10-4 (continued) 5.

Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Actual Hours of Input, Allowed for Output, at at the Standard Rate the Standard Rate (AH × SR) (SH × SR) 5,750 hours × 6,000 hours × $4.00 per hour $4.00 per hour = $23,000 = $24,000 $21,850    Variable overhead rate Variable overhead variance, efficiency variance, $1,150 F $1,000 F Spending variance, $2,150 F

Alternatively, the variances can be computed using the formulas: Variable overhead rate variance = AH (AR – SR) 5,750 hours ($3.80 per hour* – $4.00 per hour) = $1,150 F *$21,850 ÷ 5,750 hours = $3.80 per hour Variable overhead efficiency variance = SR (AH – SH) $4.00 per hour (5,750 hours – 6,000 hours) = $1,000 F

Managerial Accounting, 16th Edition

Exercise 10-5 (20 minutes) 1. If the labor spending variance is $200 unfavorable, and the labor rate variance is $150 favorable, then the labor efficiency variance must be $350 unfavorable, because the labor rate and labor efficiency variances taken together always equal the spending variance. Knowing that the labor efficiency variance is $350 unfavorable, one approach to the solution would be: Labor efficiency variance = SR (AH – SH) $25.00 per hour (AH – 125 hours*) = $350 U $25.00 per hour × AH – $3,125 = $350** $25.00 per hour × AH = $3,475 AH = $3,475 ÷ $25.00 per hour AH = 139 hours *50 jobs × 2.5 hours per job = 125 hours **When used with the formula, unfavorable variances are positive and favorable variances are negative. 2.

Labor rate variance = AH (AR – SR) 139 hours (AR – $25.00 per hour) = $150 F 139 hours × AR – $3,475 = –$150* 139 hours × AR = $3,325 AR = $3,325 ÷ 139 hours AR = $23.92 per hour (rounded) *When used with the formula, unfavorable variances are positive and favorable variances are negative.

Exercise 10-5 (continued) An alternative approach would be to work from known to unknown data in the columnar model for variance analysis: Standard Hours Actual Hours of Input, Actual Hours of Input, Allowed for Output, at at the Actual Rate at the Standard Rate the Standard Rate (AH × AR) (AH × SR) (SH × SR) 139 hours × 139 hours × 125 hours§ × $23.92 per hour $25.00 per hour* $25.00 per hour* = $3,325 = $3,475 = $3,125    Labor efficiency Labor rate variance, variance, $150 F* $350 U Spending variance, $200 U* §

50 tune-ups* × 2.5 hours per tune-up* = 125 hours *Given

Managerial Accounting, 16th Edition

Exercise 10-6 (20 minutes) 1.

Actual Quantity of Input, at Actual Price (AQ × AP) 20,000 pounds × $2.35 per pound = $47,000 

Actual Quantity Standard Quantity of Input, at Allowed for Output, Standard Price at Standard Price (AQ × SP) (SQ × SP) 20,000 pounds × 18,400 pounds* × $2.50 per pound $2.50 per pound = $50,000 = $46,000   Materials quantity Materials price variance, variance, $3,000 F $4,000 U Spending variance, $1,000 U

*4,000 units × 4.6 pounds per unit = 18,400 pounds Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) 20,000 pounds ($2.35 per pound – $2.50 per pound) = $3,000 F Materials quantity variance = SP (AQ – SQ) $2.50 per pound (20,000 pounds – 18,400 pounds) = $4,000 U

Exercise 10-6 (continued) 2.

Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Actual Hours of Input, Allowed for Output, at at the Standard Rate the Standard Rate (AH × SR) (SH × SR) 750 hours × 800 hours* × $18.00 per hour $18.00 per hour = $13,500 = $14,400 $14,925    Labor efficiency Labor rate variance, variance, $1,425 U $900 F Spending variance, $525 U

*4,000 units × 0.2 hours per unit = 800 hours Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) 750 hours ($19.90 per hour* – $18.00 per hour) = $1,425 U *14,925 ÷ 750 hours = $19.90 per hour Labor efficiency variance = SR (AH – SH) $18.00 per hour (750 hours – 800 hours) = $900 F

Managerial Accounting, 16th Edition

Exercise 10-7 (15 minutes) Notice in the solution below that the materials price variance is computed for the entire amount of materials purchased, whereas the materials quantity variance is computed only for the amount of materials used in production. Actual Quantity Standard Quantity Actual Quantity of of Input, at Allowed for Output, Input, at Actual Price Standard Price at Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 20,000 pounds × 20,000 pounds × 13,800 pounds* × $2.35 per pound $2.50 per pound $2.50 per pound = $47,000 = $50,000 = $34,500    Materials price variance, $3,000 F 14,750 pounds × $2.50 per pound = $36,875  Materials quantity variance, $2,375 U *3,000 units × 4.6 pounds per unit = 13,800 pounds Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) 20,000 pounds ($2.35 per pound – $2.50 per pound) = $3,000 F Materials quantity variance = SP (AQ – SQ) $2.50 per pound (14,750 pounds – 13,800 pounds) = $2,375 U

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 Standard Quantity of Input, at Actual Quantity of Allowed for Output, at Actual Price Input, at Standard Price Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 25,000 microns × 25,000 microns × 18,000 microns* × $1.48 per micron $1.50 per micron $1.50 per micron = $37,000 = $37,500 = $27,000    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

Managerial Accounting, 16th Edition

Exercise 10-8 (continued) b. Direct labor variances: Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Allowed Actual Hours of Input, for Output, at the at the Standard Rate Standard Rate (AH × SR) (SH × SR) 4,000 hours × 3,900 hours* × $21.00 per hour $21.00 per hour = $84,000 = $81,900 $88,000    Labor efficiency Labor rate variance, variance, $4,000 U $2,100 U Spending variance, $6,100 U

*3,000 toys × 1.3 hours per toy = 3,900 hours Alternatively, the variances can be computed using the formulas: Labor 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 Labor efficiency variance = SR (AH – SH) $21.00 per hour (4,000 hours – 3,900 hours) = $2,100 U

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 at Dawson Toys appear below:

Materials Price Variance Since this variance is favorable, 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 sharp 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. This could also occur for a variety of reasons. Some of the possibilities include poorly trained or supervised workers, improperly adjusted machines, and defective materials.

Labor 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 paid workers.

Labor Efficiency Variance Since this variance is unfavorable, the actual

number of labor 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. It is worth noting that all of these variances could have been caused by the purchase of low quality materials at a cut-rate price.

Managerial Accounting, 16th Edition

Problem 10-9 (45 minutes) This problem is more difficult than it looks. Allow ample time for discussion. 1.

Actual Quantity Standard Quantity Actual Quantity of of Input, at Allowed for Output, Input, at Actual Price Standard Price at Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 12,000 yards × 11,200 yards** × $4.00 per yard* $4.00 per yard* = $48,000 = $44,800 $45,600    Materials price Materials quantity variance, variance, $2,400 F $3,200 U Spending variance, $800 U * $22.40 ÷ 5.6 yards = $4.00 per yard ** 2,000 sets × 5.6 yards per set = 11,200 yards Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) 12,000 yards ($3.80 per yard* – $4.00 per yard) = $2,400 F *$45,600 ÷ 12,000 yards = $3.80 per yard Materials quantity variance = SP (AQ – SQ) $4.00 per yard (12,000 yards – 11,200 yards) = $3,200 U

Problem 10-9 (continued) 2. Many students will miss parts 2 and 3 because they will try to use product costs as if they were hourly costs. Pay particular attention to the computation of the standard direct labor time per unit and the standard direct labor rate per hour. Actual Hours of Input, at the Actual Rate (AH × AR)

Actual Hours of Standard Hours Input, at the Allowed for Output, Standard Rate at the Standard Rate (AH × SR) (SH × SR) 2,800 hours × 3,000 hours** × $18.00 per hour* $18.00 per hour* = $50,400 = $54,000 $49,000    Labor rate variance, Labor efficiency $1,400 F variance, $3,600 F Spending variance, $5,000 F

* 2,850 standard hours ÷ 1,900 sets = 1.5 standard hours per set, $27.00 standard cost per set ÷ 1.5 standard hours per set = $18.00 standard rate per hour. ** 2,000 sets × 1.5 standard hours per set = 3,000 standard hours. Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) 2,800 hours ($17.50 per hour* – $18.00 per hour) = $1,400 F *$49,000 ÷ 2,800 hours = $17.50 per hour Labor efficiency variance = SR (AH – SH) $18.00 per hour (2,800 hours – 3,000 hours) = $3,600 F

Managerial Accounting, 16th Edition

Problem 10-9 (continued) 3.

Actual Hours of Input, at the Actual Rate (AH × AR)

Actual Hours of Standard Hours Input, at the Allowed for Output, Standard Rate at the Standard Rate (AH × SR) (SH × SR) 2,800 hours × 3,000 hours × $2.40 per hour* $2.40 per hour* = $6,720 = $7,200 $7,000    Variable overhead rate Variable overhead variance, efficiency variance, $280 U $480 F Spending variance, $200 F

*$3.60 standard cost per set ÷ 1.5 standard hours per set = $2.40 standard rate per hour Alternatively, the variances can be computed using the formulas: Variable overhead rate variance = AH (AR – SR) 2,800 hours ($2.50 per hour* – $2.40 per hour) = $280 U *$7,000 ÷ 2,800 hours = $2.50 per hour Variable overhead efficiency variance = SR (AH – SH) $2.40 per hour (2,800 hours – 3,000 hours) = $480 F

Problem 10-10 (45 minutes) 1.

Alpha6: Direct materials—X442 ...... Direct materials—Y661 ...... Direct labor—Sintering ...... Direct labor—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 kilos 2.0 liters 0.20 hours 0.80 hours

$3.50 per kilo $1.40 per liter $19.80 per hour $19.20 per hour

$ 6.30 2.80 3.96 15.36 $28.42

3.0 kilos 4.5 liters 0.35 hours 0.90 hours

$3.50 per kilo $1.40 per liter $19.80 per hour $19.20 per hour

$10.50 6.30 6.93 17.28 $41.01

Managerial Accounting, 16th Edition

Problem 10-10 (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 kilos per unit × 1,500 units)...... Production of Zeta7 (3.0 kilos per unit × 2,000 units) ....... Total ..............................................................................

2,700 kilos 6,000 kilos 8,700 kilos

Material Y661: Production of Alpha6 (2.0 liters per unit × 1,500 units) ..... Production of Zeta7 (4.5 liters per unit × 2,000 units) ....... Total ..............................................................................

3,000 liters 9,000 liters 12,000 liters

Direct materials variances—Material X442: Materials quantity variance = SP (AQ – SQ) = $3.50 per kilo (8,500 kilos – 8,700 kilos) = $700 F Materials price variance = AQ (AP – SP) = 14,500 kilos ($3.60 per kilo* – $3.50 per kilo) = $1,450 U *$52,200 ÷ 14,500 kilos = $3.60 per kilo Direct materials variances—Material Y661: Materials quantity variance = SP (AQ – SQ) = $1.40 per liter (13,000 liters – 12,000 liters) = $1,400 U Materials price variance = AQ (AP – SP) = 15,500 liters ($1.35 per liter* – $1.40 per liter) = $775 F *$20,925 ÷ 15,500 liters = $1.35 per liter

Problem 10-10 (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) .. Production of Zeta7 (0.35 hours per unit × 2,000 units) .... Total ..............................................................................

300 hours 700 hours 1,000 hours

Finishing: Production of Alpha6 (0.80 hours per unit × 1,500 units) .. Production of Zeta7 (0.90 hours per unit × 2,000 units) .... Total ..............................................................................

1,200 hours 1,800 hours 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, 16th Edition

Problem 10-11 (45 minutes) 1. a. Materials quantity variance = SP (AQ – SQ) $11.00 per foot (AQ – 9,600 feet*) = $4,400 U $11.00 per foot × AQ – $105,600 = $4,400** $11.00 per foot × AQ = $110,000 AQ = 10,000 feet * $3,200 units × 3 foot per unit = 9,600 feet ** When used with the formula, unfavorable variances are positive and favorable variances are negative. Therefore, $111,300 ÷ 10,000 feet = $11.13 per foot b. Materials price variance = AQ (AP – SP) 10,000 feet ($11.13 per foot – $11.00 per foot) = $1,300 U The total variance for materials is: Materials price variance ................. Materials quantity variance ............. Spending variance .........................

$1,300 U 4,400 U $5,700 U

Alternative approach to parts (a) and (b): Actual Quantity Standard Quantity Actual Quantity of of Input, at Allowed for Output, Input, at Actual Price Standard Price at Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 10,000 feet × 10,000 feet × 9,600 feet** × $11.13 per foot $11.00 per foot* $11.00 per foot* = $111,300* = $110,000 = $105,600    Materials price Materials quantity variance, variance, $1,300 U $4,400 U* Spending variance, $5,700 U * Given ** 3,200 units × 3 foot per unit = 9,600 feet

Problem 10-11 (continued) 2. a. Labor rate variance = AH (AR – SR) 4,900 hours ($19.50 per hour* – SR) = $2,450 F** $95,550 – 4,900 hours × SR = –$2,450*** 4,900 hours × SR = $98,000 SR = $20.00 * $95,550 ÷ 4,900 hours = $19.50 per hour ** $450 F + $2,000 U. *** When used with the formula, unfavorable variances are positive and favorable variances are negative. b. Labor efficiency variance = SR (AH – SH) $20.00 per hour (4,900 hours – SH) = $2,000 U $98,000 – $20.00 per hour × SH = $2,000* $20.00 per hour × SH = $96,000 SH = 4,800 hours * When used with the formula, unfavorable variances are positive and favorable variances are negative. Alternative approach to parts (a) and (b): Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Actual Hours of Input, Allowed for Output, at the Standard Rate at the Standard Rate (AH × SR) (SH × SR) 4,900 hours* × 4,800 hours × $20.00 per hour $20.00 per hour = $98,000 = $96,000 $95,550*    Labor efficiency Labor rate variance, variance, $2,450 F $2,000 U* Spending variance, $450 F*

Managerial Accounting, 16th Edition

Problem 10-12 (45 minutes) 1. The standard quantity of plates allowed for tests performed during the month would be: Blood tests................................... Smears ........................................ Total ............................................ Plates per test .............................. Standard quantity allowed ............

1,800 2,400 4,200 × 2 8,400

The variance analysis for plates would be: Actual Quantity Standard Quantity Actual Quantity of of Input, at Allowed for Output, Input, at Actual Price Standard Price at Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 12,000 plates × 8,400 plates × $5.00 per plate $5.00 per plate = $60,000 = $42,000 $56,400    Materials price variance, $3,600 F 10,500* plates × $5.00 per plate = $52,500  Materials quantity Variance, $10,500 U * 12,000 purchased – 1,500 unused = 10,500 used Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) 12,000 plates ($4.70 per plate* – $5.00 per plate) = $3,600 F *$56,400 ÷ 12,000 plates = $4.70 per plate. Materials quantity variance = SP (AQ – SQ) $5.00 per plate (10,500 plates – 8,400 plates) = $10,500 U © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 10

Problem 10-12 (continued) 2. a. The standard hours allowed for tests performed during the month would be: Blood tests: 0.3 hour per test × 1,800 tests .......... Smears: 0.15 hour per test × 2,400 tests ............. Total standard hours allowed ...............................

540 hours 360 hours 900 hours

The variance analysis would be: Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Actual Hours of Input, Allowed for Output, at at the Standard Rate the Standard Rate (AH × SR) (SH × SR) 1,150 hours × 900 hours × $20.00 per hour $20.00 per hour = $23,000 = $18,000 $21,850    Labor efficiency Labor rate variance, variance, $1,150 F $5,000 U Spending variance, $3,850 U

Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) 1,150 hours ($19.00 per hour* – $20.00 per hour) = $1,150 F *$21,850 ÷ 1,150 hours = $19.00 per hour Labor efficiency variance = SR (AH – SH) $20.00 per hour (1,150 hours – 900 hours) = $5,000 U

Managerial Accounting, 16th Edition

Problem 10-12 (continued) b. The policy probably should not be continued. Although the hospital is saving $1 per hour by employing more assistants than senior technicians, this savings is more than offset by other factors. Too much time is being taken in performing lab tests, as indicated by the large unfavorable labor efficiency variance. And, it seems likely that most (or all) of the hospital’s unfavorable quantity variance for plates is traceable to inadequate supervision of assistants in the lab. 3. The variable overhead variances follow: Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Actual Hours of Input, Allowed for Output, at the Standard Rate at the Standard Rate (AH × SR) (SH × SR) 1,150 hours × 900 hours × $6.00 per hour $6.00 per hour = $6,900 = $5,400 $7,820    Variable overhead rate Variable overhead variance, efficiency variance, $920 U $1,500 U Spending variance, $2,420 U

Alternatively, the variances can be computed using the formulas: Variable overhead rate variance = AH (AR – SR) 1,150 hours ($6.80 per hour* – $6.00 per hour) = $920 U *$7,820 ÷ 1,150 hours = $6.80 per hour Variable overhead efficiency variance = SR (AH – SH) $6.00 per hour (1,150 hours – 900 hours) = $1,500 U Yes, the two variances are closely related. Both are computed by comparing actual labor time to the standard hours allowed for the output of the period. Thus, if the labor efficiency variance is favorable (or unfavorable), then the variable overhead efficiency variance will also be favorable (or unfavorable).

Problem 10-13 (45 minutes) 1. a.

Actual Quantity of Input, at Actual Price (AQ × AP) 21,600 feet** × $3.30 per foot = $71,280

Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) 21,600 feet* × $3.00 per foot = $64,800

Actual Quantity of Input, at Standard Price (AQ × SP) 21,600 feet** × $3.00 per foot = $64,800

Materials price variance = Materials quantity $6,480 U variance = $0 Spending variance = $6,480 U * 12,000 units × 1.80 feet per unit = 21,600 feet ** 12,000 units × 1.80 feet per unit = 21,600 feet Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) = 21,600 feet ($3.30 per foot – $3.00 per foot) = $6,480 U Materials quantity variance = SP (AQ – SQ) = $3.00 per foot (21,600 feet – 21,600 feet) = $0

Managerial Accounting, 16th Edition

Problem 10-13 (continued) 1. b. Actual Hours of Input, at Actual Rate (AH × AR) 11,040 hours** × $17.50 per hour = $193,200

Standard Hours Allowed Actual Hours of Input, for Actual Output, at Standard Rate at Standard Rate (AH × SR) (SH × SR) 11,040 hours** × 10,800 hours* × $18.00 per hour $18.00 per hour = $198,720 = $194,400

Labor efficiency Labor rate variance variance = $5,520 F = $4,320 U Spending variance = $1,200 F * 12,000 units × 0.90 hours per unit = 10,800 hours ** 12,000 units × 0.92 hours per unit = 11,040 hours Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) = 11,040 hours ($17.50 per hour – $18.00 per hour) = $5,520 F Labor efficiency variance = SR (AH – SH) = $18.00 per hour (11,040 hours – 10,800 hours) = $4,320 U

Problem 10-13 (continued) 1. c. Actual Hours of Input, at Actual Rate (AH × AR) 11,040 hours** × $4.50 per hour = $49,680

Standard Hours Allowed Actual Hours of Input, for Actual Output, at Standard Rate at Standard Rate (AH × SR) (SH × SR) 11,040 hours** × 10,800 hours* × $5.00 per hour $5.00 per hour = $55,200 = $54,000

Variable overhead Variable overhead rate efficiency variance variance = $5,520 F = $1,200 U Spending variance = $4,320 F * 12,000 units × 0.90 hours per unit = 10,800 hours ** 12,000 units × 0.92 hours per unit = 11,040 hours Alternatively, the variances can be computed using the formulas: Variable overhead rate variance = AH (AR – SR) = 11,040 hours ($4.50 per hour – $5.00 per hour) = $5,520 F Variable overhead efficiency variance = SR (AH – SH) = $5.00 per hour (11,040 hours – 10,800 hours) = $1,200 U 2.

Materials: Price variance ($6,480 ÷ 12,000 units) ........... Quantity variance ($0 ÷ 12,000 units) ............ Labor: Rate variance ($5,520 ÷ 12,000 units) ........... Efficiency variance ($4,320 ÷ 12,000 units) .... Variable overhead: Rate variance ($5,520 ÷ 12,000 units) ........... Efficiency variance ($1,200 ÷ 12,000 units) .... Excess of actual over standard cost per unit .......

$0.54 U 0.00 $0.54 U 0.46 F 0.36 U 0.46 F 0.10 U

0.10 F 0.36 F $0.08 U

Managerial Accounting, 16th Edition

Problem 10-13 (continued) 3. Both the labor efficiency and variable overhead efficiency variances are affected by inefficient use of labor time. Excess of actual over standard cost per unit ....... Less portion attributable to labor inefficiency: Labor efficiency variance ................................... Variable overhead efficiency variance ................. Portion due to other variances ...........................

$0.08 U 0.36 U 0.10 U

0.46 U $0.38 F

In sum, had it not been for the apparent inefficient use of labor time, the total variance in unit cost for the month would have been favorable by $0.38 rather than unfavorable by $0.08. 4. Although the excess of actual cost over standard cost is only $0.08 per unit, the details of the variances are significant. The materials price variance is $6,480 U and it warrants further investigation. The labor efficiency variance is $4,320 U and the variable overhead efficiency variance is $1,200 U. Taken together, these latter two variances highlight an opportunity for the company to pursue process improvement opportunities that would improve efficiency.

Problem 10-14 (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 Input, at Actual Price (AQ × AP)

Actual Quantity Standard Quantity of Input, at Allowed for Output, at Standard Price Standard Price (AQ × SP) (SQ × SP) 12,000 ounces × 9,375 ounces* × $20.00 per ounce $20.00 per ounce = $240,000 = $187,500 $225,000    Materials price variance, $15,000 F 9,500 ounces × $20.00 per ounce = $190,000  Materials quantity variance, $2,500 U

*3,750 units × 2.5 ounces per unit = 9,375 ounces Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) 12,000 ounces ($18.75 per ounce* – $20.00 per ounce) = $15,000 F *$225,000 ÷ 12,000 ounces = $18.75 per ounce Materials quantity variance = SP (AQ – SQ) $20.00 per ounce (9,500 ounces – 9,375 ounces) = $2,500 U b. Yes, the contract probably should be signed. The new price of $18.75 per ounce is substantially lower than the old price of $20.00 per ounce, resulting in a favorable price variance of $15,000 for the month. Moreover, the material from the new supplier appears to cause little or no problem in production as shown by the small materials quantity variance for the month. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 40

Managerial Accounting, 16th Edition

Problem 10-14 (continued) 2. a.

Actual Hours of Input, at the Actual Rate (AH × AR) 5,600 hours* × $22.00 per hour = $123,200 

Actual Hours of Standard Hours Input, at the Allowed for Output, at Standard Rate the Standard Rate (AH × SR) (SH × SR) 5,600 hours × 5,250 hours** × $22.50 per hour $22.50 per hour = $126,000 = $118,125   Labor efficiency Labor rate variance, variance, $2,800 F $7,875 U Spending Variance, $5,075 U

* 35 technicians × 160 hours per technician = 5,600 hours ** 3,750 units × 1.4 hours per technician = 5,250 hours Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) 5,600 hours ($22.00 per hour – $22.50 per hour) = $2,800 F Labor efficiency variance = SR (AH – SH) $22.50 per hour (5,600 hours – 5,250 hours) = $7,875 U b. No, the new labor mix probably should not be continued. Although it decreases the average hourly labor cost from $22.50 to $22.00, thereby causing a $2,800 favorable labor rate variance, this savings is more than offset by a large unfavorable labor efficiency variance for the month. Thus, the new labor mix increases overall labor costs.

Problem 10-14 (continued) 3.

Actual Hours of Input, at the Actual Rate (AH × AR)

Actual Hours of Standard Hours Input, at the Allowed for Output, Standard Rate at the Standard Rate (AH × SR) (SH × SR) 5,600 hours* × 5,250 hours** × $3.50 per hour $3.50 per hour = $19,600 = $18,375 $18,200    Variable overhead rate Variable overhead variance, efficiency variance, $1,400 F $1,225 U Spending Variance, $175 F

* Based on direct labor hours: 35 technicians × 160 hours per technician = 5,600 hours ** 3,750 units × 1.4 hours per unit = 5,250 hours Alternatively, the variances can be computed using the formulas: Variable overhead rate variance = AH (AR – SR) 5,600 hours ($3.25 per hour* – $3.50 per hour) = $1,400 F *$18,200 ÷ 5,600 hours = $3.25 per hour Variable overhead efficiency variance = SR (AH – SH) $3.50 per hour (5,600 hours – 5,250 hours) = $1,225 U Both the labor efficiency variance and the variable overhead efficiency variance are computed by comparing actual labor-hours to standard labor-hours. Thus, if the labor efficiency variance is unfavorable, then the variable overhead efficiency variance will be unfavorable as well.

Managerial Accounting, 16th Edition

Problem 10-15 (45 minutes) 1. a. Actual Quantity Standard Quantity Actual Quantity of of Input, at Allowed for Output, Input, at Actual Price Standard Price at Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 60,000 pounds × 60,000 pounds × 45,000 pounds* × $4.95 per pound $5.00 per pound $5.00 per pound = $297,000 = $300,000 = $225,000    Materials price variance, $3,000 F 49,200 pounds × $5.00 per pound = $246,000  Materials quantity variance, $21,000 U *15,000 pools × 3.0 pounds per pool = 45,000 pounds Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) 60,000 pounds ($4.95 per pound – $5.00 per pound) = $3,000 F Materials quantity variance = SP (AQ – SQ) $5.00 per pound (49,200 pounds – 45,000 pounds) = $21,000 U

Problem 10-15 (continued) b.

Actual Hours of Input, at the Actual Rate (AH × AR) 11,800 hours × $17.00 per hour = $200,600 

Standard Hours Actual Hours of Input, Allowed for Output, at the Standard Rate at the Standard Rate (AH × SR) (SH × SR) 11,800 hours × 12,000 hours* × $16.00 per hour $16.00 per hour = $188,800 = $192,000   Labor efficiency Labor rate variance, variance, $11,800 U $3,200 F Spending variance, $8,600 U

*15,000 pools × 0.8 hours per pool = 12,000 hours Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) 11,800 hours ($17.00 per hour – $16.00 per hour) = $11,800 U Labor efficiency variance = SR (AH – SH) $16.00 per hour (11,800 hours – 12,000 hours) = $3,200 F

Managerial Accounting, 16th Edition

Problem 10-15 (continued) c.

Actual Hours of Input, at the Actual Rate (AH × AR)

Actual Hours of Standard Hours Input, at the Allowed for Output, Standard Rate at the Standard Rate (AH × SR) (SH × SR) 5,900 hours × 6,000 hours* × $3.00 per hour $3.00 per hour = $17,700 = $18,000 $18,290    Variable overhead rate Variable overhead variance, efficiency variance, $590 U $300 F Spending variance, $290 U

*15,000 pools × 0.4 hours per pool = 6,000 hours Alternatively, the variances can be computed using the formulas: Variable overhead rate variance = AH (AR – SR) 5,900 hours ($3.10 per hour* – $3.00 per hour) = $590 U *$18,290 ÷ 5,900 hours = $3.10 per hour Variable overhead efficiency variance = SR (AH – SH) $3.00 per hour (5,900 hours – 6,000 hours) = $300 F

Problem 10-15 (continued) 2. Summary of variances: Material price variance .......................... Material quantity variance ..................... Labor rate variance............................... Labor efficiency variance....................... Variable overhead rate variance ............ Variable overhead efficiency variance..... Net variance ........................................

$ 3,000 F 21,000 U 11,800 U 3,200 F 590 U 300 F $26,890 U

The net unfavorable variance of $26,890 for the month caused the plant’s variable cost of goods sold to increase from the budgeted level of $435,000 to $461,890: Budgeted cost of goods sold at $29 per pool ......... Add the net unfavorable variance, as above .......... Actual cost of goods sold .....................................

$435,000 26,890 $461,890

This $26,890 net unfavorable variance also accounts for the difference between the budgeted net operating income and the actual net operating income for the month. Budgeted net operating income............................ Deduct the net unfavorable variance added to cost of goods sold for the month .............................. Net operating loss ...............................................

$ 6,000 26,890 $(20,890)

3. The two most significant variances are the materials quantity variance and the labor rate variance. Possible causes of the variances include: Materials quantity variance: Outdated standards, unskilled workers, poorly adjusted machines, carelessness, poorly trained workers, inferior quality materials. Labor rate variance:

Outdated standards, change in pay scale, overtime pay.

Managerial Accounting, 16th Edition

Problem 10-16 (60 minutes) 1. Standard cost for March production: Materials ....................................................................... Direct labor ................................................................... Variable manufacturing overhead.................................... Total standard cost (a) ...................................................

$16,800 21,000 4,200 $42,000

Number of backpacks produced (b) ................................

1,000

Standard cost of a single backpack (a) ÷ (b) ..................

$42.00

Standard cost of a single backpack (above)..................... Deduct difference between standard and actual cost ....... Actual cost per backpack ................................................

$42.00 0.15 $41.85

Total standard cost of materials during March (a) .......... Number of backpacks produced during March (b) .......... Standard materials cost per backpack (a) ÷ (b) .............

$16,800 1,000 $16.80

Standard materials cost per backpack $16.80 per backpack = Standard materials cost per yard $6.00 per yard = 2.8 yards per backpack

4. Standard cost of material used ............ Actual cost of material used ................ Spending variance ..............................

$16,800 15,000 $ 1,800 F

The materials price and quantity variances together equal the spending variance. If the materials quantity variance is $1,200 U, then the materials price variance must be $3,000 F: Materials price variance ...................... Materials quantity variance ................. Spending variance ..............................

$ 3,000 F 1,200 U $ 1,800 F

Problem 10-16 (continued) Alternative Solution: Actual Quantity Actual Quantity Standard Quantity of Input, at of Input, at Allowed for Output, Actual Price Standard Price at Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 3,000 yards × 3,000 yards × 2,800 yards** × $5.00 per yard $6.00 per yard* $6.00 per yard* = $15,000* = $18,000 = $16,800*    Materials price Materials quantity variance, variance, $3,000 F $1,200 U* Spending variance, $1,800 F * Given ** 1,000 units × 2.8 yards per unit = 2,800 yards 5. The first step in computing the standard direct labor rate is to determine the standard direct labor-hours allowed for the month’s production. The standard direct labor-hours can be computed by working with the variable manufacturing overhead costs, because they are based on direct labor-hours worked: Standard variable manufacturing overhead cost for March (a). Standard variable manufacturing overhead rate per direct labor-hour (b) ................................................................... Standard direct labor-hours for March (a) ÷ (b) .....................

$4,200 $3.00 1,400

Total standard direct labor cost for March $21,000 = Total standard direct labor-hours for March 1,400 DLHs = $15.00 per DLH

Managerial Accounting, 16th Edition

Problem 10-16 (continued) 6. Before the labor variances can be computed, it is necessary to compute the actual direct labor cost for the month: Actual cost per backpack produced (see requirement 2) ............................................... Number of backpacks produced ......................... Total actual cost of production ........................... Less: Actual cost of materials ............................. Actual cost of variable manufacturing overhead ............................................... Actual cost of direct labor ..................................

$15,000 3,600

$ 41.85 × 1,000 $41,850 18,600 $23,250

With this information, the variances can be computed: Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Allowed for Output, at the Standard Rate (SH × SR)

Actual Hours of Input, at the Standard Rate (AH × SR) 1,500 hours* × $15.00 per hour = $22,500 $21,000* $23,250    Labor efficiency Labor rate variance, variance, $750 U $1,500 U Spending variance, $2,250 U

*Given

Problem 10-16 (continued) 7.

Actual Hours of Input, at the Actual Rate (AH × AR)

Standard Hours Allowed for Output, at the Standard Rate (SH × SR)

Actual Hours of Input, at the Standard Rate (AH × SR) 1,500 hours* × $3.00 per hour* = $4,500 $4,200* $3,600*    Variable overhead rate Variable overhead variance, efficiency variance, $900 F $300 U Spending variance, $600 F

*Given 8.

Standard Quantity or Hours Direct materials............... Direct labor..................... Variable manufacturing overhead ..................... Total standard cost ..........

2.8 yards1 1.4 hours2 1.4 hours

Standard Price or Rate

Standard Cost

$6 per yard $16.80 3 $15.00 per hour 21.00 $3 per hour

4.20 $42.00

From requirement 3. 1,400 standard hours (from part 5) ÷ 1,000 backpacks = 1.4 hours per backpack. 3 From requirement 5. 2

Managerial Accounting, 16th Edition

Case 10-17 (60 minutes) 1. The number of units produced can be computed by using the total standard cost applied for the period for any input—direct materials, direct labor, or variable manufacturing overhead. Using the standard cost applied for direct materials, we have: Total standard cost applied for the period $405,000 = Standard cost per unit $18 per unit = 22,500 units

The same answer can be obtained by using direct labor or variable manufacturing overhead. 2. 138,000 pounds; see below for a detailed analysis. 3. $2.95 per pound; see below for a detailed analysis. 4. 19,400 direct labor-hours; see below for a detailed analysis. 5. $15.75 per direct labor-hour; see below for a detailed analysis. 6. Standard variable overhead cost applied Add: Overhead efficiency variance......... Deduct: Overhead rate variance ............ Actual variable overhead cost incurred...

$54,000 4,200 U (see below) 1,300 F $56,900

Case 10-17 (continued) Direct materials analysis: Actual Quantity of Actual Quantity Standard Quantity Inputs, at Actual of Inputs, at Allowed for Output, Price Standard Price at Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 138,000 pounds 138,000 pounds** 135,000 pounds* × $2.95 per pound*** × $3 per pound × $3 per pound = $407,100 = $414,000 = $405,000    Materials price Materials quantity variance, variance, $6,900 F $9,000 U Spending variance, $2,100 U * 22,500 units × 6 pounds per unit = 135,000 pounds ** $414,000 ÷ $3 per pound = 138,000 pounds *** $407,100 ÷ 138,000 pounds = $2.95 per pound Direct labor analysis: Actual Hours of Standard Hours Actual Hours of Input, Input, at the Allowed for Output, at the Actual Rate Standard Rate at the Standard Rate (AH × AR) (AH × SR) (SH × SR) 19,400 DLHs × 19,400 DLHs** × 18,000 DLHs* × $15.75 per DLH*** $15 per DLH $15 per DLH = $305,550 = $291,000 = $270,000    Labor efficiency Labor rate variance, variance, $14,550 U $21,000 U Spending variance, $35,550 U * 22,500 units × 0.8 DLHs per unit = 18,000 DLHs ** $291,000 ÷ $15 per DLH = 19,400 DLHs *** $305,550 ÷ 19,400 DLHs = $15.75 per DLH © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 52

Managerial Accounting, 16th Edition

Case 10-17 (continued) Variable overhead analysis: Actual Hours of Standard Hours Actual Hours of Input, Input, at the Allowed for Output, at the Actual Rate Standard Rate at the Standard Rate (AH × AR) (AH × SR) (SH × SR) $56,900** 19,400 DLHs × 18,000 DLHs × $3 per DLH $3 per DLH = $58,200 = $54,000    Variable overhead rate Variable overhead variance, efficiency variance, $1,300 F $4,200 U * $58,200 – $1,300 = $56,900.

Appendix 10A Predetermined Overhead Rates and Overhead Analysis in a Standard Costing System

Exercise 10A-1 (15 minutes) 1.

Fixed overhead Fixed portion of the = predetermined overhead rate Denominator level of activity $250,000 25,000 DLHs = $10.00 per DLH

Budget = Actual fixed - Budgeted fixed variance overhead overhead = $254,000 - $250,000 = $4,000 U

Fixed portion of Volume = the predetermined × Denominator - Standard hours variance hours allowed overhead rate

(

)

= $10.00 per DLH × (25,000 DLHs - 26,000 DLHs) = $10,000 F

Managerial Accounting, 16th Edition

Exercise 10A-2 (20 minutes) 1.

Predetermined = $3 per MH × 60,000 MHs + $300,000 overhead rate 60,000 MHs =

$480,000 60,000 MHs

= $8 per MH Variable portion of $3 per MH × 60,000 MHs the predetermined = 60,000 MHs overhead rate =

$180,000 60,000 MHs

= $3 per MH Fixed portion of $300,000 the predetermined = 60,000 MHs overhead rate = $5 per MH 2. The standard hours per unit of product are: 60,000 hours ÷ 40,000 units = 1.5 hours per unit Given this figure, the standard hours allowed for the actual production would be: 42,000 units × 1.5 hours per unit = 63,000 standard hours allowed

Exercise 10A-2 (continued) 3. Variable overhead rate variance: Variable overhead rate variance = (AH × AR) – (AH × SR) ($185,600) – (64,000 hours × $3 per hour) = $6,400 F Variable overhead efficiency variance: Variable overhead efficiency variance = SR (AH – SH) $3 per hour (64,000 hours – 63,000 hours) = $3,000 U The fixed overhead variances are as follows: Actual Fixed Overhead $302,400 

Budgeted Fixed Overhead $300,000*

Budget variance, $2,400 U



Fixed Overhead Applied to Work in Process 63,000 hours × $5 per hour = $315,000  Volume variance, $15,000 F

*As originally budgeted. Alternative approach to the budget variance:

Budget = Actual fixed - Budgeted fixed variance overhead overhead = $302,400 - $300,000 = $2,400 U Alternative approach to the volume variance: æ Fixed portion of Standardö Volume = the predetermined ´ ççDenominator - hours ÷ ÷ ÷ çç ÷ Variance hours ç overhead rate allowed ÷ è ø = $5 per hour ´ (60,000 hours - 63,000 hours) = $15,000 F

Managerial Accounting, 16th Edition

Exercise 10A-3 (15 minutes) 1. The total overhead cost at the denominator level of activity must be determined before the predetermined overhead rate can be computed. Total fixed overhead cost per year ................................. Total variable overhead cost ($2 per DLH × 40,000 DLHs) ...................................... Total overhead cost at the denominator level of activity ..

$250,000 80,000 $330,000

Predetermined = Overhead at the denominator level of activity overhead rate Denominator level of activity =

$330,000 = $8.25 per DLH 40,000 DLHs

2. Standard direct labor-hours allowed for the actual output (a) .......................... Predetermined overhead rate (b) ........... Overhead applied (a) × (b)....................

38,000 DLHs $8.25 per DLH $313,500

Exercise 10A-4 (10 minutes) Company A: This company has a favorable volume variance because the standard hours allowed for the actual production are greater than the denominator hours. Company B: This company has an unfavorable volume variance because the standard hours allowed for the actual production are less than the denominator hours. Company C: This company has no volume variance because the standard hours allowed for the actual production and the denominator hours are the same.

Managerial Accounting, 16th Edition

Exercise 10A-5 (15 minutes) 1. 9,500 units × 4 hours per unit = 38,000 hours. 2. and 3. Actual Fixed Overhead $198,700* 

Budgeted Fixed Overhead $200,000 

Budget variance, $1,300 F

Fixed Overhead Applied to Work in Process 38,000 hours × $5 per hour* = $190,000  Volume variance, $10,000 U*

*Given 4.

Budgeted fixed overhead Fixed element of the = predetermined overhead rate Denominator activity =

$200,000 Denominator activity

= $5 per hour

Therefore, the denominator activity is: $200,000 ÷ $5 per hour = 40,000 hours.

Exercise 10A-6 (15 minutes) 1.

Total overhead at the Predetermined = denominator activity overhead rate Denominator activity =

$1.90 per DLH × 30,000 DLHs + $168,000 30,000 DLHs

$225,000 30,000 DLHs

= $7.50 per DLH Fixed element: $168,000 ÷ 30,000 DLHs = $5.60 per DLH 2.

Direct materials .............. Direct labor .................... Variable manufacturing overhead ..................... Fixed manufacturing overhead ..................... Total standard cost .........

Standard Quantity or Hours

2.5 yards 3.0 hours*

Standard Price or Rate

Standard Cost

$8.60 per yard $21.50 $12.00 per hour3 36.00

3.0 hours

$1.90 per hour

5.70

3.0 hours

$5.60 per hour

16.80 $80.00

*30,000 DLHs ÷ 10,000 units = 3 DLHs per unit

Managerial Accounting, 16th Edition

Exercise 10A-7 (15 minutes) 1. 14,000 units produced × 3 MHs per unit = 42,000 MHs 2. Actual fixed overhead incurred ................ Add: Favorable budget variance .............. Budgeted fixed overhead cost .................

$267,000 3,000 $270,000

3. Budgeted fixed overhead Fixed element of the = predetermined overhead rate Denominator activity $270,000 45,000 MHs

= $6 per MH

Fixed portion of æ Standardö Volume = the predetermined ççDenominator - hours ÷ ÷ ÷ çç ÷ Variance hours overhead rate èç allowed ÷ ø = $6 per MH (45,000 MHs - 42,000 MHs) = $18,000 U

Alternative solution to parts 1-3: Actual Fixed Overhead $267,000* 

Budgeted Fixed Overhead $270,0001

Budget variance, $3,000 F*



Fixed Overhead Applied to Work in Process 42,000 MHs2 × $6 per MH3 = $252,000  Volume variance, $18,000 U

$267,000 + $3,000 = $270,000.

14,000 units × 3 MHs per unit = 42,000 MHs

$270,000 ÷ 45,000 denominator MHs = $6 per MH

Problem 10A-8 (45 minutes) 1.

Total rate:

$600,000 = $10 per DLH 60,000 DLHs

Variable rate:

$120,000 = $2 per DLH 60,000 DLHs

Fixed rate:

$480,000 = $8 per DLH 60,000 DLHs

2. Direct materials: 3 pounds at $7 per pound .......... Direct labor: 1.5 DLHs at $12 per DLH.................. Variable overhead: 1.5 DLHs at $2 per DLH .......... Fixed overhead: 1.5 DLHs at $8 per DLH .............. Standard cost per unit .........................................

$21 18 3 12 $54

3. a. 42,000 units × 1.5 DLHs per unit = 63,000 standard DLHs b.

Actual costs

Manufacturing Overhead 606,500 Applied costs Overapplied overhead

630,000 * 23,500

*63,000 standard DLHs × $10 per DLH = $630,000 4. Variable overhead variances: Actual Hours of Input, at the Actual Rate (AH × AR) $123,500

Standard Hours Actual Hours of Input, Allowed for Output, at at the Standard Rate the Standard Rate (AH × SR) (SH × SR) 65,000 DLHs × 63,000 DLHs × $2 per DLH $2 per DLH = $130,000 = $126,000    Variable overhead rate Variable overhead variance, efficiency variance, $6,500 F $4,000 U

Managerial Accounting, 16th Edition

Problem 10A-8 (continued) Alternative solution: Variable overhead rate variance = (AH × AR) – (AH × SR) ($123,500) – (65,000 DLHs × $2 per DLH) = $6,500 F Variable overhead efficiency variance = SR (AH – SH) $2 per DLH (65,000 DLHs – 63,000 DLHs) = $4,000 U Fixed overhead variances: Actual Fixed Overhead $483,000

Budgeted Fixed Overhead $480,000*



Budget variance, $3,000 U

Fixed Overhead Applied to Work in Process 63,000 DLHs × $8 per DLH = $504,000  Volume variance, $24,000 F

*Can be expressed as: 60,000 denominator DLHs × $8 per DLH = $480,000 Alternative solution: Budget variance:

Budget = Actual fixed - Budgeted fixed variance overhead overhead = $483,000 - $480,000 = $3,000 U Volume variance: Fixed portion of æ Standardö Volume = the predetermined ççDenominator - hours ÷ ÷ ÷ çç ÷ Variance hours overhead rate çè allowed ÷ ø = $8 per DLH ´ (60,000 DLHs - 63,000 DLHs) = $24,000 F

Problem 10A-8 (continued) The company’s overhead variances can be summarized as follows: Variable overhead: Rate variance ................................. $ 6,500 F Efficiency variance.......................... 4,000 U Fixed overhead: Budget variance ............................. 3,000 U Volume variance............................. 24,000 F Overapplied overhead—see requirement 3 ................................ $23,500 F 5. Only the volume variance would have changed. It would have been unfavorable because the standard DLHs allowed for the year’s production (63,000 DLHs) would have been less than the denominator DLHs (65,000 DLHs).

Managerial Accounting, 16th Edition

Problem 10A-9 (45 minutes) 1.

Total rate:

$297,500 = $8.50 per hour 35,000 hours

Variable rate:

$87,500 = $2.50 per hour 35,000 hours

Fixed rate:

$210,000 = $6.00 per hour 35,000 hours

2. 32,000 standard hours × $8.50 per hour = $272,000 3. Variable overhead variances: Actual Hours of Input, at the Actual Rate (AH × AR) $78,000

Standard Hours Actual Hours of Input, Allowed for Output, at at the Standard Rate the Standard Rate (AH × SR) (SH × SR) 30,000 hours × 32,000 hours × $2.50 per hour $2.50 per hour = $75,000 = $80,000    Variable overhead rate Variable overhead variance, efficiency variance, $3,000 U $5,000 F

Alternative solution: Variable overhead rate variance = (AH × AR) – (AH × SR) ($78,000) – (30,000 hours × $2.50 per hour) = $3,000 U Variable overhead efficiency variance = SR (AH – SH) $2.50 per hour (30,000 hours – 32,000 hours) = $5,000 F

Problem 10A-9 (continued) Fixed overhead variances: Actual Fixed Overhead $209,400 

Budgeted Fixed Overhead $210,000

Budget variance, $600 F



Fixed Overhead Applied to Work in Process 32,000 hours × $6 per hour = $192,000  Volume variance, $18,000 U

Alternative solution: Budget variance:

Budget = Actual fixed - Budgeted fixed variance overhead overhead = $209,400 - $210,000 = $600 F Volume variance: Fixed portion of æ Standardö Volume = the predetermined ççDenominator - hours ÷ ÷ ÷ çç ÷ Variance hours overhead rate çè allowed ÷ ø = $6.00 per hour (35,000 hours - 32,000 hours) = $18,000 U

Verification: Variable overhead rate variance ........ Variable overhead efficiency variance Fixed overhead budget variance ....... Fixed overhead volume variance ....... Underapplied overhead ....................

$ 3,000 U 5,000 F 600 F 18,000 U $15,400 U

Managerial Accounting, 16th Edition

Problem 10A-9 (continued) 4. Variable overhead

Rate 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. Because the variable overhead spending variance is unfavorable, 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

misnomer, because 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, the activity base is labor-hours. If variable overhead is really proportional to labor-hours, then more effective use of labor-hours has the indirect effect of reducing variable overhead. Because 2,000 fewer labor-hours were required than indicated by the labor standards, the indirect effect was presumably to reduce variable overhead spending by about $5,000 ($2.50 per hour × 2,000 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 favorable 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 in the predetermined overhead rate. In this case, the variance is unfavorable, 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.

Problem 10A-10 (45 minutes) 1. Direct materials price and quantity variances: Materials price variance = AQ (AP – SP) 64,000 feet ($8.55 per foot – $8.45 per foot) = $6,400 U Materials quantity variance = SP (AQ – SQ) $8.45 per foot (64,000 feet – 60,000 feet*) = $33,800 U *30,000 units × 2 feet per unit = 60,000 feet 2. Direct labor rate and efficiency variances: Labor rate variance = AH (AR – SR) 43,500 DLHs ($15.80 per DLH – $16.00 per DLH) = $8,700 F Labor efficiency variance = SR (AH – SH) $16.00 per DLH (43,500 DLHs – 42,000 DLHs*) = $24,000 U *30,000 units × 1.4 DLHs per unit = 42,000 DLHs 3. a. Variable overhead spending and efficiency variances: Actual Hours of Input, at the Actual Rate (AH × AR) $108,000

Actual Hours of Standard Hours Input, at the Allowed for Output, Standard Rate at the Standard Rate (AH × SR) (SH × SR) 43,500 DLHs 42,000 DLHs × $2.50 per DLH × $2.50 per DLH = $108,750 = $105,000    Variable overhead rate Variable overhead variance, efficiency 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, 16th Edition

Problem 10A-10 (continued) b. 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: Budget variance:

Budget = Actual fixed - Budgeted fixed variance overhead overhead = $211,800 - $210,000 = $1,800 U Volume variance: Fixed portion of æ Standardö Volume = the predetermined ççDenominator - hours ÷ ÷ ÷ çç ÷ Variance hours ÷ overhead rate çè allowed ø = $6.00 per DLH ´ (35,000 DLHs - 42,000 DLHs) = $42,000 F

Problem 10A-10 (continued) 4. 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 8,700 F 24,000 U 750 F 3,750 U 1,800 U 42,000 F $18,300 U

Note that the total of the variances agrees with the $18,300 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 labor 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, 16th Edition

Problem 10A-11 (30 minutes) 1. Direct materials, 3 yards × $4.40 per yard ............................. Direct labor, 1 DLH × $12.00 per DLH ................................... Variable manufacturing overhead, 1 DLH × $5.00 per DLH* ... Fixed manufacturing overhead, 1 DLH × $11.80 per DLH** .... Standard cost per unit ..........................................................

$13.20 12.00 5.00 11.80 $42.00

* $25,000 ÷ 5,000 DLHs = $5.00 per DLH ** $59,000 ÷ 5,000 DLHs = $11.80 per DLH 2. Materials variances: Materials price variance = AQ (AP – SP) 24,000 yards ($4.80 per yard – $4.40 per yard) = $9,600 U Materials quantity variance = SP (AQ – SQ) $4.40 per yard (18,500 yards – 18,000 yards*) = $2,200 U *6,000 units × 3 yards per unit = 18,000 yards Labor variances: Labor rate variance = AH (AR – SR) 5,800 DLHs ($13.00 per DLH – $12.00 per DLH) = $5,800 U Labor efficiency variance = SR (AH – SH) $12.00 per DLH (5,800 DLHs – 6,000 DLHs*) = $2,400 F *6,000 units × 1 DLH per unit = 6,000 DLHs

Problem 10A-11 (continued) 3. Variable overhead variances: Actual DLHs of Input, at the Actual Rate (AH × AR) $29,580

Actual DLHs of Standard DLHs Input, at the Allowed for Output, Standard Rate at the Standard Rate (AH × SR) (SH × SR) 5,800 DLHs 6,000 DLHs × $5.00 per DLH × $5.00 per DLH = $29,000 = $30,000    Variable overhead rate Variable overhead variance, efficiency variance, $580 U $1,000 F Spending 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: Fixed Overhead Actual Fixed Budgeted Fixed Applied to Overhead Overhead Work in Process $60,400 $59,000 6,000 DLHs × $11.80 per DLH = $70,800    Budget variance, Volume variance, $1,400 U $11,800 F

Managerial Accounting, 16th Edition

Problem 10A-11 (continued) Alternative approach to the budget variance:

Budget = Actual fixed - Budgeted fixed variance overhead overhead = $60,400 - $59,000 = $1,400 U Alternative approach to the volume variance: Fixed portion of æ Standardö Volume = the predetermined ççDenominator - hours ÷ ÷ ÷ çç ÷ Variance hours ÷ overhead rate çè allowed ø = $11.80 per DLH ´ (5,000 DLHs - 6,000 DLHs) = $11,800 F

4. 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.

