Managerial Accounting Jennifer Cainas Solution Manual by Ace Test Banks

Managerial Accounting

By Jennifer Cainas

Email: Richard@qwconsultancy.com

Chapter 1 EOC Questions and Solutions Copy edit: All dates should be changed to “2022-2023” throughout, including Ms, EOC, Widget Ms, and Art Ms.

Discussion Questions 1. What is meant by the cost-benefit constraint when developing managerial accounting systems? Difficulty: Easy Time on Task: 3 minutes Objective: LO6 AACSB: Application of knowledge Assignment: Homework Solution: The cost of obtaining the inputs and processing those inputs into information that is concise, easily understandable, and timely must be less than the benefits obtained from the information.

2. Differentiate between operational and strategic information needs. Difficulty: Moderate Time on Task: 4 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Quiz, Test and Homework Solution: Different information is required for strategic and operational decisions. Strategic decisions, which are typically made by upper-level management, require information so that managers can determine with which markets, customers, services, or products they should operate. Operational decisions, in contrast, are typically made by operations management. Those managers require information on how to efficiently and effectively render services or provide product lines. 32

3. What is the difference between effectiveness and efficiency? Difficulty: Easy Time on Task: 3 minutes Objective: LO8 AACSB: Reflective thinking Assignment: Homework Solution: Effectiveness refers to achieving the goals, whereas efficiency relates to the resources used to create the actual results. Using The Lawn Care Company example, if the goal is to cut 30 lawns per month, but you cut only 18, you were not effective in reaching your target. If your costs (in both time and money) were less than anticipated for the 18 lawns that you did cut, you were efficient.

4. What are key differences between financial and managerial accounting? Difficulty: Easy Time on Task: 3 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Homework Solution: Managerial accounting information is designed to provide management with detailed, relevant information that will help determine the future actions of the company. This is in contrast to financial accounting information, which adheres to Generally Accepted Accounting Principles (GAAP) and is used to produce summarized reports based on past performance.

5. Which actions are needed when analyzing and resolving potential ethical problems? Difficulty: Difficult Time on Task: 4 minutes Objective: LO8 AACSB: Application of knowledge Assignment: Homework

Solution: First, it is important to fully research the relevant facts to obtain a full understanding of the ethical scenario. Then, you must apply a framework such as the Institute of Management Accountants’ (IMA’s) Statement of Ethical Professional Practice, keeping in mind the policies of the company, as well as applicable laws and regulations, to determine what your obligations are so as to maintain the highest standards of ethical conduct. 6. Describe the IMA’s Statement of Ethical Professional Practice. Difficulty: Moderate Time on Task: 6 minutes Objective: LO8 AACSB: Application of knowledge Assignment: Homework Solution: The IMA’s Statement of Ethical Professional Practice serves as a guideline for expected ethical behavior for all accounting professionals. The four main standards under the code of professional conduct require the members of the IMA to exhibit: I. Competence—by maintaining their level of technical expertise in accounting and properly following applicable laws, policies, and procedures. II. Confidentiality—by keeping all company information confidential from outside parties unless authorized or legally required to disclose that information. III. Integrity—by being honest and trustworthy at all times, no matter what the circumstance. IV. Credibility—by presenting information fairly, objectively, and without bias to intended users of the information.

7. Explain the differences between the three means of gathering managerial accounting data. Difficulty: Difficult Time on Task: 5 minutes Objective: LO6 AACSB: Reflective thinking Assignment: Test Solution: The three means of gathering managerial accounting data include (1) direct observation, (2) interviewing, and (3) storyboarding.

With direct observation, you directly watch and record data. While this approach is perhaps the most accurate, it requires that you spend considerable time observing and tracking. Interviewing requires meeting with individuals familiar with the process. If the people being interviewed are experienced, this approach can yield accurate enough internal information and may require less time to gather than the process of direct observation. Storyboarding requires a facilitator to ask questions of several employees regarding which tasks are performed; the facilitator captures the answers on a board and ensures that all activities are documented according to the consensus of the group. This may be quite time intensive but can yield a more complete and visual picture that would justify the cost involved.

8. Explain the three primary uses of managerial accounting information. Difficulty: Moderate Time on Task: 4 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: Managerial accounting provides the owners and managers of a company with useful information to make decisions in three areas: the cost of a service or product, planning and performance evaluation, and nonroutine special decisions. The information can be financial (in dollars) as well as nonfinancial, such as time, quality, and customer satisfaction.

9. What are three means of gathering managerial accounting data? Difficulty: Easy Time on Task: 3 minutes Objective: LO6 AACSB: Application of knowledge Assignment: Homework Solution: The three means of gathering managerial accounting data are direct observation, interviewing, and storyboarding.

10. How is management accounting information useful to the three functions of management? Difficulty: Moderate Time on Task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: To plan, implement, and make decisions successfully, managers use managerial accounting information to create value through the process of identifying, measuring, reporting, and analyzing both financial and operating information for internal users. The output, or reports, generated from the managerial accounting system would also be relevant to managers. It is important that the reports created are easy to understand and ultimately help management make better decisions.

11. How are information needs different for higher and lower levels of management in an organization? Difficulty: Moderate Time on Task: 5 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Operational-level managers need current, frequent, and perhaps even daily details to make informed, tactical decisions. Some needed information includes the specific costs of materials, labor, other production or direct service costs, and selling and administrative costs. Upper-level managers, in contrast, need summarized, infrequent reports about costs, profitability, innovations, market opportunities and threats, investments, and customer information.

12. The elements of the accounting information system are inputs, processes, and outputs. What are some inputs into the system? Difficulty: Moderate Time on Task: 4 minutes

Objective: LO6 AACSB: Application of knowledge Assignment: Homework Solution: Inputs are unprocessed data items, including financial numbers, statistics, or other facts. Inputs can be quantitative or qualitative in nature. The data can relate to materials, employees, capacity, financing, suppliers, customers, or product lines.

13. With respect to the processing of managerial accounting information, how can efficiency be achieved with technology? Difficulty: Moderate Time on Task: 4 minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: Technology has enabled data to be processed extremely efficiently by using a database program, such as Microsoft Access, or a spreadsheet program, such as Microsoft Excel. Through the implementation of one or more of these programs, mathematical computations are seamless and data can be analyzed, manipulated, or summarized to meet the information needs of management. Additionally, a company can easily perform a “what-if” analysis or sensitivity analysis to show how sensitive calculations can be to certain changes in key assumptions.

14. One output of managerial reporting is an analysis of actual costs or a cost report. Provide three examples of cost items that could be found in a cost report for a bakery. Difficulty: Difficult Time on Task: 8 minutes Objective: LO7 AACSB: Analytical thinking Assignment: Homework Solution: Some items that could be included in a cost report for a bakery are:

● ● ● ● ●

Cost per customer Cost of inputs into the products (e.g., sugar, butter, flour) Cost of utilities paid by the bakery (e.g., electric, gas, sewer) Depreciation expense Salaries paid to employees (sales associates, bakers, owners)

15. How are a budget and a simple performance report useful to analyze the results of operations? Difficulty: Difficult Time on Task: 5 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Homework Solution: Budget and simple performance reports allow managers to examine the differences between the original plan and the actual results to understand whether the differences are within their control and likely to affect the company in the upcoming period as well. Management uses reports such as these to help identify problems and make changes that will improve results.

16. Besides a cost report, budget, and performance analysis, what are other outputs or tools available to management to achieve operational and strategic goals? Difficulty: Moderate Time on Task: 4 minutes Objective: LO7 AACSB: Application of knowledge Assignment: Test Solution: Although financial reports such as a budget or an income statement are important, information can be illustrated in the form of a chart, graph, or diagram. Often, an illustration can convey the information more clearly and concisely, emphasizing key points that might be buried if the reports contain strictly numerical values.

17. Give three examples of qualitative information that are relevant in managerial accounting but not captured and reported in financial accounting. Difficulty: Moderate Time on Task: 4 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Quiz Solution: Nonfinancial data would still focus on the company’s critical success factors, but it is not found in a company’s regular accounting system. These metrics can include the quality of suppliers, quality of customer service, and time considerations.

18. Describe the three primary functions of managers within organizations that are necessary for long-term sustainability. Difficulty: Easy Time on Task: 3 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Homework Solution: The three primary functions of managers within organizations include developing a strategic plan for the business, implementing and controlling the business plan, and making informed decisions about the business. 19. Describe the difference between structured and unstructured data. How does big data analysis use structured and unstructured data? Difficulty: Easy Time on Task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Structured data is uniform and exists in a record or file. This data is standardized for ease of processing and analysis. For example, transactional data (such as 32

sales revenues) is structured data. Unstructured data is not standardized or cannot easily fit into a relational database. Text data (like comments left on social media sites) is an example of unstructured data. Big data analysis is the process of collecting and analyzing large amounts of digital data (both structured and unstructured) to discover patterns or insights that can be used by managers to make better business decisions. 20. Differentiate between descriptive analytics, diagnostic analytics, predictive analytics, and prescriptive analytics. Difficulty: Easy Time on Task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Quiz Solution: Descriptive analytics are the simplest form of analytics, and often summarize past trends in the business. Descriptive analytics cannot tell a company why something happened; they only indicate what happened. Diagnostic analytics are used to answer why something happened. Historical data are often measured against other data (both financial and nonfinancial) to drill down and gain a deeper understanding of what has occurred. Predictive analytics help a company determine what is likely to happen in the future. It uses findings from both descriptive and diagnostic analytics to help predict future outcomes with reliable precision. Prescriptive analytics are the most complex form of analytics and suggest future actions the company can take. Prescriptive analytics use advanced business rules and algorithms, statistical modeling, and machine learning to gather and analyze vast amounts of data, determine an action plan, and take corrective actions if necessary.

Exercises

1. For each of the following decisions or actions, indicate which of the three areas of managerial accounting apply. Select the best option by placing the corresponding letter in the space provided. Areas: a. Product costing b. Planning and control c. Nonroutine decision making Decisions or Actions by Management: i.

Consider opening another store across town

ii.

Identify why production goals were not met

iii.

Evaluate the results of various advertising alternatives

iv.

Determine the direct costs and margin of various product lines

Decide whether to pay bonuses to workers

vi.

Determine how much financing is needed as well as the type of financing

vii.

Forecast what profit will be at different levels of sales

viii.

Evaluate a new technology platform

ix.

Find which process is creating a bottleneck

Measure customer satisfaction

xi.

Buy or lease new equipment

xii.

Submit financial statements to outside users such as shareholders

Difficulty: Moderate Time on Task: 1 minute each Objective: LO4 AACSB: Analytical Thinking Assignment: Varies, see chart below Solution: #

Question

Solu tion

Assign ment

1 (i.)

Consider opening another store across town

Quiz

1 (ii.)

Identify why production goals were not met

Quiz

1 (iii.)

Evaluate the results of various advertising alternatives

Quiz

1 (iv.)

Determine the direct costs and margin of various product lines

Quiz

1 (v.)

Decide whether to pay bonuses to workers

Test

1 (vi.)

Determine how much financing is needed as well as the type of financing

Test

1 (vii.)

Forecast what profit will be at different levels of sales

Test

1 (viii.)

Evaluate a new technology platform

Test

1 (ix.)

Find which process is creating a bottleneck

Home work

1 (x)

Measure customer satisfaction

Home work

1 (xi.)

Buy or lease new equipment

Home work

1 (xii.)

Submit financial statements to outside users such as shareholders

Home work

2. For each of the following types of information, identify whether the information would be most applicable to financial (F) or managerial (M) accounting. i.

Income statement given to owners (for partnerships) and to shareholders (for corporations)

ii.

Report of the amount of time needed to complete each process, to deliver to customers, and to respond to customer complaints

iii.

Amount of sales by specific geographic locations, customers, and product or service lines

iv.

Tax return filed with Internal Revenue Service

Proposal for additional or new office space

vi.

Department store rating of suppliers with respect to quality and on-time delivery

vii.

For an airline, the amount of time that the airplanes are on the ground, number of delays, and number of empty seats by flights

viii.

Scheduling and costs of the various construction processes for a house, such as the foundation, framing, and interior finishing work

ix.

For a landscape company, the number of competitors and prices charged by them

For legal firm, the tasks performed by different levels of lawyers and by paralegals

xi.

For a bank, a report differentiating profits between commercial and residential loans

xii.

For a restaurant, the breakdown between direct materials (food), direct labor (food preparers and servers), and indirect costs (electricity, insurance, rent, depreciation) Difficulty: Easy Time on Task: 1 minute each Objective: LO1 AACSB: Analytical Thinking Assignment: Varies, see chart below Solution: Varies, see chart below #

Question

Solu tion

Assign ment

1 (i.)

Income statement given to owners (for partnerships) and to shareholders (for corporations)

Quiz

1 (ii.)

Report of the amount of time needed to complete each process, to deliver to customers, and to respond to customer complaints

Quiz

1 (iii.)

Amount of sales by specific geographic locations, customers, and product or service lines

Quiz

1 (iv.)

Tax return filed with Internal Revenue Service

Quiz

1 (v.)

Proposal for additional or new office space

Test

1 (vi.)

Department store rating of suppliers with respect to quality and on-time delivery

Test

1 (vii.)

For an airline, the amount of time that the airplanes are on the ground, number of delays, and number of empty seats by flights

Test

1 (viii.)

Scheduling and costs of the various construction processes for a house, such as the foundation, framing, and interior finishing work

Test

1 (ix.)

For a landscape company, the number of competitors and prices charged by them

Home work

1 (x)

For legal firm, the tasks performed by different levels of lawyers and by paralegals

Home work

1 (xi.)

For a bank, a report differentiating profits between commercial and residential loans

Home work

1 (xii.)

For a restaurant, the breakdown between direct materials (food), direct labor (food preparers and servers), and indirect costs (electricity, insurance, rent, depreciation)

Home work

3. For each of the following, indicate whether the statement is True or False. a. Storyboarding is a financial accounting chart of accounts used by major corporations to prepare financial statements. b. If a manager wants to visually report the frequency of supplier returns due to poor quality, wrong shipments, or incorrect prices, the manager could use a histogram to show the relative results. c. Lower level managers typically would receive frequent reports identifying issues such as employee absences, unused warehouse capacity, machine stoppage incidents, information security breaches, and vendor problems. d. Higher level managers typically would receive daily reports identifying payments made by each customer, number of on-time deliveries to customers, and surveys of customer satisfaction. e. If a company sends all outgoing correspondence by certified mail, the results would probably be very effective, but not efficient. f.

If a sales call center employee answers customer complaints more quickly per call than budgeted, but many customers have to call back because the employee did not properly resolve the customer’s concern or problem, the employee was efficient but ineffective.

g. Projections of class enrollment for the upcoming period by a college would be recorded and reported under both financial and managerial accounting. h. The number of defective units in a manufacturing plant would be relevant for managerial accounting, but would not be reported under financial accounting. i.

Managerial accounting emphasizes relevant data, cost-benefit analysis, and both quantitative and qualitative data.

Manufacturers and retailers primarily use managerial accounting, but service firms do not need managerial accounting because they do not have products or inventory.

k. Predictive analytics is the simplest form of analytics, and often summarizes past trends in the business. l.

Text data (like comments left on social media sites) is an example of unstructured data.

Difficulty: Varies, see chart below Time on Task: 1 minute Objective: Varies, see chart below AACSB: Analytical Thinking Assignments: 3(a), 3(c) and 3(d) Quiz. 3(f), 3(g) and 3(h) Test. All others Homework. Solution: Varies, see chart below #

Question

Solution

Diffi culty

3 (a)

Storyboarding is a flowchart financial accounting chart of accounts system technique used by major corporations to prepare financial statements.

False

Mod erate

3 (b)

If a manager wants to visually report the frequency of supplier returns due to poor quality, wrong shipments, or incorrect prices, the manager could use a histogram to show the relative results.

True

Easy

3 (c)

Lower level managers typically would receive frequent reports identifying issues such as employee absences, unused warehouse capacity, machine stoppage incidents, information security breaches, and vendor problems.

True

Easy

3 (d)

Higher- level managers typically would receive daily reports identifying payments made by each customer, number of on-time deliveries to customers, and surveys of customer satisfaction.

False

Easy

3 (e)

If a company sends all outgoing correspondence by certified mail, the results would probably be very effective, but not efficient.

True

Easy

3 (f)

If a sales call center employee answers customer complaints more quickly than budgeted, but many customers have to call back because the employee did not properly resolve the customer’s concern or problem, the employee was efficient but ineffective.

True

Diffic ult

3 (g)

Projections of class enrollment for the upcoming period by a college would be recorded and reported under both financial and managerial accounting.

False

Mod erate

3 (h)

The number of defective units in a manufacturing plant would be relevant for managerial accounting, but would not be directly reported under financial accounting.

True

Easy

3 (i)

Managerial accounting emphasizes relevant data, cost-benefit analysis, and both quantitative and qualitative data.

True

Easy

3 (j)

Manufacturers and retailers primarily use managerial accounting, but service firms do not need managerial accounting because they do not have products or inventory.

False

Mod erate

3 (k)

Predictive analytics is the simplest form of analytics, and often summarizes past trends in the business.

False

Mod erate

3 (l)

Text data (like comments left on social media sites) is an example of unstructured data.

True

Mod erate

4. Suppose you are a recent accounting graduate and begin work for a well-known consulting firm, Shady Deals, Inc. As you are preparing the final journal entries and the financial statements for the year ended 12/31, you notice that the company is operating at a net loss of approximately $25,000 for the year. When you give the financial statements to your boss, the controller, he tells you to record some consulting revenue as of 12/31, since you knew you were going to perform these services for your customer in January. In addition, he tells you to wait to book certain expenses until January, when the bills are paid. a. What are the ethical considerations with this situation? b. If you were to follow your boss’s instructions, would you be violating the IMA’s Statement of Ethical Professional Practice? If so, which standards would you be violating? c. What should you do in this situation?

Difficulty: Difficult Time on Task: 15 minutes Objective: LO8 AACSB: Ethical understanding and reasoning Assignment: None Solutions: a. As an accountant, the primary function of your role is to ensure financial information is accurate and fairly represents the financial condition of the company. You must consider whether making the adjustments to revenue and expenses would alter the financial reports in a way that causes them

to be inaccurate. The users of the financial statements will make decisions based on the information within them, and their decisions may change based on the adjustments suggested by the controller. Further, these adjustments could result in fraud. Fraud would occur if a user suffered a loss based on reliance on the statements because they contain false information about material (significant) fact(s) and there was an intent to deceive. b. Yes, you would be violating three standards outlined in the IMA’s Statement of Ethical Professional Practice: integrity, credibility, and competence. The integrity standard requires members to be honest and trustworthy at all times, no matter what the circumstance. If you record these entries, even though you are being asked to do so by your boss, you are not being honest and trustworthy and, therefore, lack integrity. Further, you will lack credibility because you did not present information fairly, objectively, and without bias. Finally, you violated the competence standard as there are two violations of Generally Accepted Accounting Principles (GAAP). (1) Revenue should be recorded when services are provided to customers, which occurs in January. (2) Expenses should be recorded when incurred, not when paid. Therefore, expenses should be recorded in December. Recording both of those journal entries would result in profit appearing higher than it actually is and would be misleading to users of the financial statements. c. You should discuss your concerns with your boss. You should mention that you believe the financial statements may be inaccurate if these adjustments are made and you do not want to act without integrity or credibility. If your boss dismisses your concerns, you should report the misleading journal entries to a whistleblower hotline or internal counsel, if available.

Problems 1. Refer to the lawn service company illustration in the chapter. Assume that the company wanted to offer an additional line of service covering fumigation, fertilizing, and landscaping. What information should the manager obtain? Try to be specific. Difficulty: Moderate Time on Task: 10 minutes Objective: LO3, LO5

AACSB: Application of knowledge Assignment: Homework Solution: The manager should obtain the following information in order to have the appropriate data to analyze and be able to determine whether to offer additional lines of service: ●

● ● ●

● ●

Obtain information regarding market opportunities and threats to be able to determine the following: ■ Who are the biggest competitors for each service line? How would the company manage the challenge of sharing market space with these competitors? ■ Is the market overcrowded, or is there room for entry and growth? ■ What is the target market? Is the target market commercial, residential, or both? Further, does the target market consist of new customers or will you be adding the service(s) to existing customers’ current treatment? Obtain a cost analysis for each service. The manager should obtain a detailed breakdown of the variable and fixed costs as well as the product and labor costs. Obtain a profitability analysis for each service. The manager will need to estimate the pricing point necessary for each service line to break even as well as to make a profit. Obtain compliance and regulations information. The manager will need to determine if adding these services requires special licenses, processes, specialized personnel, or other resources (e.g., purchasing and disposing of fertilizer). Obtain equipment requirements information. The manager will need to assess if equipment currently owned by the company can be used in the new service lines or if more and/or different equipment is necessary. Obtain an analysis of current debt/equity levels to determine whether the company has funds available or means to borrow the capital necessary to finance expansion.

2. A home improvement store is interested in tracking why customers return merchandise. An employee suggests developing a spreadsheet to track the reasons for returns. He suggests that the return personnel tally the following: number customers who simply changed their minds; number of customers returning items that do not perform according to specifications; and number of customers who cite that they expected different functionality from the products. a. Does the information regarding reasons for merchandise returns seem relevant for the store? b. Keeping in mind the cost-benefit information constraint, does the suggestion seem appropriate? Will the costs of gathering and analyzing the data as well as the potential delay in serving customers justify the benefits to be derived from analyzing the results? Difficulty: Moderate Time on Task: 10 minutes

Objective: LO3/LO4 AACSB: Reflective thinking Assignment: Test Solutions: a. Yes, the information is relevant and useful for the store for a variety of reasons. Most importantly, managers are not able to reduce the number of returns unless they are able to determine the main drivers for customers making returns. i. Customers changing their minds: Managers might not be able to draw any useful information from this reason. However, if part of a store employee’s salary is commission based and returns are focused on one associate, then this might indicate that the employee is purposefully making sales to customers with the knowledge they will return the products, just so the employee can meet commission goals. ii. Product did not perform according to specifications: This reason could indicate that there is a quality control issue with the vendor. This information would be useful to store managers, as they might consider changing vendors. iii. Expected different functionality: This could indicate an issue with data analytics of customer satisfaction and why products are not performing as expected. b. When deciding to add a task or a procedure, a manager should be able to determine that the cost to perform the task/procedure will be less than the benefit realized. If the home improvement store has few returns that are not material to overall sales, then spending extra time tracking and analyzing return data may not be cost-effective because of the minimal amount of potential benefit to be realized. However, if the company is experiencing a heavy volume of returns (also known as reverse logistics), then it would be cost-effective to track return drivers so as to be able to reduce returns and, in turn, maximize profits. Additionally, to ensure that the cost of obtaining the information is minimal, the accounting information system used to track returns must already have the capability to include reasons for return, as having to contact customers who had previously returned a product to find out the reason for the return would not be cost-effective.

3. From a familiar setting, such as your classes or a job, describe a special decision made using managerial information, including both financial and nonfinancial information. Difficulty: Moderate Time on Task: 10 minutes Objective: LO4 32

AACSB: Reflective thinking Assignment: Homework Solution: Answers will vary based on the student's personal experiences.

4. For the following scenarios, indicate which of the four standards in the IMA’s Statement of Ethical Professional Practice is being violated: (1) competence; (2) confidentiality; (3) integrity; (4) credibility. Select all that apply. a. You tell your brother-in-law about a new product your company has developed and plans to release early next year. b. Your boss trusts you completely, and you currently write all of the company checks and reconcile the bank account. You decide to write yourself a check to cover the bonus that you did not receive last year due to economic cutbacks in your company. c. Although you have passed the CPA exam, you decide not to attend any professional education classes because you are too busy at work. d. When you prepare the financial statements for the year, you realize that the company is operating at a loss and are afraid that people will be laid off. You decide to revise your estimate for depreciation and bad debts so that you do not need to book as much expense for the year, which will allow your company to show a small profit for the year. e. Since you do not know how to use Excel, you decide to prepare all calculations using a calculator and then type all financial reports in a word processing program. f.

You find out that the company you work for is dumping toxic waste in a river about 60 miles away. You decide to call the local newspaper and give it an anonymous tip regarding the illegal activity.

g. You work for a prominent bakery in the area that specializes in pies. Your brother-in-law owns an apple orchard, and although you can purchase the apples more inexpensively from a local supplier, you decide to give the bid to your brother-in-law’s company to help boost his sales. h. Your company is trying to obtain a bank loan, and your boss has asked you to “make sure” your gross profit margins are 30%, even though realistically they have been 25% for this year. Feeling pressure, you decide to not include any information regarding sales returns or sales discounts for this year, and just report the gross sales for the year. Difficulty: Moderate Time on Task: 1 minute each Objective: LO8 AACSB: Ethical understanding and reasoning Assignment: Varies, see chart below 32

Solution: #

Question

Solu tion

Assig nment

You tell your brother-in-law about a new product your company has developed and plans to release early next year.

1, 2

Quiz Test

Your boss trusts you completely, and you currently write all of the company checks and reconcile the bank account. You decide to write yourself a check to cover the bonus that you did not receive last year due to economic cutbacks in your company.

1, 3

Quiz Test

Although you have passed the CPA exam, you decide not to attend any professional education classes because you are too busy at work.

1, 3

Quiz Test

When you prepare the financial statements for the year, you realize that the company is operating at a loss and are afraid that people will 1, 3, be laid off. You decide to revise your estimate for depreciation and 4 bad debts so that you do not need to book as much expense for the year, which will allow your company to show a small profit for the year.

Quiz Test

Since you do not know how to use Excel, you decide to prepare all calculations using a calculator and then type all financial reports in a word processing program.

Test Home work

You find out that the company you work for is dumping toxic waste in a river about 60 miles away. You decide to call the local newspaper and give it an anonymous tip regarding the illegal activity.

1, 2

Test Home work

You work for a prominent bakery in the area that specializes in pies. Your brother-in-law owns an apple orchard, and although you can purchase the apples more inexpensively from a local supplier, you decide to give the bid to your brother-in-law’s company to help boost his sales.

1, 3

Test Home work

Your company is trying to obtain a bank loan, and your boss has asked you to “make sure” your gross profit margins are 30%, even though realistically they have been 25% for this year. Feeling pressure, you decide to not include any information regarding sales returns or sales discounts for this year, and just report the gross sales for the year.

1, 3, 4

Test Home work

The IMA’s Statement of Ethical Professional Practice serves as a guideline for expected ethical behavior for all accounting professionals. There are four main standards under the code of professional conduct. The IMA’s Statement of Ethical Professional Practice requires members to exhibit: ● Competence—by maintaining their level of technical expertise in accounting and properly following applicable laws, policies, and procedures. ● Confidentiality—by keeping all company information confidential from outside parties unless authorized or legally required to disclose that information. ● Integrity—by being honest and trustworthy at all times, no matter what the circumstance. ● Credibility—by presenting information fairly, objectively, and without bias to intended users of the information.

5. Paul wants to start a barbershop. He would like to have an extra $450 per month to help with his house payments. He has found a location that will rent him space for $425 per month, plus an additional $100 for electricity and water. He will need a capital investment of $360 for the necessary clippers and equipment that he will depreciate over the first year in equal amounts. In addition, he will need small items such as towels, combs, and so on. This cost will be about $240 per year. He adds $100 per month for miscellaneous expense items that may pop up throughout the month.

a. Help Paul fill in the budget forecast that will show his monthly and yearly revenues with the numbers outlined in the problem statement. b. How much does he need in gross revenue per month to obtain the $450 profit per month? c. If he charges $12 per haircut, how many haircuts will he need to perform to make his $450 profit per month?

d. Using the principles in a sensitivity budget, what would Paul have to charge to perform only 75 haircuts and still reach his $450 profit per month? e. How many haircuts must be done to make $600 profit per month, assuming he charges $15 per haircut? f.

For data analytics and visualization, create a pie chart to analyze Paul’s expenses.

g. In the predictive analytics performed in steps (b) to (e), what other nonfinancial information would be useful for decision making? Difficulty: Moderate Time on Task: 25 minutes Objective: LO7, L05 AACSB: Application of knowledge Assignment: Homework Solutions: a.

* Depreciation calculation: Initial investment of $360 for clippers and equipment. Useful life of one year with no salvage. Monthly depreciation is calculated as $360/12 months = $30 per month. b. To realize $450 profit per month, Paul must earn $1,125 in revenue each month ($450 monthly profit + $675 monthly expenses = $1,125 monthly gross revenue). c. To realize $450 profit per month, Paul must earn $1,125 in revenue each month. To earn at least $1,125 of revenue, Paul must perform 94 haircuts

($1,125 / $12 per haircut = 93.75 haircuts) if he prices each haircut at $12 per cut. d. To realize $1,125 gross revenue monthly while performing 75 haircuts, Paul will need to charge $15 per cut ($1,125 gross revenue / 75 haircuts = $15 per cut). e. This question requires you to perform two calculations: First, you must determine how much monthly gross revenue Paul must earn to realize $600 profit per month. Paul must earn $1,275 in revenue each month ($600 monthly profit + $675 monthly expenses = $1,275 monthly gross revenue). Second, once you have calculated monthly gross revenue, you can determine the number of haircuts required to achieve the goal. To realize $1,275 monthly gross revenue while charging $15 per haircut, Paul will have to perform 85 cuts per month ($1,275 / $15 per cut = 85 cuts) f.

g. Some examples of nonfinancial information include customer trends, employee expertise, demographics, and competition.

6. Indicate whether each of the following is True or False. a. The main objective of general financial accounting is to provide management with information to budget for the future and for the IRS to tax corporations. b. Financial statements allow analysis among companies for a period and across time for the same company. c. The normal revenue recognition point is at the point of sale or service.

d. The balance sheet shows how much cash was earned and the liabilities owed for a period of time. e. The following accounts are all reported on the income statement: gain on sale of land, unearned revenue, accumulated depreciation, interest expense, and retained earnings. f.

Companies with public stock are required to report earnings per share (EPS) so that common stock owners can understand their portion of the income that the company earned for the year.

g. All of the following statements give information for a period of time: cash flow, income statement, and statement of retained earnings. h. Collections from sales of merchandise, rent payments, and payment for the purchase of supplies and salaries are cash flow operating activities. i.

Accrual basis accounting better reflects the revenues and expenses for the period than does cash basis accounting.

The proper order of preparing financial statements is (1) cash flow statement, (2) statement of retained earnings, (3) balance sheet, and (4) income statement.

k. Borrowing from the bank and issuing stock are cash flow financing activities. l.

Purchases of land and equipment with cash are cash flow investing activities.

Difficulty: Moderate Time on Task: 10 minutes Objective: Appendix A AACSB: Analytical Thinking Assignment: 6(c), 6(i), and 6(g) Quiz 6(e), 6(j) and 6(l) Test All other homework. Solution: a. False b. True c. True d. False e. False f. True g. True h. True i. True j. False k. True l. True

7. Classify each of the following as pertaining to the income statement or the balance sheet. If it is a balance sheet account, choose the proper category. A balance sheet and income statement example are provided for you. Current Asset (CA) Investments (I) Property, Plant and Equipment (PP&E) Intangible Assets (IA) Current Liabilities (CL) Long-Term Liabilities (LL) Stockholders’ Equity (SE) Accounts

Income Statement

Accounts Payable

Balance Balance Sheet Sheet Category X CL

Accounts Receivable Accumulated Depreciation Allowance for Doubtful Accounts Bad Debts Expense/Credit Losses

Bonds Payable Buildings Cash Common Stock Cost of Goods Sold Depreciation Expense Equipment Gain on Sale of Building Goodwill Interest Payable Inventory Investments Land Loss on Sale of Equipment Mortgage Payable Patents Prepaid Rent Rent Expense Retained Earnings Salaries Expense

Salaries Payable Sales Supplies Unearned Revenue Warranty Obligation

Difficulty: Moderate Time on Task: 10 minutes Objective: Appendix A AACSB: Analytical Thinking Assignment: Homework, Quiz and Test Solution: Accounts Accounts Payable

Income Balance Balance Sheet Statement Sheet Category X CL

Accounts Receivable

Accumulated Depreciation

PP&E*

Allowance for Doubtful Accounts

CA*

Bonds Payable

Buildings

PP&E

Cash

Common Stock

PP&E

Goodwill

Interest Payable

Inventory

Investments

Land

PP&E

Mortgage Payable

Patents

Bad Debts Expense/Credit Losses

Cost of Goods Sold

Depreciation Expense

Equipment Gain on Sale of Building

Loss on Sale of Equipment

Prepaid Rent

Supplies

Unearned Revenue

Warranty Obligation

Rent Expense

Retained Earnings Salaries Expense

Salaries Payable Sales

*These accounts are contra-assets.

8. For the following events, in the spaces provided, fill in the numbers of the account(s) increased and decreased when recording the entry in the first grid. Accounts may be used more than once, and some accounts need not be used. Each event does not require an increase AND a decrease in an account. 1. Cash 2. Notes Payable 3. Notes Receivable 4. Interest Expense 5. Interest Receivable 6. Interest Revenue 7. Interest Payable 8. Accumulated Depreciation 9. Sales 10. Rent Expense 11. Inventory 12. Salaries Expense 13. Cost of Goods Sold 14. Depreciation Expense 15. Salaries Payable 16. Accounts Payable 17. Accounts Receivable 18. Equipment 19. Prepaid Insurance 20. Unearned Revenue

Transactions

# of Account Increased

# of Account Decreased

a. Employees worked for the week but will be paid next week

b. Signed a note with the bank and received financing c. Purchased merchandise on credit d. Sold merchandise on credit at more than the cost e. Recorded depreciation on equipment f. Bought equipment, giving small down payment and signing note for the rest g. Paid off earlier credit purchase of merchandise h. Paid rent for the month i. Prepaid for several months of insurance j. Collected amount for future delivery of magazines

Difficulty: Moderate Time on Task: 14 minutes Objective: Appendix A AACSB: Analytical Thinking Assignment: Homework, Quiz and Test Solutions:

Transactions

# of Account Increased

a. Employees worked for the week but will be paid next week

12, 15

b. Signed a note with the bank and received financing

1, 2

c. Purchased merchandise on credit

11, 16

d. Sold merchandise on credit at more than the cost

9, 13, 17

e. Recorded depreciation on equipment

# of Account Decreased

8, 14

f. Bought equipment, giving small down payment and signing note for the rest

2, 18

g. Paid off earlier credit purchase of merchandise

1 1, 16

h. Paid rent for the month

i. Prepaid for several months of insurance

j. Collected amount for future delivery of magazines

1, 20

9. For the following events, in the spaces provided, fill in the effect on net income on the Income Statement. Use: + for increase – for decrease 0 for no net effect Transactions

Net Income (Income Statement)

a. Employees worked for the week but will be paid next week b. Signed a note with the bank and received financing c. Purchased merchandise on credit; keep perpetual records in inventory d. Sold merchandise on credit at more than the cost e. Recorded depreciation on equipment f. Bought equipment, giving small down payment and signing note for the rest g. Paid off earlier credit purchase of merchandise h. Paid for rent used during the month i. Prepaid for several months of insurance; recorded with prepaid insurance account j. Collected amount for future delivery of magazines; recorded with unearned revenue account

Difficulty: Moderate Time on Task: 12 minutes 32

Objective: Appendix A AACSB: Analytical Thinking Assignment: Homework, Quiz and Test Solution: Net Income (Income Statement)

Transactions a. Employees worked for the week but will be paid next week

–

b. Signed a note with the bank and received financing

c. Purchased merchandise on credit; keep perpetual records in inventory

d. Sold merchandise on credit at more than the cost

e. Recorded depreciation on equipment

–

f. Bought equipment, giving small down payment and signing note for the rest

g. Paid off earlier credit purchase of merchandise

h. Paid for rent used during the month

–

i. Prepaid for several months of insurance; recorded with prepaid insurance account

j. Collected amount for future delivery of magazines; recorded with unearned revenue account

10. The following is known about Pedro Company, which has a January fiscal year end:

Balance Sheet Data

1/31/22

1/31/23

Retained Earnings

$400

$1,100

Investments

$600

$900

Long-Term Liabilities

$700

$1,100

$300

$400

Property, Plant, and Equipment Current Liabilities

Intangible Assets

$900

$1,000

Capital Stock

$1,200

$1,300

Current Assets

$500

$600

Answer the following questions a. What were Long-Term Liabilities on 1/31/23? b. What was the total of Property, Plant, and Equipment on 1/31/22? c. What was Stockholders’ Equity on 1/31/23? Difficulty: Moderate Time on Task: 5 minutes Objective: Appendix A AACSB: Analytical Thinking Assignment: Homework Solutions: a. Explanation: The accounting equation must stay in balance. Assets = Liabilities + Stockholder’s Equity Current Assets + Investments + Property, Plant and Equipment + Intangible Assets = Current Liabilities + Long-Term Liabilities [missing value] + Capital Stock + Retained Earnings 600 + 900 + 1,100 + 1,000 = 400 + Long-Term Liabilities + 1,300 + 1,100 3,600 = Long-Term Liabilities + 2,800 Long-Term Liabilities = 800 Property, Current Invest Intangible Current Long-Term Capital Retained + + Plant and + = + + + Assets ments Assets Liabilities Liabilities Stock Earnings Equipment Long-Term 600 + 900 + 1,100 + 1,000 = 400 + + 1,300 + 1,100 Liabilities Long-Term 3,600 = 2,800 + Liabilities Long-Term 800 = Liabilities

b. Explanation: The accounting equation must stay in balance. Assets = Liabilities + Stockholder’s Equity Current Assets + Investments + Property, Plant and Equipment + Intangible Assets = Current Liabilities + Long-Term Liabilities [missing value] + Capital Stock + Retained Earnings Current Invest + + Assets ments

Property, Intangible Current Plant and + = + Assets Liabilities Equipment

Long-Term Liabilities

Capital Retained + Stock Earnings

c. Explanation: Stockholder’s Equity = Capital Stock + Retained Earnings Stockholder’s Equity = 1,300 + 1,100 Stockholder's Equity

Capital Stock +

Stockholder's Equity

1,300

Stockholder's Equity

2,400

Retained Earnings 1,100

Chapter 2 End of Chapter with solutions 09/24/18 Discussion Questions 1. Describe the difference between product and period costs. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: None Solution: Product costs include only those costs within the “production” element of the value chain. GAAP require all product costs to be recorded as an asset on the balance sheet rather than as an expense, which is why these types of costs are referred to as inventoriable product costs. Product costs are recorded as inventory (assets) on the balance sheet until the items are sold. Once sold, the company records all of the expenses related to the cost of the product as “cost of goods sold,” an expense on the income statement. GAAP consider all costs other than production incurred throughout the value chain to be period costs and require them to be expensed immediately. These costs are “used up” or depleted within the same period as the costs are incurred, so they cannot be included as an asset on the company’s balance sheet. Period costs are typically included as selling, general, and administrative expenses on the company’s income statement.

2. Prime costs plus conversion costs equals the cost of goods manufactured. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Difficult Time on task: 5 minutes Objective: LO2

AACSB: Reflective thinking Assignment: None Solution: No. Prime costs represent the total direct costs and include direct materials and direct labor. Conversion costs represent the costs incurred to convert direct materials into a finished product; they include both direct labor and manufacturing overhead costs. The sum of these two would result in a duplication of direct labor, as direct labor is considered to be both a prime cost and a conversion cost.

3. Direct costs are the costs that actually become a part of the product. Indirect costs are the costs that are not used in production. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 3 minutes Objective: LO2 AACSB: Reflective thinking Assignment: None Solution: No. Direct costs are costs that can be traced accurately to a cost object (individual types of products, customers, or groups of units produced). In contrast, indirect costs cannot be traced easily and accurately to a cost object but are still incurred in the manufacturing process. Both costs are used in production and would be included in the total cost of a product. 4. Describe the different inventory accounts for a manufacturing firm. Difficulty: Easy Time on task: 3 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Test Solution: Raw materials inventory includes all materials that have not yet been placed into production.

Work in process inventory includes all inventory that has started into the production process but is not completed and ready for sale at the end of the accounting period. Finished goods inventory includes all inventory that has completed the manufacturing process and is ready to be sold to a retail customer. All three accounts are considered inventory accounts and are presented in the current assets section of the balance sheet.

5. Suppose an accountant incorrectly classified direct labor costs as a period cost instead of a product cost. Explain the potential impact on the amount reported as net income. Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: Product costs are recorded as inventory (assets) on the balance sheet until the items are sold. Once they are sold, the company records all of the expenses related to the cost of those products as “cost of goods sold,” an expense on the income statement. This differs from period costs, which are expensed immediately. If the company sold all units produced in the period, then there would be no financial impact on net income due to this error. However, if the company produced more items than it sold, then expenses would be overstated (because all of the direct labor costs would be expensed this period), so net income would be understated, or lower than it should be. Inventory on the balance sheet would also be understated. 6. The cost of goods available to be sold represents the total amount of product expenses reported on the income statement. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge

Assignment: Homework Solution: No. GAAP require all product costs to be recorded as assets on the balance sheet rather than as expenses, which is why these types of costs are referred to as inventoriable product costs. Product costs are recorded as inventory (assets) on the balance sheet until the items are sold. Once they are sold, the company records all of the expenses related to the cost of the product as “cost of goods sold,” an expense on the income statement. The cost of goods available to be sold represents the beginning balance of finished goods (product costs from a previous period) and the cost of finished production from this period. However, in general, not all of these items are sold, so not all of these costs are moved to expense during this period.

7. Discuss in terms of debits and credits how raw materials, work in process, and finished goods are increased. Difficulty: Easy Time on task: 2 minutes Objective: LO6 AACSB: Application of knowledge Assignment: Quiz Solution: Raw materials, work in process, and finished goods all represent inventory accounts that are assets on the balance sheet. These asset accounts increase with a debit and decrease with a credit.

Exercises 1. Identify whether each of the following costs is a product cost or a period cost. a. b. c.

_ _ _

Depreciation on salesperson’s car Salary of factory supervisor Overtime premium paid on night shift

d. e. f. g. h. i. j. k. l.

_ _ _ _ _ _ _ _ _

Insurance on corporate offices Property taxes for factory Supplies such as nails, glue, and thread used in production Freight cost on products shipped to customers Salary of computer technician for the office Advertising expense Depreciation of machine used in production Salary of chief financial officer Salary of lawyer in a legal firm Difficulty: Easy (exception of #7: Moderate) Time on task: 1 minute each Objective: LO3 AACSB: Application of knowledge Assignment: varies, see chart below Solution:

Question

Solution

Assig nment

Depreciation on salesperson’s car

Period

Quiz

Salary of factory supervisor (foreman)

Product

Quiz

Overtime premium paid on night shift

Product

Test

Insurance on corporate offices

Period

Test

Property taxes for factory

Product

Home work

Supplies such as nails, glue, and thread used in production

Product

Home work

Freight cost on products shipped to customers

Period

Home work

Salary of computer technician for the office

Period

Home work

Advertising expense

Period

None

Depreciation of machine used in production

Product

None

Salary of chief financial officer

Period

None

Salary of lawyer in a legal firm

Period

None

2. For each of the following, indicate whether the cost is a direct cost or an indirect cost. a. b. c. d. e. f. g. h. i. j. k. l. m. n.

_ _ _ _ _ _ _ _ _ _ _ _ _ _

Nurse practitioner in a doctor’s office Server in a restaurant Housekeeper in a hotel Forklift operator in a factory warehouse Technology support in a consulting firm Accounting fraud investigator in a forensic crime lab Professor in a classroom Stocking clerk in a department store Maintenance workers in the factory Office staff for a landscape company Assembly-line operator in a car manufacturing plant Teller at a bank Lubricants (oil) used to keep production machinery in good condition Depreciation and property taxes in a factory

Difficulty: Easy Time on task: 1 minute each Objective: LO2 AACSB: Application of knowledge Assignment: varies, see chart below Solution: #

Question

Solution

Assig nment

Nurse practitioner in a doctor’s office

Direct

Quiz

Server in a restaurant

Direct

Quiz

Housekeeper in a hotel

Direct

Test

Forklift operator in a factory warehouse

Indirect

Test

Technology support in a consulting firm

Indirect

Home work

Accounting fraud investigator in a forensic crime lab

Direct

Test

Professor in a classroom

Direct

Stocking clerk in a department store

Indirect

Maintenance workers in a factory

Indirect

None

Office staff for a landscape company

Indirect

Quiz

Assembly-line operator in a car manufacturing plant

Direct

None

Teller at a bank

Direct

None

Lubricants (oil) used to keep production machinery in good condition

Indirect

None

Depreciation and property taxes in a factory

Indirect

None

Home work Home work

3. For each of the following, indicate whether the statement is true or false. a. A carpenter’s salary for a company that builds houses is both a product cost and a prime cost. b. Raw materials inventory includes all materials that have been used in the production process. c. The cost of goods manufactured schedule for the period summarizes the costs of products that were finished and are now available for sale. d. When a product has completed the manufacturing process, work in process inventory is credited and finished goods inventory is debited. e. Product costs are restricted to those costs that can be assigned to the units sold during the period. f.

Typically, overtime premium and the factory supervisors’ salaries are considered direct labor.

g. Direct materials and direct labor combined are known as prime costs. h. A salesperson’s commissions and the depreciation expense for equipment in the administrative offices would always be considered period costs for a manufacturer, a retailer, or a service organization. i.

Raw materials that become part of the finished product but are insignificant are considered overhead.

Total manufacturing costs incurred plus the change in the finished goods inventory equals the cost of goods sold.

k. If a manufacturer or retailer is responsible for paying the freight to ship the product to

the customer, the transportation cost should be considered a period cost. l.

Direct labor includes only the salaries of the people employed directly in production.

m. Total current manufacturing costs consist of prime costs and conversion costs.

Difficulty: varies, see chart below Time on task: 1 minute each Objective: varies, see chart below AACSB: Reflective thinking Assignment: varies, see chart below Solution: #

Question A carpenter’s salary for a company that builds houses is both a product cost and a prime cost. Raw materials inventory includes all materials that have been used in the production process. The cost of goods manufactured schedule for the period summarizes the costs of products that were finished and are now available for sale. When a product has completed the manufacturing process, work in process inventory is credited and finished goods inventory is debited.

Solution

Diffic ulty

Obj

Assig nment

Easy

LO2

None

False. Raw materials inventory includes all materials that have not yet Easy been placed into production.

LO1

Quiz

True

Easy

LO4

None

True

Easy

LO6

None

True

Product costs are restricted to those costs that can be e. assigned to the units sold during the period.

Typically, overtime premium and the factory supervisors’ f. salaries are considered direct labor. Direct materials and direct g. labor combined are known as prime costs. A salesperson’s commissions and the depreciation expense for equipment in the administrative offices would h. always be considered period costs for a manufacturer, a retailer, or a service organization. Raw materials that become part of the finished product but i. are insignificant are considered overhead.

Total manufacturing costs incurred plus the change in the finished goods inventory equals the cost of goods sold.

If a manufacturer or retailer is responsible for paying the freight to ship the product to k. the customer, the transportation cost should be considered a period cost. Direct labor includes only the l. salaries of the people

False. Product costs are recorded as assets on the balance sheet rather than as expenses, which is why these types of costs are referred to as inventoriable product costs. Product costs are recorded as inventory Mode (assets) on the balance sheet until the rate items are sold. Once they are sold, the company records all of the expenses related to the cost of the product as “cost of goods sold,” an expense on the income statement.

LO3

None

False. These costs may not be directly Mode traceable to individual units, so they rate are considered indirect labor costs.

LO2

None

True

Easy

LO2

Quiz

True

Mode rate

LO3

None

True

Diffic ult

LO2

None

False. Cost of goods sold represents only the cost of goods sold during the period as opposed to the total manufacturing costs for all units produced during the period.

Easy

LO5

None

True

Easy

LO3

None

True

Easy

LO2

Home work

employed directly in production. Total current manufacturing m costs consist of prime costs . and conversion costs.

False. The sum of these two would result in a duplication of direct labor, as direct labor is considered to be both a prime cost and a conversion cost.

Mode rate

LO5

None

4. JKL produces boxes. In 2022, the company incurred the following costs: Indirect labor

$10,000

Indirect materials

$5,000

Factory utilities and taxes

$12,000

Factory depreciation and rent

$17,000

Direct materials

$30,000

Selling costs

$31,000

Administrative costs

$37,000

Direct labor

$24,000

a. What is the amount of manufacturing overhead? b. What are product costs during the period? c. What are period costs?

Difficulty: varies, see chart below Time on task: varies, see chart below Objective: varies, see chart below AACSB: Application of knowledge Assignment: Quiz Solution:

Question

Time On Difficulty task

Solution

Indirect labor $10,000 What is the amount Indirect materials $5,000 a. of manufacturing Factory utilities and taxes $12,000 Easy 1 min overhead? Factory depreciation and rent $17,000 Total manufacturing overhead $44,000 Direct materials $30,000 Direct labor $24,000 What are product Overhead* $44,000 b. costs during the Moderate 2 min Total product cost $98,000 period?

What are period costs?

* Calculated in part a. Selling costs Administrative costs Total period costs

$31,000 $37,000 $68,000

Easy

2 min

5. Assume the following information for NVO, a retailer, in 2022: Gross profit

30%

Sales

$400,000

Operating income

$25,000

Finished goods inventory, beginning balance

$8,000

Finished goods inventory, ending balance

$5,000

a. What is cost of goods sold? b. What are selling and administrative costs? c. What additional information would be useful for NVO to assess if its performance for the year was good?

Difficulty: Moderate Time on task: 2 minutes each Objective: LO5

Obj

LO2

LO3

AACSB: varies, see chart below Assignment: Test Solution: #

Question

What is cost of goods sold?

Solution Sales – COGS Gross profit

$400,000 ? ?

AACSB 100% 70% 30%

Application of knowledge

COGS = 70% × $400,000 = $280,000 Sales $400,000 Application – COGS $280,000 of Gross profit $120,000 knowledge What are selling – SG&A ? and Operating income $25,000 administrative costs? SG&A = Gross profit – Operating income = $120,000 – 25,000 = $95,000 Students’ answers may vary. Reflective What additional thinking information NVO could obtain the following would be useful information to determine if for NVO to performance was good: assess if its - Prior-year costs and revenue performance for - Projected amounts for costs and the year was revenue good? - Detailed information on product costs - Detailed information on period costs

6. In Chapter 1, the Institute of Management Accounting’s Standards of Ethical Professional Practice were described as competence, confidentiality, integrity, and credibility. The president of Clever Company has suggested reporting a material amount of the product costs as period costs. This reclassification would enable the company to report the desired gross margin percentage of sales required for its loan application. Since the net income is the same, the president argues that reporting in a different category is acceptable. Identify and discuss which standards of ethical conduct the accountant and the president would be violating if the accountant agrees to the president’s suggestion. Be specific. What should the accountant do? Difficulty: Moderate Time on task: 6 minutes Objective: LO3 AACSB: Ethical understanding and reasoning Assignment: None Solution: The primary function of an accountant’s role is to ensure financial information is accurate and fairly represents the financial condition of the company. The accountant must consider whether making the reallocation of product costs to period costs would alter the financial reports in a way that causes them to be inaccurate. In this scenario, the Generally Accepted Accounting Principles (GAAP) would be violated because GAAP requires all product costs to be recorded as assets on the balance sheet rather than as expenses. Product costs should be recorded as inventory (assets) on the balance sheet until the items are sold. Once they are sold, the company should record all of the expenses related to the cost of the product as “cost of goods sold” as opposed to “period costs” on the income statement. You would be violating three of the IMA’s Standards of Ethical Professional Practice: competence, integrity, and credibility. The competence standard requires accountants to perform professional duties in accordance with all laws, regulations, and policies and to provide decision support information and recommendations that are accurate, clear, concise and timely. The integrity standard requires members to be honest and trustworthy at all times, no matter what the circumstance. If the accountant reallocates expenses, even though he has been asked to do so by his boss, he is not being honest and trustworthy and, therefore, lacks integrity. Further, he will lack credibility because he did not present information fairly, objectively, and without bias. The accountant should discuss his concerns with his boss. He should mention

that he believes the financial statements may be inaccurate if these adjustments are made and that he does not want to act without integrity or credibility. If his boss dismisses his concerns, he should report the situation to a whistleblower hotline or internal counsel, if available.

7. Affordable Tutoring Services had the following results for 2022:

Affordable Tutoring Services Income Statement for Year Ending December 31, 2022

Percent of Revenue

$101,000

100%

Tutoring revenues Salaries and payroll taxes

(52,000)

51%

Rent

(18,000)

18%

Utilities

(6,100)

Insurance

(6,800)

Depreciation

(3,600)

Supplies expense

(1,800)

Miscellaneous

(18,300)

18%

Total expenses

(106,600)

106%

Income

($5,600)

–6%

Included in the miscellaneous expense category are marketing costs, a legal retainer, accounting fees, and travel costs. a.

Is this company a service company, a retailer, or a manufacturer? Explain.

Analyze each of these costs. Which costs would you investigate further, and why?

Difficulty: varies, see chart below Time on task: varies, see chart below Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution: #

Question

Is this company a service company, a a. retailer, or a manufacturer? Explain.

Solution

Difficulty

Time On task

The company is a service company. This is evident by the lack of cost of goods sold expenses.

Easy

1 min

Analyze each of these costs. Which b. costs would you investigate further, and why?

I would investigate “miscellaneous expenses” further. At almost 20% of revenue, this line item is material to the company. Management should Moderate understand which items make up these costs. Management will then have a better understanding of how to manage the costs effectively.

2 min

8. The following information applies to Amanda Company for 2022: • Prime costs were $145,000. • Direct labor was one-third of conversion costs. • Sales were $310,000. • Conversion costs $120,000. • The balances in the work in process inventory and the finished goods Inventory were as follows: January 1

• •

December 31

Work in process

$9,000

$6,000

Finished goods

$11,000

$16,000

A 3-year insurance policy to cover selling and administrative personnel was signed on January 1, 2022, for $12,000. Other selling and administrative costs totaled $13,000.

a. Complete the T-accounts for work in process and finished goods. b. What were direct materials used? c. What was cost of goods manufactured? d. What was gross margin? e. What was operating income? f.

Record the entry for direct labor:

Difficulty: varies, see chart below Time on task: varies, see chart below Objective: LO1 AACSB: Application of knowledge

Assignment: Test Solution: #

Question

Solution

Time Difficulty On task

Complete the T-accounts for a. work in See link for solutions. Moderate 5 min process and finished goods. Prime costs = Direct materials + Direct labor $145,000 = Direct materials + $40,000* What were $105,000 = Direct materials b. direct materials Moderate 2 min used? * Direct labor = 1/3 of Conversion costs = 1/3 of $120,000 = $40,000 WIP beginning balance + Direct materials + Direct labor + Overhead – Cost of goods manufactured = WIP ending balance What was cost c. of goods manufactured?