Problem 10A-12 (45 minutes) 1. and 2. Denominator of 30,000 DLHs: $135,000 ÷ 30,000 DLHs ................. $270,000 ÷ 30,000 DLHs ................. Total predetermined rate ....................

Per Direct Labor-Hour Variable Fixed Total $4.50

Denominator of 40,000 DLHs: $180,000 ÷ 40,000 DLHs ................. $270,000 ÷ 40,000 DLHs ................. Total predetermined rate ....................

$4.50

$9.00

$ 4.50 9.00 $13.50

$6.75

$ 4.50 6.75 $11.25

Denominator Activity: 30,000 DLHs

Direct materials, 4 feet × $8.75 per foot .............. Direct labor, 2 DLHs × $15 per DLH ................. Variable overhead, 2 DLHs × $4.50 per DLH .. Fixed overhead, 2 DLHs × $9.00 per DLH .............. Standard cost per unit .....

Denominator Activity: 40,000 DLHs

$35.00

Same ........................... $35.00

30.00

Same ...........................

9.00

Same ........................... 9.00 Fixed overhead, 2 DLHs × $6.75 per DLH ........ 13.50 Standard cost per unit .. $87.50

18.00 $92.00

30.00

4. a. 18,000 units × 2 DLHs per unit = 36,000 standard DLHs b. Actual costs

Manufacturing Overhead 446,400 Applied costs Overapplied overhead

486,000 * 39,600

*36,000 standard DLHs × $13.50 predetermined rate per DLH = $486,000

Managerial Accounting, 16th Edition

Problem 10A-12 (continued) c. Variable overhead variances: Actual DLHs of Input, at the Actual Rate (AH × AR) $174,800

Actual DLHs of Standard DLHs Input, at the Allowed for Output, Standard Rate at the Standard Rate (AH × SR) (SH × SR) 38,000 DLHs × 36,000 DLHs × $4.50 per DLH $4.50 per DLH = $171,000 = $162,000    Variable overhead rate Variable overhead variance, efficiency variance, $3,800 U $9,000 U

Alternative solution: Variable overhead rate variance = (AH × AR) – (AH × SR) ($174,800) – (38,000 DLHs × $4.50 per DLH) = $3,800 U Variable overhead efficiency variance = SR (AH – SH) $4.50 per DLH (38,000 DLHs – 36,000 DLHs) = $9,000 U Fixed overhead variances: Actual Fixed Overhead $271,600 

Budgeted Fixed Overhead $270,000*

Budget variance, $1,600 U



Fixed Overhead Applied to Work in Process 36,000 DLHs × $9 per DLH = $324,000  Volume variance, $54,000 F

*Can be expressed as: 30,000 denominator DLHs × $9 per DLH = $270,000

Problem 10A-12 (continued) Alternative solution: Budget variance:

Budget = Actual fixed - Budgeted fixed variance overhead overhead = $271,600 - $270,000 = $1,600 U Volume variance: Fixed portion of æ Standardö Volume = the predetermined ççDenominator - hours ÷ ÷ ÷ çç ÷ Variance hours ÷ overhead rate çè allowed ø = $9.00 per DLH ´ (30,000 DLHs - 36,000 DLHs) = $54,000 F

Summary of variances: Variable overhead rate variance ................. Variable overhead efficiency variance ......... Fixed overhead budget variance ................ Fixed overhead volume variance ................ Overapplied overhead ...............................

$ 3,800 U 9,000 U 1,600 U 54,000 F $39,600 F

Managerial Accounting, 16th Edition

Problem 10A-12 (continued) 5. The major disadvantage of using normal activity 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 a long-run normal activity figure of 30,000 DLHs to compute the predetermined overhead rate, whereas activity for the period was expected to be 40,000 DLHs. This has resulted in a large favorable volume variance that may be difficult for management to interpret. In addition, the large favorable 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 40,000 DLHs, but managed to work only 36,000 DLHs (at standard). This unfavorable result is concealed due to using a denominator figure that is out of step with current activity. On the other hand, using long-run normal activity as the denominator results in unit costs that 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.

Appendix 10B Standard Cost Systems: A Financial Reporting Perspective Using Microsoft Excel

Exercise 10B-1 (10 minutes) 1. The cost of goods sold will decrease by: Materials price variance ................................ Materials quantity variance ........................... Labor rate variance ...................................... Labor efficiency variance .............................. Fixed overhead budget variance .................... Fixed overhead volume variance ................... Decrease in cost of goods sold ......................

$ (6,500) 10,200 3,500 (4,400) (2,500) (12,000) $(11,700)

2. The income statement is as follows: Sales (10,000 units × $135).......................... $1,350,000 Cost of goods sold at standard (10,000 units × $105) .................................................... $1,050,000 Total variance adjustments ........................... (11,700) Cost of goods sold ........................................ 1,038,300 Gross margin ............................................... 311,700 Selling and administrative expenses .............. 235,000 Net operating income ................................... $ 76,700

Managerial Accounting, 16th Edition

Exercise 10B-2 (15 minutes) 1. The cost of goods sold will increase by: Materials price variance ................................ Materials quantity variance ........................... Labor rate variance ...................................... Labor efficiency variance .............................. Fixed overhead budget variance .................... Fixed overhead volume variance ................... Increase in cost of goods sold .......................

$ 3,400 (9,000) 3,900 6,600 1,300 (5,500) $ 700

2. The first step is to compute the number of units sold as follows: Total sales (a) ............................................. Selling price per unit (b) .............................. Number of units sold (a) ÷ (b) .....................

$577,500 $165 3,500

The income statement is as follows: Sales ........................................................... Cost of goods sold at standard (3,500 units × $143) ........................................................ Total variance adjustments ........................... Cost of goods sold ........................................ Gross margin ............................................... Selling and administrative expenses .............. Net operating income ...................................

$577,500 $500,500 700

501,200 76,300 54,000 $ 22,300

3. The ending balance in Retained Earnings is computed as follows: Beginning balance in retained earnings ......... Net operating income .................................. Ending balance in retained earnings .............

$70,000 22,300 $92,300

Exercise 10B-3 (20 minutes) 1a. The Raw Materials will increase by $300,000 computed as follows: Actual quantity purchased (a) ......................... 30,000 yards Standard price per yard (b) ............................ $10.00 Increase in Raw Materials (a) × (b)................. $300,000 1b. The Cash will decrease by $294,000 computed as follows: Actual quantity purchased (a) ......................... 30,000 yards Actual price per yard (b) ................................. $9.80 Decrease in Cash (a) × (b) ............................. $294,000 2a. The Raw Materials will decrease by $300,000 computed as follows: Actual quantity used (a) ................................. 30,000 yards Standard price per yard (b) ............................ $10.00 Decrease in Raw Materials (a) × (b) ................ $300,000 2b. The Work in Process will increase by $243,000 computed as follows: Standard quantity allowed (8,100 units × 3 yards per unit) (a) .............................. 24,300 yards Standard price per yard (b) ............................ $10.00 Increase in Work in Process (a) × (b).............. $243,000 3a. The Work in Process will increase by $272,160 computed as follows: Standard hours allowed (8,100 units × 2.4 hours per unit) (a) ........................... 19,440 hours Standard rate per hour (b) ............................. $14.00 Increase in Work in Process (a) × (b).............. $272,160 3b. The Cash will decrease by $290,000—the amount of cash paid to direct laborers.

Managerial Accounting, 16th Edition

Exercise 10B-3 (continued) 4.

The Work in Process will increase by $388,800 computed as follows: Standard hours allowed (a)............................. 19,440 hours Predetermined overhead rate per hour (b)....... $20.00 Increase in Work in Process (a) × (b).............. $388,800

The Finished Goods will increase by $903,960 computed as follows: Number of units completed (a) ....................... 8,100 units Standard cost per unit (b) .............................. $111.60 Increase in Finished Goods (a) × (b) ............... $903,960

Exercise 10B-4 (30 minutes) 1a. The Raw Materials will increase by $720,000 computed as follows: Actual quantity purchased (a) ......................... 60,000 yards Standard price per yard (b) ............................ $12.00 Increase in Raw Materials (a) × (b)................. $720,000 1b. The Cash will decrease by $660,000 computed as follows: Actual quantity purchased (a) ......................... 60,000 yards Actual price per yard (b) ................................. $11.00 Decrease in Cash (a) × (b) ............................. $660,000 1c. The materials price variance is computed as follows: Materials price variance = AQ(AP – SP) 60,000 yards ($11.00 per yard – $12.00 per yard) = $60,000 F 2a. The Raw Materials will decrease by $720,000 computed as follows: Actual quantity used (a) ................................. 60,000 yards Standard price per yard (b) ............................ $12.00 Decrease in Raw Materials (a) × (b) ................ $720,000 2b. The Work in Process will increase by $672,000 computed as follows: Standard quantity allowed (28,000 units × 2 yards per unit) (a) .............................. 56,000 yards Standard price per yard (b) ............................ $12.00 Increase in Work in Process (a) × (b).............. $672,000 2c. The materials quantity variance is computed as follows: Materials quantity variance = SP (AQ – SQ) $12.00 per yard (60,000 yards – 56,000 yards) = $48,000 U 3a. The Work in Process will increase by $630,000 computed as follows: Standard hours allowed (28,000 units × 1.5 hours per unit) (a) ........................... 42,000 hours Standard rate per hour (b) ............................. $15.00 Increase in Work in Process (a) × (b).............. $630,000 © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 82

Managerial Accounting, 16th Edition

Exercise 10B-4 (continued) 3b. The Cash decrease by $600,000 computed as follows: Actual hours (a) ............................................. 40,000 hours Actual rate per hour (b) .................................. $15.00 Decrease in Cash (a) × (b) ............................. $600,000 3c. The labor rate variance is zero because the actual rate (see requirement 3b) and the standard rate are both $15.00 per hour. The labor efficiency variance is computed as follows: Labor efficiency variance = SR(AH – SH) $15.00 per hour (40,000 hours – 42,000 hours) = $30,000 F 4a. The Work in Process will increase by $1,680,000 computed as follows: Standard hours allowed (28,000 units × 1.5 hours) (a) ....................................... 42,000 hours Predetermined overhead rate per hour (b)....... $40.00 Increase in Work in Process (a) × (b).............. $1,680,000 4b. The fixed overhead budget and volume variances are computed as follows: Budget variance = Actual fixed overhead – Budgeted fixed overhead Budget variance = $1,780,000 – $1,760,000 = $20,000 U Volume variance = Budgeted fixed overhead – Fixed overhead applied Volume variance = $1,760,000 – $1,680,000 = $80,000 U 5.

The Finished Goods will increase by $2,982,000 computed as follows: Number of units completed (a) .................... 28,000 units Standard cost per unit (b) ........................... $106.50 Increase in Finished Goods (a) × (b) ............ $2,982,000

Problem 10B-5 (60 minutes) 1. The manufacturing cost variances are computed as follows: Materials price variance = AQ(AP – SP) 230,000 pounds ($29.50 per pound – $30.00 per pound) = $115,000 F Materials quantity variance = SP(AQ – SQ) $30.00 per pound (215,000 pounds – 190,000 pounds*) = $750,000 U *95,000 units × 2 pounds per unit = 190,000 pounds Labor rate variance = AH(AR – SR) 245,000 hours ($16.00 per hour – $15.00 per hour) = $245,000 U Labor efficiency variance = SR(AH – SH) $15.00 per hour (245,000 hours – 285,000 hours*) = $600,000 F *95,000 units × 3 hours per unit = 285,000 hours Budget variance = Actual fixed overhead – Budgeted fixed overhead Budget variance = $2,740,000 – $2,880,000 = $140,000 F Volume variance = Budgeted fixed overhead – Fixed overhead applied Volume variance = $2,880,000 – $2,850,000* = $30,000 U * 95,000 units × 3 hours per unit × $10 per hour = $2,850,000

Managerial Accounting, 16th Edition

Problem 10B-5 (continued) 2 and 3: The transactions (including the ending balances) are recorded as follows:

Problem 10B-5 (continued) 4. The income statement is computed as follows:

Managerial Accounting, 16th Edition

Problem 10B-6 (60 minutes) 1. The manufacturing cost variances are computed as follows: Materials price variance = AQ(AP – SP) 460,000 pounds ($26.50 per pound – $25.00 per pound) = $690,000 U Materials quantity variance = SP(AQ – SQ) $25.00 per pound (430,000 pounds – 375,000 pounds) = $1,375,000 U Labor rate variance = AH(AR – SR) 265,000 hours ($15.00 per hour – $16.00 per hour) = $265,000 F Labor efficiency variance = SR(AH – SH) $16.00 per hour (265,000 hours – 250,000 hours) = $240,000 U Variable overhead rate variance = AH(AR – SR) 265,000 hours ($1.81 per hour – $2.00 per hour) = $50,000 F Note: The variable overhead rate variance of $50,000 F agrees with cell L11 in the Excel screen capture solution for requirements 2 and 3. An answer of $50,000 F is correct when the actual rate (AR) is not rounded. Variable overhead efficiency variance = SR(AH – SH) $2.00 per hour (265,000 hours – 250,000 hours) = $30,000 U Budget variance = Actual fixed overhead – Budgeted fixed overhead Budget variance = $2,450,000 – $2,400,000 = $50,000 U Volume variance = Budgeted fixed overhead – Fixed overhead applied Volume variance = $2,400,000 – $2,500,000 = $100,000 F Note: The budgeted fixed overhead of $2,400,000 is computed as follows: Total budgeted overhead (a) .................................. Variable portion of the budget (240,000 DLH ×$2.00 per DLH) (b) ....................................................... Total budgeted fixed overhead (a) – (b) ..................

$2,880,000 $480,000 $2,400,000

Note: The fixed overhead applied of $2,500,000 is computed as follows: Standard labor-hours allowed (a) ............................ Fixed portion of the predetermined overhead rate per DLH (b)......................................................... Fixed overhead applied (a) × (b) ............................

250,000 $10 $2,500,000

Problem 10B-6 (continued) 2 and 3. The transactions (including the ending balances) are recorded as follows:

Managerial Accounting, 16th Edition

Problem 10B-6 (continued) 4. The income statement is computed as follows:

Chapter 11 Performance Measurement in Decentralized Organizations Solutions to Questions 11-1 In a decentralized organization, decision-making authority isn’t confined to a few top executives; instead, decision-making authority is spread throughout the organization. 11-2 The benefits of decentralization include: (1) by delegating day-to-day problem solving to lower-level managers, top management can concentrate on bigger issues such as overall strategy; (2) empowering lower-level managers to make decisions puts decision-making authority in the hands of those who tend to have the most detailed and up-to-date information about day-to-day operations; (3) by eliminating layers of decision-making and approvals, organizations can respond more quickly to customers and to changes in the operating environment; (4) granting decisionmaking authority helps train lower-level managers for higher-level positions; and (5) empowering lower-level managers to make decisions can increase their motivation and job satisfaction.

company’s minimum required rate of return on operating assets. 11-6 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 whose rate of return is less than the investment center’s current ROI. The residual income approach overcomes this problem because any project whose rate of return exceeds the company’s minimum required rate of return will result in an increase in residual income. 11-7 The difference between delivery cycle time and throughput time is the waiting period between when an order is received and when production on the order is started. Throughput time is made up of process time, inspection time, move time, and queue time. Process time is value-added time and inspection time, move time, and queue time are non-value-added time.

11-3 The manager of a cost center 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.

11-8 An MCE of less than 1 means that the production process includes non-value-added time. An MCE of 0.40, for example, means that 40% of throughput time consists of actual processing, and that the other 60% consists of moving, inspection, and other non-value-added activities.

11-4 Margin is the ratio of net operating income to total sales. Turnover is the ratio of total sales to average operating assets. The product of the two numbers is the ROI.

11-9 A company’s balanced scorecard should be derived from and support its strategy. Because different companies have different strategies, their balanced scorecards should be different.

11-5 Residual income is the net operating income an investment center earns above the

11-10 The balanced scorecard is constructed to support the company’s strategy, which is a

theory about what actions will further the company’s goals. Assuming that the company has financial goals, measures of financial performance must be included in the balanced scorecard as a check on the reality of the theory.

If the internal business processes improve, but the financial outcomes do not improve, the theory may be flawed and the strategy should be changed.

Managerial Accounting, 16th Edition

Chapter 11: Applying Excel The completed worksheet is shown below.

Chapter 11: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Managerial Accounting, 16th Edition

Chapter 11: Applying Excel (continued) 1. With the changes in average operating assets, the result is:

An increase in average operating assets will increase both the ROI and residual income. ROI = Net operating income/Average operating assets Residual income = Net operating income – Required return Required return = Minimum required rate of return × Average operating assets ROI increases because average operating assets is in the denominator of ROI. Residual income increases when average operating assets decreases because a reduction in the average operating assets results in a reduction of the required return.

Chapter 11: Applying Excel (continued) 2. With the revised data, the worksheet should look like this:

a. As shown above, the ROI is 14%. b. As shown above, the residual income is $(3). c. Because the ROI of 14% is less than minimum required return of 15%, the residual income is negative.

Managerial Accounting, 16th Edition

The Foundational 15 1. Last year’s margin is:

Margin = =

Net operating income Sales $200,000 = 20% $1,000,000

2. Last year’s turnover is:

Turnover = =

Sales Average operating assets $1,000,000 = 1.6 $625,000

3. Last year’s return on investment (ROI) is: ROI = Margin × Turnover = 20% × 1.6 = 32%

4. The margin for this year’s investment opportunity is:

Margin = =

Net operating income Sales $30,000* = 15% $200,000

* $200,000 – [$200,000 × (1 – 60%)] – $90,000 = $30,000 5. The turnover for this year’s investment opportunity is:

Turnover = =

Sales Average operating assets $200,000 = 1.67 (rounded) $120,000

The Foundational 15 (continued) 6. The ROI for this year’s investment opportunity is: ROI = Margin × Turnover = 15% × 1.67 = 25% (rounded)

7, 8, and 9. If the company pursues the investment opportunity, this year’s margin, turnover, and ROI would be: Margin =

Net operating income Sales

$200,000 + $30,000 $1,000,000 + $200,000

$230,000 = 19.2% (rounded) $1,200,000

Turnover =

Sales Average operating assets

$1,000,000 + $200,000 $625,000 + $120,000

$1,200,000 = 1.61 (rounded) $745,000

ROI = Margin × Turnover = 19.2% × 1.61 = 30.9% (rounded)

10. The CEO would not pursue the investment opportunity because it lowers her ROI from 32% to 30.9%. The owners of the company would want the CEO to pursue the investment opportunity because its ROI of 25% exceeds the company’s minimum required rate of return of 15%.

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 11. Last year’s residual income is: Average operating assets................ Net operating income ..................... Minimum required return: 15% × $625,000 ......................... Residual income .............................

$625,000 $200,000 93,750 $106,250

12. The residual income for this year’s investment opportunity is: Average operating assets................ Net operating income ..................... Minimum required return: 15% × $120,000 ......................... Residual income .............................

$120,000 $30,000 18,000 $12,000

13. If the company pursues the investment opportunity, this year’s residual income will be: Average operating assets................ Net operating income ..................... Minimum required return: 15% × $745,000 ......................... Residual income .............................

$745,000 $230,000 111,750 $118,250

14. The CEO would pursue the investment opportunity because it would raise her residual income by $12,000 (= $118,250 – $106,250). 15. The CEO and the company would not want to pursue this investment opportunity because it does not exceed the minimum required return: Average operating assets................ Net operating income ($200,000 × 50% – $90,000) .......................... Minimum required return: 15% × $120,000 ......................... Residual income .............................

$120,000 $10,000 18,000 $ (8,000)

Exercise 11-1 (10 minutes) 1.

Margin = =

Net operating income Sales $600,000 = 8% $7,500,000

Turnover = =

Sales Average operating assets $7,500,000 = 1.5 $5,000,000

3. ROI = Margin × Turnover

= 8% × 1.5 = 12%

Managerial Accounting, 16th Edition

Exercise 11-2 (10 minutes) Average operating assets ......................

$2,800,000

Net operating income............................ Minimum required return: 18% × $2,800,000 ............................. Residual income ...................................

$ 600,000 504,000 $ 96,000

Exercise 11-3 (20 minutes) 1. Throughput time = Process time + Inspection time + Move time + Queue time = 2.7 days + 0.3 days + 1.0 days + 5.0 days = 9.0 days 2. Only process time is value-added time; therefore the manufacturing cycle efficiency (MCE) is:

MCE =

Value-added time 2.7 days = = 0.30 Throughput time 9.0 days

3. If the MCE is 30%, then 30% of the throughput time was spent in value-added activities. Consequently, the other 70% of the throughput time was spent in non-value-added activities. 4.

Delivery cycle time = Wait time + Throughput time = 14.0 days + 9.0 days = 23.0 days

5. If all queue time is eliminated, then the throughput time drops to only 4 days (2.7 + 0.3 + 1.0). The MCE becomes:

MCE =

Value-added time 2.7 days = = 0.675 Throughput time 4.0 days

Thus, the MCE increases to 67.5%. This exercise shows quite dramatically how lean production can improve the efficiency of operations and reduce throughput time.

Managerial Accounting, 16th Edition

Exercise 11-4 (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 + completing cooking course

Exercise 11-4 (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 increases, 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. [See below.]

Managerial Accounting, 16th Edition

Exercise 11-4 (continued) 3. 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.

Exercise 11-5 (15 minutes)

Alpha

Division Bravo

Sales (a) ............................. $4,000,000 $11,500,000 * Net operating income (b) ..... $160,000 $920,000 * Average operating assets (c) ................................... $800,000 * $4,600,000 Margin (b) ÷ (a) .................. 4%* 8% Turnover (a) ÷ (c) ............... 5* 2.5 Return on investment (ROI) . 20% 20%*

Charlie

$3,000,000 $210,000 * $1,500,000 7%* 2 14%*

Note that Divisions Alpha and Bravo apparently have different strategies to obtain the same 20% return. Division Alpha has a low margin and a high turnover, whereas Division Bravo has just the opposite. *Given.

Managerial Accounting, 16th Edition

Exercise 11-6 (20 minutes) 1. ROI computations: ROI =

Net operating income Sales × Sales Average operating assets

Osaka Division: ROI =

$210,000 $3,000,000 × = 7% × 3 = 21% $3,000,000 $1,000,000

Yokohama Division: ROI =

$720,000 $9,000,000 × = 8% × 2.25 = 18% $9,000,000 $4,000,000

Average operating assets (a)...................... Net operating income ................................ Minimum required return on average operating assets: 15% × (a) ................... Residual income ........................................

Osaka

Yokohama

$210,000

$720,000

150,000 $ 60,000

600,000 $120,000

$1,000,000 $4,000,000

3. No, the Yokohama Division is simply larger than the Osaka Division and for this reason one would expect that it would have a greater amount of residual income. Residual income can’t be used to compare the performance of divisions of different sizes. Larger divisions will almost always look better. In fact, in the case above, the Yokohama Division does not appear to be as well managed as the Osaka Division. Note from Part (1) that Yokohama has only an 18% ROI as compared to 21% for Osaka.

Exercise 11-7 (45 minutes) 1. Students’ answers may differ in some details from this solution. Financial

Profit margin +

Revenue per employee

Customer

Customer satisfaction with efficiency

Internal Business Processes

Ratio of billable hours to total hours

Sales

Number of new customers acquired

Customer satisfaction with effectiveness

Customer satisfaction with + service quality

Average number of errors per tax return

–

Average time needed to prepare a return

–

Learning And Growth Percentage of job offers accepted

Amount of compensation paid above industry average

Employee morale

Average number of years to be promoted

–

Managerial Accounting, 16th Edition

Exercise 11-7 (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.

Exercise 11-7 (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.

Managerial Accounting, 16th Edition

Exercise 11-7 (continued) 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.

Exercise 11-8 (15 minutes) 1. ROI computations: ROI =

Net operating income Sales × Sales Average operating assets

Queensland Division: ROI =

$360,000 $4,000,000 × = 9% × 2 = 18% $4,000,000 $2,000,000

New South Wales Division: ROI =

$420,000 $7,000,000 × = 6% × 3.5 = 21% $7,000,000 $2,000,000

2. The manager of the New South Wales Division seems to be doing the better job. Although the New South Wales Division’s margin is three percentage points lower than the margin of the Queensland Division, its turnover is higher (a turnover of 3.5, as compared to a turnover of 2.0 for the Queensland Division). The greater turnover more than offsets the lower margin, resulting in a 21% ROI, as compared to an 18% ROI for the other division. Notice that if you look at margin alone, then the Queensland Division appears to be the stronger division. This fact underscores the importance of looking at turnover as well as at margin in evaluating performance in an investment center.

Managerial Accounting, 16th Edition

Exercise 11-9 (15 minutes)

Company A

Company B

Company C

Sales (a) ................................... $9,000,000 * $7,000,000 * $4,500,000 * Net operating income (b) ........... $540,000 $280,000 * $360,000 Average operating assets (c) ...... $3,000,000 * $2,000,000 $1,800,000 * Return on investment (ROI) (b) ÷ (c) ...................................... 18%* 14%* 20% Minimum required rate of return: Percentage (d) ........................ 16%* 16% 15%* Dollar amount (c) × (d) ........... $480,000 $320,000 * $270,000 Residual income (b) – [(c) × * (d)] ........................................ $60,000 $(40,000) $90,000 *Given.

Exercise 11-10 (20 minutes) 1.

(a) Sales

$2,500,000 $2,600,000 $2,700,000 $2,800,000 $2,900,000 $3,000,000

(b) (c) Net Average Operating Operating Income* Assets

$475,000 $1,000,000 $500,000 $1,000,000 $525,000 $1,000,000 $550,000 $1,000,000 $575,000 $1,000,000 $600,000 $1,000,000

ROI (b) ÷ (c)

47.5% 50.0% 52.5% 55.0% 57.5% 60.0%

*Sales × Contribution Margin Ratio of 25% – Fixed Expenses of $150,000 2. The ROI increases by 2.5% for each $100,000 increase in sales. This happens because each $100,000 increase in sales brings in an additional profit of $25,000. When this additional profit is divided by the average operating assets of $1,000,000, the result is an increase in the company’s ROI of 2.5%. Increase in sales ................................................... $100,000 (a) Contribution margin ratio ....................................... 25% (b) Increase in contribution margin and net operating income (a) × (b) ................................................ $25,000 (c) Average operating assets....................................... $1,000,000 (d) Increase in return on investment (c) ÷ (d) ............. 2.5%

Managerial Accounting, 16th Edition

Exercise 11-11 (30 minutes) 1.

Margin = = Turnover = =

Net operating income Sales $70,000 = 5% $1,400,000 Sales Average operating assets $1,400,000 =4 $350,000

ROI = Margin × Turnover = 5% × 4 = 20%

Margin =

Net operating income Sales

$70,000 + $18,200 $1,400,000 + $70,000

$88,200 = 6% $1,470,000

Turnover =

Sales Average operating assets

$1,400,000 + $70,000 $350,000

$1,470,000 = 4.2 $350,000

ROI = Margin × Turnover = 6% × 4.2 = 25.2%

Exercise 11-11 (continued) 3.

Margin =

Net operating income Sales

$70,000 + $14,000 $1,400,000

$84,000 = 6% $1,400,000

Turnover = =

Sales Average operating assets $1,400,000 =4 $350,000

ROI = Margin × Turnover = 6% × 4 = 24%

Margin = = Turnover =

Net operating income Sales $70,000 = 5% $1,400,000 Sales Average operating assets

$1,400,000 $350,000 - $70,000

$1,400,000 =5 $280,000

ROI = Margin × Turnover = 5% × 5 = 25%

Managerial Accounting, 16th Edition

Exercise 11-12 (30 minutes) 1. ROI computations: ROI =

Net operating income Sales × Sales Average operating assets

Division A: ROI =

$600,000 $12,000,000 × = 5% × 4 = 20% $12,000,000 $3,000,000

Division B: ROI =

$560,000 $14,000,000 × = 4% × 2 = 8% $14,000,000 $7,000,000

Division C: ROI =

$800,000 $25,000,000 × = 3.2% × 5 = 16% $25,000,000 $5,000,000

Division A

Division B

Division C

Average operating assets ......... Required rate of return ............ Minimum required return .........

$3,000,000 $7,000,000 $5,000,000 × 14% × 10% × 16% $ 420,000 $ 700,000 $ 800,000

Actual operating income........... Minimum required return (above) ................................ Residual income ......................

$ 600,000 $ 560,000 $ 800,000 420,000 $ 180,000

700,000 800,000 $(140,000) $ 0

Exercise 11-12 (continued) 3. a. and b. Return on investment (ROI) ........... Therefore, if the division is presented with an investment opportunity yielding 15%, it probably would........................... Minimum required return for computing residual income.......... Therefore, if the division is presented with an investment opportunity yielding 15%, it probably would...........................

Division A Division B Division C 20%

16%

Reject

14%

10%

16%

Reject

If performance is being measured by ROI, both Division A and Division C probably would reject the 15% investment opportunity. These divisions’ ROIs currently exceed 15%; accepting a new investment with a 15% rate of return would reduce their overall ROIs. Division B probably would accept the 15% investment opportunity because accepting it would increase the division’s overall rate of return. If performance is measured by residual income, both Division A and Division B probably would accept the 15% investment opportunity. The 15% rate of return promised by the new investment is greater than their required rates of return of 14% and 10%, respectively, and would therefore add to the total amount of their residual income. Division C would reject the opportunity because the 15% return on the new investment is less than its 16% required rate of return.

Managerial Accounting, 16th Edition

Exercise 11-13 (15 minutes) 1.

Margin = = Turnover = =

Net operating income Sales $150,000 = 5% $3,000,000 Sales Average operating assets $3,000,000 =4 $750,000

ROI = Margin × Turnover = 5% × 4 = 20%

Margin =

Net operating income Sales

$150,000(1.00 + 2.00) $3,000,000(1.00 + 0.50)

$450,000 = 10% $4,500,000

Turnover =

Sales Average operating assets

$3,000,000(1.00 + 0.50) $750,000

$4,500,000 =6 $750,000

ROI = Margin × Turnover = 10% × 6 = 60%

Exercise 11-13 (continued) 3.

Margin =

Net operating income Sales

$150,000 + $200,000 $3,000,000 + $1,000,000

$350,000 = 8.75% $4,000,000

Turnover =

Sales Average operating assets

$3,000,000 + $1,000,000 $750,000 + $250,000

$4,000,000 =4 $1,000,000

ROI = Margin × Turnover = 8.75% × 4 = 35%

Managerial Accounting, 16th Edition

Problem 11-14 (30 minutes) 1. a., b., and c.

Month Throughput time—days: Process time (x) ................................ Inspection time.................................. Move time ......................................... Queue time ....................................... Total throughput time (y) ................... Delivery cycle time—days: Wait time from order to start of production ...................................... Throughput time................................ Total delivery cycle time .....................

2.1 0.6 0.4 4.3 7.4

2.0 0.7 0.3 5.0 8.0

1.9 0.7 0.4 5.8 8.8

1.8 0.6 0.4 6.7 9.5

16.0 7.4 23.4

17.5 8.0 25.5

19.0 8.8 27.8

20.5 9.5 30.0

Manufacturing cycle efficiency (MCE): Process time (a) ................................. 2.1 2.0 1.9 1.8 Throughout time (b) .......................... 7.4 8.0 8.8 9.5 MCE (a) ÷ (b).................................... 28.4% 25.0% 21.6% 18.9% 2. All of the performance measures display unfavorable trends. Throughput time per unit is increasing—largely because of an increase in queue time. Manufacturing cycle efficiency is declining and delivery cycle time is increasing. In addition, the percentage of on-time deliveries has dropped.

Problem 11-14 (continued) 3. a. and b.

Month Throughput time—days: Process time (x) ............................................. Inspection time............................................... Move time ...................................................... Queue time .................................................... Total throughput time (y) ................................

1.8 0.6 0.4 0.0 2.8

1.8 0.0 0.4 0.0 2.2

Manufacturing cycle efficiency (MCE): Process time (x) ÷ Throughput time (y) ...........

64.3%

81.8%

As a company reduces non-value-added activities, the manufacturing cycle efficiency increases rapidly. The goal, of course, is to have an efficiency of 100%. This will be achieved when all non-value-added activities have been eliminated and process time is equal to throughput time.

Managerial Accounting, 16th Edition

Problem 11-15 (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 =

Beginning Balances

$ 140,000 450,000 320,000 680,000 $1,590,000

Ending Balances

$ 120,000 530,000 380,000 620,000 $1,650,000

$1,650,000 + $1,590,000 = $1,620,000 2

2. The margin, turnover, and return on investment (ROI) are calculated as follows: Net operating income Margin = Sales

= Turnover= =

$405,000 = 10% $4,050,000 Sales Average operating assets $4,050,000 = 2.5 $1,620,000

ROI = Margin × Turnover = 10% × 2.5 = 25% 3. The residual income is calculated as follows: Net operating income .......................................... Minimum required return (15% × $1,620,000) ..... Residual income ..................................................

$405,000 243,000 $162,000

Problem 11-16 (45 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 low-volume 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, 16th Edition

Problem 11-16 (continued) 3. Students’ answers may differ in some details from this solution. Financial Sales

Contribution margin per ton

Customer Number of new customers acquired Time to fill an order

Number of different paper grades produced

Average changeover time

Learning and Growth

Customer satisfaction with breadth of product offerings

–

Internal Business Processes

–

Average manufacturing yield

Number of employees trained to support the flexibility strategy

Problem 11-16 (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, 16th Edition

Problem 11-17 (30 minutes) 1. Breaking the ROI computation into two separate elements reveals important relationships that otherwise might remain hidden. First, the importance of asset turnover 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 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, ratios make it easier to make comparisons between segments of the organization. 2. The missing information is as follows:

Sales (a) ............................... Net operating income (b) ....... Average operating assets (c) .. Margin (b) ÷ (a) .................... Turnover (a) ÷ (c) ................. Return on investment (ROI) ...

Companies in the Same Industry A B C

$600,000 * $84,000 * $300,000 * 14% 2.0 28%

$500,000 * $70,000 * $1,000,000 14% 0.5 7% *

$2,000,000 $70,000 $1,000,000 * 3.5% * 2.0 * 7%

*Given.

NAA Report No. 35 states (p. 35): “Introducing sales to measure level of operations helps to disclose specific areas for more intensive investigation. Company B does as well as Company A in terms of 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 fifty 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?” © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 11

Problem 11-17 (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 (requiring higher salaries or transportation charges), is it due to excessive materials costs, or is it due to 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, 16th Edition

Problem 11-18 (30 minutes) Requirements 1, 2, and 3: (1) Sales .......................... (2) Net operating income .. (3) Operating assets ......... (4) Margin (2) ÷ (1) ......... (5) Turnover (1) ÷ (3) ...... (6) ROI (4) × (5) .............

This Year

$10,000,000 $800,000 $4,000,000 8% 2.5 20.0%

New Line

Next Year

$2,000,000 $12,000,000 $160,000 * $960,000 $1,000,000 $5,000,000 8% 8% 2.0 2.4 16.0% 19.2%

* Sales ......................................................... Variable expenses (60% × $2,000,000) ....... Contribution margin .................................... Fixed expenses ........................................... Net operating income..................................

$2,000,000 1,200,000 800,000 640,000 $ 160,000

4. Dell Havasi will be inclined to reject the new product line because accepting it would reduce his division’s overall rate of return. 5. The new product line promises an ROI of 16%, whereas the company’s overall ROI this year was only 15%. Thus, adding the new line would increase the company’s overall ROI. 6a through 6c:

This Year

New Line

Next Year

Operating assets ..................... $4,000,000 $1,000,000 $5,000,000 Minimum return required ......... × 12% × 12% × 12% Minimum required return ......... $ 480,000 $ 120,000 $ 600,000 Actual net operating income .... $ 800,000 $ 160,000 $ 960,000 Minimum required return (above)................................ 480,000 120,000 600,000 Residual income ...................... $ 320,000 $ 40,000 $ 360,000 6d.

Under the residual income approach, Dell Havasi would be inclined to accept the new product line because adding the product line would increase the total amount of his division’s residual income, as shown above.

Problem 11-19 (30 minutes) 1. a., b., and c.

Month Throughput time in days: Process time .................................. Inspection time .............................. Move time ..................................... Queue time during production ........ Total throughput time ..................... Manufacturing cycle efficiency (MCE): Process time ÷ Throughput time ..... Delivery cycle time in days: Wait time to start of production ...... Throughput time ............................ Total delivery cycle time .................

2.1 0.8 0.3 2.8 6.0

2.0 0.7 0.4 4.4 7.5

1.9 0.7 0.4 6.0 9.0

1.8 0.7 0.5 7.0 10.0

35.0% 26.7% 21.1% 18.0% 9.0 6.0 15.0

11.5 7.5 19.0

12.0 9.0 21.0

14.0 10.0 24.0

2. a. Areas where the company is improving:

Quality control. The number of defects has decreased by over 50% (from 185 to 91) in the last four months. Moreover, both warranty claims and customer complaints are down sharply. In short, overall quality appears to have significantly improved.

Material control. The purchase order lead time is only half (now 4

days from 8 days) of what it was four months ago, which indicates that purchases are arriving in less time. This trend may be a result of the company’s move toward JIT purchasing.

Delivery performance. The process time has decreased by 14% from 2.1 days to 1.8 days over the last four months.

Managerial Accounting, 16th Edition

Problem 11-19 (continued) b. Areas of deterioration:

Material control. Scrap as a percentage of total cost has tripled (from 1% to 3%) over the last four months.

Machine performance. Machine downtime has doubled (from 3% to 6%) over the last four months. This may be a result of the greater setup time, or it may just reflect efforts to get the new equipment operating properly. Also note that use of the machines as a percentage of availability is declining rapidly.

Delivery performance. All delivery performance measures are moving

in the wrong direction. Throughput time and delivery cycle time are both increasing, and the manufacturing cycle efficiency is decreasing. 3. a. and b.

Month Throughput time in days: Process time .......................................... Inspection time...................................... Move time ............................................. Queue time during production ................ Total throughput time ............................

1.8 0.7 0.5 0.0 3.0

1.8 0.0 0.5 0.0 2.3

Manufacturing cycle efficiency (MCE): Process time ÷ Throughput time.............

60.0% 78.3%

As non-value-added activities are eliminated, the manufacturing cycle efficiency improves. The goal, of course, is to have an efficiency of 100%. This is achieved when all non-value-added activities have been eliminated and process time equals throughput time.

Problem 11-20 (30 minutes) 1.

ROI =

Net operating income Sales × Sales Average operating assets

$360,000 $4,000,000 × $4,000,000 $2,000,000

= 9% × 2 = 18%

ROI = =

$360,000 $4,000,000 × $4,000,000 $1,600,000 9% × 2.5 = 22.5% (Unchanged) (Increase) (Increase)

ROI =

$392,000 $4,000,000 × $4,000,000 $2,000,000

9.8% × 2 = (Increase) (Unchanged)

19.6% (Increase)

4. Interest is a financing expense and thus it is not used to compute net operating income. ROI =

$380,000 $4,000,000 × $4,000,000 $2,500,000

9.5% × 1.6 = (Increase) (Decrease)

15.2% (Decrease)

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Problem 11-20 (continued) 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 net operating income of: Sales (1.20 × $4,000,000) ..... Variable expenses.................. Contribution margin............... Fixed expenses ..................... Net operating income ............

$4,800,000 3,360,000 1,440,000 840,000 $ 600,000

100 % 70 * 30 %

* $56 ÷ $80 = 70% ROI = =

ROI = =

ROI =

$600,000 $4,800,000 × $4,800,000 $2,000,000 12.5% × 2.4 = 30% (Increase) (Increase) (Increase) $320,000 $4,000,000 × $4,000,000 $1,960,000 8% × 2.04 = 16.3% (Decrease) (Increase) (Decrease) $360,000 $4,000,000 × $4,000,000 $1,800,000

= 9% × 2.22 = 20% (Unchanged) (Increase) (Increase)

Problem 11-21 (90 minutes) 1. Both companies view training as important; both companies need to leverage technology to succeed in the marketplace; and both companies are concerned with minimizing defects. There are numerous differences between the two companies. For example, Applied Pharmaceuticals is a product-focused company and Destination Resorts International (DRI) is a service-focused company. Applied Pharmaceuticals’ training resources are focused on their engineers because they hold the key to the success of the organization. DRI’s training resources are focused on their frontline employees because they hold the key to the success of their organization. Applied Pharmaceuticals’ technology investments are focused on supporting the innovation that is inherent in the product development side of the business. DRI’s technology investments are focused on supporting the day-to-day execution that is inherent in the customer interface side of the business. Applied Pharmaceuticals defines a defect from an internal manufacturing standpoint, while DRI defines a defect from an external customer interaction standpoint.

Managerial Accounting, 16th Edition

Problem 11-21 (continued) 2. Students’ answers may differ in some details from this solution. Applied Pharmaceuticals Financial

Return on Stockholders’ Equity

Customer Customer perception of first-to-market capability

Internal Business Processes

R&D Yield

Learning and Growth

Customer perception of product quality

Defect rates

Percentage of job offers accepted

Dollars invested in engineering technology

–

Dollars invested in engineering training per engineer

Problem 11-21 (continued) Destination Resorts International Financial

Sales

Customer

Number of repeat customers

Internal Business Processes

Percentage of error-free repeat customer check-ins

Learning and Growth

Room cleanliness

Employee turnover

Average time to resolve customer complaint

–

Employee morale as shown in survey

Number of employees receiving database training

–

Managerial Accounting, 16th Edition

Problem 11-21 (continued) 3. The hypotheses underlying the balanced scorecards are indicated by the arrows in each diagram. Reading from the bottom of each balanced scorecard, the hypotheses are: Applied Pharmaceuticals o If the dollars invested in engineering technology increase, then the R&D yield will increase. o If the percentage of job offers accepted increases, then the R&D yield will increase. o If the dollars invested in engineering training per engineer increase, then the R&D yield will increase. o If the R&D yield increases, then customer perception of first-tomarket capability will increase. o If the defects per million opportunities decrease, then the customer perception of product quality will increase. o If the customer perception of first-to-market capability increases, then the return on stockholders’ equity will increase. o If the customer perception of product quality increases, then the return on stockholders’ equity will increase. Destination Resort International o If the employee turnover decreases, then the percentage of errorfree repeat customer check-ins and room cleanliness will increase and the average time to resolve customer complaints will decrease. o If the number of employees receiving database training increases, then the percentage of error-free repeat customer check-ins will increase. o If employee morale increases, then the percentage of error-free repeat customer check-ins and room cleanliness will increase and the average time to resolve customer complaints will decrease. o If the percentage of error-free repeat customer check-ins increases, then the number of repeat customers will increase. o If the room cleanliness increases, then the number of repeat customers will increase. o If the average time to resolve customer complaints decreases, then the number of repeat customers will increase. o If the number of repeat customers increases, then sales will increase. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 11

Problem 11-21 (continued) Each of these hypotheses is questionable to some degree. For example, in the case of Applied Pharmaceuticals, R&D yield is not the sole driver of the customers’ perception of first-to-market capability. More specifically, if Applied Pharmaceuticals experimented with nine possible drug compounds in year one and three of those compounds proved to be successful in the marketplace it would result in an R&D yield of 33%. If in year two, it experimented with four possible drug compounds and two of those compounds proved to be successful in the marketplace it would result in an R&D yield of 50%. While the R&D yield has increased from year one to year two, it is quite possible that the customer’s perception of first-to-market capability would decrease. 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 the balanced scorecard can then be appropriately modified.

Managerial Accounting, 16th Edition

Problem 11-22 (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. 2. 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. 3. 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.

Problem 11-22 (continued) 4. As stated above, ratios can be improved by changing either the numerator or the denominator. Managers who are under pressure to increase the revenue per employee may find it easier to eliminate employees than to increase revenues. Of course, eliminating employees may reduce total revenues and total profits, but the revenue per employee will increase as long as the percentage decline in revenues is less than the percentage cut in number of employees. Suppose, for example, that a manager is responsible for business units with a total of 1,000 employees, $120 million in revenues, and profits of $2 million. Further suppose that a manager can eliminate one of these business units that has 200 employees, revenues of $10 million, and profits of $1.2 million.

Total revenue................ Total employees ............ Revenue per employee .. Total profits ..................

Before eliminating After eliminating the business unit the business unit $120,000,000 1,000 $120,000 $2,000,000

$110,000,000 800 $137,500 $800,000

As these examples illustrate, performance measures should be selected with a great deal of care and managers should avoid placing too much emphasis on any one performance measure.

Managerial Accounting, 16th Edition

Case 11-23 (60 minutes) 1. Student answers may differ concerning which category—learning and growth, internal business processes, customers, or financial—a particular performance measure belongs to.

Financial

Total profit

Average age of accounts receivable

Customer

Written-off accounts receivable as a percentage of − sales

−

Customer satisfaction with + accuracy of charge account bills

Internal Percentage of Business Processes charge account bills − containing errors

Learning and Growth

Percentage of sales clerks trained to correctly enter data on charge account slips

Unsold inventory at end of season as a percentage of total cost of sales

−

Percentage of suppliers making just-in-time deliveries

Case 11-23 (continued) A number of the performance measures suggested by managers have not been included in the above balanced scorecard. The excluded performance measures may have an impact on total profit, but they are not linked in any obvious way with the two key problems that have been identified by management—accounts receivables and unsold inventory. If every performance measure that potentially impacts profit is included in a company’s balanced scorecard, it would become unwieldy and focus would be lost. 2. The results of operations can be exploited for information about the company’s strategy. Each link in the balanced scorecard should be regarded as a hypothesis of the form “If ..., then ...”. For example, the balanced scorecard on the previous page contains the hypothesis “If customers express greater satisfaction with the accuracy of their charge account bills, then the average age of accounts receivable will improve.” If customers in fact do express greater satisfaction with the accuracy of their charge account bills, but the average age of accounts receivable does not improve, this would have to be considered evidence that is inconsistent with the hypothesis. Management should try to figure out why the average age of receivables has not improved. (See the answer below for possible explanations.) The answer may suggest a shift in strategy. In general, the most important results are those that provide evidence inconsistent with the hypotheses embedded in the balanced scorecard. Such evidence suggests that the company’s strategy needs to be reexamined.

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Case 11-23 (continued) 3. a. This evidence is inconsistent with two of the hypotheses underlying the balanced scorecard. The first of these hypotheses is “If customers express greater satisfaction with the accuracy of their charge account bills, then the average age of accounts receivable will improve.” The second of these hypotheses is “If customers express greater satisfaction with the accuracy of their charge account bills, then there will be improvement in bad debts.” There are a number of possible explanations. Two possibilities are that the company’s collection efforts are ineffective and that the company’s credit reviews are not working properly. In other words, the problem may not be incorrect charge account bills at all. The problem may be that the procedures for collecting overdue accounts are not working properly. Or, the problem may be that the procedures for reviewing credit card applications let through too many poor credit risks. If so, this would suggest that efforts should be shifted from reducing charge account billing errors to improving the internal business processes dealing with collections and credit screening. And in that case, the balanced scorecard should be modified. b. This evidence is inconsistent with three hypotheses. The first of these is “If the average age of receivables declines, then profits will increase.” The second hypothesis is “If the written-off accounts receivable decrease as a percentage of sales, then profits will increase.” The third hypothesis is “If unsold inventory at the end of the season as a percentage of cost of sales declines, then profits will increase.” Again, there are a number of possible explanations for the lack of results consistent with the hypotheses. Managers may have decreased the average age of receivables by simply writing off old accounts earlier than was done previously. This would actually decrease reported profits in the short term. Bad debts as a percentage of sales could be decreased by drastically cutting back on extensions of credit to customers—perhaps even canceling some charge accounts. (Bad debts would be zero if there were no credit sales.) This would have the effect of reducing bad debts, but might irritate otherwise loyal credit customers and reduce sales and profits.

Case 11-23 (continued) The reduction in unsold inventories at the end of the season as a percentage of cost of sales could have occurred for a number of reasons that are not necessarily good for profits. For example, managers may have been too cautious about ordering goods to restock low inventories—creating stockouts and lost sales. Or, managers may have cut prices drastically on excess inventories in order to eliminate them before the end of the season. This may have reduced the willingness of customers to pay the store’s normal prices. Or, managers may have gotten rid of excess inventories by selling them to discounters before the end of the season.

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Appendix 11A Transfer Pricing

Exercise 11A-1 (30 minutes) 1. a. 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 ³ Variable cost + per unit Number of units transferred Because there is enough idle capacity to fill the entire order from the Hi-Fi Division, no outside sales are lost. And because the variable cost per unit is $42, the lowest acceptable transfer price as far as the selling division is concerned is also $42.