$9,000 + $105,000 + $40,000 + $80,000 – COGM = $6,000

Obj

LO4

Easy

2 min

LO4

Easy

2 min

LO5

Difficult

2 min

LO5

Easy

2 min

LO6

COGM = $9,000 + $105,000 + $40,000 + $80,000 - $6,000

What was gross margin?

What was e. operating income?

Record the entry for direct labor.

COGM = $228,000 Gross margin = Sales – Cost of goods sold Gross margin = $310,000 – $223,000 Gross margin = $87,000 Gross margin – SGA = Operating income $87,000 Gross margin – $17,000 SGA* = $70,000 Operating income *SGA = Insurance + Other SGA SGA = (1/3 * $12,000) + $13,000 = $17,000

Dr. Work in process inventory $40,000 Cr. Salaries payable $40,000

9. The following information for 2022 applies to Sue, Inc., which makes pet items: Direct materials purchased on account

$70,000

Direct materials requisitioned

$50,000

Direct labor cost incurred

$90,000

Factory overhead incurred

$62,000

Cost of goods completed

$146,000

Cost of goods sold

$128,000

Beginning raw materials inventory

$10,000

Beginning WIP inventory

$30,000

Beginning finished goods inventory

$20,000

a. Complete the T-accounts for raw materials, work in process, and finished goods. b. What are prime costs? c. What are conversion costs? d. What is cost of goods manufactured? e. What is the ending balance of the raw materials inventory? f. What is the ending balance of the work in process inventory? g. What is the ending balance of the finished goods inventory?

Difficulty: varies, see chart below Time on task: varies, see chart below Objective: varies, see chart below AACSB: Application of knowledge Assignment: Quiz Solution: #

Questions

Solution

Diffic Time on Obj ulty task

Complete the Taccounts for raw a. materials, work in process, and finished goods. b. What are prime costs?

What are conversion costs?

What is cost of goods manufactured? What is the ending e. balance of the raw materials inventory? What is the ending f. balance of the work in process inventory? What is the ending g. balance of the finished goods inventory? d.

See link for solutions.

Mode rate

Prime costs = Direct materials + Direct labor Prime costs = $50,000 + $90,000 Easy Prime costs = $140,000 Conversion costs = Direct labor + Overhead Conversion costs = $90,000 + $62,000 Easy Conversion costs = $152,000

LO4

LO2

$146,000 (see T-accounts)

Easy

LO4

$30,000 (see T-accounts)

Easy

LO4

$86,000 (see T-accounts)

Easy

LO4

$38,000 (see T-accounts)

Easy

LO4

10. Answer the questions regarding the partially completed T-accounts for XYZ Company for the month of May: <ART: Use minus signs instead of hyphens. Make sure a space follows the + signs for “+ Direct Materials” and “+ Direct Labor”.>

Additional information: • Purchased direct materials were $8,000. • The labor wage rate was $24 per hour. • Manufacturing overhead was $5,200 for the month. • During the month, sales revenue was $21,000 and selling, general, and administrative costs were $5,000.

a. Complete the T-accounts for raw materials, work in process, and finished goods. b. What was the amount of direct materials issued to production during May? c. What was the ending balance of raw materials at the end of May? d. What is the amount of prime costs? e. What is the amount of conversion costs? f.

How many direct labor hours were worked in the month of May?

g. What is the amount of cost of goods manufactured for May? h. What is the ending balance of the work in process Inventory at the end of May? i.

What is the amount of cost of goods sold for May?

What is the ending balance of the finished goods inventory for the month of May?

k. What was the company’s operating income for the month of May? Difficulty: varies, see chart below Time on task: varies, see chart below Objective: varies, see chart below AACSB: Application of knowledge

Assignment: Homework Solution: #

Question

Complete the T-accounts for raw materials, work in a. process, and finished goods. What was the amount of b. direct materials issued to production during May? What was the ending c. balance of raw materials at the end of May? d.

What is the amount of prime costs?

What is the amount of conversion costs?

How many direct labor f. hours were worked in the month of May? What is the amount of g. cost of goods manufactured for May? What is the ending balance of the work in h. process inventory at the end of May? What is the amount of i. cost of goods sold for May? What is the ending balance of the finished j. goods inventory for the month of May?

Solution

Diffic Time on Obj ulty task

See link for solutions.

Mod 5 min LO4 erate

$3,600 (see T-accounts)

Easy 2 min LO4

$6,400 (see T-accounts)

Easy 2 min LO4

Prime costs = Direct materials + Direct labor Prime costs = $3,600 + $6,000 Prime costs = $9,600 Conversion costs = Direct labor + Overhead Conversion costs = $6,000 + $5,200 Conversion costs = $11,200 Direct labor cost = Rate × Hours $6,000 = $24 per hour × Hours Hours = 250 direct labor hours

Easy 2 min LO2

Mod 3 min LO3 erate

$9,200 (see T-accounts)

Easy 2 min LO4

$9,600 (see T-accounts)

Easy 2 min LO4

$7,200 (see T-accounts)

Easy 2 min LO5

$8,000 (see T-accounts)

Easy 2 min LO4

What was the company’s k. operating income for the month of May?

Sales – COGS Gross profit – SG&A Operating income

$21,000 $7,200 $13,800 $5,000 $8,800

Mod 3 min LO5 erate

Problems 1. Best Furniture had the following data in 2022: Depreciation on equipment (1/4 is for office equipment) Rent, taxes, insurance, utilities (1/3 is administrative) Salaries of factory personnel other than direct labor (other than employees directly working on production) Salaries of salespeople and administrators Freight-out (cost to deliver products to customers: selling cost) Direct labor Raw materials purchased and used (1/5 is for indirect materials) Sales

$100,000 $240,000 $60,000 $90,000 $25,000 $175,000 $300,000 $1,000,000

There were no changes in the work in process inventory or the finished goods inventory. a. What was cost of goods manufactured? b. What were period costs? c. What was gross margin? d. What was operating income? e. Prepare an income statement for external reporting purposes.

Difficulty: varies, see chart below Time on task: varies, see chart below Objective: varies, see chart below

AACSB: Application of knowledge Assignment: Test Solution: #

Question

Solution

Time Difficulty on Obj task

What was cost of goods manufactured?

$770,000 (see spreadsheet)

Moderate 3 min LO4

b. What were period costs?

$220,000 (see spreadsheet)

Moderate 3 min LO3

Sales $1,000,000 – COGS* $770,000 Gross margin $230,000 * As there were no changes in Moderate 1 min LO5 finished goods inventory, this means that all goods manufactured were sold during the period and cost of goods manufactured = cost of goods sold. Gross margin $230,000 d. What was operating income? – Period costs $220,000 Easy 1 min LO5 Operating income $10,000 Sales $1,000,000 Prepare an income – COGS $770,000 e. statement for external Gross margin $230,000 Moderate 3 min LO5 reporting purposes. – SGA $220,000 Operating income $10,000 c. What was gross margin?

2. Assume the same data from Problem 1 except that the work in process inventory increased by $2,000 and the finished goods inventory decreased by $3,000. a. What was cost of goods manufactured? b. What was cost of goods sold? c. What was gross margin? d. What was operating income?

e. What other information would be beneficial to determine whether you are managing your operations well? Difficulty: varies, see chart below Time on task: varies, see chart below Objective: varies, see chart below AACSB: Application of knowledge Assignment: Quiz Solution: # a. b.

Difficulty

Time Obj on task

$768,000 (see link to spreadsheet)

Difficult

4 min

LO4

$771,000 (see link to spreadsheet)

Difficult

3 min

LO3

Moderate

1 min

LO5

Easy

1 min

LO5

Moderate

3 min

LO5

Question What was cost of goods manufactured? What was cost of goods sold?

What was gross margin?

What was operating income?

What other information would be beneficial to determine whether you are managing your operations well?

Solution

Sales $1,000,000 – COGS $771,000 Gross margin $229,000 Gross margin $229,000 – Period costs $220,000 Operating income $9,000 Students’ answers may vary. Examples of additional information that would be beneficial for assessing operations include: - Quality of raw materials - Percent of equipment downtime - Amount of scrap or rework of products required - Gross margin by product or product line - Comparison of current-year amounts to prior-year amounts

3. Assume the same data from Problem 1. Record all necessary journal entries. Difficulty: Moderate Time on task: 5 minutes

Objective: LO6 AACSB: Application of knowledge Assignment: Test Solution: Entries

Debit

1. Purchase of raw materials Raw materials inventory Cash or accounts payable

300,000

2. Transfer of direct materials to work in process Work in process inventory Raw materials inventory

240,000

3. Add direct labor costs to work in process Work in process inventory Cash or salaries payable

175,000

4. Pay workers for indirect labor costs Manufacturing overhead Cash or salaries payable

60,000

5. Other indirect manufacturing costs Manufacturing overhead Cash (rent, taxes, insurance, utilities) Accumulated depreciation (Factory depreciation) Raw materials inventory (indirect materials)

Credit

300,000

240,000

175,000

60,000 295,000 160,000 75,000 60,000

6. Transfer manufacturing overhead costs to work in process at end of the period Work in process inventory 295,000 Manufacturing overhead 295,000 7. Complete manufacturing at the end of the period and transfer to finished goods Finished goods inventory 770,000 Work in process inventory 770,000 8. Sold items during the period Cost of goods sold Cash or accounts receivable Finished goods inventory Sales

770,000 1,000,000 770,000 1,000,000

4. DER, Inc., manufactures a single product. The following information is available for 2022: ● ● ●

Raw materials: Beginning balance: $5,000. Purchased $40,000 on credit. Direct materials used in production were three-fourths of direct materials bought. Work in process: Beginning balance: $3,100. Ending balance: $12,900. Units transferred out: 10,000. All units have the same average cost. Finished goods: Beginning balance: 0 units. Ending balance: 1,000 units.

Also known: Prime costs Indirect labor Factory insurance

$55,000 $11,000 $2,500 (80% relates to production)

Utilities

$8,000

Factory depreciation Sales Administrative and selling costs (other than utilities)

$7,000 $14 Per unit $22,000

a. Complete the T-accounts for raw materials, work in process, and finished goods. b. What is the ending balance of raw materials? c. What is overhead? d. What is cost of goods manufactured? e. What is gross margin? f.

What are period costs?

g. What are conversion costs?

Difficulty: varies, see chart below Time on task: varies, see chart below Objective: varies, see chart below AACSB: Application of knowledge Assignment: Homework Solution: #

Questions

Solution

Time Difficulty on task

Obj

b. c. d.

Complete the Taccounts for raw materials, work in process, and finished goods. What is the ending balance of raw materials? What is overhead? What is cost of goods manufactured?

See link for solutions.

What is gross margin?

12 min

LO4

$15,000 (see T-accounts)

Easy

2 min LO4

$26,900 (see T-accounts)

Easy

2 min LO4

$72,100 (see T-accounts)

Easy

2 min LO4

Sales – COGS* Gross margin e.

Moderate

$126,000 $64,890 $61,110

Units manufactured 10,000 – Units ending 1,000 = Units sold 9,000 × Sales price $14 = Sales $126,000

Sales and admin $22,000 What are period + Nonfactory utilities $1,600 f. costs? ($8,000 × 20%) Period costs $23,600 Conversion costs = Direct labor + What are Overhead g. conversion costs? Conversion costs = $25,000 + $26,900 Conversion costs = $51,900

Moderate 3 min LO5

Easy

2 min LO3

Easy

2 min LO3

5. Assume the same data from Problem 4. Record all necessary journal entries. Difficulty: Moderate Time on task: 5 minutes Objective: LO6 AACSB: Application of knowledge Assignment: Homework

Solution: Entries

Debit

1. Purchase of raw materials Raw materials inventory Accounts payable

40,000

2. Transfer of direct materials to work in process Work in process inventory Raw materials inventory

30,000

3. Add direct labor costs to work in process Work in process inventory Cash or salaries payable

25,000

4. Pay workers for indirect labor costs Manufacturing overhead Cash or salaries payable

11,000

5. Other indirect manufacturing costs Manufacturing overhead Cash or Prepaid insurance (Factory insurance) Cash or Utilities payable (Factory utilities) Accumulated depreciation (Factory depreciation)

Credit

40,000

30,000

25,000

11,000

15,900 2,500 6,400 7,000

6. Transfer manufacturing overhead costs to work in process at end of the period Work in process inventory 26,900 Manufacturing overhead

26,900

7. Complete manufacturing at the end of the period and transfer to finished goods Finished goods inventory 72,100 Work in process inventory 72,100 8. Sold items during the period Cost of goods sold Cash or accounts receivable Finished goods inventory Sales

64,890 126,000 64,890 126,000

6. Premium Manufacturers is a manufacturer. Positive selected account balances for the company as of January 1, 2022, were as follows: Cash

$15,000

Accounts receivable

$8,000

Raw materials inventory (all direct materials)

$5,000

Work in process inventory

$7,000

Finished goods inventory

$9,000

Prepaid rent

$3,000

Buildings and equipment

$40,000

Accumulated depreciation

$8,000

Accounts payable

$6,000

During the month of January, Premium Manufacturers had the following transactions: ●

Salaries: $6,800. Of this amount, $2,200 is selling and administrative; the rest is for production as follows: $2,700 for direct labor, $1,900 for indirect labor.

●

Prepaid rent expired (was used up): $1,400 relates to factory rent, $600 is administrative.

●

Depreciation: $1,800; $1,600 relates to the machinery in the factory.

●

Purchases of raw materials on credit: $12,000; includes $11,000 for direct materials and $1,000 for indirect materials.

●

Sales of finished goods for the month, all on credit: $35,000.

●

Payment of accounts payable: $11,000.

●

Collection of accounts receivable: $40,000.

●

Issued to production: $10,700; includes $10,000 for direct materials and $700 for indirect materials.

●

Transferred to finished goods: the completed units.

●

Recorded the sales and the cost of goods sold.

On January 31, 2022, the respective inventory balances were as follows: Raw materials inventory (includes $300 of indirect materials)

$6,300

Work in process inventory

$6,500

Finished goods inventory

$5,200

a. Use the T-accounts to trace the cost flow.

b. Prepare an income statement for the month of January 2022, as well as a cost of goods manufactured schedule.

Difficulty: Moderate Time on task: varies, see chart below Objective: varies, see chart below AACSB: Analytical thinking Assignment: Test Solution: #

Question

Use the T-accounts to trace the cost flow. Prepare an income statement for the month of January 2022, as well b. as a cost of goods manufactured schedule. a.

Time on task

Solution

Obj

5 min See link for solutions.

LO4

7 min See link for solutions.

LO5

7. Following are the current assets sections of the balance sheets for three different companies. Company A Current assets: Cash Accounts receivable Short-term investments Merchandise inventory Total current assets

$150,250 $475,425 $9,623 $125,263 $360,561

Company B Current assets: Cash Accounts receivable Short-term investments Prepaid expenses Total current assets

$150,250 $75,425 $9,623 $125,263 $360,561

Company C Current assets: Cash Accounts receivable Inventory: Raw materials Work in process Finished goods Total inventory Total current assets

$150,250 $75,425 $25,251 $33,652 $66,360 $125,263 $350,938

a. Which company is a service company? b. Which company is a retailer? c. Which company is a manufacturer? d. Assume a manufacturer is in the business of manufacturing textbooks. Provide an example of direct materials, direct labor, and indirect costs. e. Review the current assets section of the manufacturer’s balance sheet. Identify one potential issue with the balance sheet.

Difficulty: Moderate Time on task: varies, see chart below Objective: 7a, 7b, and 7c - LO1 7d, 7e - LO2 AACSB: 7a, 7b, 7c, and 7e - Analytical thinking 7d - Application of knowledge Assignment: 7a, 7b and 7c - Quiz 7d and 7e - None Solution: #

Question

Which company is a service company?

Which company is a retailer?

Solutions

Time on task

Company B. Company A and Company C both have inventory accounts, so they 2 min are not service companies. Company A, which has merchandise 2 min inventory accounts.

Which company is a c. manufacturer?

Assume a manufacturer is in the business of manufacturing textbooks. d. Provide an example of direct materials, direct labor, and indirect costs.

Review the current assets section of the manufacturer’s balance e. sheet. Identify one potential issue with the balance sheet.

Company C, which has raw materials, work in process, and finished goods inventory accounts. Students’ answers may vary.

2 min

Examples of direct materials could include cardboard, paper, and ink. Examples of direct labor could include employees responsible for binding books 5 min or employees responsible for monitoring manufacturing equipment. Examples of indirect costs could include thread, glue, factory supervisor, and factory utilities. The manufacturer’s current assets mostly consist of accounts receivable and inventory. While these balances should transform into cash (as receivables are collected and products are sold), the company’s immediate liquidity is affected.

3 min

Chapter 3 End of Chapter and Solutions Questions 1. Give some strategic business decisions that can benefit from a job costing system. Difficulty: Moderate Time on task: 4 Minutes Objective: LO6 AACSB: Application of knowledge Assignment: Homework Solution: Strategic business decisions that can benefit from a job order costing system include pricing jobs and products to cover costs, analyzing job profitability, changing or eliminating unprofitable jobs, making process improvements, and analyzing supplier (vendor) reliability.

2. Describe some operational business decisions that can benefit from a job costing system. Difficulty: Moderate Time on task: 4 Minutes Objective: LO6 AACSB: Application of knowledge Assignment: Homework Solution: Operational business decisions that can benefit from a job order costing system include employee scheduling, job completion time and on-time deliveries, job errors, scrap and rework, and unexpected machine downtime.

3. Distinguish between a job costing system and a process costing system. Difficulty: Easy Time on task: 4 Minutes Objective: LO1 AACSB: Application of knowledge Assignment: Test Solution: A job costing system tracks all costs (labor, materials, and overhead) by individual jobs or batches. Manufacturing companies that produce unique, easily identifiable, or custom-ordered products will also use job costing to track their costs for each job. In contrast, manufacturers that produce identical or similar products employing substantially the same production process use process costing. Since the products are the same or very similar, it theoretically costs nearly the same amount to produce each unit. Costs are accumulated for each of the processes in production and then transferred out of each production process based on the average cost of each production process.

4. Service companies do not need a job costing system since such companies do not manufacture a product. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 4 Minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: No. All companies need to track and understand their costs to work efficiently and effectively. In The Lawn Care Company example, if the lawns are very similar, you can estimate your costs and assume the average costs per lawn are the same. If the lawns are dissimilar, averaging the costs is misleading because some lawns are probably less expensive to cut, whereas more complicated lawns are more costly to cut. This could result in overcharging some customers while undercharging other customers for your services.

5. A job cost sheet is a report that summarizes the costs of direct materials, direct labor, overhead, selling, and administrative costs for a specific job. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 4 Minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: No. The job cost sheet accumulates all of the costs related to the job (direct materials, direct labor, and overhead) itself that are reported in one of the three inventory accounts at the end of the accounting period and then expensed when sold. Selling and administrative costs are period costs that do not relate to the product or service (e.g., depreciation on headquarters) and are expensed when incurred.

6. For many companies today, an electronic match of purchase orders, purchase requisitions, and receiving reports automatically triggers an electronic payment to be made to the vendor. Such a practice violates internal controls and often leads to fraud. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Difficult Time on task: 4 Minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: No. The electronic matching of purchase orders, purchase requisitions, and receiving reports to automatically trigger electronic payment is still an internal control. Instead of having a person manually perform the match, a system is performing the match. The likelihood of error and fraud theoretically would decrease when using an automated system as opposed to a manual match.

7. Under a normal costing system, overhead is typically recorded in the work in process account at the beginning of the year for the amount estimated and then allocated to specific jobs as each job is completed. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 4 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: No. In a normal costing system, a predetermined rate is established at the beginning of the year and used to allocate the overhead throughout the year, regardless of how much you actually incur in overhead costs. At the end of the period, you reconcile the actual overhead incurred with the overhead you have allocated (based on the predetermined overhead rate), and then make any necessary adjustments to the accounts.

8. Direct materials, direct labor, and overhead are usually recorded as incurred both in the general ledger and in each job cost account so that the actual overhead and the allocated overhead match. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 4 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: No. In a normal costing system, direct materials and direct labor are entered as actual costs as they are incurred, but a predetermined overhead rate is used to allocate the indirect costs of production on the job cost sheet. Actual costs are tracked in the overhead account and then reconciled at the end of the period, with any adjustment needed being made for differences between actual overhead and allocated overhead.

9. If overhead is overallocated, the actual overhead must be greater than the allocated overhead incurred. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 4 Minutes Objective: LO5 AACSB: Application of knowledge Assignment: Test Solution: No. The predetermined overhead rate is calculated based on estimated overhead and estimated use of resources. Overhead could be overallocated if the company produced more units or services and thus allocated more overhead than actually was incurred.

10. Managers should analyze underallocated overhead to determine why there was not enough overhead estimated. If overhead is overallocated, there is no need to analyze why it was overallocated. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 4 Minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: No. Managers should analyze the difference between actual overhead and allocated overhead, regardless of whether it was over- or underallocated, if the difference is considered material (i.e., large enough that it could significantly change the financial statements). If it is materially different, the difference would be prorated by the company to the different jobs still in process and in the finished goods inventory. If any jobs have been sold, an amount would also be prorated to the cost of goods sold account. Additionally, the company should analyze the changes to understand why actual overhead differed from the expectation (estimate). Was it because the estimate of total overhead used to develop the overhead rate was incorrect? Was it because the estimated total activity used to develop the overhead rate was incorrect?

11. Explain what is meant by a normal costing system. Difficulty: Easy Time on task: 3 Minutes Objective: LO5 AACSB: Reflective thinking Assignment: Quiz Solution: In a normal costing system, direct materials and direct labor are recorded at actual amounts and overhead is allocated based on a predetermined overhead rate.

12. Why is overhead typically estimated and allocated as opposed to just traced to each job and recorded as indirect costs are paid? Difficulty: Moderate Time on task: 3 Minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Indirect costs benefit all jobs rather than a single job, so it is difficult to trace the exact costs to a particular job. Further, if a company recorded indirect costs as spent, then it would have to wait until all of the actual overhead costs have been finalized for the year before assigning those costs to each job. Lastly, if a business has seasonal fluctuations, it would want to “even out” or normalize the indirect annual costs so that each job would have an average representative cost, regardless of when the job was done. Some overhead costs (depreciation, for example) also do not require the payment of cash, so if overhead was only recorded as “paid,” these costs would not be accounted for as part of overhead.

13. Explain how seasonal fluctuations may affect overhead application. Difficulty: Difficult Time on task: 3 Minutes Objective: LO4 & LO5 AACSB: Reflective thinking Assignment: Homework Solution: If a business has seasonal fluctuations, under an actual costing approach, overhead would not be allocated uniformly across jobs. In other words, during months with a higher volume of production, the allocated overhead rate would be less per job than compared to jobs produced in months with lower production volume. If a business has seasonal fluctuations, it would want to “even out” or normalize the indirect annual costs so that each job would have an average representative cost, regardless of when the job was done.

14. If the under- or overallocated overhead amount is material, it should be recorded as a separate period expense (selling, general, and administrative). Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 3 Minutes Objective: LO5 AACSB: Reflective thinking Assignment: Quiz Solution: No. If the under- or overallocated overhead amount is materially different, the difference would be prorated by the company to the different jobs still in process and in the finished goods inventory. If any jobs had been sold, an amount would also be prorated to the cost of goods sold account.

15. Distinguish between spoilage and scrap.

Difficulty: Easy Time on task: 3 Minutes Objective: LO6 AACSB: Application of knowledge Assignment: Quiz Solution: Spoilage refers to a product or service that does not meet the standards of acceptable quality and must be discarded or reworked. Scrap refers to materials that are left over from the manufacturing of a job or product.

16. Would it be unethical to intentionally develop the overhead rate by overestimating the total indirect costs or by using an incorrect driver (no cause and effect)? Difficulty: Moderate Time on task: 4 Minutes Objective: LO6 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: Yes, it would be unethical to intentionally develop the overhead rate by overestimating the total indirect costs or by using an incorrect driver, because you would be intentionally presenting inaccurate information that could lead users of the information to make poor decisions. IMA ethical standards that would be violated would be competence and integrity, and maybe credibility.

17. In an attempt to reduce direct material costs, a company may be tempted to use less expensive materials from a different supplier with an “introductory cost offer.” Given the objective of cost-benefit decision making, what do you see as costs to consider against the benefit of lower quoted direct material costs? Difficulty: Easy Time on task: 3 Minutes

Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: The company should consider not only the initial purchase cost of the direct materials but also the costs of scrap and rework that may be required due to the use of cheaper materials. The additional costs of scrap and rework may ultimately exceed the cost of purchasing higher quality materials, such that the benefit (cheaper initial purchase cost) does not outweigh the total cost. 18. Give examples of both internally and externally generated data that a company could analyze to determine possible production delays. Difficulty: Difficult Time on task: 7 Minutes Objective: LO6 AACSB: Application of knowledge Assignment: Test Solution: Potential production delays can be analyzed using data from internal and external data sources. A company can collect internal data from its construction managers; sensors and smartphones can track how materials and equipment move around the job site and the data can be analyzed to reduce time wasted. This internal data can be combined with external data such as weather conditions in order to predict and manage production delays. 19. How can predictive analytics be used by a public accounting firm to assess the risk of taking on a new client? Difficulty: Moderate Time on task: 5 Minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: A public accounting firm can use predictive analytics to assess the risk of taking on new clients by assessing the potential revenue growth, competitiveness

of the industry, and macroeconomic factors including unemployment and inflation.

Exercises 1. Identify whether each of the following companies would likely use a job order system or a process costing system. a. Construction company that builds specific bridges and highways b. Bakery that makes many regular cookies, pies, and cakes c. Company that makes unique ships d. Consulting firm e. Accounting tax preparer of basic tax returns f.

Accounting company that audits various banks

g. Advertising company that creates specific product promotion campaigns h. Electronic manufacturer of cell phones, laptops, and tablets i.

Dentistry services

Skateboard manufacturer

k. Landscaping company with many customers that are billed individually Difficulty: Easy Time on task: 1 Minutes Objective: LO1 AACSB: Application of knowledge Assignment: Varies, see chart below Solution: Varies, see chart below

Question

Solution

H,T, Q

Job

Test

Process

Test

1c Company that makes unique ships

Job

Hmwk

1d Consulting firm

Job

Test

Process

Hmwk

Job

Test

Construction company that builds specific bridges and highways Bakery that makes many regular cookies, pies, and 1b cakes 1a

1e Accounting tax preparer of basic tax returns 1f Accounting company that audits various banks

Advertising company that creates specific product Job promotion campaigns Electronic manufacturer of cell phones, laptops, and 1h Process tablets 1g

1i Dentistry services 1j Skateboard manufacturer 1k Landscaping company with many customers that are billed individually

Quiz Quiz

Job

Quiz

Process

Quiz

Job

Quiz

2. Indicate if any part of the following chart is incorrect.

Direct materials Direct labor Overhead recorded Overhead rate Overhead allocation bases (drivers)

Actual Costing Job Order System 1. Recorded at actual cost 2. Recorded at actual cost 3. Recorded at estimated cost 4. Overhead must be based on a single average company rate

Normal Job Order Costing System 6. Recorded at estimated cost 7. Recorded at actual cost 8. Recorded at allocated cost 9. Overhead must be based on departmental rates

5. None, since the full estimated cost is recorded

10. Must be direct labor hours or direct labor cost

Difficulty: Moderate Time on task: 10 Minutes 11

Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: There are several incorrect items listed in this chart. 3. Under an actual costing job order system, overhead is recorded at the actual costs to each individual job. This may result in a period of time between when the job is completed and when the actual overhead costs are added (allocated) to the job. 4. As overhead is allocated based on the actual overhead incurred, there is no need to develop an estimated predetermined overhead rate to allocate overhead as jobs are completed. 5. Budget overhead rates are not developed or used in an actual costing system (so the answer “None” is correct), however the cost recorded is the ACTUAL cost of overhead, not the ESTIMATED cost). 6. Under a normal costing system, direct materials and direct labor are recorded at actual costs. 9. Under a normal costing system, either a single average company rate may be used or departmental rates may be developed if cost drivers vary based on the resources used in the department. 10. Under a normal costing system, the cost driver does not have to be direct labor hours or direct labor cost, although these drivers are commonly used. The cost driver could be any activity that drives estimated overhead costs.

3. For each of the following document descriptions, give the letter of the document term that best fits the description. a. Purchase requisition b. Purchase order c.

Receiving report

d. Job cost sheet e. Materials requisition form

Time ticket or other labor tracking source such as scanning of identification badge

g. Bill of materials

1. Source document that a purchasing agent (buyer) uses to request that materials be purchased 2. Source document that includes a description of the materials, direct labor, and overhead assigned to a particular job 3. Document used to request and record materials issued and used in production 4. Document used to determine the direct labor time spent on each job 5. Request for an outside vendor to supply goods or services 6. Gives the quantity, condition, and description of goods received; vendor name; and receiving person’s approval/signature 7. List of different materials needed to manufacture a product or part Difficulty: Easy Time on task: 1 Minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Varies, see chart below #

Question

Solution

3 (1)

Source document that a purchasing agent (buyer) uses to request that materials be purchased

3 (2)

Source document that includes a description of the materials, direct labor, and overhead assigned to a particular job

3 (3)

Document used to request and record materials issued and used in production.

3 (4) Document used to determine the direct labor time spent on each job

3 (5) Request for an outside vendor to supply goods or services

3 (6)

Gives the quantity, condition, and description of goods received; vendor name; and receiving person’s approval/signature

3 (7) List of different materials needed to manufacture a product or part

c g

4. For each of the following, indicate whether the statement is true or false. a. The main difference between job order and process costing systems is the amount of detail captured for each product. b. Most companies apply indirect costs (overhead) based on direct materials because materials are tangible and visible. c. Overallocated overhead occurs when the actual overhead is less than the estimated overhead. d. If a company wants accurate job records, the company will insist on recording actual direct materials, actual direct labor, and actual overhead costs. e. Companies frequently use a normal cost system for simplicity, to smooth out the effects of seasonal fluctuations, and so that each job can be allocated a representative amount of indirect costs as the job is produced. Otherwise, a company could not assign actual correct indirect costs until the end of the period because overhead costs such as rent are spent in groups and are not individually traceable to a given job. f.

If the difference between allocated overhead and actual overhead is small, the difference is usually recorded as an adjustment of cost of goods sold rather than spread over all the jobs in the work in process, finished goods, and cost of goods sold accounts.

g. The work in process account is a temporary expense account that is reported on the income (profit/loss) statement. h. The finished goods account will have a balance at the end of the period only if some of the direct materials, direct labor, and overhead costs have not been paid by the customer. i.

If a company uses the maximum (100%) capacity when developing the overhead rates (as opposed to practical capacity), the overhead allocated to the jobs would probably be too low.

A plumbing company would probably include scrap and normal spoilage in the overhead rate since some waste is typically unavoidable.

k. Companies that use job order costing systems want to know what the various product costs and profits are on each distinct job and whether the jobs were completed on time and to customer satisfaction, as well as details of materials, direct labor, and indirect production costs. l.

If a company incurs overtime or some other specific cost because the customer asked for the job to be rushed, the overtime premium should be charged to the job rather than treated as an indirect cost.

m. Departmental rates are appropriate when not all products pass through the same processes and the departments are not similar in terms of their costs or drivers. n. Companies should only include internal data when creating predictive analytics.

Difficulty: Varies, see chart below Time on task: 2 Minute Objective: Varies, see chart below AACSB: Reflective thinking Assignment:

Varies, see chart below

Solution: Varies, see chart below #

Question

Diffic ulty

Solution

The main difference False. The main difference between job order and between job order and process costing systems is how costs are tracked. process costing systems is Mode Job costing tracks costs on an individual unit basis, 4a the amount of detail rate whereas process costing accumulates total costs for captured for each product. a product and then calculates an average cost per product. Most companies apply False. Overhead is allocated based on an estimated indirect costs (overhead) allocation base that has a relationship to the based on direct materials estimated overhead costs. Service companies 4b Easy because materials are typically use direct labor hours as the allocation base tangible and visible. because they obtain revenues by providing services to customers. Overallocated overhead occurs when the actual Mode 4c False. overhead is less than the rate estimated overhead.

Q,T, Hwk

Quiz

If a company wants accurate job records, the False. Accurate job records can be kept even if the company will insist on Diffic company decides to use a normal costing system, as 4d recording actual direct ult long as the predetermined overhead rate is based on materials, actual direct realistic estimated costs. labor, and actual overhead costs. Companies frequently use a normal cost system for simplicity, to smooth out the effects of seasonal fluctuations, and so that each job can be allocated a representative amount of indirect costs as the job is Mode 4e produced. Otherwise, a True rate company could not assign actual correct indirect costs until the end of the period because overhead costs such as rent are spent in groups and are not individually traceable to a given job. If the difference between allocated overhead and actual overhead is small, the difference is usually recorded as an adjustment 4f Easy True of cost of goods sold rather than spread over all the jobs in the work in process, finished goods, and cost of goods sold accounts. The work in process account is a temporary False. Work in process is an inventory account and is 4g expense account that is Easy reported on the balance sheet. reported on the income (profit/loss) statement. The finished goods account will have a balance at the False. The finished goods account will have an Mode 4h end of the period only if ending balance if there are job/units that have been rate some of the direct completed but not sold at the end of the period. materials, direct labor, and

Test

Hwk

Quiz

Test

overhead costs have not been paid by the customer.

If a company uses the maximum (100%) capacity when developing the overhead rates (as opposed Diffic 4i True to practical capacity), the ult overhead allocated to the jobs would probably be too low. A plumbing company would probably include scrap and normal spoilage in the Diffic 4j True overhead rate since some ult waste is typically unavoidable. Companies that use job order costing systems want to know what the various product costs and profits are on each distinct job and Mode 4k whether the jobs were True rate completed on time and to customer satisfaction, as well as details of materials, direct labor, and indirect production costs. If a company incurs overtime or some other specific cost because the customer asked for the job Mode 4l True to be rushed, the overtime rate premium should be charged to the job rather than treated as an indirect cost. Departmental rates are appropriate when not all 4 products pass through the Mode True m same processes and the rate departments are not similar in terms of their costs or

Quiz

Test

drivers.

Companies should only include internal data when 4n creating predictive analytics.

Easy

False. Companies should utilize both internal and external data when creating predictive analytics.

5. The accompanying diagram reflects the costs of various jobs for the month of September.

a. Which job has proportionately more overhead relative to direct labor? Why do you think this would occur? b. As a manager, would you prefer to see these “visual results” or would you want to see the numbers for each job? Would you want to track the proportion of the product costs per job in different periods and by customer? c. Discuss how you might use the information for managing jobs. d. What other information related to these jobs would be important to you as a manager in order to develop analytics? Difficulty: Varies, see chart below

Quiz

Time on task: Varies, see chart below Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: Varies, see chart below

Question

Diffic ulty

Which job has proportionately more overhead relative to direct Diffic 5a labor? Why do you think this would ult occur?

As a manager, would you prefer to see these “visual results” or would you want to see the numbers for Diffic 5b each job? Would you want to track ult the proportion of the product costs per job in different periods and by customer?

Discuss how you might use the information for managing jobs.

Mode rate

Time on task

Solution

Job 1 has proportionately more overhead relative to direct labor. If you were to put values into the graph, the Job 1 overhead to direct labor ratio is approximately 1.5, compared to 1.1 for Job 4. Job 1 could have more overhead relative to direct labor if direct labor hours are not the activity that drives overhead costs. For example, Job 1 could be automated and use machines to complete the job, whereas Job 4 uses significant manual (direct) labor.

Answers may vary depending on students’ background. Students who are good with numbers will probably elect to review numbers instead of a visual representation. However, the visual picture is easy for many to see, especially if differences are material.

Answers will vary. Example response: Visualizations such as a bar graph may be used to quickly identify outliers or outcomes that differ from expectations. This information can then be used to identify and correct any outliers.

What other information related to 5d these jobs would be important to you as a manager?

Mode rate

Answers will vary. Example response: Information related to spoilage, scrap, and rework would be useful to managers in manufacturing companies to evaluate and understand costs. This information can be combined with external information from employee satisfaction surveys and customer reviews and then to identify any process improvements and non–value-added activities.

6. Assume the following information for Donna Company for 2022. The company uses a normal cost system and a predetermined overhead rate based on direct labor hours. Estimated overhead Actual overhead costs incurred Actual direct labor hours worked Estimated direct labor hours

$400,000 $500,000 $13,000 $10,000

a. What is the predetermined overhead rate? Difficulty: Easy Time on task: 2 Minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: = Total estimated overhead/Total estimated direct labor hours = $400,000 estimated overhead / 10,000 estimated direct labor hours = $40 per direct labor hour

b. What is the allocated overhead? Difficulty: Easy Time on task: 2 Minutes Objective: LO2

AACSB: Application of knowledge Assignment: Quiz Solution: = Predetermined overhead rate × Actual amount of cost driver = $40 per DL hour × 13,000 actual DL hours = $520,000 allocated overhead

c. What is the under- or overallocated overhead? Difficulty: Moderate Time on task: 3 Minutes Objective: LO5 AACSB: Application of knowledge Assignment:

Quiz

Solution: Overhead was overallocated. Donna Company incurred $20,000 less overhead than was allocated for the period (actual overhead of $500,000 versus allocated overhead of $520,000).

7. Ellen’s Company produces boxes. In 2022, the company incurred the following costs: Indirect labor Indirect materials Factory utilities and taxes Factory depreciation and rent Direct materials Selling costs Administrative costs Direct labor Sales

$10,000 $4,000 $5,000 $6,000 $27,000 $9,000 $8,000 $30,000 $120,000

There were no balances in the beginning or ending work in process and finished goods inventories. The company uses a normal cost system and applies overhead based on 90% of direct labor cost.

a. What is the amount of allocated overhead? Was overhead over- or underallocated? By what amount? Difficulty: Moderate Time on task: 5 Minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: Step 1: Calculate allocated overhead. Allocated overhead = Overhead rate × Driver Allocated overhead = 90% × $30,000 = $27,000 Step 2: Calculate actual overhead. Actual overhead equals the summation of costs that cannot be directly traced. Actual overhead = $10,000 Indirect labor + $4,000 Indirect materials + $5,000 Factory utilities and taxes + $6,000 Factory depreciation and rent = $25,000 Step 3: Calculate the difference between actual and allocated overhead. Actual overhead $25,000 – Allocated overhead $27,000 = Over-allocated by $2,000

b. What are the period costs? Difficulty: Moderate Time on task: 2 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: Period costs are costs generated by activities that are not a necessary part of the manufacturing process. They are usually associated with the selling and/or general administration of the business. Examples of period costs from this problem include selling costs and administrative costs.

c. What are the total product costs? Difficulty: Moderate Time on task: 2 Minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: Product costs consist of all direct and indirect costs of manufacturing a product, including direct materials, direct labor, and overhead. In a normal costing system, direct materials and direct labor are recorded as the actual amounts, and overhead is allocated based on a predetermined overhead rate, Calculate total product costs: Total product cost = Actual direct labor + Actual direct materials + Allocated overhead Total product cost = $30,000 DL + $27,000 DM + $27,000 OH = $84,000

d. What is the gross margin? Difficulty: Difficult Time on task: 5 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: Calculate gross margin: Gross margin = Sales – COGS (or product costs) + Overallocated overhead Gross margin = $120,000 – $84,000 + Overallocated overhead $2,000 = $38,000

8. You have been hired by the company president to review the records of Fast Shipping Company. You found that the sales department has reported 20% of jobs as “sold,” even though the customers have not formally accepted the jobs. When you asked the sales manager, he explained that in the past customers always agreed to the jobs if the company got preliminary approval for the jobs. The sales manager is confident that the customers will, in fact, agree to the jobs and explains that those jobs are needed as “sales” so that salespeople can earn their commissions during this period and the company reports a favorable sales growth trend. In Chapter 1, you learned that the Institute of Management Accounting’s Standards of Ethical Professional Practice are competence, confidentiality, integrity, and credibility. Identify and discuss which standards of ethical conduct the sales manager, the president, and you would be violating if you agree with the sales manager’s reported sales. Be specific. What other information would you want to know? What should you do? Difficulty: Moderate Time on task: 5 Minutes Objective: LO6 AACSB: Reflective thinking Assignment: Quiz Solution: You would be violating three of the IMA’s Standards of Ethical Professional Practice: competence, integrity, and credibility. The competence standard requires accountants to perform professional duties in accordance with all laws, regulations, and policies and to provide decision support information and recommendations that are accurate, clear, concise, and timely. The integrity standard requires members to be honest and trustworthy at all times, no matter what the circumstance. If you do not disclose that sales are being reported inaccurately in your findings report, you are not being honest and trustworthy and therefore, you will lack integrity. Further, you will lack credibility because you did not present information fairly, objectively, and without bias. You should also investigate and inquire of management to determine whether the sales process is following other non-GAAP practices. Based on your initial findings, it appears that the company is recording sales too early in the process in an effort to boost sales numbers. Thus, you should question whether other problematic issues are occurring related to sales returns and/or discounts. You should discuss your concerns with the person overseeing your review—in this case, the company president. You should mention that you believe reported sales may be inaccurate and you do not want to act without integrity or credibility. If the president dismisses your concerns, you should include discussion of your findings in your report/analysis.

9. Assume that a normal costing system is used. Estimated overhead was $100. Estimated practical capacity hours were 50. Actual hours worked were 54. What was the over- or underallocated overhead? Difficulty: Moderate Time on task: 5 Minutes Objective: LO4, LO5 AACSB: Application of knowledge Assignment: Test Solution: Step 1: Calculate the predetermined overhead rate. Overhead rate = $100 Estimated overhead/50 Estimated hours = $2 per hour Step 2: Calculate the difference between actual and estimated capacity. Capacity difference = 54 actual hours worked – 50 estimated hours = 4 additional hours Step 3: Calculate the over-/underallocated overhead. Underallocated overhead = 4 additional hours worked × $2 per hours = $8 underallocated overhead.

10. Mignon Company has estimated overhead of $50,000 in 2022 ($10,000 in Department 1 and $40,000 in Department 2), and estimates a total of 10,000 machine hours in each of its two departments (20,000 machine hours total). The company has two jobs. Each job produces 4,000 units. Both jobs pass through two departments. Department 1 incurs $10,000 of overhead. Department 2 incurs $40,000 of overhead. The jobs use the following actual machine hours in each department:

Job 600: machine hours Job 601: machine hours Total

Department 1 8,000 2,000 10,000

Department 2 2,000 8,000 10,000

Total 10,000 10,000 20,000

a. If the company allocates overhead based on total machine hours, how much will be allocated to each job and each unit?

Difficulty: Moderate Time on task: 5 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: Overhead rate = Estimated overhead/Estimated cost driver Estimated overhead $50,000 Total estimated machine hours 20,000 Overhead rate $2.50 per MH

Job

Overhead Rate

Job 600 Job 601

$2.50 per MH $2.50 per MH

Units Overhead Cost per Unit Produced 10,000 machine hours $2.50 × 10,000 = $25,000 4,000 $25,000/4,000 = $6.25 10,000 machine hours $2.50 × 10,000 = $25,000 4,000 $25,000/4,000 = $6.25 Actual Activity

Overhead Allocated

b. If the company uses departmental rates based on machine hours for each department, how much will be allocated to each job and each unit? Difficulty: Moderate Time on task: 10 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: Department 1 Overhead rate = Estimated overhead/Estimated cost driver Estimated overhead $10,000 Total estimated machine hours 10,000 Overhead rate $1.00 per MH

Department 2 Overhead rate = Estimated overhead/Estimated cost driver

Estimated overhead Total estimated machine hours Overhead rate

Job Job 600: Dept 1 Job 600: Dept 2 Job 600: Total

$40,000 10,000 $4.00 per MH

Overhead Rate Actual Activity Overhead Allocated Units Overhead Cost $1.00 per MH 8,000 machine hours $1.00 × 8,000 = $8,000 Produced per Unit $4.00 per MH 2,000 machine hours $4.00 × 2,000 = $8,000 $16,000 4,000 $4.00 per unit

Job Overhead Rate Actual Activity Overhead Allocated Units Overhead Job 601: Dept 1 $1.00 per MH 2,000 machine hours $1.00 × 2,000 = $2,000 Produced Cost per Unit Job 601: Dept 2 $4.00 per MH 8,000 machine hours $4.00 × 8,000 = $32,000 Job 601: Total $34,000 4,000 $8.50 per unit

c. Which approach should Mignon use: single rate based on total hours or departmental rates? Why? Be specific. Difficulty: Difficult Time on task: 5 Minutes Objective: LO6 AACSB: Reflective thinking Assignment: Test Solution: Cost per Unit Single Overhead Rate

Departmental Overhead Rate

Job 600

$6.25

$4.00

Job 601

$6.25

$8.50

Mignon should use departmental rates to allocate overhead to each job. Under a single overhead rate, the cost per unit would be the same for both jobs. However, using departmental overhead rates, since Job 601

uses more of Department 2’s expensive machine hours, Job 601 is much more expensive than Job 600. Under a single overhead rate Job 600 would be overcosted and Job 601 would be undercosted. As an initial step in using descriptive analytics, the information obtained from tracking overhead utilizing departmental rates is more precise than total hours, and thus, is useful for making many strategic and operational decisions. For example, it might be used to identify and implement process improvements or to reduce costs without decreasing customer satisfaction or quality. Further, the company can eliminate unnecessary costs or non–value-added activities, which will ensure the company is providing the best-quality product to its customers at the lowest possible cost.

d. Which poor business decisions would be affected by the wrong choice of overhead allocation bases? Difficulty: Moderate Time on task: 5 Minutes Objective: LO6 AACSB: Reflective thinking Assignment: Test Solution: Students’ answers will vary. Management may inappropriately conclude that Job 600 and Job 601 have similar product costs. Data analytics would suggest that such simplistic allocation of overhead could result in a variety of poor decisions. A few examples include pricing of products, poor cost-cutting decisions (e.g., attempt to cut costs by using materials of inferior quality), expanding or eliminating a product line, or other decisions that do not help the company’s overall profitability.

11. HEW estimates 2022 factory overhead at $320,000 and direct labor cost at $200,000. Direct labor hours are estimated to be 20,000. Cost information for the month of April, 2022 is as follows: Actual factory overhead Estimated factory overhead Estimated direct labor costs

$42,000 $320,000 $200,000

Estimated direct labor hours

Job Job 55 Job 56

Actual Direct Labor Hours 900 DL hours 2,200 DL hours

Total

3,100 DL hours

20,000

Actual Direct Labor Cost $9,400 $20,000 $29,400

a. If factory overhead is allocated using a predetermined overhead rate based on direct labor cost, what is the amount of overhead assigned to each job? Difficulty: Moderate Time on task: 5 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: Overhead rate = Estimated overhead / Estimated cost driver Estimated overhead Estimated direct labor cost Overhead rate

Job Job 55 Job 56

Overhead Rate 160% of DL cost 160% of DL cost

$320,000 $200,000 160% of direct labor cost

Actual Activity $9,400 direct labor cost $20,000 direct labor cost

Overhead Allocated 160% × $9,400 = $15,040 160% × $20,000 = $32,000

b. If factory overhead is allocated using a predetermined overhead rate based on direct labor hours, what is the amount of overhead assigned to each job? Difficulty: Moderate Time on task: 5 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework

Solution: Overhead rate = Estimated overhead / Estimated cost driver Estimated overhead $320,000 Estimated direct labor hours 20,000 Overhead rate $16 per DL hour

Job Job 55 Job 56

Overhead Rate $16 per DL hour $16 per DL hour

Actual Activity 900 DL hours 2,200 DL hours

Overhead Allocated $16 × 900 = $14,400 $16 × 2,200 = $35,200

c. If the overhead allocations are not significantly different, which allocation base do you believe would be easier to use, from a cost-benefit perspective? Difficulty: Moderate Time on task: 5 Minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Students’ answers will vary. Overhead allocations are not significantly different based on the two allocation bases. Determining which base would be easier to use depends on the information technology environment set up at the company. For example, if employees track their hours by job via swiping their ID badges when working on specific jobs, then the data is automatically stored in a database. This makes it easier to query information and/or systematically apply the overhead allocation calculation to each job. However, if employees use manual timesheets to track hours worked, then direct labor cost would be an easier base to use to allocate overhead.

d. If factory overhead is allocated using a predetermined overhead rate based on direct labor cost, what is the amount of over- or underallocated overhead? Difficulty: Easy Time on task: 2 Minutes Objective: LO5 30

AACSB: Application of knowledge Assignment: Homework Solution: Over-allocated by $5,040: = Allocated overhead based on direct labor cost – Actual overhead = (Job 55 $15,040 + Job 56 $32,000) – $42,000 = $5,040 Overhead is overallocated since the total amount of overhead allocated exceeds the actual overhead for April 2022. Note: allocated overhead on direct labor costs was calculated in part a.

Problems 1. CMG uses a normal job order costing system and applies overhead on the basis of direct labor hours. At the beginning of 2022, management estimated that 250,000 direct labor hours would be worked and $400,000 of overhead costs would be incurred. During 2022, the company had 270,000 direct labor hours and incurred the following production costs: Prime costs (direct materials and direct labor) Indirect materials and indirect labor Insurance and utilities Depreciation and repairs Cost of jobs completed during the year

$730,000 $110,000 $125,000 $175,000 $200,000

a. What was the predetermined overhead rate? Difficulty: Moderate Time on task: 3 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: $1.60

Predetermined overhead rate = Estimated manufacturing overhead costs/Estimated allocation base Predetermined overhead rate = $400,000/250,000 direct labor hours = $1.60 per direct labor hour

b. What was the amount of overhead allocated during the year? Difficulty: Moderate Time on task: 4 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: $432,000 Allocated overhead = Predetermined overhead rate × Actual allocation base Allocated overhead = $1.60 (from Problem 1a) × 270,000 actual direct labor hours = $432,000

c. What was the ending balance of the work in process inventory? Assume there was no beginning work in process inventory. Difficulty: Moderate Time on task: 5 Minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: $962,000 Work in Process Inventory Beginning balance $0 + Prime costs $730,000 – COGM $200,000 + Overhead $432,000 Ending balance $962,000

2. Sue Enterprises uses a normal job order costing system and a predetermined overhead rate based on machine hours. At the beginning of 2022, Sue estimated the overhead for the year would be $720,000 and that production would use 90,000 machine hours. The following information relates to the month of August, when two jobs were worked on:

Work in process, August 1 Direct materials cost Direct labor costs Direct labor hours Machine hours

Job 125 $10,000 $15,000 $24,000 2,000 1,500

Job 126 $14,000 $20,000 $31,000 3,000 2,200

a. If actual overhead in August was $35,000, what was overhead allocated? Difficulty: Moderate Time on task: 5 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: $29,600 You first have to determine the predetermined overhead allocation rate, then allocate the calculated overhead rate based on actual usage during August. (1) Predetermined overhead rate = Estimated manufacturing overhead costs/Estimated allocation base Predetermined overhead rate = $720,000 / 90,000 machine hours = $8 per MH (2) Allocated overhead = Predetermined overhead rate × Actual allocation base Allocated overhead = $8/MH × (1,500 MH for Job 125 + 2,200 MH for Job 126) = $8/MH × 3,700 actual MH = $29,600

b. Assume Job 125 was completed. What was the cost of Job 125? Difficulty: Moderate 33

Time on task: 5 Minutes Objective: LO3 AACSB: Application of knowledge Assignment: Test Solution: $61,000 Beginning balance WIP $10,000 + Direct materials $15,000 + Direct labor $24,000 + Allocated overhead* $12,000 = Total cost of Job 125 $61,000 * Allocated overhead is calculated as predetermined overhead rate ($8 per MH as calculated in Problem 2a) × actual number of machine hours (1,500).

c. If Job 126 was both finished and sold, what was the cost of Job 126 that was transferred to cost of goods sold? Difficulty: Moderate Time on task: 5 Minutes Objective: LO3 AACSB: Application of knowledge Assignment: Test Solution: $82,600 Beginning balance WIP $14,000 + Direct materials $20,000 + Direct labor $31,000 + Allocated overhead* $17,600 = Total cost transferred to Finished Goods/CoGS $82,600 * Allocated overhead is calculated as predetermined overhead rate ($8 per MH as calculated in Problem 2a) × actual number of machine hours (2,200).

3. Refer to the information in Problem 2. Record the information in the T-accounts. [Click here for blank T-accounts.] Difficulty: Difficult Time on task: 7 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: [Click here for T-account solution]

4. Precious Glassworks, Inc., produces unique hand-blown glass light fixtures for custom-built homes and uses a job order costing system for its production costs. The company bases its predetermined overhead rate on the estimated number of firing hours and uses actual firing hours to apply overhead to individual jobs. Estimated overhead for 2022 is $48,000, and estimated firing hours are 800 for the year. The following information is for the month of December: ● Firing hours used for each job in December were as follows: 72 hours for Job 120; 100 hours for Job 121; and 88 hours for Job 122. ● On December 1, only Job 120 was in process and only Job 109 was complete. ● During the month, Jobs 120 and 121 were completed. ● Job 121 shipped on December 30, but Jobs 109 and 120 were not shipped until January 2, 2023. ● Job 122 is the only job currently left in production on December 31. Beginning Inventories, 12/1/21 Direct materials Work in process: Job 120 Finished goods: Job 109

$3,500 $5,000 $18,000

Materials Requisitioned for Production Job 120 Job 121 Job 122

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

Labor Costs Job 120 Job 121 Job 122 Production foreman Sales commissions

$3,000 $5,000 $2,500 $5,000 $8,000

Production Costs Purchases of Direct Materials Facilities Utilities Maintenance

$8,000 $2,500 $2,000 $1,500

a. Compute the predetermined overhead rate. Difficulty: Moderate Time on task: 3 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: $60/firing hour Predetermined overhead rate = Estimated manufacturing overhead costs/Estimated allocation base = $48,000 / 800 estimated firing hours = $60 / firing hour

b. Compute the total overhead costs allocated to all jobs during December. Difficulty: Moderate Time on task: 4 Minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework

Solution: $15,600 Allocated overhead = Predetermined overhead rate × Actual allocation base Job 120 Job 121 Job 122 Predetermined overhead rate (from Total Problem 4a) $60 $60 $60 Overhead × Actual firing hours 72 100 88 Total overhead $4,320 $6,000 $5,280 $15,600

c. Was overhead underallocated or ove-allocated in the month of December? Difficulty: Moderate Time on task: 4 Minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: Under-allocated Compare actual overhead costs to total allocated costs. Actual Overhead Indirect labor: production foreman Facilities Utilities Maintenance

$5,000 $2,500 $2,000 $1,500

Total actual overhead

$11,000

Compare this result to the Problem 4b solution of $15,600. Overhead was overallocated because more overhead was allocated than the actual overhead costs incurred.

d. What is the balance of work in process on December 31? Difficulty: Moderate Time on task: 4 Minutes

Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: $9,280 Job 122 was the only job still in process as of December 31. The total cost is:

Beginning balance Direct materials Direct labor Overhead Total cost

Job 122 $0 $1,500 $2,500 $5,280 $9,280

e. Compute the cost of goods available for sale in December. Difficulty: Moderate Time on task: 6 Minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: $46,820 The cost of goods available for sale in December includes the total cost of all jobs waiting to be sold as of December 1 (Job 109) and any jobs completed during the month (Jobs 120 and 121). Using T-accounts: The total cost of goods available for sale is the sum of all increases (left column) to finished goods. Job 109 Job 120 Job 121

$18,000 $14,320 $14,500

Total

$46,820

Not using T-accounts: (1) Calculate the cost of Jobs 120 and 121, which were completed during December. The total cost of each job includes the beginning balance, direct materials requisitioned for production, direct labor incurred during the month, and allocated overhead. Job 120 Job 121 $5,000 $0 Beginning balance $2,000 $3,500 Direct materials $3,000 $5,000 Direct labor $4,320 $6,000 Overhead $14,320 $14,500

Total

(2) Add together the cost of Jobs 109, 120, and 121. Job 109 Job 120 Job 121

$18,000 $14,320 $14,500

Total

$46,820

f. What is the balance of finished goods inventory on December 31? Difficulty: Moderate Time on task: 3 Minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: $32,320 Jobs 109 and 120 are the two jobs left completed and not sold as of December 31, 2020. Job 109 = $18,000 and Job 120 = $14,320, for a total ending balance in finished goods of $32,320.

g. What was the reported cost of goods sold on the income statement for December 31, 2022? Difficulty: Difficult Time on task: 2 Minutes 39

Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: $17,650 Only one job was sold in December, Job 121. The total cost of Job 121 was $14,500. Additionally, the company needs to close out the overhead account for the difference between actual and allocated overhead. Actual overhead was $11,000 (from (c)), while allocated overhead was $15,600 (from (b)). As the overhead is overallocated, the $4,600 difference is subtracted from cost of goods sold. Total COGS = $14,500 – $4,600 = $9,900.

5. Refer to the information in Problem 4. Record the information in the T-accounts. [Click here for T-account to be completed] Difficulty: Difficult Time on task: 7 Minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Click here for T-account solution

6. The Moez Company uses a normal job order cost system. Other data: • There are three jobs that pass through the two production departments. • Job 401 and Job 402 were completed and sold during January. • Job 403 was not completed as of December 31, 2022. • The company considers under- or overallocated overhead immaterial. Departments Department 1 Department 2

Actual Direct Labor Rates $ 12 per hour $ 15 per hour

Budget Overhead Driver Rates $10 per machine hour 150% of direct labor cost Job 401

Job 402

Job 403

Actual Overhead $ 45,000 $ 60,000 Total

Work in Process 01/01/2022 Direct materials: Department 1 Department 2 Direct labor cost: Department 1 Department 2 Machine hours: Department 1 Department 2

$20,000

$34,000

$11,000

$65,000

$40,000 $5,000

$26,000 $8,000

$50,000 $116,000 $12,000 $25,000

$9,000 $11,000

$12,000 $16,000

$7,000 $9,000

$28,000 $36,000

800 130

1,200 250

2,300 180

4,300 560

Job 401

Job 402

Job 403

Department 1 $10/machine hour × actual machine hours Department 1 allocated overhead

$10 800 $8,000

$10 1,200 $12,000

$10 2,300 $23,000

Department 2 150% of direct labor cost × actual direct labor cost Department 2 allocated overhead

150% $11,000 $16,500

150% $16,000 $24,000

150% $9,000 $13,500

Total overhead

$24,500

$36,000

$36,500

Total for all jobs

$97,000

a. What was the total allocated overhead during 2022? Difficulty: Difficult Time on task: 5 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: $97,000 Overhead Calculation:

What was the cost of work in process on December 31, 2022? Difficulty: Moderate Time on task: 6 Minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: $125,500 (1) Calculate the cost of all the jobs. The total cost of each job includes the beginning balance, direct materials requisitioned for production, direct labor incurred during the month, and allocated overhead. (2) Reduce WIP for Jobs 401 and 402, which were completed by December 31, 2022. Job 401

Job 402

Job 403

Total

Work in process 1/1/22

$20,000

$34,000

$11,000

$65,000

Direct materials

$45,000

$34,000

$62,000

$141,000

Direct labor cost

$20,000

$28,000

$16,000

$64,000

Overhead

$24,500

$36,000

$36,500

$97,000

Total cost to account for Completed and transferred to finished goods

$109,500

$132,000 $125,500

$367,000

(109,500)

(132,000)

(241,500)

$0 $125,500

$125,500

Work in process 12/31/22

Job 403 was the only job still in process as of December 31. The total cost is: Job 122 Beginning balance $11,000 Direct materials $62,000 Direct labor $16,000 Overhead $36,500 Total WIP Inventory $125,500

c. What was the value of the cost of goods sold account before any adjustment for over- or underallocated overhead?

Difficulty: Moderate Time on task: 6 Minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: $241,500 Finished goods 1/1/22 Completed during the year: Job 401 Job 402 Cost of goods available Sold during the year: Job 401 Job 402 Finished goods 12/31/22

$0 $109,500 $132,000 $241,500 (109,500) (132,000) $0

Jobs 401 and 402 were completed and sold as of December 31, 2020. Cost of goods sold is: Job 401 Job 402 Cost of goods sold

$109,500 $132,000 $241,500

d. What was the value of the cost of goods sold account after any adjustment for over- or underallocated overhead? Difficulty: Moderate Time on task: 6 Minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: $249,500

Compare actual overhead costs to total allocated costs.

Actual overhead Department 1 Department 2

$45,000 $60,000

Total actual overhead Total allocated overhead calculated in Problem 6a Underallocated overhead

$105,000 $97,000 $8,000

The company considers the underallocated overhead (less overhead allocated than actual overhead costs) of $8,000 to be immaterial, so the difference is written off to the cost of goods sold account. Cost of goods sold, before overhead adjustment Underallocated overhead Cost of goods sold, after overhead adjustment

$241,500 $8,000 $249,500

e. Why would a company use machine hours to assign overhead in one department and direct labor dollars in another department? Difficulty: Moderate Time on task: 3 Minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: When selecting the appropriate driver for costs (descriptive analytics), it is critical to select the driver that has a logical cause-and-effect relationship with costs incurred. For example, the company has chosen to allocate overhead costs for Department 1 based on machine hours because there is a strong cause-and-effect relationship between overhead costs and machine hours (high volume of machine hours). f.

If the company sells the jobs at a 20% margin based on cost, what was the selling price of Job 401?

Difficulty: Moderate Time on task: 3 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: $131,400 Cost of goods sold, after overhead adjustment (see Problem 6b for the calculation)

$109,500

Margin of 20% based on cost Margin + Cost of goods sold Selling price

20% $21,900 $109,500 $131,400

7. Refer to the information in Problem 6. Record the information in the T-accounts. [Click here for T-account to be completed.] Difficulty: Difficult Time on task: 10 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: Click here for T-account solution

8. Morgan Company, which uses a normal job order cost system, has recorded the following information in its ledgers for several jobs during July 2022. Analyze the numbers given as well as the missing data. [Click here for T-account to be completed.] Beginning work in process consisted of partial work on Jobs 330 and 331. Other overhead incurred (besides indirect materials and indirect labor) included factory insurance, utilities,

depreciation, and rent. Job 330 was completed and sold. Job 331 was completed but not sold. Job 332 is still not completed. a. What was actual overhead? Difficulty: Moderate Time on task: 3 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: $15,000 Actual overhead incurred includes the costs of indirect materials, indirect labor, and other costs. These costs are recorded on the debit (left) side of the overhead T-account. Indirect materials (IM) Indirect labor (IL) Other (OTH) Actual overhead

$4,000 $3,000 $8,000 $15,000

b. What was the cost of goods manufactured? Difficulty: Moderate Time on task: 3 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: $56,000 The cost of goods manufactured represents the cost of products completed during the period. The costs would be moved out of work in process and into finished goods. In the T-accounts, this amount is the $56,000 credit (right side) of the work in process accounts.

c. Give each of the product costs for Job 332. 46

Difficulty: Moderate Time on task: 5 Minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution:

DM: $10,000 DL: $6,000 OH: $5,000

The work in process T-account includes aggregated balances of direct materials, direct labor, and overhead. To calculate the product costs for Job 332, reduce the total cost for each product cost by the costs allocated to the other two jobs. Total Overhead Product Cost $14,000 $31,000 $18,000 $14,000 $77,000 ($8,000) ($9,000) ($5,000) ($4,000) ($26,000) ($6,000) ($12,000) ($7,000) ($5,000) ($30,000)

Beginning Direct Balance Materials

Direct Labor

$6,000

Per work in process Less: Cost allocated to Job 330 Less: Cost allocated to Job 331 = Cost allocated to Job 332

$10,000

$5,000

$21,000

Hint: The total product cost for Job 332 should equal the ending balance in work in process, as this job is still in process as of the end of the period.

d. What is the amount in cost of goods sold after adjusting for the difference between allocated and actual overhead? Difficulty: Difficult Time on task: 3 Minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: $27,000

(1) Calculate over-/underallocated overhead, which represents the difference between actual overhead and allocated overhead. Actual overhead See Problem 8a solution. – Allocated overhead See credit in the overhead T-account. = Underallocated overhead

$15,000 ($14,000) $1,000

(2) Calculate cost of goods sold. Cost of goods sold represents the total cost of the products sold during the period and is represented as a credit in the finished goods account. To solve for the unknown in the finished goods account, start with the beginning balance $0 + COGM $56,000 – ending balance $30,000 = $26,000. (3) Calculate the adjusted cost of goods sold by adding unallocated overhead to the cost. Cost of goods sold, unadjusted + Underallocated overhead = Cost of goods sold, adjusted

$26,000 $1,000 $27,000

9. You have been hired as a consultant to analyze the production job costs for a prestigious financial services company. Your analysis reveals that many tasks that were subcontracted out at cheaper rates in another country were deemed to be of inferior quality. Moreover, the single average rate used to apply overhead to these cheaper direct labor rates did not seem to correlate with the costs of specific jobs. You discuss your findings with a senior member of management. His response is that in the long run, all costs average out and it is important to be competitive in the short run to gain market share. Moreover, he explains that it is not illegal or against any specific accounting rule and, therefore, not unethical to use cheaper labor or to allocate costs based on those cheaper labor rates. In Chapter 1, you learned that the Institute of Management Accounting’s Standards of Ethical Professional Practice call for competence, confidentiality, integrity, and credibility. Identify and discuss which standards of ethical conduct you believe could be compromised by management and you in this scenario. Be specific. What other information would you want to know? What should you do? Difficulty: Moderate

Time on task: 8 Minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: You would be violating three of the IMA’s Standards of Ethical Professional Practice: competence, integrity, and credibility. The competence standard requires accountants to perform professional duties in accordance with all laws, regulations, and policies and to provide decision support information and recommendations that are accurate, clear, concise and timely. The integrity standard requires members to be honest and trustworthy at all times, no matter what the circumstance. If you do not include discussion of your findings in your analysis, you are not being honest and trustworthy and, therefore, lack integrity. Further, you will lack credibility because you did not present information fairly, objectively, and without bias. You should perform your own research to determine the validity of senior management’s claim that it is not illegal or against any specific accounting rule to allocate costs based on cheaper labor rates. If your independent research shows that it is illegal and/or against accounting rules to do so, then you should include these findings in your report and cite specific laws/rulings. You should discuss your concerns with the person overseeing your analysis. You should mention that you believe that many tasks that were subcontracted out at cheaper rates in another country were deemed to be of inferior quality, and that a single average rate used to apply overhead to these cheaper direct labor rates did not seem to correlate with the costs of specific jobs. You should further mention your discussion with senior management regarding your findings and the response to them. Lastly, you should provide your own independent research regarding the legality and ethical nature of these business practices.

10. Following are the 2022 estimated and actual recorded subsidiary ledger results from several jobs for an architectural firm:

Bid sales price: at 120% of estimated costs Actual direct materials Actual direct labor Allocated overhead: at 40% of direct labor Recorded job margin

Job 24

Job 26

Job 29

$15,600

$26,400

$44,000

(3,000) (10,000) (4,000) ($1,400)

(5,000) (12,000) (4,800) $4,600

(7,000) (20,000) (8,000) $9,000

The president is concerned with the wide differences and with the loss on Job 24.

a. Estimated costs per job used to calculate the bid sales price are as follows:

Estimated costs

Job 24 $13,000

Job 26 Job 29 $22,000 $36,667

Compare the estimated costs to the total actual recorded cost per job. Difficulty: Moderate Time on task: 7 Minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Actual direct materials Actual direct labor Actual allocated overhead

Job 24 Job 26 Job 29 $3,000 $5,000 $7,000 $10,000 $12,000 $20,000 $4,000 $4,800 $8,000

Equals actual recorded costs Estimated costs Variance (actual versus estimated)

$17,000 $13,000 $4,000

$21,800 $22,000 -$200

$35,000 $36,667 -$1,667

b. Discuss reasons why the estimated job costs and the recorded job costs may be different. Difficulty: Moderate Time on task: Minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Students’ answers will vary. It is not uncommon for recorded job costs to differ from estimated costs, as even very precise estimates are ultimately based on assumptions and

cannot anticipate all future events. For example, the estimated cost of direct materials may vary from the recorded materials due to a change in vendors and, therefore, possible changes in contracted material pricing. It is important for management to be aware of the amount by which recorded costs varied from estimated costs and to determine whether the amount is immaterial or warrants further research using diagnostic analytics.

c. The president is concerned with assigning all indirect costs based on architects’ hours (direct labor). Do you believe that some overhead costs may relate to drivers (bases) other than the architects’ time causing distortions in applying a single driver overhead rate? Discuss possible improvements in this process. Difficulty: Moderate Time on task: 5 Minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: It is possible that some overhead costs relate to drivers (bases) other than the architects’ time, and if material, would cause material distortions in application of indirect costs. For example, architects utilize specialized software to generate drawings and proposals. If the total cost of this software is not traceable to one specific project, then it is an indirect cost that should be allocated based on a driver. As use of the software is required for all projects, regardless of size or complexity, it may be more logical to use the number of projects as a driver for this specific cost.

d. What other information would you like to know about this situation? Difficulty: Moderate Time on task: 3 Minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: Part of diagnostic analytics includes understanding the various costs that comprise the overhead, as well as understanding the activities that drive 51

these costs, to determine the appropriate driver (base). Management needs to consider the cost-benefit constraints when determining whether to allocate indirect costs based on multiple/departmental drivers as opposed to a single driver, as well as the additional cost (if any) to track each driver utilized. e. Which business decisions would be affected if the company uses incorrect estimated and recorded costs per job? Difficulty: Moderate Time on task: 5 Minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: Both strategic and operational business decisions would be affected if the company uses incorrect estimated and recorded costs per job. Strategic business decisions affected might include pricing jobs and products to cover costs, analyzing job profitability, changing or eliminating unprofitable jobs, and identifying process improvements and supplier (vendor) reliability. Operational business decisions affected might include employee scheduling, job completion time and on-time deliveries, job errors, scrap and rework, and unexpected machine downtime.

Chapter 4 End of Chapter and Solutions

Discussion Questions 1. With respect to indirect costs, explain the difference between a single overall plantwide rate and a departmental rate. Difficulty: Easy Time on task: 5 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Homework Solution: A single overhead rate is computed by estimating the total expected indirect costs and dividing this amount by a single estimated denominator, or cost driver. For departmental rates, indirect costs by each department would be estimated, an applicable cost driver per department would be determined, and separate rates for each department’s indirect cost would be computed. This approach is more complex and costly than a single overhead rate but provides a better representation of what each product or job costs.

2. Which steps must an organization take to implement an activity-based costing (ABC) system? Difficulty: Easy Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Test Solution: Stage 1: The first stage captures the resources used and assigns them to activities being performed using resource drivers, or the activities that make costs increase. 1

Stage 2: The second stage assigns the activities and related costs to cost objects using activity drivers, which are the portions of the activities being performed that the products, jobs, services, or customers are using.

3. Discuss the benefits and drawbacks of ABC. Difficulty: Easy Time on task: 5 minutes Objective: LO6 AACSB: Application of knowledge Assignment: Homework Solution: A key benefit of the ABC system is more precise and readily available information regarding product costs and activities. Management can utilize this information to identify unprofitable products, services, or customers. Further, management can utilize this information to identify non–value-added activities and eliminate them. A key drawback of the ABC system is that it is costly and time-consuming to research, plan, implement, and control. Management should consider the cost of obtaining better information and ensure the benefits outweigh the costs. Some companies use activity-based costing as an analytical tool rather than converting their entire cost accounting system.

4. Companies frequently react to economic downturns by downsizing the workforce (firing employees). Describe in detail how activity-based management (ABM) could assist companies in making decisions and perhaps promote other reactions. Difficulty: Easy Time on task: 5 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework

Solution: Management often mistakenly assumes it can control costs by simply reducing the number of employees without having an understanding of the tasks being performed by these workers. ABM could assist companies in making decisions and managing costs by focusing on understanding the source of costs and then taking appropriate actions to improve processes rather than making across-theboard cuts.

5. Are ABC and ABM applicable only to the production of products, or can they be used for providing services? Explain. Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Quiz Solution: ABC and ABM are applicable to the production of products (manufacturing industries) and to the provision of services (service industry). In both types of industries, it is necessary to allocate and manage costs by activity to achieve a better understanding of the product’s or service’s true cost.

6. Give an example of how ABC can be useful in assigning general, selling, and administrative costs to various customers so that the customers are properly charged. Difficulty: Difficult Time on task: 5 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Students’ answers may vary, but all should relate to specific selling, general, and administrative costs (e.g., administrative salaries) and how the consumption by customers may differ. For example, one customer may require a significant amount of printing, emailing, and communication performed by an administrative

assistant. It would be useful to allocate the administrative assistant’s salary to each customer based on the number of copies made to better estimate the total costs required for a customer.

7. ABC and ABM can help companies identify ways to improve certain situations and develop measures to assess quality, efficiency, flexibility, and reduction of costs through a focus on prevention rather than control of costs. Describe a situation from either your work or your college experience that could benefit from the same analysis. Difficulty: Moderate Time on task: 10 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: Answers will vary.

8. How can ABM be integrated with other managerial accounting tools and data analytics? Difficulty: Moderate Time on task: 5 minutes Objective: LO7 AACSB: Application of knowledge Assignment: Test Solution: ABC and ABM can be integrated with other management accounting tools and data analytics to help identify opportunities for improvements within the organization. Examples of management accounting tools that could be integrated with ABM include the following: ● Total quality management (TQM) is a concept that emphasizes continuous quality improvements within the organization. ● Lean manufacturing is a concept that emphasizes continually striving to eliminate all non–value-added activities. ● Just-in-time (JIT) manufacturing is a concept that emphasizes reducing or eliminating carrying costs for inventory and materials handling costs by

●

applying a “pull” manufacturing approach as opposed to the traditional “push” approach. Descriptive and diagnostic analytics can be used to identify, describe, and visualize correct job, product and customer profitability as well as suggested improvements.

9. Sometimes, through ABM, management finds that the customers who were thought to be “low cost and profitable” are actually “high cost and unprofitable.” Explain. Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: If a company does not understand its costs and the ways in which resources are being used, the more complex products (in the example in the chapter, the more expensive diners) may have been assigned too little of the cost (undercosted), while the simpler products (in the chapter example, the less expensive diners) may have been assigned too much (overcosted). If costs are allocated based on an incorrect driver, this may result in an inaccurate depiction of the total costs and, therefore, overall profitability.

10. One of the key components of ABM is the analysis of value-added activities and non–valueadded activities. Contrast the two types of activities. Difficulty: Easy Time on task: 3 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: Activities are deemed to be value-added if the actions need to be done, customers are willing to pay for them, and the activities are performed efficiently. Non–value-added activities are candidates for either elimination of unneeded tasks or improvement of the way the activities are done. 5

11. Why does ABC correct the allocation of primarily batch and product- or customer-sustaining costs rather than correcting the allocation of unit or facility-sustaining costs? Difficulty: Difficult Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Generally, the allocation of unit and facility-sustaining costs does not differ under the traditional costing approach and the ABC approach. ● Unit costs are already allocated appropriately on a per-unit basis (e.g., machine hours per product are already appropriately allocated by determining the machine hours used by each product), so ABC does not correct costing of unit costs. ● Facility-sustaining costs usually cannot be traced to certain activities or resources used, so these costs may not be allocated to individual products, or they may be averaged for all products, services, jobs, or customers.

12. There is a saying, “It is better to be approximately right than precisely wrong.” Discuss how that saying could be applied to ABC if a company uses the wrong assignment of costs and drivers. Difficulty: Difficult Time on task: 8 minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: The allocation of indirect costs under ABC is based on estimates as to how much of the activities will be performed in the next year. The total actual activity may vary, but the chances of it varying by a significant amount are unlikely if the company understands how costs are being driven.

However, if the wrong activity is identified as the cost driver, the overall cost will be inaccurate. This could have a significant impact on the overall cost of the product, resulting in an incorrect price being assigned. Some indications of the use of an indirect cost driver or costing method (e.g., single overhead rate versus departmental cost versus ABC) include the following: ● Reported margins are not logical to managers because products, services, jobs, or customers that require a lot of resources are reported as very profitable, and the regular basic products, services, jobs, or customers that do not require a lot of handling or resources are reported as unprofitable. ● The accounting department receives many requests for special analyses regarding costs. ● Even as the company adds more products, services, jobs, and customers, the company is losing bids or market share. ● Despite process improvements, profit margins seem worse. ● If the company drops an unprofitable product, service, job, or customer, the profit margins actually deteriorate rather than improve.

13. The best driver (base) when assigning the electricity used in manufacturing to products or jobs would be direct labor hours, since payroll numbers are already recorded. Do you agree? If you do not agree, explain. Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: No, I do not agree. Management should dive deeper into researching what causes electricity usage to increase: Is it direct labor hours, machine hours, or another driver altogether? Keep in mind that there should be a cause-and-effect relationship between an activity and the assigned driver.

14. To reduce waste, management should focus only on reducing costs. Do you agree? If you do not fully agree, indicate why you disagree. Be specific. Difficulty: Moderate Time on task: 5 minutes

Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: No, I do not agree. If management focuses only on reducing costs, often costs are slashed throughout the organization without reducing waste and the company may potentially eliminate processes that are working well. Companies can use an ABM approach to manage costs by understanding the source of the costs, and then take appropriate actions to improve processes rather than just making across-the-board cuts.

15. In an ABC system, facility-sustaining expenses should all be assigned to specific product lines according to the direct labor hours or machine hours consumed by each product line. Do you agree? If you do not fully agree, indicate why you disagree. Be specific. Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Facility-sustaining expenses should not all be assigned to specific product lines according to the direct labor hours or machine hours consumed by each product line. These types of costs usually cannot be traced to specific activities or resources used, so the costs may not be allocated to individual products.

16. The goal of a properly constructed ABC system is to have the most precise costs (typically per-unit costs are carried out to three digits). Do you agree? If you do not fully agree, indicate why you disagree. Be specific. Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Homework 8

Solution: No, I do not agree. The goal of a properly constructed ABC system to have the most precise costs while ensuring the benefit of precision information outweighs the cost to implement, plan, and control the ABC system. Additionally, an ABC system requires management to understand how resources are used and how costs are derived to improve decision making.

17. ABC systems should be used primarily for budgeting (spending) decisions. Do you agree? If you do not fully agree, indicate why you disagree. Be specific. Difficulty: Moderate Time on task: 5 minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: No, I do not agree. While ABC systems provide management with valuable information for budgeting (spending) decisions, this information can be used for a multitude of both financial and nonfinancial decisions. For example, management can better understand the operations and focus on making process improvements.

18. One benefit of ABM is that because it provides information about which customers require a significant amount of service, marketing personnel can determine which customers to charge a high fee or, if it is not reasonable to charge a higher fee, to eliminate. Do you agree? If you do not fully agree, indicate why you disagree. Be specific. Difficulty: Easy Time on task: 5 minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution:

Yes, I agree. A key benefit of ABM is that the company has a better understanding of who are the “low-cost” customers versus who are the “highcost” customers. Customers who require more time and resources from the company should be charged a higher price or eliminated.

19. Traditional cost accounting systems typically distort product costs by overcosting the complex products and undercosting the simple products. ABC systems have been introduced primarily to correct this problem. Do you agree? If you do not fully agree, indicate why you disagree. Be specific. Difficulty: Easy Time on task: 5 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution: Traditional cost accounting systems generally do not provide a company with precise enough information that the company can identify what makes costs go up and subsequently how to manage those costs to maximize profits. This is especially true if a company has many products, services, jobs, or customers that use materially different amounts of resources. Analyzing costs using an ABC system helps managers understand how resources are used and how costs are derived so that they can make more informed decisions regarding cost management. ABC systems, however, are more complex and expensive to both implement and maintain. For this reason, if a company has very similar products, services, jobs, and so forth that use resources in a similar manner, it may not be beneficial to invest the time and money necessary to implement an ABC system, because the benefits would not outweigh the costs.

20. Most ABC systems should be initiated, planned, and controlled by top management personnel, such as the chief executive officer, because those managers are in a position to understand both the costs and the most efficient ways to perform the activities. Do you agree? If you do not fully agree, indicate why you disagree. Be specific. Difficulty: Difficult Time on task: 5 minutes Objective: LO2

AACSB: Application of knowledge Assignment: Homework Solution: No, I do not agree. ABC systems should be initiated, planned, and controlled by a cross-functional team of personnel from production, purchasing, sales, engineering, accounting, finance, and other management so that all areas of the company may provide input. While top managers are important members of this team, the workers who are most familiar with each of the activities performed are key, as these individuals have the most thorough understanding of the process and may have already thought of process improvements.

21. Distinguish between resource drivers and activity cost drivers. Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Resource drivers are numerical measures of the activity performed by the company, which in turn will drive up the costs of the activity performed. Example resource drivers include direct labor hours worked, percentage of dollars spent, and direct materials used. Activity cost drivers are the portions of the activities being performed that are being used by the products, jobs, services, or customers. Examples of activity cost drivers are number of batch setups and number of orders placed.

Exercises

1. Below you will find several activity drivers that can be used to assign indirect production costs (overhead) and general, selling, and administrative costs (period costs). For each of the activities, identify the appropriate driver that best approximates the activity, assuming the usage of resources across units or projects does not vary significantly. Drivers: U: Number of units or projects D: Sales dollars E: Number of employees H: Number of labor or machine hours C: Number of customers a. Research and development b. Product design c. Shipping goods d. Processing biweekly payroll e. Warranty work f.

Post-sales service

Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Varies, see chart below #

Question

Solution

1a Research and development

1b Product design

1c Shipping goods

1d Processing biweekly payroll

1e Warranty work

1f Post-sales service

2. Value-added costs are those that customers are willing to pay for and that are necessary for the organization. Give examples of value-added and non–value-added costs for each of the following: a. University b. Day-care center c. Hospital d. Shoe store e. Plant nursery f.

Movie theater

g. Bowling alley

Difficulty: Moderate Time on task: 1 minute Objective: LO5 AACSB: Reflective thinking Assignment: Varies, see chart below Solution: Varies, see chart below #

Question

Solution

Answers may vary. Value-added costs: Using technology to automatically grade examinations (Scantron). 2a University Non–value-added costs: Upgrading a technology suite but not providing end users with necessary training. Requiring paper applications.

Assign ment

Quiz

2b Day-care center

2c Hospital

Answers may vary. Value-added costs: Having parents electronically fill out an application. Non–value-added costs: Having parents manually fill out applications, with the data then being manually input by an assistant. Hiring too many day-care employees so that employees sit idle because there are not enough children. Answers may vary. Value-added costs: Using barcodes on patient files. Having electronic medical records. Non–value-added costs: Using barcodes on patient files that are printed from a malfunctioning printer.

Answers may vary. Value-added costs: Creating detailed instructions for maintaining inventory and providing them to employees as part of training/orientation. Tagging inventory with RFID to allow for easy 2d Shoe store scanning of products. Non–value-added costs: Creating detailed instructions for maintaining inventory but failing to distribute them to new employees. Manual inventory count procedures. No point-of-sale system and employees must keep paper records.

2e Plant nursery

2f Movie theater

2g Bowling alley

Quiz

Test

Answers may vary. Value-added costs: Training employees how to properly schedule deliveries so that plants remain fresh and healthy. Hmwk Non–value-added costs: Expedited shipping costs to get plants on time for a customer order. Answers may vary. Value-added costs: Installing self-serve kiosks at movie theaters to enable customers to purchase tickets without employee assistance. Hmwk Non–value-added costs: Improper training of purchasing department employees that results in the concession stand running out of food or drinks. Answers may vary. Value-added costs: Researching bowling ball/pin suppliers prior to making a purchase to ensure the expected quality and cost are Hmwk achieved. Non–value-added costs: Purchasing inferior-quality bowling balls and pins that need to be replaced frequently.

3. An ABM costing analysis has revealed that it should take 40 minutes to render a service that now takes 60 minutes. The cost per hour is $15, and the monthly production volume is 8,000 hours of service. What are the monthly non–value-added costs? Difficulty: Moderate Time on task: 8 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: The monthly non–value added costs total $40,000 and are calculated as follows: 8,000 hours of service currently × (40 minutes/60 minutes) = 5,333.33 hours of service, if performed efficiently. 8,000 current total hours – 5,333.33 efficient hours = 2,666.67 excess hours (non–value-added). 2,667 excess hours × $15 an hour = $40,000 non–value-added costs.

4. For each of the following activities, provide appropriate cost drivers if activities do not differ (use similar resources) and if activities vary significantly (use different resources). Drivers: U: Number of units or projects D: Sales dollars E: Number of employees H: Number of labor or machine hours C: Number of customers O: Other driver not mentioned a. Maintaining computers b. Packaging products c. Training employees d. Setting up machines e. Shipping goods to customers f.

Admitting patients at a hospital 15

g. Advertising several product lines h. Leasing factory space i.

Preparing tax returns

Cleaning houses

k. Paying vendors l.

Hiring employees

m. Teaching students n. Designing software Difficulty: Moderate Time on task: 1 minute Objective: LO3 AACSB: Reflective thinking Assignment: Varies, see chart below Solution: Varies, see chart below

Question

4a Maintaining computers 4b Packaging products 4c Training employees 4d Setting up machines

Solution Use similar resources: U Use different resources: H Use similar resources: U Use different resources: H Use similar resources: E Use different resources: H

Assign ment Hmwk Hmwk Hmwk

Use similar resources: O (number of machine setups) Use different resources: H

Test

Shipping goods to customers

Use similar resources: U Use different resources: O (packaging and shipping time)

Test

Admitting patients at a hospital

Use similar resources: C Use different resources: H

Test

Advertising several product lines

Use similar resources: U Use different resources: O (number of advertisements)

Quiz

4h Leasing factory space 4i Preparing tax returns 4j Cleaning houses 4k Paying vendors 4k Hiring employees 4l Teaching students 4m Designing software

Use similar resources: O (number of leased factories) Use different resources: O (number of square feet) Use similar resources: C Use different resources: H Use similar resources: C Use different resources: H Use similar resources: O (number of vendors) Use different resources: O (number of orders) Use similar resources: E Use different resources: H Use similar resources: C Use different resources: H Use similar resources: U Use different resources: H

Quiz Quiz Hmwk Hmwk Hmwk Hmwk Hmwk

5. The ABC team found that one of the company’s products was losing money because it was using significant resources of setups, customer handling, and material handling. The chief financial officer asked the team to ignore the findings because some workers could be laid off and the chief executive officer liked the product. a. Did the CFO violate the IMA’s Standards of Ethical Professional Practice? This was discussed as part of Chapter 1. Refer to Chapter 1 for the specific standards. Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Ethical understanding and reasoning Assignment: None Solution: The CFO would be violating three of the IMA’s Standards of Ethical Professional Practice: integrity, credibility, and competence. The integrity standard requires members to be honest and trustworthy at all times, no matter what the circumstance. Ignoring the results because the CFO doesn’t want workers to be laid off and personally likes the products shows a lack of integrity, even if it is a tough decision. Further, the CFO will lack credibility because they are asking the ABC team to not present information fairly, objectively, and without bias. Finally, the correct numbers are not used in the analysis, violating competence standard.

b. Which actions could have been taken to present the ABC results but perhaps turn the product in question into a profitable product? Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Reflective thinking Assignment: None Solution: The ABC team should utilize the ABC costing information (and the activities being performed) to focus on making operational improvements or improving efficiency. By eliminating/reducing non–value-added activities, the product may become a profitable one.

6. Brokerage Service, Inc., is a firm that charges a fee to buy and sell investment orders for its clients. The company has three types of service lines: discount brokers, mutual funds, and fullline brokerage services. Prior to fully analyzing an ABC system, indirect costs of servicing and selling were assigned based on the sales dollars of each service line. When the ABC software was used, resources were assigned to three major activity cost pools: customer acquisition, customer servicing, and customer retention. The following table shows the cost allocation results under both the traditional (sales dollar allocations) and ABC approaches.

Support Cost Allocations

Discount Brokers

Mutual Funds

Full-Line Brokerage Services

Traditional sales dollars

$30,000

$11,000

$20,000

ABC: 3 customer activities

$20,000

$9,000

$32,000

For which decisions might the preceding information be useful to the brokerage firm? Difficulty: Easy Time on task: 7 minutes Objective: LO4

AACSB: Reflective thinking Assignment: None Solution: Based on the cost analysis provided, management will be able to better understand the costs associated with its three service lines. Using the traditional costing system, management would have incorrectly concluded that the full-line brokerage service line is a low-cost service line ($20,000) and the discount broker service line is a high-cost service line ($30,000). With more precise information available from the ABC system, management is better informed regarding the cost of each service line and would accurately conclude that the full-line brokerage service is a high-cost line ($32,000) and that the discount broker service has lower costs ($20,000) than initially thought. Management has a better understanding of what drives its costs and will be able to eliminate inefficient activities and better control its overhead costs. Further, management can utilize this information to appropriately price its service lines and determine whether the lines should be expanded or eliminated.

7. For each of the following independent scenarios and items, indicate whether the activity described is: VA: Primarily value-added and efficient NVA: Primarily non–value-added (If NVA, indicate how these costs could be avoided) a. Storing and moving extra inventory in a warehouse b. Inspecting defective products c. Preparing a report that identifies quality problems and suggested improvements d. Selling and delivering the product e. Recalling automobiles for steering column problems f.

Hiring more employees to answer customer complaints

g. Expediting orders h. Training, including ethics and sustainability

Difficulty: Easy Time on task: 1 minute Objective: LO5

AACSB: Reflective thinking Assignment: Homework Solution: Varies, see chart below #

Question

Storing and moving extra 7a inventory in a warehouse Inspecting defective products Preparing a report that identifies quality problems 7c and suggested improvements Selling and delivering the 7d product 7b

Solution NVA. These costs could be eliminated by implementing a “pull” manufacturing approach, as emphasized in just-in-time (JIT) manufacturing. NVA. These costs could be eliminated by purchasing higher quality materials from vendors. VA.

VA.

Recalling automobiles for 7e steering column problems

NVA. These costs could be eliminated by reviewing materials purchased for quality issues and inspecting automobiles before they are shipped to the customers.

Hiring more employees to 7f answer customer complaints

NVA. These costs could be eliminated by researching customer complaints for patterns and trends to identify weak points that could be improved, thereby reducing the number of customer complaints.

7g Expediting orders

NVA. These costs could be reduced by scheduling the production process properly and ensuring all materials are on site when needed.

Training, including ethics and sustainability

VA.

8. For each of the following activities, identify whether the activity cost is: U: Unit B: Batch P: Product-sustaining C: Customer-sustaining F: Facility-sustaining

a. Making engineering changes

b. Manually assembling each product c. Packaging a group of items per customer order d. Providing security e. Landscaping f.

Delivering medicines for patients in a hospital

g. Processing payroll h. Completing the company’s application for a loan i.

Conducting the final inspection of a product

Grading exams

k. Analyzing customer surveys l.

Discussing service features with customers

Difficulty: Easy Time on task: 1 minute Objective: LO2 AACSB: Reflective thinking Assignment: Varies, see chart below Solution: Varies, see chart below Solution

Assign ment

8a Making engineering changes

Hmwk

8b Manually assembling each product

Hmwk

8c Packaging a group of items per customer order

Hmwk

8d Providing security

Test

8e Landscaping

Test

8f Delivering medicines for patients in a hospital

Test

Question

8g Processing payroll

Quiz

8h Completing the company’s application for a loan

Quiz

8i Conducting the final inspection of a product

Quiz

8j Grading exams

Hmwk

8k Analyzing customer surveys

Hmwk

8l Discussing service features with customers

Hmwk

9. Indicate whether each of the following statements is true or false. T: True F: False a. Building complexity into the costing process is an important part of the ABC philosophy. b. The levels of activities in ABC are unit, batch, facility-sustaining, and conversion costs. c. In an ABC system, many product-sustaining activities are reclassified as unit-level activities. d. A good driver for cafeteria costs is the number of machine production hours, and a good driver for quality control is square feet of floor space. e. Undercosting standard products and overcosting specialty products are trends in traditional cost accounting systems that average overhead. f.

Material handling and setup costs are typically treated as batch costs in ABC systems.

g. ABC’s strength lies in its ability to refine the distribution of batch and facility-sustaining costs. h. ABC is compatible with both lean accounting and just-in-time (JIT) manufacturing. i.

Storyboarding is a tool used to depict processes and identify process improvements.

Some common sources of non–value-added costs are poor training, poor procedures, poor documentation, lack of understanding of capacity needs and usage, incorrect orders, lack of understanding of customer needs, poor scheduling, improper use or lack of use of technology, and budget errors.

k. When a plantwide application rate is based on direct labor hours, the following are likely to be found: Engineers will focus on minimizing the direct labor component with little

regard for number of parts or machine time, and total inventory costs in the financial statements will be more correctly costed. l.

Most companies use traditional costing to evaluate general, selling, and administrative costs and allocate these costs properly to each class of customers.

m. In an ABC system, costs (resources) need to be assigned in stage 1 to activities. Some appropriate resource drivers are number of units for rent, number of machines for depreciation, and number of employees for salaries. n. Some appropriate resource drivers are number of units for rent, number of machines for depreciation, and number of employees for salaries. Difficulty: Varies, see chart below Time on task: 1 minute Objective: Varies, see chart below AACSB: Varies, see chart below Assignment: 9h and 9k are Quizzes. 9m is a Test. 9a, 9b, 9c, 9d, 9e, 9f, 9g, 9i, 9j, 9l and 9n are Homework. Solution: Varies, see chart below #

Question

Building complexity into the costing process is an important part of the ABC philosophy. The levels of activities in ABC are unit, batch, facility9b sustaining, and conversion costs. In an ABC system, many product-sustaining activities are 9c reclassified as unit-level activities. 9a

Diffic ulty

AACSB

Solution LO

Application of TRUE knowledge Application of Easy FALSE knowledge Moder Reflective FALSE ate thinking Easy

2 2 2

A good driver for cafeteria costs is the number of machine Moder 9d production hours, and a good driver for quality control is ate square feet of floor space.

Reflective thinking

FALSE

Undercosting standard products and overcosting specialty 9e products are trends in traditional cost accounting systems that average overhead.

Easy

Reflective thinking

FALSE

Material handling and setup costs are typically treated as batch costs in ABC systems.

Moder ate

Reflective thinking

TRUE

ABC’s strength lies in its ability to refine the distribution of batch and facility-sustaining costs. ABC is compatible with both lean accounting and just-in9h time (JIT) manufacturing. Storyboarding is a tool used to depict processes and 9i identify process improvements. 9g

Difficu lt

Reflective FALSE thinking Application of Easy TRUE knowledge Application of Easy TRUE knowledge

Some common sources of non–value-added costs are poor training, poor procedures, poor documentation, lack of understanding of capacity needs and usage, incorrect Application of 9j Easy orders, lack of understanding of customer needs, poor knowledge scheduling, improper use or lack of use of technology, and budget errors. When a plantwide application rate is based on direct labor hours, the following are likely to be found: Engineers will focus on minimizing the direct labor component with little Moder 9k regard for number of parts or machine time, and total ate inventory costs in the financial statements will be more correctly costed.

2 7 2

TRUE

Application of FALSE knowledge

Analytical thinking

. Most companies use traditional costing to evaluate 9l general, selling, and administrative costs and allocate these costs properly to each class of customers. In an ABC system, costs (resources) need to be assigned in stage 1 to activities. Some appropriate resource drivers 9 are number of units for rent, number of machines for m depreciation, and number of employees for salaries.

Easy

Reflective thinking

TRUE

Some appropriate resource drivers are number of units for 9n rent, number of machines for depreciation, and number of Easy employees for salaries.

Reflective thinking

FALSE

10. Indicate whether each of the following is more descriptive of a traditional system or an ABC system: a. Costs are classified as unit, batch, product sustaining, customer sustaining, and facility sustaining.

b. Costs are captured first by departments and then assigned to jobs, products, services, or customers. c. Standard products are often overcosted and specialty products are often undercosted. d. More indirect costs are usually directly traced to various products, services, jobs, or customers. e. Overhead is generally averaged with few bases. f.

This approach is especially appropriate if a company produces many products and has varying levels of complexity.

g. Complex, low-volume products are typically assigned very few costs even though they often use a lot of resources. Difficulty: Easy Time on task: 1 minute Objective: 10a: LO2 10b-10g: LO1 AACSB: Application of knowledge Assignment: Varies, see chart below Solution: Varies, see chart below #

Question

10a

Costs are classified as unit, batch, product sustaining, customer sustaining, and facility sustaining.

10b

Costs are captured first by departments and then assigned to jobs, products, services, or customers.

Standard products are often overcosted and specialty products are often undercosted. More indirect costs are usually directly traced to various products, 10d services, jobs, or customers. 10c

10e Overhead is generally averaged with few bases. 10f

This approach is especially appropriate if a company produces many products and has varying levels of complexity.

Solution

Assign ment

ABC

Quiz

Traditional Hmwk Traditional

Test

ABC

Hmwk

Traditional Hmwk ABC

Hmwk

10g

Complex, low-volume products are typically assigned very few costs even though they often use a lot of resources.

Traditional Hmwk

11. Comment on each of the following independent scenarios. Apply the ABC and ABM techniques of focusing on processes and identifying non–value-added activities that could be either eliminated or made more efficient. Indicate how the activities could be done differently. a. In a doctor’s office, each patient manually fills out forms and usually waits 30 minutes before seeing the doctor. The assistant then types in the patient information each time. Usually, one patient each day forgets to come for their appointment. b. The purchasing department has learned that negotiating with suppliers, updating the database, issuing purchase orders, and handling complaints from various internal departments about materials not being delivered on time or wrong items being shipped are costing the company about $30,000 each month, or 5% of sales. c. The consumer complaint department conducted an ABM project and reported that the customer returns, warranty work, and recalls averaged approximately 12% of sales. d. A company makes various types of computers, ranging from basic to fully customized and varying significantly in complexity and volume. As such, it uses the following activity drivers: purchasing dollars for purchasing activities, number of units for research and product design, and sales dollars for all customer-related costs. e. The production department indicated that it was difficult to produce the right quantity of goods because often the workers and machines were idle and waiting for parts and materials to arrive until the purchase orders could be expedited. At other times, many items were overproduced because salespeople overestimated the sales units. Management concluded that these problems could not be avoided and that no changes needed to be made. f.

Top management is skeptical of starting an ABC project because the budget is tight this year. The controller suggested that the ABC team look at the general ledger and directly assign the costs to the product or service lines according to the relative sales margins rather than spending a lot of time mapping all the processes and interviewing mid-level operational managers.

g. At a local grocery store, the owner observed that customers were waiting a long time to check out. He reprimanded the cashier and told him to scan items faster. When the cashier was not able to reduce the time spent scanning items, the owner fired him. The same process was repeated with a new employee. The employees consistently complained that products did not have prices or that customers questioned the prices that were rung up.

h. In a neighborhood restaurant, each order is placed on a ticket, which is given to the kitchen and then entered into a point-of-sale computer for internal control purposes. Each waitperson is assigned three specific tables at one time and only providers service to those tables. i.

A law firm assigns all indirect costs according to billable hours of the lawyers. Customers with simple cases have complained of being overcharged, and some have even taken their business elsewhere. Fortunately, customers with complex cases that require a lot of contract negotiations and special support by paralegals and assistants other than the lawyers have not complained and seem happy with the bills.

Difficulty: 11a, 11b, 11c, 11f, 11g, 11h, 11i are Easy 11d and 11e are Moderate Time on task: 5 minutes Objective: LO5 AACSB: 11a is Application of Knowledge 11b-11i are Reflective Thinking Assignment: Homework Solution: Varies, see chart below #

Question

Solution

Manual input of patient information is a non–value-added In a doctor’s office, each activity. Patients should complete the necessary forms patient manually fills out forms electronically prior to their scheduled doctor’s appointment. This and usually waits 30 minutes will eliminate the need for assistants to manually enter patient before seeing the doctor. The information as well as reduce patient waiting time. 11a assistant then types in the patient information each time. Additionally, the idle time from a patient not showing up for an Usually, one patient each day appointment is a non–value-added cost. To prevent no-shows, forgets to come for their the office could confirm appointments on the day prior to the appointment. appointment using an app.

Negotiating with suppliers, updating the database, issuing purchase orders, and handling complaints from various internal departments about materials not being delivered on time or wrong items being shipped are all non–value-added items. The purchasing department has learned that negotiating with suppliers, updating the database, issuing purchase orders, and handling complaints from various 11b internal departments about materials not being delivered on time or wrong items being shipped are costing the company about $30,000 each month, or 5% of sales.

Materials not being delivered on time: ● Purchasing employees should be properly trained to ensure materials are ordered correctly the first time. ● The company should consider automating the purchasing process via either standardized forms or an electronic data interchange (EDI) system. The EDI system can automatically generate purchase orders to vendors when inventory levels become low.

Wrong items being shipped: ● Distribution employees should be properly trained to ensure customer orders are shipped properly. ● The company should consider automating the distribution process to avoid human errors, which are more likely to occur with manual operations. ● Each item should be tracked via smart technologies. Customer returns, warranty work, and recalls are non–valueadded activities because they are not necessary and are not performed efficiently, and customers are not willing to pay for The consumer complaint them. Management should consider tracking and analyzing the department conducted an reason for customer complaints using data analytics or ABM project and reported that customer-relationship management (CRM) software so it can 11c the customer returns, warranty take the necessary actions to reduce complaints. For example, if work, and recalls averaged the majority of complaints relate to warranty work, the company approximately 12% of sales. should focus on understanding whether the materials utilized are of inferior quality and, therefore, although they save money at the initial purchase, they may be costing the company more in the end due to extra costs in warranty work.

As there are differences in complexity and volume by type of product, it would be more efficient to allocate activities based on type of product. Purchasing activities should be allocated by A company makes various number of purchase orders (large purchase orders for the same types of computers, ranging product that are ordered every month may take less time to from basic to fully customized process compared to multiple individual orders at a small cost). and varying significantly in complexity and volume. As Research and product design costs should be assigned based such, it uses the following on the number of different projects (products) in process. The 11d activity drivers: purchasing number of units could distort the costs depending on the dollars for purchasing complexity of the project. activities, number of units for research and product design, Customer-related costs should be allocated based on the and sales dollars for all number of customer service hours spent per customer. The customer-related costs. customer with the highest sales may require half of the customer-related costs compared to the customer with the lowest sales. Shared software between the customer and company may decrease the customer-related costs. The production department indicated that it was difficult to produce the right quantity of An analysis should be performed to identify the cause of (1) idle goods because often the time and (2) overproduction, as both are non–value-added workers and machines were activities. Idle time can be prevented by developing a detailed idle and waiting for parts and production schedule to determine (1) how many units are materials to arrive until the needed and when; (2) which materials are needed for each unit purchase orders could be and hours to complete; and (3) using that information, when 11e expedited. At other times, materials need to arrive to begin production and meet demand. many items were overproduced because Overproduction can be prevented by developing better sales salespeople overestimated the forecasts by using data analytics and data visualizations based sales units. Management on actual results. Management should perform an analysis to concluded that these problems determine the root cause of the salespeople overestimating the could not be avoided and that sales units. no changes needed to be made. Top management is skeptical of starting an ABC project because the budget is tight this year. The controller By not allocating costs according to resources, management will 11f suggested that the ABC team have inaccurate costing data when making decisions about look at the general ledger and pricing in the future. directly assign the costs to the product or service lines according to the relative sales

margins rather than spending a lot of time mapping all the processes and interviewing mid-level operational managers.

At a local grocery store, the owner observed that customers were waiting a long time to check out. He reprimanded the cashier and An analysis should be performed to identify why products are told him to scan items faster. missing price information and why prices are being scanned at When the cashier was not able different prices than are listed in the store rather than trying to to reduce the time spent get the cashier to scan faster, as these are both non-value11g scanning items, the owner added activities. fired him. The same process was repeated with a new Additionally, wait time can be reduced with an online ordering employee. The employees system with in-store pickup or delivery. consistently complained that products did not have prices or that customers questioned the prices that were rung up. In a neighborhood restaurant, If a waitperson is standing around with nothing to do, that is a each order is placed on a non–value-added cost: It means the restaurant is paying hourly ticket, which is given to the wages with no generation of revenue. An analysis should be kitchen and then entered into performed to see if (1) it makes more sense for the waitperson a point-of-sale computer for to enter in the ticket information into the point-of-sale computer 11h internal control purposes. and (2) a waitperson can take on more than three tables without Each waitperson serves only compromising quality. An analysis should also be conducted to three tables and stands determine if the benefits of an electronic ordering system where waiting for the customers to the waitperson enters the order information at the table instead leave so that they can be of creating a manual ticket outweigh the costs of attentive. implementation. A law firm assigns all indirect These are both red flags that could indicate an issue with costs according to billable assigning indirect costs. Either billable hours are not being hours of the lawyers. tracked correctly (e.g., simple cases are being assigned more Customers with simple cases hours than they actually take) or there is a more accurate 11i have complained of being activity driver. The company should perform an analysis to see if overcharged, and some have it is cost beneficial to trace hours spent on contract negotiations even taken their business and special support by paralegals and assistants to different elsewhere. Fortunately, cases, as cases appear to consume differing amounts of these customers with complex cases resources. Additionally, law firms should explore smart contracts

that require a lot of contract using blockchain technology to eliminate billable hours for negotiations and special simple contracts. support by paralegals and assistants other than the lawyers have not complained and seem happy with the bills.

12. Tucker produces 40,000 Simple and 4,000 Complex small machines. It currently allocates overhead based on machine hours. An ABC study revealed the following activity cost pool data, including the use of activity drivers by Simple machines and Complex machines:

Activity Cost Total Cost Pool Assigned

Expected Activity

Total Expected Activity

Simple

Complex

Material handling

$75,000

5,000 orders

3,000 orders

2,000 orders

Setups

$200,000

400 setups

250 setups

150 setups

Machining

$800,000 20,000 machine hours 15,000 machine hours 5,000 machine hours

Quality control

$300,000

Total indirect costs

$1,375,000

1,500 inspections

1,000 inspections

500 inspections

Single overhead rate = Total expected indirect costs/Estimated cost driver Total indirect costs $1,375,000 Total machining hours 20,000 Single overhead rate $68.75 per hour

Activity-Based Costing Information

Activity Cost Pool

Activity Rate

Expected Activity Simple

Allocated Costs Simple

Material handling

$75,000/5,000 = $15 per order

3,000 orders

$45,000

Setups

$200,000/400 = $500 per setup

250 setups

$125,000

Machining

$800,000/20,000 = $40 per machine hour

15,000 machine hours

$600,000

Quality control

$300,000/1,500 = $200 per inspection

1,000 inspections

$200,000

Total indirect overhead

$970,000

a. What is the current overhead cost per unit for Simple machines, applying overhead based on machine hours? Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Homework Solution: $25.78 Indirect Cost Allocation Product Line Simple units

Single Expected Indirect Costs Overhead Activity Allocated Rate $68.75 per 15,000 $68.75 × 15,000 = hour machine hours $1,031,250

Indirect Units ÷ Cost per Produced Unit ÷

40,000

$25.78

b. What is the material handling cost assigned to Simple machines under ABC? c. What is the machining cost assigned to Simple machines under ABC? d. What is the full overhead cost per unit for Simple machines using ABC?

Analysis for 12b, 12c and 12d only: Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solutions: 12b $45,000; 12c $600,000; 12d $24.25 Total indirect overhead

$970,000

Units produced

40,000

Indirect overhead per unit

$24.25

e. Compare the results under items (a) and (d). What do you conclude? Difficulty: Moderate Time on task: 7 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution: The indirect cost allocated to a Simple unit under the traditional costing approach was approximately $1.50 per unit greater than under the ABC costing system. Under the traditional costing approach, using a single overhead driver, Simple units were being overcosted while Complex units were being undercosted.

Which strategic and operational decisions could be affected by not having accurate product cost information? Difficulty: Moderate Time on task: 5 minutes Objective: LO5 33

AACSB: Reflective thinking Assignment: Homework Solution: Management may inappropriately conclude that the Simple units cost more to produce and, therefore, have a low profit margin. A variety of wrong decisions could result from not accurately capturing costs, especially if the costs (inputs) are used in descriptive analytics (process) for decision making (output). For example, incorrect or incomplete activity costs could result in losing competitive bids to other firms because competitors with similar products are able to price their products lower but still earn a target profit margin. Another ill-informed decision would be poor cost-cutting decisions (such as layoffs or use of materials with inferior quality) that do not help the company’s overall profitability.

g. What other information would you want to have if you were the manager of Tucker? Difficulty: Moderate Time on task: 7 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: ● Management should obtain information regarding the cost of maintaining the ABC system to determine if it is cost-beneficial based on the potential savings that more accurate costing could provide. ● Tracing costs directly to products provides the most accurate costing. Management, with assistance of a cross-functional team of company personnel, should research indirect costs to see if any of those costs can be traced directly to products (keeping in mind cost-benefit constraints) in an effort to reduce the amount of indirect costs. ● Management should review activity cost pools and activity drivers for completeness and accuracy.