Transfer price ³ $42 +

$0 = $42 5,000

b. The Hi-Fi division can buy a similar speaker from an outside supplier for $57. Therefore, the Hi-Fi Division would be unwilling to pay more than $57 per speaker. Transfer price £ Cost of buying from outside supplier = $57

c. Combining the requirements of both the selling division and the buying division, the acceptable range of transfer prices in this situation is:

$42 £ Transfer price £ $57 Assuming that the managers understand their own businesses and that they are cooperative, they should be able to agree on a transfer price within this range and the transfer should take place. d. From the standpoint of the entire company, the transfer should take place. The cost of the speakers transferred is only $42 and the company saves the $57 cost of the speakers purchased from the outside supplier. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Appendix 11A

Exercise 11A-1 (continued) 2. a. Each of the 5,000 units transferred to the Hi-Fi Division must displace a sale to an outsider at a price of $60. Therefore, the selling division would demand a transfer price of at least $60. This can also be computed using the formula for the lowest acceptable transfer price as follows:

Transfer price ³ $42 +

($60 - $42) × 5,000 5,000

= $42 + ($60 - $42) = $60 b. As before, the Hi-Fi Division would be unwilling to pay more than $57 per speaker. c. The requirements of the selling and buying divisions in this instance are incompatible. The selling division must have a price of at least $60 whereas the buying division will not pay more than $57. An agreement to transfer the speakers is extremely unlikely. d. From the standpoint of the entire company, the transfer should not take place. By transferring a speaker internally, the company gives up revenue of $60 and saves $57, for a loss of $3.

Managerial Accounting, 16th Edition

Exercise 11A-2 (20 minutes) 1. Sales ............................ Expenses: Added by the division.. Transfer price paid ...... Total expenses .............. Net operating income ....

Division A

Division B

Total Company

$2,500,000 $1,200,0002 $3,200,0003 1,800,000

400,000 500,000 1,800,000 900,000 $ 700,000 $ 300,000

20,000 units × $125 per unit = $2,500,000 4,000 units × $300 per unit = $1,200,000 3 Division A outside sales (16,000 units × $125 per unit) .................... Division B outside sales (4,000 units × $300 per unit) ...................... Total outside sales........................................

2,200,000 2,200,000 $1,000,000

1 2

$2,000,000 1,200,000 $3,200,000

Note that the $500,000 in intracompany sales have been eliminated. 2. Division A should transfer the 1,000 additional circuit boards to Division B. Note that Division B’s processing adds $175 to each unit’s selling price (B’s $300 selling price – A’s $125 selling price = $175 increase), but it adds only $100 in cost. Therefore, each board transferred to Division B ultimately yields $75 more in contribution margin ($175 – $100 = $75) to the company than can be obtained from selling to outside customers. Thus, the company as a whole will be better off if Division A transfers the 1,000 additional boards to Division B.

Exercise 11A-3 (20 minutes) 1a. 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 ³ Variable cost + per unit Number of units transferred There is no idle capacity, so each of the 40,000 units transferred from Division X to Division Y reduces sales to outsiders by one unit. The contribution margin per unit on outside sales is $20 (= $90 – $70). Transfer price ³ ($70 - $3) +

$20 × 40,000 40,000

= $67 + $20 = $87

1b. The buying division, Division Y, can buy a similar unit from an outside supplier for $86. Therefore, Division Y would be unwilling to pay more than $86 per unit. Transfer price £ Cost of buying from outside supplier = $86

1c. There is no range of acceptable transfer prices. The requirements of the two divisions are incompatible and no transfer will take place.

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Exercise 11A-3 (continued) 2a. In this case, Division X has enough idle capacity to satisfy Division Y’s 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 $60 per unit. Transfer price ³ $60 +

$0 = $60 40,000

2b. The buying division, Division Y, can buy a similar unit from an outside supplier for $74. Therefore, Division Y would be unwilling to pay more than $74 per unit. Transfer price £ Cost of buying from outside supplier = $74

2c. As shown below, the range of acceptable transfer prices is $60 to $74. In this case, the requirements of the two divisions are compatible and a transfer hopefully will take place.

$60 £ Transfer price £ $74

Problem 11A-4 (60 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 ³ 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 ³ $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 $70 a ton, less a 10% quantity discount of $7, or $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, net of the quantity discount, 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

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Problem 11A-4 (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 ³ $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.

Problem 11A-4 (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.

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Problem 11A-5 (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: Cabinet 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 cabinets to outsiders.. Variable cost of Quark Division ........................... Net loss per TV ....................................................

$340 $140 210

350 ($ 10)

Problem 11A-5 (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.

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Problem 11A-6 (60 minutes) 1a, 1b, and 1c: From the standpoint of the selling division, Alpha Division:

Total contribution margin on lost sales Transfer price ³ Variable cost + per unit Number of units transferred Transfer price ³ ($18 - $2) +

($30 - $18) × 5,000 = $16 + $12 = $28 5,000

But, from the standpoint of the buying division, Beta Division: Transfer price £ Cost of buying from outside supplier = $27

There is no range of acceptable transfer prices. Beta Division won’t pay more than $27 and Alpha Division will not accept less than $28, so no deal is possible. There will be no transfer. 2a, 2b, and 2c. From the standpoint of the selling division, Alpha Division:

Total contribution margin on lost sales Transfer price ³ Variable cost + per unit Number of units transferred Transfer price ³ ($65 - $5)+

($90 - $65) × 30,000 = $60 + $25 = $85 30,000

From the standpoint of the buying division, Beta Division: Transfer price £ Cost of buying from outside supplier = $89

In this instance, the range of acceptable transfer prices is:

$85 £ Transfer price £ $89 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 $85 while the selling division argues just as strongly for $89.

Problem 11A-6 (continued) 2d.

The loss in potential profits to the company as a whole will be: Beta Division’s outside purchase price ......................... Alpha Division’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 ........................................................

$89 85 $4 × 30,000 $120,000

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 Alpha Division will be: Suggested selling price per unit .................................. Alpha Division’s variable cost on the internal transfer ... Potential added contribution margin per unit ............... Number of units ........................................................ Potential added contribution margin and divisional profits forgone ........................................................

$88 85 $3 × 30,000 $90,000

The loss in potential profits in Beta Division 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 ........................................................

$89 88 $1 × 30,000 $30,000

The total of these two amounts equals the $120,000 loss in potential profits for the company as a whole. 3a.

From the standpoint of the selling division, Alpha Division:

Total contribution margin on lost sales Transfer price ³ Variable cost + per unit Number of units transferred Transfer price ³ $40 +

$0 = $40 20,000

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Problem 11A-6 (continued) 3b and 3c. From the standpoint of the buying division, Beta Division:

Transfer price £ Cost of buying from outside supplier Transfer price £ $75 - (0.08 × $75) = $69 In this case, the range of acceptable transfer prices is:

$40 £ Transfer price £ $69 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. 3d.

Alpha Division’s ROI should increase. The division has idle capacity, so selling 20,000 units a year to Beta Division should cause no increase in the division’s operating assets. Therefore, Alpha Division’s turnover should increase. The division’s margin should also increase, because its contribution margin will increase by $400,000 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 ...............

$60 40 $20 × 20,000 $400,000

Thus, with both the margin and the turnover increasing, the division’s ROI would also increase. 4. From the standpoint of the selling division, Alpha Division:

Total contribution margin on lost sales Transfer price ³ Variable cost + per unit Number of units transferred

Transfer price ³ $21 +

($50 - $26) × 45,000 120,000

= $21 + $9 = $30

Case 11A-7 (60 minutes) 1. The Electrical Division is presently operating at capacity; therefore, any sales of X52 electrical fittings to the Brake Division will require that the Electrical Division give up an equal number of sales to outside customers. Using the transfer pricing formula, we get a minimum transfer price of:

Total contribution margin on lost sales Transfer price ³ Variable cost + per unit Number of units transferred

Transfer price ³

$4.25 + ($7.50 - $4.25)

Transfer price ³

$4.25 + $3.25

Transfer price ³

$7.50

Thus, the Electrical Division should not supply the fitting to the Brake Division for $5 each. The Electrical Division must give up revenues of $7.50 on each fitting that it sells internally. Because management performance in the Electrical Division is measured by ROI, selling the fittings to the Brake Division for $5 would adversely affect these performance measurements. 2. The key is to realize that the $8 in fixed overhead and administrative costs contained in the Brake Division’s $49.50 “cost” per brake unit is not relevant. There is no indication that winning this contract would actually affect any of the fixed costs. If these costs would be incurred regardless of whether or not the Brake Division gets the airplane brake contract, they should be ignored when determining the effects of the contract on the company’s profits. Another key is that the variable cost of the Electrical Division is not relevant either. Whether the fittings are used in the brake units or sold to outsiders, the production costs of the fittings would be the same. The only difference between the two alternatives is the revenue on outside sales that is given up when the fittings are transferred within the company.

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Case 11A-7 (continued) Selling price of the brake units ................................. Less: The cost of the fittings used in the brakes (i.e. the lost revenue from sale of fittings to outsiders) ..... Variable costs of the Brake Division excluding the fitting ($22.50 + $14.00) .................................... Net positive effect on the company’s profit ...............

$50.00 $ 7.50 36.50

44.00 $ 6.00

Therefore, the company as a whole would be better off by $6.00 for each brake unit that is sold to the airplane manufacturer. 3. As shown in part (1) above, the Electrical Division would insist on a transfer price of at least $7.50 for the fitting. Would the Brake Division make any money at this price? Again, the fixed costs are not relevant in this decision because they would not be affected. Once this is realized, it is evident that the Brake Division would be ahead by $6.00 per brake unit if it accepts the $7.50 transfer price. Selling price of the brake units ................................ $50.00 Less: Purchased parts (from outside vendors) ................ $22.50 Electrical fitting X52 (assumed transfer price) ........ 7.50 Other variable costs ............................................. 14.00 44.00 Brake Division contribution margin .......................... $ 6.00 In fact, because there is a positive contribution margin of $6, any transfer price within the range of $7.50 to $13.50 (= $7.50 + $6.00) will improve the profits of both divisions. So yes, the managers should be able to agree on a transfer price.

Case 11A-7 (continued) 4. It is in the best interests of the company and of the divisions to come to an agreement concerning the transfer price. As demonstrated in part (3) above, any transfer price within the range $7.50 to $13.50 would improve the profits of both divisions. What happens if the two managers do not come to an agreement? In this case, top management knows that there should be a transfer and could step in and force a transfer at some price within the acceptable range. However, such an action, if done on a frequent basis, would undermine the autonomy of the managers and turn decentralization into a sham. Our advice to top management would be to ask the two managers to meet to discuss the transfer pricing decision. Top management should not dictate a course of action or what is to happen in the meeting, but should carefully observe what happens in the meeting. If there is no agreement, it is important to know why. There are at least three possible reasons. First, the managers may have better information than the top managers and refuse to transfer for very good reasons. Second, the managers may be uncooperative and unwilling to deal with each other even if it results in lower profits for the company and for themselves. Third, the managers may not be able to correctly analyze the situation and may not understand what is actually in their own best interests. For example, the manager of the Brake Division may believe that the fixed overhead and administrative cost of $8 per brake unit really does have to be covered in order to avoid a loss. If the refusal to come to an agreement is the result of uncooperative attitudes or an inability to correctly analyze the situation, top management can take some positive steps that are completely consistent with decentralization. If the problem is uncooperative attitudes, there are many training companies that would be happy to put on a short course in team building for the company. If the problem is that the managers are unable to correctly analyze the alternatives, they can be sent to executive training courses that emphasize economics and managerial accounting.

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Appendix 11B Service Department Charges

Exercise 11B-1 (15 minutes) 1. and 2.

Northern Southern Plant Plant

Total

Variable cost charges: $0.25 per ton × 130,000 tons........... $ 32,500 $0.25 per ton × 50,000 tons ............ $ 12,500 $ 45,000 Fixed cost charges: 70% × $300,000 ............................. 210,000 30% × $300,000 ............................. 90,000 300,000 Total charges ..................................... $242,500 $102,500 $345,000 3. Part of the $364,000 in total cost will not be charged to the plants, as follows:

Total actual cost incurred .................... Total charges (above) ......................... Spending variance ..............................

Variable Cost

Fixed Cost

Total

$54,000 $310,000 $364,000 45,000 300,000 345,000 $ 9,000 $ 10,000 $ 19,000

The overall spending variance of $19,000 represents costs incurred in excess of the budgeted $0.25 per ton variable cost and budgeted $300,000 in fixed costs. This $19,000 in uncharged cost is the responsibility of the Transport Services Department.

Exercise 11B-2 (20 minutes) 1. Percentage of this year’s sales ....................... Allocation of this year’s fixed administrative expenses (based on the above percentages) 2. This year’s allocation (above) ......................... Last year’s allocation ..................................... Increase (decrease) in allocation ....................

Restaurants Rick’s Imperial Harborside Garden

Ginger Wok

$640,000 $1,000,000

$360,000 $2,000,000

$640,000 $1,000,000 800,000 750,000 $(160,000) $ 250,000

$360,000 $2,000,000 450,000 2,000,000 $(90,000) $ 0

32%

50%

18%

Total

100%

The manager of the Imperial Garden undoubtedly will be upset about the increased allocation of fixed administrative expense. Such an increased allocation may be viewed as a penalty for an outstanding performance. 3. Sales dollars is not ordinarily a good base for allocating fixed costs. The departments with the greatest sales will be allocated the greatest amount of cost and the costs allocated to a department will be affected by the sales in other departments. In our illustration above, the sales in two restaurants remained static and the sales in the third increased. As a result, less cost was allocated to the restaurants with static sales and more cost was allocated to the one restaurant that showed improvement during the period.

Managerial Accounting, 16th Edition

Exercise 11B-3 (20 minutes) 1. Cutting Department ....... Milling Department ........ Assembly Department.... Total .............................

Long-Run Average Number of Employees Percentage 180 120 300 600

30% 20% 50% 100%

Cutting

Variable cost charges: $80 per employee × 150 employees . $ 12,000 $80 per employee × 80 employees ... $80 per employee × 270 employees . Fixed cost charges: 30% × $400,000 ............................. 120,000 20% × $400,000 ............................. 50% × $400,000 ............................. Total charges ..................................... $132,000

Milling $ 6,400

Assembly

$ 21,600

80,000

200,000 $86,400 $221,600

2. Part of the total actual cost should not be charged to the operating departments as shown below:

Total actual costs incurred .............. Total charges ................................. Spending variance ..........................

Variable Cost

Fixed Cost

Total

$41,000 $408,000 $449,000 40,000 400,000 440,000 $ 1,000 $ 8,000 $ 9,000

The overall spending variance of $9,000 represents costs incurred in excess of the budgeted variable cost of $80 per employee and the budgeted fixed cost of $400,000. This $9,000 in uncharged costs is the responsibility of the Medical Services Department.

Problem 11B-4 (45 minutes) 1. Variable costs: $3 per meal × 20,000 meals ..... $3 per meal × 20,000 meals ..... Fixed costs: 65% × $40,000 ........................ 35% × $40,000 ........................ Total cost charged .......................

Auto Division $60,000 26,000 $86,000

Truck Division $60,000 14,000 $74,000

The variable costs are charged using the budgeted rate per meal and the actual meals served. The fixed costs are charged in predetermined, lump-sum amounts, based on budgeted fixed costs and peak-load capacity. Any difference between budgeted and actual costs is not charged to the operating divisions, but rather is treated as a spending variance of the cafeteria: Total actual cost for the month ................. Total cost charged above ($60,000 + $60,000; $26,000 + $14,000) ................ Spending variance—not allocated ............. 2. Actual variable cost ............... Actual fixed cost.................... Total actual cost ....................

Variable

Fixed

$128,000

$42,000

120,000 $ 8,000

40,000 $ 2,000

$128,000 42,000 $170,000

One-half of the total cost, or $85,000, would be allocated to each division, because the same number of meals was served in the two divisions during the month.

Managerial Accounting, 16th Edition

Problem 11B-4 (continued) 3. This method has two major problems. First, allocating the total actual cost of the service department to the operating departments essentially allocates the spending variances to the operating departments. This forces the inefficiencies of the service department onto the operating departments. Second, allocating the fixed costs of the service department according to the actual level of activity in each operating department results in the allocation to one operating department being affected by the actual activity in the other operating departments. For example, if the activity in one operating department falls, the fixed charges to the other operating departments will increase. 4. Managers may understate their peak-period needs to reduce their charges for fixed service department costs. Top management can control such ploys by careful follow-up, with rewards being given to those managers who estimate accurately, and severe penalties assessed against those managers who understate their departments’ needs. For example, departments that exceed their estimated peak-period maintenance requirements may be forced to hire outside maintenance contractors, at market rates, to do their maintenance work during peak periods.

Problem 11B-5 (20 minutes) 1. Variable costs: $0.40 per machine-hour × 190,000 machine-hours ....... $0.40 per machine-hour × 70,000 machine-hours ......... Fixed costs: 70% × $150,000 ................... 30% × $150,000 ................... Total cost charged ....................

Forming Assembly Department Department

Total

$ 76,000

105,000 $181,000

$28,000

$104,000

45,000 $73,000

150,000 $254,000

2. Any difference between the budgeted and actual variable cost per machine-hour or between the budgeted and actual total fixed cost would not be charged to the other departments. The amount not charged would be:

Variable Cost

Fixed Cost

Total

Actual cost incurred during the year ... $110,000 $153,000 $263,000 Cost charged (above) ........................ 104,000 150,000 254,000 Cost not charged (spending variance) . $ 6,000 $ 3,000 $ 9,000 The costs not charged are spending variances of the Maintenance Department and are the responsibility of the Maintenance Department’s manager.

Managerial Accounting, 16th Edition

Chapter 12 Differential Analysis: The Key to Decision Making Solutions to Questions 12-1 A relevant cost is a cost that differs in total between the alternatives in a decision. 12-2 An incremental cost (or benefit) is the change in cost (or benefit) that will result from some proposed action. An opportunity cost is the benefit that is lost or sacrificed when rejecting some course of action. A sunk cost is a cost that has already been incurred and that cannot be changed by any future decision. 12-3 No. Variable costs are relevant costs only if they differ in total between the alternatives under consideration. 12-4 No. Not all fixed costs are sunk—only those for which the cost has already been irrevocably incurred. A variable cost can be a sunk cost if it has already been incurred. 12-5 No. A variable cost is a cost that varies in total amount in direct proportion to changes in the level of activity. A differential cost is the difference in cost between two alternatives. If the level of activity is the same for the two alternatives, a variable cost will not be affected and it will be irrelevant. 12-6 No. Only those future costs that differ between the alternatives are relevant. 12-7 Only those costs that would be avoided as a result of dropping the product line are relevant in the decision. Costs that will not be affected by the decision are irrelevant. 12-8 Not necessarily. An apparent loss may be the result of allocated common costs or of sunk costs that cannot be avoided if the product is dropped. A product should be discontinued only if the contribution margin that will be lost

as a result of dropping the product is less than the fixed costs that would be avoided. Even in that situation the product may be retained if it promotes the sale of other products. 12-9 Allocations of common fixed costs can make a product (or other segment) appear to be unprofitable, whereas in fact it may be profitable. 12-10 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 used to make the part. The company’s opportunity cost is measured by the benefits that could be derived from the best alternative use of the facilities. 12-11 Any resource that is required to make products and get them into the hands of customers could be a constraint. Some examples are machine time, direct labor time, floor space, raw materials, investment capital, supervisory time, and storage space. While not covered in the text, constraints can also be intangible and often take the form of a formal or informal policy that prevents the organization from furthering its goals. 12-12 Assuming that fixed costs are not affected, profits are maximized when the total contribution margin is maximized. A company can maximize its total contribution margin by focusing on the products with the greatest amount of contribution margin per unit of the constrained resource. 12-13 Joint products are two or more products that are produced from a common input. Joint costs are the costs that are incurred up to the split-off point. The split-off point is the point in

the manufacturing process where joint products can be recognized as individual products. 12-14 Joint costs should not be allocated among joint products for decision-making purposes. If joint costs are allocated among the joint products, then managers may think they are avoidable costs of the end products. However, the joint costs will continue to be incurred as long as the process is run regardless of what is done with one of the end products. Thus, when making decisions about the end products, the joint costs are not avoidable and are irrelevant.

12-15 If the incremental revenue from further processing exceeds the incremental costs of further processing, the product should be processed further. 12-16 Most costs of a flight are either sunk costs, or costs that do not depend on the number of passengers on the flight. Depreciation of the aircraft, salaries of personnel on the ground and in the air, and fuel costs, for example, are the same whether the flight is full or almost empty. Therefore, adding more passengers at reduced fares when seats would otherwise be empty does little to increase the total costs of operating the flight, but increases the total contribution and total profit.

Managerial Accounting, 16th Edition

Chapter 12: Applying Excel The completed worksheet is shown below.

Chapter 12: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Managerial Accounting, 16th Edition

Chapter 12: Applying Excel (continued) 1. With the change in the cost of further processing undyed course wool, the result is:

With the reduction in the cost of further processing undyed coarse wool, it is now profitable to process undyed coarse wool into dyed coarse wool. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 12

Chapter 12: Applying Excel (continued) 2. With the revised data, the worksheet should look like this:

Managerial Accounting, 16th Edition

Chapter 12: Applying Excel (continued) a. The profit of the overall operation is now $30,000 if all intermediate products are processed into final products. b. The financial advantage (disadvantage) from further processing each intermediate product is shown below. Coarse Wool

Fine Wool

Superfine Wool

Financial advantage (disadvantage) from further processing.................... $30,000 $40,000 $(10,000) c. To maximize profit, the company should process undyed coarse wool into dyed coarse wool and undyed fine wool into dyed fine wool. However, undyed superfine wool should be sold as is rather than processed into dyed superfine wool. If this plan is followed, the overall profit of the company should be $40,000 as shown below: Combined sales value ($180,000 + $210,000 + $90,000)......... Less costs of producing the end products: Cost of wool ......................................... Cost of separation process ..................... Combined costs of dyeing ($50,000 + $60,000) ........................ Profit ........................................................

$480,000 $290,000 40,000 110,000

440,000 $ 40,000

The Foundational 15 1. The total traceable fixed manufacturing overhead for Alpha and Beta is computed as follows:

Alpha

Beta

Traceable fixed overhead per unit (a) ........ $16 $18 Level of activity in units (b) ....................... 100,000 100,000 Total traceable fixed overhead (a) × (b) .... $1,600,000 $1,800,000 2. The total common fixed expenses is computed as follows:

Alpha

Beta

Common fixed expenses per unit (a) ......... $15 $10 Level of activity in units (b) ....................... 100,000 100,000 Total common fixed expenses (a) × (b) ..... $1,500,000 $1,000,000 The company’s total common fixed expenses would be $2,500,000.

3. The financial advantage of accepting the order is computed as follows:

Incremental revenue ............................ Incremental costs: Variable costs: Direct materials............................... Direct labor..................................... Variable manufacturing overhead ..... Variable selling expenses ................. Total variable cost ............................. Financial advantage of accepting the order ................................................

Per Unit

$80 30 20 7 12 $69

Total 10,000 units

$800,000 300,000 200,000 70,000 120,000 690,000 $110,000

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 4. The financial (disadvantage) is computed as follows:

Incremental revenue ............................ Incremental costs: Variable costs: Direct materials............................... Direct labor..................................... Variable manufacturing overhead ..... Variable selling expenses ................. Total variable cost ............................. Financial (disadvantage) of accepting the order ...........................................

Per Unit

$39

Total 5,000 units

12 15 5 8 $40

$195,000 60,000 75,000 25,000 40,000 200,000

$ (5,000)

5. The financial (disadvantage) is computed as follows: Incremental revenue (10,000 units × $80 per unit) (a) ............................. Incremental variable costs: Direct materials (5,000 units × $30 per unit) ........................................................... $150,000 Direct labor (5,000 units × $20 per unit) ................................................................. 100,000 Variable manufacturing overhead (5,000 units × $7 per unit)................................. 35,000 Variable selling expenses (5,000 units × $12 per unit) ............................... 60,000 Total incremental variable cost (b) ........................... Foregone sales to regular customers (5,000 units × $120 per unit) (c) ............................. Financial (disadvantage) of accepting the order (a) − (b) – (c) ...............................................

$800,000

345,000 600,000 $(145,000)

Note to instructors: There will be additional sales of 10,000 units to the new customer, but because sales to existing customers will decline by 5,000 units the net effect will be to increase production and sales by 5,000 units.

The Foundational 15 (continued) 6. The financial (disadvantage) of dropping the Beta product line is computed as follows: Contribution margin lost if the Beta product line is dropped* ................................................................. $(3,600,000) Traceable fixed manufacturing overhead ....................... 1,800,000 Financial (disadvantage) if Beta is dropped ........... $(1,800,000) * Beta’s contribution margin per unit is $40 (= $80 − $40). Therefore, the decrease in contribution margin if Beta is dropped would be $3,600,000 (= 90,000 units × $40 per unit). Note to instructors: Emphasize that the traceable fixed manufacturing overhead is avoidable and the common fixed expenses are not. 7. The financial advantage of dropping the Beta product line is computed as follows: Contribution margin lost if the Beta product line is dropped* ................................................................... $(1,600,000) Traceable fixed manufacturing overhead ......................... 1,800,000 Financial advantage if Beta is dropped .................. $ 200,000 * Beta’s contribution margin per unit is $40 ($80 − $40). Therefore, the decrease in contribution margin if Beta is dropped would be $1,600,000 (= 40,000 units × $40 per unit). 8. The financial advantage of dropping the Beta product line is computed as follows: Contribution margin lost if the Beta product line is dropped* ................................................................... $(2,400,000) Traceable fixed manufacturing overhead ......................... 1,800,000 Contribution margin on additional Alpha sales** .......... 765,000 Financial advantage if Beta is dropped .................. $ 165,000 * Beta’s contribution margin per unit is $40 (= $80 − $40). Therefore, the decrease in contribution margin if Beta is dropped would be $2,400,000 (= 60,000 units × $40 per unit). ** Alpha’s contribution margin per unit is $51 ($120 − $69). Therefore, the increase in Alpha’s contribution margin if Beta is dropped would be $765,000 (= 15,000 units × $51 per unit). © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 10

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 9. The financial (disadvantage) of buying 80,000 Alphas from a supplier rather than making them is computed as follows: Cost of purchasing (80,000 units × $80 per unit) ......................................................... Direct materials (80,000 units × $30 per unit) Direct labor (80,000 units × $20 per unit)...... Variable manufacturing overhead (80,000 units × $7 per unit) ....................... Traceable fixed manufacturing overhead (100,000 units × $16 per unit) ................... Total costs ................................................... Financial (disadvantage) of buying 80,000 Alphas from a supplier ...............................

Make

Buy

$2,400,000 1,600,000

$6,400,000

560,000 1,600,000 $6,160,000 $6,400,000 $(240,000)

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 Alphas. 10. The financial advantage of buying 50,000 Alphas from a supplier rather than making them is computed as follows: Cost of purchasing (50,000 units × $80 per unit) Direct materials (50,000 units × $30 per unit) Direct labor (50,000 units × $20 per unit ....... Variable manufacturing overhead (50,000 units × $7 per unit) ....................... Traceable fixed manufacturing overhead ........ Total costs ................................................... Financial advantage of buying 50,000 Alphas from the supplier .......................................

Make $1,500,000 1,000,000

Buy $4,000,000

350,000 1,600,000 $4,450,000 $4,000,000 $450,000

The Foundational 15 (continued) Note to instructors: Emphasize that the variable selling expenses are irrelevant to this decision in requirement 10 because they will be incurred regardless of whether the company makes or buys its Alphas. 11. The pounds of raw material per unit are computed as follows: Direct material cost per unit (a) ............................ Cost per pound of direct materials (b) ................... Pounds of direct materials per unit (a) ÷ (b) ..........

Alpha $30 $6 5

Beta $12 $6 2

12. The contribution margins per pound of raw materials are computed as follows: Selling price per unit.............................. Variable cost per unit ............................ Contribution margin per unit (a) ............. Pounds of direct material required to produce one unit (b) ........................... Contribution margin per pound (a) ÷ (b)

Alpha

Beta

5 pounds $10.20 per pound

2 pounds $20.00 per pound

$120 69 $ 51

$80 40 $40

13. The optimal number of units to produce would be computed as follows:

Product

Beta ................................... Alpha.................................. Total pounds available .........

Pounds Per Unit 2 5

Units Produced 60,000 8,000

Total Pounds

120,000 40,000 160,000

The company should produce Beta first because it earns the highest contribution margin per pound of raw materials. After customer demand for Beta has been satisfied by producing 60,000 units, there are 40,000 pounds of raw materials remaining to use for making Alphas. Since each Alpha requires 5 pounds of raw materials, the company would be able to produce 8,000 Alphas (40,000 pounds ÷ 5 pounds per unit) before running out of raw materials. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 12

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 14. The total contribution margin would be computed as follows:

Alpha

Beta

Number of units produced (a) ...............................8,000 60,000 Contribution margin per unit (b) ............................ $51 $40 Total contribution margin (a) × (b) ........................ $408,000 $2,400,000 The company’s total contribution margin would be $2,808,000 ($408,000 + $2,400,000). 15. The maximum price per pound is computed as follows: Regular direct material cost per pound ............................. Contribution margin per pound of direct materials ............. Maximum price to be paid per pound................................

Alpha

$ 6.00 10.20 $16.20

Because the company has satisfied all demand for Betas, it would use additional raw materials to produce Alphas.

Exercise 12-1 (15 minutes)

Item

a. Sales revenue ................. b. Direct materials .............. c. Direct labor .................... d. Variable manufacturing overhead ..................... e. Depreciation— Model B100 machine .............. f. Book value— Model B100 machine .............. g. Disposal value— Model B100 machine .............. h. Market value—Model B300 machine (cost) .... i. Fixed manufacturing overhead (general) ....... j. Variable selling expense .. k. Fixed selling expense ...... l. General administrative overhead .....................

Case A Relevant Irrelevant X X X

Case B Relevant Irrelevant X

X X

X X X X

X X

X X X X

Managerial Accounting, 16th Edition

Exercise 12-2 (30 minutes) 1. The financial (disadvantage) of discontinuing the racing 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 Racing 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 racing bikes are discontinued; thus, they are not relevant to the decision. Alternative Solution:

Sales .......................................... Variable expenses ....................... Contribution margin..................... Fixed expenses: Advertising, traceable ............... Depreciation on special equipment* ........................... Salaries of product-line managers .............................. Common allocated costs ........... Total fixed expenses .................... Net operating income ..................

Current Total

$300,000 120,000 180,000

Difference: Net Total If Operating Racing Income Bikes Are Increase or Dropped (Decrease) $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

25,000 60,000 132,000 $ 21,000

10,000 0 16,000 $ (11,000)

*Includes pro-rated loss on the special equipment if it is disposed of.

Exercise 12-2 (continued) 2. No, production and sale of the racing bikes should not be discontinued. 3. The segmented report can be improved by eliminating the allocation of the common fixed expenses. Following the format introduced in Chapter 6 for a segmented income statement, 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 ....... Net operating income ...........

Total

Dirt Bikes

Mountain Bikes

Racing Bikes

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

$300,000 $90,000 $150,000 $60,000

88,000 28,000 36,000 24,000 92,000 $35,000 $ 54,000 $ 3,000 60,000 $ 32,000

Managerial Accounting, 16th Edition

Exercise 12-3 (30 minutes) 1.

Cost of purchasing....................... Direct materials ........................... Direct labor ................................. Variable manufacturing overhead . Fixed manufacturing overhead, traceable1 ................................. Fixed manufacturing overhead, common ................................... Total costs .................................. Financial (disadvantage) of buying the carburetors ......................... 1

Per Unit Differential Costs Make Buy $14 10 3

$35

15,000 units Make Buy $210,000 150,000 45,000

$525,000

30,000

$29 $35

$435,000 $525,000

$(6)

$(90,000)

Only the supervisory salaries of $2 per unit (= $6 per unit × 1/3) can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost; hence, the $4 per unit depreciation expense (= $6 × 2/3) per unit is not relevant to this decision.

2. Based on these data, the company should reject the offer and should continue to produce the carburetors internally. 3.

Make

Buy

Cost of purchasing (see requirement 1) .......... $525,000 Cost of making (see requirement 1) ............... $435,000 Opportunity cost—segment margin foregone on a potential new product line ................... 150,000 Total cost ...................................................... $585,000 $525,000 Financial advantage of buying the carburetors

$60,000

4. Given the new assumption, the company should accept the offer and purchase the carburetors from the outside supplier.

Exercise 12-4 (15 minutes) 1. 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.

Total for 20 Per Unit Bracelets

Incremental revenue ............................$169.95 $3,399.00 Incremental costs: Variable costs: Direct materials ............................... $ 84.00 1,680.00 Direct labor ..................................... 45.00 900.00 Variable manufacturing overhead ..... 4.00 80.00 Special filigree ................................. 2.00 40.00 Total variable cost..............................$135.00 2,700.00 Fixed costs: Purchase of special tool ................... 250.00 Total incremental cost .......................... 2,950.00 Financial advantage of accepting the special order ...................................... $ 449.00 2. Even though the price for the special order is below the company's regular price for such an item, the company would be better off accepting the order. 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, 16th Edition

Exercise 12-5 (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:

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) ................................

Ski Guard

Golf Guard

Fishing Guard

2 minutes

5 minutes

4 minutes

$70 per minute

$32 per minute

$50 per minute

$200 60 $140

$300 140 $160

$255 55 $200

2. 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. 3. In this part, the constraint is the available pounds of plastic pellets.

Selling price per unit.................. Variable cost per unit ................ Contribution margin per unit (a) . Pounds of plastic pellets required to produce one unit (b) ........... Contribution margin per unit of the constrained resource (a) ÷ (b) ................................

Ski Guard

Golf Guard

Fishing Guard

7 pounds

4 pounds

8 pounds

$20 per pound

$40 per pound

$25 per pound

$200 60 $140

$300 140 $160

$255 55 $200

4. 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.

Exercise 12-5 (continued) 5. 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.

Managerial Accounting, 16th Edition

Exercise 12-6 (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................................................... $1,800 Variable cost per unit ................................................. 1,200 Contribution margin per unit (a) .................................. $ 600 Upholstery shop time required to produce one unit (b) . 10 hours Contribution margin per unit of the constrained resource (a) ÷ (b) ................................................... $60 per hour The company should be willing to pay an overtime premium of 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 the Love Seat:

Love Seat

Selling price per unit................................................... $1,500 Variable cost per unit ................................................. 1,000 Contribution margin per unit (a) .................................. $ 500 Upholstery shop time required to produce one unit (b) .......................................................................... 5 hours Contribution margin per unit of the constrained resource (a) ÷ (b) ................................................... $100 per hour The additional contribution margin per hour earned by hiring the nearby company is $55 ($100 – $45). 3. The offer by the nearby upholstering company 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 Loveseats, 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 these units upholstered in the other company would free up capacity to produce more of the other two product-lines. In both cases, the additional time is worth more than $45 per hour.

Exercise 12-7 (10 minutes) 1. The financial advantage (disadvantage) of further processing each product is calculated as follows:

Selling price after further processing ... $20 $13 $32 Selling price at the split-off point ........ 16 8 25 Incremental revenue per pound or gallon ............................................. $4 $5 $7 Total quarterly output in pounds or gallons ........................................... × 15,000 × 20,000 × 4,000 Total incremental revenue .................. $60,000 $100,000 $28,000 Total incremental processing costs ...... 63,000 80,000 36,000 Financial advantage (disadvantage) of further processing ........................... $(3,000) $ 20,000 $(8,000) 2. Products A and C should be sold at the split-off point. Only product B should be processed further.

Managerial Accounting, 16th Edition

Exercise 12-8 (30 minutes) 1.

(1) Contribution margin per unit ........................... (2) Direct material cost per unit ........................... (3) Direct material cost per pound ........................ (4) Pounds of material required per unit (2) ÷ (3) . (5) Contribution margin per pound (1) ÷ (4) .........

$54 $100 $24 $80 $8 $8 3 10 $18 $10

$60 $32 $8 4 $15

2. If the company has unlimited demand for all three products, it should concentrate all of its available material on product A, which would yield the highest total contribution margin of $108,000 computed as follows:

Contribution margin per pound (above) . $ 18 $ 10 $ 15 Pounds of material available .................. × 6,000 × 6,000 × 6,000 Total contribution margin ...................... $108,000 $60,000 $90,000 Although product A has the lowest contribution margin per unit and the second lowest contribution margin ratio, it is preferred over the other two products because it has the highest contribution margin per pound of material, and material is the company’s constrained resource. 3. If customer demand is limited to 500 units per product the maximum contribution margin of $82,000 is computed as follows:

Total

Contribution margin per pound (above) .............................................$ 18 $ 10 $ 15 Pounds of material used........................× 1,500 × 2,500 × 2,000 Total contribution margin ......................$27,000 $25,000 $30,000 $82,000 Product A would be produced first because it earns the highest contribution margin per pound. Since Product A has customer demand of 500 units, it would consume 1,500 pounds of material (= 500 units × 3 pounds per unit). Product C, which also has customer demand of 500 units, would be produced next because it has the second highest contribution margin per pound. It would consume 2,000 pounds of material (= 500 units × 4 pounds per unit). Since Products A and C consume a total of 3,500 pounds of material (= 1,500 pounds + 2,000 pounds = 3,500 pounds), it leaves 2,500 pounds available (= 6,000 pounds – 3,500 pounds) for making the least profitable product, which is Product B. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 12

Exercise 12-8 (continued) 4. Assuming Barlow has customer demand of 500 units per product line and that it has already used its 6,000 pounds in an optimal fashion, any additional raw materials would have to be used to make more of Product B. Thus, the company should be willing to pay up to $18 per pound ($8 usual price plus $10 contribution margin per pound) to manufacture more product B.

Managerial Accounting, 16th Edition

Exercise 12-9 (15 minutes) 1. The financial advantage is computed as follows:

Incremental sales ................................ Incremental costs: Direct materials ................................ Direct labor ...................................... Variable manufacturing overhead....... Variable selling and administrative ..... Total incremental costs ........................ Financial advantage of accepting the special order ....................................

Per Unit

15,000 Units

5.10 3.80 1.00 1.50 11.40

76,500 57,000 15,000 22,500 171,000

$14.00 $210,000

$ 2.60 $ 39,000

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.

Exercise 12-10 (15 minutes) The financial advantage per unit and in total is computed as follows:

Direct materials ...... Direct labor ............ Variable manufacturing overhead ............. Supervision ............ Depreciation Rent ...................... Outside purchase price ................... Total cost ...............

“Cost” Differential Per Costs Unit Make Buy

Explanation

$3.10 $3.10 2.70 2.70

Can be avoided by buying Can be avoided by buying

0.60 1.50 1.00 0.30

Can be avoided by buying Can be avoided by buying Sunk Cost Allocated Cost

0.60 1.50 — —

$8.40 $9.20 $7.90 $8.40

The company should make the starters, rather than continuing to buy from the outside supplier. Making the starters provides a per unit financial advantage of $0.50 per starter ($8.40 per unit – $7.90 per unit = $0.50 per unit), or a total financial advantage of $20,000 per period: $0.50 per starter × 40,000 starters = $20,000

Managerial Accounting, 16th Edition

Exercise 12-11 (20 minutes) The costs that can be avoided as a result of purchasing from the outside are relevant in a make-or-buy decision. The analysis is:

Cost of purchasing ................... Cost of making: Direct materials ..................... Direct labor ........................... Variable overhead ................. Fixed overhead ..................... Total cost ................................

Per Unit Differential Costs Make Buy

30,000 Units Make Buy

$ 3.60 10.00 2.40 3.00 * $19.00 $21.00

$108,000 300,000 72,000 90,000 $570,000 $630,000

$21.00

$630,000

* The remaining $6 of fixed overhead cost ($9 per unit × 2/3 = $6 per unit) would not be relevant, because it will continue regardless of whether the company makes or buys the parts. The $80,000 rental value of the space being used to produce part S-6 is an opportunity cost of continuing to produce the part internally. Thus, the complete analysis is: Total cost, as above ........................................ Rental value of the space (opportunity cost) ..... Total cost, including opportunity cost ............... Financial advantage of accepting the outside supplier’s offer .............................................

Make

$570,000 80,000 $650,000

Buy

$630,000 $630,000

$20,000

The company would be $20,000 better off if it accepted the outside supplier’s offer.

Exercise 12-12 (15 minutes) 1. The contribution margin per pound of the constraining resource for each product is computed as follows: (1) Direct materials required per unit ...... (2) Cost per pound ................................ (3) Pounds required per unit (1) ÷ (2) .... (4) Contribution margin per unit ............. (5) Contribution margin per pound of materials used (4) ÷ (3) ................

Product A

Product B

Product C

$4.00

$2.80

$7.00

$24 $3 8 $32

$15 $3 5 $14

$9 $3 3 $21

2. The company should accept orders first for Product C, second for Product A, and third for Product B. Because Product C uses the least amount of material per unit of the three products, and because it is the most profitable of the three in terms of its use of materials, 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 Product A uses more material (the constrained resource) than Product B, but yet it is preferred over Product B. 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. 3. If customer demand is limited to 800 units per product the maximum contribution margin of $27,200 is computed as follows:

Total

Contribution margin per pound (above) .............................................$ 4.00 $ 2.80 $ 7.00 Pounds of material used........................× 2,600 × 0 × 2,400 Total contribution margin ...................... $10,400 $ 0 $16,800 $27,200

Managerial Accounting, 16th Edition

Exercise 12-12 (continued) 3. Product C would be produced first because it earns the highest contribution margin per pound. Given that Product C has customer demand of 800 units, it would consume 2,400 pounds of material (= 800 units × 3 pounds per unit). Product A, which also has customer demand of 800 units, would be produced next because it has the second highest contribution margin per pound. It would consume the remaining 2,600 pounds of material (= 325 units × 8 pounds per unit). Since Products C and A consume a total of 5,000 pounds of material (2,400 pounds + 2,600 pounds), it leaves zero pounds available for making the least profitable product, which is Product B.

Exercise 12-13 (10 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.

Managerial Accounting, 16th Edition

Exercise 12-14 (20 minutes) 1. Average fixed cost per mile ($3,200* ÷ 10,000 miles) ..... $0.32 Variable operating cost per mile ..................................... 0.14 Average cost per mile ................................................... $0.46 * Depreciation .............................. $1,600 Insurance .................................. 1,200 Garage rent ............................... 360 Automobile tax and license ......... 40 Total ......................................... $3,200 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 tax and license 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 figuring the incremental cost of the more expensive 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 and automobile tax and license. The original purchase price of the old car is a sunk cost and therefore is irrelevant. The variable operating cost would be the same and therefore is irrelevant. (Students are inclined to think that variable costs are always relevant and fixed costs are always irrelevant in decisions. This requirement helps to dispel that notion.)

Exercise 12-15 (30 minutes) The financial (disadvantage) of discontinuing the bilge pump product line is computed as follows: Contribution margin lost if the line is dropped ..... $(460,000) Fixed costs that can be avoided: Advertising (for the bilge pump product line) .... $270,000 Salary of the product-line manager .................. 32,000 Insurance on inventories ................................. 8,000 310,000 Financial (disadvantage) of dropping the line ...... $(150,000) The same solution can be obtained by preparing comparative income statements:

Sales ............................................... Variable expenses: Variable manufacturing expenses ... Sales commissions ........................ Shipping ....................................... Total variable expenses .................... Contribution margin ......................... Fixed expenses: Advertising (for the bilge pump product line) .............................. Depreciation of equipment ............. General factory overhead ............... Salary of product-line manager ...... Insurance on inventories................ Purchasing department .................. Total fixed expenses......................... Net operating loss ............................

Keep Product Line

Drop Product Line

$850,000 $

Difference: Net Operating Income Increase or (Decrease)

330,000 42,000 18,000 390,000 460,000

0 0 0 0 0

330,000 42,000 18,000 390,000 (460,000)

270,000 0 80,000 80,000 105,000 105,000 32,000 0 8,000 0 45,000 45,000 540,000 230,000 $ (80,000) $(230,000)

270,000 0 0 32,000 8,000 0 310,000 $(150,000)

$(850,000)

Managerial Accounting, 16th Edition

Exercise 12-16 (30 minutes) 1. The relevant costs of a hunting trip would be: Travel expense (100 miles @ $0.21 per mile) . Shotgun shells ............................................. One bottle of whiskey ................................... Total............................................................

$21 20 15 $56

This answer assumes that Bill would not be drinking the bottle of whiskey if he stayed home. It also assumes that the resale values of the camper, pickup truck, and boat are not affected by taking one more hunting trip. The money lost in the poker game is not relevant because Bill would have played poker even if he did not go hunting. He plays poker every weekend. The other costs are sunk at the point at which the decision is made to go on another hunting trip. 2. If Bill gets lucky and bags another two ducks, all of his costs are likely to be the same as they were on his last trip. Therefore, it doesn’t cost him anything to shoot the last two ducks. If he were to use more shotgun shells to kill more ducks, then he would incur additional costs related to the shotgun shells. However, in this particular case he bagged two more ducks than on his prior trip using the same number of shotgun shells. 3. In a decision of whether to give up hunting entirely, more of the costs listed by John are relevant. If Bill did not hunt, he would not need to pay for: gas, oil, and tires; shotgun shells; the hunting license; and the whiskey. In addition, he would be able to sell his camper, equipment, boat, and possibly pickup truck, 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. These three requirements illustrate the slippery nature of costs. A cost that is relevant in one situation can be irrelevant in the next. None of the costs are relevant when we compute the cost of bagging two additional ducks; some of them are relevant when we compute the cost of a hunting trip; and more of them are relevant when we consider the possibility of giving up hunting. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 12

Exercise 12-17 (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)

Managerial Accounting, 16th Edition

Problem 12-18 (60 minutes) 1. Selling price per unit ............................................ 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......................... Financial advantage of the investment ..................

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 .................... Import duties per unit ......................................... Permits and licenses ($9,000 ÷ 20,000 units)........ Shipping cost per unit .......................................... Break-even price per unit .....................................

$16.80 * 1.70 0.45 3.20 $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 Dak. Because the irregular units have already been produced, all production costs (including the variable production costs) are sunk. The fixed selling expenses are not relevant because 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 years = 10,000 units 10,000 units × 30% = 3,000 units produced and sold

Problem 12-18 (continued) Given this information, the simplest approach to solving 4a, 4b, and 4c 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%) ............................ Financial (disadvantage) of closing the plant .......

$(42,000)

$20,000 7,000

27,000 $(15,000)

Some students will take a longer approach such as that shown below:

Sales (3,000 units × $32 per unit) ............... Variable expenses (3,000 units × $18 per unit)........................................................ Contribution margin .................................... 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 ................................... Net operating income (loss) ........................

Continue to Operate

Close the Plant

54,000 42,000

0 0

$ 96,000

50,000

30,000

35,000

28,000 85,000 58,000 $(43,000) $(58,000)

4d. The company should not close the plant for two months because it will be $15,000 worse off if it closes.

Managerial Accounting, 16th Edition

Problem 12-18 (continued) 5. The relevant costs are those that can be avoided by purchasing from the outside supplier. These costs are: Variable manufacturing cost per unit............................ Fixed manufacturing overhead cost ($300,000 × 75% = $225,000; $225,000 ÷ 60,000 units) ..................... Variable selling expense ($1.20 × 1/3) ......................... Avoidable cost per unit ...............................................

$16.80 3.75 0.40 $20.95

To be acceptable, the outside supplier’s price must be less than $20.95 per unit.

Problem 12-19 (60 minutes) 1. The financial (disadvantage) of discontinuing the Housekeeping program is calculated as follows: Contribution margin lost if the Housekeeping program is dropped .......................................... Fixed costs that can be avoided: Liability insurance ............................................. $15,000 Program administrator’s salary ........................... 37,000 Financial (disadvantage) of discontinuing the Housekeeping program .....................................

$(80,000) 52,000 $(28,000)

Depreciation on the van is a sunk cost and the van has no salvage value since it would be donated to another organization. The general administrative overhead is allocated and none of it would be avoided if the program were dropped; thus it is not relevant to the decision. The same result can be obtained with the alternative analysis below:

Current Total

Revenues .................................... $900,000 Variable expenses........................ 490,000 Contribution margin..................... 410,000 Fixed expenses: Depreciation* ........................... 68,000 Liability insurance ..................... 42,000 Program administrators’ salaries 115,000 General administrative overhead 180,000 Total fixed expenses .................... 405,000 Net operating income (loss) ......... $ 5,000

Difference: Net Total If Operating HouseIncome keeping Is Increase or Dropped (Decrease) $660,000 330,000 330,000

$(240,000) 160,000 (80,000)

68,000 27,000 78,000 180,000 353,000 $(23,000)

0 15,000 37,000 0 52,000 $ (28,000)

*Includes pro-rated loss on disposal of the van if it is donated to a charity.

Managerial Accounting, 16th Edition

Problem 12-19 (continued) 2. To give the administrator of the entire organization a clearer picture of the financial viability of each of the organization’s programs, the general administrative overhead should not be allocated. It is a common cost that should be deducted from the total program segment margin. A better income statement would be:

Total

Home Nursing

Meals On HouseWheels keeping

Revenues ............................. $900,000 $260,000 $400,000 $240,000 Variable expenses................. 490,000 120,000 210,000 160,000 Contribution margin.............. 410,000 140,000 190,000 80,000 Traceable fixed expenses: Depreciation ...................... 68,000 8,000 40,000 20,000 Liability insurance .............. 42,000 20,000 7,000 15,000 Program administrators’ salaries ........................... 115,000 40,000 38,000 37,000 Total traceable fixed expenses ........................... 225,000 68,000 85,000 72,000 Program segment margins .... 185,000 $ 72,000 $105,000 $ 8,000 General administrative overhead ........................... 180,000 Net operating income ........... $ 5,000

Problem 12-20 (15 minutes) 1. Sales from further processing: Sales price of one filet mignon (6 ounces × $12.00 per pound ÷ 16 ounces per pound).... Sales price of one New York cut (8 ounces × $8.80 per pound ÷ 16 ounces per pound) ..... Total revenue from further processing ................ Less sales revenue from one T-bone steak .......... Incremental revenue from further processing ...... Less cost of further processing ........................... Financial advantage of further processing ...........

Per 16-Ounce T-Bone $4.50 4.40 8.90 7.95 0.95 0.55 $0.40

2. The T-bone steaks should be processed further into the filet mignon and the New York cut. The $4.15 “profit” per pound shown in the text is not relevant to the decision because it contains allocated joint costs. The company will incur the joint costs regardless of whether the T-bone steaks are sold outright or processed further; thus, this cost should be ignored in the decision.

Managerial Accounting, 16th Edition

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 ...... Financial (disadvantage) of discontinuing the flight.

$(12,950) $ 750 5,800 1,400 1,500 300

9,750 $ (3,200)

The following costs are not relevant to the decision:

Cost

Reason

Salaries, flight crew

Fixed annual salaries, which will not change.

Depreciation of aircraft

Sunk cost.

Liability insurance (two-thirds)

Two-thirds of the liability insurance is unaffected by this decision.

Baggage loading and flight preparation

This is an allocated cost that will continue even if the flight is discontinued.

Problem 12-21 (continued) Alternative Solution:

Difference: Net Operating Income Keep the Drop the Increase or Flight Flight (Decrease)

Ticket revenue ...................................... $14,000 $ 0 Variable expenses .................................. 1,050 0 Contribution margin ............................... 12,950 0 Less flight expenses: Salaries, flight crew ............................. 1,800 1,800 Flight promotion ................................. 750 0 Depreciation of aircraft ........................ 1,550 1,550 Fuel for aircraft ................................... 5,800 0 Liability insurance ............................... 4,200 2,800 Salaries, flight assistants ..................... 1,500 0 Baggage loading and flight preparation 1,700 1,700 Overnight costs for flight crew and assistants at destination.................... 300 0 Total flight expenses .............................. 17,600 7,850 Net operating loss ................................. $ (4,650) $ (7,850)

$(14,000) 1,050 (12,950) 0 750 0 5,800 1,400 1,500 0 300 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-thanaverage 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 requirement 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.

Managerial Accounting, 16th Edition

Problem 12-22 (30 minutes) 1. Because 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 because there is no assurance of future business from the retail chain.

Sales from the order ($50 × 84%) ...................... Less costs associated with the order: Direct materials ............................................... Direct labor ..................................................... Variable manufacturing overhead ...................... Variable selling expense ($4 × 25%) ................. Special machine ($10,000 ÷ 5,000 units) .......... Total costs ......................................................... Financial advantage of accepting the order ..........

Total— Unit 5,000 units $42

$210,000

15 8 3 1 2 29 $13

75,000 40,000 15,000 5,000 10,000 145,000 $ 65,000

2. Sales 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) ...................................... Financial advantage of accepting the order ................... 3. Sales: From the U.S. Army (above) ...................................... From regular channels ($50 per unit × 5,000 units) .... Net decrease in revenue .............................................. Less variable selling expenses avoided if the Army’s order is accepted ($4 per unit × 5,000 units) ............. Financial (disadvantage) of accepting the order ............

$175,000 9,000 184,000 130,000 $ 54,000 $184,000 250,000 (66,000) 20,000 $(46,000)

Note: This answer assumes that regular customers will return after this one-time special order rather than buy from a competitor in the future. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 12

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 labor ($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 ......... $ 1.15 Less price paid to supplier ............................................. 1.35 Financial (disadvantage) per box of Chap-Off ................. $(0.20) 3. The financial (disadvantage) of outsourcing 100,000 boxes of Chap-Off is computed as follows: Number of boxes (a)..................................................... 100,000 Financial (disadvantage) per box of Chap-Off (b)............ $(0.20) Financial (disadvantage) in total (a) × (b) ...................... $(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).

Managerial Accounting, 16th Edition

Problem 12-23 (continued) 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. 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 ..... $115,000 Cost of buying: 20,000 boxes × $1.35 per box ........ 27,000 Total cost .............................................................. $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. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 12

Problem 12-24 (45 minutes) 1. Product RG-6 has a contribution margin of $8 per unit (= $22 – $14). If the plant closes, this contribution margin will be lost on the 16,000 units (= 8,000 units per month × 2 months) that could have been sold during the two-month period. However, the company will be able to avoid some fixed costs as a result of closing down. The analysis is: Contribution margin lost by closing the plant for two months ($8 per unit × 16,000 units).......... $(128,000) Costs avoided by closing the plant for two months: Fixed manufacturing overhead cost ($45,000 per month × 2 months) ................................ $90,000 Fixed selling costs ($30,000 per month × 10% × 2 months) ................................................ 6,000 96,000 Net disadvantage of closing, before start-up costs .............................................................. (32,000) Add start-up costs ............................................. 8,000 Financial (disadvantage) of closing the plant ....... $ (40,000) 2. No, the company should not close the plant; it should continue to operate at the reduced level of 8,000 units produced and sold each month. Closing will result in a $40,000 greater loss over the two-month period than if the company continues to operate. An additional factor is the potential loss of goodwill among the customers who need the 8,000 units of RG-6 each month. By closing down, the needs of these customers will not be met (no inventories are on hand), and their business may be permanently lost to another supplier.

Managerial Accounting, 16th Edition

Problem 12-24 (continued) Alternative Solution:

Plant Kept Open

Sales (8,000 units × $22 per unit × 2)............................. $ 352,000 Variable expenses (8,000 units × $14 per unit × 2) ............. 224,000 Contribution margin ............... 128,000 Less fixed costs: Fixed manufacturing overhead costs ($150,000 × 2)................................. 300,000 Fixed selling costs ($30,000 × 2) .................. 60,000 Total fixed costs ..................... 360,000 Net operating loss before start-up costs ...................... (232,000) Start-up costs ........................ 0 Net operating loss .................. $(232,000)

Difference: Net Operating Income Increase or (Decrease)

Plant Closed $

$(352,000)

0 0

224,000 (128,000)

210,000

90,000

54,000 * 264,000

6,000 96,000

(264,000) (8,000) $(272,000)

(32,000) (8,000) $ (40,000)

* $30,000 × 90% = $27,000; $27,000 × 2 = $54,000

Problem 12-24 (continued) 3. Birch Company will be indifferent if it can sell 11,000 units over the twomonth period. The computations are: Cost avoided by closing the plant for two months (see above) ......................................................... Less start-up costs ................................................. Net avoidable costs ................................................

$96,000 8,000 $88,000

Net avoidable costs $88,000 = = 11,000 units Per unit contribution margin $8 per unit Verification:

Sales (11,000 units × $22 per unit) .......... Variable expenses (11,000 units × $14 per unit) .............................................. Contribution margin................................. Fixed expenses: Manufacturing overhead ($150,000 and $105,000, × 2) .................................. Selling ($30,000 and $27,000, × 2)........ Total fixed expenses ................................ Start-up costs ......................................... Total costs .............................................. Net operating loss ...................................

Operate at 11,000 Units for Two Months

Close for Two Months

154,000 88,000

0 0

$ 242,000 $

300,000 210,000 60,000 54,000 360,000 264,000 0 8,000 360,000 272,000 $(272,000) $(272,000)

Managerial Accounting, 16th Edition

Problem 12-25 (60 minutes) 1.

Debbie

Trish

Sarah

Mike

Sewing Kit

Direct labor cost per unit (a) .... $6.40 $4.00 $11.20 $8.00 $3.20 Direct labor rate per hour (b) ... $16.00 $16.00 $16.00 $16.00 $16.00 Direct labor hours per unit (a) ÷ (b) ................................... 0.40 0.25 0.70 0.50 0.20 2. Variable overhead per hour (a) Direct labor hours per unit (b) . Variable overhead per unit (a) × (b) ...................................

Debbie

Trish

Sarah

Mike

Sewing Kit

$0.80

$0.50

$1.40

$1.00

$0.40

Mike

Sewing Kit

1.10 6.44 2.00 4.00 11.20 8.00 0.50 1.40 1.00 5.60 19.04 11.00 $1.90 $ 7.56 $ 3.00 0.25 0.70 0.50

3.20 3.20 0.40 6.80 $ 2.80 0.20

$2.00 0.40

$2.00 0.25

$2.00 0.70

$2.00 0.50

$2.00 0.20

Debbie

Selling price ............................ $16.70 Variable costs: Direct materials .................... 4.30 Direct labor .......................... 6.40 Variable overhead ................. 0.80 Total variable costs .................. 11.50 Contribution margin (a) ........... $ 5.20 Direct labor hours per unit (b) . 0.40 Contribution margin per DLH (a) ÷ (b) .............................. $13.00

Trish

Sarah

$7.50 $26.60 $14.00

$ 9.60

$7.60 $10.80 $ 6.00 $14.00

Problem 12-25 (continued) 4. The first step is to compute how many direct labor-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 Debbie doll @0.40 hours per unit .............. Remaining constrained resource available ................ Less: Hours required for production of 35,000 units of the Sarah 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 Mike 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 labor-hours committed to each product by its respective contribution margin per direct labor-hour as shown below:

Contribution margin per DLH (a) ...................... DLH committed to each product (b) . Total contribution margin (a) × (b) .

Sewing Kit

Debbie

Sarah

Trish

Mike

$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).

Managerial Accounting, 16th Edition

Problem 12-25 (continued) 5. Because the additional capacity would be used to produce the Mike 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 labor 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 labor were removed from the variable cost category, the net effect would be to bump up the contribution margin per direct labor-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 labor is considered variable or fixed. However, this only works when the fixed cost is the cost of the constraint itself.

Problem 12-26 (60 minutes) 1. and 2. The avoided employee salaries and employment taxes are computed as follows: Sales salaries .......................................... Delivery salaries ...................................... Store management salaries ...................... Salary of new manager ............................ General office salaries ............................. Total employee salaries avoided .................. Employment tax rate .................................. Total employment taxes avoided .................

$70,000 4,000 9,000 11,000 6,000 100,000 × 15% $15,000

3. The simplest approach to the solution is: Gross margin lost if the store is closed ............ Costs that can be avoided: Employee salaries (see requirement 1) ...... $100,000 Employment taxes (see requirement 2) .... $15,000 Direct advertising ..................................... 51,000 Store rent ................................................ 85,000 Insurance on inventories ($7,500 × 2/3) ... 5,000 Utilities .................................................... 31,000 Financial (disadvantage) of closing the North Store .......................................................

$(316,800)

287,000 $ (29,800)

Managerial Accounting, 16th Edition

Problem 12-26 (continued) Alternative Solution (Total cost approach):

Sales ........................................... Cost of goods sold ....................... Gross margin ............................... Selling and administrative expenses: Selling expenses: Sales salaries.......................... Direct advertising ................... General advertising ................. Store rent .............................. Depreciation of store fixtures... Delivery salaries ..................... Depreciation of delivery equipment ........................... Total selling expenses ................ Administrative expenses: Store management salaries ..... Salary of new manager ........... General office salaries ............. Insurance on fixtures and inventory ............................. Utilities .................................. Employment taxes .................. General office—other .............. Total administrative expenses .... Total operating expenses .............. Net operating income (loss)..........

North Store Kept Open

$720,000 403,200 316,800

North Store Closed

Difference: Net Operating Income Increase or (Decrease)

0 $(720,000) 0 403,200 0 (316,800)

70,000 51,000 10,800 85,000 4,600 7,000

0 0 10,800 0 4,600 3,000

70,000 51,000 0 85,000 0 4,000

3,000 231,400

3,000 21,400

0 210,000

21,000 11,000 12,000

12,000 0 6,000

9,000 11,000 6,000

7,500 2,500 5,000 31,000 0 31,000 18,150 3,150 15,000 * 18,000 18,000 0 118,650 41,650 77,000 350,050 63,050 287,000 $(33,250) $(63,050) $ (29,800)

Problem 12-26 (continued) 4. Based on the data in requirement (3), the North Store should not be closed. The company would be $29,800 worse off per quarter if it closed the North Store. If the store space cannot be subleased or the lease broken without penalty, a decision to close the store would become even less viable. If the $85,000 rent cannot be avoided and the North Store is closed, the financial (disadvantage) of closing the North Store would grow from $(29,800) to $(114,800) per quarter. 5. Under these circumstances, the North Store should be closed. The computations are as follows: Gross margin lost if the North Store is closed (see requirement 3) .......................................................... Gross margin gained from the East Store: $720,000 × 1/4 = $180,000; $180,000 × 45%* = $81,000 ............ Net operating loss in gross margin ................................. Less costs that can be avoided if the North Store is closed (see requirement 3) ......................................... Financial advantage of closing the North Store ...............

$(316,800) 81,000 (235,800) 287,000 $ 51,200

*The East Store’s gross margin percentage is: $486,000 ÷ $1,080,000 = 45%

Managerial Accounting, 16th Edition

Problem 12-27 (60 minutes) 1. The incremental revenue per jar from further processing of the Grit 337 is: Selling price of the silver polish, per jar................. Selling price of 1/4 pound of Grit 337 ($2.00 ÷ 4) . Incremental revenue per jar .................................

$4.00 0.50 $3.50

2. The incremental contribution margin per jar: Incremental revenue per jar ................................. Incremental variable costs per jar: Other ingredients ................................................ Direct labor ......................................................... Variable manufacturing overhead (25% × $1.48) .. Variable selling costs (7.5% × $4.00).................... Total incremental variable cost per jar................... Incremental contribution margin per jar ................

$3.50 $0.65 1.48 0.37 0.30

2.80 $0.70

The $1.60 cost per pound (= $0.40 per 1/4 pound) required to produce the Grit 337 would not be relevant in this computation because it is incurred regardless of whether the Grit 337 is further processed into silver polish or sold outright.

Problem 12-27 (continued) 3. 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 Grit 337 into silver polish is: Production supervisor .......... Advertising—direct............... Avoidable fixed costs ...........

$3,000 4,000 $7,000

Avoidable fixed costs $7,000 = = 10,000 jars per month Incremental CM per jar $0.70 per jar If 10,000 jars of silver polish can be sold each month, the company would be indifferent between selling it or selling all of the Grit 337 as a cleaning powder. If the sales of the silver polish are greater than 10,000 jars per month, then continued processing of the Grit 337 into silver polish would be advisable because the company’s total profits will be increased. If the company can’t sell at least 10,000 jars of silver polish each month, then production of the silver polish should be discontinued. 4. and 5. The financial advantage (disadvantage) is computed as follows:

9,000 jars

11,500 jars

Incremental contribution margin .................... $6,300 Less avoidable fixed costs .............................. 7,000 Financial advantage (disadvantage) ................ $ (700)

$8,050 7,000 $1,050

Incremental contribution margin per jar (a) .... $0.70 Number of jars sold (b).................................. 9,000 Incremental contribution margin (a) × (b) ...... $6,300

$0.70 11,500 $8,050

Managerial Accounting, 16th Edition

Problem 12-28 (60 minutes) 1. The $2.80 per drum general overhead cost is not relevant to the decision because this cost will be the same regardless of whether the company decides to make or buy the drums. Also, the present depreciation figure of $1.60 per drum is not a relevant cost because it represents a sunk cost (in addition to the fact that the old equipment is worn out and must be replaced). The cost of supervision is relevant to the decision because this cost can be avoided by buying the drums.

Outside supplier’s price . Direct materials ............ Direct labor ($6.00 × 70%) .......... Variable overhead ($1.50 × 70%) .......... Supervision .................. Equipment rental* ........ Total cost .....................

Differential Costs Per Drum Make Buy

Total Differential Costs— 60,000 Drums Make Buy

$10.35

$621,000

$18.00

4.20

252,000

1.05 0.75 2.25 * $18.60

63,000 45,000 135,000 $1,116,000

$18.00

$1,080,000

Financial advantage from buying......................................................................... $0.60 $36,000 $135,000 per year ÷ 60,000 drums per year = $2.25 per * drum.

Problem 12-28 (continued) 2. Notice that unit costs for both supervision and equipment rental decrease with the greater volume because these fixed costs are spread over more units.

Outside supplier’s price .... Direct materials ............... Direct labor ..................... Variable overhead ............ Supervision ($45,000 ÷ 75,000 drums) .............. Equipment rental ($135,000 ÷ 75,000 drums) ......................... Total cost ........................ Difference .......................

Differential Cost Per Drum Make Buy $10.35 4.20 1.05

$18.00

0.60

Total Differential Cost— 75,000 Drums Make Buy $776,250 315,000 78,750

$1,350,000

45,000

1.80 $18.00 $18.00

135,000 $1,350,000 $1,350,000

The company would be indifferent between the two alternatives if 75,000 drums were needed each year.

Managerial Accounting, 16th Edition

Problem 12-28 (continued) 3. Again, notice that the unit costs for both supervision and equipment rental decrease with the greater volume of units.

Outside supplier’s price .... Direct materials ............... Direct labor ..................... Variable overhead ............ Supervision ($45,000 ÷ 90,000 drums) .............. Equipment rental ($135,000 ÷ 90,000 drums) ......................... Total cost ........................ Financial (disadvantage) of buying from supplier .....

Differential Costs Per Drum Make Buy $10.35 4.20 1.05

$18.00

0.50

Total Differential Cost— 90,000 Drums Make Buy $931,500 378,000 94,500

$1,620,000

45,000

1.50 $17.60 $18.00

135,000 $1,584,000 $1,620,000

$(0.40)

$(36,000)

The company should rent the new equipment and make the drums if 90,000 units per year are needed.

Problem 12-28 (continued) 4. Other factors that the company should consider include: • Will volume in future years increase, or will it remain constant at 60,000 units per year? (If volume increases, then renting the new equipment becomes more desirable, as shown in the computations above.) • Can quality control be maintained if the drums are purchased from the outside supplier? • Will costs for materials and labor increase in future years? • Will the outside supplier dependably meet shipping schedules? • Can the company begin making the drums again if the supplier proves to be undependable? Are there alternative suppliers? • What is the labor outlook in the supplier’s industry (e.g., are frequent labor strikes likely)? • If the outside supplier’s offer is accepted and the need for drums increases in future years, will the supplier have the added capacity to provide more than 60,000 drums per year? • Will the rental cost of the equipment change in the future?

Managerial Accounting, 16th Edition

Case 12-29 (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: Added revenue ($30.00 – $20.00) ....... Added costs: Buttons, thread, lining ...................... Direct labor ..................................... Financial advantage ............................

Per Sweater

$10.00

$2.00 5.80

7.80 $ 2.20

2. The company should process the wool yarn into sweaters because 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. 3. 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: Selling price .......................... Variable expenses: Raw wool ........................... Direct labor ........................ Contribution margin ...............

Per Spindle

$20.00

$7.00 3.60

10.60 $ 9.40

Case 12-29 (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 ................................................... $7.00 Direct labor ................................................ 3.60 Added variable costs of producing a sweater: Buttons, etc. ............................................... 2.00 Direct labor ................................................ 5.80 Total variable costs ........................................ Opportunity cost—contribution margin if the yarn is sold outright .................................... Minimum selling price per sweater ..................

$10.60 7.80 18.40 9.40 $27.80

Managerial Accounting, 16th Edition

Case 12-30 (90 minutes) 1. The original cost of the facilities at Clayton is a sunk cost and should be ignored in any decision. The decision being considered here is whether to continue operations at Clayton. The only relevant costs are the future facility costs that would be affected by this decision. If the facility were shut down, the Clayton facility has no resale value. In addition, if the Clayton facility were sold, the company would have to rent additional space at the remaining processing centers. On the other hand, if the facility were to remain in operation, the building should last indefinitely, so the company does not have to be concerned about eventually replacing it. Essentially, there is no real cost at this point of using the Clayton facility despite what the financial performance report indicates. Indeed, it might be a better idea to consider shutting down the other facilities because the rent on those facilities might be avoided. The costs that are relevant in the decision to shut down the Clayton facility are: Increase in rent at Billings and Great Falls ................. Decrease in local administrative expenses .................. Financial (disadvantage) of closing the Clayton facility

$(600,000) 90,000 $(510,000)

In addition, there would be costs of moving the equipment from Clayton and there might be some loss of sales due to disruption of services. In sum, closing down the Clayton facility would almost certainly lead to a decline in BSC’s profits. 2. Haley’s self-interest is to focus on the performance report that probably plays an instrumental role in how her boss evaluates her performance. So, even though closing down the Clayton facility would result in a decline in overall company profits, from Haley’s standpoint it would result in an improved performance report (as shown on the next page) for the Rocky Mountain Region (ignoring the costs of moving equipment and potential loss of revenues from disruption of service to customers).

Case 12-30 (continued)

Financial Performance After Shutting Down the Clayton Facility Rocky Mountain Region Sales ............................................................. Selling and administrative expenses: Direct labor ................................................. Variable overhead........................................ Equipment depreciation ............................... Facility expense* ......................................... Local administrative expense** .................... Regional administrative expense................... Corporate administrative expense ................. Total operating expense ................................. Net operating income .....................................

Total

$50,000,000 32,000,000 850,000 3,900,000 2,300,000 360,000 1,500,000 4,750,000 45,660,000 $ 4,340,000

* $2,800,000 – $1,100,000 + $600,000 = $2,300,000 ** $450,000 – $90,000 = $360,000 If the Clayton facility is shut down, BSC’s profits will decline, employees will lose their jobs, and customers will at least temporarily suffer some decline in service. Therefore, Romeros is willing to sacrifice the interests of the company, its employees, and its customers just to make her performance report look better. While Romeros is not a management accountant, the Standards of Ethical Conduct for Management Accountants still provide useful guidelines. By recommending closing the Clayton facility, Romeros will have to violate the Credibility Standard, which requires the disclosure of all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendation. Presumably, if the corporate board were fully informed of the consequences of this action, they would disapprove. In sum, it is difficult to describe the recommendation to close the Clayton facility as ethical behavior. In Romeros’ defense, however, it is not fair to hold her responsible for the mistake made by her predecessor. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 64

Managerial Accounting, 16th Edition

Case 12-30 (continued) It should be noted that the performance report required by corporate headquarters is likely to lead to other problems such as the one illustrated here. The arbitrary allocations of corporate and regional administrative expenses to processing centers may make other processing centers appear to be unprofitable even though they are not. In this case, the problems created by these arbitrary allocations were compounded by using an irrelevant facilities expense figure on the performance report. 3. Prices should be set ignoring the depreciation on the Clayton facility. As argued in part (1) above, the real cost of using the Clayton facility is zero. Any attempt to recover the sunk cost of the original cost of the building by charging higher prices than the market will bear will lead to less business and lower profits.

Case 12-31 (90 minutes) 1. The lowest price Wesco could bid for the one-time special order of 20,000 pounds (20 lots) and still exactly cover its incremental manufacturing costs is calculated as follows: Direct materials: AG-5: 300 pounds per lot × 20 lots = 6,000 pounds. Substitute BH-3 on a one-for-one basis to its total of 3,500 pounds. If BH-3 is not used in this order, it will be salvaged for $600. Therefore, the relevant cost is............................ The remaining 2,500 pounds (= 6,000 pounds – 3,500 pounds) would be AG-5 at a cost of $1.20 per pound ........ KL-2: 200 pounds per lot × 20 lots = 4,000 pounds at $1.05 per pound ....................................................................... CW-7: 150 pounds per lot × 20 lots = 3,000 pounds at $1.35 per pound .............................................................. DF-6: 175 pounds per lot × 20 lots = 3,500 pounds. Use 3,000 pounds in inventory at $0.60 per pound ($0.70 market price – $0.10 handling charge), and purchase the remaining 500 pounds (= 3,500 pounds – 3,000 pounds) at $0.70 per pound .......................................................... Total direct materials cost ...................................................

$ 600 3,000 4,200 4,050

2,150 14,000

Direct labor: 25 DLHs per lot × 20 lots = 500 DLHs. Because only 400 hours can be scheduled during regular time this month, overtime would have to be used for the remaining 100 hours. 400 DLHs × $14.00 per DLH ............................................... 100 DLHs × $21.00 per DLH ............................................... Total direct labor cost .........................................................

5,600 2,100 7,700

Overhead: This special order will not increase fixed overhead costs. Therefore, only the variable overhead is relevant. 500 DLHs × $3.00 per DLH ................................................. 1,500 Total relevant cost of the special order...................................

$23,200

Managerial Accounting, 16th Edition

Case 12-31 (continued) 2. In this part, we calculate the price for recurring orders of 20,000 pounds (20 lots) using the company’s rule of marking up its full manufacturing cost. This is not the best pricing policy to follow, but is a common practice in business. Direct materials: Because the initial order will exhaust existing inventories of BH-3 and DF-6 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. AG-5: 6,000 pounds × $1.20 per pound ............................ KL-2: 4,000 pounds × $1.05 per pound ............................. CW-7: 3,000 pounds × $1.35 per pound............................ DF-6: 3,500 pounds × $0.70 per pound ............................. Total direct materials cost .................................................

$ 7,200 4,200 4,050 2,450 17,900

Direct labor: 90% (i.e., 450 DLHs) of the production of a batch can be done on regular time; but the remaining production (i.e., 50 DLHs) must be done on overtime. Regular time 450 DLHs × $14.00 per DLH ......................... Overtime premium 50 DLHs × $21.00 per DLH .................. Total direct labor cost .......................................................

6,300 1,050 7,350

Overhead: The full manufacturing cost includes both fixed and variable manufacturing overhead. Manufacturing overhead applied: 500 DLHs × $13.50 per DLH ..........................................

6,750

Full manufacturing cost ...................................................... Markup (40% × $32,000) ................................................... Selling price (full manufacturing cost plus markup) ...............

32,000 12,800 $44,800

Case 12-32 (120 minutes) 1. The product margins computed by the accounting department for the drums and bike frames 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. Assuming direct labor is a fixed cost, the contribution margin per unit for each product is calculated as follows:

Manufactured

Selling price ..................................... Variable costs: Direct materials ............................. Variable manufacturing overhead .... Variable selling and administrative .. Total variable cost ............................ Contribution margin..........................

Purchased WVD Drums

WVD Drums

Bike Frames

$149.00

$239.00

138.00 0.00 0.75 138.75 $ 10.25

52.10 1.35 0.75 54.20 $ 94.80

99.40 1.90 1.30 102.60 $136.40

3. Assuming direct labor is a fixed cost, the contribution margin per welding machine hour for each product is calculated as follows:

Manufactured WVD Bike Drums Frames

Contribution margin per unit (above) (a) ............ $94.80 Welding hours per unit (b) ................................. 0.4 hour Contribution margin per welding hour (a) ÷ (b) .. $237.00 per hour

$136.40 0.5 hour $272.80 per hour

Managerial Accounting, 16th Edition

Case 12-32 (continued) 4.

Because the contribution margin per unit of the constrained resource (i.e., welding time) is larger for the bike frames than for the WVD drums, the frames make the most profitable use of the welding machine (assuming direct labor is a fixed cost). Consequently, the company should manufacture as many bike frames as possible up to demand and then use any leftover capacity to produce WVD drums. Buying the drums from the outside supplier can fill any remaining unsatisfied demand for WVD drums. The necessary calculations are carried out below.

(a)

Total hours available ................... Bike frames produced ................. WVD Drums—make .................... WVD Drums—buy ...................... Total contribution margin ............

Quantity

(b) Unit Contribution Margin

1,600 3,000 3,000

$136.40 $94.80 $10.25

(c)

(a) × (c)

Welding Time per Unit

Total Welding Time

0.5 0.4

800 1,200

Less: Contribution margin from present operations: 5,000 drums × $94.80 CM per drum .. Increased contribution margin and net operating income ........

2,000 1,200 0

Total Contribution $218,240 284,400 30,750 533,390

474,000 $ 59,390

Balance of Welding Time

(a) × (b)

Case 12-32 (continued) 5. Assuming direct labor is a variable cost, the contribution margin per unit for each product is calculated as follows:

Manufactured

Selling price ................................... Variable costs: Direct materials ........................... Direct labor ................................. Variable manufacturing overhead .. Variable selling and administrative Total variable cost .......................... Contribution margin........................

Purchased WVD Drums

WVD Drums

Bike Frames

$149.00

$239.00

138.00 0.00 0.00 0.75 138.75 $ 10.25

52.10 3.60 1.35 0.75 57.80 $ 91.20

99.40 28.80 1.90 1.30 131.40 $107.60

6. Assuming direct labor is a variable cost, the contribution margin per welding hour for each product is calculated as follows:

Contribution margin per unit (above) (a) .......... Welding hours per unit (b) ............................... Contribution margin per welding hour (a) ÷ (b)

Manufactured WVD Bike Drums Frames

$91.20 0.4 hour $228.00 per hour

$107.60 0.5 hour $215.20 per hour

When direct labor is assumed to be a variable cost, the conclusion is reversed from the case in which direct labor is assumed to be a fixed cost—the WVD drums appear to be a better use of the constraint than the bike frames. The assumption about the behavior of direct labor really does matter.

Managerial Accounting, 16th Edition

Case 12-32 (continued) 7. Assuming direct labor is a variable cost, the optimal product mix and increase in net operating income is computed as follows:

(a)

Total hours available .................... WVD Drums—make ..................... Bike frames produced .................. WVD Drums—buy ....................... Total contribution margin .............

Quantity

(b) Unit Contribution Margin

5,000 0 1,000

$91.20 $107.60 $10.25

(c)

(a) × (c)

Welding Time per Unit

Total Welding Time

0.4 0.5

2,000 0

Less: Contribution margin from present operations: 5,000 drums × $91.20 CM per drum ... Increased contribution margin and net operating income .........

2,000 0 0

Total Contribution $456,000 0 10,250 466,250

456,000 $ 10,250

Balance of Welding Time

(a) × (b)

Case 12-32 (continued) 8. The case strongly suggests that direct labor is fixed: “The bike frames could be produced with existing equipment and personnel.” Nevertheless, it would be a good idea to examine how much labor time is really needed under the two opposing plans.

Plan 1: Bike frames ................. WVD drums ................ Plan 2: WVD drums ................

Production

Direct LaborHours Per Unit

Total Direct Labor-Hours

1,600 3,000

1.6* 0.2**

2,560 600 3,160

5,000

0.2**

1,000

* $28.80 ÷ $18.00 per hour = 1.6 hour ** $3.60 ÷ $18.00 per hour = 0.2 hour Some caution is advised. Plan 1 assumes that direct labor is a fixed cost. However, this plan requires 2,160 more direct labor-hours than Plan 2 and the present situation (3,160 DLHs – 1,000 DLHs = 2,160 DLHs). At 40 hours per week a typical full-time employee works about 1,900 hours a year, so the added workload is equivalent to more than one full-time employee. Does the plant really have that much idle time at present? If so, and if shifting workers over to making bike frames would not jeopardize operations elsewhere, then Plan 1 is indeed the better plan. However, if taking on the bike frame as a new product would lead to pressure to hire another worker, more analysis is in order. It is still best to view direct labor as a fixed cost, but taking on the frames as a new product could lead to a jump in fixed costs of about $34,200 (1,900 hours × $18 per hour)—assuming that the remaining 260 hours (= 2,160 hours – 1,900 hours) could be made up using otherwise idle time. See the additional analysis on the next page.

Managerial Accounting, 16th Edition

Case 12-32 (continued) Contribution margin from Plan 1: Bike frames produced (1,600 × $136.40) ............ WVD Drums—make (3,000 × $94.80) ................. WVD Drums—buy (3,000 × $10.25) ................... Total contribution margin ................................... Less: Additional fixed labor costs .......................... Net effect of Plan 1 on net operating income .........

218,240 284,400 30,750 533,390 34,200 $499,190

Contribution margin from Plan 2: .......................... WVD Drums—make (5,000 × $94.80) ................. WVD Drums—buy (1,000 × $10.25) ................... Net effect of Plan 2 on net operating income .........

$474,000 10,250 $484,250

If an additional direct labor employee would have to be hired, Plan 1 is still optimal.

Case 12-33 (75 minutes) 1. Continuing to obtain covers from its own Denver Cover Plant would allow QualSupport to maintain its current level of control over the quality of the covers and the timing of their delivery. Keeping the Denver Cover Plant open also allows QualSupport more flexibility than purchasing the covers from outside suppliers. QualSupport could more easily alter the covers’ design and change the quantities produced, especially if long-term contracts are required with outside suppliers. QualSupport should also consider the economic impact that closing Denver Cover will have on the community and how this might affect QualSupport’s other operations in the region. 2. a. The following costs can be avoided by closing the plant, and therefore are relevant to the decision: Materials ................................... Labor: Direct ..................................... Supervision ............................. Indirect plant .......................... Differential pension cost ($5,000,000 – $3,000,000) ...... Total annual relevant costs .........

$14,000,000 $13,100,000 900,000 4,000,000

18,000,000 2,000,000 $34,000,000

b. The following costs can’t be avoided by closing the plant, and therefore are not relevant to the decision: Depreciation—equipment ....................................... Depreciation—building ........................................... Continuing pension cost ($5,000,000 – $2,000,000). Plant manager and staff ......................................... Corporate expenses ............................................... Total annual continuing costs..................................

$ 3,200,000 7,000,000 3,000,000 800,000 4,000,000 $18,000,000

Managerial Accounting, 16th Edition

Case 12-33 (continued) Depreciation is not relevant because it is a sunk cost. The annual pension expense of $3,000,000 is not relevant because it would continue whether or not the plant is closed. The amount for plant manager and staff is not relevant because Vosilo and his staff would continue with QualSupport and administer the three remaining plants. The corporate allocation is not relevant because this represents costs incurred outside Denver Cover and assigned to the plant. c. The following nonrecurring costs would arise in the year that the plant is closed, but would not be incurred in any other year: Termination charges on canceled material orders ($14,000,000 × 20%) .......................................... Employment assistance ........................................... Total nonrecurring costs ..........................................

$2,800,000 1,500,000 $4,300,000

These two costs are relevant to the decision because they will be incurred only if the plant is closed. 3. No, the plant should not be closed. The computations are:

First Year

Other Years

Cost of purchasing the covers outside ..... $(35,000,000) $(35,000,000) Costs avoided by closing the plant [see requirement 2(a)]......................... 34,000,000 34,000,000 Cost of closing the plant (first year only) . (4,300,000) Salvage value of equipment and building . 3,200,000 Financial (disadvantage) of closing the plant ................................................... $ (2,100,000) $ (1,000,000)

Case 12-33 (continued) 4. Factors that should be considered by QualSupport before making a decision include: • Alternative uses of the building and equipment. • Any tax implications. • The outside supplier’s prices in future years. • The cost to manufacture covergs at the Denver Cover Plant in future years. • The value of the time Vosilo and his staff would have spent managing the Denver Cover Plant. This time may be spent on other important matters. • The morale of QualSupport employees at remaining plants.

Managerial Accounting, 16th Edition

Appendix 12A Pricing Decisions Exercise 12A-1 (10 minutes) 1. Required ROI + Selling and administraive ( expenses Markup percentage = × Investment ) on absorption cost

Unit sales × Unit product cost

= =

(12% × $750,000) + $50,000 14,000 units × $25 per unit $140,000 = 40% $350,000

2. Unit product cost ............... Markup (40% × $25)......... Selling price per unit ..........

$25 10 $35

Exercise 12A-2 (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 1,400 Original price/volume (a) ........................................ 3.50 1,800 Change (b) ............................................................ $0.50 (400) Percentage increase/(decrease) (b) ÷ (a) ................ 14.3% (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)

Managerial Accounting, 16th Edition

Exercise 12A-3 (20 minutes) 1. The reference value is the price of the competing alternative, which is $1,200. 2. The differentiation value has two components. First, customers who purchase an IC-75 rather than the competing alternative would avoid the need to buy a second component part for $1,200 to achieve 4,000 hours of usage. Second, customers who purchase an IC-75 rather than the competing alternative would realize preventive maintenance savings of $100 over a 4,000-hour period, computed as follows:

Preventive maintenance cost for 4,000 hours: $200 × (4,000 hours ÷ 2,000 hours)............. $300 × (4,000 hours ÷ 4,000 hours)............. Differentiation value .......................................

Competing Equipment $400 $100

IC-75 $300

Thus, the total differentiation value is $1,200 + $100 = $1,300. 3. The economic value to the customer (EVC) is computed as follows: EVC = Reference value + Differentiation value EVC = $1,200 + $1,300 EVC = $2,500 4. The range of possible prices is as follows: Reference value ≤ Value-based price ≤ EVC $1,200 ≤ Value-based price ≤ $2,500

Exercise 12A-4 (10 minutes) Sales (300,000 units × $15 per unit)........ Less desired profit (12% × $5,000,000) ... Target cost for 300,000 units ...................

$4,500,000 600,000 $3,900,000

Target cost per unit = $3,900,000 ÷ 300,000 units = $13 per unit

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Exercise 12A-5 (30 minutes) 1. The profit at a price of $24.00 is computed as follows: Profit = (P – V) × Q − Fixed expenses Profit = ($24.00 − $13.00) × 84,000 − $800,000 Profit = $11.00 × 84,000 − $800,000 Profit = $924,000 − $800,000 Profit = $124,000 2. Northport would need to sell 76,364 units computed as follows: Profit = (P – V) × Q − Fixed expenses $40,000 = ($24.00 − $13.00) × Q − $800,000 $40,000 = $11.00 × Q − $800,000 $11Q = $840,000 Q = 76,364 units (rounded) 3. The percentage decrease is computed as follows: (120,000 units – 76,364 units) ÷ 120,000 units = 36.4% (rounded)

Exercise 12A-5 (continued) 4a and 4b. The optimal selling price ($26.59) and the optimal profit ($134,178) are as shown below:

4c. The additional profit is computed as follows: Net operating income at a price of $26.59........................ $134,178 Net operating income at a price of $24.00........................ 124,000 Increase in net operating income..................................... $ 10,178

Managerial Accounting, 16th Edition

Exercise 12A-5 (continued) 5a. The optimal selling price ($22.54) and optimal profit ($63,069) are as shown below:

5b. The optimal price in requirement 5a is lower than the price in requirement 4a because the customers are more sensitive to the price increase (35% vs. 30%). Generally speaking, when customers are more sensitive to price increases (i.e. demand is elastic) it leads to lower prices. 5c. If unit sales decrease by 35% instead of 30%, the price increase is still a good idea. The company is currently earning a profit of $40,000 at a price of $20, whereas it would earn a profit of $63,069 at the optimal price of $22.54.

Exercise 12A-6 (30 minutes) 1. The absorption cost-plus price of $15,540 is computed as follows: Unit product cost ............... $ 8,400 Markup (85% × $8,400) .... 7,140 Selling price per unit .......... $15,540 2. The economic value to the customer (EVC) is computed as follows: EVC = Reference value + Differentiation value EVC = $15,000 + $18,400 EVC = $33,400 The differentiation value shown above ($18,400) includes three components. First, customers who purchase an XP-200 rather than the competing alternative would avoid the need to buy a second piece of equipment for $15,000 to achieve 20,000 hours of usage. Second, customers who purchase an XP-200 rather than the competing alternative would realize preventive maintenance savings of $3,000 over a 20,000-hour period, computed as follows: Preventive maintenance cost for 20,000 hours: $2,000 × (20,000 hours ÷ 10,000 hours) ...... $1,000 × (20,000 hours ÷ 20,000 hours) ...... Differentiation value .......................................

Competing Equipment

XP-200

$4,000

$1,000 $3,000

Third, customers who purchase an XP-200 rather than the competing alternative would realize electricity savings of $400 over a 20,000-hour period, computed as follows: Electricity cost for 20,000 hours: $140 × (20,000 hours ÷ 1,000 hours) ..... $120 × (20,000 hours ÷ 1,000 hours) ..... Differentiation value..................................

Competing Equipment

XP-200

$2,800 $400

$2,400

Thus, the total differentiation value is $15,000 + $3,000 + $400 = $18,400.

Managerial Accounting, 16th Edition

Exercise 12A-6 (continued) 3. The range of possible prices is as follows: Reference value ≤ Value-based price ≤ EVC $15,000 ≤ Value-based price ≤ $33,400 4. The absorption approach to cost-plus pricing ignores the value that XP-200 offers customers relative to the best available alternative. It is quite possible that the absorption cost-plus price of $15,540 is lower than what customers might be willing to pay given XP-200’s differentiation value relative to its primary competitor.

Exercise 12A-7 (30 minutes) 1. The postal service’s contribution margin (CM) at a price of $8.00 is computed as follows: CM = (P – V) × Q CM = ($8.00 − $0.80) × 80,000 CM = $7.20 × 80,000 CM = $576,000 2. The percentage decrease in the selling price and the percentage increase in unit sales are computed as follows:

Price

Revised price/volume .............................................. $ 7.00 Original price/volume (a) ........................................ 8.00 Change (b) ............................................................ $(1.00) Percentage (decrease)/increase (b) ÷ (a) ................ (12.5%)

Volume

93,600 80,000 13,600 17.0%

3. The postal service’s contribution margin at a price of $7.00 is computed as follows: CM = (P – V) × Q CM = ($7.00 − $0.80) × 93,600 CM = $6.20 × 93,600 CM = $580,320 4. The increase in contribution margin is computed as follows: Contribution margin at a price of $7.00 ............................ $580,320 Contribution margin at a price of $8.00 ............................ 576,000 Increase in contribution margin ....................................... $ 4,320 5. The postal service would have to sell 92,904 sheets computed as follows: CM = (P – V) × Q $576,000 = ($7.00 − $0.80) × Q $576,000 = $6.20 × Q Q = 92,904 sheets (rounded) © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 86

Managerial Accounting, 16th Edition

Exercise 12A-7 (continued) 6. The percentage increase is computed as follows: (92,904 units – 80,000 units) ÷ 80,000 units = 16.2% 7. The postal service should not allocate a portion of its common fixed costs to these two pricing alternatives. Using sales dollars as the allocation base would cause differing amounts of common fixed costs to be allocated to each of the pricing alternatives. This would be misleading because the prices charged for the souvenir stamps and the number of sheets sold at those prices has no effect on the total common fixed costs incurred by the postal service.

Problem 12A-8 (45 minutes) 1. a. Number of pads manufactured each year: 38,400 labor-hours ÷ 2.4 labor-hours per pad = 16,000 pads. Selling and administrative expenses: Variable (16,000 pads × $9 per pad) .... Fixed .................................................. Total ...................................................

$144,000 732,000 $876,000

Required ROI + Selling and administrative ( × Investment ) expenses Markup percentage = on absorption cost

Unit sales × Unit product cost

= =

(24% × $1,350,000) + $876,000 16,000 pads × $60 per pad $1,200,000 $960,000

= 125% b. Direct materials ...................................... Direct labor ............................................ Manufacturing overhead ......................... Unit product cost .................................... Add markup: 125% of unit product cost .. Selling price ...........................................

$ 10.80 19.20 30.00 60.00 75.00 $135.00

Managerial Accounting, 16th Edition

Problem 12A-8 (continued) c. The income statement is: Sales (16,000 pads × $135 per pad) .............. Cost of goods sold (16,000 pads × $60 per pad) ...................... Gross margin ................................................ Selling and administrative expenses (16,000 pads × $9 per pad + $732,000) .................. Net operating income ....................................

$2,160,000 960,000 1,200,000 876,000 $ 324,000

The company’s ROI computation for the pads will be: ROI = =

Net Operating Income Average Operating Assets $324,000 $1,350,000

= 24%

2. Variable cost per unit: Direct materials .............................................. Direct labor .................................................... Variable manufacturing overhead (1/5 × $30) .. Sales commissions .......................................... Total ..............................................................

$10.80 19.20 6.00 9.00 $45.00

If the company has idle capacity and sales to the retail outlet would not affect regular sales, any price above the variable cost of $45 per pad would add to profits. The company should aggressively bargain for more than this price; $45 is simply the price floor below which the company should not go in its pricing.

Problem 12A-9 (10 minutes) 1. The unit product cost is computed as follows: Direct materials .............................................. Direct labor .................................................... Variable manufacturing overhead..................... Fixed manufacturing overhead ($116,000 ÷ 16,000 units) ............................................... Unit product cost ............................................

$ 7.00 5.00 2.00 7.25 $21.25

2. The markup percentage is computed as follows: Required ROI + Selling and administraive ( × Investment ) expenses Markup percentage = on absorption cost

Unit sales × Unit product cost

= =

(18% × $200,000) + [($1 × 16,000 units) + $50,000] 16,000 units × $21.25 per unit $102,000 = 30% $340,000

3. The selling price is computed as follows: Unit product cost ...................... Markup (30% × $21.25) ........... Selling price per unit (rounded) .

$21.25 6.38 $27.63

Managerial Accounting, 16th Edition

Problem 12A-10 (45 minutes) 1. The unit product cost is computed as follows: Direct materials ..................................................... Direct labor ........................................................... Variable manufacturing overhead............................ Fixed manufacturing overhead ($66,000 ÷ 12,000 units) ................................................................. Unit product cost ...................................................

$ 4.00 3.00 1.00 5.50 $13.50

2. The markup percentage is computed as follows: Required ROI + Selling and administraive ( × Investment ) expenses Markup percentage = on absorption cost

Unit sales × Unit product cost

= =

(16% × $150,000) + [($1 × 12,000 units) + $45,000] 12,000 units × $13.50 per unit $81,000 = 50% $162,000

3. The selling price is computed as follows: Unit product cost ...................... Markup (50% × $13.50) ........... Selling price per unit .................

$13.50 6.75 $20.25

4. The revised unit product cost is computed as follows: Direct materials ..................................................... Direct labor ........................................................... Variable manufacturing overhead............................ Fixed manufacturing overhead ($66,000 ÷ 10,000 units) ................................................................. Unit product cost ...................................................

$ 4.00 3.00 1.00 6.60 $14.60

Problem 12A-10 (continued) 4. continued The net operating income at a sales volume of 10,000 units is computed as follows: Sales (10,000 units × $20.25 per unit)............. Cost of goods sold (10,000 units × $14.60 per unit) ............................................................ Gross margin .................................................. Selling and administrative expenses ($1 per unit × 10,000 units + $45,000)..................... Net operating income......................................

$202,500 146,000 56,500 55,000 $ 1,500

The return on investment (ROI) at a sales volume of 10,000 units is computed as follows: ROI = Net operating income ÷ Average operating assets ROI = $1,500 ÷ $150,000 ROI = 1.0%

Managerial Accounting, 16th Edition

Problem 12A-10 (continued) 5. The revised markup percentage would be computed as follows: Required ROI + Selling and administraive ( expenses Markup percentage = × Investment ) on absorption cost

Unit sales × Unit product cost

= =

(16% × $150,000) + [($1 × 10,000 units) + $45,000] 10,000 units × $14.60 per unit $79,000 = 54.1% $146,000

The revised selling price would be computed as follows: Unit product cost ......................$14.60 Markup (54.1% × $14.60) ........ 7.90 Selling price per unit .................$22.50 It is quite possible that customers will be displeased with the price increase of $2.25 per unit (= $22.50 per unit – $20.25 per unit). This may cause sales volume to drop below 10,000 units, thereby further depressing profits. Currington’s customers are not required to pay whatever price is necessary for the company to meet its financial goals. The customers can choose to reject Currington’s price increase and spend their money elsewhere.

Problem 12A-11 (45 minutes) 1. Projected sales (100 machines × $4,950 per machine) .. Less desired profit (15% × $600,000) .......................... Target cost for 100 machines .......................................

$495,000 90,000 $405,000

Target cost per machine ($405,000 ÷ 100 machines) .... Less National Restaurant Supply’s variable selling cost per machine ............................................................. Maximum allowable purchase price per machine ...........

$4,050 650 $3,400

2. The relation between the purchase price of the machine and ROI can be developed as follows: ROI = =

Total projected sales - Total cost Investment $495,000 - ($650 + Purchase price of machines) × 100 $600,000

The above formula can be used to compute the ROI for purchase prices between $3,000 and $4,000 (in increments of $100) as follows:

Purchase price $3,000 $3,100 $3,200 $3,300 $3,400 $3,500 $3,600 $3,700 $3,800 $3,900 $4,000

ROI

21.7% 20.0% 18.3% 16.7% 15.0% 13.3% 11.7% 10.0% 8.3% 6.7% 5.0%

Managerial Accounting, 16th Edition

Problem 12A-11 (continued) Using the above data, the relation between purchase price and ROI can be plotted as follows: 25.0%

Realized ROI

20.0%

15.0%

10.0%

5.0%

0.0% $3,000

$3,200

$3,400

$3,600

$3,800

$4,000

Purchase price

Problem 12A-11 (continued) 3. A number of options are available in addition to simply giving up on adding the new sorbet machines to the company’s product lines. These options include: • Check the projected unit sales figures. Perhaps more units could be sold at the $4,950 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 sorbet machines 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 15% ROI? Does it cost the company this much to acquire more funds?

Managerial Accounting, 16th Edition

Problem 12A-12 (45 minutes) 1. The unit product cost is computed as follows: Direct materials .............................................. Direct labor .................................................... Variable manufacturing overhead..................... Fixed manufacturing overhead ($100,000 ÷ 20,000 units) ............................................... Unit product cost ............................................

$12.00 8.00 3.00 5.00 $28.00

2. The markup percentage on absorption cost is computed as follows: Required ROI + Selling and administraive ( × Investment ) expenses Markup percentage = on absorption cost

Unit sales × Unit product cost

= =

(20% × $650,000) + [($1 × 20,000 units) + $60,000] 20,000 units × $28.00 per unit $210,000 = 37.5% $560,000

3. The selling price is computed as follows: Unit product cost ...................... Markup (37.5% × $28.00) ........ Selling price per unit .................

$28.00 10.50 $38.50

Problem 12A-12 (continued) 4. The absorption net operating income at a price of $38.50 and a production and sales volume of 19,000 units is computed in two steps: First, the unit product cost should be recomputed as follows: Direct materials .............................................. Direct labor .................................................... Variable manufacturing overhead..................... Fixed manufacturing overhead ($100,000 ÷ 19,000 units) ............................................... Unit product cost (rounded) ............................

$12.00 8.00 3.00 5.26 $28.26

The second step is to compute the net operating income as follows: Sales (19,000 units × $38.50 per unit)............. Cost of goods sold (19,000 units × $28.26 per unit) ............................................................ Gross margin .................................................. Selling and administrative expenses ($1 per unit × 19,000 units + $60,000)..................... Net operating income......................................