13. VBD has started a home delivery business that buys items at wholesale prices and sells them to customers at retail prices. The owner has identified several key indirect cost activities for its distribution center, the cost driver rate per activity, and the activity usage for the month, as follows:

Activity Cost Pool

Activity Driver Activity Cost Driver × Base Rate

Tracking orders Number of and pulling items orders placed from inventory Inspecting and Number of items packaging packaged orders Number of Delivering orders orders delivered Number of Providing postcustomers sales services serviced

Activity Usage

Total Cost

$9 per order

4,000 orders

= $36,000

$3 per item

18,000 items

= $54,000

$4 per order

3,100 orders

= $12,400

$12 per customer

450 = $5,400 customers

Distribution center activities include all of the above except providing post-sales services. Total cost is $102,400 ($36,000 + $54,000 + $12,400).

a. What is the total indirect cost assigned to the distribution center? Difficulty: Easy Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: $102,400 b. Currently, all of the costs are added and assigned to the products based on the total number of orders placed for the month. Which benefits can be gained by assigning costs using the ABC analysis? Be specific. Difficulty: Moderate Time on task: 5 minutes Objective: LO3 35

AACSB: Reflective thinking Assignment: Homework Solution: By assigning costs using the ABC analysis, the company will more accurately assign costs for the following activities because costs for these activity pools are driven by factors other than number of orders: ● Inspecting and packaging orders ● Delivering orders ● Providing post-sales services Real-time descriptive data on inspecting, delivering, and providing postsales services could be gathered using sensors and RFID tags.

c. Do you agree with the activity cost drivers chosen? Should the company use time-based drivers for any of the activities? What if the items vary in weight or their need for special handling? Difficulty: Difficult Time on task: 7 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: To identify the appropriate cost drivers, the ABC team should directly observe, track, or interview workers to determine which are involved in these processes. Based on the information obtained, the ABC team may determine that the chosen activity drivers do not have a strong causeand-effect relationship and, therefore, are not the appropriate drivers. A time-based driver may be more appropriate for packaging and inspecting orders if the main cost is labor and different products require varying levels of labor hours to package/inspect per order. If items vary in weight or their need for special handling, then the activity driver chosen for delivering orders may be a poor choice: One delivered order may require substantially more shipping cost and/or labor hours involved in delivering the product.

d. The company is concerned with the costs associated with tracking the usage versus the benefits from the information gathered. As such, for the post-sales service activity, all customers with issues were lumped together. Do you think that changes, returns, and collections warrant further breakdown? Discuss. Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: When deciding whether to add the task of tracking return type, the company should be able to confirm that the cost to perform the task/procedure is less than the benefit that would be realized. If the company has few returns that are not material to overall sales, then spending extra time tracking and analyzing return data may not be costeffective due to the minimal potential benefit to be realized. However, if the company is experiencing a heavy volume of returns, then it would be cost-effective to track sources of returns. Using available technology and data analytics, the company might be able to reduce returns by identifying non–value-added activities that are driving the volume of returns.

e. Management is interested in ranking the previously mentioned activities with respect to “value added.” What would be your ranking of the activities from most value-added to least value-added? Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: 1. Delivering orders 2. Taking orders and pulling items from inventory 3. Inspecting and packaging orders 4. Providing post-sales services

Management has concluded that post-sales service is the primary activity candidate for improvement. How could the company reduce the post-sales service costs? What additional customer information would be useful? Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Before it can determine how to reduce post-sales service costs, the company must first gather data to understand why the activity is occurring. Then, the company must use descriptive and diagnostic analytics to ascertain the factors associated with high post-sales service costs: Are the costs due to changes, returns, or collections? The company should break down customer issues by type to better understand what is driving this activity. Once the company has an understanding of which customer issue is more prevalent, the company should focus on this issue and research the reason it is occurring by reviewing the four “M’s”: materials, manpower, methods, and machines.

g. Would it be useful to present this information in a visual format (e.g., bar graph, pie chart)? Explain. Difficulty: Easy Time on task: 5 minutes Objective: LO5 AACSB: Information technology Assignment: Homework Solution: Yes, it would be useful to present information regarding post-sales services in a visual format. Using an illustration can convey the information more clearly and concisely and can emphasize key points that sometimes are buried if the reports contain strictly numerical values.

14. The management of Toth Company has always taken pride in the quality of its motor products. Some of the company’s principles are: ➢ Products should be designed for “manufacturability,” functionality, quality, ease of maintenance and serviceability, and reliability. ➢ Standardization with fewer different parts and machines that are multifunctional reduce costs. ➢ Strong key supplier relationships are critical. ➢ Financial statements organized by chart of accounts are not necessarily sufficient. ➢ Problems should be analyzed to determine whether the root causes are related to materials, manpower, machines, or methods. In the last year, Toth Company has experienced higher costs than expected. The company initiated an ABC and ABM pilot project to better understand the root causes of its unexpected high production costs using a data analytics tool. Below is a graphical representation of the results of the ABC and ABM project for the last three quarters:

Additional information: ● Actual costs exceeded budgeted costs by $40,000 in Quarter 1, $35,000 in Quarter 2, and $60,000 in Quarter 3. ● Total sales for the company were $500,000 in Quarter 1, $450,000 in Quarter 2, and $600,000 in Quarter 3. ● Net income was $30,000 in Quarter 1, $25,000 in Quarter 2, and $42,000 in Quarter 3. ● Production workers complained that long-time suppliers were not delivering the materials on time and that some materials were defective; both issues caused the workers to be idle and rework goods. These costs were included in the “Materials” amounts.

● ●

In Quarter 1, two unexpected breakdowns of old equipment occurred. One of the machines was replaced in Quarter 3. In all quarters, some system conversion changes in procedures occurred without accompanying training sessions.

a. Would the information about problems with materials, manpower, machines, and methods be readily available from the financial accounting system? Difficulty: Easy Time on task: 2 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: No. These items would not be readily available from the financial accounting system. The financial accounting system tracks assets, liabilities, equity, revenue, and expenses; it would not include information on materials, manpower, machines, and methods.

b. Which other internal and external information would you be interested in obtaining to better plan, evaluate performance, and maximize the value chain relationships (suppliers and customers)? Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: Students’ answers will vary. ● Available technology improvements ● Disaggregated financial information (e.g., by customer, by vendor) ● Information on seasonal fluctuations ● Specific customer input and suggestions ● Vendor metrics (e.g., time to deliver, number of defective products)

●

Sources of problems with machines

15. After an ABC and ABM study, Analytical Company identified four groups of activities, as follows: ● ● ● ●

Group 1: Activities designed to prevent errors and mistakes during production and delivery Group 2: Activities designed to review, evaluate, and measure conformance with procedures Group 3: Activities designed to correct errors before delivery to customers Group 4: Activities designed to correct errors after delivery to customers

a. Classify each of the following specific activities into one of these four groups (Group 1, Group 2, Group 3, or Group 4): Inspections Rework Warranty charges Lawsuits Training Handle complaints Expedite late orders Quality planning Process reviews b. Are Groups 1 and 2 more likely to be value-added than Groups 3 and 4? Should management focus on Groups 1 and 2 or on Groups 3 and 4? Explain. Difficulty: 15a: Easy 15b: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Varies, see chart below #

Question

Solution

Classify each of the following specific activities into one of Inspections: Group 2 these four groups (Group Group 1: Training, Quality Rework: Group 3 1, 2, 3, or 4): planning Warranty charges: Group 4 Inspections Group 2: Inspections, Process Lawsuits: Group 4 Rework reviews 15a Training: Group 1 Warranty charges Group 3: Expedite late orders, Handle complaints: Group 4 Lawsuits Rework Expedite late orders: Group 3 Training Group 4: Warranty charges, Quality planning: Group 1 Handle complaints Lawsuits, Handle complaints Process reviews: Group 2 Expedite late orders Quality planning Process reviews Groups 1 and 2 are more likely to be value-added procedures, Are Groups 1 and 2 more especially if performed efficiently. While management should likely to be value-added always strive for continuous improvements, activities in than Groups 3 and 4? Groups 1 and 2 (if performed efficiently) would not be a 15b Should management source of concern and could cause decreases in activities of focus on Groups 1 and 2 Groups 3 and 4. Management should focus on activities in or on Groups 3 and 4? Groups 3 and 4 to identify process improvements that will Explain. reduce or eliminate these activities.

16. Kralik’s Krazy Kostumes, LLC, manufactures its own costumes for business professionals and has two main products: the “Accounting Nerd” and the “Master Marketer.” The Accounting Nerd is a high-volume product, selling 25,000 costumes annually, while the Master Marketer is a low-volume product, selling 5,000 costumes annually. The direct materials cost per unit is $40 for the Accounting Nerd and $30 for the Master Marketer. The direct labor costs are $12 per hour, and it takes 1 hour to make a costume. Total manufacturing overhead costs for the year are expected to be $900,000. Under a traditional approach, the company uses direct labor hours to compute its predetermined overhead rate. Julie Kralik, the company’s owner, decides she would like to analyze the activities being performed in the manufacturing process to better understand her costs and possibly to obtain better information with which to make decisions. In her analysis, she determines that three main activities are being performed, identifies the appropriate cost drivers, and estimates the expected use. The data she gathered are as follows: Activity Cost Pool

Cost Driver

Setting up machines

Number of setups

Expected Use per Activity 1,500 setups

Estimated Overhead $300,000

Sewing

Machine hours Number of inspections

Inspecting

50,000 machine hours

$500,000

2,000 inspections

$100,000

She then developed the expected use for each of her two product lines, as shown here: Activity Cost Pool Setting up machines Sewing Inspecting

Expected Activity Accounting Nerd Magic Marketer 500 1,000 30,000 20,000 500 1,500

a. Compute the total cost and unit cost for each of the two products under a traditional costing approach. Difficulty: Moderate Time on task: 6 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Quiz Solution: Accounting Nerd: Unit cost = $82, Total cost = $2,050,000 Master Marketer: Unit cost = $72, Total cost = $360,000 (1) Calculate the predetermined overhead rate Predetermined overhead rate = Total estimated overhead/Total estimated driver (in this case direct labor hours) = $900,000/(1 hour/costume × 30,000 costumes produced) = $900,000/30,000 direct labor hours = $30 overhead per direct labor hour (2) Calculate the unit cost and total cost for Accounting Nerd and Magic Marketer Accounting Nerd Magic Marketer Direct materials $40 $30 Direct labor $12 $12 Overhead* $30 $30 Unit cost × Number of units

$82 25,000

$72 5,000

Unit cost

$2,050,000

$360,000

*Each unit takes 1 direct labor hour to make; therefore, the calculation for each = 1 direct labor hour × $30/direct labor hour

b. Compute the activity-based overhead rates for each activity. Difficulty: Moderate Time on task: 6 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: Setting up machine = $200 per setup Sewing = $10 per machine hour Inspecting = $50 per inspection Activity Cost Pool

Cost Driver

Setting up machines # of setups Sewing Machine hours Inspecting # of inspections

Estimated Overhead $300,000 $500,000 $100,000

Expected Use per Activity / 1,500 setups / 50,000 machine hours / 2,000 inspections /

Estimated Overhead = $200 = $10 = $50 =

c. Compute the total cost and the unit cost for each of the two products under an ABC approach. What have you learned from this analysis? Difficulty: Moderate Time on task: 6 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: Accounting Nerd: Unit cost = $69, Total cost = $1,725,000 Master Marketer: Unit cost = $137, Total cost = $68,500 Based on the analysis performed, the Accounting Nerd was overcosted under the traditional approach ($82 vs. $69 per unit) and the Magic Marketer was undercosted ($72 versus $137 per unit). This is primarily

driven by the greater use of setups and the larger number of inspections for the Magic Marketer, which have a higher estimated overhead cost.

Overhead Setting up machines Sewing Inspecting Total overhead / Number of units

(1) Calculate the total overhead which is then used to calculate the overhead per unit Accounting Magic Calculations (Driver x Actual Hours) Nerd Marketer Accounting Nerd Magic Marketer = $200/setup x 500 = $200/setup x 1,000 $100,000 $200,000 setups setups $300,000 $200,000 = $10/MH x 30,000 MH = $10/MH x 20,000 MH = $50/inspection x 500 = $50/inspection x 1,500 $25,000 $75,000 inspections inspections $425,000 $475,000 25,000 5,000

Overhead per unit

$17

$95

(2) Calculate the unit cost and total cost for Accounting Nerd and Magic Marketer Accounting Magic Nerd Marketer Direct materials $40 $30 Direct labor $12 $12 Overhead per unit $17 $95 Unit cost × Number of units Unit cost

$69 25,000

$137 5,000

$1,725,000

$685,000

17. Katelynn Corporation manufactures two products—kites and gliders. Annual production: ● Kites: 2,000 units and 2,000 direct labor hours ● Gliders: 400 units and 2,000 direct labor hours ● Total estimated overhead: $154,000 The company is looking at the possibility of changing to an ABC system for its products. If the company used an ABC system, it would have the following three activity cost pools: Activity Cost Pool Setup costs

Estimated Activity Driver Overhead Cost $6,000 Batches

Expected Activity Kites Gliders Total 200 400 600

Engineering costs Sewing costs Total

$68,000 Engineering hours $80,000 Direct labor hours (DLH)

200 2,000

800 1,000 2,000 4,000

$154,000

The company currently calculates the predetermined overhead rate as follows: = Total estimated overhead ÷ Total estimated direct labor hours = $154,000 ÷ 4,000 direct labor hours = $38.50 overhead per direct labor hour a. Calculate the total overhead cost per glider using Katelynn Corporation’s existing (traditional) costing system. Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Test Solution: = Predetermined overhead rate × Actual direct labor hours (DLH) = $38.50 × 2,000 direct labor hours = $77,000 b. Calculate the overhead cost per glider under the proposed ABC system. Difficulty: Moderate Time on task: 10 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Test Solution: (1) Calculate the overhead rate per activity: Activity Cost Estimated Expected Use per Overhead Cost Driver Pool Overhead Activity Rate Setup costs Batches $6,000 ÷ 600 batches = $10

Engineering costs

Engineering hours Direct labor Sewing costs hours (DLH)

1,000 engineering = hours 4,000 direct labor $80,000 ÷ = hours $68,000 ÷

$68 $20

(2) Calculate the total overhead, which is then used to calculate the overhead per unit: Calculations Gliders (Driver × Actual Hours) Overhead Gliders Setup costs $4,000 = $10/batch × 400 batches Engineering hours $54,400 = $68/EH × 800 EH Sewing costs $40,000 = $20/DLH × 2,000 DLH Total overhead

$98,400

c. What information do these results provide to management? Be specific. Difficulty: Difficult Time on task: 5 minutes Objective: LO4 AACSB: Written and oral communication Assignment: Test Solution: These results provide management with more detailed information on the different activities that drive costs. By breaking out the overhead by activity, we can see that the most expensive activity is engineering hours ($68 OH per EH versus $10 per batch and $20 per DLH). Therefore, when comparing the overhead cost under the traditional method to ABC, it appears that gliders were undercosted ($77,000 versus $98,400), as gliders require five times as many engineering hours as do kites.

Problems

1. Wizard Architects has three types of service lines: ●

Basic: Customer accepts the quoted “off the shelf” service with no modifications.

●

Upgrade: Customer is allowed three changes.

●

Specialized: Customer meets with both salespeople and architects multiple times to understand specific needs.

Although the direct materials and direct labor are directly traceable, the indirect costs of servicing and selling are assigned based on the direct labor hours of the architects. Wizard estimates total indirect costs of $440,000 and total direct labor hours for architects of 22,000. Using ABC software, resources are assigned to three major activity cost pools: Customer acquisition, Customer servicing, and Customer retention. Below are the ABC assignments to the three service lines. Activities and Direct Labor Hours Customer acquisition Customer service Customer retention Architect direct labor hours

Basic Upgrade Specialized $15,000 $18,000 $42,000 $62,000 $75,000 $90,000 $23,000 $40,000 $75,000 13,000 5,000 4,000

Total $75,000 $227,000 $138,000 22,000

a. What are the indirect customer-related cost allocations to the three service lines under the traditional approach using architect direct labor hours?

Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: None Solution: Basic: $260,000; Upgrade: $100,000; Specialized: $80,000 (1) Calculate the predetermined overhead rate. Predetermined overhead rate = Total estimated overhead/Total estimated driver (this case architect direct labor hours) = $440,000/22,000 architect DLH = $20 overhead per architect DLH (2) Allocate the indirect customer costs between the different service lines.

Rate × Architect direct labor hours Overhead unit cost

Basic Upgrade Specialized $20.00 $20.00 $20.00 13,000 5,000 4,000 $260,000 $100,000 $80,000

b. What are the indirect customer-related cost allocations to the three service lines under the ABC customer-related activity cost pool assignment? Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: The total overhead under ABC is provided here. To calculate the total indirect customer costs, sum all of the activities. Basic

Upgrade Specialized

$15,000 $62,000 $23,000

$18,000 $75,000 $40,000

$42,000 $90,000 $75,000

Total indirect customer costs $100,000 $133,000

$207,000

Indirect customer costs: Customer acquisition Customer service Customer retention

c. Which specific tasks or individual activities might be included in each of the three activity cost pools? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Students’ answers will vary, but some examples of activities include the following:

● ● ●

Customer acquisition: direct contact, referrals, social media and other websites Customer service: customer communications (e.g., phone calls, emails, visits) Customer retention: outreach, feedback surveys, discounts

d. Management was surprised to learn that indirect customer costs of the specialized service line were so much greater under the ABC analysis than under the simple allocation base of architect direct labor hours. Explain possible reasons for such a difference. Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: The specialized service line requires more meetings with both salespeople and architects to understand specific needs, which has a higher cost per hour than other activities. Technology can be utilized to decrease the number of hours spent on customization by communicating through email and online portals. e. Discuss whether analyzing the preceding customer-related activities would be relevant for other service companies, such as department stores or insurance companies. Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Yes. Other companies such as retailers or insurance companies would also incur indirect costs to acquire, maintain, and keep customers. These activities could be applied to those companies as well.

2. The following information is known about the purchasing department of Busy Company Traditional General Ledger Salaries $240,000 Utilities $35,000 Depreciation $90,000 Supplies $30,000 Insurance $5,000 Total

$400,000

ABC Activities Ordering goods Verifying orders Expediting orders Creating reports Supplier relations

$170,000 $55,000 $45,000 $40,000 $90,000

Total

$400,000

a. Identify several non–value-added activities in the purchasing department. Difficulty: Easy Time on task: 3 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Non–value-added activities within the purchasing department (found under the ABC activities) include verifying orders, expediting orders, and creating reports.

b. Poor coordination of activities and poor scheduling may create the need to expedite orders. Expediting is often considered a non–value-added cost because customers do not want to pay to expedite (speed up) their orders when the items were not properly purchased originally. What might be some other specific causes of problems that would require expediting? Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers will vary. Other causes of an order being expedited 51

include the following: (1) Sales department fails to communicate with the purchasing department about a large order or increased demand. (2) Vendor fails to provide materials on the requested date, requiring an expedited order. (3) Website or point-of-sale system does not accurately reflect the number of units on hand, causing sales personnel to believe there are more units on hand than are actually available. (4) Heightened customer expectations.

c. Which insights and potential decisions would be possible with the ABC activities information provided that is not available with the traditional reporting of the general ledger accounts for the purchasing department? Be specific. Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: The information in the traditional general ledger provides only details on total costs as presented on the financial statements. The costs do not provide enough detail to understand why salaries are $240,000. Students’ answers will vary and may include the following: (1) By breaking costs down by activity under ABC, the company can use ABM to evaluate the activities and classify them as value-added or non– value-added. This allows a company to identify and eliminate non–valueadded activities. (2) By breaking down costs by activity, the company can identify the main driver of costs and then evaluate whether it meets expectations. Why is ordering goods almost two times more costly than the second most costly activity?

3. Simple Company uses a traditional volume-based costing system with a single overhead cost pool and direct labor hours as the cost driver. Simple estimates total overhead for the year at $76,200 and total direct labor hours of 10,000. The company has conducted an ABC analysis with the following data:

Activity Setups Machining Packaging Testing

Cost Driver Number of setups Number of machine hours Number of units Number of testing hours

Activity Driver Rate $0.50 $10.00 $2.00 $4.00

The two jobs processed in the month of June had the following characteristics: Cost Driver Direct materials cost Direct labor cost Number of direct labor hours Number of setups Number of machine hours Number of units Number of testing hours

Job A $20,000 $10,000 100 90 1,000 300 25

Job B $80,000 $100,000 2,500 100 800 110 200

a. What is Simple Company’s single overhead cost driver rate if the company allocates all overhead based on direct labor hours? Difficulty: Easy Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: $7.62 = $76,200 total estimated overhead ÷ 10,000 total estimated DL hours = $7.62 overhead per DLH

b. Compute for Simple Company the unit manufacturing costs of each job under the traditional costing system, whereby all overhead costs are assigned based on direct labor hours. Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: Job A: $103 Job B: $1,810 (1) Allocate the indirect customer costs between the different service lines: Job A Job B Rate (calculated in A) $7.62 $7.62 × direct labor hours per unit 100 2,500 Total overhead cost

$762

$19,050

(2) Calculate the unit cost and total cost for each job: Job A Direct materials $20,000 Direct labor $10,000 Total overhead cost (per above) $762

Job B $80,000 $100,000 $19,050

Total manufacturing costs ÷ Number of units

$30,762 ÷ 300

$199,050 ÷ 110

Unit manufacturing cost

$103

$1,810

c. Compute for Simple Company the unit manufacturing costs of each job under the ABC system. Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking

Assignment: Homework Solution: Job A: $136; Job B: $1,719 [A] Activity Cost Pool

Activity Rate

Setups Machining Packaging Testing

$0.50 $10.00 $2.00 $4.00

[B] Expected Activity Job A 90 1,000 300 25

[A] × [B] [C] Allocated Expected Costs Activity Job A Job B $45.00 100 $10,000.00 800 $600.00 110 $100.00 200

Total indirect $10,745.00 cost

Total indirect cost

Job A $20,000 $10,000 $10,745

Job B $80,000 $100,000 $9,070

Total manufacturing costs ÷ Number of units

$40,745 ÷ 300

$189,070 ÷ 110

Unit manufacturing cost

$136

$1,719

Direct materials Direct labor Overhead per unit

[A] × [C] Allocated Costs Job B $50.00 $8,000.00 $220.00 $800.00 $9,070.00

d. Compare Simple Company’s unit manufacturing costs for Jobs A and B when the overhead costs are assigned based on ABC and when the overhead costs are assigned based on direct labor hours. Difficulty: Moderate Time on task: 2 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: When overhead costs are assigned based on direct labor hours, Job A is undercosted and Job B is overcosted, compared to when costs are assigned under ABC.

e. Why do the two cost systems differ on the total cost for each job? Difficulty: Moderate Time on task: 8 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: The unit manufacturing costs differ between the two costing systems based on the difference in how costs are consumed. Job A uses significantly fewer direct labor hours than Job B; therefore, when allocating overhead based on direct labor hours, more than 96% of all the overhead costs are assigned to Job B. However, when assigning overhead based on activities, it appears as if both jobs consume the most expensive resources equally.

Do you believe that some of the overhead costs could be directly captured for each job using technology? Discuss. Difficulty: Moderate Time on task: 2 minutes Objective: LO4 AACSB: Information technology Assignment: Homework Solution: Yes, technology could be useful in capturing actual usage for all the activities listed in this problem. Specifically, direct labor hours could be tracked using an automated payroll system in which an employee clocks in and out by using a time clock on a computer, a badge to sign in, or a phone app using GPS. The number of units produced could be tracked using bar-code technology to scan each unit as it is completed.

g. For which strategic and operational control decisions might these differences be important? Difficulty: Difficult

Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Management may inappropriately conclude that Job A units cost less to produce and, therefore, have an inflated profit margin. A variety of wrong decisions could result from not accurately capturing costs, such as losing competitive bids to other firms because competitors with similar products are able to price their products lower but still earn a target profit margin. Another ill-informed decision would be poor cost-cutting decisions (such as layoffs or use of materials with inferior quality) that do not help the company’s overall profitability.

h. How would you present this information to management to make it useful? Difficulty: Moderate Time on task: 2 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: It would be useful to present information to management in a visual format. An illustration such as a bar chart or line graph can convey the information more clearly and concisely and emphasize key points that sometimes may be buried if the reports contain strictly numerical values. For example, the total overhead cost per job can be presented in a bar chart under the different approaches.

ed y

4. Wall, Inc., has identified the following overhead costs and cost drivers: Activity Setups Ordering Maintenance Power

Estimated Cost $10,000 $16,000 $40,000 $25,000

Cost Driver Number of setups Number of orders Number of machine hours Number of kilowatt hours

500 4,000 8,000 50,000

The following are two of the jobs completed during the year:

Direct materials Direct labor Units completed Number of direct labor hours Number of setups Number of orders Number of machine hours Number of kilowatt hours

Job 25 $5,000 $1,400 300 100 2 8 25 60

Job 18 $3,000 $2,400 150 70 8 12 45 100

The company’s normal activity is 4,000 direct labor hours.

a. If Wall uses direct labor hours to allocate overhead costs, what is the total cost for Job 25? Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Quiz Solution: $8,675.00 Single overhead rate = Total expected indirect costs ÷ Estimated cost driver = ($10,000 + $16,000 + $40,000 + $25,000) ÷ 4,000 direct labor hours = $91,000 ÷ 4,000 direct labor hours = $22.75 per direct labor hour Indirect Cost Allocation Single Indirect Product Expected Units Indirect Cost Overhead Costs Line Activity Produced per Unit Rate Allocated 100 direct $22.75 × 100 $2,275.00/300 Job 25 $22.75 300 labor hours = $2,275.00 = $7.58

Job 25 Direct materials

$5,000.00

Direct labor

$1,400.00

Indirect costs

$2,275.00

Total cost

$8,675.00

b. If Wall uses machine hours to allocate overhead costs, what is the total cost of Job 25? (Do not round your final answer.) Difficulty: Moderate Time on task: 5 minutes

Objective: LO1 AACSB: Analytical thinking Assignment: Quiz Solution: $6,684.38 Single overhead rate = Total expected indirect costs ÷ Estimated cost driver = ($10,000 + $16,000 + $40,000 + $25,000) ÷ 8,000 machine hours = $91,000 ÷ 8,000 direct labor hours = $11.375 per direct labor hour Indirect Cost Allocation Single Product Indirect Costs Overhead × Expected Activity Line Allocated Rate Job 25 $11.375 × 25 machine hours $284.38

Direct materials Direct labor Indirect costs

Job 25 $5,000.00 $1,400.00 $284.38

Total cost

$6,684.38

Units Indirect Produc Cost per ed Unit 300 $0.95

c. If Wall uses ABC drivers to allocate overhead costs, what is the total cost for Job 25 using the provided tables?

Activity Cost Pool

Activity Cost Pool Setup Ordering

Total Cost Assigned $10,000 $16,000

Maintenance

$40,000

Power

$25,000

Total

$91,000

Activity Rate

Total Expected Activity 500 setups 4,000 orders 8,000 machine hours 50,000 kilowatt hours

Activity Rate

Expected Activity Job 25

Allocated Costs Job 25

Setup Ordering Maintenance Power

x x x x Total indirect overhead Units produced Indirect overhead per unit

Direct materials Direct labor Indirect costs

Job 25 $5,000.00 $1,400.00

Total cost

Difficulty: Moderate Time on task: 8 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: $6.627.00 Activity Cost Pool

Activity Cost Pool

Total Cost Assigned

Total Expected Activity

Setup

$10,000

500 setups

Ordering

$16,000

4,000 orders

Maintenance

$40,000

Power

$25,000

Total

$91,000

Activity Rate

8,000 machine hours 50,000 kilowatt hours

Activity Rate $10,000/500 = $20.00 per setup $16,000/4,000 = $4.00 per order $40,000/8,000 = $5.00 per mhr $25,000/50,000 = $0.50 per khr

Expected Activity Job 25

Allocated Costs Job 15

Setup $10,000/500 = $20.00 per setup Ordering $16,000/4,000 = $4.00 per order Maintenance $40,000/8,000 = $5.00 per mhr Power $25,000/50,000 = $0.50 per khr

× 2 setups × 8 orders × 25 machine hours × 60 kilowatt hours

Total indirect overhead

$40.00 $32.00 $125.00 $30.00 $227.00

Units produced Indirect overhead per unit

Direct materials Direct labor Indirect costs

Job 25 $5,000.00 $1,400.00 $227.00

Total cost

$6,627.00

300 $0.76

d. Compare the results for letters (b) and (c). If Wall uses machine hours to allocate overhead costs, is Job 25 overcosted or undercosted? Explain. Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Quiz Solution: If Wall uses machine hours to allocate overhead costs, then Job 25 will be overcosted. Utilizing machine hours to allocate overhead costs, the total cost for Job 25 is $6,684.38, compared to ABC costing of $6,627.00; the difference is $57.38. While Job 25 is overcosted, this does not mean that all other jobs will be undercosted. Perhaps some other jobs that are similar to Job 25 consume very few resources compared to machine hours.

e. Compare the answers for letters (a), (b), and (c). Comment on the implications for decision making from the resulting cost of Job 25 in those answers. Difficulty: Moderate Time on task: 10 minutes

Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: When comparing the cost calculations of Job 25 under the three different approaches in (a), (b), and (c), it is easy to see that picking the appropriate costing approach and related drivers is very important to calculate precise costing. Direct labor hours from (a) is a poor cost driver to allocate overhead costs, resulting in overcosting of Job 25 by almost 30%. When comparing the cost calculated utilizing a single overhead rate with machine hours as a cost driver to the cost calculated using ABC costing, the difference is minimal. If management determines that the difference is minimal for other jobs as well and that changes in volume do not have a material impact, then management may determine that the additional costs of ABC costing do not outweigh the benefit of a more precise calculation.

5. XYZ Company manufactures two products: Product DDD and Product EEE. Indirect manufacturing costs (overhead) are budgeted at $600,000 annually. The company is concerned about the assignment of the manufacturing support costs. Other data include the following: General Data Direct materials cost Direct labor ($12/hour) Estimated production in units Direct labor hours per unit Direct labor hours per product

DDD $25 $60 5,000 5 25,000

EEE $30 $84 8,000 7 56,000

Activity Data Activity Cost Driver Activity Cost Setting up Purchasing Machining

Activity Driver

$100,000 Number of setups $80,000 Number of orders $200,000 Number of machine hours

Expected Activity DDD EEE Combined 200 80 280 50 10 60 2,000 500 2,500

Packaging, inspecting, shipping

$220,000 Number of shipments

Total

$600,000

900

200

1,100

a. Estimate the manufacturing cost per unit of each product if support costs are assigned to products on the basis of units.

Difficulty: Easy Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: DDD: $131.15 EEE: $160.15 Single overhead rate = Total expected indirect costs ÷ Estimated cost driver = $600,000 ÷ (5,000 units DDD + 8,000 units EEE) = $600,000 ÷ 13,000 units = $46.15 indirect labor costs per unit

Direct materials Direct labor Indirect costs

DDD $25.00 $60.00 $46.15

EEE $30.00 $84.00 $46.15

Total cost per unit

$131.15

$160.15

b. Estimate the manufacturing cost per unit of each product if support costs are assigned to products on the basis of direct labor hours using the following chart.

Direct materials Direct labor Indirect costs: Overhead rate

DDD $25.00 $60.00

EEE $30.00 $84.00

× direct labor hours Total indirect costs Total cost per unit

Difficulty: Easy Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: Single overhead rate = Total expected indirect costs/Estimated cost driver = $600,000 ÷ (25,000 DDD direct labor hours + 56,000 EEE direct labor hours) = $600,000 ÷ 81,000 direct labor hours = $7.41 indirect labor costs per direct labor hour DDD $25.00 $60.00

Direct materials Direct labor Indirect costs: Overhead rate × direct labor hours Total indirect costs

$7.41 5

Total cost per unit

EEE $30.00 $84.00 $7.41 7

$37.04

$51.85

$122.04

$165.85

c. Estimate the manufacturing cost per unit of each product if support costs are assigned to products on the basis of activities using the following charts.

Setting up Purchasing

Total Cost Assigned $100,000 $80,000

Machining

$200,000

Activity Cost Pool

Total Expected Activity ÷ 280 setups ÷ 60 orders

= =

÷ 2,500 machine hours

= Activity Rate

Packaging, inspecting, shipping

$220,000

Total

$600,000

Activity Cost Pool

÷ 1,100 shipments

[A]

[B]

[A] × [B]

[C]

[A] × [C]

Activity Rate

Expected Activity DDD

Allocated Costs DDD

Expected Activity EEE

Allocated Costs EEE

Setting up Purchasing Machining Packaging, inspecting, shipping Total indirect cost Units produced Indirect cost per unit

Direct materials Direct labor Indirect costs Total cost per unit

Total indirect cost Units produced Indirect cost per unit

DDD $25.00 $60.00

EEE $30.00 $84.00

$180.62

$129.24

Difficulty: Moderate Time on task: 10 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: DDD: $180.62 EEE: $129.24 Activity Cost Pool Total Cost

Total Expected

Activity Rate

Assigned

Activity

Packaging, inspecting, shipping

$100,000/280 = $357.14 per setup $80,000/60 = $80,000 60 orders $1,333.33 per order $200,000/2,500 = $200,000 2,500 machine hours $80 per machine hour $220,000/1,100 = $220,000 1,100 shipments $200 per shipment

Total

$600,000

Setting up

$100,000 280 setups

Purchasing Machining

Activity Cost Pool Setting up Purchasing Machining Packaging, inspecting, shipping

[A]

[B]

[A] × [B]

[C]

[A] × [C]

Activity Rate

Expected Activity DDD

Allocated Costs DDD

Expected Activity EEE

Allocated Costs EEE

$357.14 $1,333.33 $80.00

200 50 2,000

$71,428.00 $66,666.50 $160,000.00

80 10 500

$28,571.20 $13,333.30 $40,000.00

$200.00

900

$180,000.00

200

$40,000.00

Total indirect cost Units produced Indirect cost per unit

Total indirect cost Units 5,000 produced Indirect cost $95.62 per unit

$478,094.50

Direct materials Direct labor Indirect costs

DDD $25.00 $60.00 $95.62

EEE $30.00 $84.00 $15.24

Total cost per unit

$180.62

$129.24

$121,904.50 8,000 $15.24

d. What do you conclude with respect to strategic costing (which product is more profitable), assuming both products have the same selling price? Be specific in discussing the differences in assigning indirect costs based on number of units, based on direct labor hours, and based on ABC. Difficulty: Moderate

Time on task: 8 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: If management assigns indirect costs based on number of units sold or direct labor hours, management will inappropriately overcost product EEE and conclude it is less profitable than product DDD by $29.00 (unit basis) or $43.81 (direct labor hours basis) per unit. By utilizing an ABC system and data analytics, management is able to identify which product consumes more resources and the costs associated with these resources. Under the ABC approach, product DDD is allocated $95.62 in indirect costs per unit compared to product EEE, which consumes only $15.24 in indirect costs per unit. Indirect costs are only a portion of the total cost per unit, and management should also evaluate the costs of direct labor and materials when determining overall profitability. The total cost per unit difference between product DDD and EEE is $51.38 per unit.

e. Which factors should be considered in determining the drivers? Do you agree with the drivers used, or do you suggest others? Elaborate. Difficulty: Difficult Time on task: 8 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: When determining cost drivers, management should choose a cost driver with a cause-and-effect relationship with the activity. In other words, as the activity driver increases, the activity cost increases as well. However, management should also consider (1) if it is possible to track the driver, (2) whether management already tracks the driver, and (3) if not, what the additional cost of tracking the driver will be. Management must weigh the benefit against the additional cost. The drivers identified by management for setting up, purchasing, machining, and packaging/inspecting/shipping seem reasonable. One 68

would expect that as each driver selected increases in frequency, the overall activity cost would also increase. Management could determine if more appropriate drivers exist through observation of the activity or interviews of personnel. For example, while it seems reasonable that number of shipments is a good driver for shipment costs, based on interviews with distribution personnel, management may realize that shipment costs can vary greatly from one shipment to the next based on weight, such that a more appropriate driver is shipment weight.

Should the company first try to identify some of the preceding costs as directly traceable to the two products? If so, why? Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Yes, if this step is cost-effective, management should trace costs directly to products when possible. Direct tracing provides the most accurate product costing.

g. Could management use the information about the activities to learn about what is done and suggest improvements? If you were on the ABC team, which questions would you ask the employees? Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Once management has identified the activities and related drivers that increase costs, management can use data analytics to focus on the activities performed to determine how and why the costs are derived. If

management can determine exactly how things are actually done, it can also determine how things can be done differently to improve the process currently in place, thereby reducing costs.

6. Sanchez has developed the following product activity cost pool information for this year:

Activity

Budgeted Cost

Total Budgeted Activity

Cost Driver

Direct tracing

$305,000

Purchasing and material handling

$120,000

12,000 Number of pounds of materials

Product design

$90,000

600 Number of design changes

Setups

$80,000

400 Number of setups

Running machines

$200,000

20,000 Number of machine hours

Inspection

$45,000

1,500 Number of batches

Rent, storage, and occupancy

$100,000

10,000 Number of square feet

Packaging

$26,000

2,600 Number of units

Customer handling

$29,000

2,900 Number of customers

Total indirect costs

$690,000

Actual information follows for Standard Product A, Standard Product B, and Specialty Products:

Directly traceable costs Number of pounds of materials Number of design changes Number of setups Number of machine hours Number of batches Number of square feet Number of units

Product A

Product B

$100,000 4,000 100 60 8,000 400 4,000 1,100

$120,000 5,000 100 100 7,000 300 4,000 1,000

Specialty Total Products Activity $105,000 $325,000 3,000 12,000 400 600 240 400 5,000 20,000 800 1,500 2,000 10,000 500 2,600

Number of customers

1,200

1,300

400

2,900

a. Determine the total unit cost of each product if the indirect costs are determined based on the number of units produced using the following chart. Product A

Product B

Specialty Products

Directly traceable cost Indirect cost rate × Number of actual units Total indirect cost Total cost ÷ Total units Total unit cost

Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: (1) Calculate Indirect cost allocation rate = Total indirect costs/Total number of units = $690,000 ÷ 2,600 units = $265.38 per unit (2) Allocate overhead to each product and add to any directly traceable costs to determine total unit cost. Product A Directly traceable cost

$100,000

Product B $120,000

Specialty Products $105,000

Indirect cost rate $265.38 × Number of 1,100 actual units Total indirect cost Total cost ÷ Total units Total unit cost

$265.38

1,000

500

$291,918

$265,380

$132,690

$391,918 ÷ 1,100

$385,380 ÷ 1,000

$237,690 ÷ 500

$356.29

$385.38

$475.38

b. Determine the total unit cost of each product if the indirect costs are determined based on the number of machine hours using the following chart. Product A

Product B

Specialty Products

Directly traceable cost Indirect cost rate × Number of actual units Total indirect cost Total cost ÷ Total units Total unit cost

Difficulty: Moderate Time on task: 8 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: (1) Calculate Indirect cost allocation rate = Total indirect costs ÷ Total number of machine hours = $690,000 ÷ 20,000 machine hours = $34.50 per machine hour

(2) Allocate overhead to each product and add to any directly traceable costs to determine total unit cost. Product A Directly traceable cost Indirect cost rate × Number of actual units

Product B

$100,000

Specialty Products

$120,000

$105,000

$34.50

8,000

7,000

5,000

Total indirect cost Total cost ÷ Total units Total unit cost

$276,000

$241,500

$172,500

$376,000 ÷ 1,100

$361,500 ÷ 1,000

$277,500 ÷ 500

$341.82

$361.50

$555

c. Determine the total unit cost of each product if the indirect costs are determined based on the number of customers using the following chart. Product A

Product B

Specialty Products

Directly traceable cost Indirect cost rate × Number of actual units Total indirect cost Total cost ÷ Total units Total unit cost

Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework

Solution: Product A: $350.47 Product B: $429.31 Specialty Products: $400.34 (1) Calculate Indirect cost allocation rate = Total indirect costs ÷ Total number of customers = $690,000 ÷ 2,900 customers = $237.93 ÷ customer (2) Allocate overhead to each product and add to any directly traceable costs to determine total unit cost. Product A Directly traceable cost Indirect cost rate × Number of customers

Product B

$100,000

Specialty Products

$120,000

$105,000

$237.93

1,200

1,300

400

Total indirect cost Total cost ÷ Total units Total unit cost

$285,516

$309,309

$95,172

$385,516 ÷ 1,100

$429,309 ÷ 1,000

$200,172 ÷ 500

$350.47

$429.31

$400.34

d. Determine the total unit cost of each product if the indirect costs are determined based on the preceding ABC information using the following charts.

Materials purchasing Design changes Setups Machining Inspections Occupancy Packaging Customer services

Budgeted Cost Total Activity $120,000 12,000 $90,000 600 $80,000 400 $200,000 20,000 $45,000 1,500 $100,000 10,000 $26,000 2,600 $29,000 2,900

Rate

Expected Expected Allocated Expected Allocated Allocated Activity Activity Activity Costs Activity Costs Activity Cost Pool Costs Rate Product Product Product Specialty Specialty Product A A B B Product Product Materials purchasing 4,000 5,000 3,000 Design changes 100 100 400 Setups 60 100 240 Machining 8,000 7,000 5,000 Inspections 400 300 800 Occupancy 4,000 4,000 2,000 Packaging 1,100 1,000 500 Customer services 1,200 1,300 400 Total indirect cost Directly traceable costs

Total indirect cost Directly traceable costs

Total cost ÷ Units produced

Total cost per unit

Difficulty: Easy Time on task: 15 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Product A: $292.73 Product B: $347 Specialty Products: $692 (1) Calculate Indirect cost allocation rate for each activity = Total indirect costs/Total activity [A] [B] [A] / [B] Budgeted Cost Total Activity Rate

Materials purchasing Design changes Setups Machining Inspections Occupancy Packaging Customer service

$120,000 $90,000 $80,000 $200,000 $45,000 $100,000 $26,000 $29,000

12,000 600 400 20,000 1,500 10,000 2,600 2,900

10.00 150.00 200.00 10.00 30.00 10.00 10.00 10.00

(2) Allocate overhead to each product and add to any directly traceable costs to determine total unit cost. = [A] × [D] = [A] × [D] [C] Expected Expected Allocated Expected Allocated Allocated Activity Activity Activity Costs Activity Costs Activity Cost Pool Costs Rate Product Product Product Specialty Specialty Product A A B B Product Product Materials purchasing $10 4,000 $40,000 5,000 $50,000 3,000 $30,000 Design changes $150 100 $15,000 100 $15,000 400 $60,000 Setups $200 60 $12,000 100 $20,000 240 $48,000 Machining $10 8,000 $80,000 7,000 $70,000 5,000 $50,000 Inspections $30 400 $12,000 300 $9,000 800 $24,000 Occupancy $10 4,000 $40,000 4,000 $40,000 2,000 $20,000 Packaging $10 1,100 $11,000 1,000 $10,000 500 $5,000 Customer services $10 1,200 $12,000 1,300 $13,000 400 $4,000 [A]

[B]

= [A] × [B]

[C]

Total indirect cost Directly traceable costs

Total $222,000 indirect cost Directly $100,000 traceable costs

Total cost ÷ Units produced

$322,000 Total cost $347,000 Total cost ÷ Units ÷ Units 1,100 1,000 produced produced

Total cost per unit

$292.73

Total cost per unit

Total $227,000 indirect cost Directly $120,000 traceable costs

$347

Total cost per unit

$241,000

$105,000 $346,000 500 $692

e. Explain why in item (d), the total unit cost of the Specialty Products is so much higher than the total unit cost of Standard Product A or Standard Product B using ABC. Be specific. Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Specialty Products are more than twice the cost of Products A and B, as Specialty Products require four times the number of design changes and more than twice the number of setups. Design changes and setup represent the most expensive activities: $150 per design change and $200 per setup. All other activities have costs between $10 and $30.

Could management use the information gathered on the activities to learn about what is done and suggest improvements? For example, suppose descriptive analytics reveal that materials are not delivered on time and workers are not properly trained, which could cause setups to be inefficient. If you were on the ABC team, which questions would you ask the employees regarding activities other than setups to identify inefficiencies? Elaborate. Difficulty: Moderate Time on task: 5 minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: Yes. Management could use the different activities to perform an ABM with integrated diagnostic analytics to determine whether there are any non–value-added activities that can be improved or eliminated. For example, rent, storage, and occupancy is an activity that could potentially be improved if there are storage costs for holding materials or completed units.

7. The Neighborhood Bank has gathered data related to its customers for a pilot project at one of its branches. The ABC team has identified three main product lines: regular account holders, loans, and investments (certificates of deposit, retirement investments, and so on). The team initially identified the following support activities: process transactions related to customer accounts, process applications for loans and for investments, answer customer inquiries, and balance customer accounts. The following data regarding activities are provided:

Support Activity Process transactions Process applications Answer inquiries Balance accounts Total

Estimated Activity Cost Driver Cost $50,000 Number of transactions $24,000 Number of applications $18,000 Number of inquiries $9,000 Number of accounts

Budgeted Level 30,000 4,000 36,000 3,000

Rate $1.67 $6.00 $0.50 $3.00

$101,000

a. Express the calculation of total support activity cost as a linear equation. Hint: Use words to describe what you are multiplying each rate by, as you are not provided with actual information. Difficulty: Easy Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Total support activity costs = ($1.67 per transaction × number of transactions) + ($6 per application × number of applications) + ($0.50 per inquiry × number of inquiries) +($3 per account × number of accounts).

b. If a long-time high-account-balance customer uses the following monthly quantity of activities, determine the support costs for this type of customer: 15 transactions, 2 applications, 7 inquiries, and 4 accounts. Difficulty: Easy Time on task: 5 minutes Objective: LO4

AACSB: Analytical thinking Assignment: Test Solution: $52.55 Support Activity

Rate

Process transactions Process applications Answer inquiries Balance accounts

$1.67 $6.00 $0.50 $3.00

× × × ×

Actual Activity 15 2 7 4

= = = =

Total Activity $25.05 $12.00 $3.50 $12.00

Total Indirect Costs

$52.55

c. If instead the bank allocated its support costs by the number of accounts held, what cost would be assigned to this high-account-balance customer? Difficulty: Easy Time on task: 4 minutes Objective: LO41 AACSB: Analytical thinking Assignment: Test Solution: Predetermined rate = Total estimated costs ÷ Total estimated accounts Predetermined rate = $101,000 ÷ 3,000 accounts Predetermined rate = $33.67 per account Total allocated costs = $33.67 × 4 accounts Total allocated costs = $134.68

d. Compare the answers in (b) and (c). What are the advantages and disadvantages of the approach in (b) versus those of the approach in (c)? Difficulty: Moderate Time on task: 4 minutes Objective: LO6 AACSB: Reflective thinking

Assignment: Test Solution: In (b), the ABC system is used to identify the total support costs for the customer. Pro: More accurate calculation of support costs. Con: It takes time to (1) identify activities that drive costs, (2) collect the data on each activity driver, and (3) perform the calculation. In (c), a single driver of costs (accounts) is used. Pro: Easier to calculate and allocate indirect costs. Con: Average cost per customer may be distorted, resulting in customers being overcosted and undercosted.

e. Evaluate each of the following suggestions made to the ABC team: i. Use the time spent on each activity instead of the number of transactions to allocate support costs. ii. Separate the processing of online banking accounts from the processing of on-site banking and robotics process automation (RPA) as different activity cost pools and cost objects.

Difficulty: Difficult Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Test Solution: Students’ answers will vary. i. If the time spent on each transaction varies significantly between customers, then using time spent on processing transactions, processing applications, answering inquiries, and balancing accounts would be a better driver of costs. However, the costs to obtain this data might be too great to justify the information provided. For example, a clerk may perform all of these activities at varying times during the day. If each clerk is required to track their time by activity, they could end up spending an hour per day tracking time that does not add value to the organization. ii. If there are different processes and costs with online and on-site

banking as well as with robotics process automation, then this could be a more accurate method to track costs. This would depend on the allocation between online and on-site transactions.

8. Caring Hospital directly captures the cost of surgical labor. The hospital has collected the following indirect cost information and identified the corresponding cost drivers:

Activity Cost Driver Nursing care Laboratory Medical supplies Occupancy and feeding Medical recordkeeping Equipment related

Activity Cost

Activity Driver

$2,700,000 Number of hours of nursing care $540,000 Number of tests $800,000 Number of supplies and medicines $1,260,000 Number of patient days $22,000 Number of patients $450,000 Number of procedures

Budgeted Activity Rate Level 27,000 $100 18,000 $30 40,000 $20 18,000 $70 2,000 $11 9,000 $50

a. With respect to medical recordkeeping, can you identify any non–value-added tasks or steps that might be part of the activity and could be reduced, improved, or eliminated without compromising the quality of the care? Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers will vary, as each activity is associated with many potential non–value-added tasks. Some examples include: Laboratory: Tests are performed that were not requested or required. Medical recordkeeping: If a paper-based system is used, then the time spent to find manual records or time spent to input data into the system.

b. Do you believe that any other activity cost (supplies, laboratory, and so on) could be more directly traced? Difficulty: Easy

Time on task: 3 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Yes. Medical procedures are tracked by patients for billing purposes. Laboratory and medical supplies could then be traced directly to each patient based on the procedures performed.

c. Prior to the ABC analysis, the hospital believed that the indirect cost per patient was a flat room rate of $125 per day during the stay and an average daily nursing rate of $200. As such, a patient staying a total of 12 days would be assessed for indirect costs (other than the operating room) of $325 × 12 = $3,900. What information is necessary to calculate the cost per patient using an ABC analysis? Why might the total indirect costs per patient for 12 days be different from $3,900 under the flat rate system? Difficulty: Easy Time on task: 3 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: To calculate the total indirect cost per patient for 12 days under the ABC system, we need to know the actual level of activity for each driver (e.g, total hours of nursing, care, actual number of tests). An ABC system allocates costs based on activities, so the total cost for 12 days may differ from $3,900 if a patient uses more or less than the average level of activity. For example, if a customer requires a significant number of hours for nursing care, it would be expected that this patient’s total costs would be higher than $3,900, as the rate for each nursing hour is $100 (the most expensive).

d. Would the ABC information be useful in negotiating insurance company and government contracts, in budgeting, or in making other decisions? Discuss fully. 82

Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Yes. Insurance companies and governmental contracts are typically based on information at the activity level. By having detailed information by activity, the hospital can use the more accurate information to develop diagnostic analytics, thus better determining actual costs and profitability.

e. Do you think that using averages for the costs of procedures, tests, or nursing care is a problem for obtaining accurate cost information? Difficulty: Easy Time on task: 3 minutes Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: Yes. Averages may distort actual cost data and provide inaccurate figures for insurance reimbursement or billing. If an average is used, those patients with high levels of nursing care and equipment use will be undercosted.

The hospital is considering refining the nursing care by types of care (types of nurses and activity levels). Three cost pools would be used to assign the actual care provided for recovery rooms, because a patient undergoing a knee replacement would require a different level of nursing care than a patient with a heart condition being treated in a semi-intensive care environment. Comment on the proposal from a cost-benefit perspective.

Difficulty: Moderate Time on task: 3 minutes

Objective: LO3 AACSB: 8a: Application of knowledge; 8b–8f: Reflective thinking Assignment: Homework Solution: The hospital should refine the ABC system only if the cost of obtaining the data is less than the benefit provided by the additional information. Data would have to be already tracked to be beneficial and easily accessible. Otherwise, the additional information obtained by type of care might be useful for decision making.

9. Valiente Company makes equipment for three major customers. As part of its ABC and ABM project, the following customer profitability report for 2022 was prepared. Valiente Customer Profitability Report for 2022 Customer A Customer B Customer C Sales $200,000 $600,000 $900,000 Less: Sales discounts and returns (25,000) (42,000) (154,000) Net sales 175,000 558,000 746,000 Cost of goods sold (94,000) (400,000) (580,000) Gross margin 81,000 158,000 166,000 % Gross margin of sales 40.5% 26.3% 18.4% Customer costs Order taking and order processing (5,000) (11,000) (17,000) Delivery costs (excluding expediting) (1,100) (2,000) (4,000) Other: expediting costs for delivery and (100) (700) (5,450) restocking costs for returned items Post-sales service visits (250) (430) (820) Billing and collection costs (50) (70) (130) Net customer profit $74,500 $143,800 $138,600 % Net customer profit of sales 37.3% 24.0% 15.4%

Other facts:

Customer C has successfully negotiated significant volume sales discounts. Commissions are paid to salespeople on gross total sales. Because Customer C buys the most, salespeople often go to the production area and demand that Customer C’s order be prioritized. In addition, Customer C often requests that the company expedite (pay extra shipping) for earlier delivery. Production has complained about the disruptions that Customer C’s demands create.

a. Rank the customers in terms of true profitability. Analyze the results, and discuss sales terms, returns, expediting orders, billing and payments, and service. b. Should the company compensate the salespeople on some basis other than gross total sales? Discuss. c. If you were a manager at Valiente, which changes in processes and procedures would you consider as a result of this customer profitability report?

Difficulty: Varies, see chart below Time on task: 5 minutes Objective: LO5 AACSB: 9a: Analytical thinking; 9b–9c: Application of knowledge Assignment: Homework Solution: Varies, see chart below #

Question

Diffic ulty

Solution

On a dollar-value basis, ranked from highest profitability to lowest: Customer B, Customer C, and Customer A. However, when net customer profit is calculated as a percentage of total sales, Customer A is the most profitable, followed by Customer B and then Customer C.

Rank the customers in terms of true profitability. Analyze the results, and discuss Mode 9a Even though Customer C has the highest dollar-value sales, sales terms, returns, rate Customer C is the least profitable due to significant sales expediting orders, discounts and expediting costs when compared to Customer A billing and payments, and Customer B. These costs are non–value-added to the and service. Company and can be prevented or mitigated. Billing and collections costs are almost two times higher for Customer C than for Customer A and Customer B.

Should the company compensate the 9b salespeople on some basis other than gross total sales? Discuss.

Yes. If commissions are calculated based on gross sales, salespeople have no incentive to monitor or manage sales discounts and returns. This could cause salespeople to offer large discounts as incentives to customers. At the very least, Easy salespeople should be paid commissions on net sales. If possible, the company should also gather data on deductions for non–value-added activities such as expediting costs and post-sales service visits.

Students’ answers will vary. Some recommended changes to processes and procedures may include: - Change the commission structure. Recommend commissions based on net sales and deductions for non–value-added If you were a manager activities, such as expediting costs and post-sales service at Valiente, which visits, if the data are readily accessible. changes in processes - Evaluate the significant volume discounts provided to Mode 9c and procedures would Customer C. Are the discounts necessary to keep Customer rate you consider as a C? result of this customer - Change the process for expediting orders for Customer C, as profitability report? it causes significant non–value-added costs and has the potential for loss of other customers. - Review billing and collection costs for Customer C. Why are these costs twice as much as for Customer B? Is there a different process that can be streamlined?

10. Look up a company such as Southwest Airlines or any of the companies listed in the chapter that have incorporated ABC into their operations. Write a memo to your boss on what you learned from your research and recommend whether ABC should be considered for your organization. Difficulty: Difficult Time on task: 60 minutes Objective: LO5 AACSB: Written and oral communication Assignment: Homework Solution: Responses will vary.

Chapter 05 End of Chapter with Solutions Discussion Questions 1. How is process costing different than job costing? Difficulty: Easy Time on task: 4 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Quiz Solution: A job costing system tracks the costs (direct materials, direct labor, and manufacturing overhead costs) to each individual job and is generally used by manufacturers of unique or custom-ordered products, for which the costs can vary significantly between jobs. Conversely, a process costing system tracks jobs by each manufacturing process or department rather than to each individual job. This costing approach is generally used by manufacturers that produce identical, high-volume products.

2. When is process costing used? Difficulty: Easy Time on task: 3 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Test Solution: Process costing is generally used by manufacturers that produce identical, highvolume products. Industries that typically use process costing include food, clothing, petroleum, chemicals, and plastics. 1

3. How are costs accumulated in a process costing system? Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Costs are accumulated in a separate work in process account for each process, which is a clearly distinguishable stage of production.

4. Under process costing, a unit cost is determined for each product and then used to price the product at a margin above cost. Do you agree? If you disagree, explain why. Difficulty: Difficult Time on task: 3 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Yes, I agree. By tracking costs through the production processes, management is able to understand the company’s total costs and the costs for each unit by product. Having this information enables management to make pricing decisions and manage its costs and profit margins efficiently.

5. Under process costing, since all units are the same, there is no distinction in the cost accumulation between direct materials costs and conversion costs. Do you agree? If you disagree, explain why. Difficulty: Moderate Time on task: 3 minutes Objective: LO2

AACSB: Reflective thinking Assignment: Homework Solution: No, I do not agree. While all units are identical once completed, costs are usually tracked and calculated separately as either direct materials costs or conversion costs (direct labor and manufacturing overhead). The reason for the distinction is that direct materials costs can be added at any stage during the process, whereas conversion costs are typically added evenly throughout the process.

6. Describe the cost flow for a process costing system. Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: Direct materials, direct labor, and overhead costs are incurred and recorded in the work in process account for each process. After units (and the associated costs) have moved through the different processes and the manufacturing is complete, the units are transferred to finished goods inventory and the total costs accumulated are transferred to the finished goods inventory account. These costs will include all the manufacturing costs (direct materials, direct labor, and manufacturing overhead) from each stage of production that have been accumulated and transferred from the work in process accounts for each process. Once these items are sold, the cost is transferred out of the finished goods inventory account and recorded as cost of goods sold on the company’s income statement.

7. Give the steps used to allocate costs in a process costing system. Difficulty: Easy Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge

Assignment: Test Solution: The steps used to allocate costs in a process costing system are: 1. Summarize the physical flow of units. 2. Calculate the equivalent units. 3. Calculate the cost per equivalent unit for direct materials and conversion costs (direct labor and manufacturing overhead). 4. Allocate total costs between the work in process inventory and finished goods inventory accounts.

8. Explain what is meant by the term equivalent unit as used in process costing. Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: An equivalent unit is equivalent to a fully completed unit and is calculated for work in process inventory that is partially completed.

9. How are unit costs calculated under the weighted average method and under the FIFO method? Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Under the weighted average method, all units and the associated costs are combined and averaged to determine the equivalent unit and the cost per equivalent unit. The first-in, first-out (FIFO) method is similar to the weighted average method except that it assumes the beginning inventory units are the first units to be completed, so those costs will transfer to finished goods inventory

first. Thus, under the FIFO method, beginning inventory units and costs are tracked separately from current costs and units that were started during the current period.

10. How are unit cost calculations different in the first and second production departments of a process costing system? Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: The difference in calculating the unit cost in the first department compared to the second department relates to the inclusion of transferred-in costs. Transferred-in costs are the costs incurred from a previous process or department that are transferred to the next department in the manufacturing process. These costs are part of the cost of the units being produced and continue to be transferred with the units to each process until the units are finished and ready for sale. The first department would not have any transferred-in costs because it is the first step in the production process.

11. If a company does not have any beginning inventory in work in process, unit costs will be the same under the weighted average and FIFO process costing methods. Do you agree? If you disagree, explain why. Difficulty: Difficult Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Yes, I agree. The calculation of unit costs under the weighted average and firstin, first-out (FIFO) methods will result in the same unit cost if there is no beginning inventory. If a company chooses the FIFO method, it assumes that the

beginning inventory units and costs will be the first units to be completed, so those costs will transfer to finished goods inventory first, before any other units are started and completed. Because of this, beginning inventory units and costs are tracked separately from current costs and units started during the current period.

12. Discuss the differences in cost allocations when using the weighted average versus the FIFO method. Difficulty: Moderate Time on task: 5 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Quiz Solution: To allocate costs, companies can use either the weighted average method or the first in, first out (FIFO) method for process costing. The weighted average method assumes that all units and associated costs (including beginning inventory units and current units) should be used to calculate equivalent units and costs per equivalent unit. Essentially, all units and the associated costs are combined and averaged together to determine the equivalent unit and the cost per equivalent unit. When a company chooses the FIFO method, it assumes that the beginning inventory units and costs will be the first units to be completed and those costs will transfer to finished goods inventory first, before any other units are started and completed. As a consequence, beginning inventory units and costs are tracked separately from current costs and units started during the current period. Usually the differences between the two methods are immaterial, so many companies use the weighted average method for simplicity.

13. Companies use process costing systems in an effort to have lower cost of goods sold than if they used job order costing systems. Do you agree? If you disagree, explain why. Difficulty: Moderate Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking

Assignment: Homework Solution: No, I do not agree. Companies choose to use process costing versus job order costing based on how costs are tracked and driven. Job costing systems are often used in the custom-made furniture, custom construction, printing, and ship building industries, as well as in service companies, such as law firms and advertising agencies. The cost of servicing individual clients can be drastically different, depending on the requirements of each client. In contrast, manufacturers that produce identical units in large quantities use process costing. With process costing, the production costs are tracked by each manufacturing process or department rather than by individual jobs. Because each unit goes through the same production processes, all are considered identical and it is not necessary to track costs by certain batches or jobs.

14. How is spoilage accounted for in a process costing system? Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Quiz Solution: In a process costing system, spoilage is accounted for based on the type of spoilage. Normal spoilage, or spoilage that cannot be avoided, is added to the cost of the goods (product cost). Abnormal spoilage, or spoilage that can be avoided and is due to inefficiencies in the manufacturing process, is recorded as a loss on the income statement (period cost).

15. Distinguish between normal and abnormal spoilage. Difficulty: Easy Time on task: 4 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Test

Solution: In a manufacturing environment, spoilage is categorized as either normal or abnormal. Normal spoilage is spoilage that cannot be avoided and is inherent to the normal operations of the manufacturing process, even if the manufacturing process is running efficiently and effectively. If this is the case, then despite all quality improvements, some spoilage occurs within the manufacturing process that cannot be avoided. Abnormal spoilage is spoilage that is not inherently unavoidable in the manufacturing process. After applying descriptive analytics to identify the abnormal spoilage, diagnostic analytics can pinpoint the sources of spoilage that occurs due to inefficiencies in the manufacturing process. Examples of abnormal spoilage include losses due to equipment failures, human errors, and poor training, among other causes. Abnormal spoilage is considered avoidable and controllable. Because abnormal spoilage is controllable, it is expensed on the income statement in a separate loss account rather than included as part of the costs incurred for the good units that were produced.

16. Both job order and process costing systems include direct materials, direct labor, and overhead as product costs. Do you agree? If you disagree, explain why. Difficulty: Moderate Time on task: 3 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Yes, I agree. Both systems include the tracking of costs related to direct materials, direct labor, and overhead. Once the unit is completed, it will be recorded on the income statement as cost of goods sold (product cost).

17. As goods are finished in a process costing department, the costs are transferred from finished goods to cost of goods sold. Do you agree? If you disagree, explain why. Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking

Assignment: Homework Solution: No, I do not agree. The goods need to be finished and then sold to be recorded as part of cost of goods sold. The physical flow of goods is as follows: 1. Direct materials, direct labor, and overhead costs are incurred and recorded in the work in process account for each process. 2. As a process is completed, the units and the costs associated with those units are transferred out of that process and into the next process. Then, additional costs incurred are added to these costs in the work in process account for that process. 3. After units (and the associated costs) have moved through the different processes and the manufacturing is complete, the units are transferred to finished goods inventory and the total costs accumulated are transferred to the finished goods inventory account. 4. Once the units are sold, the costs are recorded on the company’s income statement as the cost of goods sold. 18. The two process costing methods are FIFO and weighted average. Weighted average is the most widely used because it is the more accurate approach. Do you agree? If you disagree, explain why. Difficulty: Difficult Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: No, I do not agree. The two process costing methods that are used are weighted average and FIFO. Usually the differences between the two methods are immaterial, so many companies use the weighted average method for simplicity, rather than because of its accuracy.

Exercises 1. Pretty Lawn Products uses a process costing system. The following is known for July: ● ●

The company started 90,000 units and completed 87,000 units. The beginning work in process was 3,000 units.

How many units were in work in process at the end of the month? Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: 6,000 units remain in work in process at the end of July. = 3,000 Units in beginning balance + 90,000 Units started – 87,000 Units completed

2. Match the terms with their descriptions a. Transferred-in costs b. Conversion costs c. Normal spoilage d. Process costing e. Equivalent units f. FIFO method g. Weighted average method h. Abnormal spoilage

(1) Waste that is inherent in the process and cannot be avoided (2) Process costing method that assumes all units and associated costs should be used to calculate equivalent units and unit costs (3) Costs incurred from the previous process or department (4) Spoilage that is due to inefficiencies that are controllable and avoidable (5) Unit that is representative of a complete unit (6) Cost system that accumulates costs by departments or distinct processes (7) Process costing system that distinguishes between the beginning inventory and the current activity and uses only current activity for equivalent units and unit costs

(8) Direct labor and manufacturing overhead

Difficulty: Easy Time on task: 1 minute Objective: Varies, see chart below AACSB: Application of knowledge Assignment: Homework Solution: Varies, see chart below

Question

2 (1) Waste that is inherent in the process and cannot be avoided

Solution LO c

Cost system that accumulates costs by departments or distinct processes

Process costing system that distinguishes between the beginning 2 (7) inventory and the current activity and uses only current activity for equivalent units and unit costs

2 (8) Direct labor and manufacturing overhead

2 (2)

Process costing method that assumes all units and associated costs should be used to calculate equivalent units and unit costs

2 (3) Costs incurred from the previous process or department 2 (4)

Spoilage that is due to inefficiencies that are controllable and avoidable

2 (5) Unit that is representative of a complete unit 2 (6)

3. Light Plastics uses a process costing system. The following is known for September: ● The company transferred out 66,000 units. ● The beginning work in process was 10,000 units. ● The ending work in process was 4,000 units. How many units were started during the period? Difficulty: Moderate

Time on task: 4 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: 60,000 units were started during September Beginning WIP 10,000 + Units started – Units transferred out 66,000 = Ending WIP 4,000 Units started = 60,000 units

4. Great Paint Company uses a process costing system. The following applies to materials for June: ● Materials are added halfway through the process. ● The company started 20,000 units. ● There were 2,000 units in the beginning inventory. ● There were 5,000 units left in work in process, which are 50% complete. What are the equivalent units for conversion costs if the weighted average method is used? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: The equivalent units for materials under the weighted average method = Number of units completed* + Work in process, ending × % Complete = 17,000 + 5,000 × 50% = 19,500 equivalent units * Number of units completed is determined by taking: WIP, beginning + Units started – WIP, ending = 2,000 + 20,000 – 5,000 = 17,000

5. Shiny Metals had a cost per equivalent unit of $6.00 for direct materials. Materials are added at the beginning of the first process. There were 20,000 units in work in process at the beginning of the period. During the period, 45,000 units were started. At the end of the month, only 5,000 units were not completed. a. What were the total direct materials costs to account for? Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Total direct materials costs to account for is equal to the number of units started and in beginning work in process times the cost per equivalent unit. Materials are added at the beginning of the process, so the full materials cost would be added as soon as the unit is started. = (WIP, beginning + units started) × $6.00 = (20,000 + 45,000) × $6.00 = $390,000 b. What were the costs for direct materials transferred out using the weighted average method? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Total costs transferred out is equal to the number of units transferred out times the cost per equivalent unit. Finished units = WIP, beginning + Units started – WIP, ending = 20,000 + 45,000 – 5,000 = 60,000 EU × $6.00 per EU = $360,000 transferred out

6. Indicate whether job order costing or process costing best fits the scenario. a. Flour mill b. Brewery c. Tire manufacturer d. Printing shop e. Identical units are made continuously f.

Costs are accumulated by departments

g. Large number of homogeneous products h. Unit costs are calculated for materials, conversion costs, and transferred-in costs by dividing costs by equivalent units i.

Total costs to account for are allocated between ending work in process and units transferred out using weighted average or FIFO Difficulty: Easy Time on task: 1 minute Objective: LO1 AACSB: Application of knowledge Assignment: Varies, see chart below Solution: Varies, see chart below

Solution

Assign ment

6a Flour mill

Process

Test

6b Brewery

Process

Quiz

6c Tire manufacturer

Process

Test

Job

Quiz

6e Identical units are made continuously

Process

Test

6f Costs are accumulated by departments

Process

Quiz

6g Large number of homogeneous products

Process

Quiz

Question

6d Printing shop

Unit costs are calculated for materials, conversion costs, and transferred-in costs by dividing costs by equivalent units

Process

Quiz

Total costs to account for are allocated between ending work in process and units transferred out using weighted average or FIFO

Process

Test

7. Flour Everywhere uses a process costing system. The following applies to conversion costs for April: ● Conversion costs are added uniformly throughout the process. ● The company started 40,000 units. ● There were 8,000 units in the beginning inventory. ● There were 12,000 units left in work in process, which are 60% complete. What are the equivalent units for conversion costs if the weighted average method is used? Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Equivalent units for conversion costs under the weighted average method = Number of units completed* + (Work in process, ending × % Complete) = 36,000 + (12,000 × 60%) = 43,200 equivalent units * Number of units completed is determined by: WIP, beginning + Units started – WIP, ending = 8,000 + 40,000 – 12,000 =36,000

8. Pencils and Pens uses a weighted average process costing system. The following applies to conversion costs for October: ● ● ● ●

27,000 units were completed and transferred out. 6,000 units were in the ending work in process, which were 50% completed. Cost of conversion costs in the beginning work in process were $100,000. Cost of conversion costs added during the period were $500,000.

a. What is the cost per unit for conversion costs? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: Summarize physical units

Conversion costs

100% complete +

6,000

27,000

27,000 Finished Units and Transferred + Out

Work in Process, Ending

Equivalent Units =

27,000

6,000 (50%)

30,000

Beginning WIP

Current Costs

Total Costs

Equivalent Units ÷ =

Cost per Equivalent Unit

$600,000

30,000

$20.00

$100,000

$500,000

b. What are the conversion costs transferred out? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: Equivalent Cost per Total Cost Allocated × = Units Equivalent Unit to Transferred Out Conversion costs

27,000

$20.00

$540,000

9. Flowers uses a weighted average process costing system. The following is known for November: Equivalent units for materials

36,000

Equivalent units for transferred-in costs

40,000

Equivalent units for conversion costs

30,000

Units completed and transferred out

32,000

Equivalent unit cost for materials

$2.00

Equivalent unit cost for transferred-in costs

$3.50

Equivalent unit cost for conversion costs

$2.50

a. What were the total costs to account for and allocate? Difficulty: Moderate Time on task: 4 minutes Objective: LO3, LO4 AACSB: Analytical thinking Assignment: Homework Solution: Equivalent Cost per Total Cost × = Units Equivalent Unit to Allocate Materials Conversion costs Transferred in

36,000 30,000 40,000

Totals

× × ×

$2.00 $2.50 $3.50 $8.00

= = =

$72,000 $75,000 $140,000 $287,000

b. What is the cost of goods completed and transferred out? Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking

Assignment: Homework Solution: Units Finished units

× Cost per Unit =

Allocated Costs

32,000 × $8.00* = $256,000 * Sum of individual cost per equivalent unit.

10. Cable Products uses a weighted average costing system with two departments: cutting and packaging. The following is known for February:

Cutting: completed and transferred out

16,000 units for $64,000

Packaging: beginning work in process: materials

$11,000

Packaging: beginning work in process: conversion costs

$19,000

Packaging: beginning work in process: transferred-in costs

$16,000

Packaging: units completed and transferred out Packaging: units in beginning work in process

15,000 4,000

a. What are the equivalent units for transferred-in costs in the packaging department? Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: Transferred-in costs would come from the cutting department. Total equivalent units for conversion costs would be composed of the 4,000 units in beginning inventory, which were transferred from the cutting department in a previous period, plus the 16,000 units transferred out of the cutting department and into the packaging department this period, or 20,000 total equivalent units. The cost per equivalent unit is calculated as: Cost per Beginning Current Total Equivalent + = ÷ = Equivalent WIP Costs Costs Units Unit Transferred-in costs $16,000 + $64,000 = $80,000 ÷ 20,000 = $4.00

from cutting

b. What is the transferred-in cost associated with the units completed and transferred out of the packaging department? Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: Units × Finished units – packaging 15,000 ×

Cost per Allocated = Unit Costs $4.00

= $60,000

11. Questionable is the controller for a company that uses a process costing system. Questionable is concerned with the spoilage costs that have been identified as abnormal and has asked the staff accountant to review the criteria for classifying spoilage as either normal or abnormal. The staff accountant wrote a brief report indicating that approximately 50% of the spoilage costs that require rework are attributable to equipment malfunctions and poor-quality materials from the suppliers. a. Should the rework cost described in the accountant’s report be classified as normal or abnormal spoilage? Discuss. Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: The rework costs described in the accountant’s report should be classified primarily as abnormal spoilage. With the Internet of things and other technology upgrades, real-time information is available to identify

the sources of abnormal spoilage. Rework required as a result of equipment malfunctions and poor-quality materials from suppliers are costs that are mostly avoidable and controllable. Equipment malfunctions can be prevented by performing routine maintenance, and poor material quality can be prevented by changing suppliers or purchasing higherquality materials.

b. Refer to the Institute of Management Accounting’s Standards of Ethical Professional Practice in Chapter 1. Which IMA Standards would the staff accountant be violating if he shifts the spoilage to normal costing so that lower expenses are reported? Difficulty: Difficult Time on task: 5 minutes Objective: LO5 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: The staff accountant would be violating three of the IMA’s Standards of Ethical Professional Practice: integrity, credibility, and competence. The integrity standard requires members to be honest and trustworthy at all times, no matter what the circumstance. If the staff accountant does not disclose abnormal spoilage as a current period expense, he is not being honest and trustworthy and, therefore, lacks integrity. Further, he will lack competence because he knowingly did not prepare the income statement in accordance with Generally Accepted Accounting Principles (GAAP). Since the numbers would be wrong, the credibility standard would also be violated.

c. What should the staff accountant do? Difficulty: Difficult Time on task: 3 minutes Objective: LO5 AACSB: Ethical understanding and reasoning Assignment: Homework

Solution: The staff accountant should discuss his concerns with the person overseeing his review. He should mention that he believes reported spoilage costs may be inaccurate and he does not want to act without integrity or credibility. If his superior dismisses his concerns, the accountant should include discussion of his findings in his report/analysis. Additionally, he should review his company’s Code of Conduct to determine the company’s policies in relation to ethical violations.

Problems 1. On March 1, Winston Company had 25,000 units of beginning inventory in work in process, which were 60% complete with the following costs: Direct materials Direct labor Factory overhead

$15,150 $50,000 $75,220

During March, 60,000 units were started. There were 15,000 units remaining in work in process at the end of the month, which were 80% complete. Materials are added at the beginning of the process, and direct labor and conversion costs are incurred evenly during the process. March costs were: Direct materials Direct labor Factory overhead

$120,000 $200,000 $225,000

a. Trace the physical flow of the units. Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework

Solution: Beginning inventory, March 1 + Units started

25,000 units 60,000 units

Total units to account for Less: work in process units, March 31

85,000 units (15,000 units)

= Finished units as of March 31

70,000 units

b. Assume use of the weighted average method. Determine the equivalent units for each product cost. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: 100% complete Summarize physical units

70,000

Finished Units and Transferred Out

Direct materials

70,000

Conversion costs

70,000

15,000

85,000

Work in Process, Equivalent = Ending Units 15,000 × 100% = 15,000 15,000 × 80% = 12,000

85,000

82,000

c. Assume use of the weighted average method. Calculate the unit cost for each product cost. Difficulty: Moderate Time on task: 5 minutes Objective: LO3

AACSB: Application of knowledge Assignment: Homework Solution: Beginning Current + = WIP Costs

Total Costs

Direct materials Conversion costs*

$15,150 + $120,000 = $125,220 + $425,000 =

$135,150 $550,220

Totals

$140,370

$685,370

$545,000

Cost per Equivalent ÷ = Equivalent Units Unit ÷ 85,000 = $1.59 ÷ 82,000 = $6.71 $8.30

* Conversion costs = direct labor + factory overhead.

d. Assume use of the weighted average method. Allocate the total costs between the finished goods and the goods still in work in process. Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution:

Finished units Work in process: Direct materials Conversion costs

Equivalent Cost per × = Units Equivalent Unit 70,000 × $8.30 = 15,000 12,000

× ×

Total costs: work in process Total costs to account for

$1.59 $6.71

= =

WIP Costs

Allocated Costs $581,000

23,850 80,520 104,370 $685,370

2. Sturdy Paper, which uses a process costing system, had the following production data during September: ● ● ● ●

10,000 units were in the beginning inventory. 80,000 units were started in production. 60,000 units were completed. The remaining units were one-fourth complete.

● ● ●

The materials are added at the end of the process. Total costs to account for direct materials were $240,000. Total costs to account for conversion costs were $319,950; of the total costs, $294,400 were current costs. a. Trace the physical flow of the units. Difficulty: Easy Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Beginning inventory, September 1

10,000 units

+ Units started

80,000 units

Total units to account for Less: finished units as of September 30

90,000 units – 60,000 units

= Work in process units as of September 30

30,000 units

100% complete Summarize physical units

60,000

30,000

90,000

Finished Units and Work in Equivalent + = Transferred Out Process, Ending Units

Direct materials Conversion costs

60,000 60,000

+ +

30,000 (0%) 30,000 (25%)

= =

60,000 67,500

c. Assume use of the weighted average method. Calculate the unit cost for each product cost. Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution:

Direct materials Conversion costs

$240,000 $319,950

Cost per Equivalent ÷ = Equivalent Units Unit ÷ 60,000 = $4.00 ÷ 67,500 = $4.74

Totals

$559,950

Total Costs

$8.74

60,000

Cost per Equivalent Unit $8.74

= =

Allocated Costs $524,400

Work in process: Direct materials Conversion costs

0 7,500

× ×

$4.00 $4.74

= =

$0 $35,550

Total costs – work in process

$35,550

Total costs to account for

$559,950

3. Awesome Clothes has two departments. Other facts are as follows: ● In the first department, material is introduced at the beginning of the process. ● In the second department, material is introduced at the end of the process. ● Conversion costs are applied uniformly throughout both processes. ● As units are finished, they are transferred to finished goods. ● Additional data for August for the second department: Beginning Inventory August Activity Units

Ending Inventory

8,000 units (60% complete) Transferred in 36,000 units 4,000 units (40% complete) Product Cost

Beginning Inventory

Current Costs Added in August

$0 $24,192 $40,000

$72,000 $126,400 $180,000

Direct materials Conversion costs Transferred in

a. Trace the physical flow of the units. Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Test Solution: Beginning inventory, August 1 + Transferred in

8,000 36,000

Total units to account for Less finished units in August

44,000 *40,000

Finished inventory, August 31

4,000

* Goods completed in August = Beginning inventory + Transferred in units – Units in ending inventory

b. Assume use of the weighted average method. Determine the equivalent units for each product cost. Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Test Solution: Summarize physical units: Finished Units and Transferred Out

Direct materials

40,000

Conversion costs

40,000

Transferred in

40,000

Weighted Average Equivalent Units 40,000

41,600

44,000

Work in Process, = Ending 0 4,000 × 40% = 1,600 4,000 × 100% × 4,000

c. Assume use of the weighted average method. Calculate the unit cost for each product cost. Difficulty: Moderate Time on task: 8 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution:

Beginning + Costs

Current Costs

Direct materials Conversion costs Transferred-in costs

$0 $24,192 $40,000

$72,000 $126,400 $180,000

Totals

$64,000

+ + +

$378,400

Cost per Equivalent = Total Costs ÷ = Equivalent Units Unit = $72,000 ÷ 40,000 = $1.80 = $150,592 ÷ 41,600 = $3.62 = $220,000 ÷ 44,000 = $5.00 $442,592

125,600

$10.42

d. Assume use of the weighted average method. Allocate the total costs between the finished goods and the ending work in process. Difficulty: Moderate Time on task: 8 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: Total units to account for (from part a)

44,000 units

– Ending inventory, August 31

(4,000) units

Transferred out × Cost per equivalent unit

40,000 units $10.42

Total cost transferred out – Ending inventory, August 31

$416,800 4,000 units

Total cost of work in process

Additional information: $0, as all direct materials are added upon completion. Additional information: Number of units in $5,792 WIP, ending × Cost per equivalent unit for conversion costs × Percent complete. Additional information: Number of units in $20,000 WIP, ending × Cost per equivalent unit for conversion costs × Percent complete (100%). $25,792

Total costs to account for

$442,592

Direct materials Conversion costs

Transferred-in costs

Check figure. This amount should equal total costs calculated in part c.

Chapter 05 Appendix EOC with Solutions

Exercises 1. Great Paint Company uses a process costing system. The following applies to materials for June: ● Materials are added halfway through the process. ● The company started 20,000 units. ● There were 2,000 units in the beginning inventory, which were 25% complete. ● There were 5,000 units left in work in process, which are 50% complete. What are equivalent units for materials if FIFO is used?

Difficulty: Moderate Time on task: 5 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Quiz Solution: The equivalent units for materials under the FIFO method = Number of units completed* + (Work in process, ending × % Complete) – (Work in process, beginning × % Complete) = 17,000 + (5,000 × 50%) – (2,000 × 25%) = 19,000 equivalent units * Number of units completed is determined by taking: WIP, beginning + Units started – WIP, ending = 2,000 + 20,000 – 5,000 = 17,000 Note to Instructor: The same data are used in Chapter 5, Exercise 4.

2. Flour Everywhere uses a process costing system. The following applies to conversion costs for April: ● Conversion costs are added uniformly through the process. ● The company started 40,000 units. ● There were 8,000 units in the beginning inventory, which were 30% complete. ● There were 12,000 units left in work in process, which are 60% complete. What are equivalent units for conversion costs if FIFO is used?

Difficulty: Moderate Time on task: 5 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Homework Solution: The equivalent units for materials under the FIFO method = Number of units completed* + (Work in process, ending × % Complete) – (Work in process, beginning × % Complete) = 36,000 + (12,000 × 60%) – (8,000 × 30%) = 40,800 equivalent units * Number of units completed is determined by: WIP, beginning + Units started – WIP, ending = 8,000 + 40,000 – 12,000 = 36,000 Note to Instructor: The same data are used in Chapter 5, Exercise 7.

Problems 1. On March 1, Winston Company had 25,000 units of beginning inventory in work in process, which were 60% complete with the following costs: Direct materials Direct labor Factory overhead

$15,150 $50,000 $75,220

Total beginning inventory costs

$140,370

$120,000 $200,000 $224,780 $544,780

a. Determine the equivalent units for each product cost using FIFO. Difficulty: Moderate Time on task: 5 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Homework Solution: Beginning inventory, March 1 + Units started

25,000 units 60,000 units

Total units to account for Less: work in process units, March 31

85,000 units

= Finished units as of March 31

Summarize physical units

70,000

15,000

(15,000 units) 70,000 units

85,000

–

(25,000)

60,000

Finished Weighted Work in FIFO Units and Average Beginning + Process, = – = Equivalent Transferred Equivalent Inventory Ending Units Out Units

Direct materials

70,000

Conversion costs

70,000

15,000 × + 100% = = 15,000 15,000 × + 80% = = 12,000

85,000

–

82,000

–

25,000 × 100% = (25,000) 25,000 × 60% = (15,000)

60,000

67,000

b. Calculate the unit cost for each product cost using FIFO. Difficulty: Moderate Time on task: 5 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Homework Solution: Current Costs

Direct materials Conversion costs

$120,000 = $424,780 =

Totals Plus: Beginning inventory costs

$544,780

Total costs to account for

Cost per Equivalent = Equivalent Units Unit $120,000 ÷ 60,000 = $2.00 $424,780 ÷ 67,000 = $6.34 Total Costs

$544,780 $140,370

$8.34

$685,150

Equivalent Units

Cost per × Equivalent = Unit

Allocated Costs

Finished units Beginning inventory costs

$140,370

Costs to finish beginning inventory Direct materials Conversion costs

25,000 × 0% = 0 × 25,000 × 40% = 10,000 ×

$2.00 $6.34

= $0.00 = $63,400

45,000

$8.34

= $375,300

Started and completed all this month*

Total costs: Allocated to finished goods

$438,700

Work in process Direct materials Conversion costs

15,000 × 100% = × 15,000 15,000 × 80% = 12,000 ×

$2.00

= $30,000

$6.34

= $76,080

Total costs: Work in process

$106,080

Total costs to account for

$685,150

* Units started – ending WIP.

Note to Instructor: Similar data are used in Chapter 5, Problem 1.

2. Sturdy Paper, which uses a process costing system, had the following production data during September: ●

10,000 units were in the beginning inventory.

●

80,000 units were started in production.

●

60,000 units were completed.

●

The remaining units were one-fourth complete.

●

The materials are added at the end of the process.

●

Total costs to account for materials were $240,000.

●

Total costs to account for conversion costs were $320,000; of the total costs, $294,375 was current costs.

a. Determine the equivalent units for each product cost using FIFO. Difficulty: Moderate Time on task: 8 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Homework Solution: Beginning inventory, September 1 + Units started

10,000 80,000

Total units to account for: Less: finished units as of September 30

90,000 (60,000)

= work in process units as of September 30

30,000

*Answers in units.

100% complete Summarize 60,000 + physical units Finished Units and + Transferred Out Direct materials

60,000

Conversion costs

60,000

30,000 Work in Process, Ending

30,000 × 0% = =0 30,000 × + = 25% = 7,500 +

90,000

–

Weighted Average – Equivalent Units 60,000 67,500

10,000 Beginning Inventory

FIFO = Equivalent Units

10,000 × 0% = =0 10,000 × 50% – = = (5,000) –

80,000

60,000 62,500

b. Calculate the unit cost for each product cost using FIFO. Difficulty: Difficult Time on task: 7 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Homework

Solution: Cost per Equivalent = Total Costs ÷ = Equivalent Units Unit $240,000 = $240,000 ÷ 60,000 = $4.00 $294,375 = $294,375 ÷ 62,500 = $4.71

Current Costs Direct materials Conversion costs

Totals $534,375 Plus: Beginning inventory costs

$534,375 $25,625

Total costs to account for

$560,000

$8.71

c. Allocate the total costs between the finished goods and goods still in work in process using FIFO. Difficulty: Difficult Time on task: 10 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Homework Solution: Equivalent Units Finished units Beginning inventory costs Costs to finish beginning inventory 10,000 Direct materials (100%) 10,000 Conversion costs (50%) Started and completed all this 50,000 month*

Allocated Costs

$25,625

$4.00

$40,000

$4.71

$23,550

$8.71

= $435,500

Total costs allocated to finished goods Work in process Direct materials 30,000 (0%) × 30,000 Conversion costs × (25%) Total costs – work in process

Cost per Equivalent Unit

$499,050 $4.00

$4.71

$35,325 $35,325

Total costs to account for

$560,000

* Units started – ending WIP.

Note to Instructor: Similar data are used in Chapter 5, Problem 2.

Ending Inventory

8,000 units (60% complete) Transferred in 36,000 units 4,000 units (40% complete) Product Cost

Beginning Inventory

Current Costs Added in August

$0 $24,192 $40,000

$72,000 $126,224 $180,000

Direct materials Conversion costs Transferred in

Assume the company uses FIFO process costing.

a. Determine the equivalent units for each product cost using FIFO. Difficulty: Moderate Time on task: 75 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Test Solution: Beginning inventory, August 1 + Transferred in

8,000 36,000

Total units to account for

44,000

Less fininshed units in August

*4,000

Finished inventory, Aug 31 40,000 * Goods completed in August = Beginning inventory + Transferred in units – Units in ending inventory Summarize physical units

40,000 + Finished Units and Transferred + Out

Direct materials

40,000

Conversion costs

40,000

4,000 Work in Process, Ending

–

8,000 = 36,000 Work in FIFO – Process, = Equivalent Beginning Units 8,000 × 0% = + 4,000 × 0% = 0 – = 40,000 0 4,000 × 40% = 8,000 × 60% = + – = 36,800 1,600 (4,800)

b. Calculate the unit cost for each product cost using FIFO. Difficulty: Difficult Time on task: 10 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Test Solution: Current Costs Direct materials Conversion costs Transferred in costs Totals

$72,000 = $126,224 = $180,000 =

Cost per Equivalent ÷ = Equivalent Units Unit $72,000 ÷ 40,000 = $1.80 $126,224 ÷ 36,800 = $3.43 $180,000 ÷ 36,000 = $5.00 Total Costs

$378,224 $378,224 Plus: Beginning inventory costs $64,192

$10.23

Total costs to account for $442,416

c. Allocate the total costs between the finished goods and goods still in work in process using FIFO.

Difficulty: Difficult Time on task: 10 minutes Objective: Appendix AACSB: Application of knowledge Assignment: Test Solution: Equivalent × Units Finished units Beginning inventory costs Costs to finish beginning inventory 8,000 Direct materials × (100%) Conversion 8,000 (40%) × Started and completed all this 32,000 × month* Total costs allocated to finished goods Work in process, ending Direct materials 4,000 (0%) × Conversion costs 4,000 (40%) ×

Cost per Equivalent Unit

Allocated Costs

$64,192

$1.80

$14,400

$3.43

$10,976

$10.23

= $327,360 $352,736

$1.80 $3.43

= =

$0 $5,488

Total costs – work in process

$5,488

Total costs to account for

$422,416

* Units started – ending WIP.

Note to Instructor: Similar data are used in Chapter 5, Problem 3.

Chapter 06 End of Chapter with Solutions

Discussion Questions 1. Discuss the differences between fixed costs, variable costs, and mixed costs. Difficulty: Easy Time on task: 3 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Homework Solution: A fixed cost is a cost that does not change in total, regardless of the changes in volume. For planning and control purposes, fixed costs can also be categorized as either committed fixed costs or discretionary fixed costs. A variable cost is a cost that changes in direct proportion to changes in an activity level (or units), but the cost per unit remains the same. A mixed cost is a cost that changes in total, but not in direct proportion to changes in a given activity level.

2. Which information is found in the contribution margin statement that is not found in the traditional (functional) income statement? Difficulty: Easy Time on task: 3 minutes

Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: A contribution margin income statement provides information on variable and fixed costs (according to cost behavior), rather than classifying costs based on whether they are product or period costs (as in the income statement prepared for external use in accordance with GAAP).

3. For retailers and service companies, product costs are variable and period costs are fixed. As such, retailers and service companies do not need to break down costs into variable and fixed costs. Do you agree? If you do not agree, explain why not. Difficulty: Moderate Time on task: 4 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Test Solution: No, I do not agree that all period costs are fixed. Period costs may be fixed or variable. For example, $3,000 in monthly rent for a retail space would be considered a fixed cost and a period cost. In contrast, the cost of bags given to customers after they make a purchase would be considered a variable cost, yet is also a period cost (e.g., selling and administrative cost).

● 4. Simple Company compensates its salespeople based on a percentage of sales volume (items sold). Some of the salespeople have sold to customers with bad credit. The new chief operating officer has suggested that the commission be based on net contribution margin (deducting uncollected amounts), so that salespeople are rewarded for the sale of higher margin items. Do you agree with the proposal? Explain. Difficulty: Difficult

Time on task: 5 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: No, I do not completely agree with the proposal. If commissions are based on contribution margin, there may be an unintended consequence in which salespeople will sell only those items with a higher contribution margin. However, salespeople should not sell to customers with bad credit. Instead, commissions should be based on a mix of both units sold and contribution margin. Additionally, Simple Company should have a process in place and reliable analytics so that the salespeople are required to obtain information about the customer’s credit prior to recording the sale.

5. Direct materials and direct labor will always be completely variable. Do you agree? If you do not agree, explain why not. Difficulty: Moderate Time on task: 4 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution: No, I do not agree. Direct labor and direct materials are typically assumed to be variable costs if they change in direct proportion to changes in an activity level (or units) but the cost per unit remains the same. If direct labor will be paid even when there is no production (e.g., salaried employees), then direct labor would be considered fixed. 6. Contribution margin is the same as gross profit. Do you agree? If you do not agree, explain why not. Difficulty: Moderate Time on task: 2 minutes

Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: No, I do not agree. Contribution margin and gross profit represent different outcomes. Contribution margin is calculated by taking Sales – Variable costs, whereas gross profit is equal to Sales – Cost of goods sold. The differences are attributable to fixed overhead and variable selling cost. 7. As R2 approaches +1, we are given a higher level of assurance that the independent variable accounts for most of the variability in the dependent variable. Do you agree? Explain. Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Yes, I agree. The R-square value (R2) determines how close the actual observations are to the predicted line; thus, it indicates the strength of the relationship between the dependent and independent variables. A larger number (closer to 1) indicates the data points are highly correlated. 8. The wages of salespeople who are paid strictly on commission will always be variable, and the wages of those who are paid only a salary will be considered fixed. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Easy Time on task: 2 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Homework Solution: Yes, I agree.

9. “Committed costs” is a term used to refer to fixed costs, whereas “discretionary costs” refers to variable costs. Do you agree? If you do not agree, explain why the statement is false. Difficulty: Moderate Time on task: 3 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: No, I do not agree. Discretionary costs are fixed costs incurred from management decisions about spending in certain areas. These costs may be fixed in the short term (normally within a one-year time span). If the company is facing cash-flow constraints, management can make changes to these discretionary fixed costs without significantly impacting the organization’s longterm profitability or long-term strategic goals. Examples of discretionary fixed costs are company perks and advertising.

10. Why is the organization of costs by behavior (variable versus fixed) useful for budgeting profits at different volume levels? Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: It is important to organize costs by behavior to be able to budget for profits at different volume levels because volume is the key driver for variable costs. Total variable costs are determined by the number of units sold. If a variable cost is mistakenly classified as a fixed cost, then total profits may be understated if the company sells fewer units and overstated if it sells more units. 11. Why might there be a difference in operating income in a contribution margin income statement compared to a traditional income statement? Difficulty: Difficult

Time on task: 6 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: The difference in calculating operating income in the two income statements is how fixed overhead is treated under each method. With a traditional income statement, fixed overhead is a product cost, meaning all costs related to making a product are capitalized on the balance sheet (as inventory) until the products are sold. Once a product is sold, the product costs are expensed as cost of goods sold on a traditional income statement. A contribution margin income statement, on the other hand, uses a variable costing approach where only variable costs are included as inventoriable product costs. All fixed costs are treated as period costs and expensed immediately (including fixed overhead). Operating income will be the same amount on each income statement if the units sold for the period equal the units produced. If the units sold for the period are more (less) than the units produced, operating income under the traditional income statement will be lower (higher) than the contribution margin income statement.

Exercises 1. Examine these graphs for Kristen Company and answer the following questions.

Assume that if activity increased beyond 40 units, a new relevant range would apply (for example, if fixed costs are expected to be $280 from 41 to 80 units).

a. What is the cost equation? b. Explain why the total cost graphs differ for fixed and variable costs. c. Explain why the average cost graphs differ for fixed and variable costs. d. What are total costs at 30 units? e. What is the new cost equation if activity is between 41 and 80 units? f. What are total costs at 60 units? Difficulty: 1a and 1e - Moderate 1b, 1c, 1d, and 1f - Easy Time on task: 1a and 1e - 2 minutes 1b, 1c, 1d, and 1f - 1 minute Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: #

Question

1a What is the cost equation? Explain why the total cost 1b graphs differ for fixed and variable costs. Explain why the average 1c cost graphs differ for fixed and variable costs.

What are total costs at 30 units?

What is the new cost equation if activity is

Solution y = a + b(x) y = $150 + $3(x) Total fixed costs remain constant, regardless of changes in volume. Total variable costs, in contrast, depend on the volume: As volume increases, total variable costs increase. Average variable costs remain constant, regardless of changes in volume. Average fixed costs, in contrast, depend on the volume. As volume increases, average fixed costs decrease because the total fixed cost is spread over more units. $240 y = $150 + $3 (30 units) y = $150 + $90 y = $240 y = a + b(x) y = $280 + $3(x)

between 41 and 80 units? $460 1f

What are total costs at 60 units?

y = $280 + $3 (60 units) y = $280 + $180 y = $460

2. Identify the cost behavior in the graph.

Difficulty: Easy Time on task: 2 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution:

3. From the visual fit, do you believe that there is a strong relationship between activity and costs and that all observations are a good representation?

Difficulty: Easy

Time on task: 3 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: While not all observations are a good representation (note the presence of at least one outlier), there is a strong linear relationship between the activity and costs.

4. The Humble Company determined that feet of lumber was the appropriate measure of activity for the cutting department. A sample of actual cost data for 2022 was selected as follows: Month of Observation

Total Costs

January February March April May

$100,000 200,000 170,000 280,000 210,000

Activity (feet of lumber) 60,000 120,000 90,000 240,000 180,000

a. Draw the sample observations on a scatterplot. Apply visual approximation to determine the variable and fixed costs. Does your graph resemble the graph below?

Difficulty: Moderate Time on task: 3 minutes

Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers should approximate the graph shown.

b. Compare this graph with the graph presented in Exercise 3. Which graph gives you more assurance of a positive relationship between the dependent (costs) and independent (activity) variables? Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: While the graph in Exercise 3 included an outlier, it also provided many more data points. For this reason, the graph in Exercise 3 provides more assurance of a positive relationship between the dependent and independent variables.

c. Apply the high–low method to the data and determine the variable and fixed costs. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Variable cost = (Cost of highest activity point –Cost of lowest activity point) (High activity – Low activity) Variable cost = ($280,000 – $100,000) (240,000 – 60,000) = $1.00 Fixed cost (a) y = a + b(x) $280,000 = a + $1.00(240,000) a = $40,000

d. Using the high–low method, what is the total cost estimate for 90,000 feet of lumber? Difficulty: Moderate Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: y = a + b(x) y = $40,000 + $1.00(90,000) y = $130,000

5. Bellis Company produces pottery items. Bellis sells each item for an average sales price of $10. The company has a choice of two production methods: hand-crafting and painting versus machine production, with costs as follows: ●

Hand-crafting and painting: $7 variable costs per unit and $900 fixed costs within the relevant range 13

●

Machine production: $2 variable costs and $2,000 fixed costs a. Calculate total costs for each method at 100 units. Difficulty: Moderate Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Hand-Crafting and Painting y = a + b(x) y = $900 + $7(100) y = $1,600 Machine Production y = a + b(x) y = $2,000 + $2(100) y = $2,200

b. Calculate total costs for each method at 300 units. Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Hand-Crafting and Painting y = a + b(x) y = $900 + $7(300) y = $3,000 Machine Production y = a + b(x) y = $2,000 + $2(300) y = $2,600

6. Match the following terms to the definitions below: Terms: i. Variable cost ii. Fixed cost iii. Independent variable iv. Dependent variable v. Scatter diagram vi. High–low method vii. Regression analysis viii. Outliers ix. Account analysis

Definitions: a. Method used to allocate costs based on review of the general ledger account detail. b. Total cost remains the same despite changes in volume over a relevant range. c. One data point that does not fit the pattern of other data points due to error, irregularity, or presence outside the relevant range. d. Method used to approximate a cost equation so as to estimate the fixed and variable cost components of a mixed cost. e. Costs depend on both the costs that do not change and the costs that do change with a change in activity. f.

Chosen activity driver that is most closely related to (drives) the mixed costs (e.g., units, miles, feet, hours).

g. Costs per activity level; cost per unit remains constant as activity level increases. h. Statistical technique that includes all data points to determine the relationships between dependent and independent variables. i.

A plot of all data points collected to determine the relationships between the data points.

Difficulty: Easy Time on task: 1 minute each Objective: Varies, see chart below AACSB: Application of knowledge Assignment: Homework Solution: # 6a 6b 6c

6f 6g 6h 6i

Question

Solution

Method used to allocate costs based on review of ix. Account analysis the general ledger account detail. Total cost remains the same despite changes in ii. Fixed cost volume over a relevant range. One data point that does not fit the pattern of other data points due to error, irregularity, or viii. Outliers presence outside the relevant range. Method used to approximate a cost equation so as to estimate the fixed and variable cost vi. High–low method components of a mixed cost. Costs depend on both the costs that do not change and the costs that do change with a iii. Dependent variable change in activity. Chosen activity driver that is most closely related to (drives) the mixed costs (e.g., units, miles, feet, iv. Independent variable hours). Costs per activity level; cost per unit remains I. Variable cost constant as activity level increases. Statistical technique that includes all data points to determine the relationships between vii. Regression analysis dependent and independent variables. A plot of all data points collected to determine the v. Scatter diagram relationships between the data points.

3 1 3

3 1 3 3

7. For each of the following statements, indicate whether the statement is true or false. a. The high–low method is superior to regression analysis because the high–low method consistently uses the highest and lowest activity levels in each period. Difficulty: Easy

Time on task: 1 minute each Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: False. Regression analysis is superior to the other methods described for separating total costs because it uses all of the data points to determine the “best-fitting line” as opposed to using just two points.

b. The equation for total costs is represented as x = b + a(y). Difficulty: Easy Time on task: 1 minute each Objective: LO2 AACSB: Application of knowledge Assignment: Test Solution: False. The equation is y = a + b(x).

c. The contribution margin income statement is primarily used for internal decision making and classifies costs by behavior rather than by their function in the company. Difficulty: Easy Time on task: 1 minute each Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: True.

d. The main reason to separate costs into variable and fixed costs is to comply with reporting requirements to outside users. Difficulty: Moderate Time on task: 1 minute each Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: False. Managers need to identify which costs are variable and which costs are fixed so that they can make predictions and good business decisions regarding pricing, costs, and products. e. Sunk costs are relevant for current decisions because they are the actual costs incurred during the period. Difficulty: Easy Time on task: 1 minute each Objective: LO1 AACSB: Application of knowledge Assignment: Homework Solution: False. A sunk cost is the cost of resources that have already been committed and cannot be changed, regardless of any current decisions being made.

8. An experienced company uses account analysis to separate its costs. For each of the following costs, indicate the category in which it would likely be classified: i. ii. iii.

Variable Fixed Mixed 18

Costs: a. Sale representatives’ commissions b. Direct materials (ignore purchasing discounts) c. Training seminar d. Depreciation e. Rent f.

Utilities

g. Monthly data analytics software fee h. Insurance Difficulty: Easy Time on task: 1 minute each Objective: LO1 AACSB: Application of knowledge Assignment: Varies, see chart below Solution: #

Question

Solution

Assignment

Sale representatives’ commissions

i. Variable

Quiz

Direct materials (ignore purchasing discounts)

i. Variable

Homework

Training seminar

ii. Fixed

Homework

8d Depreciation

ii. Fixed

Quiz

8e Rent

ii. Fixed

Homework

iii. Mixed

Quiz

8g Monthly data analytics software fee

ii. Fixed

Homework

8h Insurance

ii. Fixed

Homework

Utilities

9. Stuart Advertising Company decided to analyze its travel and entertainment expenses based on the number of customers it serviced each month. The regression analysis for the prior 12 months gave the following results:

a. Identify the R-square value, the fixed costs, and the variable costs. Difficulty: Moderate Time on task: 1 minute Objective: LO3 AACSB: Reflective thinking Assignment: Test Solution: R-square = 0.999 Intercept coefficient = 756.91 X variable 1 coefficient = 676.49

b. What is the cost equation line? Difficulty: Easy Time on task: 1 minute Objective: LO2

AACSB: Application of knowledge Assignment: Test Solution: y = a + b(x) y = 756.91 + 676.49x

c. Is there a strong correlation between the number of customers and the travel and entertainment expenses? Difficulty: Moderate Time on task: 1 minute Objective: LO3 AACSB: Reflective thinking Assignment: Test Solution: Yes, there is a strong correlation between the number of customers and the travel and entertainment expenses, as the R2 value from the company’s regression analysis is approximately 1.

10. Clean Company reported the following information on its current-year contribution margin income statement: Fixed costs

$120,000

Sales

$300,000

Contribution margin

$180,000

Income taxes

$15,000

a. The marketing department suggests that a new advertising campaign costing $15,000 can increase the contribution margin by 10%. What is the net effect on operating income? Ignore the effect of taxes. Difficulty: Moderate

Time on task: 5 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Increase in contribution margin Less: Increase in fixed costs = Net effect on operating income (10% × $180,000) – $15,000 = $3,000 increase in operating income

b. Refer to the facts in part (a). As the chief financial officer, what support would you seek for the marketing department projections? What other information is relevant to the decision to launch the campaign? Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: I would request that the marketing department provide the assumptions and supporting data used to project the 10% increase in contribution margin. Is it based on increased consumer demand? Is it based on purchasing cheaper products, which might compromise product quality? Further, I would seek information regarding how sustainable the increase in contribution margin will be and how likely it is that advertising expenditures will end up exceeding $15,000.

11. Party Planner is considering two options, as follows: ● Pay a variety entertainer (a comedian who is also a musician) a fixed amount of $10,000 and $100 per job ● Pay the entertainer $600 per job

a. How many jobs must be booked for both options to cost the same amount? b. Which option is cheaper for Party Planner if 10 jobs are booked? If 30 jobs are booked? c. Higher risks are associated with high fixed costs at low volumes and would be applicable if the company is unsure about booking sufficient venues. Besides the expected quantity of jobs, what other information is relevant for Party Planner before making the decision?

Difficulty: Varies, see chart below Time on task: Varies, see chart below Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: #

Question

Diffic ulty

Time on Task

Solution Option A: 10,000 + $100x

How many jobs must be 11a booked for both options to cost the same amount?

Which option is cheaper for Party Planner if 10 jobs are 11b booked? If 30 jobs are booked?

Moder ate

Option B: $600x $10,000 + $100x = $600x $10,000 = $500x x = 20 jobs When 10 jobs are booked, option B is cheaper. Option A: $10,000 + ($100 × 10) = $11,000 Option B: $600 × 10 = $6,000

4 When 30 jobs are booked, option A is cheaper. Option A: $10,000 + ($100 × 30) = $13,000 Option B: $600 × 30 = $18,000

The concept of operating leverage suggests that higher risks are associated with high fixed costs at low volumes and would be applicable if the company is unsure about Moder 11c booking sufficient venues. ate Besides the expected quantity of jobs, what other information is relevant for Party Planner before making the decision?

The company should consider the quality of the entertainer being hired and the convenience cost of being able to change entertainers as needed. For example, if the entertainer ends up being a poor choice and needs to be replaced, then having paid him $10,000 up front would be an expensive sunk cost. In addition to the quality of the entertainer being hired, the company should consider his availability, the likelihood that he will increase his rates, and exclusivity.

12. Following are two income statements: internal (contribution margin income statement, with costs classified by behavior) and external (a traditional income statement, with GAAP-based costs classified by function). Contribution Margin Income Statement Sales $ xx Variable Costs: Direct Materials $ x Direct Labor x Variable Overhead x Variable Selling and Administrative (xx) Contribution Margin: $ xx Fixed Costs: Fixed Overhead $ x

Traditional (Functional) Income Statement Sales: $ xx Cost of Goods Sold: Direct Materials $ x Direct Labor x Variable Overhead x Fixed Overhead (xx) Gross Margin: $ xx Selling and Administrative Expense: Variable Selling and Administrative $ x

Fixed Selling and Administrative (xx)

Net Income: $ xx

a. Identify the items that would have a different amount reported (not just placement on the income statement). Difficulty: Difficult Time on task: 5 minutes Objective: LO4 AACSB: Application of knowledge

Assignment: Test Solution: Fixed overhead. On the traditional income statement, fixed overhead is not fully expensed until the items are sold. In contrast, on a contribution margin income statement, all fixed overhead is expensed in the period, regardless of what is sold.

b. In terms of planning and controlling, in making the decision to increase unit sales, which information is found on the contribution margin income statement that is not found on the external income statement? Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: A contribution margin income statement classifies expenses by cost behavior (either variable or fixed), not by whether they are product or period costs (as on the income statement, which is prepared for external use in accordance with GAAP). By aggregating cost information based on cost behavior, management can assess the impact that changes in sales volumes, prices, or costs will have on profits.

13. For each of the following fixed costs, indicate if the costs are committed costs or discretionary costs: i. ii.

Committed costs Discretionary costs

Fixed costs: a. Company picnic costs b. Salary of factory supervisor c. Cost of potential additional advertising campaign d. Cost of proposed enhanced research and development activities

e. Utilities cost f.

Insurance costs

g. Building depreciation costs Difficulty: Easy Time on task: 1 minute each Objective: LO1 AACSB: Application of knowledge Assignment: Varies, see chart below Solution: #

Question

Solution

Assignment

13a Company picnic costs

ii. Discretionary costs

Quiz

13b Salary of factory supervisor

i. Committed costs

Quiz

ii. Discretionary costs

Quiz

ii. Discretionary costs

Homework

13e Utilities cost

i. Committed costs

Homework

13f Insurance costs

i. Committed costs

Homework

13g Building depreciation costs

i. Committed costs

Homework

Cost of potential additional advertising campaign Cost of proposed enhanced 13d research and development activities 13c

14. Understanding cost behavior is important. Select the graph for Williams Company that matches each description given. The vertical (or y) axes represent total dollars and the horizontal (or x) axes represent activity for a year. Letters may be used more than once, and not all letters need to be used.

Supervisors’ salaries where one supervisor is required for every 75 workers.

ii.

Cost of direct materials used to produce tires.

iii.