$731,500 536,940 194,560 79,000 $115,560

The return on investment (ROI) at a sales volume of 19,000 units is computed as follows: ROI = Net operating income ÷ Average operating assets ROI = $115,560 ÷ $650,000 ROI = 17.8% (rounded)

Managerial Accounting, 16th Edition

Problem 12A-12 (continued) 5a. The new markup percentage is computed as follows: Required ROI + Selling and administraive ( × Investment ) expenses Markup percentage = on absorption cost

Unit sales × Unit product cost

= =

(20% × $650,000) + [($1 × 19,000 units) + $60,000] 19,000 units × $28.26 per unit $209,000 = 38.9% $536,940

5b. The new selling price is computed as follows: Unit product cost ................ Markup (38.9% × $28.26) .. Selling price per unit ...........

$28.26 10.99 $39.25

Problem 12A-12 (continued) 6a and 6b. The optimal selling price ($34.77) and optimal profit ($124,345) are shown below:

6c. The controller’s recommendation does not take into account the customers’ sensitivity to changes in price. When the customers’ latitude is factored into the pricing decision, the optimal price of $34.77 is actually less than, rather than greater than, the original price of $38.50

Managerial Accounting, 16th Edition

Problem 12A-13 (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: Number of readers (a) .................................... Percent of readers who buy products (b).......... Number of readers who buy products (a) × (b)

Midwest Trophy Whitetails Whitetails 130,000 .007 910

200,000 .005 1,000

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

Differentiation value ........................................

$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

101

Chapter 13 Capital Budgeting Decisions Solutions to Questions 13-1 A capital budgeting screening decision is concerned with whether a proposed investment project passes a preset hurdle, such as a 15% rate of return. A capital budgeting preference decision is concerned with choosing from among two or more alternative investment projects, each of which has passed the hurdle. 13-2 The “time value of money” refers to the fact that a dollar received today is more valuable than a dollar received in the future simply because a dollar received today can be invested to yield more than a dollar in the future. 13-3 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. 13-4 Accounting net income is based on accruals rather than on cash flows. Both the net present value and internal rate of return methods focus on cash flows. 13-5 Unlike other common capital budgeting methods, discounted cash flow methods recognize the time value of money and take into account all future cash flows. 13-6 Net present value is the present value of cash inflows less the present value of the cash outflows. The net present value can be negative if the present value of the outflows is greater than the present value of the inflows. 13-7 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.

13-8 No. The cost of capital is not simply the interest paid on long-term debt. The cost of capital is a weighted average of the costs of all sources of financing, both debt and equity. 13-9 The internal rate of return is the rate of return on an investment project over its life. It is computed by finding the discount rate that results in a zero net present value for the project. 13-10 The cost of capital is a hurdle that must be cleared before an investment project will be accepted. (a) In the case of the net present value method, the cost of capital is used as the discount rate. If the net present value of the project is positive, then the project is acceptable because its rate of return is greater than the cost of capital. (b) In the case of the internal rate of return method, the cost of capital is compared to a project’s internal rate of return. If the project’s internal rate of return is greater than the cost of capital, then the project is acceptable. 13-11 No. As the discount rate increases, the present value of a given future cash flow decreases. For example, the present value factor for a discount rate of 12% for cash to be received ten years from now is 0.322, whereas the present value factor for a discount rate of 14% over the same period is 0.270. If the cash to be received in ten years is $10,000, the present value in the first case is $3,220, but only $2,700 in the second case. Thus, as the discount rate increases, the present value of a given future cash flow decreases. 13-12 The internal rate of return is more than 14% because the net present value is positive. The internal rate of return would be 14% only if the net present value (evaluated using a 14%

discount rate) is zero. The internal rate of return would be less than 14% if the net present value (evaluated using a 14% discount rate) is negative. 13-13 The project profitability index is computed by dividing the net present value of the cash flows from an investment project by the required investment. The index measures the profit (in terms of net present value) provided by each dollar of investment in a project. The higher the project profitability index, the more desirable is the investment project.

out of the cash receipts that it generates. The payback method is used as a screening tool for investment proposals. The payback method is useful when a company has cash flow problems. The payback method is also used in industries where obsolescence is very rapid. 13-15 Neither the payback method nor the simple rate of return method considers the time value of money. Under both methods, a dollar received in the future is weighed the same as a dollar received today. Furthermore, the payback method ignores all cash flows that occur after the initial investment has been recovered.

13-14 The payback period is the length of time for an investment to fully recover its initial cost

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Chapter 13: Applying Excel The completed worksheet is shown below.

Note: Your worksheet may differ from the above in rows 29 and 30. The worksheet above has been set to use the rounded-off discount factors rather than more exact factors without rounding. For example, the factor 0.519 is rounded off from 0.519368664. If the more exact factor is used to calculate the present value of the $150,000 total cash flow at the end of year 5, the answer is $77,905 rather than $77,850. These rounding errors cumulate so that the more exact net present value is $31,493 rather than the $31,410 as displayed. Either answer is okay.

Chapter 13: Applying Excel (continued) The completed worksheet, with formulas displayed, is shown below.

Managerial Accounting, 16th Edition

Chapter 13: Applying Excel (continued) 1. With the change in the discount rate, the result is:

The net present value increases because the positive cash inflows occur in the future. When the discount rate decreases, the future cash flows have a larger present value.

Chapter 13: Applying Excel (continued) 2. For the new project, the worksheet should look like this:

Managerial Accounting, 16th Edition

Chapter 13: Applying Excel (continued) a. The net present value of the project is $(17,340). Again, your answer may differ due to the precision of the calculations. b. Increasing the discount rate results in making the negative net present value even more negative. Decreasing the discount rate improves the net present value. It turns positive when decreasing the discount rate from 11% to 10% as shown below.

Chapter 13: Applying Excel (continued) c. The internal rate of return is the discount rate at which the net present value is zero. This occurs somewhere between the discount rates 10% and 11%. The net present value at 10% is $5,330 as shown above. The net present value at 11% is $(740) as shown below. Therefore, the internal rate of return is between 10% and 11%.

Managerial Accounting, 16th Edition

Chapter 13: Applying Excel (continued) d. The amount of future uncertain salvage value that would be required to make the net present value positive, which is $53,410 ($33,410 + $20,000), can be found by experimenting with the salvage value in the worksheet. It can also be computed using the formula from the text as follows: Additional salvage = Negative net present value to be offset value required Present value factor =

$17,340 = $33,410 0.519

The Foundational 15 1.

The depreciation expense of $595,000 is the only non-cash expense.

The annual net cash inflows are computed as follows: Net operating income ................................ $ 405,000 Add: Noncash deduction for depreciation .... 595,000 Annual net cash inflow............................... $1,000,000

The present value of the annual net cash inflows is computed as follows:

Item

Annual net cash inflows .................. 4.

Year(s)

Cash Flow

Present 14% Value of Factor Cash Flows

1-5

$1,000,000

3.433 $3,433,000

The project’s net present value is computed as follows:

Purchase of equipment .......... Sales .................................... Variable expenses.................. Out-of-pocket costs ............... Total cash flows (a) ... ........... Discount factor (b) ................ Present value (a)×(b) ............ Net present value ..................

Now $(2,975,000) __________ $(2,975,000) 1.000 $(2,975,000) $458,000

Years 1-5 $2,735,000 (1,000,000) (735,000) $1,000,000 3.433 $3,433,000

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The Foundational 15 (continued) 5.

The project profitability index for the project is:

Item

Project

Net Present Value (a)

Investment Required (b)

$458,000

$2,975,000

Project Profitability Index (a) ÷ (b) 0.15*

* The answer of 0.1539 was rounded to 0.15. 6.

The project’s internal rate of return is: Factor of the internal = Investment required rate of return Annual cash inflow =

$2,975,000 = 2.975 $1,000,000

Looking in Exhibit 13B-2, and scanning along the five-period line, we can see that the factor computed above, 2.975, is closest to 2.991, the factor for the 20% rate of return. Therefore, to the nearest whole percent, the internal rate of return is 20%. 7.

The payback period is determined as follows:

Year 1 2 3 4 5

Investment

Cash Inflow

$2,975,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000

Unrecovered Investment

$1,975,000 $975,000 $0 $0 $0

The investment in the project is fully recovered in the 3rd year. To be more exact, the payback period is approximately 2.98 years [= 2 + ($975,000 ÷ $1,000,000)].

The Foundational 15 (continued) 8.

The simple rate of return is computed as follows:

Simple rate = Annual incremental net operating income of return Initial investment = 9.

$405,000 = 13.61% $2,975,000

If the discount rate was 16%, instead of 14%, the project’s net present value would be lower because the discount factors would be smaller.

10. 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. 11. 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. 12. 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 net operating income and the simple rate of return.

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 13. The new annual variable expense would be $1,230,750 ($2,735,000 × 45%). The project’s actual net present value would be computed as follows:

Purchase of equipment ........ Sales .................................. Variable expenses ................ Out-of-pocket costs ............. Total cash flows (a) ............. Discount factor (b) .............. Present value (a)×(b) .......... Net present value ................

Now $(2,975,000) __________ $(2,975,000) 1.000 $(2,975,000) $(334,165)

Years 1-5 $2,735,000 (1,230,750) (735,000) $ 769,250 3.433 $2,640,835

14. The payback period is computed as follows:

Year 1 2 3 4 5

Investment

$2,975,000

Cash Inflow

$769,250 $769,250 $769,250 $769,250 $769,250

Unrecovered Investment

$2,205,750 $1,436,500 $667,250 $0 $0

The investment in the project is fully recovered in the 4th year. To be more exact, the payback period is approximately 3.87 years [= 3 + ($667,250 ÷ $769,250)]. 15. The simple rate of return is computed as follows:

Simple rate = Annual incremental net operating income of return Initial investment =

$174,250* = 5.86% $2,975,000

* $2,735,000 – $1,230,750 – $735,000 – $595,000 = $174,250 © The McGraw-Hill Companies, Inc., 2018 Solutions Manual, Chapter 13

Exercise 13-1 (10 minutes) 1. The payback period is determined as follows:

Year Investment Cash Inflow 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

Unrecovered Investment $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 [= 6 + ($2,500 ÷ $5,000)]. 2. Because 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, 16th Edition

Exercise 13-2 (10 minutes) 1. Now $(27,000) ________ $(27,000) 1.000 $(27,000) $(1,765)

Purchase of machine....................... Reduced operating costs ................. Total cash flows (a) ........................ Discount factor (12%) (b) ............... Present value (a)×(b) ..................... Net present value ...........................

Years 1-5 $7,000 $7,000 3.605 $25,235

Item

Cash Flow

Annual cost savings .. $7,000 Initial investment ..... $(27,000) Net cash flow ...........

Years 5 1

Total Cash Flows

$ 35,000 (27,000) $ 8,000

Exercise 13-3 (20 minutes) 1. Annual savings in part-time help ............................ Added contribution margin from expanded sales (1,000 dozen × $1.20 per dozen) ........................ Annual cash inflows ...............................................

$3,800 1,200 $5,000

2. Factor of the internal Investment required = rate of return Annual cash inflow =

$18,600 = 3.720 $5,000

3. Looking in Exhibit 13B-2, and scanning along the six-period line, we can see that the factor computed above, 3.720, is closest to 3.685, the factor for the 16% rate of return. Therefore, to the nearest whole percent, the internal rate of return is 16%. 4. The cash flows will not be even over the six-year life of the machine because of the extra $9,125 inflow in the sixth year. Therefore, the above approach cannot be used to compute the internal rate of return in this situation. Using trial-and-error or some other method, the internal rate of is 22%: Now Purchase of machine.......................... Reduced part-time help...................... Added contribution margin ................. Salvage value of machine................... Total cash flows (a) ........................... Discount factor (22%) (b) .................. Present value (a)×(b) ........................ Net present value ..............................

$(18,600)

Years 1-6

$3,800 1,200 _______ ______ $(18,600) $5,000 1.000 3.167 $(18,600) $15,835 $0

Year 6

$9,125 $9,125 0.303 $2,765

Managerial Accounting, 16th Edition

Exercise 13-4 (15 minutes) The equipment’s net present value without considering the intangible benefits would be:

Item

Cost of the equipment ... Annual cost savings ....... Net present value ..........

Year(s) Now 1-15

Amount of Cash Flows

$(2,500,000) $400,000

20% Present Value Factor of Cash Flows 1.000 4.675

$(2,500,000) 1,870,000 $ (630,000)

The annual value of the intangible benefits would have to be great enough to offset a $630,000 negative present value for the equipment. This annual value can be computed as follows: Required increase in present value $630,000 = = $134,759 Factor for 15 years 4.675

Exercise 13-5 (10 minutes) 1. The project profitability index for each proposal is:

Proposal Number A B C D

Net Present Value (a) $36,000 $38,000 $35,000 $40,000

Investment Required (b) $90,000 $100,000 $70,000 $120,000

Project Profitability Index (a)  (b) 0.40 0.38 0.50 0.33

2. The ranking is:

Proposal Project Profitability Number Index C A B D

0.50 0.40 0.38 0.33

Note that proposal D has the highest net present value, but it ranks lowest in terms of the project profitability index.

Managerial Accounting, 16th Edition

Exercise 13-6 (10 minutes) 1. The annual depreciation expense is computed as follows: Cost of the new machine (a) ...................... Useful life in years (b) ............................... Annual depreciation expense (a) ÷ (b) .......

$120,000 10 $12,000

2. The annual incremental net operating income is computed as follows: Operating cost of old machine .................... Less operating cost of new machine ........... Less annual depreciation on the new machine ($120,000 ÷ 10 years) ............... Annual incremental net operating income ...

$ 30,000 12,000 12,000 $ 6,000

3. The initial investment is computed as follows: Cost of the new machine ........................... Less salvage value of old machine .............. Initial investment ......................................

$120,000 40,000 $ 80,000

4. The simple rate of return is computed as follows: Simple rate = Annual incremental net operating income of return Initial investment =

$6,000 = 7.5% $80,000

Exercise 13-7 (15 minutes) 1. Project A: Now Purchase of equipment ............. $(100,000) Annual cash inflows .................. Salvage value ........................... _______ Total cash flows (a) .................. $(100,000) Discount factor (14%) (b) ......... 1.000 Present value (a)×(b) ............... $(100,000) Net present value ..................... $(14,683)

Years 1-6

Year 6

$21,000 ______ $21,000 3.889 $81,669

$8,000 $8,000 0.456 $3,648

Years 1-6

Year 6

$16,000 ______ $16,000 3.889 $62,224

$100,000 $100,000 0.456 $45,600

2. Project B: Working capital invested ...... Annual cash inflows ............. Working capital released ...... Total cash flows (a) ............ Discount factor (14%) (b) .... Present value (a)×(b) .......... Net present value ................

Now $(100,000) _______ $(100,000) 1.000 $(100,000) $7,824

3. The $100,000 should be invested in Project B rather than in Project A. Project B has a positive net present value whereas Project A has a negative net present value.

Managerial Accounting, 16th Edition

Exercise 13-8 (15 minutes) 1. Computation of the annual cash inflow associated with the new electronic games: Net operating income .......................................... Add noncash deduction for depreciation ............... Annual net cash inflow.........................................

$40,000 35,000 $75,000

The payback computation would be: Payback period = =

Investment required Annual net cash inflow $300,000 = 4.0 years $75,000 per year

Yes, the games would be purchased. The payback period is less than the maximum 5 years required by the company. 2. The simple rate of return would be: Simple rate = Annual incremental net income of return Initial investment =

$40,000 = 13.3% $300,000

Yes, the games would be purchased. The 13.3% return exceeds 12%.

Exercise 13-9 (20 minutes) 1. The net present value is computed as follows: Now Purchase of equipment ........ Sales .................................. Variable expenses ................ Out-of-pocket costs ............. Total cash flows (a) ............. Discount factor (15%) (b) .... Present value (a)×(b) .......... Net present value ................

$(3,000,000)

Years 1-5

$ 2,500,000 (1,000,000) __________ (600,000) $(3,000,000) $ 900,000 1.000 3.352 $(3,000,000) $3,016,800 $16,800

2. The simple rate of return would be: Simple rate = Annual incremental net income of return Initial investment =

$300,000 = 10.0% $3,000,000

3. The company would want Derrick to pursue the investment opportunity because it has a positive net present value of $16,800. However, Derrick might be inclined to reject the opportunity because its simple rate of return of 10% is well below his historical return on investment (ROI) of 20%. Derrick may be justifiably concerned that implementing this project would lower his ROI and his next pay raise.

Managerial Accounting, 16th Edition

Exercise 13-10 (10 minutes) 1. Purchase of stock ........................ Annual cash dividend ................... Sale of stock ............................... Total cash flows (a) ..................... Discount factor (14%) (b) ............ Present value (a)×(b) .................. Net present value ........................

Now $(13,000) _______ $(13,000) 1.000 $(13,000) $(1,225)

Years 1-3

Year 3

$420 ____ $420 2.322 $975

$16,000 $16,000 0.675 $10,800

2. No, Kathy did not earn a 14% return on the Malti Company stock. The negative net present value indicates that the rate of return on the investment is less than the minimum required rate of return of 14%.

Exercise 13-11 (30 minutes) 1. The project profitability index is computed as follows:

Project

Project Net Present Investment Profitability Value Required Index (a) (b) (a) ÷ (b)

A............

$44,323

$160,000

0.28

B............

$42,000

$135,000

0.31

C............

$35,035

$100,000

0.35

D ...........

$38,136

$175,000

0.22

2. a., b., and c.

First preference ........ Second preference ... Third preference....... Fourth preference .....

Net Present Value A B D C

Project Profitability Index C B A D

Internal Rate of Return D C A B

Managerial Accounting, 16th Edition

Exercise 13-11 (continued) 3. Oxford Company’s opportunities for reinvesting funds as they are released from a project will determine which ranking is best. The internal rate of return method assumes that any released funds are reinvested at the rate of return shown for a project. This means that funds released from project D would have to be reinvested in another project yielding a rate of return of 22%. Another project yielding such a high rate of return might be difficult to find. The project profitability index approach also assumes that funds released from a project are reinvested in other projects. But the assumption is that the return earned by these other projects 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 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 C as fourth because of its low net present value; yet this project is the best available in terms of the net present value generated for each dollar of investment (as shown by the project profitability index).

Exercise 13-12 (10 minutes) Note: All present value factors in the computation below have been taken from Exhibit 13B-1 in Appendix 13B, using a 12% discount rate. Amount of the investment............................ $104,950 Less present value of Year 1 and Year 2 cash inflows: Year 1: $30,000 × 0.893 ........................... $26,790 Year 2: $40,000 × 0.797 ........................... 31,880 58,670 Present value of Year 3 cash inflow .............. $ 46,280 Therefore, the expected cash inflow for Year 3 is: $46,280 ÷ 0.712 = $65,000.

Managerial Accounting, 16th Edition

Exercise 13-13 (15 minutes) 1. The payback period is: Payback period =

Investment required Annual net cash inflow

$432,000 = 4.8 years $90,000

No, the equipment would not be purchased because the payback period (4.8 years) exceeds the company’s maximum payback time (4.0 years). 2. The simple rate of return would be computed as follows: Annual cost savings............................................... Less annual depreciation ($432,000 ÷ 12 years) ..... Annual incremental net operating income ............... Simple rate of return = =

$90,000 36,000 $54,000

Annual incremental net operating income Initial investment $54, 000 = 12.5% $432, 000

No, the equipment would not be purchased because its 12.5% rate of return is less than the company’s 14% required rate of return.

Exercise 13-14 (10 minutes) 1. Project X: Initial investment............. Annual cash inflows ......... Total cash flows (a) ......... Discount factor (18%) (b) Present value (a)×(b) ...... Net present value ............

Now $(35,000) ________ $(35,000) 1.000 $(35,000) $6,976

Years 1-6 $12,000 $12,000 3.498 $41,976

2. Project Y: Initial investment............... Single cash inflow .............. Total cash flows (a) ........... Discount factor (18%) (b) .. Present value (a)×(b) ........ Net present value ..............

Now $(35,000) _______ $(35,000) 1.000 $(35,000) $(1,700)

Year 6 90,000 $90,000 0.370 $33,300

3. Project X should be selected. Project Y does not provide the required 18% return, as shown by its negative net present value.

Managerial Accounting, 16th Edition

Exercise 13-15 (30 minutes) 1. Factor of the internal Investment required = rate of return Annual net cash inflow =

$137,320 = 3.433 $40,000

Looking in Exhibit 13B-2 and scanning along the 5-period line, a factor of 3.433 represents an internal rate of return of 14%. 2. The machine’s net present value is computed as follows: Now Purchase of machine .......... Annual cash inflows ............ Total cash flows (a) ............ Discount factor (b) ............. Present value (a)×(b) ......... Net present value ...............

$(137,320) _________ $(137,320) 1.000 $(137,320) $0

Years 1-5 $40,000 $40,000 3.433 $137,320

The reason for the zero net present value 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.

Exercise 13-15 (continued) 3. Factor of the internal Investment required = rate of return Annual net cash inflow =

$137,320 = 3.696 (rounded) $37,150

Looking in Exhibit 13B-2 and scanning along the 5-period line, a factor of 3.696 corresponds to the factor for 11%. Thus, the internal rate of return is 11%.

Managerial Accounting, 16th Edition

Problem 13-16 (20 minutes) Purchase of equipment ...... Working capital investment Annual net cash receipts .... Road construction.............. Working capital released .... Salvage value of equipment Total cash flows (a) ........... Discount factor (20%) (b) .. Present value (a)×(b) ........ Net present value ..............

Now $(275,000) (100,000)

_________ $(375,000) 1.000 $(375,000) $(8,070)

$120,000

$120,000 (40,000)

$120,000

________ $120,000 0.833 $99,960

_______ $120,000 0.694 $83,280

_______ $80,000 0.579 $46,320

100,000 65,000 $285,000 0.482 $137,370

No, the project should not be accepted; it has a negative net present value at a 20% discount rate. This means that the rate of return on the investment is less than the company’s required rate of return of 20%. Note: The annual net cash receipts ($120,000) can also be discounted their present value using the appropriate discount factor (2.589) from Exhibit 13B-2 in Appendix 13B.

Problem 13-17 (20 minutes) 1. The net present value is computed as follows: Now Purchase of equipment ........ Sales .................................. Variable expenses ............... Out-of-pocket costs ............. Total cash flows (a) ............. Discount factor (16%) (b) .... Present value (a)×(b) .......... Net present value ................

$(3,500,000)

Years 1-5

$3,400,000 (1,600,000) __________ (700,000) $(3,500,000) $1,100,000 1.000 3.274 $(3,500,000) $3,601,400 $101,400

2. The internal rate of return is computed as follows: Factor of the internal = Investment required rate of return Annual net cash inflow =

$3,500,000 = 3.182 (rounded) $1,100,000

Looking in Exhibit 13B-2 and scanning along the five-period line, we can see that the factor computed above, 3.182, is closest to 3.199, the factor for the 17% rate of return. Therefore, to the nearest whole percent, the internal rate of return is 17%. 3. The simple rate of return is computed as follows: Simple rate of return = =

Annual incremental net operating income Initial investment $400, 000 = 11.4% $3,500, 000

Managerial Accounting, 16th Edition

Problem 13-17 (continued) 4. The company would want Casey to invest in the project because it has a positive net present value of $101,400 and an internal rate of return of 17%. However, Casey might be inclined to reject the project because its simple rate of return of 11.4% is well below his historical return on investment (ROI) of 20%. Casey may be justifiably concerned that implementing this project would lower his ROI and his next pay raise.

Problem 13-18 (20 minutes) The net present value is computed as follows: Purchase of equipment ........ Working capital investment .. Sales .................................. Variable expenses ................ Fixed out-of-pocket costs ..... Overhaul of equipment ........ Working capital released ...... Salvage value of equipment . Total cash flows (a) ............. Discount factor (15%) (b) .... Present value (a)×(b) .......... Net present value ................

Now $(130,000) (60,000)

_________ $(190,000) 1.000 $(190,000) $16,496

$250,000 (120,000) (70,000)

$250,000 (120,000) (70,000) (8,000)

$250,000 (120,000) (70,000)

_______ $52,000 0.756 $39,312

_______ $60,000 0.658 $39,480

60,000 12,000 $132,000 0.572 $75,504

________ $60,000 0.870 $52,200

Note: The sales ($250,000), variable expenses ($120,000), and fixed out-of-pocket costs ($70,000) can also be discounted their present values using the appropriate discount factor (2.855) from Exhibit 13B-2 in Appendix 13B.

Managerial Accounting, 16th Edition

Problem 13-19 (30 minutes) 1. The income statement would be: Sales ........................................................ Variable expenses: Cost of ingredients (20% × $300,000) ..... Commissions (12.5% × $300,000)........... Contribution margin................................... Fixed expenses: Salaries .................................................. Rent ($3,500 × 12) ................................. Depreciation* ......................................... Insurance ............................................... Utilities................................................... Net operating income ................................

$300,000 $60,000 37,500 70,000 42,000 16,800 3,500 27,000

97,500 202,500

159,300 $ 43,200

* $270,000 – $18,000 = $252,000 $252,000 ÷ 15 years = $16,800 per year 2. The formula for the simple rate of return is: Simple rate of return = =

Annual incremental net operating income Initial investment $43,200 = 16.0% $270,000

Yes, the franchise would be acquired because it promises a rate of return in excess of 12%.

Problem 13-19 (continued) 3. The formula for the payback period is: Payback period =

Investment required Annual net cash inflow

$270,000 = 4.5 years $60,000*

*Net operating income + Depreciation = Annual net cash inflow $43,200 + $16,800 = $60,000 According to the payback computation, the franchise would not be acquired. The 4.5 years payback is greater than the maximum 4 years allowed. Payback and simple rate of return can give conflicting signals as in this example.

Managerial Accounting, 16th Edition

Problem 13-20 (30 minutes) 1. The annual net cost savings would be: Reduction in labor costs .......................................... Reduction in material waste .................................... Total ...................................................................... Less increased maintenance costs ........................... Annual net cost savings ..........................................

$108,000 6,500 114,500 36,000 $ 78,500

2. Using this cost savings figure, and other data from the text, the net present value analysis would be: Now $(250,000) (80,000)

Cost of machine ........... Software and installation Salvage value of old equipment.................. 12,000 Annual net cost savings Replacement of parts .... Salvage value of new machine ..................... _______ Total cash flows (a) ...... $(318,000) Discount factor (16%) (b) 1.000 Present value (a)×(b) ... $(318,000) Net present value ......... $(49,450)

$78,500

$78,500 $78,500 $78,500 $78,500 (45,000)

$78,500

______ $78,500 0.862 $67,667

______ ______ $78,500 $33,500 0.743 0.641 $58,326 $21,474

20,000 $98,500 0.410 $40,385

______ ______ $78,500 $78,500 0.552 0.476 $43,332 $37,366

No, the automated welding machine should not be purchased. Its net present value is negative. Note: The annual net cost savings ($78,500) can also be discounted to their present value using the appropriate discount factor (3.685) from Exhibit 13B-2 in Appendix 13B. © The McGraw-Hill Companies, Inc., 2018 Solutions Manual, Chapter 13

Problem 13-20 (continued) 3. The dollar value per year that would be required for the intangible benefits is: Negative net present value to be offset $49,450 = = $13,419 Present value factor 3.685

Thus, the automated welding machine should be purchased if management believes that the intangible benefits are worth at least $13,419 per year.

Managerial Accounting, 16th Edition

Problem 13-21 (30 minutes) 1. The formula for the project profitability index is: Project profitability index =

Net present value of the project Investment required by the project

The indexes for the projects under consideration would be: Project 1: Project 2: Project 3: Project 4:

$66,140 ÷ $270,000 = 0.24 $72,970 ÷ $450,000 = 0.16 $73,400 ÷ $360,000 = 0.20 $87,270 ÷ $480,000 = 0.18

2. a., b., and c.

First preference ........ Second preference ... Third preference....... Fourth preference .....

Project Net Present Profitability Internal Rate Value Index of Return 4 3 2 1

1 3 4 2

2 1 4 3

Problem 13-21 (continued) 3. Which ranking is best will depend on Revco Products’ opportunities for reinvesting funds as they are released from the project. The internal rate of return method assumes that any released funds are reinvested at the internal rate of return. 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 project 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 only 10%. On balance, the project profitability index is 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 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 project profitability index).

Managerial Accounting, 16th Edition

Problem 13-22 (20 minutes) 1. The annual net cash inflows would be: Reduction in annual operating costs: Operating costs, present hand method ..... Operating costs, new machine ................. Annual savings in operating costs ............ Increased annual contribution margin: 6,000 boxes × $1.50 per box................... Total annual net cash inflows .....................

$30,000 7,000 23,000 9,000 $32,000

2. The net present value is computed as follows: Purchase of machine....... Annual net cash inflows . Replacement parts .......... Salvage value of machine Total cash flows (a) ........ Discount factor (20%) (b) Present value (a)×(b) ..... Net present value ...........

Now $(120,000) ________ $(120,000) 1.000 $(120,000) (26,516)

$32,000

______ $32,000 0.833 $26,656

______ $32,000 0.694 $22,208

$32,000 (9,000) _______ $23,000 0.579 $13,317

______ $32,000 0.482 $15,424

7,500 $39,500 0.402 $15,879

Note: The annual net cash inflows ($32,000) can also be discounted to their present value using the appropriate discount factor (2.991) from Exhibit 13B-2 in Appendix 13B.

Problem 13-23 (45 minutes) 1. The payback periods for Products A and B are calculated using a twostep process. First, the annual net cash inflows are calculated as follows: Sales revenues ................................. Variable expenses ............................. Fixed out-of-pocket operating costs ... Annual net cash inflows ....................

Product A $250,000 (120,000) (70,000) $ 60,000

Product B $350,000 (170,000) (50,000) $130,000

The second step is to compute each product’s payback period as follows: Investment required (a) .................... Annual net cash inflow (b) ................. Payback period (a) ÷ (b) ...................

Product A Product B $170,000 $380,000 $60,000 $130,000 2.83 years 2.92 years

Managerial Accounting, 16th Edition

Problem 13-23 (continued) 2. The net present values for Products A and B are computed as follows: Product A: Purchase of equipment .............. Sales ........................................ Variable expenses ...................... Fixed out-of-pocket costs ........... Total cash flows (a) ................... Discount factor (16%) (b) .......... Present value (a)×(b) ................ Net present value ......................

Now $(170,000)

Years 1-5

$250,000 (120,000) (70,000) $(170,000) $60,000 1.000 3.274 $(170,000) $196,440 $26,440

Product B: Purchase of equipment .............. Sales ........................................ Variable expenses ...................... Fixed out-of-pocket costs ........... Total cash flows (a) ................... Discount factor (b) .................... Present value (a)×(b) ................ Net present value ......................

Now $(380,000)

$(380,000) 1.000 $(380,000) $45,620

Years 1-5 $350,000 (170,000) (50,000) $130,000 3.274 $425,620

Problem 13-23 (continued) 3. The internal rate of return for each product is calculated as follows: Investment required (a) ............................. Annual net cash inflow (b) ......................... Factor of the internal rate of return (a) ÷ (b)

Product A Product B $170,000 $380,000 $60,000 $130,000 2.833 2.923

Looking in Exhibit 13B-2 and scanning along the 5-period line, a factor of 2.833 falls right between 22% and 23%, so we’ll estimate an internal rate of return for Product A of 22.5%. A factor of 2.923 is closest to 21%, so we’ll estimate an internal rate of return for Product B of 21%. 4. The project profitability index for each product is computed as follows: Net present value (a) ................................. Investment required (b) ............................. Project profitability index (a) ÷ (b) .............

Product A Product B $26,440 $45,620 $170,000 $380,000 0.16 0.12

5. The simple rate of return for each product is computed as follows: Annual net cash inflow ............................... Depreciation expense................................. Annual incremental net operating income....

Product A Product B $60,000 $130,000 34,000 76,000 $26,000 $ 54,000

Annual incremental net operating income (a) Initial investment (b) ................................. Simple rate of return (a) ÷ (b) ...................

Product A Product B $26,000 $54,000 $170,000 $380,000 15.3% 14.2%

6. The net present value calculations suggest that Product B is preferable to Product A. However, the project 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%. © The McGraw-Hill Companies, Inc., 2018 44

Managerial Accounting, 16th Edition

Problem 13-24 (45 minutes) 1. Present cost of transient workers .......................... $40,000 Less out-of-pocket costs to operate the cherry picker: Cost of an operator and assistant ....................... $14,000 Insurance.......................................................... 200 Fuel .................................................................. 1,800 Maintenance contract......................................... 3,000 19,000 Annual savings in cash operating costs .................. $21,000 2. The first step is to determine the annual incremental net operating income: Annual savings in cash operating costs ............. Less annual depreciation ($94,500 ÷ 12 years) . Annual incremental net operating income ......... Simple rate of return = =

$21,000 7,875 $13,125

Annual incremental net operating income Initial investment $13,125 = 13.9% (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

$94,500 = 4.5 years $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 answer conflicts with the answer in Part 2.

Problem 13-24 (continued) 4. The formula for the internal rate of return is: Factor of the internal = Investment required rate of return Annual net cash inflow =

$94,500 = 4.500 $21,000

Looking in Exhibit 13B-2 and scanning along the 12-period line, we can see that the factor computed above, 4.500, is closest to 4.439, the factor for the 20% rate of return. Therefore, to the nearest whole percent, the internal rate of return is 20%. No, the simple rate of return is not an accurate guide in investment decisions. It ignores the time value of money.

Managerial Accounting, 16th Edition

Problem 13-25 (30 minutes) 1. The present value of the purchase alternative is computed as follows: Purchase Alternative: Purchase of cars ......... Annual servicing costs. Repairs ...................... Resale value of cars .... Total cash flows (a) .... Discount factor (b) ..... Present value (a)×(b) . Net present value .......

Now $(170,000) ________ $(170,000) 1.000 $(170,000) $(132,554)

$(3,000) (1,500) ______ $(4,500) 0.847 $(3,812)

$(3,000) (4,000) ______ $(7,000) 0.718 $(5,026)

$(3,000) (6,000) 85,000 $76,000 0.609 $46,284

2. The present value of the lease alternative is computed as follows: Lease Alternative: Now $(10,000)

Security deposit .......... Annual lease payments $(55,000) $(55,000) $(55,000) Refund of deposit ....... _______ _______ _______ 10,000 Total cash flows (a) .... $(10,000) $(55,000) $(55,000) $(45,000) Discount factor (b) ..... 1.000 0.847 0.718 0.609 Present value (a)×(b) . $(10,000) $(46,585) $(39,490) $(27,405) Net present value ....... $(123,480) Note: The annual servicing costs ($3,000) and the annual lease payments ($55,000) can also be discounted to their present values using the appropriate discount factor (2.174) from Exhibit 13B-2 in Appendix 13B. 3. The company should lease the cars because this alternative has the lowest present value of total costs.

Problem 13-26 (30 minutes) 1. The annual incremental net 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 ... Net 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 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 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.

Managerial Accounting, 16th Edition

Problem 13-27 (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 receipts 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 receipts from operations........

$70,200 21,060 91,260 $ 7,020 2,106 20,400 5,400 900 6,000

41,826 $49,434

Problem 13-27 (continued) 2. The net present value is computed as follows:

Purchase of equipment ..... Working capital ................ Annual net cash flows ....... Working capital released ... Salvage value ($200,000 × 10%) ............................... Total cash flows (a) .......... Discount factor (b) ........... Present value (a)×(b) ....... Net present value .............

Now $(200,000) (2,000)

________ $(202,000) 1.000 $(202,000) $(934)

Years 1-5 $49,434

Year 5

$2,000

______ 20,000 $49,434 $22,000 3.791 0.621 $187,404 $13,662

No, Mr. Duncan should not open the auto wash. The negative net present value indicates that the rate of return on this investment is slightly less than the 10% required rate of return.

Managerial Accounting, 16th Edition

Problem 13-28 (20 minutes) 1. The net present value of keeping the old truck is computed as follows: Keep the old truck: Now Overhaul needed now ...... Annual operating costs..... Salvage value (old) .......... Total cash flows (a) ......... Discount factor (b) .......... Present value (a)×(b) ...... Net present value ............

$(7,000) ______ $(7,000) 1.000 $(7,000) $(39,264)

Years 1-5

Year 5

(10,000) _______ $(10,000) 3.274 $(32,740)

$1,000 $1,000 0.476 $476

2. The net present value of purchasing the new truck is computed as follows: Purchase the new truck: Now Purchase new truck ......... Salvage value (old) .......... Annual operating costs..... Salvage value (new) ........ Total cash flows (a) ......... Discount factor (b) .......... Present value (a)×(b) ...... Net present value ............

$(30,000) 9,000 _______ $(21,000) 1.000 $(21,000) $(40,377)

Years 1-5

Year 5

(6,500) ______ $(6,500) 3.274 $(21,281)

$4,000 $4,000 0.476 $1,904

3. The company should keep the old truck because the present value of the net cash outflows is $1,113 lower for that alternative.

Problem 13-29 (45 minutes) 1. A net present value computation for each investment follows: Common stock: Purchase of the stock . Sales of the stock ....... Total cash flows (a) .... Discount factor (b) ..... Present value (a)×(b) . Net present value ....... Preferred stock: Purchase of the stock . Annual cash dividend ($30,000 × 0.06)........ Sales of the stock ....... Total cash flows (a) .... Discount factor (b) ..... Present value (a)×(b) . Net present value ....... Bonds: Purchase of the bonds Annual interest income Sales of the bonds ...... Total cash flows (a) .... Discount factor (b) ..... Present value (a)×(b) . Net present value .......

Now $(95,000) ________ $(95,000) 1.000 $(95,000) $7,560 Now $(30,000) ________ $(30,000) 1.000 $(30,000) $(8,650) Now $(50,000) ________ $(50,000) 1.000 $(50,000) $(2,743)

Years 1-3

Year 3

______ $0 2.246 $0

$160,000 $160,000 0.641 $102,560

Years 1-3

Year 3

$1,800 ______ $1,800 2.246 $4,043

$27,000 $27,000 0.641 $17,307

Years 1-3

Year 3

$6,000 ______ $6,000 2.246 $13,476

$52,700 $52,700 0.641 $33,781

Linda earned a 16% rate of return on the common stock, but not on the preferred stock or the bonds.

Managerial Accounting, 16th Edition

Problem 13-29 (continued) 2. Considering all three investments together, Linda did not earn a 16% rate of return. The computation is:

Common stock .......................... Preferred stock.......................... Bonds ....................................... Overall net present value ...........

Net Present Value

$ 7,560 (8,650) (2,743) $(3,833)

The defect in 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.

Factor of the internal = Investment required rate of return Annual net cash inflow

Substituting the $239,700 investment and the factor for 14% for 12 periods into this formula, we get: $239,700 = 5.660 Annual cash inflow

Therefore, the required annual net cash inflow is: $239,700 ÷ 5.660 = $42,350.

Problem 13-30 (60 minutes) 1. Computation of the annual net cost savings: Savings in labor costs (25,000 hours × $16 per hour) .. Savings in inventory carrying costs .............................. Total.......................................................................... Less increased power and maintenance cost ................ Annual net cost savings ..............................................

$400,000 210,000 610,000 30,000 $580,000

2. The net present value is computed as follows: Cost of the robot ..... Installation & software ................. Annual net cost savings ................... Inventory reduction . Salvage value (old) .. Total cash flows (a) . Discount factor (b) .. Present value (a)×(b) ................... Net present value ....

Now $(1,600,000)

$580,000 400,000 _______ $980,000 0.833

$580,000

_______ $580,000 0.694

_______ $580,000 0.579

_______ $580,000 0.482

70,000 $650,000 0.402

$816,340

$402,520

$335,820

$279,560

$261,300

(450,000)

_________ $(2,050,000) 1.000 $(2,050,000) $45,540

Yes, the robot should be purchased. It has a positive net present value at a 20% discount rate. Note: The annual net cost savings ($580,000) can also be discounted to their present value using the appropriate discount factor (2.991) from Exhibit 13B-2 in Appendix 13B. © The McGraw-Hill Companies, Inc., 2018 54

Managerial Accounting, 16th Edition

Problem 13-30 (continued) 3. Recomputation of the annual net cost savings: Savings in labor costs (22,500 hours × $16 per hour) Savings in inventory carrying costs ........................... Total....................................................................... Less increased power and maintenance cost ............. Annual net cost savings ...........................................

$360,000 210,000 570,000 30,000 $540,000

The revised present value computations are follows: Cost of the robot ..... Installation & software ................. Annual net cost savings ................... Inventory reduction . Salvage value (old) .. Total cash flows (a) . Discount factor (b) .. Present value (a)×(b) ................... Net present value ....

Now $(1,600,000)

$540,000 400,000 _______ $940,000 0.833

$540,000

_______ $540,000 0.694

_______ $540,000 0.579

_______ $540,000 0.482

70,000 $610,000 0.402

$783,020

$374,760

$312,660

$260,280

$245,220

(525,000)

_________ $(2,125,000) 1.000 $(2,125,000) $(149,060)

It appears the rate of return that will be earned by the new equipment is less than 20%. Note: The annual net cost savings ($540,000) can also be discounted to their present value using the appropriate discount factor (2.991) from Exhibit 13B-2 in Appendix 13B. © The McGraw-Hill Companies, Inc., 2018 Solutions Manual, Chapter 13

Problem 13-30 (continued) 4. a. Several intangible benefits are usually associated with investments in automated equipment. These intangible benefits include: ◼ Greater throughput. ◼ Greater variety of products. ◼ Higher quality. ◼ Reduction in inventories. The value of these benefits can equal or exceed any savings that may come from reduced labor cost. However, these benefits are hard to quantify. b. Negative net present value to be offset $149,060 = = $49,836 Present value factor, 5 years at 20% 2.991 Thus, the intangible benefits in (a) would have to generate a cash inflow of $49,836 per year in order for the robot to yield a 20% rate of return.

Managerial Accounting, 16th Edition

Case 13-31 (45 minutes) 1. Rachel Arnett’s revision of her first proposal can be considered a violation of the IMA’s Statement of Ethical Professional Practice. She discarded her reasonable projections and estimates after she was questioned by William Earle. She used figures that had a remote chance of occurring. By doing this, she violated the requirements to “Communicate information fairly and objectively” and “disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations.” By altering her analysis, she also violated the Integrity standard. She engaged in an activity that would prejudice her ability to carry out her duties ethically. In addition, she violated the Competence standard—“Provide decision support information and recommendations that are accurate, clear, concise, and timely.” 2. Earle was clearly in violation of the Standards of Ethical Conduct for Management Accountants because he tried to persuade a subordinate to prepare a proposal with data that was false and misleading. Earle has violated the standards of Competence (Provide decision support information and recommendations that are accurate, clear, concise, and timely.), Integrity (Mitigate actual conflicts of interest. Regularly communicate with business associates to avoid apparent conflicts of interest.), and Credibility (Communicate information fairly and objectively. Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations.).

Case 13-31 (continued) 3. The internal controls Fore Corporation could implement to prevent unethical behavior include:  approval of all formal capital expenditure proposals by the Controller and/or the Board of Directors.  designating a non-accounting/finance manager to coordinate capital expenditure requests and/or segregating duties during the preparation and approval of capital expenditure requests.  requiring that all capital expenditure proposals be reviewed by senior operating management, which includes the Controller, before the proposals are submitted for approval.  requiring the internal audit staff to review all capital expenditure proposals or contracting external auditors to review the proposal if the corporation lacks manpower. (Unofficial CMA Solution, adapted)

Managerial Accounting, 16th Edition

Case 13-32 (45 minutes) 1. The net cash inflow from sales of the device for each year would be:

Year 1

Sales in units ....................... 9,000 15,000 Sales in dollars (@ $35 each) .................... $315,000 $525,000 Variable expenses (@ $15 each) .................... 135,000 225,000 Incremental contribution margin .............................. 180,000 300,000 Fixed expenses: Salaries and other* ............ 85,000 85,000 Advertising ........................ 180,000 180,000 Incremental fixed expenses... 265,000 265,000 Net cash inflow (outflow) ...... $(85,000) $ 35,000

18,000

4-6

22,000

$630,000 $770,000 270,000

330,000

360,000

440,000

85,000 85,000 150,000 120,000 235,000 205,000 $125,000 $235,000

* Depreciation is not a cash expense and therefore must be eliminated from this computation. The analysis is: ($315,000 – $15,000 = $300,000) ÷ 6 years = $50,000 depreciation; $135,000 total expense – $50,000 depreciation = $85,000.

Case 13-32 (continued) 2. The net present value of the proposed investment would be:

Cost of equipment .. Working capital ...... Yearly net cash flows ..................... Release of working capital.................... Salvage value of equipment ............. Total cash flows (a) Discount factor (14%) (b) .............. Present value (a)×(b) .................. Net present value ...

Now $(315,000) (60,000)

$(85,000) $35,000 $125,000 $235,000 $235,000 $235,000 60,000 _______ $(375,000) 1.000 $(375,000) $64,190

______ ______ ______ ______ ______ 15,000 $(85,000) $35,000 $125,000 $235,000 $235,000 $310,000 0.877

0.769

$(74,545) $26,915

0.675

0.592

0.519

0.456

$84,375 $139,120 $121,965 $141,360

Since the net present value is positive, the company should pursue the new product.

Managerial Accounting, 16th Edition

Appendix 13A The Concept of Present Value

Exercise 13A-1 (10 minutes)

Amount of Cash Flows Investment Investment Year A B 1 2 3 4

$3,000 $6,000 $9,000 $12,000

$12,000 $9,000 $6,000 $3,000

18% Factor

0.847 0.718 0.609 0.516

Present Value of Cash Flows Investment Investment A B $ 2,541 4,308 5,481 6,192 $18,522

$10,164 6,462 3,654 1,548 $21,828

Investment project B is best.

Exercise 13A-2 (10 minutes) The present value of the first option is $150,000, since the entire amount would be received immediately. The present value of the second option is: Annual annuity: $14,000 × 7.469 (Exhibit 13B-2) ......... Lump-sum payment: $60,000 × 0.104 (Exhibit 13B-1) . Total present value .....................................................

$104,566 6,240 $110,806

Thus, Julie should accept the first option, which has a much higher present value. On the surface, the second option appears to be a better choice because it promises a total cash inflow of $340,000 over the 20-year period ($14,000 × 20 = $280,000; $280,000 + $60,000 = $340,000), whereas the first option promises a cash inflow of only $150,000. However, the cash inflows under the second option are spread out over 20 years, causing the present value to be far less.

Managerial Accounting, 16th Edition

Exercise 13A-3 (10 minutes) 1. From Exhibit 13B-1, the factor for 10% for 3 periods is 0.751. Therefore, the present value of the required investment is: $8,000 × 0.751 = $6,008 2. From Exhibit 13B-1, the factor for 14% for 3 periods is 0.675. Therefore, the present value of the required investment is: $8,000 × 0.675 = $5,400

Exercise 13A-4 (10 minutes) 1. From Exhibit 13B-1, the factor for 10% for 5 periods is 0.621. Therefore, the company must invest: $500,000 × 0.621 = $310,500 2. From Exhibit 13B-1, the factor for 14% for 5 periods is 0.519. Therefore, the company must invest: $500,000 × 0.519 = $259,500

Managerial Accounting, 16th Edition

Exercise 13A-5 (10 minutes) 1. From Exhibit 13B-2, the factor for 16% for 8 periods is 4.344. The computer system should be purchased only if its net present value is positive. This will occur only if the purchase price is less: $7,000 × 4.344 = $30,408 2. From Exhibit 13B-2, the factor for 20% for 8 periods is 3.837. Therefore, the maximum purchase price would be: $7,000 × 3.837 = $26,859

Exercise 13A-6 (10 minutes) 1. From Exhibit 13B-2, the factor for 12% for 20 periods is 7.469. Thus, the present value of Mr. Ormsby’s winnings is: $80,000 × 7.469 = $597,520 2. Whether or not it is correct to say that Mr. Ormsby is the state’s newest millionaire depends on your point of view. He will receive more than a million dollars over the next 20 years; however, he is not a millionaire as shown by the present value computation above, nor will he ever be a millionaire if he spends his winnings rather than investing them.

Managerial Accounting, 16th Edition

Appendix 13C Income Taxes and Net Present Value Analysis

Exercise 13C-1 (10 minutes) The project’s net present value is computed as follows: Now Purchase of equipment ......................... Sales ................................................... Variable expenses ................................. Out-of-pocket costs .............................. Income tax expense ($300,000 × 30%) . Total cash flows (a) .............................. Discount factor (b) ............................... Present value (a)×(b) ........................... Net present value .................................

$(2,000,000)

__________ $(2,000,000) 1.000 $(2,000,000) $145,370

Years 1-5 $2,800,000 (1,600,000) (500,000) (90,000) $610,000 3.517 $2,145,370

Exercise 13C-2 (20 minutes) 1. The annual income tax expense is computed as follows: Years 1-5

Annual tax expense:

Sales ...................................... Variable expenses .................... Out-of-pocket costs ................. Depreciation expense ($130,000 ÷ 5) ..................... Incremental net income ........... Tax rate .................................. Income tax expense ................

$250,000 (120,000) (70,000) (26,000) $ 34,000 30% $(10,200)

2. The net present value is computed as follows:

Net present value:

Purchase equipment ................ Sales ...................................... Variable expenses .................... Out-of-pocket costs ................. Income tax expense ................ Total cash flows (a) ................. Discount factor (b) .................. Present value (a) × (b) ............ Net present value ....................

Now

Years 1-5

$(130,000)

$250,000 (120,000) (70,000) ________ (10,200) $(130,000) $ 49,800 1.000 3.352 $(130,000) $166,930 $36,930

Managerial Accounting, 16th Edition

Problem 13C-3 (30 minutes) 1. and 2. The annual income tax expense for each year and the net present value are computed as follows: Now

Annual tax expense:

Sales ......................... Variable expenses ....... Out-of-pocket costs .... Repair of equipment ... Depreciation expense.. Incremental net income Tax rate ..................... Income tax expense ... Net present value: Purchase equipment ... $(250,000) Working capital .......... (60,000) Sales ......................... Variable expenses ....... Out-of-pocket costs .... Repair of equipment ... Release working capital Income tax expense ... ________ Total cash flows (a) .... $(310,000) Discount factor (b) ..... 1.000 Present value (a) × (b) $(310,000) Net present value ....... $(4,832)

$350,000 $350,000 (180,000) (180,000) (80,000) (80,000) (18,000) (50,000) (50,000) $ 40,000 $ 22,000 30% 30% $(12,000) $(6,600)

$350,000 $350,000 (180,000) (180,000) (80,000) (80,000)

$350,000 (180,000) (80,000)

(50,000) (50,000) $ 40,000 $ 40,000 30% 30% $(12,000) $(12,000)

(50,000) $ 40,000 30% $(12,000)

$350,000 $350,000 $350,000 $350,000 (180,000) (180,000) (180,000) (180,000) (80,000) (80,000) (80,000) (80,000) (18,000)

$350,000 (180,000) (80,000)

60,000 (12,000) (6,600) (12,000) (12,000) (12,000) $ 78,000 $ 65,400 $ 78,000 $ 78,000 $ 138,000 0.893 0.797 0.712 0.636 0.567 $69,654 $52,124 $55,536 $49,608 $78,246

Problem 13C-4 (30 minutes) 1. and 2. The annual income tax expense and net present value are computed as follows: Now

Annual tax expense:

Sales ......................... $410,000 Variable expenses ....... (175,000) Out-of-pocket costs .... (100,000) Equipment maintenance Depreciation expense.. (84,000) Incremental net income $ 51,000 Tax rate ..................... 30% Income tax expense ... $(15,300) Net present value: Purchase equipment ... $(420,000) Working capital .......... (65,000) Sale of old equipment . $80,000 Sales ......................... $410,000 Variable expenses ....... (175,000) Out-of-pocket costs .... (100,000) Equipment maintenance Release working capital Income tax expense ... ________ (15,300) Total cash flows (a) .... $(405,000) $119,700 Discount factor (b) ..... 1.000 0.893 Present value (a) × (b) $(405,000) $106,892 Net present value ....... $44,501

$410,000 $410,000 (175,000) (175,000) (100,000) (100,000) (20,000) (84,000) (84,000) $ 51,000 $ 31,000 30% 30% $(15,300) $(9,300)

$410,000 (175,000) (100,000) (20,000) (84,000) $ 31,000 30% $(9,300)

$410,000 (175,000) (100,000) (84,000) $ 51,000 30% $(15,300)

$410,000 $410,000 $410,000 $410,000 (175,000) (175,000) (175,000) (175,000) (100,000) (100,000) (100,000) (100,000) (20,000) (20,000) 65,000 (15,300) (9,300) (9,300) (15,300) $119,700 $105,700 $105,700 $184,700 0.797 0.712 0.636 0.567 $95,401 $75,258 $67,225 $104,725

Managerial Accounting, 16th Edition

Problem 13C-5 (45 minutes) 1. and 2. The annual income tax expense and net present value of Product A are computed as follows: Now

Annual tax expense:

Sales ......................... Operating expenses .... Repairs ...................... Depreciation expense.. Incremental net income Tax rate ..................... Income tax expense ... Net present value: Purchase equipment ... $(400,000) Working capital .......... (85,000) Sales ......................... Operating expenses .... Repairs ...................... Release working capital Income tax expense ... ________ Total cash flows (a) .... $(485,000) Discount factor (b) ..... 1.000 Present value (a) × (b) $(485,000) Net present value ....... $28,629

$370,000 $370,000 $370,000 $370,000 (200,000) (200,000) (200,000) (200,000) (45,000) (80,000) (80,000) (80,000) (80,000) $90,000 $90,000 $ 45,000 $90,000 30% 30% 30% 30% $(27,000) $(27,000) $(13,500) $(27,000)

$370,000 (200,000)

$370,000 $370,000 $370,000 $370,000 (200,000) (200,000) (200,000) (200,000) (45,000)

$370,000 (200,000)

(27,000) (27,000) (13,500) (27,000) $143,000 $143,000 $111,500 $143,000 0.877 0.769 0.675 0.592 $125,411 $109,967 $75,263 $84,656

(80,000) $90,000 30% $(27,000)

85,000 (27,000) $228,000 0.519 $118,332

Note: The sales ($370,000) and operating expenses ($200,000) can also be discounted to their present values using the appropriate discount factor (3.433) from Exhibit 13B-2 in Appendix 13B. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Appendix 13C

Problem 13C-5 (continued) 3. and 4. The annual income tax expense and net present value of Product B are computed as follows: Now

Annual tax expense:

Sales ......................... Operating expenses .... Repairs ...................... Depreciation expense.. Incremental net income Tax rate ..................... Income tax expense ... Net present value: Purchase equipment ... $(550,000) Working capital .......... (60,000) Sales ......................... Operating expenses .... Repairs ...................... Release working capital Income tax expense ... ________ Total cash flows (a) .... $(610,000) Discount factor (b) ..... 1.000 Present value (a) × (b) $(610,000) Net present value ....... $29,849

$390,000 (170,000)

(110,000) $110,000 30% $(33,000)

$390,000 $390,000 $390,000 $390,000 (170,000) (170,000) (170,000) (170,000) (70,000)

$390,000 (170,000)

$390,000 $390,000 $390,000 (170,000) (170,000) (170,000) (70,000) (110,000) (110,000) (110,000) $110,000 $110,000 $ 40,000 30% 30% 30% $(33,000) $(33,000) $(12,000)

(33,000) (33,000) (12,000) (33,000) $187,000 $187,000 $138,000 $187,000 0.877 0.769 0.675 0.592 $163,999 $143,803 $93,150 $110,704

60,000 (33,000) $247,000 0.519 $128,193

Note: The sales ($390,000) and operating expenses ($170,000) can also be discounted to their present values using the appropriate discount factor (3.433) from Exhibit 13B-2 in Appendix 13B. © The McGraw-Hill Companies, Inc., 2018 72

Managerial Accounting, 16th Edition

Problem 13C-5 (continued) 5. Students should use the project profitability index to answer this question as follows: Product A Product B Net present value (a) ................................ $28,629 $29,849 Investment required (b) ............................ $485,000 $610,000 Project profitability index (a) ÷ (b) ............ 0.059 0.049 Although Product A has the lower net present value, it has the higher project profitability index; therefore, it should be chosen over Product B.

Chapter 14 Statement of Cash Flows Solutions to Questions 14-1 The statement of cash flows highlights the major activities that impact cash flows and hence affect the overall cash balance. 14-2 Cash equivalents are short-term, highly liquid investments such as Treasury bills, commercial paper, and money market funds. They are included with cash because investments of this type are made solely for the purpose of generating a return on temporarily idle funds and they can be easily converted to cash. 14-3 (1) Operating activities: Include cash inflows and outflows related to revenue and expense transactions that affect net income. (2) Investing activities: Include cash inflows and outflows related to acquiring or disposing of noncurrent assets. (3) Financing activities: Include cash inflows and outflows related to borrowing from and repaying principal to creditors and completing transactions with the company’s owners. 14-4 The company’s specific circumstances should be considered when interpreting the statement of cash flows. The relationships among numbers should also be considered rather than evaluating each number in isolation. 14-5 Since the entire cash proceeds from the sale of a noncurrent asset appear as a cash inflow from investing activities, the gain must be deducted from net income to avoid double counting a portion of those proceeds.

14-7 The repayment of $300,000 and the borrowing of $500,000 must both be shown “gross” on the statement of cash flows. That is, the company would show $500,000 of cash provided by financing activities and then show $300,000 of cash used by financing activities. 14-8 The direct method reconstructs the income statement on a cash basis by restating revenues and expenses in terms of cash inflows and outflows. The indirect method starts with net income and adjusts it to a cash basis to determine the net cash provided by operating activities. 14-9 Depreciation is not a cash inflow, even though it is added to net income on the statement of cash flows. Adding depreciation to net income to compute the amount of net cash provided by operating activities creates the illusion that depreciation is a cash inflow. It isn’t. 14-10 An increase in the Accounts Receivable account must be subtracted from net income under the indirect method because this is an increase in a noncash asset. 14-11 A sale of equipment for cash would be classified as an investing activity. Any transaction involving the acquisition or disposition of noncurrent assets is classified as an investing activity. 14-12 Free cash flow is net cash provided by operating activities minus capital expenditures and dividends.

14-6 Transactions involving accounts payable are not considered to be financing activities because such transactions relate to a company’s day-to-day operating activities rather than to its financing activities. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 14

The Foundational 15 1.

The net decrease in cash and cash equivalents would equal the $9,000 decrease in the cash balance (from $57,000 to $48,000) as shown on the balance sheet.

The basic equation for stockholders’ equity accounts can be applied to the Retained Earnings account to compute the net income of $2,000 as follows: Beginning balance – Debits + Credits = Ending balance $61,000 – $6,000 + Credits = $57,000 $55,000 + Credits = $57,000 Credits = $2,000

The basic equation for contra-asset accounts can be applied to the Accumulated Depreciation account to compute the depreciation of $19,000 that needs to be added to net income as follows: Beginning balance – Debits + Credits = Ending balance $35,000 – $4,000 + Credits = $50,000 $31,000 + Credits = $50,000 Credits = $19,000 Note to Instructors: Questions 4-9 are intended to help students move past strict memorization to better understand the underlying reasons for the adjustments in step 2 of the indirect method.

The completed T-account is as follows: Beg. Bal. Sales on account End. Bal.

Accounts Receivable 44,000 600,000 Cash collections 41,000

603,000

The total amount of credits recorded in accounts receivable is $603,000. This amount represents the cash collections from customers.

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 5.

The accounts receivable balance decreased by $3,000; therefore, the $3,000 decrease is added to net income. This adjustment reflects the fact (as depicted in the solution to question 4) that cash collections from customers of $603,000 were $3,000 higher than the credit sales of $600,000 included in the income statement.

The completed T-accounts are as follows: Beg. Bal. Purchases End. Bal.

Supplier payments

Inventory 50,000 405,000 Goods sold 55,000 Accounts Payable Beg. Bal. 430,000 Purchases End. Bal.

400,000

57,000 405,000 32,000

The total amount of inventory purchases debited to inventory and credited to accounts payable is $405,000. Therefore, the total amount of the debits to accounts payable is $430,000. The amount of the debits to accounts payable represents to total cash paid to suppliers. 7.

The inventory balance increased by $5,000; therefore, this amount is subtracted from net income. The accounts payable balance decreased by $25,000; therefore, this amount is also subtracted from net income. The combined amount of these adjustments is a $30,000 deduction from net income. This adjustment reflects the fact (as shown in the solution to question 6) that cash paid to suppliers of $430,000 is $30,000 higher than the cost of goods sold of $400,000 included in the income statement.

The completed T-account is as follows;

Tax payments

Income Taxes Payable Beg. Bal. 3,700 Taxes payable End. Bal.

28,000 700 25,000

The total amount of debits recorded in income taxes payable is $3,700. This amount represents the cash paid for income taxes. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 14

The Foundational 15 (continued) 9.

The income taxes payable balance decreased by $3,000; therefore, the $3,000 decrease is subtracted from net income. This adjustment reflects the fact (as depicted in the solution to question 8) that cash paid for income taxes of $3,700 is $3,000 higher than the income tax expense of $700 included in the income statement.

10. The operating activities section of the statement of cash flows would contain an adjustment related to a gain on the sale of a piece of equipment. The equipment was sold for $3,000 and it had a book value at the time of its sale of $2,000 (= $6,000 original cost − $4,000 of accumulated depreciation); therefore, the company would record a $1,000 gain on the sale (= $3,000 cash proceeds – $2,000 book value). This amount would be subtracted from net income in the operating activities section of the statement. 11. The net cash provided by (used in) operating activities would be computed as follows: Net income .................................................... Adjustments to convert net income to a cash basis: Depreciation................................................ Decrease in accounts receivable ................... Increase in inventory ................................... Decrease in accounts payable....................... Decrease in income taxes payable ................ Gain on sale of equipment ........................... Net cash provided by (used in) operating activities .....................................................

$ 2,000 $19,000 3,000 (5,000) (25,000) (3,000) (1,000) (12,000) $(10,000)

12. The gross cash outflows of $16,000 can be computed by applying the basic equation for assets to the Property, Plant, and Equipment account as follows: Beginning balance + Debits – Credits = Ending balance $140,000 + Debits – $6,000 = $150,000 Debits = $150,000 – $140,000 + $6,000 Debits = $16,000 © The McGraw-Hill Companies, Inc., 2018. All rights reserved. 4

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 13. The net cash provided by (used in) investing activities is $(13,000). This amount includes the $(16,000) cash outflow related to the purchase of property, plant, and equipment (as computed in question 12) and the $3,000 cash inflow from the sale of equipment. 14. The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact financing cash flows as follows:

Liabilities and Stockholders’ Equity Bonds payable ....................................... Common stock .......................................

Increase in Decrease Account in Account Balance Balance + 10,000 + 10,000

Because Ravenna did not retire any bonds or repurchase any of its own common stock during the year, the corresponding amounts in the table above represent the gross cash inflows that are included in financing section of the statement of cash flows. 15. The cash inflows of $20,000 from the issuance of bonds and common stock (as computed in question 14) minus the cash dividend of $6,000 equals net cash provided by (used in) financing activities of $14,000.

Exercise 14-1 (15 minutes)

Transaction

a. Collected cash from customers ............................ b. Paid cash to repurchase its own stock .................. c. Borrowed money from a creditor ......................... d. Paid suppliers for inventory purchases ................. e. Repaid the principal amount of a debt.................. f. Paid interest to lenders ....................................... g. Paid a cash dividend to stockholders .................... h. Sold common stock............................................. i. Loaned money to another entity .......................... j. Paid taxes to the government .............................. k. Paid wages and salaries to employees .................. l. Purchased equipment with cash .......................... m. Paid bills to insurers and utility providers ..............

Activity Operating Investing Financing X

X X

X X X

X X

Managerial Accounting, 16th Edition

X X

Exercise 14-2 (15 minutes) The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows:

Current Assets Accounts receivable........... Inventory ......................... Prepaid expenses .............. Current Liabilities Accounts payable .............. Accrued liabilities .............. Income taxes payable .......

Increase Decrease in Account in Account Balance Balance – 19,000 – 33,000 + 1,000 + 15,000 + 4,000

– 2,000

The net cash provided by (used in) operating activities is computed as follows:

Net income ............................................................. Adjustments to convert net income to a cash basis: Depreciation ......................................................... Increase in accounts receivable.............................. Increase in inventory ............................................. Decrease in prepaid expenses ................................ Increase in accounts payable ................................. Decrease in accrued liabilities ................................ Increase in income taxes payable ........................... Net cash provided by (used in) operating activities ....

$35,000 $20,000 (19,000) (33,000) 1,000 15,000 (2,000) 4,000 (14,000) $21,000

Exercise 14-3 (5 minutes) Free cash flow computation: Net cash provided by operating activities . Less: Capital expenditures ............................... Dividends .............................................. Free cash flow ..........................................

$ 34,000 $110,000 30,000

140,000 $(106,000)

Managerial Accounting, 16th Edition

Exercise 14-4 (30 minutes) Net cash provided by (used in) operating activities: Step 1: The company did not sell or retire any plant and equipment during the year (land is not depreciated); therefore, the $60 increase in Accumulated Depreciation equals the credit to the account that is added to net income. Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows: Current Assets Accounts receivable ......... Inventory ........................ Prepaid expenses............. Current Liabilities Accounts payable ............. Accrued liabilities ............. Income taxes payable ......

Increase in Account Balance – 110 – 9 + 35 +8

Decrease in Account Balance + 70

–4

Step 3: The gain on sale of investments ($10) is subtracted from net income and the loss on the sale of land ($6) is added to net income.

Exercise 14-4 (continued) The net cash provided by (used in) operating activities is computed as follows: Net income ........................................................... Adjustments to convert net income to a cash basis: Depreciation ....................................................... Increase in accounts receivable ........................... Decrease in inventory ......................................... Increase in prepaid expenses .............................. Increase in accounts payable............................... Decrease in accrued liabilities .............................. Increase in income taxes payable ........................ Gain on sale of long-term investments ................. Loss on sale of land ............................................ Net cash provided by (used in) operating activities ..

$ 84 $60 (110) 70 (9) 35 (4) 8 (10) 6

46 $130

2. Prepare a statement of cash flows for the year Investing and Financing activities: The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:

Noncurrent Assets Property, plant, and equipment................... Long-term investments............................... Liabilities and Stockholders’ Equity Bonds payable ........................................... Common stock ...........................................

Increase Decrease in Account in Account Balance Balance – 185

+150

– 80

Managerial Accounting, 16th Edition

Exercise 14-4 (continued) Because Pavolik did not retire any bonds or issue any of its own stock during the year, the corresponding amounts in the table on the prior page represent the gross cash flows that are included in the statement of cash flows. Property, plant, and equipment, long-term investments, and retained earnings require further analysis as follows: Property, Plant, and Equipment Additions 200 Sale of land 15 Change 185 The statement of cash flows must report the gross cash outflow of $200 and the gross cash inflow related to the sale of land of $9. Long-Term Investments Additions 0 Sale Change

6 6

The statement of cash flows must report the gross cash inflow related to the sale of the investment of $16. The company did not purchase any long-term investments during the year. Retained Earnings Dividends 30 Net income Change

84 54

The statement of cash flows must report the dividend payment of $30.

Exercise 14-4 (continued) Pavolik Company Statement of Cash Flows

Operating activities:

Net cash provided by (used in) operating activities .........

$ 130

Investing activities:

Proceeds from sale of long-term investments ................. $ 16 Proceeds from sale of land ............................................ 9 Additions to property, plant, & equipment ...................... (200) Net cash provided by (used in) investing activities.......... (175)

Financing activities:

Issuance of bonds payable............................................ Purchase of common stock ........................................... Cash dividends paid ..................................................... Net cash provided by (used in) financing activities ......... Net decrease in cash and cash equivalents .................... Beginning cash and cash equivalents ............................. Ending cash and cash equivalents .................................

150 (80) (30)

40 (5) 90 $ 85

Managerial Accounting, 16th Edition

Exercise 14-5 (10 minutes)

Item

Accounts receivable ................... Inventory .................................. Prepaid expenses....................... Accounts payable....................... Accrued liabilities ....................... Income taxes payable ................ Sale of equipment ..................... Sale of long-term investments ....

Amount

$90,000 decrease $120,000 increase $3,000 decrease $65,000 decrease $8,000 increase $12,000 increase $7,000 gain $10,000 loss

Add X X X X X

Subtract X X X

Exercise 14-6 (30 minutes) 1. Prepare a statement of cash flows: Operating activities: Step 1: The following equation can be applied to the Accumulated Depreciation account to compute the depreciation to add back to net income: Beginning balance – Debits + Credits = Ending balance $50 – $0 + Credits = $65 Credits = $65 – $50 Credits = $15 Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows: Current Assets Accounts receivable ......... Inventory ........................

Increase in Account Balance – 10

Current Liabilities Accounts payable .............

Decrease in Account Balance +2

Step 3: There were no gains or losses reported in the income statement.

Managerial Accounting, 16th Edition

Exercise 14-6 (continued) Investing and Financing activities: The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:

Noncurrent Assets Property, plant, and equipment .............. Liabilities and Stockholders’ Equity Common stock ......................................

Increase Decrease in Account in Account Balance Balance – 40 +5

Because Carmono did not sell any plant and equipment and it did not repurchase any of its own stock, the amounts above represent gross cash flows. The following equation can be applied to the Retained Earnings account to compute the dividend payment (the debit to the account): Beginning balance – Debits + Credits = Ending balance $39 – Debits + $35 = $60 $74 = $60 + Debits Debits = $14

Exercise 14-6 (continued) Carmono Company Statement of Cash Flows For This Year Ended December 31

Operating activities:

Net income ............................................................. Adjustments to convert net income to a cash basis: Depreciation ......................................................... Decrease in accounts receivable ............................. Increase in inventory ............................................. Increase in accounts payable ................................. Net cash provided by (used in) operating activities ....

Investing activities:

Additions to property, plant, & equipment ................. Net cash provided by (used in) investing activities .....

Financing activities:

Issuance of common stock ....................................... Cash dividends paid ................................................. Net cash provided by (used in) financing activities .....

$35 $15 2 (10) 4

(40)

5 (14)

Net decrease in cash and cash equivalents ................ Beginning cash and cash equivalents ........................ Ending cash and cash equivalents .............................

11 46

(40)

(9) (3) 6 $ 3

2. Free cash flow computation: Net cash provided by operating activities ... Less: Capital expenditures ............................... Dividends .............................................. Free cash flow ..........................................

$ 46 $40 14

54 $(8)

Managerial Accounting, 16th Edition

Problem 14-7 (30 minutes) 1. Net cash provided by (used in) operating activities: Step 1: The following equation can be applied to the Accumulated Depreciation account to compute the depreciation to add back to net income: Beginning balance – Debits + Credits = Ending balance $85 – $16 + Credits = $93 Credits = $93 – $85 + $16 Credits = $24 Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows:

Current Assets Accounts receivable ....... Inventory ...................... Prepaid expenses ........... Current Liabilities Accounts payable ........... Accrued liabilities ........... Income taxes payable ....

Increase in Account Balance – 100 –4 + 80 +6

Decrease in Account Balance + 50

– 12

Step 3: The gain on sale of investments ($7) is subtracted from net income and the loss on the sale of equipment ($4) is added to net income.

Problem 14-7 (continued) The net cash provided by (used in) operating activities is computed as follows: Net income ......................................................... Adjustments to convert net income to cash basis: Depreciation .................................................. Increase in accounts receivable....................... Decrease in inventory ..................................... Increase in prepaid expenses .......................... Increase in accounts payable .......................... Decrease in accrued liabilities ......................... Increase in income taxes payable .................... Gain on sale of investments ............................ Loss on sale of equipment .............................. Net cash provided by (used in) operating activities

$ 63 $24 (100) 50 (4) 80 (12) 6 (7) 4

41 $104

2. Prepare a statement of cash flows. Investing and Financing activities: The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:

Noncurrent Assets Property, plant, and equipment................. Long-term investments ............................ Liabilities and Stockholders’ Equity Bonds payable ......................................... Common stock .........................................

Increase Decrease in Account in Account Balance Balance –140

+ 110

– 40

Managerial Accounting, 16th Edition

Problem 14-7 (continued) The decrease in the long-term investments account ($3) equals the cost of the long-term investment sold; therefore, Weaver did not purchase any long-term investments during the year. The proceeds from the sale of a long-term investment ($10) should be recorded as a cash inflow in the investing activities section of the statement. Because Weaver did not retire any bonds during the year, the corresponding amount in the table on the prior page (+110) represents the gross cash inflow pertaining to a bond issuance. The company repurchased $40 of its own stock, so the corresponding amount on the prior page is reported as a cash outflow in the financing activities section in the statement of cash flows. Property, plant, and equipment and retained earnings require further analysis as follows: Property, plant, and equipment: Beginning balance + Debits – Credits = Ending balance $470 + Debits – $40 = $610 Debits = $610 – $470 + $40 Debits = $180 The additions to property, plant, and equipment ($180) are recorded as a cash outflow and the proceeds from the sale of equipment ($20) are recorded as a cash inflow. Retained earnings: Beginning balance – Debits + Credits = Ending balance $74 – Debits + $63 = $107 $137 = $107 + Debits Debits = $30 The dividend payment ($30) should be recorded as a cash outflow in the financing activities section of the statement.

Problem 14-7 (continued) Weaver Company Statement of Cash Flows For This Year Ended December 31

Operating activities:

Net income ........................................................... Adjustments to convert net income to cash basis: Depreciation .................................................... Increase in accounts receivable ......................... Decrease in inventory ....................................... Increase in prepaid expenses ............................ Increase in accounts payable ............................ Decrease in accrued liabilities............................ Increase in income taxes payable ...................... Gain on sale of investments .............................. Loss on sale of equipment ................................ Net cash provided by (used in) operating activities ..

Investing activities:

Proceeds from sale of long-term investments .......... Proceeds from sale of equipment............................ Additions to property, plant, & equipment ............... Net cash provided by (used in) investing activities ...

Financing activities:

Issuance of bonds payable ..................................... Repurchase of common stock ................................. Cash dividends paid ............................................... Net cash provided by (used in) financing activities ... Net decrease in cash and cash equivalents .............. Beginning cash and cash equivalents ...................... Ending cash and cash equivalents...........................

$ 63 $ 24 (100) 50 (4) 80 (12) 6 (7) 4

10 20 (180)

110 (40) (30)

41 104

(150)

40 (6) 15 $ 9

Managerial Accounting, 16th Edition

Problem 14-8 (20 minutes)

Transaction

a. Paid suppliers for inventory purchases .... b. Bought equipment for cash .................... c. Paid cash to repurchase its own stock ..... d. Collected cash from customers ............... e. Paid wages to employees ....................... f. Equipment was sold for cash .................. g. Common stock was sold for cash to investors............................................. h. Cash dividends were declared and paid ... i. A long-term loan was made to a supplier j. Income taxes were paid to the government ........................................ k. Interest was paid to a lender .................. l. Bonds were retired by paying the principal amount due...........................

Operating Investing Financing X X X

X X

Cash Outflow X X X X

X X X X

Cash Inflow

Problem 14-9 (60 minutes) The forthcoming explanation is broken down into eight steps. 1. The statement of cash flows summarizes all of a company’s cash inflows and outflows during a period, thereby explaining the difference between its beginning and ending cash balance. 2. The statement is divided into three sections—operating activities, investing activities, and financing activities. The operating activities section summarizes the cash inflows and outflows related to revenue and expense transactions that affect net income. The investing activities section summarizes the cash inflows and outflows related to acquiring or disposing of noncurrent assets. The financing activities section summarizes the cash inflows and outflows related to borrowing from and repaying principal to creditors and completing transactions with the company’s owners. 3. The indirect method of preparing the operating activities section of the statement of cash flows begins with net income and adjusts it to a cash basis. The first step in completing the indirect method is to add depreciation to net income. The total credits to Brock’s Accumulated Depreciation account equal $140, so this amount is added to net income. Because Brock is a merchandiser, the $140 corresponds to its depreciation expense, which is a noncash expense that must be added to net income to translate to a cash basis. 4. The second step is to analyze net changes in noncash balance sheet accounts that impact the computation of net income. For Brock, this includes Accounts Receivable, Inventory, Accounts Payable, Accrued Liabilities, and Income Taxes Payable. The accounts receivable balance increased by $24. This means that Brock’s sales on account were greater than its cash collections from customers by $24. Because the income statement records sales and not cash collections from customers, $24 must be subtracted from net income to translate it to a cash basis.

Managerial Accounting, 16th Edition

Problem 14-9 (continued) The inventory balance decreased by $39. This means that Brock’s inventory purchases were less than its cost of goods sold by $39. Brock’s cost of goods sold was $2,980; therefore, its inventory purchases were $2,941. The company’s accounts payable balance decreased by $45. This means that Brock’s inventory purchases were $45 less than its cash payments to suppliers. Brock’s inventory purchases were $2,941; therefore, its payments to suppliers must be $2,986. Because the income statement records cost of goods sold ($2,980) and not cash paid to suppliers ($2,986), $6 must be subtracted from net income to translate it to cash basis. If the inventory and accounts payable adjustments are combined it equals a $6 subtraction from net income. The accrued liabilities balance decreased by $5. This means that Brock’s accrued expenses are $5 less than its payments to vendors. Because the income statement records accrued expenses and not cash payments to vendors, $5 must be subtracted from net income to translate it to a cash basis. The income taxes payable balance increased by $6. This means that Brock’s accrued income tax expense is $6 greater than its tax payments to governmental bodies. Because the income statement records income tax expense and not tax payments, $6 must be added to net income to translate it to a cash basis. 5. The third step of the indirect method is to adjust for gains/losses included in the income statement. This adjustment is necessary because the cash realized from the sale of noncurrent assets must be disclosed in the investing activities section of the statement of cash flows. The adjustment in step 3 cancels the impact a gain or loss has on the computation of net income. Because gains increase net income, we subtract them from net income. Brock’s income statement includes a gain of $4, so this amount must be subtracted from net income.

Problem 14-9 (continued) 6. The investing activities section of Brock’s statement of cash flows records the gross cash flows related to its property, plant, and equipment. The statement includes a $150 cash outflow related to additions to property, plant, and equipment, and a $19 cash inflow related to the proceeds from the sale of property, plant, and equipment. 7. The financing activities section of Brock’s statement of cash flows records the gross cash flows related to its bonds payable, common stock, and dividends. The statement includes a $40 cash inflow related to the issuance of bonds. It also includes a $4 cash inflow related to issuing common stock and a $35 cash outflow related to paying dividends. 8. The net increase in cash and cash equivalents ($260) explains the difference between the beginning and ending cash balances.

Managerial Accounting, 16th Edition

Problem 14-10 (45 minutes) 1. Net cash provided by (used in) operating activities: Step 1: The following equation can be applied to the Accumulated Depreciation account to compute the depreciation to add back to net income: Beginning balance – Debits + Credits = Ending balance $120,000 – $30,000 + Credits = $132,000 Credits = $132,000 – $120,000 + $30,000 Credits = $42,000 Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows:

Current Assets Accounts receivable ............. Inventory ............................ Prepaid expenses................. Current Liabilities Accounts payable ................. Accrued liabilities ................. Income taxes payable ..........

Increase Decrease in Account in Account Balance Balance – 80,000 – 50,000

+ 60,000 + 3,000

+ 7,000

– 10,000

Step 3: The gain on sale of equipment ($8,000) is subtracted from net income.

Problem 14-10 (continued) The net cash provided by (used in) operating activities is computed as follows: Net income ........................................................... Adjustments to convert net income to cash basis: Depreciation ....................................................... Increase in accounts receivable ........................... Increase in inventory .......................................... Decrease in prepaid expenses ............................. Increase in accounts payable ............................... Decrease in accrued liabilities .............................. Increase in income taxes payable ........................ Gain on sale of equipment................................... Net cash provided by (used in) operating activities ..

$56,000 $ 42,000 (80,000) (50,000) 7,000 60,000 (10,000) 3,000 (8,000) (36,000) $20,000

Noncurrent Assets Property, plant, and equipment......... Loan to Hymans Company ................ Liabilities and Stockholders’ Equity Bonds payable ................................. Common stock .................................

Increase Decrease in Account in Account Balance Balance – 110,000 – 40,000

+ 120,000 + 30,000

Managerial Accounting, 16th Edition

Problem 14-10 (continued) The loan to Hymans ($40,000) is recorded as a cash outflow in the investing activities section of the statement. Because Joyner did not retire any bonds during the year, the corresponding amount in the table on the prior page (+120,000) represents a cash inflow pertaining to a bond issuance. Joyner did not repurchase any of its own stock during the year, so the increase in common stock (+30,000) is reported as a cash inflow in the financing activities section of the statement. Property, plant, and equipment and retained earnings require further analysis as follows: Property, plant, and equipment: Beginning balance + Debits – Credits = Ending balance $400,000 + Debits – $40,000 = $510,000 Debits = $510,000 – $400,000 + $40,000 Debits = $150,000 The additions to property, plant, and equipment ($150,000) are recorded as a cash outflow and the proceeds from the sale of equipment ($18,000) are recorded as a cash inflow. Retained earnings: Beginning balance – Debits + Credits = Ending balance $83,000 – Debits + $56,000 = $124,000 $139,000 = $124,000 + Debits Debits = $15,000 The dividend payment ($15,000) should be recorded as a cash outflow in the financing activities section of the statement.

Problem 14-10 (continued) Joyner Company Statement of Cash Flows For Year 2

Operating activities:

Net income ....................................................... $ 56,000 Adjustments to convert net income to cash basis: Depreciation................................................... $ 42,000 Increase in accounts receivable ....................... (80,000) Increase in inventory ...................................... (50,000) Decrease in prepaid expenses ......................... 7,000 Increase in accounts payable .......................... 60,000 Decrease in accrued liabilities .......................... (10,000) Increase in income taxes payable .................... 3,000 Gain on sale of equipment .............................. (8,000) (36,000) Net cash provided by (used in) operating activities ........................................................ 20,000

Investing activities:

Proceeds from sale of equipment ....................... Loan to Hymans Company ................................. Additions to property, plant, & equipment ........... Net cash provided by (used in) investing activities ........................................................

Financing activities:

Issuance of bonds payable ................................ Issuance of common stock ................................ Cash dividends paid .......................................... Net cash provided by (used in) financing activities ........................................................ Net decrease in cash and cash equivalents ......... Beginning cash and cash equivalents.................. Ending cash and cash equivalents ......................

18,000 (40,000) (150,000) (172,000) 120,000 30,000 (15,000) 135,000 (17,000) 21,000 $ 4,000

Managerial Accounting, 16th Edition

Problem 14-10 (continued) 3. Free cash flow computation: Net cash provided by operating activities ...... $ 20,000 Less: Capital expenditures ................................. $150,000 Dividends ................................................. 15,000 165,000 Free cash flow ............................................ $(145,000) 4. The relatively small amount of net cash provided by operating activities during the year was largely the result of a large increase in accounts receivable. (The large increase in inventory was offset by a large increase in accounts payable.) Most of the cash that was provided by operating activities was paid out in dividends. The small amount that remained, combined with the cash provided by the issue of bonds and the issue of common stock, was insufficient to purchase a large amount of equipment and make a loan to another company. As a result, the cash on hand declined sharply during the year.

Problem 14-11 (45 minutes) To begin the problem, fill in the question mark pertaining to item “a” using the following T-account: Retained Earnings Dividends 20,000 Net income Change

70,000 50,000

The change in the retained earnings balance is $50,000 and the cash dividends are $20,000; therefore, the net income must be $70,000. Step 1: The following equation can be applied to the Accumulated Depreciation account to compute the depreciation to add back to net income: Beginning balance – Debits + Credits = Ending balance $675,000 – $37,000 + Credits = $680,000 Credits = $680,000 – $675,000 + $37,000 Credits = $42,000 Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows:

Current Assets Accounts receivable .... Inventory ................... Prepaid expenses........ Current Liabilities Accounts payable ........ Accrued liabilities ........ Income taxes payable .

Increase in Account Balance – 110,000

+ 32,000 + 16,000

Decrease in Account Balance + 65,000 + 8,000

– 9,000

Managerial Accounting, 16th Edition

Problem 14-11 (continued) Step 3: The company had a $2,000 gain on the sale of equipment. The book value of the equipment was $13,000 (= $50,000 – $37,000). The company sold the equipment for $15,000, so its gain on the sale of $2,000 (= $15,000 – $13,000) is subtracted from net income. The net cash provided by (used in) operating activities can now be calculated as follows: Net income .................................................. $ 70,000 Adjustments to convert net income to cash basis: Depreciation.............................................. $ 42,000 Increase in accounts receivable .................. (110,000) Decrease in inventory ................................ 65,000 Decrease in prepaid expenses .................... 8,000 Increase in accounts payable...................... 32,000 Decrease in accrued liabilities ..................... (9,000) Increase in income taxes payable ............... 16,000 Gain on sale of equipment ......................... (2,000) 42,000 Net cash provided by (used in) operating activities ................................................... $112,000 Investing and Financing activities: The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:

Noncurrent Assets Plant and equipment ............................. Long-term investments.......................... Long-term loans to subsidiaries.............. Liabilities and Stockholders’ Equity Bonds payable ...................................... Common stock ......................................

Increase in Account Balance – 220,000 – 80,000

+ 400,000

Decrease in Account Balance

+ 30,000

– 170,000

Problem 14-11 (continued) As stated in item “f” in the problem, it is reasonable to assume that the $80,000 increase in long-term investments corresponds with a cash outflow that needs to be recorded in the investing section of the statement. The $30,000 repayment of loan received from a subsidiary corresponds with a cash inflow that needs to be recorded in the investing section of the statement. The increase in bonds payable (+400,000) represents a cash inflow that needs to be recorded in the financing section of the statement. The $170,000 decrease in common stock represents a stock repurchase that needs to be recorded as a cash outflow in the financing section of the statement. The dividend of $20,000 is given in the problem; therefore, property, plant, and equipment is the only account that requires further analysis as follows: Property, plant, and equipment: Beginning balance + Debits – Credits = Ending balance $1,580,000 + Debits – $50,000 = $1,800,000 Debits = $1,800,000 – $1,580,000 + $50,000 Debits = $270,000 The additions to property, plant, and equipment ($270,000) are recorded as a cash outflow and the proceeds from the sale of equipment ($15,000) are recorded as a cash inflow.

Managerial Accounting, 16th Edition

Problem 14-11 (continued) Given the amounts above, the statement of cash flows would be as follows: Yoric Company Statement of Cash Flows

Operating activities:

Net income ......................................................... Adjustments to convert net income to cash basis: Depreciation ..................................................... Increase in accounts receivable.......................... Decrease in inventory ........................................ Decrease in prepaid expenses ............................ Increase in accounts payable ............................. Decrease in accrued liabilities ............................ Increase in income taxes payable ....................... Gain on sale of equipment ................................. Net cash provided by (used in) operating activities

Investing activities:

Decrease in long-term loan to subsidiary ............... Proceeds from sale of equipment .......................... Additions to long-term investments....................... Additions to property, plant, & equipment ............. Net cash provided by (used in) investing activities .

Financing activities:

Issuance of bonds payable ................................... Repurchase of common stock ............................... Cash dividends paid ............................................. Net cash provided by (used in) financing activities . Net increase in cash and cash equivalents ............. Beginning cash and cash equivalents .................... Ending cash and cash equivalents .........................

$ 70,000 $ 42,000 (110,000) 65,000 8,000 32,000 (9,000) 16,000 (2,000)

30,000 15,000 (80,000) (270,000)

400,000 (170,000) (20,000)

42,000 112,000

(305,000)

210,000 17,000 23,000 $ 40,000

Problem 14-12 (45 minutes) 1 Prepare a statement of cash flows (all numbers in millions). Operating activities: Step 1: The following equation can be applied to the Accumulated Depreciation account to compute the depreciation to add back to net income: Beginning balance – Debits + Credits = Ending balance $641 – $8 + Credits = $765 Credits = $765 – $641 + $8 Credits = $132 Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows: Current Assets Accounts receivable .......... Inventory ......................... Current Liabilities Accounts payable .............. Accrued liabilities .............. Income taxes payable .......

Increase in Account Balance

Decrease in Account Balance

– 65 – 45 + 95 + 25 +6

Step 3: The gain on sale of equipment ($3) is subtracted from net income.

Managerial Accounting, 16th Edition

Problem 14-12 (continued) As an intermediate step, the net cash provided by (used in) operating activities can now be calculated as follows: Net income ....................................................... Adjustments to convert net income to cash basis: Depreciation................................................... Increase in accounts receivable ....................... Increase in inventory ...................................... Increase in accounts payable .......................... Increase in accrued liabilities ........................... Increase in income taxes payable .................... Gain on sale of equipment .............................. Net cash provided by (used in) operating activities ........................................................

$115 $132 (65) (45) 95 25 6 (3)

145 $260

Investing and Financing activities: The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:

Noncurrent Assets Property, plant, and equipment ............... Liabilities and Stockholders’ Equity Bonds payable ........................................

Increase Decrease in Account in Account Balance Balance – 49 – 170

Problem 14-12 (continued) Burgess did not issue any bonds during the year; therefore, the amount in the table on the prior page (–170) represents a cash outflow pertaining to a bond retirement. Property, plant, and equipment and retained earnings require further analysis as follows: Property, plant, and equipment: Beginning balance + Debits – Credits = Ending balance $1,466 + Debits – $13 = $1,515 Debits = $1,515 – $1,466 + $13 Debits = $62 The additions to property, plant, and equipment ($62) are recorded as a cash outflow and the proceeds from the sale of equipment ($8) are recorded as a cash inflow. Retained earnings: Beginning balance – Debits + Credits = Ending balance $928 – Debits + $115 = $977 $1,043 = $977 + Debits Debits = $66 The dividend payment ($66) should be recorded as a cash outflow in the financing activities section of the statement.

Managerial Accounting, 16th Edition

Problem 14-12 (continued) Burgess Company Statement of Cash Flows

Operating activities:

Net income ........................................................... Adjustments to convert net income to cash basis: Depreciation....................................................... Increase in accounts receivable ........................... Increase in inventory .......................................... Increase in accounts payable .............................. Increase in accrued liabilities ............................... Increase in income taxes payable ........................ Gain on sale of equipment .................................. Net cash provided by (used in) operating activities..

Investing activities:

Proceeds from sale of equipment ........................... Additions to property, plant, & equipment ............... Net cash provided by (used in) investing activities ..

Financing activities:

Retirement of bonds payable ................................. Cash dividends paid .............................................. Net cash provided by (used in) financing activities .. Net decrease in cash and cash equivalents ............. Beginning cash and cash equivalents...................... Ending cash and cash equivalents ..........................

$ 115 $132 (65) (45) 95 25 6 (3)

8 (62)

(170) (66)

145 260

(54)

(236) (30) 79 $ 49

2. Burgess’s net income decreased by $20 million (= $135 million – $115 million); however, its net cash provided by operating activities increased by $110 million (= $260 million – $150 million) over the prior year. When net income and net cash provided by operating activities move in opposite directions it warrants further inquiry. It appears that Burgess has inflated its net cash provided by operating activities by delaying payments to suppliers (see $95 million increase related to Accounts Payable). The company’s accounts receivable balance has increased substantially (+65 million) even though sales have declined. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 14

Problem 14-12 (continued) This suggests that Burgess may be inflating its net income by failing to record a growing amount of uncollectible accounts. The company’s inventory has increased (+45 million) even though sales have declined. This suggests that Burgess may be inefficiently managing its inventory. The company’s depreciation ($132 million) is much larger than its additions to property, plant, and equipment ($62 million). This suggests that the company is not making sufficient investments to maintain its noncurrent assets. Burgess’s free cash flow is $132 (= $260 – $62 – $66); however, a skeptic would emphasize that this figure may be artificially inflated because of the huge increase in accounts payable and the insufficient investment in property, plant, and equipment.

Managerial Accounting, 16th Edition

Problem 14-13 (45 minutes) 1. Net cash provided by (used in) operating activities: Step 1: The following equation can be applied to the Accumulated Depreciation account to compute the depreciation to add back to net income: Beginning balance – Debits + Credits = Ending balance $50,000 – $10,000 + Credits = $60,000 Credits = $60,000 – $50,000 + $10,000 Credits = $20,000 Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows: Current Assets Accounts receivable .... Inventory ................... Prepaid expenses ........ Current Liabilities Accounts payable ........ Accrued liabilities ........ Income taxes payable .

Increase in Account Balance – 40,000 – 50,000

+63,000 + 8,000

Decrease in Account Balance

+ 4,000

– 9,000

Step 3: The gain on sale of investments ($10,000) is subtracted from net income. The loss on sale of equipment ($2,000) is added to net income.

Problem 14-13 (continued) The net cash provided by (used in) operating activities can now be calculated as follows: Net income ............................................... $30,000 Adjustments to convert net income to cash basis: Depreciation ........................................... $20,000 Increase in accounts receivable ............... (40,000) Increase in inventory .............................. (50,000) Decrease in prepaid expenses ................. 4,000 Increase in accounts payable................... 63,000 Decrease in accrued liabilities .................. (9,000) Increase in income taxes payable ............ 8,000 Loss on sale of equipment....................... 2,000 Gain on sale of investments .................... (10,000) (12,000) Net cash provided by (used in) operating activities ................................................ $18,000 2. Prepare a statement of cash flows. Investing and Financing activities: The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:

Noncurrent Assets Property, plant, and equipment............... Long-term investments .......................... Liabilities and Stockholders’ Equity Bonds payable ....................................... Common stock .......................................

Increase in Account Balance

– 130,000

Decrease in Account Balance + 20,000

+ 70,000 +20,000

Managerial Accounting, 16th Edition

Problem 14-13 (continued) The decrease in the long-term investments account ($20,000) equals the cost of the long-term investment sold; therefore, Rusco did not purchase any long-term investments during the year. The proceeds from the sale of the long-term investment ($30,000) should be recorded as a cash inflow in the investing activities section of the statement. The company did not retire any bonds during the year, so the amount on the prior page (+70,000) represents a cash inflow from a bond issuance. The company did not repurchase any of its own stock, so the amount on the prior page (+20,000) represents a cash inflow from issuing common stock. Property, plant, and equipment and retained earnings require further analysis as follows: Property, plant, and equipment: Beginning balance + Debits – Credits = Ending balance $300,000 + Debits – $20,000 = $430,000 Debits = $430,000 – $300,000 + $20,000 Debits = $150,000 The additions to property, plant, and equipment ($150,000) are recorded as a cash outflow and the proceeds from the sale of equipment ($8,000) are recorded as a cash inflow. Retained earnings: Beginning balance – Debits + Credits = Ending balance $85,000 – Debits + $30,000 = $106,000 $115,000 = $106,000 + Debits Debits = $9,000 The dividend payment ($9,000) should be recorded as a cash outflow in the financing activities section of the statement.

Problem 14-13 (continued) Rusco Company Statement of Cash Flows For This Year Ended July 31

Operating activities:

Net income ...................................................... $ 30,000 Adjustments to convert net income to cash basis: Depreciation.................................................. $ 20,000 Increase in accounts receivable ...................... (40,000) Increase in inventory ..................................... (50,000) Decrease in prepaid expenses ........................ 4,000 Increase in accounts payable ......................... 63,000 Decrease in accrued liabilities ......................... (9,000) Increase in income taxes payable ................... 8,000 Loss on sale of equipment.............................. 2,000 Gain on sale of investments ........................... (10,000) (12,000) Net cash provided by (used in) operating activities ....................................................... 18,000

Investing activities:

Proceeds from sale of long-term investments ..... Proceeds from sale of equipment ...................... Additions to property, plant, & equipment .......... Net cash provided by (used in) investing activities .......................................................

Financing activities:

Issuance of bonds payable................................ Issuance of common stock ............................... Cash dividends paid ......................................... Net cash provided by (used in) financing activities ....................................................... Net decrease in cash and cash equivalents ........ Beginning cash and cash equivalents................. Ending cash and cash equivalents .....................

30,000 8,000 (150,000) (112,000) 70,000 20,000 (9,000) 81,000 (13,000) 21,000 $ 8,000

Managerial Accounting, 16th Edition

Problem 14-13 (continued) 3. Free cash flow computation: Net cash provided by operating activities ...... $ 18,000 Less: Capital expenditures ................................. $150,000 Dividends ................................................. 9,000 159,000 Free cash flow ............................................ $(141,000) 4. Although the company reported $30,000 of net income for the year, a smaller amount of cash was provided by operating activities ($18,000) due to increases in accounts receivable and inventory. The cash provided by operations, when added to the cash provided by the sale of investments, the issue of bonds, and the sale of common stock, was not sufficient to cover the purchase of plant and equipment during the year. Note that the company increased its investment in plant and equipment by almost 50%. More care should have been taken in planning for this major investment in plant assets. Also, the company should get better control over its accounts receivable and inventory.

Problem 14-14 (45 minutes) 1. Prepare a statement of cash flows. Operating activities: Step 1: The following equation can be applied to the Accumulated Depreciation account to compute the depreciation to add back to net income: Beginning balance – Debits + Credits = Ending balance $755,000 – $40,000 + Credits = $810,000 Credits = $810,000 – $755,000 + $40,000 Credits = $95,000 Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows: Current Assets Accounts receivable .... Inventory ................... Prepaid expenses ........ Current Liabilities Accounts payable ........ Accrued liabilities ........ Income taxes payable

Increase in Account Balance – 180,000 – 5,000 + 300,000 + 15,000

Decrease in Account Balance + 12,000

– 17,000

Step 3: The gain on sale of investments ($60,000) is subtracted from net income. The loss on sale of equipment ($20,000) is added to net income.

Managerial Accounting, 16th Edition

Problem 14-14 (continued) The net cash provided by (used in) operating activities can now be calculated as follows: Net income .............................................. $170,000 Adjustments to convert net income to cash basis: Depreciation .......................................... $ 95,000 Increase in accounts receivable .............. (180,000) Decrease in inventory ............................ 12,000 Increase in prepaid expenses ................. (5,000) Increase in accounts payable.................. 300,000 Decrease in accrued liabilities ................. (17,000) Increase in income taxes payable ........... 15,000 Loss on sale of equipment...................... 20,000 Gain on sale of investments ................... (60,000) 180,000 Net cash provided by (used in) operating activities ............................................... $350,000 Investing and Financing activities: The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:

Noncurrent Assets Property, plant, and equipment............. Long-term investments ........................ Long-term loans to subsidiaries ............ Liabilities and Stockholders’ Equity Bonds payable ..................................... Common stock .....................................

Increase in Decrease in Account Account Balance Balance – 570,000 – 44,000

+ 50,000

+ 220,000 + 90,000

The decrease in the long-term investments account ($50,000) equals the cost of the long-term investment sold; therefore, Lomax did not purchase any long-term investments during the year. The proceeds from the sale of the long-term investment ($110,000) should be recorded as a cash inflow in the investing activities section of the statement. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Chapter 14

Problem 14-14 (continued) Lomax’s subsidiaries did not repay any loans during the year, therefore, the amount in the table on the prior page (– 44,000) represents a cash outflow pertaining to a new loan. The company did not repurchase any of its own stock, so the amount on the prior page represents a $90,000 cash inflow related to a stock issuance. Property, plant, and equipment, bonds payable, and retained earnings require further analysis as follows: Property, plant, and equipment: Beginning balance + Debits – Credits = Ending balance $2,600,000 + Debits – $130,000 = $3,170,000 Debits = $3,170,000 – $2,600,000 + $130,000 Debits = $700,000 The additions to property, plant, and equipment ($700,000) are recorded as a cash outflow and the proceeds from the sale of equipment ($70,000) are recorded as a cash inflow. Bonds Payable: Beginning balance – Debits + Credits = Ending balance $600,000 – 350,000 + Credits = $820,000 Credits = $820,000 – $600,000 + 350,000 Credits = $570,000 Retained earnings: Beginning balance – Debits + Credits = Ending balance $478,000 – Debits + $170,000 = $573,000 $648,000 = $573,000 + Debits Debits = $75,000 The dividend payment ($75,000) should be recorded as a cash outflow in the financing activities section of the statement.