Cost for water. Fee is $40 up to 60 acre feet per month; a rate of $2 per acre foot is used thereafter.

iv.

Straight-line depreciation for the period.

Salaries of sales representatives: Each receives a $1,400 fee per month plus 10% commission on sales.

vi.

Lease of equipment: Fixed $1,800 for first 100 machine hours; $2 per hour for next 500 hours; $1.20 per hour above 600 hours. Difficulty: Moderate Time on task: 1 minute each Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution:

Question

Solution

14 i.

Supervisors’ salaries where one supervisor is required for every 75 workers.

14 ii. Cost of direct materials used to produce tires. 14 iii.

Cost for water. Fee is $40 up to 60 acre feet per month; a rate of $2 per acre foot is used thereafter.

14 iv. Straight-line depreciation for the period.

B D A

Salaries of sales representatives: Each receives a $1,400 fee per month plus 10% commission on sales.

Lease of equipment: Fixed $1,800 for first 100 14 vi. machine hours; $2 per hour for next 500 hours; $1.20 per hour above 600 hours.

14 v.

15. WKC Company reported the following overhead charges for the first 3 months: Cost Item Electricity Rent Direct materials Activity for each month

January February Costs Costs $20,000 $24,000 $13,000 $13,000 $6,400 $8,000 3,200 4,000

March Costs $29,000 $13,000 $10,000 5,000

a. Which of the costs are fixed? Explain why. b. Which of the costs are variable? Explain why. c. Which of the costs are mixed? Explain why. Difficulty: Moderate Time on task: 2 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: #

Question

Solution

Which of the costs are fixed? Explain why. Which of the costs are 15b variable? Explain why. Which of the costs are 15c mixed? Explain why. 15a

Fixed costs include rent, as the total cost remains the same each month. Variable costs include direct materials, as the per-unit cost remains the same each month. Mixed costs include electricity, as the total costs and perunits costs differ each month.

16. BBC manufactures whiteboards. In March 2022, the variable production costs per unit were $15 and the average fixed production costs per unit (based on 5,000 whiteboards produced and sold) were $25. The relevant range is 0 to 8,000 units. a. What are fixed costs? Difficulty: Easy Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: Fixed Costs = Fixed cost per unit × Number of units = $25 × 5,000 = $120,000 b. What are the total production costs in March? Difficulty: Easy Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: Total Cost = Variable cost per unit × Number of units + Fixed cost = $15 per unit × 5,000 + $120,000 = $200,000

c. Assume that in April, 4,000 whiteboards are produced and sold. What are total production costs in April? Difficulty: Moderate Time on task: 2 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: Total Cost = Variable cost per unit × Number of units + Fixed cost = $15 per unit × 4,000 + $25 × 5,000* = $185,000 * Fixed costs remain the same no matter how many units are produced. Therefore, if total fixed costs were $120,000 in March, this amount would remain the same in April.

Problems 1. Assume the following information is known for Simple Watches Company: ● ● ● ●

The average sales price per unit is $37. Total costs at the lowest observed activity of 150 units are $3,822 and at the highest observed activity of 310 units are $5,902. The relevant range is from 0 units to 350 units. The company uses the high–low method to separate total costs into variable and fixed costs.

a. What are variable and fixed costs? Difficulty: Moderate Time on task: 3 minutes Objective: LO2 AACSB: Reflective thinking

Assignment: Homework Solution: Variable cost = (Cost of highest activity – Cost of lowest activity) (High activity – Low activity) Variable cost = ($5,902 – $3,822) (310 – 150) = $13 In the equation y = a + b(x), Total costs = Fixed costs + Variable costs per unit × Number of units, where: $5,902 = Fixed costs + $13(310) Fixed costs = $1,872

b. What is the contribution margin? Difficulty: Moderate Time on task: 2 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Contribution margin = Sales price per unit – Variable cost per unit = $37 Sales price – $13 Variable cost) = $24

c. What is the operating income if 80 units are sold? Difficulty: Moderate Time on task: 2 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Operating income = Contribution margin – Fixed costs

= 80 × $24 – $1,872 = $1,920 – $1,872 = $48

2. Hi-Tech Company sells small labeling machines for $60 each. Expected units, sales, and total costs in the next four quarters are as follows: Period Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total for year

Units 5,000 8,000 9,000 13,000 35,000

Sales $300,000 $480,000 $540,000 $780,000 $2,100,000

Total costs $205,000 $280,000 $315,000 $405,000 $1,205,000

a. What are fixed costs? Assume that the linear relationship assumption is appropriate within the relevant range of 0 to 15,000 units. The company uses the high–low method to separate total costs by cost behavior. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Variable cost = (Cost of highest activity – Cost of lowest activity) (High activity – Low activity) Variable cost = ($405,000 – $205,000) (13,000 – 5,000) = $25

y = a + b(x), where Total costs = Fixed costs + Variable costs per unit × Number of units $405,000 = Fixed costs + $25 (13,000) a = $80,000

b. What is the contribution margin per unit? Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Contribution margin per unit = $60 – $25 = $35

c. Is it appropriate to use this information to project operating income at 20,000 units? Why or why not? Difficulty: Moderate Time on task: 3 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: No, it is not appropriate. The relevant range for the fixed costs is 0 to 15,000 units. A total of 20,000 units is outside the range, so different costs would apply.

d. For which decisions is this information useful when costs are broken down by cost behavior? Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking

Assignment: Homework Solution: Using a contribution margin approach to analyze costs makes it fairly easy for a company to compute key pieces of information, such as the amount of sales it needs to reach certain profit goals. Managers can use this information to determine how changes in volume or costs will affect the company’s profits.

e. What other internal and external information would be relevant to understand profit predictions, pricing, performance evaluation, and customer demand? Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: In addition to information on cost behavior, relevant information includes evaluation of the assumptions used in the analysis to determine if they are realistic. Companies face both internal risks and external risks; having a clear understanding of their risks and how to manage them is the challenge.

3. Style Company sells luggage sets for $200 each. its variable costs include $80 of manufacturing costs and $10 for selling costs. In 2022, the company sold 2,000 luggage sets. Its fixed costs depend on the number of sets produced and sold, as shown in the following table:

Relevant Range of Units

Total Fixed Costs

0–3,000 sets

$120,000

3,001–6,000 sets

$260,000

6,001–10,000 sets

$400,000

a. Determine operating income for 2022. 34

Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Variable costs per unit = $80 + $10 Variable costs per unit = $90 Contribution margin per unit = Sales price – Variable costs Contribution margin per unit = $200 – $90 Contribution margin per unit = $110 Operating income = Sales – Variable costs – Fixed costs = 2,000 × $110 – $120,000 = $220,0000 – $120,000 = $100,000

b. What is the maximum amount of profit that can be generated? Difficulty: Difficult Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: The maximum profit is based on the total number of units that can be sold. Hint: Compare the operating income for the maximum number of units for each range of fixed costs. Operating income = Contribution margin – Fixed costs Operating income at 3,000 units produced: = ($110 × 3,000) – $120,000 = $330,000 – $120,000

= $210,000 Operating income at 6,000 units produced: = ($110 × 6,000) – $260,000 = $$660,000 – $260,000 = $400,000 Operating income at 10,000 units produced: = ($110 × 10,000) – $400,000 = $1,100,000 – $400,000 = $700,000 The maximum operating income the company can expect is $700,000.

c. What other internal and external information would you want to know? Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: In addition to information about cost behavior, relevant information includes evaluation of the assumptions used in the analysis to determine if they are realistic. Companies face both internal risks and external risks; having a clear understanding of these risks and how to manage them is the challenge.

4. All Weather Company makes umbrellas and outerwear items for rainy and snowy days. It had the following cost structure for the past year: Items Units produced and sold Average sales price per unit Direct materials cost per unit Direct labor cost per unit Variable overhead per unit

Umbrellas

Clothing

Total

100,000 $12 $3 $1.50 $0.60

10,000 $75 $16 $5.50 $3.50

110,000 $1,950,000 $460,000 $205,000 $95,000

Fixed overhead per unit Selling and administrative cost per unit

$2.50 $0.40

$11 $4

$360,000 $80,000

Direct fixed selling and administrative costs $76,000 total

$78,000 total

$154,000

Allocated fixed administrative costs

$37,000 total

$88,000

$51,000 total

a. What is the product cost per unit and gross margin per unit for each product line under the traditional (functional) income statement format? Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Sales – COGS Gross margin

Umbrellas $12.00 $7.60

Clothing $75.00 $36.00

$4.40

$39.00

b. What is the variable cost per unit and the contribution margin per unit for each product line under the contribution margin income statement format? Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Sales – Variable cost Contribution margin

Umbrellas $12.00 $5.50

Clothing $75.00 $29.00

$6.50

$46.00

c. What are the differences in classification of costs between the traditional (functional) income statement and the contribution margin income statement? Difficulty: Easy Time on task: 4 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: A traditional income statement must follow Generally Accepted Accounting Principles (GAAP); it categorizes costs as either product costs or period costs. Product costs are considered part of the cost of the inventory and are expensed on the income statement as “cost of goods sold” when the inventory is sold. Period costs are any selling, general, and administrative costs that a company incurs, and are expensed on the income statement immediately. By contrast, a contribution margin income statement classifies expenses by cost behavior (either variable or fixed), not by whether they are product or period costs (as in the income statement prepared for external use in accordance with GAAP). d. The allocated fixed administrative costs represent costs that must be covered but do not vary regardless of the product line. Such costs would include executive salaries, corporate costs of depreciation, utilities, accounting services, legal services, insurance, and property taxes. Why would it be important to distinguish between the direct fixed selling and administrative costs and the allocated administrative costs? Difficulty: Difficult Time on task: 5 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Homework Solution: It is important to distinguish between allocated fixed expenses and direct fixed expenses in order to identify whether certain costs can be controlled or eliminated to achieve the desired profit. e. Consider the cost-benefit analysis. If you were the manager, what information would you seek in deciding whether it was necessary to refine the analysis further by breaking down the clothing into boots versus coats? 38

Difficulty: Difficult Time on task: 5 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers may vary. Some examples include: ● How easy is it to separate the fixed and variable costs for clothing between boots and coats? (For example, a simple export into Excel = easy; manually reviewing each item of clothing sold to separate = difficult.) ● What percentage does clothing contribute to total sales? If it is small, then separating this cost out might not be worth the additional effort.

5. The Outer Border Company determined that its packaging costs were a function of the weight of the packages. For budgeting purposes, the company wishes to identify the fixed costs and the variable costs of the packaging department. A sample of actual cost data from 2022 is provided in the table: Month July August September October November

Total Costs $200,000 $280,000 $100,000 $210,000 $170,000

Pounds 120,000 240,000 60,000 180,000 90,000

a. If the company used the high–low method, what are its fixed costs, variable costs per pound, and cost equation? Difficulty: Easy Time on task: 5 minutes

Objective: LO2 and LO3 AACSB: Reflective thinking Assignment: Homework Solution: Variable cost = (Cost of highest activity – Cost of lowest activity) (High activity number of pounds – Low activity number of pounds) Variable cost = ($280,000 – $100,000) (240,000 – 60,000) Variable cost = $180,000 ÷ $180,000 = $1.00 per pound Cost equation: y = a + b(x) Total costs = Fixed costs + Variable costs per unit × Number of units Using lowest activity level: $100,000 = Fixed costs + $1 × 60,000 pounds $40,000 = Fixed costs Using highest activity level: $280,000 = Fixed costs + $1 × 240,000 pounds $40,000 = Fixed costs

b. Create a scatterplot of these observations and draw a line through the group of points that best represents the trend of the points and the distribution of points above and below the line. Difficulty: Easy Time on task: 5 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution:

c. Now assume a regression analysis was run. The output identifies that the fixed costs are $74,286 (intercept coefficient) and the variable costs are $.853 per pound (X Variable 1). Compare the results to the results obtained using the high–low method in part (a). What are the consequences of using one method versus the other? Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Total fixed costs are $34,286 higher and variable costs are $0.147 per pound lower under the regression analysis compared to the calculations using the high–low method. The high–low method is easy to compute and can provide some insight into the company’s cost behavior. However, a major drawback of this method is that it uses only two data points to develop the cost equation. If these data points are not representative of the company’s true cost behavior, managers could make serious mistakes in budgeting or profit planning. Analyzing more than two points of data with a regression analysis will yield much better information for managers on which to base their decisions.

d. What are some issues that the company should be concerned about with respect to the data itself? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 and LO5 AACSB: Reflective thinking Assignment: Homework Solution: Decision makers should make sure that they are reviewing the data for incomplete and incorrect data that could represent outliers. Outliers could be the result of erroneous data; an irregular event, such as a strike, which resulted in higher costs; or a data point that could be considered outside the relevant range. Outliers are not usually considered relevant for predicting cost behavior and making decisions and should be discarded from any analysis.

6. Fun in the Sun sells beach chairs. The following facts are known for 2022: ● ● ● ●

Each chair sells for $15. Variable costs are $80,000 for 10,000 chairs. Current production and sales are 16,000 chairs. Fixed costs are as follows: Production Range in Units

Fixed Costs

0–25,000

$105,000

25,001–35,000

$182,000

35,001–50,000

$285,000

a. What is the operating income for the 16,000 chairs produced and sold? Difficulty: Easy Time on task: 3 minutes Objective: LO4

AACSB: Reflective thinking Assignment: Homework Solution: Variable costs per unit = $80,000 ÷ 10,000 = $8 per unit Contribution margin per unit = $15 sales price – $8 variable cost per unit = $7 per unit Operating income for 16,00 units = Contribution margin – Fixed costs = ($7 × 16,000) – $105,000 = $112,000 – $105,000 = $7,000

b. Discuss why fixed costs would change for different relevant ranges. Difficulty: Easy Time on task: 3 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution: The fixed costs are step fixed costs, which increase at certain stages or “steps.” As the company’s production increases, the company will need more capacity (i.e., space, equipment, labor), which will require additional fixed costs.

c. What is the maximum operating income that the company can expect, given the relevant range and fixed cost information? Hint: Compare the operating income for 25,000 units, for 35,000 units, and for 50,000 units. Difficulty: Moderate Time on task: 8 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution:

Operating income at 25,000 units produced: = ($7 × 25,000) – $105,000 = $175,000 – $105,000 = $70,000 Operating income at 35,000 units produced: = ($7 × 35,000) – $182,000 = $245,000 – $182,000 = $63,000 Operating income at 50,000 units produced: = ($7 × 50,000) – $105,000 = $350,000 – $285,000 = $65,000 The maximum operating income the company can expect is $70,000 when it produces 25,000 units.

d. For this part, assume that additional chairs beyond 16,000 will have to be sold at $12.50 each. Variable costs will remain the same except for the sales commission, which will decrease by $0.50. How many additional units must be sold at the $12.50 price to have additional income of $18,000? Difficulty: Difficult Time on task: 10 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: As determined in part (a), the company exceeded fixed costs and generated operating income with the production and sale of 16,000 chairs. This means that every additional chair sold will add the full contribution margin to income, as fixed costs are already covered. Stated as an equation: Additional income = Contribution margin per unit × Number of units. Contribution margin per unit = $12.50 New sales price – $7.50 Variable cost = $5.00 Contribution margin per unit Additional income = Contribution margin per chair × Number of chairs $18,000 = $7 per unit × Number of chairs

Number of additional chairs = 3,600

7. Confused Company is considering changing its legal fee representation. Information on the current and proposed annual costs is as follows: ● Current structure: $7,000 fixed retainer fee and $120 per legal hour billed. ● Proposal from new firm: $3,000 fixed retainer fee, $80 per associate legal hour, and $250 per partner legal hour. ● Over the past three years, the company used an average of 70 hours of legal services per year. ● Management estimates that 40% of the hours billed by the current legal firm are related to the partner’s time. ● The company has used the current legal firm for the last 10 years. ● The new firm enjoys a good reputation. Even though the managing partner of the new firm is the cousin of the chief operating officer, the company’s Code of Ethics does not prohibit the company from entering into such a relationship.

a. What is the cost savings with the new firm at the current estimated usage? Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Cost estimate under current structure: Total costs = $7,000 Fixed costs + ($120 per legal hour) Total costs = $7,000 + ($120 × 70 hours) Total costs = $15,400 Cost estimate under proposed structure: Total costs = $3,000 Fixed costs + ($80 × associate legal hour) + ($250 × partner legal hour) Total costs = $3,000 + ($80 × 42 associate legal hours) + ($250 × 28 partner legal hours) Total costs with proposed structure = $13,360

Cost savings = $15,400 – $13,360 = $2,040

b. What other information is relevant? Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: It is important to consider the longstanding relationship with the current firm and the possibility of additional hours being incurred with the new firm as the firm becomes familiar with the company. Additionally, while the company’s Code of Ethics does not restrict the related party transaction, the company should consider the implications and appearance that will arise from hiring a law firm that is a related party.

8. Hayes Consulting Company builds database and point-of-sale systems for golf courses and country clubs. Mr. Hayes is trying to determine total revenues for the coming year and feels he can estimate revenues based on the number of customers each month. He gathers the following data for the prior 12 months: Month January February March April May June July August September October November December

Customers

Sales

222 196 243 139 175 144 184 181 145 237 144 221

$2,681,554 $2,403,559 $3,021,324 $1,684,360 $2,171,832 $1,745,904 $2,389,984 $2,321,345 $1,840,303 $2,922,339 $1,835,080 $2,637,129

Perform a regression analysis on the data provided. Is there a strong correlation between Hayes Consulting’s revenues and the number of customers? 46

Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Test Solution:

R2 = 0.984 Intercept coefficient = 88,848.94 X variable 1 coefficient = 11,917.64 The cost equation line is: y = a + b(x) y = $88,848.94 + $11,917.64(x) There is a strong correlation between the number of customers and total revenues, as R2 is almost 1.

9. FQR’s Gadgets manufactures and sells a single product. A partially completed schedule of the company’s total and per-unit costs over a relevant range of 60,000 to 100,000 units produced and sold during a given year is provided here:

Variable costs

Units Produced and Sold 60,000 80,000 100,000 $180,000

Fixed costs Total costs Variable cost per unit Fixed cost per unit

$4.00

Average cost per unit

a. Complete the schedule for the company’s total and unit costs. Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Test Solution:

Variable costs Fixed costs Total costs

Units Produced and Sold 60,000 80,000 100,000 $180,000 $240,000 $300,000 $320,000 $320,000 $320,000 $500,000 $560,000 $620,000

Variable cost per unit

$3.00

Fixed cost per unit

$5.33

$4.00

$3.20

Average cost per unit

$8.33

$7.00

$6.20

b. Assume that the company sells 90,000 units during a year. The selling price is $9.00 per unit. Prepare an income statement using the contribution margin format for that year. Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Application of knowledge 48

Assignment: Test Solution: FQR’s Gadgets Contribution Margin Income Statement For the period ending 2022 Sales $810,000 – Variable costs 270,000 Contribution margin – Fixed costs

540,000 320,000

Net income

$220,000

Data for Calculations Selling price per unit

Units sold 90,000 * Refer to Excel formulas for calculations.

10. PNH Company produces plastic specialty toys. In 2022, the company produced and sold 80,000 toys. Each toy was sold at $8 and has the following production costs: Direct materials Direct labor

$1.90 $0.65

Variable overhead

$0.35

Fixed overhead

$1.60

Total

$4.50

Selling and administrative costs for the year consisted of variable costs of $0.50 per toy and fixed costs of $140,000 for the period.

a. Using Excel, prepare an income statement in good form for financial reporting by product versus period cost functions. Difficulty: Easy Time on task: 4 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz

Solution: PNH Company Income Statement For the period ending 2022 Sales $640,000 – COGS 360,000 Contribution margin

280,000

– SG&A

180,000

Net income

$100,000

b. Using Excel, prepare an income statement in good form for internal reporting by cost behavior of variable costs versus fixed cost behavior. Difficulty: Easy Time on task: 4 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: PNH Company Contribution Margin Income Statement For the period ending 2022 Sales $640,000 – Variable costs 272,000 Contribution margin

368,000

– Fixed costs

268,000

Net income

$100,000

c. Assume that the relevant range for the company is from 60,000 to 110,000 units. Using Excel, prepare an internal reporting income statement assuming that the company actually produces and sells 60,000 toys. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking 50

Assignment: Homework Solution: PNH Company Contribution Margin Income Statement For the period ending 2022 Sales $480,000 – Variable costs 204,000 Contribution margin

276,000

– Fixed costs

268,000

Net income

$8,000

d. Assume that the relevant range for the company is from 60,000 to 110,000 units. Using Excel, prepare an internal reporting income statement assuming that the company actually produces and sells 100,000 toys. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: PNH Company Contribution Margin Income Statement For the period ending 2022 Sales $800,000 – Variable costs 340,000 Contribution margin – Fixed costs

460,000 268,000

Net income

$192,000

e. Describe which questions and relevant financial and nonfinancial information the owners should also examine to be sure that the assumptions are valid. Difficulty: Moderate Time on task: 2 minutes Objective: LO5

AACSB: Reflective thinking Assignment: Homework Solution: Students’ answers may vary. To evaluate the assumptions used within the analysis, the owners should question the ability of the company to meet its sales goals. Are the goals reasonable based on the sales and costs that were incurred in the prior year? If not, does the company have an achievable plan in place to accomplish those goals? Are there any macroeconomic factors that might influence the achievement of goals? Recession? Increased competition?

How could this information be presented visually to better communicate potential decisions? Discuss. Difficulty: Difficult Time on task: 2 minutes Objective: LO5 AACSB: Written and oral communication Assignment: Homework Solution: This information could be presented in bar charts or pie charts to show the breakdown of variable and fixed expenses based on each operating level. The contribution margin income statements for the various sales assumptions should be presented side by side to allow users to compare results. An example is provided below.

g. Would this company benefit from storyboarding the processes and related costs or from tracking costs by observations? Discuss. Difficulty: Moderate Time on task: 2 minutes Objective: LO5 AACSB: Written and oral communication Assignment: Homework Solution: Yes. The company would benefit from observation and documentation of processes in place. This could allow the company to identify areas where costs do not add value to the company and can be eliminated.

Chapter 07 End of Chapter with Solutions

Discussion Questions 1. Explain why examining cost behavior is important when using cost-volume-profit analysis. Difficulty: Moderate Time on task: 3 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution: Cost behavior is important for understanding the inputs into the cost-volumeprofit analysis because it allows managers to better assess how changes in assumptions (such as sales volume and prices) will affect the overall profitability of the organization. Since fixed costs are assumed to remain the same within a relevant range of activity, the primary effect on profits comes from changes in sales, changes in variable costs, and/or the volume of activity (which creates changes in contribution margin).

2. What is meant by the term operating leverage? How is operating leverage relevant to costvolume-profit analysis? Difficulty: Difficult Time on task: 4 minutes Objective: LO7 AACSB: Application of knowledge Assignment: Homework Solution: Operating leverage measures how changes in sales volume will cause a change in the company’s profits. Operating leverage is relevant to cost-volume-profit

analysis because it helps the analyst identify whether the assumptions used are realistic. If a company has a high degree of operating leverage, the fixed costs are higher, which means the company is susceptible to more risk if changes occur in either the company’s sales or its contribution margin.

3. What is meant by the term margin of safety? How is the margin of safety used in costvolume-profit analysis? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: The margin of safety is the additional revenues that the company generates over the breakeven revenues. Margin of safety is used in cost-volume-profit analysis to determine how much “cushion” exists, in case sales targets are not reached, before the company would actually start losing money.

4. Name some internal and external business risks that a company needs to consider for costvolume-profit analysis. Why is it important to consider these risks? Difficulty: Moderate Time on task: 3 minutes Objective: LO7 AACSB: Application of knowledge Assignment: Test Solution: Business risks can be categorized as service line risk, financial risk, and global (external) risk. Examples include entrance of competitors into the market (service line risk), rent increases for the retail space (financial risk), and tax laws and regulation (global risk). Although CVP analysis can help the company understand the effects of changes on its profits, it is also important to evaluate this information in the context of the business environment and the risks faced by the company. Risks can be both internal and external; having a clear understanding of these risks and how to manage them is the challenge. Sometimes, this risk

analysis is prepared in conjunction with a CVP analysis and sensitivity analysis to evaluate different possible scenarios. Once the risks have been identified (and quantified), managers can develop a plan to eliminate or at least minimize the risks as much as possible.

5. List the assumptions of cost-volume-profit analysis. Difficulty: Easy Time on task: 3 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Test Solution: In CVP analysis, accountants apply the following key simplifying assumptions: ● Sales price per unit, variable costs per unit, and total fixed costs are expected to remain the same within the relevant range; graphically, the revenues and costs are linear in relation to the number of units sold. ● ● ● ●

Total costs can be easily separated and accurately classified as either fixed or variable costs. Changes in revenues or costs are affected only by changes in volume/activity level (usually units produced or sold). The sales mix of products remains constant, if the company has more than one product. The number of units produced is equal to the number of units sold.

6. Most companies have a sales mix (they sell more than one type of product or service). For each of the following, provide an example of a product line or service line: grocery stores, hospitals, bakery, bank, computer store. Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Quiz Solution:

Answers may vary by student. Example product lines or service lines by type of business include, but are not limited to: ● Grocery stores: deli, frozen foods, catering, and pharmacy ● Hospitals: emergency room, pediatric services, cardiac services, and rehabilitation services ● Bakery: cupcakes, cakes, cookies, and pies ● Bank: deposit banking, credit cards, retirement accounts, and loans ● Computer store: equipment sales, repair services, and upgrade/installation services

7. If a company has a sales mix, the company cannot perform cost-volume-profit analysis. Do you agree? If you do not agree, explain. Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: No, I do not agree. A company can still perform CVP analysis even if it has multiple service lines or products. However, a company that offers more than one product or service must first compute the weighted average contribution margin, which takes into consideration the company’s sales mix of products and how each product or service line contributes to the overall contribution margin and profits for the company. Then, a CVP analysis can be performed as if the company has only one product or service. 8. When analyzing cost-volume-profit scenarios, what other information would you seek beyond just the costs, revenues, and volume? Difficulty: Difficult Time on task: 4 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Quiz Solution:

Management should consider the assumptions utilized to generate various CVP scenarios that might not always hold true (e.g., changes in sales price and changes in fixed and variable costs). Management should also take into account changes in sales mix as well as the impact of macroeconomic events. Management must be aware of these limitations when interpreting and making decisions based on the results of the CVP analysis.

9. Identify two advantages and two disadvantages of using CVP analysis. Difficulty: Easy Time on task: 3 minutes Objective: LO6 AACSB: Application of knowledge Assignment: Homework Solution: Student answers may vary but can include two of the following advantages: ● ● ● ● ● ● ●

Measures the company’s breakeven point, both in units sold and dollars Models changes in costs, revenues, or activity to determine what target profits will be as a result of the changes Measures the proportion of every sales dollar contributed, first to cover the fixed costs and then to contribute to profits (the contribution margin ratio) Identifies which variables are most sensitive to changes in assumptions and quantifies the effects of those changes Communicates visually the expenditure dollars versus revenues at different levels of activity Provides useful revenue and cost information that is not available from a traditional income statement Use the information learned from CVP analysis to assist with many long-term, strategic decisions in addition to the day-to-day decisions.

Students' answers may also include two of the following disadvantages: ● A company’s revenues and variable costs are not necessarily linear. ● Selling prices and costs are not always known and do not necessarily remain constant. ● All units produced may not be sold within the period. ● All fixed and variable costs may not be properly identified and classified. ● If a company has multiple product lines, the sales mix of those different lines may not necessarily remain constant.

Exercises 1. For each of the following statements, indicate whether the statement is true or false. a. Companies with the highest degree of operating leverage include those in service industries, such as insurance agencies, realtors, and law firms. Companies with the lowest degree of operating leverage include utilities, theme parks, railroads, and airlines. Difficulty: Easy Time on task: 1 minute each Objective: LO7 AACSB: Application of knowledge Assignment: Test Solution: False. Companies within the same industry may have drastically different operating leverage. If a company has higher fixed costs, its operating leverage is higher, which means the company is susceptible to more risk if it experiences changes in its sales or contribution margin.

b. At the breakeven point, contribution margin equals selling and administrative costs. Difficulty: Easy Time on task: 1 minute each Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: False. At the breakeven point, contribution margin equals total fixed costs. c. A cost behavior analysis provides the information needed to perform a CVP analysis.

Difficulty: Easy Time on task: 1 minute each Objective: LO1 AACSB: Application of knowledge Assignment: Quiz Solution: True. The results (or outputs) from classifying costs in a cost behavior analysis can, in turn, be used (and become the inputs) for the CVP analysis. If costs are classified as either variable or fixed costs, management can determine the company’s breakeven point, its targeted sales revenues or operating income, and the effects that changes in pricing or costs can have on profits.

d. After the breakeven point is identified, there is no value in performing a sensitivity analysis as variable costs, revenues, and fixed costs cannot be changed. Difficulty: Moderate Time on task: 1 minute each Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: False. Remember from Chapter 6 that fixed costs can be committed or discretionary. Further, although managers do their best to predict customer demand, it is unlikely their estimates are perfectly accurate. e. The number of products or services sold by a company is relevant when performing a CVP analysis and, therefore, should be considered when calculating the breakeven point. Difficulty: Moderate Time on task: 1 minute each Objective: LO5 AACSB: Application of knowledge

Assignment: Test Solution: True. f.

The CVP analysis is a useful decision-making tool as it provides useful revenue and cost information that is not available from a traditional income statement. Difficulty: Moderate Time on task: 1 minute each Objective: LO2 AACSB: Application of knowledge Assignment: Test Solution: True.

2. Able Company manufactures and sells boxes of envelopes. The company sold 50,000 boxes of envelopes, with revenue of $200,000, variable costs of $120,000, and operating income of $30,000. a. What is the total contribution margin and what is the contribution margin per unit? Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Contribution margin = Sales – Variable costs = $200,000 – 120,000 = $80,000 Contribution margin per unit = Contribution margin ÷ 50,000 units = $1.60 per unit

What are the total fixed costs?

Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: Solve for fixed costs before proposed changes: Contribution margin – Fixed costs = Operating income $80,0000 – Fixed costs = $30,000 Fixed costs = $50,0000

What is the breakeven point in units? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Breakeven point (BEP) in units = Total fixed costs ÷ Contribution margin dollars = $50,000 ÷ $1.60 = 31,250 units

What is the breakeven point in sales dollars? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: Breakeven point (BEP) in sales dollars

= Total fixed costs ÷ Contribution margin dollars = $50,000 ÷ ($80,000 ÷ $200,000) = $50,000 ÷ 40% = $125,000

3. Incentive Company compensates salespeople on a monthly basis at 5% of the average sales achieved in the previous three months and 10% if the monthly sales exceed the average monthly sales of the previous quarter. J. Smith realized that he would be paid twice the commission amount if he convinced his customers to either accelerate or defer the actual sales to match the 10% required pattern. He consistently asked customers for the following types of favors: ●

● ●

If he needed a low sales quarter so that the next quarter would be higher, he gave customers goods out on approval with the understanding that they would formally buy the goods shortly after the end of the low sales quarter. In a high sales quarter, he asked known customers to agree to the goods but to have the product shipped after quarter end—a practice known as “bill and hold” or channel stuffing. Since salespeople were not held accountable for returns (“reverse logistics”), he encouraged customers to buy in high sales periods, telling them that they could return the goods early in the next low sales month. a. Is J. Smith just smart or is he violating the ethical standards presented in Chapter 1 regarding competence, confidentiality, integrity, and credibility? Difficulty: Moderate Time on task: 5 minutes Objective: LO7 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: J. Smith is violating the Institute of Management Accounting’s Statement of Ethical Professional Practice Standards—specifically, the standards of integrity, competence, and credibility. The integrity standard requires members to be honest and trustworthy at all times, no matter what the circumstance. J. Smith is violating this standard by manipulating sales and return practices. The credibility standard requires members to present information fairly, objectively, and without bias to intended users of the information. J. Smith is violating this standard by presenting his sales information in a manner that is neither fair nor objective in an effort to ensure favorable sales figures; the sales figures he provides don’t actually represent sales. Further, he lacks competence because he 10

knowingly did not prepare the financial statements in accordance with Generally Accepted Accounting Principles (GAAP).

b. Assume that you are a manager at Incentive Company. After hours at a social setting, J. Smith bragged that he had successfully gamed the system for two years. If you confronted J. Smith, what would you say? Difficulty: Moderate Time on task: 4 minutes Objective: LO7 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: I would inform J. Smith that he is acting in a manner that is unethical and violates company policies. Further, I would describe to him how he is violating the IMA standards. If J. Smith was not receptive and planned to continue acting unethically, I would call my company’s fraud hotline and report him.

c. As the manager, you are contemplating changing the compensation system for sales representatives to a salary and a consistent 5% commission. How can cost-volume-profit analysis help you anticipate what the effect on profits of each plan would be? Difficulty: Moderate Time on task: 4 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Homework Solution: By utilizing CVP analysis, you can determine the effect that changing one of the cost inputs has on overall profitability. You can compare various scenarios (compensation plans based on commission versus salary plus commission) at different volume levels to determine which compensation plan is the best option.

4. Assume that the breakeven point of Dollar Company is $37,500 in terms of sales. Fixed costs are $15,000. a. What is the contribution margin ratio? Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: BEP sales dollars = Total fixed costs ÷ Contribution margin ratio $37,500 = $15,000 ÷ x x = $15,000 ÷ $37,500 x = 40%

b. What is the sales price if the variable costs are $18 per unit? Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: If the contribution margin ratio is 40%, then the variable cost ratio is 60% of sales. 60% of variable costs x = $18 Sales price = $30

c. What is the amount of the margin of safety both in units and in dollars if 1,400 units are sold? Difficulty: Moderate Time on task: 3 minutes

Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Total Revenues = Selling price per unit × Number of units = $30 per unit × 1,400 units = $42,000 Margin of safety = Total revenues – Breakeven revenues = $42,000 – $37,500 = $4,500 or 150 units ($4,500 ÷ $30)

5. Low Volume Company reported the following results for last year:

Sales for 20,000 units

$200,000

Variable costs

$80,000

Operating loss

($30,000)

a. What is the contribution margin per unit? Difficulty: Easy Time on task: 2 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Contribution margin = Sales – Variable costs = $200,000 – $80,000 = $120,000 Contribution margin per unit = Contribution margin ÷ Total units = $120,000 ÷ 20,000 units = $6.00 per unit

b. What are fixed costs?

Difficulty: Moderate Time on task: 2 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Operating income (loss) = Contribution margin – Fixed costs ($30,000) = $120,000 – Fixed costs x = $150,0000

c. To break even, how many additional units would the company have to sell? Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: The company needs to earn an additional $30,000 (amount of operating loss) in order to break even. Each additional unit sold contributes $6 of income, as calculated in (a). Required additional sales is simply calculated as $30,000/$6 = 5,000 additional units.

6. For each of the following changes, indicate the effect on contribution margin and breakeven point. Use + for increase, – for decrease, and 0 for no effect.

Change

Contribution Breakeven Margin Point

(a) New data analytics software and computer installed; no change in selling price or variable costs (b) Increase in sales of the product with the highest contribution margin relative to sales of the product with the lowest contribution margin (c) Decrease in cost of raw materials

(d) Increase in administrative salaries (e) Lower tax rate (f) Discard fully depreciated equipment with $0 salvage value (g) Current margin of safety is 10,000 units and the company has idle production capacity; new customer will buy 5,000 additional units Difficulty: Moderate Time on task: 10 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Change

Contribution Breakeven Margin Point

(a) New data analytics software and computer installed; no change in selling price or variable costs

(b) Increase in sales of the product with the highest contribution margin relative to sales of the product with the lowest contribution margin

–

(d) Increase in administrative salaries

(e) Lower tax rate

Additional Explanation The breakeven point would decrease, as the new software would increase fixed costs for depreciation on the new software if it was acquired or by the monthly software fee if it was cloudbased. As more units of a product with a higher contribution margin are sold, the weighted average contribution margin will increase, which means fewer total products must be sold to break even. Lower cost of raw materials results in a higher contribution margin. If the contribution margin is higher, fewer units are required to be sold to break even. Higher fixed costs require more units to be sold to break even. At breakeven, there is zero operating income and, therefore, no income to be taxed on.

(f) Discard fully depreciated equipment with $0 salvage value.

Discarding equipment would not have an impact on the income statement. It would lead to a reduction of equipment available and accumulated depreciation of equipment.

(g) Current margin of safety is 10,000 units and the company has idle production capacity; new customer will buy 5,000 additional units

There is no change in fixed costs or contribution margin, just higher income.

7. Clean Company reported the following information on its current-year contribution margin income statement: Fixed costs

$120,000

Sales

$300,000

Contribution margin

$180,000

Income taxes

$15,000

a. What was the dollar amount of the margin of safety? Difficulty: Moderate Time on task: 8 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: 1) Calculate contribution margin ratio: = Contribution margin ÷ Sales = $180,000 ÷ $300,000 = 60% 2) Calculate breakeven point in sales dollars: = Total fixed costs ÷ Contribution margin ratio = $120,000 ÷ 60%

= $200,000 3) Calculate margin of safety: = Total revenues – Breakeven revenues = $300,000 – $200,000 = $100,000

b. The marketing department suggests that a new advertising campaign costing $15,000 can increase the contribution margin by 10%. What is the net effect on operating income? Ignore the effect of taxes. Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Increase in contribution margin Less: Increase in fixed costs = Net effect on operating income (10% × $180,000) – $15,000 = $3,000 increase in operating income

c. Refer to the facts in part (b). As the chief financial officer, what support would you seek for the marketing department projections? What other information is relevant to the decision to launch the campaign? Difficulty: Moderate Time on task: 5 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Homework Solution: I would request that the marketing department provide the assumptions and supporting data used to project the 10% increase in contribution margin. Is it based on increased consumer demand? Is it based on

purchasing cheaper products, which might compromise product quality? Further, I would seek information regarding how sustainable the increase in contribution margin will be and how likely it is that advertising expenditures will end up exceeding $15,000.

8. Thompson is interested in entering the after-school tutoring business. He estimates that his fixed costs will be $18,000 per year and his variable costs will be 25% of sales. His tutoring price is $15 per hour. a. What is the contribution margin per unit? What is his breakeven point (BEP) in hours and sales dollars? Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Quiz Solution: Calculate the contribution margin per unit. If variable costs = 25% of sales, then 75% of sales must be attributed to the contribution margin. Sales × 75% = Contribution margin $15 × 75% = $11.25

b. What is his BEP in hours? Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Quiz Solution: Calculate BEP hours. BEP units = Total fixed costs ÷ Contribution margin per unit BEP units = $18,000 ÷ $11.25 BEP Units = 1,600 hours

c. What is his BEP in sales dollars? Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Quiz Solution: Calculate BEP in sales dollars. BEP $ = BEP units × Selling price per unit BEP $ = 1,600 hours × $15 BEP $ = $24,000

d. Which types of costs would you have included in the fixed cost and variable cost categories if you were Thompson entering the tutoring business? Difficulty: Easy Time on task: 5 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Homework Solution: Some examples of fixed costs would include your monthly cell phone bill, laptop, and advertising. Examples of variable costs would include transportation costs; the costs of pencils, papers, and other materials utilized during study sessions; and the hourly wages of tutors.

e. What other internal and external information is relevant in deciding whether to pursue the tutoring business? Difficulty: Moderate Time on task: 4 minutes Objective: LO7

AACSB: Reflective thinking Assignment: Quiz Solution: Before deciding to pursue the tutoring business, I would consider the business risks involved. Business risks can be categorized as service line risk, financial risk, and global (external) risk. Examples include entrance of competitors into the market (service line risk), rent increases for the study space (financial risk), and tax laws and regulation (global risk). Additionally, I would be interested in understanding the initial start-up costs and hours necessary before I recoup the start-up costs (break even).

9. Able Company manufactures and sells boxes of envelopes. The company sold 50,000 boxes of envelopes at a contribution margin of $80,000 or $1.60 per unit. The total fixed costs were $50,000. The current breakeven point was 31,250 units. Management has proposed increasing the contribution margin per unit by 10% and reducing fixed costs by 20%. a. Which actions is the company likely to take to reduce fixed costs without impacting variable costs or the number of units sold? Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: To reduce the company’s fixed costs in the short term, management will need to reduce its discretionary fixed costs, as opposed to its committed fixed costs. Some examples of discretionary fixed costs that management can reduce or eliminate include company picnics, advertising expenses, discretionary bonuses, and training programs.

b. What are the proposed contribution margin per unit and the proposed fixed costs? Difficulty: Moderate Time on task: 4 minutes

Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: Inputs assuming proposed changes occur: Contribution margin =Contribution margin per unit × 10% increase = $1.60 × 1.1 = $1.76 Fixed costs Proposed fixed costs = $50,000 × 0.80 = $40,000

c. What will be the new breakeven point in units? Difficulty: Difficult Time on task: 5 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: Breakeven point (BEP) sales dollars = Total fixed costs ÷ Contribution margin ratio = $40,000 ÷ $1.76 = 22,728 units

d. Should management take the suggested action? Difficulty: Easy Time on task: 3 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution:

If management is able to reduce the company’s fixed costs without compromising employees’ morale, product quality, or customer satisfaction while also increasing sales, then management should take the suggested action, as the company is now required to sell fewer units to break even.

e. Which questions would you pose of management beyond the information provided? Difficulty: Moderate Time on task: 2 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Homework Solution: Management should consider the effects on employees’ morale, product quality, and customer satisfaction when deciding whether to decrease costs or increase sales price. Further, management should consider that the assumptions utilized to generate the breakeven analysis may not always hold true (e.g., variable cost per unit may change) and should determine whether the assumptions used are realistic.

10. Natasha is interested starting an after-school gymnastics program for kids ages 5 to 10. She estimates that her fixed costs will be $9,000 per year and her contribution margin will be $15 per hour. She desires to achieve an operating profit of $15,000. She believes by increasing her advertising, she can increase her gymnastics class hours to 2,000 hours annually.

a. How much can she spend on sales-promotion costs so that she can increase her class hours to 2,000 hours? Difficulty: Difficult Time on task: 5 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Quiz Solution:

(Fixed costs + Additional promotion costs + Desired income) ÷ Contribution margin per hour = Total hours ($9,000 + Additional promotion costs + $15,000) ÷ $15 = 2,000 hours ($9,000 + Additional promotion costs + $15,000) = $30,000 Additional promotion costs = $6,000

b. What are some examples of variable costs for Natasha's gymnastics class business? Difficulty: Easy Time on task: 2 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Homework Solution: Examples of variable costs would include: cleaning supplies, chalk, teachers’ wages (if paid hourly), utilities.

c. What types of costs would you have included in the fixed costs categories for Natasha's gymnastics class business? Difficulty: Easy Time on task: 2 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Homework Solution: Examples of fixed costs would include: rent for the studio space, equipment rental, liability insurance, Natasha's monthly salary.

d. What other internal and external information is relevant in deciding whether to pursue the gymnastics class business? Difficulty: Moderate Time on task: 4 minutes Objective: LO7 AACSB: Reflective thinking

Assignment: Quiz Solution: Before deciding to pursue the tutoring business, I would consider the business risks involved. Business risks can be categorized as service line risk, financial risk and global (external) risk. Examples include entrance of competitors into the market (service line risk), changes in costs such as cleaning supplies or increases in rent for the gymnastics studio (financial risk), and changes in regulations regarding after school programs (global risk). Additionally, I would be interested in understanding the initial startup costs and hours necessary before I recoup the start-up costs (breakeven).

11. Natsuko Company produces decorative art figurines with the following sales mix:

Product

Allocated Fixed Costs

Sales Units

A B C

$15,750 $25,000 $60,000

3,000 5,000 12,000

Total

$100,750

20,000

Variable Costs per Unit $3 $4 $6

Sales Prices per Unit $18 $14 $11

a. What is the weighted average contribution margin and weighted average contribution margin ratio? Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Test Solution: WACM/unit = $7.75; WACM ratio = 57.6% Weighted Weighted Average Average Contribution Contribution Margin Margin per Unit Ratio SP per unit – VC per unit = CM per unit × Sales mix = WACM per unit $18 $3 $15 15% $2.25 12.5%

Sales Variable Contribution Sales Product Prices per Costs per Margin per Mix Unit Unit Unit

B C

$14 $11

$4 $6

$10 $5

25% 60%

Total

$2.50 $3.00

17.9% 27.3%

$7.75

57.6%

b. What is the number of units required for breakeven by product line? Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Test Solution: BEP units = fixed costs ÷ WACM per unit = 100,750 ÷ 7.75 = 13,000 Product

Total Units

A B C

13,000 13,000 13,000

Sales Mix 15% 25% 60%

Breakeven Point 1,950 3,250 7,800

c. If the company wishes to have $19,375 in operating income, how many units of A must be sold? Difficulty: Difficult Time on task: 6 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Test Solution: 2,323 units of product A must be sold to realize $20,125 in operating profit. BEP units = (Fixed costs + Desired operating profit) ÷ WACM per unit 25

BEP units = (100,750 + 19,375) ÷ 7.75 BEP units = 15,500 Product A

Total Units 15,500

Sales Mix 15%

Breakeven Point 2,325

Problems 1. Assume the following information is known for Wonderful Wallets Company: ● ● ● ●

The average sales price per unit is $40. Variable costs per wallet are $12, and fixed costs are $2,184. The relevant range is from 0 units to 350 units. The company uses the high–low method to separate total costs into variable and fixed costs.

a. What is the contribution margin ratio? Difficulty: Moderate Time on task: 2 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Contribution margin ratio = Contribution margin per unit ÷ Sales price per unit = ($40 sales price – $12 variable cost) ÷ $28 = $28 ÷ $40 = 70%

b. What is breakeven in units and sales dollars? Difficulty: Moderate Time on task: 2 minutes

Commented [LB1]: AU: Rounding to 2 decimal places will allow for the same answer in c below using both methods.

Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: BEP units = Total fixed costs ÷ Contribution margin per unit BEP units = $2,184 ÷ ($28) = 78 units BEP $ = Total fixed costs ÷ Contribution margin ratio BEP units = $2,184 ÷ 70% = $3,120 Or BEP $ = BEP units × Sales per unit = 78 units × $40 = $3,120

c. What is the margin of safety if 300 units are sold? Difficulty: Moderate Time on task: 2 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Margin of safety = Number of units sold – BEP units = 300 – 78 = 222 units × $40 = $8,880

d. What is the operating income if 80 units are sold? Difficulty: Moderate Time on task: 2 minutes Objective: LO3

AACSB: Reflective thinking Assignment: Homework Solution: Operating income = Contribution margin – Fixed costs = (80 × $28) – $2,184 = $2,240 – $2,184 = $56 Or Number of units above BEP units × Contribution margin per unit = 2 × $28 = $56

e. Now assume that the company wishes to have $140 of operating income. How many units must the company sell? Difficulty: Moderate Time on task: 2 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Operating income ÷ Contribution margin per unit = 140 ÷ 28 =5 Above breakeven + BEP units = 78 + 5 = 83

2. Fancy Company reported a contribution margin of $10 per unit. The company’s fixed costs per period were $30,000. Sales were $48,000 for the 3,200 units sold during the period. The income tax rate is 25%.

a. What is current net income? Difficulty: Moderate

Time on task: 3 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Contribution margin – Fixed costs Operating income Income tax expense (25%) Net income

$32,000 (30,000) $2,000 (400) $1,600

b. What is the breakeven point (BEP) in units? Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: BEP units = Total fixed costs ÷ Contribution margin per unit BEP units = $30,000 ÷ $10 = 3,000 units

c. If the income tax rate is increased to 30%, what is the BEP in dollars? Difficulty: Difficult Time on task: 4 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: There is no change to the BEP in units calculated in (b). At breakeven, income is $0, which means taxes are also $0. The formula is based on

operating income, not on net income for this reason. Therefore, 3,000 units x $15 selling price = $45,000.

d. If the number of units sold decreases to 3,100 units, what is the BEP in dollars? Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: There is no change to the BEP. The BEP remains unchanged no matter the actual number of units sold.

e. If the sales price is increased by $2, what is the BEP in units? Assume the variable costs, which consist of direct materials, direct labor, and variable overhead, are not changing as a result of increasing the sales price. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: BEP units = Total fixed costs ÷ Contribution margin per unit BEP units = $30,000 ÷ ($10 + $2) = 2,500 units The BEP decreases by 500 units as a result of increasing the sales price by $2, as the higher contribution margin requires fewer units to cover all fixed costs.

3. All Weather Company makes umbrellas and outerwear items for rainy and snowy days. It had the following cost structure for the past year: Items

Umbrellas

Clothing

Total

100,000 $12 $3 $1.50 $0.60 $2.50 $0.40

10,000 $75 $16 $5.50 $3.50 $11 $4

110,000 $1,950,000 $460,000 $205,000 $95,000 $360,000 $80,000

Direct fixed selling and administrative costs $76,000 total

$78,000 total

$154,000

Allocated fixed administrative costs

$37,000 total

$88,000

Units produced and sold Average sales price per unit Direct materials cost per unit Direct labor cost per unit Variable overhead per unit Fixed overhead per unit Selling and administrative cost per unit

$51,000 total

Commented [JC3R2]: Remove sections a-c

a. What is the weighted average contribution margin per unit rounded to the nearest cent? Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution:

Product

Umbrellas Clothing

Weighted Variable Cost Contribution Average Average Sales Sales per Unit Margin per Contribution Price per Unit Mix [from Part B] Unit Margin per Unit SP per unit – VC per unit = CM per unit × Sales mix = WACM per unit $12.00 $5.50 $6.50 90.9% $5.91 $75.00 $29.00 $46.00 9.1% $4.19

Total

Commented [KS2]: AU: This shares content with problem 4 in chapter 6-not all sections are used in ch 6--please advise.

$10.10

b. Assume that the sales mix is quite constant. How many units of each product line are required to break even? Difficulty: Moderate

Time on task: 4 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: (1) Calculate the BEP units. BEP units = Fixed costs ÷ WACM per unit = (154,000 + 88,000 + 360,000) ÷ 10.10 = 59,604 (2) Allocate the BEP units to each product based on sales mix. Total Breakeven Product Sales Mix Units Point Umbrellas 59,604 90.9% 54,181 Clothing 59,604 9.1% 5,424

c. What are the particular internal and external business risks that the company faces? Difficulty: Moderate Time on task: 4 minutes Objective: LO7 AACSB: Analytical thinking Assignment: Homework Solution: Students’ answers may vary and may discuss product line risks, financial or fixed costs risks, and global or external risks. Some examples include competitors, financing, the business model, customer satisfaction, competition of new entrants, poor performance of products, unexpected weather conditions, other-periods analysis, practical capacity and usage, relevant range, and learning curves.

d. Assume that the company wishes to generate $375,000 of operating income. How many units in total does the company need to produce and sell? Difficulty: Moderate 32

Time on task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: BEP $ = (Fixed costs + Desired operating income) ÷ Contribution margin ratio = (154,000 + 88,000 + 360,000 + $375,000) ÷ 10.10 = 96,733 e. Assume the company wants to earn a $105,000 target operating income. What sales revenues must be generated? Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: BEP $ = (Fixed costs + Desired operating income) ÷ Contribution margin ratio = (154,000 + 88,000 + 360,000 + $105,000) ÷ 10.10 = 70,000 units 70,000 x 90.9% = 63,630 x $12 selling price = $763,560 70,000 x 9.1% = 6,370 x $75 = $477,750 Total revenues = $1,241,310

Many more umbrellas are sold than clothing. Should more advertising and other efforts be directed toward promoting the clothing lines in an effort to increase the number of units sold? Difficulty: Difficult Time on task: 5 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution:

Commented [JC4]: Insert Letter e here: Assume the company wants to earn a $105,000 target operating income. What sales revenues must be generated? Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: BEP $ = (Fixed costs + Desired operating income) ÷ Contribution margin ratio = (154,000 + 88,000 + 360,000 + 105,000) / 10.10 = 70,000 units 70,000 x 90.9% = 63,630 x $12 selling price = $763,560 70,000 x 9.1 = 6,370 x $ 75 = $477,750 total revenues = $1,241,250

Yes. Clothing has a higher contribution margin per unit. Thus, the more clothing sold compared to umbrellas, the higher the weighted average contribution margin and the smaller the number of units that must be sold to break even.

4. For each of the following independent situations, compute the required calculations. a. Basic Company has fixed costs of $50,000 and breakeven sales of $250,000. What is the projected income at $400,000 sales? b. Pride Company has sales of $500,000 and a margin of safety of $200,000. The contribution margin is 15%. What are fixed costs? c. Fixed costs are $12,800. The sales price is $16 per unit and the variable cost percentage is 60%. What are sales dollars at breakeven, and how many units are required to break even? d. Fixed costs are $6,600. The variable cost per unit is $7. At breakeven, there were 300 units sold. How much will the next unit sold, unit #301, contribute to operating income and what is the sales price per unit? e. If the variable cost per unit of $15 represents a 30% variable cost percentage, what is the contribution margin per unit and the sales price per unit? Difficulty: 4a, 4c, 4d and 4e - Moderate 4b - Difficult Time on task: 4 minutes each Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: #

Question

Solution

Basic Company has fixed costs of $50,000 and breakeven sales of 9a $250,000. What is the projected income at $400,000 sales?