Managerial Accounting, 16th Edition

Problem 14-14 (continued) Lomax Company Statement of Cash Flows

Operating activities:

Net income ...................................................... $170,000 Adjustments to convert net income to cash basis: Depreciation .................................................. $ 95,000 Increase in accounts receivable ...................... (180,000) Decrease in inventory .................................... 12,000 Increase in prepaid expenses ......................... (5,000) Increase in accounts payable .......................... 300,000 Decrease in accrued liabilities ......................... (17,000) Increase in income taxes payable ................... 15,000 Loss on sale of equipment .............................. 20,000 Gain on sale of investments ............................ (60,000) 180,000 Net cash provided by (used in) operating activities........................................................ 350,000

Investing activities:

Proceeds from sale of long-term investments ...... 110,000 Proceeds from sale of equipment ....................... 70,000 Loans to subsidiaries ......................................... (44,000) Additions to property, plant, & equipment ........... (700,000) Net cash provided by (used in) investing activities......................................................... (564,000)

Financing activities:

Issuance of bonds payable ................................. 570,000 Issuance of common stock ................................. 90,000 Retirement of bonds payable.............................. (350,000) Cash dividends paid ........................................... (75,000) Net cash provided by (used in) financing activities......................................................... 235,000 Net increase in cash and cash equivalents........... Beginning cash and cash equivalents .................. Ending cash and cash equivalents ......................

21,000 40,000 $ 61,000

Problem 14-14 (continued) 2. The large amount of cash provided by operating activities is traceable for the most part to the $300,000 increase in accounts payable. If the accounts payable had remained basically unchanged, the same as inventory, then operating activities would have provided very little cash and the company might have experienced serious cash problems. Note particularly that the cash provided by operating activities was used to purchase plant and equipment. Thus, the company is using cash derived from a short-term source (buildup of accounts payable) to finance long-term asset acquisitions. In short, although the company is generating substantial cash from operating activities, the quality of this source is open to question. Also, note the substantial increase in accounts receivable. Apparently, the company’s collections from customers are lagging, perhaps because of sales to customers whose credit is weak. This may be the result of trying to increase sales so fast that proper credit checks are not being made. Again, this can lead to serious cash problems if the trend continues. In the company’s financing activities, it appears that long-term debt sources, rather than equity sources, are being used to provide for expansion. Although companies frequently use debt to finance expansion, the level of debt in this company is increasing rapidly. (See Chapter 15 for a discussion of the Debt-to-Equity ratio and other financial ratios.)

Managerial Accounting, 16th Edition

Appendix 14A The Direct Method of Determining the Net Cash Provided by Operating Activities Exercise 14A-1 (15 minutes) Sales.......................................................... Adjustments to a cash basis: Increase in accounts receivable .............. Cost of goods sold ...................................... Adjustments to a cash basis: Decrease in inventory ............................ Increase in accounts payable ................. Selling and administrative expenses ............. Adjustments to a cash basis: Increase in prepaid expenses ................. Decrease in accrued liabilities ................. Depreciation.......................................... Income tax expense ................................... Adjustments to a cash basis: Increase in income taxes payable ........... Net cash provided by (used in) operating activities ..................................................

$700 – 110 $590 400 – 70 – 35

295

184 +9 +4 – 60

137

36 –8

28 $130

Note that the $130 “net cash provided” figure agrees with the indirect method presented in Exercise 14-4.

Exercise 14A-2 (15 minutes) 1. Sales ............................................................. $150,000 Adjustments to a cash basis: Increase in accounts receivable.................. – 10,000 $140,000 Cost of goods sold.......................................... Adjustments to a cash basis: Increase in inventory ................................. Increase in accounts payable ..................... Selling and administrative expenses ................ Adjustments to a cash basis: Increase in prepaid expenses ..................... Decrease in accrued liabilities .................... Depreciation ............................................. Income taxes ................................................. Adjustments to a cash basis: Decrease in income taxes payable .............. Net cash provided by (used in) operating activities .....................................................

90,000 + 9,000 – 7,000

92,000

40,000 + 2,000 + 3,000 – 7,500

37,500

8,000 + 500

8,500 $ 2,000

2. Gains and losses on the sale of assets would have no effect on the computations in (1). The reason is that these items are not part of sales, cost of goods sold, selling and administrative expenses, or income taxes. Thus, gains and losses on the income statement are ignored under the direct method.

Managerial Accounting, 16th Edition

Exercise 14A-3 (15 minutes) Sales......................................................... Adjustments to a cash basis: Decrease in accounts receivable ............

$275

Cost of goods sold ..................................... Adjustments to a cash basis: Increase in inventory ............................ Increase in accounts payable ................

150

Selling and administrative expenses ............ Adjustments to a cash basis: Depreciation......................................... Net cash provided by (used in) operating activities .................................................

+ 2 $277

+ 10 – 4

156

90 – 15

75 $ 46

Exercise 14A-4 (15 minutes) Sales.............................................................. $ 350,000 Adjustments to a cash basis: Increase in accounts receivable .................. – 19,000 $331,000 Cost of goods sold .......................................... 140,000 Adjustments to a cash basis: Increase in inventory ................................. + 33,000 Increase in accounts payable ..................... – 15,000

158,000

Selling and administrative expenses ................. Adjustments to a cash basis: Decrease in prepaid expenses .................... Decrease in accrued liabilities ..................... Depreciation..............................................

141,000

Income taxes ................................................. Adjustments to a cash basis: Increase in income taxes payable ............... Net cash provided by (used in) operating activities ......................................................

160,000 – 1,000 + 2,000 – 20,000 15,000 – 4,000

11,000 $ 21,000

Note that the $21,000 above agrees with the amount provided by operating activities under the indirect method in Exercise 14-2.

Managerial Accounting, 16th Edition

Problem 14A-5 (45 minutes) 1. The income statement adjusted to a cash basis: Sales ......................................................... $500,000 Adjustments to a cash basis: Increase in accounts receivable .............. – 40,000 $460,000 Cost of goods sold ...................................... Adjustments to a cash basis: Increase in inventory ............................. Increase in accounts payable ................. Selling and administrative expenses............. Adjustments to a cash basis: Decrease in prepaid expenses ................ Decrease in accrued liabilities................. Depreciation ......................................... Income taxes ............................................. Adjustments to a cash basis: Increase in income taxes payable ........... Net cash provided by (used in) operating activities..................................................

300,000 + 50,000 – 63,000

287,000

158,000 – 4,000 + 9,000 – 20,000

143,000

20,000 – 8,000

12,000 $ 18,000

Problem 14A-5 (continued) 2.

Rusco Company Statement of Cash Flows For This Year Ended July 31

Operating activities:

Cash received from customers ......................... Less cash disbursements for: Cost of merchandise purchased ..................... Selling and administrative expenses ............... Income taxes ............................................... Total cash disbursements................................. Net cash provided by (used in) operating activities ......................................................

Investing activities:

Proceeds from sale of investments ................... Proceeds from sale of equipment ..................... Additions to property, plant, & equipment ......... Net cash provided by (used in) investing activities ......................................................

Financing activities:

Issuance of bonds payable............................... Issuance of common stock .............................. Cash dividends paid ........................................ Net cash provided by (used in) financing activities ...................................................... Net decrease in cash and cash equivalents ....... Beginning cash and cash equivalents ................ Ending cash and cash equivalents ....................

$460,000 $287,000 143,000 12,000

442,000 18,000

30,000 8,000 (150,000) (112,000) 70,000 20,000 (9,000) 81,000 (13,000) 21,000 $ 8,000

Managerial Accounting, 16th Edition

Problem 14A-5 (continued) 3. There are two reasons for the sharp decline in cash. First, note that a relatively small amount of cash was provided by operations during the year. This is due to a build-up in accounts receivable and inventory, which together have grown by $90,000 (= $40,000 + $50,000); the build-up of receivables reduced the amount of cash received from customers, and the build-up of inventory increased the amount of cash required to purchase goods. Second, the company paid out in dividends half of the cash provided by operations, while at the same time increasing its investment in plant and equipment by almost 50%. These uses of cash far outstripped the amount of cash available through operations and the sale of bonds, common stock, and investments, resulting in a sharp decrease in the amount of cash available.

Problem 14A-6 (30 minutes) 1. Sales .................................................................... $800 Adjustments to a cash basis: Increase in accounts receivable......................... – 100 $700 Cost of goods sold................................................. Adjustments to a cash basis: Decrease in inventory ....................................... Increase in accounts payable ............................ Selling and administrative expenses ....................... Adjustments to a cash basis: Increase in prepaid expenses ............................ Decrease in accrued liabilities ........................... Depreciation .................................................... Income taxes ........................................................ Adjustments to a cash basis: Increase in income taxes payable ...................... Net cash provided by (used in) operating activities ..

500 – 50 – 80

370

213 +4 + 12 – 24

205

27 –6

21 $104

Managerial Accounting, 16th Edition

Problem 14A-6 (continued) 2.

Weaver Company Statement of Cash Flows For This Year Ended December 31

Operating activities:

Cash received from customers ................................. $700 Less cash disbursements for: Cost of merchandise purchased ............................. $370 Selling and administrative expenses ....................... 205 Income taxes ....................................................... 21 Total cash disbursements......................................... 596 Net cash provided by (used in) operating activities .... 104

Investing activities:

Proceeds from sale of long-term investments ............ Proceeds from sale of equipment ............................. Additions to property, plant, & equipment ................. Net cash provided by (used in) investing activities.....

Financing activities:

Issuance of bonds payable....................................... Repurchase of common stock .................................. Cash dividends paid ................................................ Net cash provided by (used in) financing activities .... Net decrease in cash and cash equivalents ............... Beginning cash and cash equivalents ........................ Ending cash and cash equivalents ............................

10 20 (180)

110 (40) (30)

(150)

40 (6) 15 $ 9

Problem 14A-7 (45 minutes) 1. Sales ............................................................. $900,000 Adjustments to a cash basis: Increase in accounts receivable.................. – 80,000 $820,000 Cost of goods sold.......................................... 500,000 Adjustments to a cash basis: Increase in inventory ................................. + 50,000 Increase in accounts payable ..................... – 60,000

490,000

Selling and administrative expenses ................ 328,000 Adjustments to a cash basis: Decrease in prepaid expenses .................... – 7,000 Decrease in accrued liabilities .................... + 10,000 Depreciation ............................................. – 42,000

289,000

Income taxes ................................................. Adjustments to a cash basis: Increase in income taxes payable ...............

21,000

Net cash provided by (used in) operating activities .....................................................

24,000 – 3,000

$ 20,000

Managerial Accounting, 16th Edition

Problem 14A-7 (continued) 2.

Joyner Company Statement of Cash Flows For Year 2

Operating activities:

Cash received from customers .......................... Less cash disbursements for: Cost of merchandise purchased ...................... $490,000 Selling and administrative expenses ................ 289,000 Income taxes ................................................ 21,000 Total cash disbursements.................................. Net cash provided by (used in) operating activities .......................................................

$820,000

800,000 20,000

Investing activities:

Proceeds from sale of equipment ...................... 18,000 Loan to Hymans Company ................................ (40,000) Additions to property, plant, & equipment .......... (150,000) Net cash provided by (used in) investing activities .......................................................

Financing activities:

Issuance of bonds payable................................ Issuance of common stock ............................... Cash dividends paid ......................................... Net cash provided by (used in) financing activities ....................................................... Net decrease in cash and cash equivalents ........ Beginning cash and cash equivalents ................. Ending cash and cash equivalents .....................

(172,000)

120,000 30,000 (15,000) 135,000 (17,000) 21,000 $ 4,000

3. The decline in cash occurs largely because the company only generated $20,000 from operating activities. This small amount is due primarily to the buildup of accounts receivable. Even though an additional $150,000 was obtained from an issue of bonds and an issue of common stock ($120,000 + $30,000 = $150,000), the cash available was not sufficient to expand the plant, make a substantial loan to another company, and pay a cash dividend. As a result, cash declined during the year. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Appendix 14A

Chapter 15 Financial Statement Analysis Solutions to Questions 15-1 Horizontal analysis examines how a particular item on a financial statement such as sales or cost of goods sold behaves over time. Vertical analysis involves analysis of items on an income statement or balance sheet for a single period. In vertical analysis of the income statement, all items are typically stated as a percentage of sales. In vertical analysis of the balance sheet, all items are typically stated as a percentage of total assets. 15-2 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. 15-3 Price-earnings ratios reflect investors’ expectations concerning future earnings. The higher the price-earnings ratio, the greater the growth in earnings investors expect. For this reason, two companies might have the same current earnings and yet have quite different price-earnings ratios. By definition, a stock with current earnings of $4 and a price-earnings ratio of 20 would be selling for $80 per share. 15-4 A rapidly growing tech company would probably have many opportunities to make investments at a rate of return higher than stockholders could earn in other investments. It would be better for the company to invest in such opportunities than to pay out dividends and thus one would expect the company to have a low dividend payout ratio. 15-5 The dividend yield is the dividend per share divided by the market price per share. The other source of return on an investment in stock is increases in market value.

15-6 Financial leverage results from borrowing funds at an interest rate that differs from the rate of return on assets acquired using those funds. If the rate of return on the assets is higher than the interest rate at which the funds were borrowed, financial leverage is positive and stockholders gain. If the return on the assets is lower than the interest rate, financial leverage is negative and the stockholders lose. 15-7 If the company experiences big variations in net cash flows from operations, stockholders might be pleased that the company has no debt. In hard times, interest payments might be very difficult to meet. On the other hand, if investments within the company can earn a rate of return that exceeds the interest rate on debt, stockholders would get the benefits of positive leverage if the company took on debt. 15-8 The market value of a share of common stock often exceeds the book value per share. Book value represents the cumulative effects on the balance sheet of past activities, evaluated using historical prices. The market value of the stock reflects investors’ expectations about the company’s future earnings. For most companies, market value exceeds book value because investors anticipate future earnings growth. 15-9 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 and difficult-to-liquidate inventory, or the inventory may contain large amounts of obsolete goods. Second, the receivables may be low quality, including large amounts of accounts that may be difficult to collect.

The Foundational 15 1.

The earnings per share is computed as follows:

Net income Average number of common shares outstanding $92,400 = = $0.77 per share 120,000 shares*

Earnings per share =

* $120,000 ÷ $1 par value per share = 120,000 shares 2.

The price-earnings ratio is computed as follows: Market price per share Earnings per share $2.75 = = 3.57 (rounded) $0.77

Price-earnings ratio =

The dividend payout ratio is computed as follows: Dividends per share Earnings per share $0.55 = = 71% (rounded) $0.77

Dividend payout ratio =

The dividend yield ratio is computed as follows: Dividends per share Market price per share $0.55 = = 20% $2.75

Dividend yield ratio =

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 4.

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% rounded ($450,000 + $460,000) /2

The return on equity is computed as follows: Net income Return on = equity Average stockholders' equity =

$92,400 = 28% ($320,000 + $340,000)/2

The book value per share is computed as follows: Book value per share = =

Total stockholders' 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 Foundational 15 (continued) 8.

The acid-test ratio is computed as follows:

Cash + Marketable securities + Accounts receivable + Short-term notes receivable Acid-test ratio = Current liabilities $35,000 + $0 + $60,000 + $0 = = 1.58 (rounded) $60,000 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: Cost of goods sold Average inventory balance $400,000 = = 6.96 (rounded) ($55,000 + $60,000)/2

Inventory turnover =

The average sale period is computed as follows: 365 days Inventory turnover 365 days = = 52.44 days (rounded) 6.96

Average sale period =

Managerial Accounting, 16th Edition

The Foundational 15 (continued) 11. The operating cycle is computed as follows:

Operating cycle = Average sale period + Average collection period = 52.44 days + 28.67 days = 81.11 days 12. The total asset turnover is computed as follows: Sales Average total assets $700,000 = = 1.54 (rounded) ($450,000 + $460,000)/2

Total asset turnover =

13. The times interest earned ratio is computed as follows:

Earnings before interest expense and income taxes Times interest = earned ratio Interest expense =

$140,000 = 17.5 $8,000

14. The debt-to-equity ratio is computed as follows: Total liabilities Stockholders' equity $130,000 = = 0.41 (rounded) $320,000

Debt-to-equity ratio =

15. The equity multiplier is computed as follows: Average total assets Average stockholders' equity ($450,000 + $460,000)/2 = = 1.38 (rounded) ($320,000 + $340,000)/2

Equity multiplier =

Exercise 15-1 (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.

Managerial Accounting, 16th Edition

Exercise 15-2 (10 minutes) 1. Calculation of working capital: Current assets................. Current liabilities ............. Working capital ...............

$25,080 10,400 $14,680

2. Calculation of the current ratio: Current assets Current liabilities $25,080 = = 2.41 (rounded) $10,400

Current ratio =

3. Calculation of the acid-test ratio:

Cash + Marketable securities + Accounts receivable + Short-term notes receivable Acid-test ratio = Current liabilities $1,280 + $0 + $12,300 + 0 = = 1.31 (rounded) $10,400

Exercise 15-3 (20 minutes) 1. Calculation of accounts receivable turnover: Sales on account Accounts receivable = turnover Average accounts receivable balance =

$79,000 = 7.38 (rounded) ($12,300 + $9,100)/2

2. Calculation of the average collection period: 365 days Accounts receivable turnover 365 days = = 49.46 days (rounded) 7.38

Average collection period =

3. Calculation of inventory turnover: Cost of goods sold Average inventory balance $52,000 = = 5.81 (rounded) ($9,700 + $8,200)/2

Inventory turnover =

4. Calculation of the average sale period: 365 days Inventory turnover 365 days = = 62.82 days (rounded) 5.81

Average sale period =

Managerial Accounting, 16th Edition

Exercise 15-3 (continued) 5.

The operating cycle is computed as follows:

Operating cycle = Average sale period + Average collection period = 62.82 days + 49.46 days = 112.28 days 6.

The total asset turnover is computed as follows: Sales Average total assets $79,000 = = 1.64 (rounded) ($50,280 + $45,960)/2

Total asset turnover =

Exercise 15-4 (10 minutes) 1. Calculation of the times interest earned ratio:

Earnings before interest expense and income taxes Times interest = earned ratio Interest expense =

$6,500 = 10.83 (rounded) $600

2. Calculation of the debt-to-equity ratio: Total liabilities Stockholders' equity $15,400 = = 0.44 (rounded) $34,880

Debt-to-equity ratio =

3. Calculation of the equity multiplier: Average total assets Average stockholders' equity ($50,280 + $45,960)/2 = = 1.45 (rounded) ($34,880 + $31,660)/2

Equity multiplier =

Managerial Accounting, 16th Edition

Exercise 15-5 (10 minutes) 1. Calculation of the gross margin percentage: Gross margin Sales $27,000 = = 34.2% (rounded) $79,000

Gross margin percentage =

2. Calculation of the net profit margin percentage: Net income Sales $3,540 = = 4.5% (rounded) $79,000

Net profit margin percentage =

3. Calculation of the return on total assets:

Net income + [Interest expense × (1 - Tax rate)] Return on total assets = Average total assets =

$3,540 + [$600 × (1 - 0.40)] = 8.1% (rounded) ($50,280 + $45,960)/2

4. Calculation of the return on equity: Net income Average total stockholders' equity $3,540 = = 10.64% (rounded) ($34,880 + $31,660)/2

Return on equity =

Exercise 15-6 (15 minutes) 1. Calculation of the earnings per share:

Net income Average number of common shares outstanding $3,540 = = $4.43 per share (rounded) 800 shares

Earnings per share =

2. Calculation of the price-earnings ratio: Market price per share Earnings per share $18 = = 4.06 (rounded) $4.43

Price-earnings ratio =

3. Calculation of the dividend payout ratio: Dividends per share Earnings per share $0.40 = = 9.03% (rounded) $4.43

Dividend payout ratio =

4. Calculation of the dividend yield ratio: Dividends per share Market price per share $0.40 = = 2.22% (rounded) $18.00

Dividend yield ratio =

5. Calculation of the book value per share: Book value per share = =

Total stockholders' equity Number of common shares outstanding $34,880 = $43.60 per share 800 shares

Managerial Accounting, 16th Edition

Exercise 15-7 (15 minutes) 1. The trend percentages (rounded) are: Sales ........................

Year 1

Year 2

Year 3

Year 4

Year 5

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% 96.0% 80.0% 60.0% 115.0% 135.0% 170.0% 190.0% 110.0% 115.0% 120.0% 125.0% 112.6% 120.3% 133.7% 142.1%

Current liabilities .......

100.0% 110.0% 130.0% 145.0% 160.0%

2. Sales:

The sales are increasing at a steady and consistent rate.

Assets:

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 wellbalanced rate in comparison with sales.

Liabilities:

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.

Exercise 15-8 (20 minutes) 1. Calculation of working capital: Current assets................. $115,000 Current liabilities ............. 50,000 Working capital ............... $65,000 2. Current ratio:

Current assets $115,000 = = 2.3 Current liabilities $50,000 3. Acid-test ratio:

Cash + Marketable securities + Accounts receivable + Short-term notes receivable Acid-test ratio = Current liabilities $6,500 + $0 + $35,000 + 0 = = 0.83 $50,000 4. Debt-to-equity ratio:

Total liabilities $130,000 = = 0.76 (rounded) Total stockholders' equity $170,000 5. Times interest earned:

Earnings before interest and income taxes Times interest earned = Interest expense =

$38,000 = 4.75 $8,000

Managerial Accounting, 16th Edition

Exercise 15-8 (continued) 6. Average collection period:

Accounts receivable turnover =

Sales on account Average accounts receivable

$420,000 = 14 ($25,000 + $35,000)/2

Average collection period =

365 days Accounts receivable turnover

365 days = 26.1 days (rounded) 14

7. Average sale period:

Inventory turnover = = Average sale period = 8.

Cost of goods sold Average inventory $292,500 = 4.5 ($60,000 + $70,000)/2 365 days = 81.11 days (rounded) 4.5

The operating cycle is computed as follows:

Operating cycle = Average sale period + Average collection period = 81.1 days + 26.1 days = 107.2 days

Exercise 15-9 (20 minutes) 1. Calculation of the gross margin percentage: Gross margin Sales $127,500 = = 30.36% (rounded) $420,000

Gross margin percentage =

2. Calculation of the net profit margin percentage: Net income Net profit margin percentage = Sales $21,000 = = 5.0% $420,000 3. Return on total assets: é ù Return on = Net Income + êëInterest expense × (1 - Tax rate)úû total assets Average total assets = =

$21,000 + éêë$8,000 × (1 - 0.30)ùúû

($280,000 + $300,000) / 2

$26,600 = 9.2% (rounded) $290,000

4. Return on equity:

Return on equity =

Net income Average common stockholders' equity

$21,000 ($161,600 + $170,000) / 2

$21,000 = 12.7% (rounded) $165,800

Managerial Accounting, 16th Edition

Exercise 15-9 (continued) 5. Financial leverage was positive because the return on equity (12.7%) was greater than the return on total assets (9.2%). This positive leverage is traceable in part to the company’s current liabilities, which may have no interest cost, and in part, to the bonds payable, which have an after-tax interest cost of only 7%. 10% interest rate × (1 – 0.30) = 7%

Exercise 15-10 (15 minutes) 1. Earnings per share: Net income $21,000 = = $3.50 per share Average number of common 6,000 shares* shares outstanding

* $30,000 ÷ $5 par value per share = 6,000 shares 2. Dividend payout ratio:

Dividends paid per share $2.10 = = 60% Earnings per share $3.50 3. Dividend yield ratio:

Dividends paid per share $2.10 = = 5% Market price per share $42.00 4. Price-earnings ratio:

Market price per share $42.00 = = 12 Earnings per share $3.50 5. Book value per share: Book value per share = =

Total stockholders' equity Number of common shares outstanding $170,000 = $28.33 per share (rounded) 6,000 shares

Managerial Accounting, 16th Edition

Exercise 15-11 (15 minutes) 1. Return on total assets:

Return on = Net income + [Interest expense × (1 - Tax rate)] total assets Average total assets =

$280,000 + [$60,000 × (1 - 0.30)] ($3,000,000 + $3,600,000) / 2

$322,000 = 9.8% (rounded) $3,300,000

2. Return on equity: Net income Return on = equity Average total stockholders' equity =

$280,000 =12.2% (rounded) ($2,200,000 + $2, 400,000) / 2

3. Leverage is positive because the return on equity (12.2%) is greater than the return on total assets (9.8%). This positive leverage arises from the long-term debt, which has an after-tax interest cost of only 8.4% [12% interest rate × (1 – 0.30)]. Since 8.4% is lower than the return on assets of 9.8%, the difference goes to the common stockholders.

Exercise 15-12 (15 minutes) 1. Current assets ($90,000 + $260,000 + $490,000 + $10,000) ............. Current liabilities ($850,000 ÷ current ratio of 2.5) ......... Working capital ............................................................ 2.

$850,000 340,000 $510,000

Cash + Marketable securities + Accounts receivable + Short-term notes receivable Acid-test = ratio Current liabilities =

$90,000 + $0 + $260,000 + $0 = 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 (of 2.5) would increase to 2.7 if the company makes a $40,000 payment on accounts payable: Current ratio =

Current assets Current liabilities

$810,000 = 2.7 $300,000

Managerial Accounting, 16th Edition

Problem 15-13 (45 minutes)

Effect on Ratio

Reason for Increase, Decrease, or No Effect

Decrease

The current ratio is obtained by dividing current assets by current liabilities. Declaring a cash dividend will increase current liabilities, but have no effect on current assets. Therefore, the current ratio will decrease.

Increase

The acid-test ratio is obtained by dividing quick assets by current liabilities. A sale of inventory on account will increase the quick assets (cash or accounts receivable) but have no effect on the current liabilities. For this reason, the acid-test ratio will increase. The same effect would result regardless of whether the inventory was sold at cost, at a profit, or at a loss. That is, the acid-test ratio would increase in all cases; the only difference would be the amount of the increase.

Increase

The return on equity is obtained by dividing net income by average stockholders’ equity. The interest rate on the bonds is only 8%. Since the company’s assets earn at a rate of return of 10%, positive leverage would come into effect, increasing the return to the common stockholders.

Decrease

The times interest earned ratio is obtained by dividing earnings before interest expense and income taxes by interest expense. A decrease in net income would mean less income available to cover interest payments. Therefore, the times-interest-earned ratio would decrease.

Increase

The current ratio is obtained by dividing current assets by current liabilities. Payment of a previously declared cash dividend will reduce both current assets and current liabilities by the same amount. Assuming that current assets exceed the current liabilities before this transaction, an equal reduction in both current assets and current liabilities will result in an increase in the current ratio.

Problem 15-13 (continued)

Effect on Ratio

Reason for Increase, Decrease, or No Effect

6. No Effect

The dividend payout ratio is obtained by dividing the dividends per share by the earnings per share. Therefore, changes in the market price of the company’s common stock have no effect on this ratio.

Increase

The inventory turnover ratio is obtained by dividing cost of goods sold by average inventory. A write-off of inventory will reduce the inventory balance, thereby increasing the turnover in relation to a given level of sales.

8. Decrease

The debt-to-equity ratio is obtained by dividing total liabilities by stockholders’ equity. Sale of inventory at a profit will increase net income, which increases retained earnings and stockholders’ equity. An increase in stockholders’ equity will decrease the debt-to-equity ratio.

9. Decrease

The accounts receivable turnover is obtained by dividing sales on account by average accounts receivable. Extended credit terms for customers means that customers on the average will be taking longer to pay their bills. As a result, the accounts receivable will “turn over,” or be collected, less frequently during a given year.

10. Decrease

Book value per share is obtained by dividing total stockholders’ equity by the number of common shares outstanding. A common stock dividend will result in a greater number of shares outstanding, with no change in the underlying assets. The result will be a decrease in the book value per share.

11. No Effect

Book value per share is obtained by dividing total stockholders’ equity by the number of common shares outstanding. It is not affected by current market prices for the company’s stock.

Managerial Accounting, 16th Edition

Problem 15-13 (continued)

Effect on Ratio

Reason for Increase, Decrease, or No Effect

12. No Effect

Working capital is obtained by subtracting current liabilities from current assets. Payments on account reduce cash and accounts payable by equal amounts; thus, the amount of working capital is not affected.

13. Decrease

Earnings per share is obtained by dividing net income by the average number of common shares outstanding. The stock dividend will increase the number of common shares outstanding, thereby decreasing the earnings per share.

14. Decrease

The debt-to-equity ratio is obtained by dividing total liabilities by stockholders’ equity. Payments to creditors will reduce the total liabilities of a company, thereby decreasing the debt-to-equity ratio.

15. Decrease

The acid-test ratio is obtained by dividing quick assets by current liabilities. A purchase of inventory on account will increase current liabilities, but will not increase the quick assets. Therefore, the ratio of quick assets to current liabilities will decrease.

16. No Effect

The current ratio is obtained by dividing current assets by current liabilities. Write-off of an uncollectible account against the Allowance for Bad Debts will decrease Accounts Receivable, but that decrease will be offset by the decrease in the Allowance for Bad Debts. Therefore, the current ratio will remain unchanged.

Problem 15-13 (continued) 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

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.

Managerial Accounting, 16th Edition

Problem 15-14 (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 + Short-term notes receivable $280,000 = = 1.4 Current liabilities $200,000

Problem 15-14 (continued) 2.

Transaction

The Effect on Working Current Acid-Test Capital Ratio Ratio

(a) Issued capital stock for cash .......... Increase Increase Increase (b) Sold inventory at a gain ................. Increase Increase Increase (c) Wrote off uncollectible accounts ..... None None None (d) Declared a cash dividend ............... Decrease Decrease Decrease (e) Paid accounts payable ................... None Increase Increase (f) Borrowed on a short-term note ...... None Decrease Decrease (g) Sold inventory at a loss ................. Decrease Decrease Increase (h) Purchased inventory on account ..... None Decrease Decrease (i) Paid short-term notes .................... None Increase Increase (j) Purchased equipment for cash ....... Decrease Decrease Decrease (k) Sold marketable securities at a loss Decrease Decrease Decrease (l) Collected accounts receivable ......... None None None

Managerial Accounting, 16th Edition

Problem 15-15 (90 minutes) 1. a. Earnings before interest and income taxes (a).......................................... Interest expense (b) ........................... Times interest earned (a) ÷ (b) ...........

This Year

Last Year

$1,560,000 $360,000 4.33

$1,020,000 $300,000 3.40

b. Total liabilities (a) ............................... Stockholders’ equity (b) ...................... Debt-to-equity ratio (a) ÷ (b) ..............

$7,500,000 $9,600,000 0.78

$5,760,000 $9,120,000 0.63

c. Gross margin (a) ................................ Sales (b) ............................................ Gross margin percentage (a) ÷ (b) ......

$3,150,000 $2,580,000 $15,750,000 $12,480,000 20.0% 20.7%

d. Net income........................................... $ 840,000 $ Add after-tax cost of interest: $360,000 × (1 – 0.30) ........................ 252,000 $300,000 × (1 – 0.30) ........................ Total (a) ............................................... $ 1,092,000 $

504,000 210,000 714,000

Average total assets (b) ........................ $15,990,000 $13,920,000 Return on total assets (a) ÷ (b) .............

6.8%

5.1%

e. Net income (a) ..................................... $ 840,000 Average total stockholders’ equity* (b) .. $ 9,360,000 Return on equity (a) ÷ (b) .................... 9.0%

$ 504,000 $ 9,084,000 5.6%

* [($9,120,000 + $9,600,000) ÷ 2] = $9,360,000 [($9,048,000 + $9,120,000) ÷ 2] = $9,084,000 f. Leverage is positive for this year because the return on equity (9.0%) is greater than the return on total assets (6.8%). For last year, leverage is also positive because the return on equity (5.6%) is greater than the return on total assets (5.1%).

Problem 15-15 (continued)

This Year

Last Year

100,000 $8.40

100,000 $5.04

b. Dividends per share (a) .......................... Market price per share (b) ...................... Dividend yield ratio (a) ÷ (b) ..................

$3.60 $72.00 5.0%

$2.52 $40.00 6.3%

c. Dividends per share (a) .......................... Earnings per share (b) ........................... Dividend payout ratio (a) ÷ (b) ...............

$3.60 $8.40 42.9%

$2.52 $5.04 50.0%

d. Market price per share (a) ....................... Earnings per share (b) ............................ Price-earnings ratio (a) ÷ (b) ...................

$72.00 $8.40 8.57

$40.00 $5.04 7.94

2. a. Net income (a) ...................................... Average number of common shares outstanding (b) ................................... Earnings per share (a) ÷ (b)...................

$840,000

$504,000

Notice from the data given in the problem that the typical P/E ratio for companies in Lydex Company’s industry is 10. Since Lydex Company presently has a P/E ratio of only 8.57, investors appear to regard its potential for earnings growth unfavorably relative to other companies in the industry. That is, investors are willing to pay only 8.57 times current earnings for a share of Lydex Company’s stock, as compared to 10 times current earnings for a share of stock for the typical company in the industry. e. Stockholders’ equity (a).......................... $9,600,000 Number of common shares outstanding (b) ..................................................... 100,000 Book value per share (a) ÷ (b) ...............

$96.00

$9,120,000 100,000 $91.20

Managerial Accounting, 16th Edition

Problem 15-15 (continued) Notice that the market value of common stock is below its book value for both years. This does not necessarily indicate that the stock is selling at a bargain price. Market value reflects investors’ expectations concerning future earnings, whereas book value is a result of already completed transactions and is geared to the past.

This Year

Last Year

3. a. Current assets ........................................ Current liabilities ..................................... Working capital .......................................

$7,800,000 3,900,000 $3,900,000

$5,940,000 2,760,000 $3,180,000

b. Current assets (a) ................................... Current liabilities (b) ............................... Current ratio (a) ÷ (b).............................

$7,800,000 $3,900,000 2.00

$5,940,000 $2,760,000 2.15

c. Quick assets (a) ...................................... Current liabilities (b) ............................... Acid-test ratio (a) ÷ (b) ...........................

$3,660,000 $3,900,000 0.94

$3,360,000 $2,760,000 1.22

d. Sales on account (a) ............................... $15,750,000 $12,480,000 Average accounts receivables (b) ............. $2,250,000 $1,680,000 Accounts receivable turnover (a) ÷ (b) ..... 7.0 7.4 Average collection period, 365 days ÷ turnover ............................. 52.1 days 49.3 days e. Cost of goods sold (a) ........................... Average inventory balance (b) ............... Inventory turnover ratio (a) ÷ (b) .......... Average sale period, 365 days ÷ Inventory turnover ratio ....

$12,600,000 $3,150,000 4.0

$9,900,000 $2,160,000 4.6

91.3 days

79.3 days

f. Average sale period............................... Average collection period....................... Operating cycle .....................................

91.3 days 52.1 days 143.4 days

79.3 days 49.3 days 128.6 days

Problem 15-15 (continued) g. Sales (a) .............................................. Average total assets (b) ........................ Total asset turnover (a) ÷ (b) ................

This Year

Last Year

$15,750,000 $12,480,000 $15,990,000 $13,920,000 0.99 0.90

4. With respect to profitability, the return on total assets has improved from 5.1% to 6.8%; however, 6.8% is well below the industry average of 9.5%. Regarding debt management, the times interest earned ratio has increased from 3.40 to 4.33; however, 4.33 is below the industry average of 5.7. From a market performance perspective, the earnings per share increased from $5.04 to $8.40. However, Lydex’s price earnings ratio of 8.57 is below the industry average of 10. In terms of asset management, Lydex’s average sale period and average collection period of 91.3 days and 52.1 days, respectively, are well above industry averages of 60 days and 30 days, respectively. Overall, Lydex’s performance is improving in some areas, but it is not doing very well relative to its competitors.

Managerial Accounting, 16th Edition

Problem 15-16 (30 minutes) 1.

Lydex Company Comparative Balance Sheets Current assets: Cash ................................................... Marketable securities ........................... Accounts receivable, net....................... Inventory ............................................ Prepaid expenses ................................. Total current assets ................................ Plant and equipment, net........................ Total assets ............................................ Current liabilities .................................... Note payable, 10% ................................. Total liabilities ........................................ Stockholders’ equity: Common stock, $78 par value .............. Retained earnings ................................ Total stockholders’ equity ........................ Total liabilities and equity ........................

This Year Last Year 5.6 % 8.5 % 0.0 2.0 15.8 12.1 22.8 16.1 1.4 1.2 45.6 39.9 54.4 60.1 100.0 % 100.0 % 22.8 % 21.1 43.9

18.5 % 20.2 38.7

45.6 52.4 10.5 8.9 56.1 61.3 100.0 % 100.0 %

Problem 15-16 (continued) 2.

Lydex Company Comparative Income Statements

This Year Last Year

Sales ..................................................... 100.0 % Cost of goods sold .................................... 80.0 Gross margin............................................ 20.0 Selling and administrative expenses........... 10.1 Net operating income ............................... 9.9 Interest expense ...................................... 2.3 Net income before taxes ........................... 7.6 Income taxes (30%) ................................. 2.3 Net income .............................................. 5.3%

100.0 % 79.3 20.7 12.5 8.2 2.4 5.8 1.7 4.0 %*

*Due to rounding, figures may not fully reconcile down a column. 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 + marketable securities). 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 15-15 for a ratio analysis of the current assets.) Apparently a 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, as noted in the solution to the preceding problem there has been a slight deterioration in the gross margin percentage. Ordinarily, the increase in sales (and in inventories) should have resulted in an increase in the gross margin percentage because fixed manufacturing costs would be spread across more units. Note that the selling and administrative expenses are down as a percentage of sales—possibly because many of them are likely to be fixed.

Managerial Accounting, 16th Edition

Problem 15-17 (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. 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.

Problem 15-18 (60 minutes)

This Year

Last Year

1. a. Current assets ......................................... $1,520,000 $1,090,000 Current liabilities ..................................... 800,000 430,000 Working capital ....................................... $ 720,000 $ 660,000 b. Current assets (a) ................................... $1,520,000 $1,090,000 Current liabilities (b) ................................ $800,000 $430,000 Current ratio (a) ÷ (b) ............................. 1.90 2.53 c. Quick assets (a) ...................................... Current liabilities (b) ................................ Acid-test ratio (a) ÷ (b) ...........................

$550,000 $800,000 0.69

$468,000 $430,000 1.09

d. Sales on account (a) ................................ $5,000,000 Average receivables (b) ........................... $390,000 Accounts receivable turnover (a) ÷ (b) ..... 12.8

$4,350,000 $275,000 15.8

Average collection period: 365 days ÷ Accounts receivable turnover .................

28.5 days

23.1 days

e. Cost of goods sold (a) ............................. $3,875,000 $3,450,000 Average inventory (b) .............................. $775,000 $550,000 Inventory turnover ratio(a) ÷ (b).............. 5.0 6.3 Average sales period: 365 days ÷ Inventory turnover ratio ......

73.0 days

57.9 days

f. Average sale period ................................. Average collection period ......................... Operating cycle .......................................

73.0 days 28.5 days 101.5 days

57.9 days 23.1 days 81.0 days

g. Sales (a) ................................................. $5,000,000 $4,350,000 Average total assets (b) ........................... $2,730,000 $2,440,000 Total asset turnover (a) ÷ (b)................... 1.83 1.78

Managerial Accounting, 16th Edition

Problem 15-18 (continued)

This Year

Last Year

$472,000 $72,000 6.56

$352,000 $72,000 4.89

h. Total liabilities (a) .................................... $1,400,000 $1,030,000 Stockholders’ equity (b) ........................... $1,600,000 $1,430,000 Debt-to-equity ratio (a) ÷ (b) ................... 0.88 0.72 i. Net income before interest and taxes (a) .. Interest expense (b) ................................ Times interest earned (a) ÷ (b) ................

j. Average total assets (a) ........................... $2,730,000 $2,440,000 Average stockholders’ equity (b)............... $1,515,000 $1,425,000 Equity multiplier (a) ÷ (b) ........................ 1.80 1.71

Problem 15-18 (continued) 2. a.

Sabin Electronics Common-Size Balance Sheets

This Year Last Year

Current assets: Cash...................................................... 2.3 % Marketable securities .............................. 0.0 Accounts receivable, net ......................... 16.0 Inventory............................................... 31.7 Prepaid expenses ................................... 0.7 Total current assets................................... 50.7 Plant and equipment, net .......................... 49.3 Total assets .............................................. 100.0 % Current liabilities ....................................... 26.7 % Bonds payable, 12% ................................. 20.0 Total liabilities ........................................ 46.7 Stockholders’ equity: Common stock, $10 par .......................... 25.0 Retained earnings .................................. 28.3 Total stockholders’ equity .......................... 53.3 Total liabilities and equity .......................... 100.0 %

6.1 % 0.7 12.2 24.4 0.9 44.3 55.7 100.0 % 17.5 % 24.4 41.9 30.5 27.6 58.1 100.0 %

Managerial Accounting, 16th Edition

Problem 15-18 (continued) b.

Sabin Electronics Common-Size Income Statements

This Year Last Year

Sales ..................................................... 100.0 % Cost of goods sold ................................. 77.5 Gross margin ......................................... 22.5 Selling and administrative expenses ........ 13.1 Net operating income ............................. 9.4 Interest expense .................................... 1.4 Net income before taxes ......................... 8.0 Income taxes ......................................... 2.4 Net income ............................................ 5.6 %

100.0 % 79.3 20.7 12.6 8.1 1.7 6.4 1.9 4.5 %

3. The following points can be made from the analytical work in parts (1) and (2) above: a. The company’s current position has deteriorated significantly since last year. Both the current ratio of 1.9 and the acid-test ratio of 2.53 are well below the industry averages of 2.5 and 1.3, respectively, and are trending downward. At the present rate, it will soon be impossible for the company to pay its bills as they come due. b. The drain on the cash account seems to be a result mostly of a large buildup in accounts receivable and inventory. Notice that the average collection period has increased by over five days (to 28.5 days) since last year, and now is 10 days over the industry average of 18 days. Many of the company’s customers are not taking their discounts because the average collection period is 28.5 days and the collections 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.

Problem 15-18 (continued) c. The inventory turned only 5.0 times this year as compared to 6.3 times last year. It takes nearly two weeks longer for the company to turn its inventory than the average for the industry (73 days as compared to 60 days for the industry). This suggests that inventory stocks are higher than they need to be. d. The debt-to-equity ratio of 0.88 is aligned with the industry average of 0.90 and the times interest earned ratio of 6.56 slightly exceeds the industry benchmark of 6.0. e. In the authors’ opinion, the loan should be approved only if the company gets its accounts receivable and inventory back under control. If the accounts receivable collection period is reduced to about 20 days, and if the inventory is pared down enough to reduce the turnover time to about 60 days, enough funds could be released to substantially improve the company’s cash position. Then a loan might not even be needed.

Managerial Accounting, 16th Edition

Problem 15-19 (45 minutes) 1. a. Net income (a) ..................................... Average number of common shares* (b) Earnings per share (a) ÷ (b) .................

This Year Last Year

$280,000 $196,000 50,000 50,000 $5.60 $3.92

* $750,000 ÷ $15 par value per share = 50,000 shares b. Dividends per share (a) ........................ Market price per share (b) .................... Dividend yield ratio (a) ÷ (b) ................

$2.20 $40.00 5.5%

$1.90 $36.00 5.3%

c. Dividends per share (a) ........................ Earnings per share (b) .......................... Dividend payout ratio (a) ÷ (b) .............

$2.20 $5.60 39.3%

$1.90 $3.92 48.5%

d. Market price per share (a) .................... Earnings per share (b) .......................... Price-earnings ratio (a) ÷ (b) ................

$40.00 $5.60 7.14

$36.00 $3.92 9.18

Investors regard Sabin Electronics less favorably than other companies in the industry. This is evidenced by the fact that they are willing to pay only 7.14 times current earnings for a share of Sabin’s stock, as compared to 12 times current earnings for other companies in the industry. If investors were willing to pay 12 times current earnings for Sabin’s stock, it would be selling for about $67.20 per share (12 × $5.60), rather than for only $40 per share.

Problem 15-19 (continued)

This Year

Last Year

e. Total stockholders’ equity (a) .................... $1,600,000 $1,430,000 Number of common shares outstanding [see requirement 1(a)](b) ...................... 50,000 50,000 Book value per share (a) ÷ (b) ................. $32.00 $28.60 The market value is above book value for both years. However, this does not necessarily indicate that the stock is overpriced. Market value reflects investors’ perceptions of future earnings, whereas book value is a result of already completed transactions.

This Year

Last Year

2. a. Gross margin (a) ................................... $1,125,000 $900,000 Sales (b) ............................................... $5,000,000 $4,350,000 Gross margin percentage (a) ÷ (b) ......... 22.5% 20.7% b. Net income (a) ...................................... $280,000 $196,000 Sales (b) ............................................... $5,000,000 $4,350,000 Net profit margin percentage (a) ÷ (b) ... 5.6% 4.5% c. Net income ........................................... $ 280,000 $ 196,000 Add after-tax cost of interest paid: [$72,000 × (1 – 0.30)]........................ 50,400 50,400 Total (a)................................................ $ 330,400 $ 246,400 Average total assets (b) ......................... $2,730,000 $2,440,000 Return on total assets (a) ÷ (b) .............

12.1%

10.1%

d. Net income (a) ...................................... $ 280,000 $ 196,000 Average stockholders’ equity (b)............. $1,515,000 $1,425,000 Return on equity (a) ÷ (b) ..................... 18.5% 13.8%

Managerial Accounting, 16th Edition

Problem 15-19 (continued) e. Financial leverage is positive in both years because the return on equity is greater than the return on total assets. This positive financial leverage is due to two factors: the bonds, which have an after-tax interest cost of only 8.4% [12% interest rate × (1 – 0.30) = 8.4%]; and the accounts payable, which may bear no interest cost. 3. All profitability measures and the earnings per share are trending upwards, which is a good sign. However, the price-earnings ratio has dropped from 9.18 to 7.14. This decline indicates investor concerns about Sabin’s potential for earnings growth. Perhaps investors are concerned about Sabin’s accounts receivable and inventory management problems. Conceivably, this problem could worsen, leading to an eventual reduction in profits through an inability to operate, a suspension of dividends, and a precipitous drop in the market price of the company’s stock. That said, if Sabin can get its current assets under control the stock price may very well have the potential for further growth.

Problem 15-20 (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 interest on the loan must be less than four times net operating income. These ratios are computed below: Current assets Current liabilities

Current ratio = =

$290,000 = 1.8 (rounded) $164,000

Cash + Marketable securities + Accounts receivables + Short - term notes receivable Acid-test ratio = Current liabilities =

$70,000 + $0 + $50,000 + $0 = 0.7 (rounded) $164,000

Net operating income $20,000 = = 5.0 Interest on the loan $80,000 × 0.10 × (6/12) The company would fail to qualify for the loan because both its current ratio and its acid-test ratio are too low.

Managerial Accounting, 16th Edition

Problem 15-20 (continued) 2. By reclassifying the $45 thousand net book value of the old machine 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. Current ratio = =

Current assets Current liabilities $290,000 + $45,000 = 2.0 (rounded) $164,000

Cash + Marketable securities + Accounts receivables + Short - term notes receivable Acid-test ratio = Current liabilities =

$70,000 + $0 + $50,000 + $0 = 0.7 (rounded) $164,000

Even if this tactic had succeeded in qualifying the company for the loan, we strongly advise against it. 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.

Problem 15-20 (continued) Nevertheless, the old machine is an asset that could be turned into cash. If this were done, the company would immediately qualify for the loan because the $45,000 in cash would be included in the numerator in both the current ratio and in the acid-test ratio. Current ratio = =

Current assets Current liabilities $290,000 + $45,000 = 2.0 (rounded) $164,000

Acid-test ratio =

Cash + Marketable securities + Current receivables Current liabilities

$70,000 + $0 + $50,000 + $45,000 = 1.0 (rounded) $164,000

However, other options may be available. The old machine is being used to relieve bottlenecks in the plastic injection molding process and it would be desirable to keep this standby capacity. We would advise Russ to fully and honestly explain the situation to the loan officer. The loan officer might insist that the machine be sold before any loan is approved, but she 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 machine. Or she may approve the loan on the condition that the machine is pledged as collateral. In that case, Russ would only have to sell the machine if he would otherwise be unable to pay back the loan.

Managerial Accounting, 16th Edition

Problem 15-21 (60 minutes or longer) Pepper Industries Income Statement For the Year Ended March 31 Sales................................................ Cost of goods sold ............................ Gross margin .................................... Selling and administrative expenses ... Net 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

Key to Computation (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 .................................. Stockholders’ equity: Common stock, $5 par value........... Retained earnings .......................... Total stockholders’ 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

(m) (o) (n) (p)

Problem 15-21 (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

Managerial Accounting, 16th Edition

Problem 15-21 (continued) Therefore, the total quick assets must be $400,000. Because there are no marketable securities, no short-term notes receivable, 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 (in this case, 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.

Net operating income = Gross margin - Operating expenses Operating expenses = Gross margin - Net operating income = $1,470,000 - $540,000 = $930,000

Problem 15-21 (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.

Earnings per share =

Net income - Preferred dividends Average number of common shares outstanding

$322,000 Average number of common shares outstanding

= $2.30

Therefore, the average number of shares must be 140,000. The stock is $5 par value per share, so the total common stock must be $700,000 ($5 × 140,000 shares). n.

Debt-to-equity ratio =

Total liabilities Stockholders' equity

$1,120,000 Stockholders' equity

= 0.875

Therefore, the total stockholders’ equity must be $1,280,000. o.

Total stockholders' equity = Common stock + Retained earnings Retained earnings = Total stockholders' equity - Common Stock = $1,280,000 - $700,000 = $580,000

Managerial Accounting, 16th Edition

Problem 15-21 (continued) p.

Total assets = Liabilities + Stockholders' 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). q.

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

Integration Exercises

Integration Exercise 1 (15 minutes) 1. The mozzarella cheese activity variance is computed as follows:

Number of pizzas (q) ................... Mozzarella cheese ($2.40q)..........