(1) Calculate the contribution margin ratio. BEP sales dollars = Total fixed costs ÷ Contribution margin ratio $250,000 = $50,000 ÷ Contribution margin ratio Contribution margin ratio = 20%

(2) Use the contribution margin ratio to calculate the total contribution margin at $400,000 sales and then subtract the fixed costs. Operating profit = (Sales × Contribution margin ratio) – Fixed costs Operating profit = ($400,000 × 20%) – $50,000 Operating profit = $30,000 Margin of safety = Sales – Breakeven revenues Pride Company has sales of $200,000 = $500,000 – Breakeven revenues $500,000 and a margin of Breakeven revenues = $300,000 9b safety of $200,000. The contribution margin is 15%. BEP sales dollars = Total fixed costs ÷ Contribution margin ratio What are fixed costs? $300,000 = Total fixed costs ÷ 15% Total fixed costs = $45,000 Fixed costs are $12,800. BEP sales dollars = Total fixed costs ÷ Contribution margin ratio The sales price is $16 per BEP sales dollars = $12,800 ÷ (1 – 60%) unit and the variable cost BEP sales dollars = $32,000 percentage is 60%. What 9c are sales dollars at breakeven and how many Units sold = BEP sales dollars ÷ Sales price per unit units are required to break Units sold = $32,000 ÷ $16 even? Units sold = 2,000 units BEP in units = Total fixed costs ÷ Contribution margin per unit Fixed costs are $6,600. The 300 units = $6,600 ÷ CM per unit variable cost per unit is $7. CM per unit = $22 At breakeven, there were 300 units sold. How much 9d Unit #301 will contribute $22 to operating income. will the next unit sold, unit #301, contribute to Contribution margin per unit = Sales price – Variable costs per unit operating income and what $22 = Sales price – $7 is the sales price per unit? Sales price = $29 $15 Variable costs = 30% × Sales price If the variable cost per unit Sales price = $15 Variable cost per unit ÷ 30% of $15 represents a 30% Sales price = $50 per unit variable cost percentage, 9e what is the contribution Contribution margin = Sales price – Variable costs margin per unit and the Contribution margin = $50 – $15 sales price per unit? Contribution margin = $35 per unit

5. Mixed Company is evaluating the following two options: Option A: Sell a product domestically that will require a significant capital investment of $400,000 and variable costs of $20 per unit. The company would like to price the product at $52 per unit. Option B: Produce and sell a product in a foreign country with attractive labor rates, so that less automation is required. Fixed costs are projected to be $143,000 and variable costs are $15 per unit. The company is planning to sell the product at $28 per unit. a. How many units need to be sold under each option to break even? Difficulty: Moderate Time on task: 8 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Test Solution: Option A: Contribution margin per unit = Sales price per unit – Variable cost per unit Contribution margin per unit = $52 – $20 Contribution margin per unit = $32 BEP in units = Fixed costs ÷ Contribution margin per unit BEP in units = $400,000 ÷ $32 BEP in units = 12,500 units Option B: Contribution margin per unit = Sales price per unit – Variable cost per unit Contribution margin per unit = $28 – $15 Contribution margin per unit = $13 BEP in units = Fixed costs ÷ Contribution margin per unit BEP in units = $143,000 ÷ $13 BEP in units = 11,000 units

b. At what level of unit sales would operating income for the two options be the same? Hint: Set up an equation to equate the operating incomes: total contribution margin less fixed costs. Difficulty: Difficult

Time on task: 7 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Test Solution: Option A operating income = Option B operating income Contribution margin – Fixed costs = Contribution margin – Fixed costs ($32 × units) – $400,000 = ($13 × units) – $143,000 $32x – $400,000 = $13x – $143,000 $19x = $257,000 x = 13,526

c. What other factors, risks, and challenges should the company consider, given the information provided? Difficulty: Moderate Time on task: 5 minutes Objective: LO7 AACSB: Reflective thinking Assignment: Test Solution: The company should also consider product line and service line risks, financial/fixed costs risks, and global risks when making a decision. Product line and service line risks affect the sales price, customer demand, and costs to produce products. Example risks that would affect the assumptions utilized in the CVP analysis include increased labor costs (which would increase the variable unit costs) and an overly crowded market (which would decrease the selling price or volume). Financial/fixed costs risks occur because changing fixed costs in the short term is difficult. Higher fixed costs result in higher operating leverage, which means the company is susceptible to more risk if its sales or contribution margin changes. Global risks represent external factors that are generally outside of the

company’s control, such as fluctuations in the economy and an increased regulatory environment.

Chapter 8 End of Chapter and Solutions

Discussion Questions 1. In an input-process-output system for relevant costing special decisions, the input is the data gathered, the process is the analysis of the specific decision, and the output is the units or service revenue being generated. Do you agree? Explain. Difficulty: Moderate Time on task: 3 minutes Objective: LO10 AACSB: Analytical thinking Assignment: Quiz Solution: No. In an input-process-output system for relevant costing special decisions, the output is the actual results of the decision. The company should also prepare a post-audit, which will compare the actual costs incurred with the costs the company had originally estimated.

2. Give the definition of opportunity costs. Discuss whether opportunity costs are relevant for product costing, planning and control, and special decisions. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Test Solution: 1

An opportunity cost is the profit foregone or lost by a firm by selecting one alternative over another. Opportunity costs are relevant to special decisions, but are not relevant for product costing.

3. Relevant information for special decisions must be the same in the future as in the past, be different between alternatives, and be precise. Do you agree? Explain. Difficulty: Moderate Time on task: 2 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Quiz Solution: No. Relevant information for special decisions does not have to be the same in the future as it was in the past. It can be, but that is not a requirement. For information to be relevant, it must relate to the future and be different for each alternative being considered.

4. Describe the decision-making process in general. Consider one decision that you have faced in the last month and discuss what relevant factors you used to analyze the decision. Difficulty: Difficult Time on task: 5 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Quiz Solution: Decision making is a process that involves evaluating different alternatives and ultimately choosing a course of action. It is an ongoing process, which requires management to:

1. Identify or define a problem, need, or opportunity. 2. Develop and analyze possible alternatives, considering any limiting factors and consequences of each alternative. 3. Choose the best alternative given the information available. 4. Implement the decision. 5. Review and evaluate a decision, and determine if any further action is necessary. Students’ answers may vary in part two. Some examples of decisions the students may have faced include: - Do I go out with friends or stay home? - Do I purchase the textbook for class or not? - Do I attend the football game or do my homework?

5. For a make or buy decision, only the relevant future variable manufacturing costs need to be considered. Do you agree? Explain. Difficulty: Easy Time on task: 3 minutes Objective: L06 AACSB: Analytical thinking Assignment: Quiz Solution: No. In a make or buy (outsourcing) decision, a manager should consider avoidable fixed costs, opportunity costs, and other qualitative factors including quality control, proprietary information, reliability of suppliers, and so on.

6. Management is considering dropping a product line. The freed-up productive capacity can be used elsewhere. Management ignores the fixed costs and examines only the contribution margin of the product line under consideration to be dropped. Has management included the appropriate relevant costs in its decision? Explain. Difficulty: Difficulty Time on task: 5 minutes Objective: L04 AACSB: Reflective thinking Assignment: None Solution: No. If management is considering replacing a product line, it must also: 1. Compare the dropped product’s contribution margin to the replaced product’s contribution margin to make sure that there is a benefit. 2. Evaluate if any fixed costs are avoidable.

7. Give the criteria used to analyze whether to introduce a new product line to replace an existing one. Difficulty: Moderate Time on task: 3 minutes Objective: L04 AACSB: Analytical thinking Assignment: None Solution: 1. Determine the contribution margin of the product line. 2. Assess whether fixed costs are avoidable. 3. Calculate the difference in relevant costs under each scenario (keep as is, add, or drop). 4. Select the alternative with the highest net income.

5. Evaluate whether qualitative considerations would change the decision.

8. The increase in total profits from accepting a special order is the number of units in the special order multiplied by the gross margin. Do you agree? Explain. Difficulty: Easy Time on task: 2 minutes Objective: L03 AACSB: Analytical thinking Assignment: Quiz Solution: No. The increase in total profits from accepting a special order is the number of units multiplied by the contribution margin.

9. Joint costs are relevant for special decisions of whether to produce products further, since the joint cost must be incurred. Do you agree? Explain. Difficulty: Easy Time on task: 2 minutes Objective: L07 AACSB: Analytical thinking Assignment: None Solution: No. Joint costs are the costs incurred during a production process up until the split-off point. These costs are incurred regardless of whether the joint products could be produced after the split-off.

10. When considering whether to rework defective products, management should focus on which products require the least amount of direct materials to correct. Do you agree? Explain.

Difficulty: Moderate Time on task: 3 minutes Objective: L08 AACSB: Analytical Thinking Assignment: Homework Solution: No. The only relevant information for this decision is the expected revenues that the company can generate by selling the defective units as scrap, and the additional revenues less the additional costs the company will incur to rework the products.

11. In a multiproduct firm with multiple constraints, the product with the highest contribution margin per unit should be the only product produced. Do you agree? Explain. Difficulty: Easy Time on task: 3 minutes Objective: L05 AACSB: Analytical thinking Assignment: Homework Solution: No. In a multiproduct firm with multiple constraints, the product with the highest contribution margin per constraint should be produced. If there is enough customer demand for that product, then, yes, the product should be produced exclusively. If there is not enough customer demand for the product, then the product should be produced up to demand and then the product with the next highest contribution margin should be produced.

12. Companies should never sell any product lines with revenues below the variable costs. Do you agree? Explain. Difficulty: Moderate Time on task: 2 minutes

Objective: L04 AACSB: Reflective thinking Assignment: None Solution: Yes. When a product has a negative contribution margin, each sale results in a loss for the company, regardless of whether there are additional fixed costs.

13. Give five special decisions discussed in the chapter. Difficulty: Easy Time on task: 2 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers will vary but may include the following special decisions that Island Joe’s Coffee might face: 1. What would be a competitive price for its coffee? 2. How many different blends of coffee should the company make? 3. Should the company accept a large special order from a new customer at a reduced price? 4. Should it roast all of its own coffee blends, or outsource the production to another roasting company? 5. Should the company continue with retail sales, or should it work with a distributor to sell its coffee wholesale to different grocery store chains? 6. Given its current capacity, should Island Joe’s Coffee lease or purchase a production warehouse to expand its business?

14. Administrative costs should typically be ignored for special decisions since they will not be avoidable and, therefore, do not represent relevant costs. Do you agree? Explain. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: None Solution: It depends. If administrative costs would change due to the acceptance of a special order, then the incremental (or differential) change in administrative costs should be considered when evaluating different alternatives.

15. In deciding how to price special orders, the cost of goods sold during the period should be considered. Do you agree? Explain. Difficulty: Difficult Time on task: 4 minutes Objective: L03 AACSB: Application of knowledge Assignment: None Solution: I do not agree. The cost of goods sold represents the product costs, which include both variable and fixed costs. When determining how to price special order products, management should consider only changes in cost that would occur as a result of the special order (relevant costs). Only product costs that will change as a result of the order should be considered.

16. The production costs up to the inspection point are irrelevant to scrap or rework decisions for defective units. Do you agree? Explain. Difficulty: Easy Time on task: 2 minutes Objective: L08 AACSB: Application of knowledge Assignment: None Solution: Yes. The inspection point is the stage at which the units are determined to be defective. Production costs up to the inspection point are irrelevant, as they represent past information (sunk cost).

17. Variable costs are always relevant costs and fixed costs are always irrelevant costs. Do you agree? Explain. Difficulty: Easy Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Homework Solution: I do not agree. Variable costs may be considered irrelevant if the variable cost is the same between the proposed alternatives. Additionally, if some fixed costs are avoidable, then the incremental (or differential) change in fixed costs is relevant.

18. Fixed costs are always sunk costs and are thus irrelevant. Do you agree? Explain. Difficulty: Easy Time on task: 3 minutes 9

Objective: LO2 AACSB: Application of knowledge Assignment: None Solution: I do not agree. If some fixed costs are avoidable, then the incremental (or differential) change in fixed costs is relevant.

19. Past information, although always irrelevant for special decisions, may be very useful. Future information is not reliable because future amounts are only estimates; it is also probably not very useful. Do you agree? Explain. Difficulty: Moderate Time on task: 2 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Test Solution: I do not agree. While it is true that past information is irrelevant in the decisionmaking phase, this information may be useful in other ways, such as in the initial brainstorming phase. While future information is not always reliable and represents estimates as opposed to actual data, the information is very useful in understanding potential changes in revenues and costs.

20. Gross profit is synonymous with contribution margin. Do you agree? Explain. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: None

Solution: I do not agree. Gross profit is calculated as sales minus cost of goods sold. Contribution margin is calculated as sales minus variable costs. Cost of goods sold includes product costs and excludes selling, general, and administrative costs. Variable costs include all variable product costs and variable selling, general, and administrative costs while excluding any fixed costs.

21. Discuss why topics such as supply chain and theory of constraints are important when considering relevant costing decisions. Difficulty: Difficult Time on task: 3 minutes Objective: LO10 AACSB: Reflective thinking Assignment: Homework Solution: By utilizing such tools as supply chain management and the theory of constraints, companies like Island Joe’s Coffee can become more efficient and effective, reduce costs, and still provide a quality product to their customers. Having clear, relevant cost and qualitative information in a timely manner is critical so that managers can make better decisions, helping the company to achieve its short-term and long-term goals.

22. Why do companies conduct post-audit reviews of their relevant costing decisions? Difficulty: Easy Time on task: 3 minutes Objective: LO9 AACSB: Application of knowledge Assignment: None Solution:

Management should conduct a post-audit review of the results of decisions to make sure the desired results have been obtained, to take corrective actions, and to better inform decisions in the future. If the desired results have not been obtained, management must start the decision-making process again. 23. Describe why data analytics is relevant to supply chain management. Recall that supply chain management is the process of designing, implementing, controlling, and monitoring all activities along the supply chain. Difficulty: Moderate Time on task: 9 minutes Objective: LO10 AACSB: Reflective thinking Assignment: Homework Solution: Data analytics can incorporate financial and nonfinancial data using structured and unstructured data from internal and external sources. The integration of multiple data sources allows the company to make better decisions across the supply chain. For example, more accurate predictions about the timing and quantity of products demanded by customers allows the company to acquire inventory with minimal waste.

Exercises 1. Following are important terms described in Chapter 8: a. b. c. d. e. f. g. h. i. j. k. l.

post-audit incremental analysis total quality management inspection point avoidable cost split-off point relevant costs price-taker opportunity cost idle capacity target costing sunk costs

m. complementary good n. contribution margin income statement o. defective products p. special order q. joint costs r. relevant information s. constraint t. decision making u. joint products v. unavoidable costs w. supply chain management Match these terms to their definitions. 1. The point in the production process at which the joint products are considered to be separate, differentiated products. 2. Criteria for facts to be used in short-term decision making; they must relate to the future and be different for each alternative being considered. 3. The time spent when no production is occurring. 4. Anything that limits our actions or behavior. 5. Information about revenues and costs that will differ among the different alternatives being considered. 6. Profit foregone or lost from a firm’s selection of one alternative over another. 7. The multiple products derived from a single product, which occurs at the split-off point. 8. The process that one must go through to evaluate different alternatives and ultimately choose a course of action. 9. Any cost that can be eliminated by choosing a different alternative. 10. The costs incurred during a production process up until the split-off point. 11. Costs that do not change regardless of the alternative and should not be considered when making a decision because the decision will not impact the cost. 12. An initiative that seeks to improve operations throughout the value chain of the organization. 13. Those products that do not meet production standards. 14. Costs that have already been incurred and cannot be recovered. 15. The point at which the units are determined to be defective.

16. Analysis that compares the actual costs a company incurred with the costs the company had originally estimated. 17. A company that has little control over the prices it can charge in the marketplace. 18. An approach that management can use to manage costs and still meet the necessary profit margins. Selling price less desired margin equals maximum costs that can be spent. 19. An order placed by a customer that is not part of a company’s current business, often at a reduced sales price. 20. Analysis in which management considers only the changes in revenues, costs, and volume that would occur as a result of a special order. 21. A product that is normally consumed with another good. 22. An income statement that organizes costs by cost behavior (variable costs and fixed costs) instead of by function (manufacturing costs included in cost of goods sold, and selling, general, and administrative costs). 23. The process of designing, implementing, controlling, and monitoring all activities along the supply chain. Difficulty: Easy Time on task: 1 minute each Objective: varies, see chart AACSB: Analytical thinking Assignment: varies, see chart below Solution: varies, see chart below Solution

Assig nment

1. The point in the production process at which the joint products are considered to be separate, differentiated products. 2. Criteria for facts to be used in short-term decision making; they must relate to the future and be different for each alternative being considered.

f. split-off point

Quiz

g. relevant costs

Home work

3. The time spent when no production is occurring.

j. idle capacity

4. Anything that limits our actions or behavior.

s. constraint

Question

Home work Home work

5. Information about revenues and costs that will differ among the different alternatives being considered. 6. Profit foregone or lost from a firm’s selection of one alternative over another. 7. The multiple products derived from a single product, which occurs at the split-off point. 8. The process that one must go through to evaluate different alternatives and ultimately choose a course of action. 9. Any cost that can be eliminated by choosing a different alternative. 10. The costs incurred during a production process up until the split-off point. 11. Costs that do not change regardless of the alternative and should not be considered when making a decision because the decision will not impact the cost. 12. An initiative that seeks to improve operations throughout the value chain of the organization.

r. relevant information

Test

i. opportunity cost

Home work

u. joint products

Test

t. decision making

Quiz

e. avoidable cost

q. joint costs

v. unavoidable costs

Home work

l. sunk costs

d. inspection point

Home work Home work Home work Test

a. post-audit

Test

h. price-taker

Home work

k. target costing

Quiz

p. special order

Home work

20. Analysis in which management considers only the changes in revenues, costs, and volume that would occur as a result of a special order. 21. A product that is normally consumed with another good.

b. incremental analysis

Quiz

m. complementary good

Home work

22. An income statement that organizes costs by cost behavior (variable costs and fixed costs) instead of by function (manufacturing costs included in cost of goods sold versus selling, general, and administrative costs). 23. The process of designing, implementing, controlling, and monitoring all activities along the supply chain.

n. contribution margin income statement

Home work

w. supply chain management

Quiz

13. Those products that do not meet production standards. 14. Costs that have already been incurred and cannot be recovered. 15. The point at which the units are determined to be defective. 16. Analysis that compares the actual costs a company incurred with the costs the company had originally estimated. 17. A company that has little control over the prices it can charge in the marketplace. 18. An approach that management can use to manage costs and still meet the necessary profit margins. Selling price less desired margin equals maximum costs that can be spent. 19. An order placed by a customer that is not part of a company’s current business, often at a reduced sales price.

c. total quality management o. defective products

Home work Home work

3 3

2. Janitorial Service, Inc., manufactures household cleaners. Revenue per unit is $6.50. The household cleaners have a cost of goods sold of $6.00 per unit, of which $3.20 is for allocated fixed overhead. Total selling expenses for the 300 household cleaners currently being sold per week are $100, of which $70 are allocated fixed costs. a. If the household cleaners are discontinued, what would be the effect on income? b. What other information should management consider?

Difficulty: Moderate Time on task: 5 minutes Objective: L04 AACSB: 2a - Analytical thinking 2b - Application of knowledge Assignment: Quiz Solutions: #

Question

Solution Income will decrease by the contribution margin per unit. Fixed costs are not relevant, as there is no mention that the fixed costs can be avoided.

If the household cleaners are 2a discontinued, what would be the effect on net income?

= Revenue – (Variable COGS + Variable SG&A) × # units = $6.50 – ($2.80 + $0.10) × 300 units = $3.60 × 300 units = $1,080 decrease in net income *Variable COGS = $6.00 - $3.20 = $2.80 *Variable SG&A = $30/300 = $0.10

What other information should 2b management consider?

Management should also consider: - Are there complementary products? - Is there an effect on competitive advantage and customer loyalty? - Will there be an effect on the quality of other products?

3. Mighty Confectioners faces the decision of whether to make or buy specialty cupcakes. Manufacturing costs per unit for the cupcakes are direct materials, $0.50; direct labor $2; and variable overhead, $0.10. Fixed overhead is $1,600 per period. If the company buys the finished product at $2.00 per unit, the company will be able to lease out the facilities and earn $1,200 in lease revenue. Current and projected production calls for 8,000 cupcakes per period. a. What is the monetary difference? Ignore taxes. b. What other information should management consider? c. What is the best course of action: buy the cupcakes or make them?

Difficulty: Moderate Time on task: 5 minutes Objective: L06 AACSB: 3a and 3b - Analytical thinking 3c - Application of knowledge Assignment: Homework Solutions: #

Question

Solution Make = Variable costs × Number of units = (Direct materials $0.50 + Direct labor $2.00 + Variable overhead $0.10) × 8,000 units = $2.60 × 8,000 units = $20,800 cost to make cupcakes

What is the monetary difference?

Buy = (Purchase price × Number of units) – Lease revenue = ($2.00 × 8,000 units) – $1,200 lease revenue = $16,000 – $1,200 = $14,800 cost to buy cupcakes – lease revenue It is $6,000 cheaper per period to buy the cupcakes from a vendor than it is to make the cupcakes in house.

What other information 3b should management consider?

Management should also consider: - Will the purchased cupcakes be at an acceptable level of quality? - Will the vendor deliver the cupcakes on time? - Could competitors obtain the cupcake recipes and the company lose its competitive advantage? - Will the vendor increase the cost of the cupcakes in the future?

What is the best course 3c of action: buy the Buy the cupcakes. cupcakes or make them?

4. The Apple Everything Company has three products with the following data: Apple Cider

Applesauce

Apple Pies

Sales, if processed further

$90

$150

$210

Costs, after split-off

$40

$90

$175

Sales at split-off

$40

$50

$55

a. Which product should be processed further (if any)? Difficulty: Moderate Time on task: 4 minutes Objective: L07 AACSB: Assignment: Test Solution: Apple cider and applesauce. The apple pies are better to sell at split-off.

Sales, if processed further – Costs, after split-off Net Realizable Value

Apple Cider $90 $40 $50

Applesauce $150 $90 $60

Apple Pies $210 $175 $35

Sales at split-off $40 $50 $55 **Select higher NRV of processing further or Sales at Split-Off b. Which of the following pieces of information should management also consider? ● The joint costs before split-off (growing the apples) ● The demand for each product and competition ● The total capacity of the company ● The allocated costs to each product line ● Which product line is favored by managers ● Special requirements with respect to handling, storage, and distribution for each product line after the split-off point Difficulty: Moderate Time on task: 4 minutes Objective: L07 AACSB: Application of knowledge Assignment: Test Solution: Management should also consider: ● The demand for each product and competition ● The total capacity of the company ● Special requirements with respect to handling, storage, and distribution for each product line after the split-off point All other information is irrelevant to the decision-making process.

5. Canasi currently makes 10,000 units of part D with the following costs per unit: direct materials, $6; direct labor, $15; variable overhead, $6; and fixed overhead, $8. Eriksen has offered to sell Canasi 10,000 units of part D for $37 per unit. If Canasi accepts Eriksen’s offer, the released facilities could be used to save $20,000 in relevant costs in the manufacture of part M. In addition, $3 of the fixed overhead allocated to part D would be eliminated. a. Indicate if any of the following is true. ● The $3 of the fixed overhead is irrelevant since the company has extra capacity. ● Canasi should buy the part from Eriksen and save $40,000. b. Give one other fact that would be relevant to the decision. Difficulty: Moderate

Time on task: 15 minutes Objective: L05 AACSB: 5a - Analytical thinking 5b - Reflective thinking Assignment: Quiz Solutions: #

Question

Solution - The $3 of the fixed overhead is irrelevant since the company has extra capacity. False. The $3 is relevant because it reduces the cost of another product that would not be saved if continued to make part D.

Indicate if any - Canasi should buy the part from Eriksen and save $40,000. False. of the following is true. Relevant Costs to Make - The $3 of the The variable cost to make each unit is $27 ($6 Direct materials + $15 Direct fixed overhead labor + $6 Variable overhead) to make. is irrelevant since the The relevant fixed overhead is $3 (see above). 5a company has extra capacity. Total relevant costs per unit are $30 ($27 + $3) times the number of units to - Canasi should be purchased (10,000 units) equals $300,000. buy the part from Eriksen Relevant Costs to Buy and save Relevant costs to buy $37/unit x 10,000 units to purchase = $370,000 less $40,000. the savings of $20,000 in released facilities equals $350,000. Comparison It is better to make the product and save $50,000 ($350,000 cost to buy versus $300,000 cost to make) Students’ answers may vary and could include: Management should also consider: Give one other - Is part D a core product? If not, is it worth $10,000 so that we can spend fact that would 5b more time and effort on core products? be relevant to - Is the product a routine product that would be better to outsource? the decision. - Would the quality be the same if we were to purchase the product from an outside vendor? - Will the cost from the supplier change over time?

6. Many mistakes are made in business because the relevant amounts and factors are not properly identified rather than because the amounts are not correctly calculated. For each of the following scenarios and decisions, give examples of: ▪ Relevant quantitative items ▪ Relevant qualitative factors ▪ Amounts that are not relevant

Scenarios and Decisions

Relevant Quantitative

Relevant Qualitative

Amounts Not Relevant

A university adding an extra class A restaurant opening for lunch rather than just for dinner A library dedicating space for a special collection of history books Outsourcing accounting, legal, and human resources services Providing training through a webinar or a face-toface class A grocery store carrying more of its own “private house-brand label” products A theme park giving state residents an annual fixed fee pass at a discounted price A homebuilding supplies company having selfcheckout or more cashiers

Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework

Solution: Relevant Relevant Amounts Quantitative Qualitative Not Relevant A university adding an extra Cost of hiring an Impact on quality of Administrator’s class additional professor other courses salary Cost of labor A restaurant opening for lunch (kitchen, greeter, Customer demand for Cost of rent rather than just for dinner servers) for lunch lunch menu hours A library dedicating space for a Competitive Cost of history special collection of history advantage of special Librarian’s salary books books history collection Outsourcing accounting, legal, Cost of outsourcing Quality of outsourcing CEO’s salary and human resources services services services Providing training through a Cost of technology Cost of developing Networking ability webinar or a face-to-face class to host webinar course materials A grocery store carrying more Profit margin on Relationship with Utilities on the of its own “private house-brand private house-brand vendor that provides store label” products products raw materials A theme park giving state Discounted annual Demand for passes Roller-coaster residents an annual fixed fee fee from state residents construction costs pass at a discounted price A homebuilding supplies Ability to easily use Cost of selfStore manager’s company having self-checkout self-checkout checkout machines salary or more cashiers machines Scenarios and Decisions

7. Alive Company sells two cosmetics products, Bright and Shine, with contribution margins per unit of $10 and $14, respectively. Bright takes 2 hours to produce and Shine 3½ hours. The total machine hours available are 5,000 and fixed costs are $6,000. a. What is the contribution margin per hour for each product? b. To maximize profits, how many units of Bright and Shine should be produced? c. What are the maximum profits for Alive Company? d. You are provided with very limited information about the company and the situation. What are four other questions that you would ask before making the decision? Difficulty: varies, see chart below Time on task: varies, see chart below

Objective: L05 AACSB: varies, see chart below Assignment: Homework Solution: varies, see chart below

Question

Diffic ulty

Time on task

AACSB

Solution Contribution margin per hour = Total contribution margin / Number of hours to produce

What is the contribution margin 7a per hour for each product?

Mode rate

To maximize profits, how many units of Mode 7b Bright and Shine rate should be produced?

What are the 7c maximum profits for Alive Company?

Diffic ult

You are provided with very limited information about the company and the 7d Easy situation. What are four other questions that you would ask before making the

Analytical Bright = $10 / 2 hours thinking = $5 CM per hour Shine = $14 / 3.5 hours = $4 CM per hour To maximize profits, Alive Company should produce first the product with the highest contribution margin as long as there is enough customer demand. As customer demand is not mentioned, Alive should produce as many units of Analytical Bright as possible and no units of Shine. thinking Units = Available machine hours / Machine hours per Unit of Bright = 5,000 MH / 2 MH per unit = 2,500 units of Bright $19,000 Analytical Profits = CM per unit Bright × Number of units thinking Bright – Fixed costs = $10 × 2,500 units – $6,000 fixed costs = $19,000 Students’ answers may vary and could include:

Management should also consider: Reflective - What is customer demand for Bright? thinking - If the company produces only Bright, are there any avoidable fixed costs for Shine? - Are the two products complementary?

decision?

8. Le Industries is considering a special order of 1,000 units at $64 per unit. Currently, Le sells 11,000 units at $98 per unit. The current per-unit costs are $47 cost of goods sold and $18 selling cost. The fixed factory overhead is $13 per unit and the fixed selling costs are $3 per unit. A special additional freight charge of $2 per unit would be incurred with the special order. Le has excess idle productive capacity. a. Should Le accept the special order? Give supporting calculations. Difficulty: Easy Time on task: 3 minutes Objective: L03 AACSB: Application of knowledge Assignment: Test Solution: Using an incremental analysis and not considering qualitative factors, management should accept the special order as it will result in an additional $13,000 of profit to cover existing fixed costs.

Incremental revenues

Per Unit Total 1,000 Units $ 64 $ 64,000

Less incremental costs: Variable product costs Variable selling costs Special freight charge

34 15 2

34,000 15,000 2,000

Total Costs

51,000

Incremental net operating income

$ 13,000

b. Indicate whether the following information is also relevant: ●

The contribution margin of other products and whether more of the other products could be produced instead of additional products of this line

●

If this is an introductory offer that has potential to turn the customer into a regular customer

●

Whether other customers would insist on the same concession on the sales price

●

If the company did not have extra capacity, in which case the company should charge the same sales price to all customers

Difficulty: Easy Time on task: 2 minutes Objective: L03 AACSB: Application of knowledge Assignment: Test Solution: Yes, all of these are relevant factors that management should consider when deciding whether to accept the special order.

c. Give two other relevant factors for this special order decision. Difficulty: Moderate Time on task: 3 minutes Objective: L03 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers may vary. Possible answers include: 1. Does the production facility have idle capacity? 2. Would accepting this special order impact the service to its current customers? 3. Are there other potential special orders to choose from? 4. Would an increase in production put a strain on quality?

9. Chundas is considering dropping product X, which last year reported a net loss of $12,000. The income statement showed variable costs of $70,000 and sales of $90,000. If product X is dropped, the productive capacity will not be used to produce any other product. Which of the following statements is true with respect to the decision concerning product X? a. Chundas should not drop the product line since the contribution margin is a positive $20,000. b. The fixed costs of $32,000 would have to be absorbed by the other product lines and those product lines might then have net losses, making them candidates for elimination. Eventually, the company could face a “death spiral” since no product line would be able to absorb the unavoidable fixed costs. c. The company should consider whether product X is a complementary product and whether dropping product X would have an effect on other product lines. Difficulty: varies, see chart below Time on task: varies, see chart below Objective: L04 AACSB: Reflective thinking Assignment: Test Solution: varies, see chart below

Question

Time Diffic on ulty Task

Chundas should not drop the product line 9a since the contribution margin is a positive Easy $20,000 The fixed costs of $32,000 would have to be absorbed by the other product lines and those product lines might then have net losses, making them candidates for Mod 9b elimination. Eventually, the company erate could face a “death spiral” since no product line would be able to absorb the unavoidable fixed costs.

Solution

True. Contribution margin equals sales $90,000 less variable costs $70,000. The $20,000 in contribution margin covers part of the overall unavoidable fixed costs.

True. Contribution margin $20,000 less fixed costs equals net loss $12,000. Thus, fixed costs are $32,000.

The company should consider whether product X is a complementary product 9c and whether dropping product X would have an effect on other product lines.

Easy

True.

10. Indicate whether each of the following statements is true or false. a. Important qualitative considerations for a special order include all of the following: impact on current customers if they learn that other customers paid less for the same items, future expectations of the special order customers, additional scheduling, and wear on equipment. Difficulty: Easy Time on task: 1 minute Objective: L03 AACSB: Reflective thinking Assignment: Homework Solution: True.

b. For relevant cost decisions, variable costs are always relevant and fixed costs are always irrelevant. Difficulty: Easy Time on task: 2 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: False. Variable costs may be considered irrelevant if they are the same between the alternatives being decided on. When the costs are variable, since they would not change between the two (or more) alternatives, they are irrelevant. Additionally, if some fixed costs are avoidable, then the incremental (or differential) change in fixed costs is relevant.

c. Once a make or buy decision is made, a company should not second-guess itself and review how well it actually estimated the costs. Difficulty: Easy Time on task: 1 minute Objective: LO9 AACSB: Reflective thinking Assignment: Quiz Solution: False. It is important for management to perform a post-audit review to determine if the desired results were achieved.

d. Sunk costs are typically irrelevant since they represent past costs and not future costs. Difficulty: Easy Time on task: 1 minute Objective: LO2 AACSB: Reflective thinking Assignment: Quiz Solution: True.

e. Joint costs are irrelevant to a sell at split-off or process further decision since they represent costs that have already been incurred. Difficulty: Easy Time on task: 1 minute Objective: L07 AACSB: Reflective thinking Assignment: Homework Solution: True.

A company should typically accept a special order when the company would earn a positive contribution margin from the special order and the company has enough capacity to fill the special order without affecting the regular sales. Difficulty: Easy Time on task: 2 minutes Objective: L03 AACSB: Reflective thinking Assignment: Quiz Solution: True.

g. When deciding whether to drop a department or product line, the common fixed costs that had been allocated to that department are allocated to the remaining departments and product lines. Difficulty: Difficult Time on task: 3 minutes Objective: L04 AACSB: Reflective thinking Assignment: Quiz Solution: False. The analysis should focus on only the change in costs based on dropping the department or product line.

h. If a firm is at full capacity, the minimum special order price to accept should be the regular sales price to current customers. Difficulty: Moderate Time on task: 3 minutes Objective: L03 AACSB: Reflective thinking Assignment: Test Solution: 29

False. The firm should not accept the special order because it is at full capacity. Accepting the special order would result in rejecting current customer orders and potentially result in future loss of sales.

In the short run, companies should always outsource parts if the price of the parts is cheaper than the cost of making the parts. Difficulty: Easy Time on task: 2 minutes Objective: L06 AACSB: Reflective thinking Assignment: Test Solution: False. It is important that management does not simply consider quantitative factors but also considers qualitative factors such as quality control.

Post-audits of relevant cost decisions are useful to determine if the assumptions were valid and the decision was properly executed. Difficulty: Easy Time on task: 1 minute Objective: LO9 AACSB: Reflective thinking Assignment: Quiz Solution: True.

k. The optimal mix of products should be to produce and sell the maximum amount of the products with the highest contribution margin per constraint. Difficulty: Easy Time on task: 1 minute Objective: L05

AACSB: Reflective thinking Assignment: Test Solution: True.

A product line should be dropped when its allocated common fixed costs are greater than its contribution margin. Difficulty: Moderate Time on task: 2 minutes Objective: L04 AACSB: Reflective thinking Assignment: Homework Solution: False. Allocated common fixed costs are irrelevant when making the decision to keep or drop a product line. Avoidable fixed costs should be considered.

m. The steps in the theory of constraints analysis are to identify the main (binding) constraint, determine the most efficient utilization of the binding constraint, and manage the flow through the binding constraint. Difficulty: Moderate Time on task: 3 minutes Objective: LO10 AACSB: Reflective thinking Assignment: Homework Solution: False. The steps are: 1. Fully describe the existing situation so that a solution can be developed. 2. Map out how the company should change after breaking the bottleneck. 3. Develop a detailed action plan so everyone in the organization

understands how to achieve the desired goal.

n. The production costs up to the inspection point would be irrelevant to a decision of whether to rework defective units or sell the defective products as scrap. Difficulty: Easy Time on task: 1 minute Objective: L08 AACSB: Reflective thinking Assignment: Homework Solution: True.

o. Opportunity costs represent the monetary difference between the alternative chosen and the next best alternative. Difficulty: Easy Time on task: 1 minute Objective: LO9 AACSB: Reflective thinking Assignment: Test Solution: True.

p. The term relevant as used in relevant costing decisions refers to the relative size (materiality) of the cost in relation to revenue. Difficulty: Easy Time on task: 2 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution:

False. Relevant information is information about revenues and costs that will differ among the alternatives being considered. Materiality is not a factor.

q. If a department is eliminated, the company will avoid fixed costs that have been allocated to that department. Difficulty: Easy Time on task: 2 minutes Objective: L04 AACSB: Reflective thinking Assignment: Homework Solution: False. Eliminating a department does not result in eliminating the allocated fixed costs, as some of these costs are unavoidable.

A disadvantage of using an outside supplier is the associated loss of quality control over the production process. Difficulty: Easy Time on task: 1 minute Objective: L06 AACSB: Reflective thinking Assignment: Quiz Solution: True.

11. Snacks Company is considering adding a new product line called Party Munchies. The company currently has excess productive capacity that could be used to produce Party Munchies. Each Party Munchies would sell for $12 and the variable costs per unit would be $5. Expected demand for Party Munchies per year is 24,000 units. Of the total fixed costs, Snacks plans to allocate $45,000 to the Party Munchies product line. a. Should Party Munchies be added? Support your position with calculations.

b. Which of the following statements is true with respect to the decision concerning Party Munchies? 1. The $45,000 is relevant since the fixed costs must still be incurred. 2. Since there is excess productive capacity, the fixed costs are irrelevant. 3. The opportunity cost of adding the product is $45,000. 4. Other relevant factors include demand for other product lines that could be increased, expertise with the new line, and advertising and other selling costs.

Difficulty: Moderate Time on task: 11a - 5 minutes 11b - 3 minutes Objective:3b AACSB: 11a - Application of knowledge 11b - Reflective thinking Assignment: None Solution: #

Question

Solution

Based on the following calculations, Snacks should add Party Munchies to its product mix, as the positive contribution margin will be used to cover any existing fixed costs. Note that the fixed costs that would be allocated to this product line are not relevant to the calculation because those costs are unavoidable costs that would not change Should Party Munchies be added? Support 11a regardless of the decision. Further, management your position with calculations. should also consider relevant qualitative factors in making the final decision. Per Unit Total Sales $12 $288,000 Less: Variable costs ($5) ($120,000) Contribution margin $7 $168,000

Which of the following statements is true with respect to the decision concerning Party Munchies? 1. The $45,000 is relevant since the fixed costs must still be incurred. 2. Since there is excess productive 11b capacity, the fixed costs are irrelevant. 3. The opportunity cost of adding the product is $45,000. 4. Other relevant factors include demand for other product lines that could be increased, expertise with the new line, and advertising and other selling costs.

1. False. Fixed unavoidable costs are not relevant. 2. False. Fixed costs are irrelevant because they are unavoidable. 3. False. The opportunity cost of adding the product would be any additional profit that could be realized by selecting a different alternative. 4. True.

12. Liles Company sells a product for $110 per unit. In 2022, it reported sales of $770,000 and a contribution margin of $308,000. The gross profit percentage was 50%. Variable costs consist of manufacturing and selling costs. Fixed costs of $108,000 are two-thirds manufacturing costs and one-third selling costs. a. What is cost of goods sold? Difficulty: Difficult Time on task: 10 minutes Objective: 3 AACSB: Reflective thinking Assignment: Quiz Solution: $385,000 b. What is fixed overhead? Difficulty: Difficult Time on task: 10 minutes Objective: 3 AACSB: Reflective thinking Solution: $72,000 c. What are the variable manufacturing costs in 2022?

Difficulty: Difficult Time on task: 10 minutes Objective: 3 AACSB: Reflective thinking Assignment: Quiz Solution: $313,000 See link: “Solutions-Exercises” for supporting calculations

13. Review each of the following independent scenarios. a. For each scenario, indicate whether the IMA Statement of Ethical Professional Practice Standards have been violated. b. Discuss what course of action you would recommend for various personnel in the company. Assume that each situation is independent.

Scenario 1: A salesperson was able to secure a special order that would increase his commission for this period. He is concerned that production will not be able to fill the order as he promised to the new potential customer. The salesperson gives two special game tickets to the production manager so that the production manager will expedite the special order (prioritize it over other orders already scheduled for production). Difficulty: Easy Time on task: 4 minutes Objective: L03 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: a. Yes, the IMA Statement of Ethical Professional Practice Standards have been violated. The salesperson has violated the integrity standard, which requires that an individual be honest and trustworthy at all times, no matter what the circumstance. Providing kickbacks and bribery are not considered ethical business practices and are generally against a company’s code of conduct. Additionally, the salesperson has violated the

competence standard. The competence standard requires accountants to perform professional duties in accordance with all laws, regulations, and policies and to provide decision support information and recommendations that are accurate, clear, concise and timely. b. The production manager should reject the salesperson’s offer and report the bribery to the appropriate channel.

Scenario 2: Even though Protective Company knows that some of the fixed costs could be eliminated, the division manager listed the costs as unavoidable so that the jobs and division will not be eliminated. Difficulty: Easy Time on task: 4 minutes Objective: LO2 AACSB: Ethical understanding and reasoning Assignment: Quiz Solution: a. Yes, the IMA Statement of Ethical Professional Practice Standards have been violated. The division manager has violated three standards: ● Competence: Perform professional duties in accordance with all laws, regulations, and policies and to provide decision support information and recommendations that are accurate, clear, concise and timely. ● Integrity: Be honest and trustworthy at all times, no matter what the circumstance. ● Credibility: Present information fairly, objectively, and without bias to intended users of the information. b. Before management utilizes the reporting to make decisions, the division manager should correct the report to accurately list the costs as avoidable and provide an updated report to management.

Scenario 3: Uneven Company is facing variability production problems and a lot of time in production. The official company policy is to inspect the products at the 20% completion mark and sell the defective times to a discount store. However, since many of the products would fail inspection, the manager has decided to delay inspection until the 50% mark, which would delay having to reject the defective products until the next period. He is convinced that with the extra time, he can identify the production problem and the company will not lose money or consider buying the product from an outside supplier.

Difficulty: Difficult Time on task: 4 minutes Objective: L08 AACSB: Ethical understanding and reasoning Assignment: Test Solution: a. While it sounds like Uneven Company has delayed inspection for reasons that are in the best interest of the company, by circumventing company policy, the manager has violated three of the IMA Statement of Ethical Professional Practice Standards: ● Competence: Perform professional duties in accordance with all laws, regulations, and policies and to provide decision support information and recommendations that are accurate, clear, concise and timely. ● Integrity: Be honest and trustworthy at all times, no matter what the circumstance. ● Credibility: Present information fairly, objectively, and without bias to intended users of the information. b. Uneven Company should continue to inspect products at the 20% completion mark to follow company policy. However, the manager should discuss his concerns with upper management.

Scenario 4: The CEO has a special request from an potential overseas customer whom he met while on vacation. The CEO asks the division manager to sell to the potential customer at a 20% negative contribution margin in the hope that he can foster the relationship. Since there are no avoidable fixed costs, company policy is to require a positive contribution margin on special orders. Difficulty: Difficult Time on task: 4 minutes Objective: L03 AACSB: Ethical understanding and reasoning Assignment: None Solution: a. It depends. If the CEO requested that the division manager create falsified reporting to show the product producing a positive contribution margin to circumvent company policy, then the IMA Statement of Ethical Professional Practice Standards would be violated. However, if special 38

permission to make an exception to company policy is given by the appropriate parties (and documented), then no violations would occur. b. The CEO and the division manager should seek approval to proceed with this special order by providing accurate information about the costs and benefits to the appropriate parties. 14. Find an article that discusses the role of data analytics in supply chain management. Write a one-page summary of the article. Make sure to cite your sources. Difficulty: Moderate Time on task: 20 minutes Objective: LO10 AACSB: Written and oral communication Assignment: None Solution: Recall that supply chain management is the process of designing, implementing, controlling, and monitoring all activities along the supply chain. Students’ responses will vary based on the article selected but should include some discussion on one or more aspects of the supply chain. If students struggle to identify an appropriate article, we recommend Walmart, Tesla, Amazon, and Honeywell.

Problems 1. The following represents the activity for last year: Unit production and sales

7,000

Unit sales price

$17.00

Unit variable production costs

$6.00

Unit variable selling costs

$1.00

Fixed overhead production costs

$21,000

Fixed selling and administrative costs

$14,000

a. What is the contribution margin? 39

b. What is the gross margin? c. Why is contribution margin different than gross margin? Is contribution margin more useful for product costing or for relevant costing special decisions? Explain. d. What is net income?

Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: varies, see below a. $70,000 Contribution margin = Sales – Variable costs = $17 – ($6 + $1) × 7,000 units = $70,000 Contribution margin b. $56,000 Gross margin = Sales – Cost of goods sold = ($17 × 7,000) – $63,000 = $119,000 – $63,000 = $56,000 *Cost of goods sold = Variable production costs + Fixed overhead production costs Cost of goods sold = (6 × 7,000) + 21,000 = 63,000 c. A contribution margin income statement is an income statement that organizes costs by cost behavior (variable costs and fixed costs) instead of by function (product costs and period costs). Therefore, the difference between the two is the amount of fixed selling and administrative costs. d. As discussed in Chapter 6, variable costs increase in direct proportion to an increase in volume. With these types of costs changing based on the different alternatives, variable costs are relevant for most decisions. Fixed costs do not change in the short run, which makes them irrelevant for most short-term decisions. $35,000 = Contribution margin – (Fixed overhead + Fixed SG&A 40

= $70,000 – (21,000 + 14,000) = $35,000 Or = Gross Margin – (Variable SG&A + Fixed SG&A) = $56,000 – (1 × 7,000 )+ 14,000) = $35,000 2. Veronic Company sells shoes for an average of $100 per pair. Variable manufacturing costs in 2022 were $220,000 and variable selling costs were $20,000. Total sales in 2022 were $600,000. The total fixed costs of $160,000 were 80% for manufacturing and 20% for selling. The following changes are being contemplated: reducing the sales price by $8 per unit, with an expected 20% increase in pairs of shoes, and increasing fixed advertising costs by $3,000. a. Should the proposed changes be made to the existing shoe line? Difficulty: Difficult Time on task: 10 minutes Objective: LO3 AACSB: Reflective thinking Assignment: None Solution: Yes. The changes will result in $11,400 increase in net income. [See “CH 08 V2 Roadmap, Solutions - Problem” for solution calculations]

b. Give three qualitative considerations that you believe are relevant, should be identified, and estimated.

Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: None Solution:

Students’ answers may vary and could include: Management should also consider: ● How was the 20% increase in customer demand determined? ● Is it necessary to spend $3,000 on advertising and to reduce the selling price per unit by $8? ● What type of advertising is appropriate? ● Will the increased production affect the quality of other products?

3. Ideal Movers has the following product lines:

Product

University Moving

Commercial Moving

Packing

Hours to produce one unit of service

Contribution margin per unit of service

$10

$16

$18

100 units

80 units

120 units

Maximum demand for product line

The Packing line includes “junk removal.” Maximum production time for the company is 500 hours per year. Fixed costs will not be affected.

a. What is the contribution margin per hour for each product line? Difficulty: Moderate Time on task: 8 minutes Objective: L05 AACSB: Analytical thinking Assignment: Test Solution: University Moving: $5 Commercial Moving: $4 Packing: $2 Product

University Moving

Contribution margin per unit of service

$10

Commercial Moving Packing $16

$18

/ Hours to produce one unit of service

CM per hour

b. How many units of each product line should be produced? Difficulty: Difficult Time on task: 3 minutes Objective: L05 AACSB: Analytical thinking Assignment: Test Solution: University Moving: 100 units Commercial Moving: 75 units Packing: 0 units [See “CH 08 V2 Roadmap, Solutions-Problems” for calculations]

c. What is the maximum income for the company? Difficulty: Moderate Time on task: 3 minutes Objective: L05 AACSB: Analytical thinking Assignment: Test Solution: $2,200 [See “CH 08 V2 Roadmap, Solutions-Problems” for calculations]

4. Gonska manufactures 20,000 units of computer accessories per year and sells them for $9.00 each. The costs per unit are as follows:

Direct materials

$1.50

Direct labor

$2.25

Variable overhead

$0.50

Fixed overhead allocated

$1.75

Unit cost

$6.00

Bailey has offered to sell Gonska the 20,000 units of part G for $5.25 per unit. Following are independent assumptions as to what would happen to the fixed costs. Gonska has enough capacity to produce and sell 25,000 units. Give the effect on costs under each of the situations described. The regular sale price of computer accessories is irrelevant as it is the same under all scenarios. Hint: Calculate the cost to make part G and compare the cost to buy part G under each of the assumptions. a. The allocated fixed overhead would have to be absorbed by other products. Difficulty: Moderate Time on task: 3 minutes Objective: L06 AACSB: Reflective thinking Assignment: Test Solution: Increase by $20,000 [See “CH 08 V2 Roadmap, Solutions-Problems” for calculations] b. Half of the fixed overhead would remain (e.g., rent, depreciation), but Gonska would be able to produce a new product line that has a contribution margin of $4.00. Difficulty: Moderate Time on task: 3 minutes Objective: L06 AACSB: Reflective thinking

Assignment: Test Solution: Decrease by $77,500 [See “CH 08 V2 Roadmap, Solutions-Problems” for calculations]

c. Half of the fixed overhead would remain but Gonska could rent out the facilities for a fixed fee of $15,000. Difficulty: Moderate Time on task: 3 minutes Objective: L06 AACSB: Reflective thinking Assignment: Test Solution: Decrease by $12,500 [See “CH 08 V2 Roadmap, Solutions-Problems” for calculations]

d. Of the allocated overhead, $5,000 would remain. Gonska is considering increasing the production of an existing product line by 12,000 units. The other product line has a contribution margin of $2.50. Gonska anticipates spending $1,500 on supply chain logistics to increase the sale of the other product line. Difficulty: Moderate Time on task: 3 minutes Objective: L06 AACSB: Reflective thinking Assignment: Test Solution: Decrease by $38,500 [See “CH 08 V2 Roadmap, Solutions-Problems” for calculations]

e. List other relevant information that you were not provided about each of the scenarios. Difficulty: Easy 45

Time on task: 3 minutes Objective: L06 AACSB: Application of knowledge Assignment: Test Solution: Management should also ask the following questions to get additional relevant information: - Will the purchased accessories be at an acceptable level of quality? - Will Bailey deliver the accessories on time? - Could competitors obtain and replicate the accessories so that the company loses its competitive advantage? - Will Bailey increase the cost of the accessories in the future?

5. We Are Printers has decided to discontinue its basic printer model. The company has some partially completed units on hand with incurred costs of $50 per unit. The company could complete the printers with the following additional unit costs: direct materials, $11; direct labor, $19; variable overhead, $6; and allocated fixed overhead, $14. The fixed costs relate to assigned rent, supervision, warehousing, and depreciation on plant assets. If We Are Printers completes the printers, the printers can be sold at $95 per unit. Another company is willing to buy the printers as is for $61. a. Discuss why each of the following statements is true or false with respect to the decision of whether to complete the printers or accept the outside offer. 1. We Are Printers should complete the printers since the relevant profits would be $59 with the option of completing the printers. 2. We Are Printers should accept the outside offer since the company could make $11 more per unit. 3. We Are Printers is indifferent since the incurred costs equal the additional costs. 4. We Are Printers should accept the outside offer since the net relevant profit between the two options is $2. Difficulty: Moderate Time on task: 6 minutes Objective: L08 AACSB: Reflective thinking Assignment: Quiz

Solution: See “CH 08 V2 Roadmap, Solutions - Problems” for calculations. 1. False. Yes, the relevant profit is $59 but the company could make $61 by selling the printers as is. 2. False. The company would make only $2 more per unit. $61 versus $59. 3. False. The relevant costs are $36 compared to the purchase costs of $61. 4. True.

b. Besides the information provided in the problem, give three qualitative factors that the company should keep in mind. Difficulty: Easy Time on task: 3 minutes Objective: L08 AACSB: Application of knowledge Assignment: Quiz Solution: See “CH 08 V2 Roadmap, Solutions - Problems” for calculations. Management should ask the following questions to get additional relevant information: ● Will the reworked printers be at an acceptable level of quality? ● Will selling the printers as is hurt the company’s brand or reputation? ● Is the difference in profits worth the effort to rework the product? ● If the printers are sold as is, could the excess capacity be used to produce a more profitable product? ● If the printers are sold as is, could some of the fixed costs be avoidable?

6. To make appropriate decisions, companies attempt to consider not only the quantifiable costs but also relevant qualitative costs. It is also helpful to estimate in dollars the qualitative factors so that the factors are included and not just identified but then disregarded. For each of the following items, identify which special decision(s) would be applicable and whether the factor is typically originally quantifiable or qualitative (sometimes referred to as “soft data”) and would be separately estimated. Type of relevant cost decision: a. Special order b. Keep or drop a product line

c. d. e. f.

Constraint of resources Make or buy Joint process sell at split-off or process further Rework defective units

Type of information: i. Readily viewed as quantitative originally ii. Qualitative (not easily obtained) and must be separately estimated

Factors

Type of Relevant Cost Decision(s)

Type of Information

Actual and perceived (by the customer) quality, price, convenience, and on-time delivery after the sale Special payment options offered by suppliers Number of returns due to poor quality Number of special design features and packaging required beyond the basic model Bottlenecks and scheduling problems Availability of materials and labor Cost of maintaining adequate inventory Ordering costs Available production capacity Complementary product or service lines Competition’s likely response to our decision Avoidable fixed costs Joint costs to split off Results of post-audit from last year’s decision Sales commission incentives Turnover, creativity skills, and experience of workforce Rent on machines

Difficulty: Moderate Time on task: 15 minutes Objective: L03-3f AACSB: Reflective thinking 48

Assignment: None Solutions: Type of Relevant Cost Decision(s)

Type of Information

Actual and perceived (by the customer) quality, price, convenience, and on-time delivery after the sale Special payment options offered by suppliers

a, d

Number of returns due to poor quality

Number of special design features and packaging required beyond the basic model

c, d, e, f

Availability of materials and labor

a, d

Cost of maintaining adequate inventory

Ordering costs

Available production capacity

Complementary product or service lines

Competition’s likely response to our decision

b, d

Avoidable fixed costs

b, d

Joint costs to split off

a, b, c, d, e, f

a, b,

Factors

Bottlenecks and scheduling problems

Results of post-audit from last year’s decision Sales commission incentives Turnover, creativity skills, and experience of workforce Rent on machines

7. For a make or buy decision, the company produced the following fishbone diagram outlining problems with one of the new products. The company is considering paying considerably more just to buy the finished product from an external supplier.

Based on the fishbone diagram, give five relevant factors and suggestions that could lower the cost and improve efficiencies and effectiveness so that the company can be competitive by making the product. Difficulty: Moderate Time on task: 15 minutes Objective: L04 AACSB: Application of knowledge Assignment: None Solution: Relevant Factors: 1. Cost to purchase finished product 2. Avoidable fixed costs (if any) 3. Customer reaction if product were discontinued 4. Quality level of purchased product 5. Responsiveness of supplier and ability to change volumes as needed Suggestions: 1. Discontinue the product and use the extra capacity for a more profitable product. 2. If the savings in personnel expenses as well as the increase in quality offset the increased cost, then purchase the finished product. 3. Invest in a redesign of the product to increase quality. 4. Increase training of the ordering/supplier communications department as well as the sales department. 5. Reevaluate price and customer responsiveness to changes in price.

8. Contentious Law Firm offers litigation, divorce, and estate planning services. The partners are concerned about the profitability of their litigation business. If the firm drops the litigation work, the lawyers might do more divorce work. The firm estimates that 20% of the fixed costs associated with litigation would be eliminated and that the increase in divorce work revenue (and variable costs) could be 50%. Following are recent income numbers: Litigation

Divorce

Estate Planning

Sales

$300,000

$500,000

$600,000

Variable costs

(250,000)

(300,000)

(350,000)

Contribution margin

$50,000

$200,000

$250,000

Fixed costs

(50,000)

(60,000)

(80,000)

$140,000

$170,000

Income

a. Should the firm drop its litigation work? What would be the effect on income of just dropping litigation without increasing divorce work? Difficulty: Moderate Time on task: 5 minutes Objective: L04 AACSB: Reflective thinking Assignment: None Solution: No. Due to unavoidable fixed costs of $40,000, income would decrease by $40,000 if litigation was simply dropped.