Flexible Budget

Planning Budget

Activity Variance

$2,640

$2,400

$240 U

1,100

1,000

2. The mozzarella cheese spending variance is computed as follows:

Number of pizzas (q) ................... Mozzarella cheese ($2.40q)..........

Actual Results

Flexible Budget

Spending Variance

$2,632

$2,640

$8 F

1,100

3.a., 3.b., and 3.c. The materials price, quantity, and spending variances are computed as follows: Standard Quantity Actual Quantity of Actual Quantity of Allowed Input, Input, for Actual Output, at Actual Price at Standard Price at Standard Price (AQ × AP) (AQ × SP) (SQ × SP) 9,400 ounces × 9,400 ounces × 8,800 ounces** × $0.28 per ounce* $0.30 per ounce $0.30 per ounce = $2,632 = $2,820 = $2,640 Materials price Materials quantity variance = $188 F variance = $180 U Spending variance = $8 F * $2,632 ÷ 9,400 ounces = $0.28 per ounce **1,100 pizzas × 8 ounces per pizza = 8,800 ounces © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Integration Exercises

Integration Exercise 2 (60 minutes) 1. The total amount of product costs is computed as follows: Direct materials........................................... Direct labor................................................. Variable manufacturing overhead ................. Variable manufacturing cost per unit ............

$ 8.00 5.00 1.00 $14.00

$14.00 25,000 $6.00 25,000

$350,000

150,000 $500,000

The total amount of period costs is computed as follows: Sales commissions ...................................... Variable administrative expense ................... Variable selling and administrative per unit ...

$4.00 1.00 $5.00

Variable selling and admin. per unit (a) ........ Number of units sold (b).............................. Total variable selling and administrative expense (a) × (b) ..................................... Average fixed selling and administrative expense per unit ($3.50 fixed selling + $2.50 fixed administrative) (c) ................... Number of units sold (d).............................. Total fixed selling and administrative expense (c) × (d) ..................................... Total period (nonmanufacturing) cost ...........

$5.00 25,000 $125,000 $6.00 25,000 150,000 $275,000

Note: The average fixed manufacturing overhead per unit ($6.00) and the average fixed selling and administrative expense per unit ($6.00) are valid for only one level of activity—25,000 units. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Integration Exercises

Integration Exercise 2 (continued) 2. The variable manufacturing cost per unit produced is computed as follows: Direct materials ....................................... Direct labor ............................................. Variable manufacturing overhead ............. Variable manufacturing cost per unit.........

$ 8.00 5.00 1.00 $14.00

The average fixed manufacturing cost per unit is computed as follows: Total fixed manufacturing cost (see requirement 1) (a) ......................... Number of units produced (b) .................. Average fixed manufacturing cost per unit produced (a) ÷ (b)................................

$150,000 24,000 $6.25

3. The variable manufacturing cost per unit produced is computed as follows: Direct materials ....................................... Direct labor ............................................. Variable manufacturing overhead ............. Variable manufacturing cost per unit.........

$ 8.00 5.00 1.00 $14.00

$150,000 26,000 $5.77

Integration Exercise 2 (continued) 4.

The total direct and indirect manufacturing costs are computed as follows: Direct materials per unit ............................. Direct labor per unit ................................... Direct manufacturing cost per unit (a) .........

$ 8.00 5.00 $13.00

Number of units produced (b) ..................... Total direct manufacturing cost (a) × (b) .....

27,000 $351,000

$1.00 27,000

The incremental manufacturing cost is computed as follows: Direct materials per unit .......................................... Direct labor per unit ................................................ Variable manufacturing overhead per unit ................. Incremental manufacturing cost per unit produced ....

$ 27,000 150,000 $177,000

$ 8.00 5.00 1.00 $14.00

The contribution margin per unit is computed as follows: Selling price per unit ........................... Variable expenses per unit: Direct materials ................................ Direct labor ...................................... Variable manufacturing overhead ...... Sales commissions............................ Variable administrative expense ........ Total variable expenses ...................... Contribution margin per unit ...............

$34 $8.00 5.00 1.00 4.00 1.00

19 $15

Integration Exercise 2 (continued) The contribution margin ratio is computed as follows: Contribution margin per unit (a) ....................... Selling price per unit (b) ................................... Contribution margin ratio (rounded) (a) ÷ (b)....

$15 $34 44.1%

7. The break-even point in unit sales is computed using the equation method as follows: Profit = Unit CM × Q − Fixed expenses $0 = ($34 − $19) × Q − $300,000 $0 = $15 × Q − $300,000 15Q = $300,000 Q = $300,000 ÷ $15 Q = 20,000 units The break-even point in dollar sales is: 20,000 units × $34 = $680,000 8. The increase in net operating income is computed as follows: Additional units sold (26,500 – 25,000) (a) ...... Contribution margin per unit (b) ..................... Increase in net operating income (a) × (b) ......

1,500 $15 $22,500

9. The margin of safety is computed as follows: Sales (25,000 units × $34) .............................. Break-even sales (20,000 units × $34) ............. Margin of safety ..............................................

$850,000 680,000 $170,000

Integration Exercise 2 (continued) 10. The first step is to prepare a contribution format income statement at a sales volume of 25,000 units as follows: Sales (25,000 units × $34)....................... Variable expenses (25,000 units × $19) .... Contribution margin ................................. Fixed expenses ($150,000 + $150,000) .... Net operating income ..............................

$850,000 475,000 375,000 300,000 $ 75,000

The second step is to compute the degree of operating leverage as follows: Contribution margin (a) . .......................... Net operating income (b) ......................... Degree of operating leverage (a) ÷ (b) .....

$375,000 $75,000 5.0

Integration Exercise 3 (60 minutes) 1. The first step is to compute the unit product cost under absorption costing as follows: Direct materials .............................. Direct labor .................................... Variable manufacturing overhead .... Fixed manufacturing overhead ($450,000 ÷ 25,000 units) ........... Unit product cost............................

$20 16 4 18 $58

The second step is to compute the absorption costing net operating income as follows: Sales (20,000 units × $66 per unit) ........................... $1,320,000 Cost of goods sold (20,000 units × $58 per unit) ....... 1,160,000 Gross margin ........................................................... 160,000 Selling and administrative expenses [(20,000 units × $2 per unit) + $70,000] ................ 110,000 Net operating income ............................................... $ 50,000 2. The first step is to compute the revised unit product cost under absorption costing as follows: Direct materials .............................. Direct labor .................................... Variable manufacturing overhead .... Fixed manufacturing overhead ($450,000 ÷ 25,000 units) ........... Unit product cost............................

$21 16 4 18 $59

The second step is to compute the revised absorption costing net operating income as follows: Sales (21,000 units × $66 per unit) ........................... $1,386,000 Cost of goods sold (21,000 units × $59 per unit) ....... 1,239,000 Gross margin ........................................................... 147,000 Selling and administrative expenses [(21,000 units × $2 per unit) + $70,000] ................ 112,000 Net operating income ............................................... $ 35,000 © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Integration Exercises

Integration Exercise 3 (continued) 3. The unit product cost does not change; therefore, the revised absorption costing net operating income is computed as follows: Sales (18,500 units × $67 per unit) ........................... $1,239,500 Cost of goods sold (18,500 units × $58 per unit) ....... 1,073,000 Gross margin ........................................................... 166,500 Selling and administrative expenses [(18,500 units × $2 per unit) + $70,000] ................ 107,000 Net operating income ............................................... $ 59,500 4. The first step is to compute the unit product cost under variable costing as follows: Direct materials .............................. Direct labor .................................... Variable manufacturing overhead .... Unit product cost............................

$20 16 4 $40

The second step is to compute the variable costing net operating income as follows: Sales (20,000 units × $66) ................. Variable expenses: Variable cost of goods sold (20,000 units × $40 per unit) ........ Variable selling and administrative (20,000 units × $2 per unit) .......... Contribution margin............................ Fixed expenses: Fixed manufacturing overhead .......... Fixed selling and administrative ........ Net operating loss ..............................

$1,320,000 $800,000 40,000 450,000 70,000

840,000 480,000 520,000 $ (40,000)

Integration Exercise 3 (continued) 5. The first step is to compute the revised unit product cost under variable costing as follows: Direct materials .............................. Direct labor .................................... Variable manufacturing overhead .... Unit product cost............................

$21 16 4 $41

The second step is to compute the variable costing net operating income as follows: Sales (21,000 units × $66) ................. Variable expenses: Variable cost of goods sold (21,000 units × $41 per unit) ........ Variable selling and administrative (21,000 units × $2 per unit) .......... Contribution margin............................ Fixed expenses: Fixed manufacturing overhead .......... Fixed selling and administrative ........ Net operating loss ..............................

$1,386,000 $861,000 42,000 450,000 70,000

903,000 483,000 520,000 $ (37,000)

6. The unit product cost does not change; therefore, the revised variable costing net operating income is computed as follows: Sales (18,500 units × $67) ................. Variable expenses: Variable cost of goods sold (18,500 units × $40 per unit) ........ Variable selling and administrative (18,500 units × $2 per unit) .......... Contribution margin............................ Fixed expenses: Fixed manufacturing overhead .......... Fixed selling and administrative ........ Net operating loss ..............................

$1,239,500 $740,000 37,000 450,000 70,000

777,000 462,500 520,000 $ (57,500)

Integration Exercise 3 (continued) 7. The break-even point in unit sales is computed as follows: Profit = Unit CM × Q − Fixed expenses $0 = ($66 − $42) × Q − $520,000 $0 = $24 × Q − $520,000 24Q = $520,000 Q = $520,000 ÷ $24 Q = 21,667 units (rounded) Note: The variable cost per unit ($42) includes variable manufacturing costs ($40) and variable selling and administrative costs ($2). The break-even point in dollar sales is: 21,667 units × $66 = $1,430,022 8. The margin of safety is computed as follows: Sales (20,000 units × $66) .............................. Break-even sales (21,667 units × $66) ............. Margin of safety ..............................................

$1,320,000 1,430,022 $ (110,022)

Integration Exercise 4 (120 minutes+) 1. Schedule of expected cash collections: Cash sales—July ($310,000 × 20%) ................... Collections on account receivable: June 30 balance ............................................. July sales ($310,000 × 80% × 30%) ............... Total cash collections .........................................

$ 62,000 166,000 74,400 $302,400

2. The merchandise purchases for July are computed as follows: Cost of goods sold ($310,000 × 60%) ................ Add: Desired ending inventory ($330,000 × 60% × 20%).......................................................... Total needs ....................................................... Deduct: Beginning inventory .............................. Merchandise purchases ......................................

$186,000 39,600 225,600 37,200 $188,400

The expected cash disbursements for merchandise purchases is computed as follows: June 30 accounts payable balance ...................... July purchases ($188,400 × 40%)...................... Total cash disbursements ...................................

$ 93,000 75,360 $168,360

Integration Exercise 4 (continued) 3.

Millen Corporation Cash Budget For the Month of July Beginning cash balance ..................................... Add collections from customers (above).............. Total cash available ........................................... Less cash disbursements: Purchase of inventory (above) ......................... Selling and administrative expenses ................. Total cash disbursements ................................... Excess of cash available over disbursements ....... Financing: Borrowing—note ............................................. Repayments—note .......................................... Interest .......................................................... Total financing .................................................. Ending cash balance ..........................................

$120,000 302,400 422,400 168,360 60,000 228,360 194,040 0 0 0 0 $194,040

4. Millen Corporation Income Statement For the Month of July Sales ................................................................ Cost of goods sold ($310,000 × 60%) ................ Gross margin .................................................... Selling and administrative expenses ................... Net operating income ........................................ Interest expense ............................................... Net income .......................................................

$310,000 186,000 124,000 70,000 54,000 0 $ 54,000

Integration Exercise 4 (continued) 5.

Millen Corporation Budgeted Balance Sheet July 31

Assets

Cash .......................................................................... Accounts receivable ($310,000 × 80% ×70%) ............. Inventory ($330,000 × 60% × 20%)........................... Plant and equipment, net of depreciation ($554,800 – $10,000) ................................................................. Total assets ................................................................

Liabilities and Stockholders’ Equity

Accounts payable (188,400 × 60%) ............................ Common stock ........................................................... Retained earnings ($199,000 + $54,000) ..................... Total liabilities and stockholders’ equity ........................

$194,040 173,600 39,600 544,800 $952,040 $113,040 586,000 253,000 $952,040

Integration Exercise 4 (continued) 6. The accounts receivable turnover and inventory turnover are computed as follows: Sales on account Accounts receivable = turnover Average accounts receivable balance =

$248,000* = 1.46 (rounded) ($166,000 + $173,600)/2

* Sales on account = $310,000 × 80% = $248,000 Cost of goods sold Average inventory balance $186,000 = = 4.84 (rounded) ($37,200 + $39,600)/2

Inventory turnover =

The operating cycle is computed by calculating the average collection period and average sale period and then adding them together as follows: 30 days Accounts receivable turnover 30 days = = 20.55 days (rounded) 1.46

Average collection period =

30 days Inventory turnover 30 days = = 6.20 days (rounded) 4.84

Average sale period =

Operating cycle = Average sale period + Average collection period = 6.20 days + 20.55 days = 26.75 days

Integration Exercise 4 (continued) 8. The net cash provided by operating activities is computed as follows: Net income .................................................... Adjustments to convert net income to a cash basis: Depreciation................................................ $10,000 Increase in accounts receivable .................... (7,600) Increase in inventory ................................... (2,400) Increase in accounts payable........................ 20,040 Net cash provided by operating activities .........

$54,000

20,040 $74,040

Integration Exercise 5 (75 minutes) 1. The first step to completing the statement of cash flows is to calculate the net cash provided by operating activities as follows: Step 1: Apply the following equation to the Accumulated Depreciation account to compute the depreciation to add back to net income: Beginning balance – Debits + Credits = Ending balance $480 – $9 + Credits = $640 Credits = $640 – $480 + $9 Credits = $169 Step 2: Use the guidelines from Exhibit 14-2 to analyze the changes in noncash balance sheet accounts that impact net income as follows:

Current Assets Accounts receivable ....... Inventory ...................... Current Liabilities Accounts payable ........... Accrued liabilities ........... Income taxes payable ....

Increase in Account Balance – 40 + 25

Decrease in Account Balance + 36

– 11 – 16

Step 3: The gain on sale of equipment ($4) is subtracted from net income.

Integration Exercise 5 (continued) The net cash provided by operating activities is computed as follows: Net income ......................................................... Adjustments to convert net income to cash basis: Depreciation .................................................. Decrease in accounts receivable ...................... Increase in inventory ...................................... Increase in accounts payable .......................... Decrease in accrued liabilities ......................... Decrease in income taxes payable ................... Gain on sale of equipment .............................. Net cash provided by operating activities ..............

$ 42 $169 36 (40) 25 (11) (16) (4)

159 $201

The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:

Noncurrent Assets Property, plant, and equipment................. Liabilities and Stockholders’ Equity Bonds payable .........................................

Increase Decrease in Account in Account Balance Balance –63 – 130

Because Rowan did not issue any bonds during the year, the corresponding amount shown above (–130) represents the gross cash outflow pertaining to a bond retirement.

Integration Exercise 5 (continued) Property, plant, and equipment and retained earnings require further analysis as follows: Property, plant, and equipment: Beginning balance + Debits – Credits = Ending balance $1,656 + Debits – $16 = $1,719 Debits = $1,719 – $1,656 + $16 Debits = $79 The additions to property, plant, and equipment ($79) are recorded as a cash outflow and the proceeds from the sale of equipment ($11) are recorded as a cash inflow. Retained earnings: Beginning balance – Debits + Credits = Ending balance $936 – Debits + $42 = $954 $42 = Debits + $18 Debits = $24 The dividend payment ($24) should be recorded as a cash outflow in the financing activities section of the statement.

Integration Exercise 5 (continued) Rowan Company Statement of Cash Flows For the Year Ended December 31

Operating activities:

Net income ......................................................... Adjustments to convert net income to cash basis: Depreciation .................................................. $169 Decrease in accounts receivable ...................... 36 Increase in inventory ...................................... (40) Increase in accounts payable .......................... 25 Decrease in accrued liabilities .......................... (11) Decrease in income taxes payable ................... (16) Gain on sale of equipment .............................. (4) Net cash provided by operating activities ..............

Investing activities:

Proceeds from sale of equipment.......................... Additions to plant and equipment ......................... Net cash used in investing activities ......................

Financing activities:

Retired bonds payable ......................................... Cash dividends .................................................... Net cash used in financing activities......................

11 (79)

(130) (24)

Net decrease in cash ........................................... Beginning cash and cash equivalents .................... Ending cash and cash equivalents.........................

$ 42

159 201

(68)

(154) (21) 91 $ 70

2. The free cash flow is computed as follows: Net cash provided by operating activities ... Capital expenditures ............................... Dividends .............................................. Free cash flow ..........................................

$79 24

$201 103 $ 98

Integration Exercise 5 (continued) 3.a. and 3.b. The current ratio and acid-test (quick) ratio are computed as follows: Current assets Current liabilities $1,226 = = 3.30 (rounded) $371

Current ratio =

Cash + Marketable securities + Accounts receivable + Short-term notes Acid-test ratio = Current liabilities $70 + $0 + $536 + $0 = = 1.63 (rounded) $371 4.a. and 4.b. The average collection period is calculated as follows: Sales on account Accounts receivable = turnover Average accounts receivable balance =

$4,350 = 7.85 (rounded) ($572 + $536)/2 365 days Accounts receivable turnover 365 days = = 46.50 days (rounded) 7.85

Average collection period =

Integration Exercise 5 (continued) The average sale period is computed as follows: Cost of goods sold Average inventory balance $3,470 = = 5.78 (rounded) ($580 + $620)/2

Inventory turnover =

365 days Inventory turnover 365 days = = 63.15 days (rounded) 5.78

Average sale period =

5.a. and 5.b. The debt-to-equity ratio is computed as follows: Total liabilities Stockholders' equity $551 = = 0.31 (rounded) $1,754

Debt-to-equity ratio =

The equity multiplier is computed as follows: Average total assets Average stockholders' equity ($2,419 + $2,305)/2 = = 1.35 (rounded) ($1,736 + $1,754)/2

Equity multiplier =

Integration Exercise 5 (continued) 6.a and 6.b. The net profit margin percentage is calculated as follows: Net income Sales $42 = = 1.0% (rounded) $4,350

Net profit margin percentage =

The return on equity is calculated as follows: Net income Average total stockholders' equity $42 = = 2.4% ($1,736 + $1,754)/2

Return on equity =

7.a and 7.b. The earnings per share is calculated as follows:

Net income Average number of common shares outstanding $42 = = $0.53 per share (rounded) 80 shares*

Earnings per share =

* $800,000 ÷ $10 par value per share = 80,000 shares, 80 shares (in thousands. The dividend payout ratio is calculated as follows: Dividends per share Earnings per share $0.30 = = 56.6% $0.53

Dividend payout ratio =

Integration Exercise 6 (90 minutes) 1.a. The plantwide overhead rate is computed as follows: Estimated total manufacturing overhead (a) ... $1,350,000 Estimated total direct labor-hours (DLHs) (b) .. 45,000 DLHs Plantwide overhead rate (a) ÷ (b) .................. $30.00 per DLH 1.b. The overhead assigned to each product is computed as follows:

Basic Advanced

Direct labor-hours worked (a) ...................... 30,000 15,000 Manufacturing overhead rate per DLH (b) .... $30.00 $30.00 Manufacturing overhead assigned (a) × (b) . $900,000 $450,000 2.a. The departmental overhead rates are computed as follows: Molding Department: Estimated total manufacturing overhead (a) ... Estimated total machine-hours (MHs) (b)........ Manufacturing overhead rate (a) ÷ (b) ...........

$787,500 22,000 MHs $35.80 per MH

Assemble and Pack Department: Estimated total manufacturing overhead (a) ... Estimated total direct labor-hours (DLHs) (b) .. Manufacturing overhead rate (a) ÷ (b) ...........

$562,500 30,000 DLHs $18.75 per DLH

2.b. The overhead assigned to each product is computed as follows:

Basic

Advanced

Molding Department ($35.80 × 12,000 MHs; ($35.80 × 10,000 MHs) ............................ $429,600 $358,000 Assemble and Pack Department ($18.75 × 20,000 DLHs; $18.75 × 10,000 DLHs) ......... 375,000 187,500 Total manufacturing overhead assigned ......... $804,600 $545,500

Integration Exercise 6 (continued) 2.c. The first step to redoing the controller’s segmented income statement is to compute each product’s cost of goods sold as follows: Direct materials ($40 × 20,000; $60 × 10,000)............................................. Direct labor ($20 × 30,000; $20 × 15,000) ............................................ Manufacturing overhead (see 2.b.) ..... Cost of goods sold ...............................

Basic

Advanced

$ 800,000

$ 600,000

600,000 804,600 $2,204,600

300,000 545,500 $1,445,500

The controller’s revised segmented income statement is calculated as follows: Sales..................................... Cost of goods sold ................. Gross margin ......................... Selling and administrative expenses............................. Net operating income.............

Basic

$3,000,000 2,204,600 795,400

Advanced

Total

$2,000,000 $5,000,000 1,445,500 3,650,100 554,500 1,349,900

720,000 $ 75,400

480,000 $ 74,500

1,200,000 $ 149,900

Note: The net operating income in this income statement ($149,900) differs from the income statement as given in the exercise ($150,000) by $100 because the departmental overhead rates have been rounded to two decimal places.

Integration Exercise 6 (continued) 3.a. The activity rates (rounded to two decimal places) are computed as follows:

Activity Cost Pool

Machining ............... Assemble and pack . Order processing..... Setups ....................

(a) Overhead Cost

(b) Activity Level

$417,500 22,000 MH $282,500 30,000 DLHs $230,000 250 Orders $340,000 650 Hours

(a) ÷ (b) Activity Rate

$18.98 per MH $9.42 per DLH $920 per order $523.08 per hour

The number of orders (250) and number of setup hours (650) are computed as follows:

Basic

Unit sales (a) ........................... Average order size (b) .............. Number of orders (a) ÷ (b).......

20,000 400 50

Number of orders (a) ............... Setup hours per order (b) ......... Total setup hours (a) × (b) .......

50 1 50

Advanced

10,000 50 200 200 3 600

Total 250

650

Integration Exercise 6 (continued) 3.b. Using the ABC system, the total manufacturing overhead assigned to the Basic and Advanced models is computed as follows (This solution uses activity rates that have been rounded to two decimal places):

Machining, at $18.98 per MH .............................. Assemble and pack, at $9.42 per DLH ................. Order processing, at $920 per order .................... Setups, at $523.08 per hour ............................... Total overhead cost assigned ..............................

Basic Activity Level Amount

12,000 20,000 50 50

$227,760 188,400 46,000 26,154 $488,314

Advanced Activity Level Amount

10,000 10,000 200 600

$189,800 94,200 184,000 313,848 $781,848

Note: The Other activity costs are not assigned to products because they represent unused capacity costs. 3.c. The total selling and administrative cost traced to the Basic and Advanced models is computed as follows: Sales commissions ($3,000,000 × 5%; $2,000,000 × 10%) ................................................................... Advertising.............................................................. Total traceable selling and administrative cost ...........

Basic

Advanced

$150,000 150,000 $300,000

$200,000 200,000 $400,000

Integration Exercise 6 (continued) 4. The contribution format income statement (adapted from Exhibit 6-8) would appear as follows: Sales...................................... Variable expenses: Direct materials .................... Direct labor .......................... Sales commissions ................ Total variable expenses ........... Contribution margin ................ Traceable fixed expenses: Machining............................. Assemble and pack ............... Order processing .................. Setups ................................. Advertising ........................... Total traceable fixed expenses . Segment margin ..................... Common fixed expenses: Other (unused capacity) ........ Selling and administrative ..... Total common fixed expenses .. Net operating income..............

Total

$5,000,000

Basic

Advanced

$3,000,000 $2,000,000

1,400,000 900,000 350,000 2,650,000 2,350,000

800,000 600,000 150,000 1,550,000 1,450,000

600,000 300,000 200,000 1,100,000 900,000

417,560 282,600 230,000 340,002 350,000 1,620,162 729,838

227,760 188,400 46,000 26,154 150,000 638,314 $ 811,686

189,800 94,200 184,000 313,848 200,000 981,848 $ (81,848)

80,000 500,000 580,000 $ 149,838

The common fixed selling and administrative expense is computed as follows: $1,200,000 – $350,000 in sales commissions – $350,000 in advertising = $500,000. Note: The net operating income in this income statement ($149,838) differs from the income statement as given in the exercise ($150,000) by $162 because the activity rates have been rounded to two decimal places.

Integration Exercise 6 (continued) 5. The break-even point for the Advanced model is computed as follows: Dollar sales for a segment to break even

Segment traceable fixed expenses Segment CM ratio

$981,848 0.45*

= $2,181,884 (rounded) * $900,000 ÷ $2,000,000 = 0.45 6. Koontz’s activity-based approach offers four improvements over its plantwide and departmental approaches. First, the ABC system allocates some of the manufacturing overhead costs (Order processing and Setups) using non-volume-related cost drivers, whereas the plantwide and departmental approaches rely exclusively on volume-related overhead cost allocation. Second, the ABC system does not assign Koontz’s unused capacity costs ($80,000) to products. Conversely, the plantwide and departmental methods rely on an absorption approach that allocates all manufacturing overhead to the units produced. Third, Koontz’s ABC approach assigns its traceable selling and administrative costs to products (i.e., sales commissions and advertising), whereas the controller’s plantwide and departmental approaches arbitrarily assign these costs to products based on sales dollars. Fourth, the ABC approach does not assign the selling and administrative costs that are organization-sustaining in nature ($500,000) to products. The controller’s plantwide and departmental approaches arbitrarily assigned these costs to products based on sales dollars.

Integration Exercise 7 (45 minutes) 1.a. The estimated total manufacturing overhead cost is computed as follows: Y = $1,000,000 + ($12.00 per unit)(50,000 units) Estimated fixed manufacturing overhead .................. Estimated variable manufacturing overhead: $12.00 per unit × 50,000 units ......................................... Estimated total manufacturing overhead cost ............

$1,000,000 600,000 $1,600,000

The plantwide predetermined overhead rate is computed as follows: Estimated total manufacturing overhead (a) .. $1,600,000 Estimated total units produced (b) ................ 50,000 units Predetermined overhead rate (a) ÷ (b) .......... $32.00 per unit 1.b. The unit product cost is computed as follows: Direct materials .............................. Direct labor .................................... Manufacturing overhead ................. Unit product cost............................

$ 78 60 32 $170

1.c. The schedule of cost of goods manufactured is prepared as follows: Direct materials: Beginning raw materials inventory .............. $ 0 Add: Purchases of raw materials ($78 × 40,000 units) ........................................... 3,120,000 Total raw materials available ...................... 3,120,000 Deduct: Ending raw materials inventory ...... 0 Raw materials used in production ............... $3,120,000 Direct labor ($60 × 40,000 units) .................... 2,400,000 Manufacturing overhead applied to work in process ($32 × 40,000 units) ........................ 1,280,000 Total manufacturing costs ............................... 6,800,000 Add: Beginning work in process inventory ........ 0 6,800,000 Deduct: Ending work in process inventory ....... 0 Cost of goods manufactured ........................... $6,800,000 © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Integration Exercises

Integration Exercise 7 (continued) 1.c. The schedule of cost of goods sold is prepared as follows: Beginning finished goods inventory ..................... $ 0 Add: Cost of goods manufactured ....................... 6,800,000 Cost of goods available for sale ........................... 6,800,000 Deduct: Ending finished goods inventory ($170 × 2,000 units ...................................................... 340,000 Unadjusted cost of goods sold ............................ 6,460,000 Add: Underapplied overhead* ............................. 200,000 Adjusted cost of goods sold ................................ $6,660,000 * The actual manufacturing overhead of $1,480,000 [$1,000,000 + ($12 × 40,000 units)] minus $1,280,000 of applied overhead equals underapplied overhead of $200,000. 1.d. The absorption costing net operating income is computed as follows: Sales ($200 × 38,000 units)............................. Cost of goods sold ........................................... Gross margin .................................................. Selling and administrative expenses ($15 × 38,000 + $350,000) ...................................... Net operating income ......................................

$7,600,000 6,660,000 940,000 920,000 $ 20,000

2.a. The absorption unit product cost is computed as follows: Direct materials .............................. Direct labor .................................... Variable manufacturing overhead .... Fixed manufacturing overhead ($1,000,000 ÷ 40,000 units) ........ Unit product cost............................

$ 78 60 12 25 $175

2.b. The absorption costing net operating income is computed as follows: Sales ($200 × 38,000 units)............................. $7,600,000 Cost of goods sold ($175 × 38,000 units) ........ 6,650,000 Gross margin .................................................. 950,000 Selling and administrative expenses ($15 × 38,000 + $350,000) ...................................... 920,000 Net operating income ...................................... $ 30,000 © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Integration Exercises

Integration Exercise 7 (continued) 3. The actual costing net operating income is $10,000 higher than the normal costing net operating income because it attaches $5 additional dollars of fixed manufacturing overhead to each of the 2,000 units in ending inventory. The underlying computations are as follows:

Units in ending inventory (a) ................. Fixed manufacturing overhead attached to each unit (b) ................................. Fixed manufacturing overhead deferred in ending inventory (a) × (b) .............

Normal Costing

Actual Costing

$20*

$25

40,000

50,000

2,000

* The plantwide predetermined overhead rate using normal costing is $32 per unit. This rate includes a variable component of $12 per unit and fixed component of $20 per unit (= $1,000,000 ÷ 50,000 units). Note to professors: You can extend the analysis by explaining how allocating the underapplied overhead between finished goods and cost of goods sold would increase normal costing net operating by $10,000; thereby, equaling the actual costing net operating income.

Integration Exercise 8 (45 minutes) Note to instructors: We recommend performing the present value calculations for this exercise using Microsoft Excel because it eliminates rounding errors that complicate the interpretation of the results. Accordingly, we present the solutions to this exercise using Microsoft Excel screen captures that rely on unrounded discount factors. 1. The net present value is computed as follows:

Integration Exercise 8 (continued) 2. The margin, turnover, and ROI is the same for years 1 through 3:

3. The residual incomes for each year are computed as follows:

4. The store manager is unlikely to pursue the investment because its ROI of 18.75% is less than her historical ROI of at least 22%. The company would want the manager to pursue the investment because it earns a return that exceeds the company’s minimum required rate of return.

Integration Exercise 8 (continued) 5. The present value of the residual incomes is computed as follows:

The present value of the residual incomes ($49,410) equals the net present value from requirement 1. This is not a coincidence. The key to understanding their equivalence is to focus on how the two methods use different (but equivalent) ways to account for the cost of the $800,000 investment in working capital. The net present value method accounts for the immediate $800,000 cash outflow and the $800,000 cash inflow at the end of year 3. Conversely, the residual income method assesses a 16% capital charge on the $800,000 of working capital in each of years 1 through 3. The equivalence of these two approaches can be shown as follows:

Both methods recognize a cost of $287,474 related to tying up $800,000 of working capital for three years. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Integration Exercises

Integration Exercise 9 (8 hours+) Note to Instructors: We recommend providing students with the row headings for the ending finished goods inventory budget (in Requirement 6) as depicted in the solution to simplify the complexity of the assignment. 1. The sales budget and schedule of expected cash collections:

2. The production budget:

Integration Exercise 9 (continued) 3. The direct materials budget and schedule of expected cash disbursements for purchases of materials:

4. The direct labor budget:

Integration Exercise 9 (continued) 5. The manufacturing overhead budget:

6. The ending finished goods inventory budget:

Integration Exercise 9 (continued) 7. The selling and administrative expense budget:

8. The cash budget:

Integration Exercise 9 (continued) 9. The income statement:

Integration Exercise 9 (continued) 10. The balance sheet:

Integration Exercise 10 (45 minutes) 1. The net cash provided by operating activities: Step 1: The company did not sell or retire any plant and equipment during the year; therefore, the $112,000 ($404,000 – $292,000) increase in Accumulated Depreciation equals the credit to the account that is added to net income. Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows: Current Assets Accounts receivable ......... Raw materials inventory ... Finished goods inventory..

Increase in Account Balance – 1,500 – 10,106

Current Liabilities Accounts payable .............

Decrease in Account Balance +60,000

– 87,728

Step 3: There are no gains or losses on the sale of assets.

Integration Exercise 10 (continued) The net cash provided by operating activities is computed as follows: Net income ............................................... Adjustments to convert net income to a cash basis: Depreciation ........................................... Decrease in accounts receivable .............. Increase in raw materials inventory ......... Increase in finished goods inventory ........ Decrease in accounts payable .................. Net cash provided by operating activities ....

$260,377 $112,000 60,000 (1,500) (10,106) (87,728)

72,666 $333,043

Integration Exercise 10 (continued) 2. The budgeted statement of cash flows: Endless Mountain Company’s budget does not include any investing activities. The financing activities (as shown in the cash budget) include borrowing and repaying $80,350 and paying $60,000 in dividends for the year. Thus, the complete statement of cash flows (as shown in Excel) would appear as follows:

Integration Exercise 11 (60 minutes) 1.a. Working capital: Working capital = Current assets - Current liabilities = $574,349 - $70,272 = $504,077

1.b. The current ratio: Current assets Current liabilities $574,349 = = 8.17 $70,272

Current ratio =

2.a. The accounts receivable turnover: Sales on account Accounts receivable = turnover Average accounts receivable balance =

$2,848,000 = 12.38 (rounded) ($260,000 + $200,000)/2

2.b. The average collection period:

365 days Accounts receivable turnover 365 days = = 29.48 days (rounded) 12.38

Average collection period =

2.c. The inventory turnover: Cost of goods sold Average inventory balance $1,998,732 = = 40.54 (rounded) ($43,500 + $55,106)/2

Inventory turnover =

Integration Exercise 11 (continued) 2.d. The average sale period: 365 days Inventory turnover 365 days = = 9.00 days (rounded) 40.54

Average sale period =

2.e. The operating cycle: Operating cycle = Average sale period + Average collection period = 9.00 days + 29.48 days = 38.48 days

3.a. The times interest earned ratio:

Earnings before interest expense and income taxes Times interest = earned ratio Interest expense =

$270,018 = 28.00 $9,642

3.b. The equity multiplier: Average total assets Average stockholders' equity ($957,700 + $1,070,349)/2 = = 1.13 (rounded) ($799,700 + $1,000,077)/2

Equity multiplier =

4.a. The net profit margin percentage: Net income Sales $260,377 = = 9.1% (rounded) $2,848,000

Net profit margin percentage =

Integration Exercise 11 (continued) 4.b. The return on equity: Net income Average total stockholders' equity $260,377 = = 28.9% ($799,700 + $1,000,077)/2

Return on equity =

Integration Exercise 11 (continued) 5.

Management preferences and the accompanying explanations are summarized below: Increase Decrease Explanation Generally speaking, increasing work in capital improves liquidity. However, if working capital 1.a. Working capital √ grows due to bloated inventories, aging accounts receivables, or dormant cash hoards, it may signal poor management performance. Generally speaking, increasing the current ratio improves liquidity. However, if the current 1.b. Current ratio √ ration grows due to bloated inventories, aging accounts receivables, or dormant cash hoards, it may signal poor management performance. An increasing accounts receivable turnover Accounts receivable 2.a. √ indicates that management is collecting cash turnover from customers sooner. A decreasing average collection period Average collection 2.b. √ indicates that management is collecting cash period from customers in fewer days. An increasing inventory turnover indicates that 2.c. Inventory turnover √ management is achieving a better balance between inventory levels and sales.

Integration Exercise 11 (continued) Increase Decrease Explanation A decreasing average sale period indicates that 2.d. Average sale period √ inventory is on hand fewer days before being sold to customers. A decreasing operating cycle means that the elapsed time from when inventory is purchased 2.e. Operating cycle √ from suppliers until cash is collected from customers is shrinking. An increasing times interest earned ratio Times interest 3.a. √ signifies that a company can pay it lenders’ earned ratio interest obligations with growing ease. This answer depends on whether a company has positive or negative financial leverage. If a company has positive financial leverage, an increasing equity multiplier may signal that 3.b. Equity multiplier * * management is making profitable use of a growing debt obligation. If a company has negative financial leverage, then an increasing equity multiplier may be worrisome. An increasing net profit margin percentage Net profit margin 4.a. √ indicates that a growing portion of each sales percentage dollar remains after covering expenses. An increasing return on equity means that 4.b. Return on equity √ management is earning higher profits per dollar of stockholders’ equity. © The McGraw-Hill Companies, Inc., 2018. All rights reserved. Solutions Manual, Integration Exercises

Integration Exercise 12 (60 minutes) 1.a. The total fixed cost is computed as follows: Fixed manufacturing overhead (per quarter) ..... Fixed selling and administrative (per quarter): Advertising................................................... Executive salaries ......................................... Insurance .................................................... Property tax ................................................. Depreciation ................................................ Total fixed selling and administrative (per quarter) ....................................................... Total fixed cost (per quarter) ...........................

$150,000 $25,000 64,000 12,000 8,000 8,000 117,000 $267,000

Total fixed cost (per quarter) (a) ........................................ Number of quarters per year (b) ........................................ Total fixed cost per year (a) × (b) ......................................

$267,000 4 $1,068,000

1.b. The variable cost per unit sold is computed as follows: Variable manufacturing cost per unit: Direct materials ($3.00 per yard × 3.5 yards) .. Direct labor ($18.00 per DLH × 0.25 DLH per unit) ............................................................ Variable manufacturing overhead ($3.00 × 0.25 DLH per unit) ....................................... Total variable manufacturing cost per unit .......... Variable selling and administrative cost per unit .. Total variable cost per unit sold..........................

$10.50 4.50 0.75

$15.75 1.25 $17.00

1.c. The contribution margin per unit sold: Selling price per unit ............................................ Variable cost per unit sold.................................... Contribution margin per unit sold .........................

$32 17 $15

Integration Exercise 12 (continued) 1.d. The break-even point in unit sales is computed as follows: Profit = Unit CM × Q − Fixed expenses $0 = ($32 − $17) × Q − $1,068,000 $0 = $15 × Q − $1,068,000 $15Q = $1,068,000 Q = $1,068,000 ÷ $15 Q = 71,200 units The break-even point in dollar sales is computed as follows: Unit sales to break even (a) ........................... Selling price per unit (b) .................................. Dollar sales to break even (a) × (b) .................

71,200 $32 $2,278,400

1.e. The margin of safety is computed as follows: Budgeted sales .............................................. Dollar sales to break even ............................... Margin of safety..............................................

$2,848,000 2,278,400 $ 569,600

1.f. The degree of operating leverage is computed as follows: The first step is to compute the budgeted net operating income using a contribution format as follows: Sales .............................................................. Variable expenses ($17 per unit × 89,000 units sold)............................................................ Contribution margin ........................................ Fixed expenses (see requirement 1.a.) ............. Net operating income ......................................

$2,848,000 1,513,000 1,335,000 1,068,000 $ 267,000

The second step is to compute the degree of operating leverage: Contribution margin (a) .................................. Net operating income (b) ................................ Degree of operating leverage (a) ÷ (b) ............

$1,335,000 267,000 5.0

Integration Exercise 12 (continued) 2.a. The variable costing income statement is prepared as follows: Sales ................................................. Variable expenses: Variable cost of goods sold (89,000 units × $15.75 per unit) .... Variable selling and administrative (89,000 units × $1.25 per unit)...... Contribution margin............................ Fixed expenses: Fixed manufacturing overhead .......... Fixed selling and administrative ........ Net operating income .........................

$2,848,000 $1,401,750 111,250 1,513,000 1,335,000 600,000 468,000 1,068,000 $ 267,000

Notice that the variable costing net operating income ($267,000) agrees with the net operating income derived in requirement 1.f. to help compute the degree of operating leverage. 2.b. The reconciliation that explains the difference in the absorption and variable costing net operating incomes will be explained in a six-step process as follows: The first step is to note from the Production Budget that the number of units in finished goods inventory at the end of the year (1,950 units) is greater than the number of units in finished goods inventory at the beginning of the year (1,500 units). The growth in finished goods inventory of 450 units enables us to ignore any fixed manufacturing overhead included in beginning inventory under absorption costing. We can ignore it because the company uses a LIFO inventory flow assumption. The fixed manufacturing overhead in beginning inventory does not flow through to absorption cost of goods sold in 2017.

Integration Exercise 12 (continued) The second step is to calculate the fixed portion of the predetermined overhead rate as follows: Total budgeted fixed manufacturing overhead (a) .. Total budgeted direct labor-hours (b) ..................... Fixed portion of the predetermined overhead rate (rounded) (a) ÷ (b) .............................................

$600,000 22,363 $26.83 per DLH

The third step is to calculate the amount by which the number of units produced during the year exceeds the number of units sold: Total units produced (see production budget) ........ Total units sold (see production budget) ................. Units produced in excess of unit sales .....................

89,450 89,000 450

The fourth step is to calculate the amount of fixed manufacturing overhead that will be attached to each unit produced during 2017: Fixed portion of the predetermined overhead rate (rounded) (a).......................................................... Budgeted direct labor-hours per unit (b) ..................... Budgeted fixed manufacturing overhead per unit (a) ÷ (b) .........................................................................

$26.83 per DLH 0.25 DLH $6.7075 per unit

The fifth step is to calculate the amount of fixed manufacturing overhead that will be attached to the 450 units that are produced during the year and retained in ending finished goods inventory as of December 31, 2017: Units produced and unsold (a) ................................... Budgeted fixed manufacturing overhead per unit (b) ... Budgeted fixed manufacturing overhead deferred in ending inventory (rounded) (a) × (b) .......................

450 $6.7075 $3,018

The sixth step is to reconcile the variable and absorption costing net operating incomes as follows: Variable costing net operating income ....................... Add fixed manufacturing overhead cost deferred in inventory under absorption costing ........................ Absorption costing net operating income (see requirement 9 of Integration Exercise 9) ................

$267,000 3,018 $270,018

Integration Exercise 13 (120 minutes+) Note to instructors: This exercise requires students to “stress test” the integrity of the Microsoft Excel spreadsheets that they created in Integration Exercises 9 through 12. Rather than allowing them to ASSUME that their spreadsheets are properly designed, this exercise asks students to use their accounting knowledge to figure out what answers should materialize in response to “what-if” questions. Once the class agrees on what answers should arise in response to various “what-if” questions, then students should be asked to input the new information into their budgeting assumptions tab to verify that their spreadsheets generate answers that match accounting intuition. 1.a. If the percentage of sales that are collected in the quarter of sale increases from 75% to 100%, the net income (absorption basis) will become approximately $270,019. The underlying calculations will be explained in three steps: Step 1: The cash collections under both collection patterns (75% and 100%) is computed as follows: Percentage of credit sales that are collected in the quarter of sale ................................. Beginning accounts receivable ...................... First quarter sales collected in the first quarter ($384,000 × 75%; $384,000 × 100%) ...................................................... Total cash collections in the first quarter ........

Quarter 1 75%

100%

$260,000

288,000 $548,000

384,000 $644,000

Integration Exercise 13 (continued) Step 2: The excess (deficiency) of cash available over disbursements under both collection patterns (75% and 100%) is computed as follows: Percentage of credit sales that are collected in the quarter of sale ................................. Beginning cash balance ................................ Collections from customers (see above) ......... Total cash available ...................................... Total cash disbursements ............................. Excess (deficiency) of cash available over disbursements ...........................................

Quarter 1 75%

100%

$ 46,200 548,000 594,200 644,550

$ 46,200 644,000 690,200 644,550

$(50,350)

$ 45,650

Step 3: If the percentage of sales that are collected in the quarter of sale increases from 75% to 100%, the excess of cash available over disbursements will increase from $(50,350) to $45,650. Since $45,650 is greater than the company’s minimum cash balance of $30,000, it will not need to borrow any money or incur any interest expense under the revised scenario. Thus, the revised net income will be approximately $270,019, computed as follows: Net income (original scenario @ 75%).............. Increase in net income due to avoiding the interest expense (see the Cash budget) ......... Net income (revised scenario @ 100%) ............

$260,377 9,642 $270,019

1.b. If the percentage of sales that are collected in the quarter of sale increases from 75% to 100%, the accounts receivable turnover will become 21.91. The key to calculating the revised accounts receivable turnover is understanding that credit sales in the numerator and the beginning balance in accounts receivable (within the denominator) do not change. Only the ending accounts receivable changes from $200,000 to $0. Therefore, the revised accounts receivable turnover is calculated as follows:

Integration Exercise 13 (continued) Sales on account Accounts receivable = turnover Average accounts receivable balance =

$2,848,000 = 21.91 (rounded) ($260,000 + $0)/2

1.c. If the percentage of sales that are collected in the quarter of sale increases from 75% to 100%, the net cash provided by operating activities will become $542,685. The underlying calculations will be explained in two steps: Step 1: Calculate the additional decrease in the accounts receivable balance. The amount of the additional decrease in accounts receivable will increase the net cash provided by operating activities. Percentage of credit sales that are collected in the quarter of sale ................................. Ending balance in accounts receivable ........... Beginning balance in accounts receivable ...... Increase (decrease) in accounts receivable .... Additional (decrease) in accounts receivable ..

75%

100%

$ 200,000 $ 0 260,000 260,000 $(60,000) $(260,000) $(200,000)

Step 2: Calculate the revised net cash provided by operating activities. Net cash provided by operating activities (see requirement 1.b. of Integration Exercise 10) . Increase in net cash provided by operating activities due to avoiding the interest expense (see the Cash budget) .................... Increase in net cash provided by operating activities due to the additional decrease in the accounts receivable balance ................... Net cash provided by operating activities (revised scenario) ........................................ 2.

$333,043 $ 9,642 200,000

209,642 $542,685

If students change the percentage of credit sales that are collected in the quarter of sale from 75% to 100% and do not derive the correct answers to 1.a., 1.b., and 1.c., then they need to review their spreadsheets to find the root cause of the problem.

Integration Exercise 13 (continued) 3.a. If the budgeted direct labor cost per hour increases from $18 to $19, the ending finished goods inventory at December 31, 2017 will become approximately $42,469. The underlying calculations will be explained in four steps: Step 1: Determine the number of units that will be produced in 2017 and retained in ending inventory at December 31, 2017: Units in ending finished goods inventory at December 31, 2017 (see production budget) ...................................... Units in beginning finished goods inventory at January 1, 2017 (see production budget) ....................................... Units produced in 2017 and retained in ending finished goods inventory at December 31, 2017 ..........................

1,950 1,500 450

Step 2: Determine the number of direct labor-hours needed to produce the 450 units that will be manufactured in 2017 and retained in ending finished goods inventory at December 31, 2017: Units produced in 2017 and retained in ending finished goods inventory at December 31, 2017 (a) ....................... Direct labor-hours per unit (see direct labor budget) (b) ....... Direct labor-hours needed to produce the 450 units that will be manufactured in 2017 and retained in ending finished goods inventory at December 31, 2017 (rounded) (a) × (b) ..................................................................................

450 0.25

113

Step 3: Determine the additional direct labor cost that needs to be added to ending finished goods inventory at December 31, 2017: Direct labor-hours needed to produce the 450 units that will be manufactured in 2017 and retained in ending finished goods inventory at December 31, 2017 (a) ........ Additional direct labor cost per hour ($19 ‒ $18) (b) ......... Additional direct labor cost that needs to be added to ending finished goods inventory at December 31, 2017 (rounded (a) × (b)........................................................

113 $1.00 $113

Integration Exercise 13 (continued) Step 4: Calculate the revised ending finished goods inventory at December 31, 2017: Original finished goods inventory at December 31, 2017 .... Additional direct labor cost that needs to be added to finished goods inventory at December 31, 2017 ............. Revised finished goods inventory at December 31, 2017....

$42,356 113 $42,469

3.b. If the budgeted direct labor cost per hour increases from $18 to $19, the break-even point in unit sales will become 72,407 units. The underlying calculations will be explained in three steps: Step 1: Calculate the revised variable cost per unit as follows: Variable manufacturing cost per unit: Direct materials ($3.00 per yard × 3.5 yards) .................................................... Direct labor ($19.00 per DLH × 0.25 DLH per unit) ................................................. Variable manufacturing overhead ($3.00 × 0.25 DLH per unit) .................................. Total variable manufacturing cost per unit ..... Variable selling and administrative cost per unit........................................................... Total variable cost per unit ...........................

$10.50 4.75 0.75

$16.00 1.25 $17.25

Step 2: Calculate the revised contribution margin per unit: Selling price per unit.......................................................... Variable cost per unit ........................................................ Contribution margin per unit ..............................................

$32.00 17.25 $14.75

Integration Exercise 13 (continued) Step 3: Calculate the revised break-even point in unit sales as follows: Profit = Unit CM × Q − Fixed expenses $0 = ($32 − $17.25) × Q − $1,068,000 $0 = $14.75 × Q − $1,068,000 $14.75Q = $1,068,000 Q = $1,068,000 ÷ $14.75 Q = 72,407 units (rounded) 3.c. If the budgeted direct labor cost per hour increases from $18 to $19, the variable costing net operating income will become $244,750. The underlying calculations will be explained in three steps: Step 1: Determine the decrease in contribution margin per unit: Revised contribution margin per unit .................................. Original contribution margin per unit .................................. Decrease in contribution margin per unit ............................

$14.75 15.00 $(0.25)

Step 2: Determine the decrease in total contribution margin for 2017: Budgeted unit sales for 2017 (see sales budget) (a) ............ Decrease in contribution margin per unit (b) ....................... Decrease in total contribution margin for 2017 (a) × (b)......

89,000 $(0.25) $(22,250)

Step 3: Determine the revised variable costing net operating income for 2017: Original variable costing net operating income for 2017 ....... Decrease in total contribution margin for 2017 .................... Revised variable costing net operating income for 2017 ....... 4.

$267,000 (22,250) $244,750

If students change the direct labor cost per hour from $18 to $19 and do not derive the correct answers to 2.a., 2.b., and 2.c., then they need to review their spreadsheets to find the root cause of the problem.