Sales Variable costs Fixed costs Income

Keep Litigation Drop Litigation Difference $300,000 $0 -$300,000 250,000 0 -250,000 50,000 40,000 -10,000 $0

-$40,000

b. Should the firm drop its litigation work and increase its divorce work? What would be the effect on income? Difficulty: Difficult Time on task: 8 minutes Objective: L04 AACSB: Reflective thinking Assignment: None Solution: Yes. If litigation was dropped and the excess capacity was utilized to increase divorce sales, the firm would realize a $60,000 increase in profit.

Sales Variable costs Fixed costs Income

Keep Litigation Drop Litigation Difference $300,000 $250,000 -$50,000 250,000 150,000 -100,000 50,000 40,000 -10,000 $0 $60,000 $60,000

c. Give three other factors that the firm should consider when evaluating whether to keep or drop the litigation work. Difficulty: Difficult Time on task: 5 minutes Objective: L04 AACSB: Application of knowledge Assignment: None Solution: 1. Management should consider whether using the excess capacity for estate planning would be more profitable than using it for divorce work. 2. Management should consider whether litigation is complementary to the other practices and if eliminating litigation would adversely affect the revenues from another practice. 3. Management should consider whether eliminating the litigation work could impact its competitiveness with other legal firms that provide more services.

9. Pet Services offers two product lines: home sitting and grooming. Income statement data for the most recent year is presented below: Home Sitting

Grooming

Total

Sales revenue Variable costs

$50,000 (24,000)

$80,000 (30,000)

$130,000 (54,000)

Contribution margin Avoidable fixed costs Allocated fixed costs

26,000 (7,000) (20,000)

50,000 (10,000) (30,000)

$76,000 (17,000) (50,000

Operating income (loss)

($1,000)

$10,000

$9,000

a. Assuming fixed costs remain unchanged, how would dropping the home sitting line affect operating income? b. Discuss whether each of the following costs would likely be included as variable or fixed costs: gasoline, insurance, hourly pay of employees who directly perform the service, supervisor’s salary. c. You have learned that with $1,500 of additional advertising, the owners estimate that the revenues from the home sitting line could be increased by 10%. None of the other fixed costs are expected to change. What would be the income for home sitting and total income? d. The company is considering adding a “walking service” line. Ignore part c. The company hopes to attract new customers in addition to drawing from existing customers. The company is considering adding an introductory offer coupon of 25% off the regular price. Expected results for the upcoming period are: Home Sitting

Grooming

Total

Sales revenue

$43,000

$75,000

$24,000

Variable costs

(20,000)

(27,000)

(8,000)

Contribution margin

$23,000

$48,000

$16,000

Avoidable fixed costs

(7,000)

(10,000)

(2,000)

Allocated fixed costs

(16,000)

(25,000)

(9,000)

Operating income (loss)

$13,000

$5,000

Evaluate whether the company should add the product line. Discuss what you believe would be the source of information for the estimated expected results. Be specific. 53

e. The company has identified the following other relevant facts that the owners wish to incorporate into an income statement quantitative analysis: relative amount of time for each product line, including new line; regulations and new permits that might be required for the new line; source of additional part-time employees for the new line; and type of promotion to develop the new line as a major service line. Discuss whether each of those items is relevant and give three other quantitative or qualitative relevant facts.

Difficulty: Moderate Time on task: 9a, 9b, and 9c - 5 minutes 9d and 93 - 3 minutes Objective: L04 AACSB: 9a, 9c, and 9d - Reflective thinking 9b and 9e - Application of knowledge Assignment: Homework Solution: varies, see below #

Question

Assuming fixed costs remain unchanged, how would dropping 9a the home sitting line affect operating income?

Solution If home sitting was dropped, the company would recognize an additional $19,000 in losses.

[See “CH 08 V2 Roadmap, Solutions - Problem” for supporting calculations.] - Gasoline is a variable cost based on number of Discuss whether each of the visits and distance. following costs would likely be - Insurance is generally a fixed cost. included as variable or fixed - Hourly pay for employees who directly perform 9b costs: gasoline, insurance, hourly the service is a variable cost. pay of employees who directly - Supervisor’s salary is a fixed cost as the perform the service, supervisor’s amount paid to the supervisor will not fluctuate salary. based on service hours. You have learned that with If the company spent an additional $1,500 on $1,500 of additional advertising, advertising and experienced an increase of 10% the owners estimate that the in sales, then the home sitting line would profit by 9c revenues from the home sitting $100 as opposed to having a loss of $1,000. line could be increased by 10%. None of the other fixed costs is [See “CH 08 V2 Roadmap, Solutions - Problem”

expected to change. What would for supporting calculations.] be the income for home sitting and total income?

The company is considering adding a “walking service” line. Ignore part c. The company hopes to attract new customers in addition to drawing from existing customers. The company is considering adding an Based on the analysis performed, adding a introductory offer coupon of 25% “walking service” would double the net income, off the regular price. Expected from $9,000 to $18,000. Based on quantitative 9d results for the upcoming period factors alone, the company should add the are: product. However, it is important for management [see chart above] to consider qualitative factors as well. Evaluate whether the company should add the product line. Discuss what you believe would be the source of information for the estimated expected results. Be specific. The company has identified the following other relevant facts that the owners wish to incorporate Each of the factors listed would be relevant in into an income statement making the decision of whether to add another quantitative analysis: relative line. amount of time for each product line, including the new line; Other factors that management should consider: regulations and new permits that - Will the added service affect the quality of other 9e might be required for the new services provided? line; source of additional part-time - Will the added service impact scheduling and employees for the new line; and availability negatively? type of promotion to develop the - How sensitive will customers be to the increase new line as a major service line. in price after the introductory period? Discuss whether each of those items is relevant and give three other quantitative or qualitative relevant facts.

10. Superior Lessons offers three product lines: music lessons, sports lessons, and early grades tutoring after school lessons. The following represents the income statements for the most recent period: Income Statement Items

Music

Sports Early Grades

Total

800

1,600

3,000

5,400

Sales

$15,000

$14,000

$30,000

$59,000

Direct materials, variable overhead, and selling

(3,300)

(800)

(5,000)

(9,100)

Direct labor

(3,000)

(2,200)

(6,200)

(11,400)

Fixed costs: allocated

(2,300)

(2,100)

(4,500)

(8,900)

Fixed costs: avoidable

(2,400)

(1,600)

(3,000)

(7,000)

Net Income

$4,000

$7,300

$11,300

$22,600

Number of lessons

Qualitative factors that may impact future performance: ● A competitor has opened up within 2 miles. ● There is a rumor that the new lease company will try to raise the rent by 10%. ● A nearby college is willing to give service hours and non-paid internships if college students work/assist at Superior Lessons in the early grades division. ● The most recent customer survey indicates high satisfaction with the progress made by early grades students in their regular classes. The sports students have provided average satisfaction ratings for golf and baseball and high satisfaction for basketball and tennis. Other facts: ● To increase interest in music lessons, the company offered social media discount coupons of half price for an introductory set of lessons. The sales reflect the additional volume, and the selling costs reflect the discount given. The company conducted an exit survey and was surprised to learn that the purchasers of the coupon lessons were not interested in paying full price in the future to continue lessons. ● The previous margin (income divided by sales) for music lessons was approximately 50%. ● The company is considering adding another line, “dance lessons,” since many of the music instructors could also teach dance lessons. The company is trying to determine which numbers/facts would be relevant.

a. Identify which of the following would be relevant in terms of decisions and product line profitability: i. The rent and property taxes of the facilities ii. The additional insurance for potential student accidents iii. The interest in dance lessons (with and without coupons) from current customers in the sports and early grades

iv. Competition v. The advertising costs Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Test Solution: i. Not relevant in the decision to add dance lessons because the rent and property taxes of the facilities will not change based on the addition of the class. ii. Relevant because the cost of insurance will change with the addition of the class. iii. Relevant because sales revenue will change with the addition of the class. iv. Relevant because competition from other companies will affect the potential revenue realizable. v. - Relevant because selling costs will increase with the addition of the class.

b. List at least three other facts/types of information that you believe would be relevant to the decision of adding dance lessons. Difficulty: Moderate Time on task: 3 minutes Objective: LO2 AACSB: Application of knowledge Assignment: Test Solution: 1. Strain on teachers’ schedules with the increased class load 2. Whether the addition of dance classes will result in a reduction of attendance in other classes due to cannibalization 3. Competitiveness in the dance instruction market (i.e., how many competitors are there, how tight is pricing, is there a large market of students interested in dance classes)

c. Discuss (in terms of cost/benefit) whether it is enough to just give a list of relevant items or if it is important to try to estimate the “soft data.” Difficulty: Moderate Time on task: 3 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Test Solution: Generally, it is important to try to estimate the “soft data” for all relevant items so that they are not ignored in the quantitative analysis. However, management must consider the cost-benefit constraint when gathering information to estimate “soft data,” to ensure that the cost of obtaining the additional information does not outweigh the benefit.

11. Superior Lessons offers three product lines: music lessons, sports lessons, and early grades tutoring after school lessons. The following charts were produced using Google Sheets to visualize the relationships between sales, segment income and net income. Segment income represents the income attributable to the product line (i.e., Sales less variable costs and avoidable fixed costs).

a. Match each question to the chart that best provides an answer to the question. Which product line generates the most sales? Which product line is the most profitable? Which product line has the greatest amount of allocated fixed costs?

Difficulty: Moderate

Time on task: 2 minutes Objective: LO2 AACSB: Reflective thinking Assignment: None Solution: Which product line generates the most sales? - Chart 1 Which product line is the most profitable? - Chart 3 Which product line has the greatest amount of allocated fixed costs? - Chart 2 b. Provide an answer to each of the questions using the charts. Which product line generates the most sales? Which product line is the most profitable? Which product line has the greatest amount of allocated fixed costs? Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: None Solution: Which product line generates the most sales? Chart 1 indicates that Early Graders generates the greatest amount of sales of approximately $30,000. Which product line is the most profitable? It depends on how profitability is defined. If it is defined as the percent profit generated, then Chart 3 indicates that Sports is the most profitable product line. If profitability is defined in terms of dollars, then Chart 1 indicates that Early Graders is the most profitable product line. Which product line has the greatest amount of allocated fixed costs? Chart 2 indicates that Early Graders has the greatest amount of allocated fixed costs. This is shown as the greatest difference between Net Income and Segment Income. c. Given the data below, recreate the three charts using a data visualization tool such as Microsoft Excel, Google Sheets, or Tableau.

Income Statement Items

Music

Sports Early Grades

Sales

$15,000

$14,000

$30,000

Segment income

6,300 4,000

9,400 7,300

15,800 11,300

Net income Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Written or oral communications Assignment: None

Solution: Refer to the charts provided in the problem.

12. The following articles provide some insight into the current and emerging trends and considerations in supply chain management. Select one of the articles from the list below. ● ●

●

“Mitigating Supply Chain Risk” JLL Industrial, https://www.us.jll.com/en/views/mitigatingsupply-chain-risk?utm_campaign “Supply Chain Technology Trends: Investments and Adoption,” Jabil, https://www.jabil.com/blog/supply-chain-technology-trends-investments-andadoption.html “Honeywell Robotics hub will focus on warehouse automation,” SupplyChainDive, https://www.supplychaindive.com/news/honeywell-robotics-hub-warehouseautomation/565943/

Difficulty: Moderate Time on task: 12 minutes Objective: LO10 AACSB: Written and oral communication Assignment: None

Solution: Recall that supply chain management is the process of designing, implementing, controlling, and monitoring all activities along the supply chain. Students’ responses will vary based on the article selected but the paragraph should be a summary of the article and not a copy and paste exercise.

b. Identify three observations that were interesting or unknown prior to reading the article.

Difficulty: Moderate Time on task: 8 minutes Objective: LO10 AACSB: Reflective thinking Assignment: None Solution: Students’ responses will vary based on the article selected but responses should be their opinion and not a copy and paste from the provided articles.

Chapter 09 End of Chapter with Solutions Questions 1. What are capital projects? Explain the purpose of capital projects. Difficulty: Easy Time on task: 2 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Quiz Solution: A capital project is a long-term investment made by a company that normally requires a large amount of planning and resources. The purpose of capital projects is to benefit the company for longer than one year by supporting the company’s operations.

2. Describe the input-process-output model as it applies to capital budgeting. Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Test Solution: The first part of the capital budgeting process is the input gathering phase. Management should identify potential capital investments and collect the relevant information and key inputs for the decision. One key input is predicted net cash flows from the investment. Once the managers have collected key information, they process this information through various capital budgeting models to financially analyze the potential projects, including analysis of factors such as feasibility factors and tangible and intangible benefits. In the output phase, managers use the results from the capital budgeting models to consider the alternative capital investment projects (both quantitatively and qualitatively), and then select and implement the decision. Finally, after implementation, managers perform a post-audit to evaluate the decision.

3. Give several capital budgeting decisions for an electric company. Difficulty: Moderate Time on task: 4 minutes Objective: LO1 AACSB: Application of knowledge Assignment: Test Solution: Strategic investments: Deciding whether to invest in solar panel energy, which is not part of the current energy sourcing. Replacement or cost savings investments: Decide between performing substantial repairs and upgrades to an aged truck fleet or investing in new trucks to replace the current fleet. Regulatory or compliance investments: Invest in a training program to ensure workers involved in turning on/off gas lines are adhering to all safety and environmental requirements.

4. What are the main categories of capital projects? Difficulty: Easy Time on task: 3 minutes Objective: LO1 AACSB: Reflective thinking Assignment: Homework Solution: 1. Strategic investments: Management’s strategic vision and goals for the company in the future, as opposed to addressing certain needs the company has right now. 2. Replacement or cost savings investments: Based on the current needs of the company. 3. Regulatory or compliance investments: Address certain regulatory or legal requirements to which the company must adhere. 5. Discuss how capital budgeting is linked to an enterprise’s vision, mission statement, and strategic plan. Difficulty: Easy Time on task: 3 minutes Objective: LO1

AACSB: Reflective thinking Assignment: Test, Homework Solution: Capital budgeting supports a company’s ability to accomplish or strive to achieve its vision, mission statement, and strategic plan by enabling the company to determine which project(s), out of a variety of projects, will best satisfy the company’s needs while providing a good return on investment.

6. Capital budgeting decisions are difficult because of increased uncertainty of risks due to changing technology, security, global pressures, competition, and regulations. Do you agree? Discuss. Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Test Solution: Yes. Capital budgeting decisions rely heavily on the accuracy of the inputs utilized in the various financial models. However, these inputs are assumptions and estimates based on available information at the time. With an increased uncertainty of risks, the input values also have an increased uncertainty. For example, technology is changing rapidly, and the useful life estimates may be shortened dramatically from the expected useful life specified in the capital budgeting decision process. Further, enhanced competition and regulation may have a significant impact on the cash flows that are actually realized in the future. For these reasons, it is imperative that management performs a sensitivity analysis and considers the results in making capital budgeting decisions.

7. Some intangible benefits are difficult to estimate and quantify. Give some intangible benefits of setting up an “online store” in addition to having a physical store location. Difficulty: Easy Time on task: 3 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: Some intangible benefits of setting up an online store in addition to a physical store include:

● ● ● ●

Increased customer satisfaction from enabling customers to pick their preferred shopping experience (online or in store) Increased customer satisfaction from enabling customers to shop whenever they want as opposed to during business hours Increased visibility because customers can learn about the store via online searches in addition to driving by, word of mouth, and targeted ads Increased demand because the company has the ability to sell to customers outside of the current physical location

8. If management is not committed to funding a project or does not believe that the project is a strategic fit for the organization, the potential for not approving the project is high, even if the project has a high net present value. Do you agree? Discuss. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Yes. When evaluating a capital project, management commitment plays a key role in the economic feasibility of that project. Although a project might be financially attractive, management might choose to not fund it for a variety of reasons. The company may have several competing projects to invest in, yet not have enough resources to fund them all, so tough choices have to be made. Or, the project might be a good investment, but the company chooses to not fund it because that particular project does not fit with the company’s overall strategy and goals. Management might also choose against funding a project if it does not fit with the company’s social or political objectives. Any capital budgeting decision will not be feasible without management’s long-term commitment to fund, implement, and operate the project. 9. “The effectiveness of the capital budgeting methodology is questionable because predicting future cash inflows is often difficult and full of uncertainties.” Do you agree with this statement? Explain why or why not. Difficulty: Difficult Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Quiz Solution: 4

I do not agree. Capital budgeting methodology is useful in evaluating different capital projects. Predicting future cash inflows can be difficult and subject to uncertainty, but that does not make the techniques any less effective. Rather, decision makers need to remain aware of the potential risks when evaluating the different capital budgeting decisions.

10. Companies may choose to use both a nondiscounted cash flow model, such as payback period, and a discounted cash flow model, such as net present value, to get a more complete picture of a capital budgeting decision. Do you agree? Discuss. Difficulty: Easy Time on task: 3 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Quiz Solution: Yes. Companies should use multiple capital budgeting models to obtain a more complete picture of a capital budgeting decision, including nondiscounted and discounted cash flow models.

11. Cash flows for capital budgeting projects should be estimated solely by accountants since they would have the most expertise and objectivity in the company. Do you agree with this statement? Explain why or why not. Difficulty: Difficult Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Quiz, Homework Solution: I do not agree. Accountants might not have all the information available to develop accurate estimates of future cash flows. Accountants typically have a lot of insight into the historical performance of the company, but often lack information about future performance.

12. If the future cash flows are different in various years, only payback period and accounting rate of return models should be used. Do you agree with this statement? Explain why or why not. Difficulty: Easy Time on task: 3 minutes 5

Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: I do not agree. All methods should be considered, no matter whether the future cash flows are even or uneven.

13. If the net present value is zero, the project has no value in the present and should be rejected. Do you agree with this statement? Explain why or why not. Difficulty: Difficult Time on task: 5 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: I do not agree. If the net present value is zero, then the discounted future cash inflows are equal to the cash outflows today, which means the company has achieved exactly the required rate of return used to discount those cash flows. Before rejecting the project, one should assess other capital budgeting models, such as the payback period and accounting rate of return models, as well as the intangible benefits that the project might provide to the organization.

14. Describe the major benefits and weaknesses of the payback period and accounting rate of return methods. Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: Payback period: ● Benefits: Easy to understand and use, emphasizes risk and liquidity, emphasizes cash flow

●

Drawbacks: Ignores the time value of money, ignores cash flows after payback period so it does not measure total profitability

Accounting rate of return: ● Benefits: Easy to understand and use, related to income statement and performance evaluation ● Drawbacks: Does not emphasize cash flows, ignores the time value of money, often leads to wrong decisions because true return is not measured

15. Companies today face many uncertainties that make predicting future cash flows difficult for major projects. Several such risks are data security breaches (hacking, stealing of data), terrorist attacks, inflation, global competition, and product tampering. How can companies use sensitivity analysis, ranking of intangible benefits, and cost-benefit analysis to properly analyze capital projects under such conditions of uncertainty? Difficulty: Moderate Time on task: 4 minutes Objective: LO3, LO4 AACSB: Reflective thinking Assignment: None Solution: Companies can first use a sensitivity analysis to measure how “sensitive” the results are (outputs) to certain changes in assumptions (inputs). Then, a company can assess the intangible benefits that the investment might provide that could assist in minimizing risks. Finally, companies should undertake a cost-benefit analysis to assess whether the benefits of investing in the capital project exceed the cost and risks. 16. Identify how prescriptive and descriptive analytics can be used in the capital budgeting process. Difficulty: Moderate Time on task: 4 minutes Objective: LO2 AACSB: Reflective thinking Assignment: None Solution: Predictive and prescriptive analytics are valuable in developing projections used in capital investment decisions. Analytics incorporating multiple data sources improve the projection accuracy, resulting in higher-quality capital investment decisions (i.e., selecting a capital

investment alternative that results in a positive return). The projections can be about future cash flows, future resource usage, or customer demand.

Exercises 1. The Taylor Company is planning to purchase a new machine for $30,000. The payback period is expected to be 5 years. The new machine is expected to provide after tax cash flow from operations of $7,000 per year in each of the next 3 years, and $5,500 in the fourth year. Depreciation of $5,000 per year will be charged to income for each of the 5 years of the payback period. What is the amount of the cash flow from operations that the new machine is expected to produce in the last (fifth) year of the payback period? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: Year 0 1 2 3 4 5

Original Investment

Cash Inflows

($30,000) 7,000 7,000 7,000 5,500 3,500

Net Cash Flows ($30,000) 7,000 7,000 7,000 5,500 3,500

Remaining Cash Flows to be Recovered ($30,000) (23,000) (16,000) (9,000) (3,500) 0

Since the payback period is 5 years, the remaining investment cost that must be recovered in year 5 must be cash inflows of $3,500 (the remaining balance in year 4). Depreciation is not considered, as it is a noncash expense and does not involve cash.

2. Limon Company is planning to invest in a machine with a useful life of 5 years and no salvage value. The machine is expected to produce after-tax cash inflows from operations of $20,000 per year. Limon’s expected internal rate of return is 10%. How much will the machine cost?

Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Quiz Solution: An initial investment of $75,816 would produce cash flows from operations of $20,000 per year for 5 years, assuming an internal rate of return of 10%. Annual after-tax cash inflow (P i, n) = Cost of investment Annual after-tax cash inflow (3.7908) = $75,816 Annual after-tax cash inflow = $20,000 Excel Solution: Net Cash Flows Annuity Factor Present Value n = 5, i = 10% Present value of annuity 20,000.00 3.7908 75,816.00

3. Windy Company invested in a 2-year project with an expected internal rate of return of 10%. The machine is expected to produce cash flows from operations of $50,000 in the first year and $45,000 in the second year. How much will the project cost?

Difficulty: Difficult Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Quiz Solution: The project will cost approximately $82,645. 9

Approach 1 (Manual calculation): Present Increased Subtotal Value Single Net Original Year Cash Annual Net of Sum Present Investment Flows Cash Flows Factor (i = Value 10%) Today (82,647.50) (82,647.50) 1.00 (82,647.50) Year 1 50,000.00 50,000.00 0.9091 45,455.00 Year 2 45,000.00 45,000.00 0.8265 37,192.50 Total 0.00 The original investment is calculated by summing the net present value of the increased cash flows in years 1 and 2. Note that the present value factor utilized is the present value of a single-sum factor utilizing an IRR of 10% for each respective period. Approach 2 (Utilizing NPV function): Increased cash flows year 1 Increased cash flows year 2 Initial investment

50,000.00 45,000.00 82,644.63

The Excel NPV formula is =NPV(10%, B38:B39), where 10% represents the internal rate of return required and B38:B39 represents the payments. Note that the difference between approaches 1 and 2 relates to rounding of the PV SS factors.

4. The Amber Company expects a 16% accounting rate of return on an investment that cost $30,000 and has an expected 8-year life and no salvage value. a. What is depreciation expense? Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Test Solution: Depreciation Expense = $30,000/8-year useful life = $3,750

b. What are the annual average net cash inflows? Difficulty: Moderate Time on task: 3 minutes 10

Objective: LO3 AACSB: Analytical thinking Assignment: Test Solution: Accounting rate of return = (Annual average net cash flows – Depreciation expense)/Initial investment 16% = (X – $3,750)/$30,000 Annual net cash flows = $8,550

c. What is the payback period for the project (approximately)? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Test Solution: Payback period = Initial investment/Expected annual net cash flows Payback period = $30,000 / $8,550 Payback period = 3.5 years, or year 4

5. Expo is considering buying a new truck costing $32,000, which should generate after-tax cost savings of $10,000 for each of the first 3 years and $9,000 in each of the last 3 years. The salvage value is $2,000. a. What is the annual depreciation expense? b. What are the average annual net cash flows? c. What is the accounting rate of return?

Difficulty: Easy Time on task: 3 minutes each Objective: LO3 AACSB: Analytical thinking

Assignment: None Solution: a. Depreciation = ($32,000 – $2,000)/6 years = $5,000 per year b. Annual average net cash flows = [($10,000 × 3 years) + ($9,000 × 3 years)]/6 years = $9,500 average per year c. Accounting rate of return = (Annual average net cash flows – Depreciation expense)/Initial investment Accounting rate of return = ($9,500 – $5,000)/$32,000 Accounting rate of return = 14.06%

6. Mr. Ambitious is considering purchasing a new machine to be used in his dry-cleaning business. The following cash savings are expected from the $40,000 investment over the next 5 years: years 1 and 2, $15,000 per year; years 3, 4, and 5, $10,000 per year. a. What is the annual depreciation expense? b. What are the average annual net cash flows? c. What is the accounting rate of return? d. If the required rate of return is 8%, should the machine be purchased?

Difficulty: a. Easy; b., c., and d. Moderate Time on task: 3 minutes each Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: a. Depreciation = ($40,000 – $0)/5 years = $8,000 per year b. Annual average net cash flows = [($15,000 × 2 years) + ($10,000 × 3 years)]/5 years = $12,000 average per year c. Accounting rate of return = (Annual average net cash flows – Depreciation expense)/Initial investment Accounting rate of return = ($12,000 – $8,000)/$40,000 Accounting rate of return = 10% d. Considering only the accounting rate of return, the machine should be purchased. The machine achieves an accounting rate of return of 10%, which is greater than the minimum desired rate of 8%.

7. Mr. Ambitious is considering the purchase of a new machine to be used in his dry-cleaning business. The following after-tax cash savings are expected from the $40,000 investment over the next 5 years: years 1 and 2, $15,000 per year; years 3, 4, and 5, $10,000 per year.

a. What is the net present value, assuming a required rate of return of 8%? b. Should the machine be purchased?

Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: a. Year

Today Year 1 Year 2 Year 3 Year 4 Year 5

Subtotal Increased Present Value Net Annual Cash Single of Sum Present Net Cash Flows Factor (i = 8%) Value Flows (40,000) (40,000) 1.00 (40,000) 15,000 0.926 13,890 15,000 0.857 12,855 10,000 0.794 7,940 10,000 0.735 7,350 10,000 0.681 6,810 Total 8,845

Original Investment

b. Yes. The net present value is positive. . 8. The following facts are known about an investment for Amol Company: The payback period is 4 years, the expected after-tax cash flows per year are $8,000, and the life of the project is 6 years. a. What is the initial cost?

Difficulty: Moderate

Time on task: 6 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Payback period = Initial investment/Expected net cash inflows 4 years = Initial investment/$8,000 per year Initial investment = $32,000

b. What is the internal rate of return? Choose one: i. Between 8% and 10% ii. Between 10% and 12% iii. Between 12% and 14% iv. Greater than 14% v. None of the above

Difficulty: Moderate Time on task: 6 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: iii. Between 12% and 14% Initial Investment (32,000.00) Year 1 Expected net cash inflows 8,000.00 Year 2 Expected net cash inflows 8,000.00 Year 3 Expected net cash inflows 8,000.00 Year 4 Expected net cash inflows 8,000.00 Year 5 Expected net cash inflows 8,000.00 Year 6 Expected net cash inflows 8,000.00 Internal rate of return 12.98% [Using f(x) function for IRR] c. If the net present value is $888, what is the approximate cost of capital (discount rate)?

Difficulty: Difficult Time on task: 6 minutes Objective: LO3 14

AACSB: Analytical thinking Assignment: Homework Solution: 14% Approach 1: Solve for discount rate utilizing f(x) function. Initial Investment (31,112.00) = (32,000) initial cost + $888 NPV Year 1 Expected net cash inflows 8,000.00 Year 2 Expected net cash inflows 8,000.00 Year 3 Expected net cash inflows 8,000.00 Year 4 Expected net cash inflows 8,000.00 Year 5 Expected net cash inflows 8,000.00 Year 6 Expected net cash inflows 8,000.00 Internal rate of return 14.00% [Using f(x) function for IRR] Approach 2: Solve for annuity factor using PV of annuity formula. Net Cash Annuity Factor Net Present Flows n = 6, i = unknown Value Present value of annuity 8,000.00 3.889 31,112.00 Annuity factor = Present value/Net cash flows = 3.889 Utilizing PV of ANN tables, a factor of 3.889 for 6 periods correlates with a discount rate of 14%.

9. Morales Company is planning to invest in high-tech equipment costing $580,000, which has a useful life of 6 years and a $40,000 salvage value. The investment is expected to produce net cash (after taxes) operating savings of $120,000 per year. A repair of $10,000 is anticipated at the end of 2 years. The corporate salaries are $55,000. The company uses straight-line depreciation. The desired rate of return is 10%. a. What is the net present value if the cost of capital is 10%? Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: None Solution: ($43,220)

Year

Today Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Increased Original Cash Investment Flows (580,000) 120,000 120,000 120,000 120,000 120,000 120,000

Present Value Net Single of Sum Present Factor (i = Value 10%) 1.00 (580,000) 0.909 109,080 (10,000) 0.826 90,860 0.751 90,120 0.683 81,960 0.621 74,520 40,000 0.564 90,240 Other Cash Flows

Total

(43,220)

* Depreciation is not considered because it is a noncash expense and there is no mention of cash savings for taxes. Corporate salaries are not considered because there is no mention that individuals were hired or promoted as a result of the investment in high-tech equipment (sunk cost). Alternative Method: = Cash outflow for purchase of equipment + Annual cash savings – Year 2 Repair + Salvage value = –$580,000 + $120,000(PV ann n = 6, i = 10%) – $10,000(PV ss n = 2, i = 10%) + $40,000(PV ss n = 6, i = 10%) = –$580,000 + $120,000(4.355) – $10,000(0.826) + $40,000(0.564) = –$43,100 The two methods result in slightly different values due to the rounding of present value factors. b. Should the machine be purchased? Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: None Solution: No, the machine should not be purchased, as it has a negative NPV.

10. You are the outside accountant for ABC Company. During your audit, you learn that the controller is planning to purchase a new piece of equipment for the company. You have also heard that the salesperson is a friend of the controller. Even though other bids were lower, the controller has indicated that the company will buy the equipment from his friend. You then learn that the current equipment is functioning well. What facts do you need to gather, and do you have a responsibility to discuss the proposed purchase with the controller? Difficulty: Moderate Time on task: 4 minutes Objective: LO3 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: In addition to the initial cost of the equipment, you should obtain an understanding of any differences in the future cash inflows or cost savings between the bids. Also, you should gain an understanding of the rationale behind purchasing the new equipment if the current equipment is functioning well. Is the new equipment expected to be more efficient than the old equipment? Does the old equipment undergo a lot of maintenance (higher operating costs)? You do have a responsibility to ensure that the best bid is selected, and that the controller is not making the decision solely based on his/her relationship with the salesperson.

11. You are reviewing a capital budgeting analysis that was prepared by your boss (the controller) at the request of the director of marketing. The director wants to purchase new software to manage all the company’s customer information and buying preferences. The analysis assumes the cost savings with the new system to be $50,000 per year for the next 5 years. You agree that the cost savings will be $50,000 in the first year but expect the savings to decline over the next 4 years as the company grows. When you question the controller, he tells you that he mentioned this to the director, but the director said to “make the numbers work” because the marketing department needs this software. What should you do? Difficulty: Moderate Time on task: 4 minutes Objective: LO5 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: You should first perform a sensitivity analysis to see the impact of the capital budgeting analysis with decline in the cost savings after year 1. Then, you should express your 17

concerns with the inputs into the capital budgeting analysis to the controller and director of marketing. The marketing department may want this new software, but the expenditure could negatively impact other departments in the organization.

12. MOP factors were described as important considerations for the success of projects. For each of the items described, select the appropriate category. Choose from: M = Management view, including strategic fit and economic support O = Operational considerations such as scheduling, employee skills, and time scheduling issues P = Promise versus reality of technical support, vendor quality, and delivery issues

a. At the present time, senior management is not willing to commit funds for the development of a new corporate gymnasium for employees. b. The equipment being considered is too complex and sophisticated for the employees. c. The project will take a year to implement but it needs to be finished within 6 months. d. The company conducted due diligence on a potential vendor and learned that some implementations did not go smoothly due to vendor delays. e. The potential new product line will require modifications in the warehouse distribution system and potentially lead to delays in promised delivery dates to customers. f.

Management is concerned that the new international division is not a strategic fit with the mission of the rest of the company. Difficulty: Easy Time on task: 1 minute Objective: LO4 AACSB: Application of knowledge Assignment: Varies, see chart below Solutions: Varies, see chart below #

Question

At the present time, senior management is not willing to 12a commit funds for the development of a new corporate gymnasium for employees. The equipment being considered is too complex and 12b sophisticated for the employees. The project will take a year to implement but it needs to be 12c finished within 6 months.

Solution

Q,T, Hwk

Quiz

Test 18

The company conducted due diligence on a potential 12d vendor and learned that some implementations did not go smoothly due to vendor delays. The potential new product line will require modifications in 12e the warehouse distribution system and potentially lead to delays in promised delivery dates to customers. Management is concerned that the new international 12f division is not a strategic fit with the mission of the rest of the company.

Test

Hwk

13. For each of the following scenarios that involve significant investments in technology, provide examples of one tangible benefit and one intangible benefit. a. Wearable technology such as uniforms, smart watches, or shirts that track time spent at stations in a factory b. Driverless cars c. Radio-frequency identification (RFID) chips attached to clothing d. “Cloud” technology storage of data e. Mannequins that monitor customer movement f.

Electronic messages and coupons sent to customers while shopping Difficulty: Difficult Time on task: 7 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Varies; see the chart. #

Question

Tangible Benefit

13a Wearable technology such Increased accuracy ● as uniforms, smart watches, of overhead or shirts that track time allocation and ● spent at stations in a factory product costing 13b Driverless cars

● ●

Decreased labor ● costs Decreased ● insurance costs

Intangible Benefit Increased employee productivity Less stress from reduced tracking of time Increased on-time deliveries Less stress from driving

13c Radio-frequency identification (RFID) chips attached to clothing 13d “Cloud” technology storage of data

13e Mannequins that monitor customer movement

13f Electronic messages and coupons sent to customers while shopping

from monitoring actual driving Decreased ● shrinkage costs ● Decreased storage ● costs

● Increased sales by ● responding to customer ● preferences Increased customer ● purchases ●

Increased customer satisfaction Consistency Increased employee productivity because employees have easier access to data More secure data Increased customer satisfaction More available data for analytics Increased customer engagement More data for future planning

14. For each of the statements, indicate which capital budgeting accounting method applies. More than one method may be used for a given item. P = Payback ARR = Accounting rate of return IRR = Internal rate of return NPV = Net present value a. Assumes that funds are reinvested at the company’s cost of capital b. Assumes that funds are reinvested at the project’s rate of return c. Projects that have a positive net monetary amount should be accepted d. Does not consider the time value of money e. Does not necessarily include total project cash flows f.

Considers the time value of money

g. Not affected by the timing of the cash flows and directly includes depreciation in the computation Difficulty: Easy Time on task: 1 minute

Objective: LO3 AACSB: Application of knowledge Assignment: varies; see the chart Solution: varies; see the chart

Question

Assumes that funds are reinvested at the company’s cost of capital Assumes that funds are reinvested at the project’s 14b rate of return Projects that have a positive net monetary amount 14c should be accepted 14d Does not consider the time value of money 14e Does not necessarily include total project cash flows 14f Considers the time value of money Not affected by the timing of the cash flows and 14g directly includes depreciation in the computation 14a

Solution

Q, T, Hwk

NPV

Quiz

IRR

Quiz

NPV

Test

P, ARR Test P Hwk IRR, NPV Hwk ARR

Hwk

15. True or False: For each of the following statements, identify whether the statement is true (T) or false (F). a. The internal rate of return assumes that funds are reinvested at the company’s cost of capital. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: False. IRR assumes that the funds are reinvested at the project’s rate of return. b. All projects that have a positive internal rate of return (higher than zero) should be accepted. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge

Assignment: Homework Solution: False. Only projects with an IRR that exceeds the company’s cost of capital should be accepted. c. The payback period and accounting rate of return methods do not consider the time value of money. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: True d. The following are all considered tangible benefits that can be quantified: lower material costs, lower labor costs, lower overhead costs, higher revenues, less scrap, less rework costs. Difficulty: Easy Time on task: 1 minute Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: True e. The accounting rate of return method is more accurate than the internal rate of return method since it does not use the time value of money. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: False. It is less accurate because it does not use the time value of money.

Depreciation is subtracted in the calculation of the accounting rate of return because money is set aside for future replacement of assets. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: False. Depreciation is subtracted because it is a noncash expense.

g. Relevant capital budgeting considerations other than the quantitative analysis include management support, operational infrastructure, and the “promise versus reality” of assumptions, including risk. Difficulty: Easy Time on task: 1 minute Objective: LO4 AACSB: Application of knowledge Assignment: Quiz Solution: True h. If net present value is positive, then the internal rate of return is higher than the cost of capital. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: True i.

The following may be considered intangible benefits but could possibly be quantified or at least included in a rating of projects: better delivery, higher customer satisfaction, higher quality of service, more product flexibility, increased security of data, ease of familiarity for employees. Difficulty: Easy Time on task: 1 minute

Objective: LO4 AACSB: Application of knowledge Assignment: Test Solution: True j.

If two projects have the same net present value but different initial investment requirements, the company should be indifferent between the projects. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: False. The company may prefer the alternative that requires a smaller initial investment requirement.

k. Capital budgeting is primarily the process of planning for the issuance of capital stock. Difficulty: Easy Time on task: 1 minute Objective: LO1 AACSB: Application of knowledge Assignment: Quiz Solution: False. Capital budgeting assists management in evaluating and planning the various capital projects available, to determine which projects will yield the company the highest possible returns and how the company’s resources should be allocated between the possible projects. Issuance of common stock may be part of the process of raising funds to pay for the project but is not the primary objective of capital budgeting. l.

Relevant information concerning long-term investment opportunities consists of information about the initial investment and the incremental future cash flows. Past data are useful only in assisting with the estimation of future amounts. Difficulty: Easy

Time on task: 1 minute Objective: LO2 AACSB: Application of knowledge Assignment: Quiz Solution: True m. The term “discounted cash flows,” as used in capital budgeting, refers to taking all the discounts available if payment of merchandise is made early—within the discount period. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: False. Discounted cash flows refers to the time value of money concept. n. To find the net present value, you would determine the total present value of the future cash flows and subtract the initial investment. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: True

o. If the net present value is positive, at least the minimum desired rate of return will be earned, and the project is acceptable. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge

Assignment: Homework Solution: True p. If the internal rate of return is greater than the cost of capital, the project is too expensive and should be rejected. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: False. If the IRR is greater than the cost of capital, the project is generating a higher return than the cost of capital. q. The payback period represents the time required to recover the initial investment. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: True r.

Payback is used by some firms because it is simple, it can be used in conjunction with the discounted cash flow methods, and with risky projects, a company may be more interested in the payback period than in total profitability. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: True

s. The accounting rate of return method uses income statement data to estimate the percentage of the project’s time that it will take to recover the initial investment. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: True t.

The payback period and accounting rate of return methods represent nondiscounted cash flow methods that ignore the time value of money. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: True

u. The steps involved in analyzing capital projects include gathering data within a month, meeting to discuss whether management will support the project, implementing the project, and then conducting a review. At the review stage, net present value is calculated and compared to actual results. Difficulty: Easy Time on task: 1 minute Objective: LO2 AACSB: Application of knowledge Assignment: Test Solution: False. There is no time requirement to obtain the data, and the NPV is calculated during the analysis of the capital projects stage. v. The longer the life of the investment, the higher the internal rate of return. Difficulty: Easy 27

Time on task: 1 minute Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: True. The more cash inflows received, the higher the IRR. 14. Find an article that discusses a capital investment decision. Write a one-page summary of the article that includes discussion of the relevant internal and external factors and risks. Make sure to cite your sources. Difficulty: Moderate Time on task: 20 minutes Objective: LO2 AACSB: Written and oral communication Assignment: Homework Solution: Recall that capital investments become critical for a company to achieve long-term growth, increase its market share and competitive position, and maintain profitability. Students’ responses will vary based on the article selected but the paragraph should be a summary of the article and not a copy and paste exercise.

Problems 1. Cristina Company is considering investing in a new electronic data interchange (EDI) integrated system. The expected data follow. The cost savings are already after taxes, so taxes can be ignored. Acquisition cost Useful life Additional major improvement in 3 years Salvage value at end of 8 years Years 1, 2, 3, 4 Years 5, 6, 7, 8 Salary of janitor per year whether the company buys the system or not Management estimates of the old, fully depreciated system if sold today Cost of capital is 12%. Annual cost savings

$450,000 8 years $36,000 $84,000 $130,000 $150,000 $22,000 $12,000

a. Set up the schedule of relevant cash flows below. Label clearly the relevant items. Calculate the net present value in the last column. Year

Label Relevant Items

Annual Cash Flows

PV Factor

Present Value

Now Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Difficulty: Moderate Time on task: 8 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Quiz Solution: Year Now Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

PV Annual Sale of Additional Salvage Net Cash Factor Present Cost Current Improvement Value Flows (i = Value Savings Equipment Costs 12%) (450,000) 12,000 (438,000) 1.0000 (438,000) 130,000 130,000 0.8929 116,077 130,000 130,000 0.7972 103,636 130,000 (36,000) 94,000 0.7118 66,909 130,000 130,000 0.6355 82,615 150,000 150,000 0.5674 85,110 150,000 150,000 0.5066 75,990 150,000 150,000 0.4523 67,845 150,000 84,000 234,000 0.4039 94,513 Total 254,695

Original Investment

b. Calculate the payback period. Difficulty: Easy 29

Time on task: 2 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Quiz Solution: 3.65 years Year 0 1 2 3 4 5 6 7 8

Net Cash Flows (438,000) 130,000 130,000 94,000 130,000 150,000 150,000 150,000 234,000

Balance -438,000 -308,000 -178,000 -84,000 46,000

Year 4 is the first year with a positive balance; thus it is the payback year. As it is paid back during the period, we can calculate the fraction of the year by taking the amount remaining to be paid at the end of year 3 divided by the annual cost savings in year 4 (84,000/130,000). The total payback period is 3.65 years.

2. Cainas/Jozsi Cookies is considering leasing a new kitchen space and purchasing new equipment, or completing an addition on the current kitchen space and refurbishing some of the old equipment. Other relevant known facts follow: Option 1: Sign a 5-year lease for new kitchen space, with anticipated increased revenues of $80,000 per year, additional operating expenses of $20,000 per year, and additional rent (not included in the operating expenses) of $15,000 per year. The company also anticipates an upfront cost for leasehold improvements to outfit the new space to a commercial-grade kitchen, at a one-time cost of $100,000. The current equipment can be sold today for $10,000. At the end of the lease term, the leasehold improvements should be worth $7,000. Option 2: If the company adds to the current space and renews the lease for another 5 years, the addition will cost $100,000 today. With the new space, revenues should increase $70,000 per year, additional operating costs will be $10,000 per year, and additional rent charged will be $10,000 per year. Refurbishing the current equipment at the end of year 3 will cost $15,000. At the end of the 5-year lease term, the refurbished equipment will be worth $5,000.

a. Identify the relevant cash flows for each option. 30

Difficulty: Moderate Time on task: 4 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Option 1: ● Increased revenues of $80,000 ● Increased expenses of $20,000 ● Increased rent of $15,000 ● Leasehold improvements of $100,000 ● Sale of current equipment for $10,000 ● Salvage value of $7,000 Option 2: ● Cost of addition of $100,000 ● Increased revenues of $70,000 ● Increased expenses of $10,000 ● Increased rent of $10,000 ● Refurbish costs of $15,000 ● Salvage value of $5,000

b. What is the accounting rate of return for Option 1? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Accounting rate of return = (Annual average net cash flows – Depreciation expense)/Initial investment Accounting rate of return = ($45,000 – $18,600)/$90,000 Accounting rate of return = 29.3% * Depreciation expense = ($100,000 – $7,000)/5-year useful life = $18,600 * Annual average net cash flows = $80,000 – $20,000 – $15,000 = $45,000 * Initial investment = $100,000 – $10,000 = $90,000 31

c. What is the internal rate of return for Option 1? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: 41.87% Initial Investment (90,000.00) Year 1 Expected net cash inflows 45,000.00 Year 2 Expected net cash inflows 45,000.00 Year 3 Expected net cash inflows 45,000.00 Year 4 Expected net cash inflows 45,000.00 Year 5 Expected net cash inflows* 52,000.00 Internal rate of return 41.87% [Using f(x) function for IRR] • Year 5 CF = Annual CF ($45,000) + Salvage Value ($7,000) d. Since the two options are mutually exclusive (if the company chooses one option, the company will not choose the other option), net the relevant cash flows from the two options from the standpoint of Option 1. What is the payback period? Difficulty: Difficult Time on task: 5 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: Increased revenues of $80,000 – $70,000 = Net increase of $10,000 Increased expenses of $20,000 – $10,000 = Net increase of $10,000 Increased rent of $15,000 – $10,000 = Net increase of $5,000 Overall net decrease of cash flow is $5,000 Initial investment of $90,000 – $100,000 = savings of $10,000 In this scenario, as we are comparing the differences between two options, our analysis of the payback period changes. The payback period is 2 years. In the context of this scenario, it will take 2 years for Option 1 to absorb the savings over

Option 2. After year 2, Option 1 will be $5,000 (overall net decrease) more expensive than Option 2.

e. What is the net present value from the standpoint of Option 1 if the cash flows are netted? The cost of capital is 10%. Difficulty: Moderate Time on task: 6 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: = Initial investment – Net annual decrease in cash flow + Year 3 Refurbish cost savings + Salvage value = –$10,000 – $5,000(PV ann n = 5, i = 10%) + $15,000(PV ss n = 3, i = 10%) + $2,000(PV ss n = 5, i = 10%) = –$10,000 – $5,000(3.791) + $15,000(0.751) + $2,000(0.621) = –$16,448 f.

Which option should Cainas/Jozsi choose? Difficulty: Easy Time on task: 3 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: Option 2, as the netting under Option 1 yields a negative NPV.

g. Give two intangible (qualitative benefits) that should be considered beyond the facts presented. Difficulty: Easy Time on task: 3 minutes Objective: LO4 AACSB: Application of knowledge 33

Assignment: Homework Solution: 1. Will quality increase with the introduction of a commercial-grade kitchen? 2. Will customer loyalty decrease during the renovation period?

h. Discuss the application of feasibility factors that Cainas/Jozsi should consider. Feasibility factors discussed in the chapter included the following: M = Management view, including strategic fit and economic support O = Operational considerations such as scheduling, employee skills, and time scheduling issues P = Promise versus reality of technical support, vendor quality, and delivery issues Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: In addition to evaluating the results from financial models such as those utilized earlier in the problem, management should perform a feasibility study, which also considers many other aspects of the project that could impact its success. Feasibility factors that management should consider include the following: ● Does expanding the kitchen space align with the strategic goals for the company? (M) ● Are there other capital projects that management should fund instead of kitchen expansion? (M) ● How would the kitchen expansion affect the current schedule and operating hours? (O) ● Will additional employees need to be hired and trained to run the new kitchen space? (O) ● How likely are the estimated increased revenues to be realized? (P) ● If the company selects Option 2, would additional refurbishing expenses be needed? (P)

3. Jenny’s Flower Shop wants to expand its operations and is looking for a larger facility. The company can add to the current building or sell the building and lease a larger facility nearby. Other relevant known facts follow: Option 1: It will cost $300,000 to add to the existing capacity but the company will increase revenues by $100,000 per year and will have additional operating expenses due to the increased space (e.g., more 34

electricity, increase in property taxes, insurance) of approximately $25,000 per year. At the end of year 2, the company will incur an additional charge to upgrade the current flower coolers, for a one-time cost of $25,000. The owner is expecting to retire in 5 years and to be able to sell the building for $600,000. Option 2: Sell the building today as-is for $375,000, and lease a larger facility for $50,000 per year. Anticipated increased revenues will be $80,000 per year and additional operating costs (not including rent) will be $15,000 per year. Jenny will need to renovate the building today to meet the company’s needs, at a one-time cost of $50,000. At the end of the lease term, the residual value of the leasehold improvements will be $5,000. The lease has a 5-year term and cost of capital is 10%. Using the net present value method, determine which option is better for Jenny using the template. Option 1: P.V. Additional Original Increased Increased Salvage Net Cash Factor Present Year Improvem Investment Revenue Expenses Value Flows (i = Values ent Costs 10%) Now Year 1 Year 2 Year 3 Year 4 Year 5 NPV Option 2: P.V. Additional Original Increased Increased Salvage Net Cash Factor Present Year Improvem Investment Revenue Expenses Value Flows (i = Values ent Costs 10%) Now Year 1 Year 2 Year 3 Year 4 Year 5 NPV

Difficulty: Difficult Time on task: 15 minutes Objective: LO3 AACSB: Analytical thinking 35

Assignment: Test Solution: Option 2 should be selected as it offers a higher NPV, as shown below: Option 1 PV Additional Original Increased Increased Salvage Net Cash Factor Present Year Improvem Investment Revenue Expenses Value Flows (i = Value ent Costs 10%) (300,000) Now (300,000) 1.0000 (300,000) 100,000 (25,000) 68,183 Year 1 75,000 0.9091 100,000 (25,000) (25,000) 41,320 Year 2 50,000 0.8264 100,000 (25,000) 56,348 Year 3 75,000 0.7513 100,000 (25,000) 51,225 Year 4 75,000 0.6830 100,000 (25,000) 600,000 Year 5 675,000 0.6209 419,108 NPV

336,183

Option 2 PV Initial Rent Increased Increased Salvage Net Cash Factor Present Year Investment Expense Revenue Expenses Value Flows (i = Value 10%) 325,000 Now 325,000 1.0000 325,000 (50,000) 80,000 (15,000) 13,637 Year 1 15,000 0.9091 (50,000) 80,000 (15,000) 12,396 Year 2 15,000 0.8264 (50,000) 80,000 (15,000) 11,270 Year 3 15,000 0.7513 (50,000) 80,000 (15,000) 10,245 Year 4 15,000 0.6830 (50,000) 80,000 (15,000) 5,000 12,418 Year 5 20,000 0.6209 NPV 384,965

4. Use the chart to answer questions 4a–4d: Acquisition cost Useful life Additional major improvement in 3 years Salvage value at end of 6 years Years 1, 2 Annual cost savings Years 3, 4 Years 5, 6 Cost of capital is 10%.

$200,000 6 years $16,000 $20,000 $60,000 $50,000 $45,000

a. Set up the schedule of relevant cash flows. Remember: Relevant items are those that differ between alternatives and occur in the future. Calculate the NPV in the last column.

Relevant Items Year

Cost of Equipment

Cost Savings

Salvage Value

Repair

Annual Cash Flow

PV Factor

Present Value

0 1 2 3 4 5 6 Difficulty: Easy Time on task: 8 minutes Objective: LO2 & 3 AACSB: Analytical thinking Assignment: Test Solution: Relevant Items Year

Cost of Equipment

0 1 2 3 4 5

(200,000.00)

Annual PV Factor Cash Flow (i = 10%)

Cost Savings

Salvage Value

60,000.00 60,000.00 50,000.00 50,000.00 45,000.00

(200,000.00) 60,000.00 60,000.00 (16,000.00) 34,000.00 50,000.00 45,000.00 65,000.00 20,000.00

45,000.00

Repair

Present Value

1.0000 (200,000.00) 0.9091 54,546.00 0.8264 49,584.00 0.7513 25,544.20 0.6830 34,150.00 0.6209 27,940.50 0.5645 36,692.50 NPV 28,457.20

b. Calculate the payback period. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Test

Solution: Annual Cash Flow 0 (200,000.00) 1 60,000.00 2 60,000.00 3 34,000.00 4 50,000.00 5 45,000.00 6 65,000.00 = 3 years + (46,000/50,000) = 3.92 years Year

Balance (200,000.00) (140,000.00) (80,000.00) (46,000.00) 4,000.00

c. Should the company buy the equipment based on the quantitative analysis? Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Test Solution: Yes. Based on the quantitative analysis of NPV (positive NPV) and payback period (less than the useful life), the company should buy the equipment.

5. Assume that the amounts in Problem 4 are before taxes and the tax rate is 30%. As a result, the analysis would differ as follows: ●

The after-tax cash cost savings net only 70% of the amounts.

●

The after-tax repair is only 70% of the value given.

●

The company uses accelerated depreciation to take greater depreciation deductions in the earlier years. The depreciation deductions and the 30% tax savings have already been calculated as follows: Depreciation Expense Year 1 Year 2 Year 3 Year 4 Year 5

$40,000 $64,000 $38,400 $23,040 $23,040

Depreciation Tax Savings

$12,000 $19,200 $11,520 $6,912 $6,912

$11,520

Year 6

$3,456

●

The after-tax salvage value is only 70% of the amount.

●

The acquisition cost is not affected by taxes since it is a balance sheet account.

a. Set up the schedule of relevant cash flows below. Remember: Relevant items are those that differ between alternatives and occur in the future. Calculate the NPV in the last column. Relevant Items Year

Cost of Cost Salvage Equipment Savings Value

Repair

Annual Cash Flow

PV Factor

Annual Cash Flow

PV Factor

Prese nt Value

0 1 2 3 4 5 6 Difficulty: Moderate Time on task: 8 minutes Objective: LO3 & 4 AACSB: Analytical thinking Assignment: Test Solution: Relevant Items Year

0 1 2 3 4 5 6

Cost of Equipment

Cost Savings, Net of Tax

Salvage Value

Repair

Depreciati on Tax Savings

(200,000) 42,000 42,000 35,000 35,000 31,500 31,500

11,200

14,000

11,100 17,700 10,620 6,012 6,012 2,556

Present Value

(200,000) 1.00 (200,000.00) 53,100 0.9091 48,273.21 59,700 0.8264 49,336.08 56,820 0.7513 42,688.87 41,012 0.683 28,011.20 37,512 0.6209 23,291.20 48,056 0.5645 27,127.61 NPV 18,728.16

b. Calculate the payback period assuming after-tax cash flows. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Test Solution: 3.65 years Year 0 1 2 3 4 5 6

Annual Cash Flow (200,000) 53,100 59,700 56,820 41,012 37,512 48,056

Balance (200,000) (146,900 ) (87,200) (30,380) 10,632

= 3 years + 30,380 / 41,012 = 3.74 years

c. Should the company buy the equipment based on the quantitative analysis? Difficulty: Moderate Time on task: 2 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Test Solution: Yes. Based on the quantitative analysis of NPV (positive NPV) and the payback period (less than the useful life), the company should buy the equipment.

6. Sporty is interested in expanding its operations. A new facility will provide cash savings. Additionally, the company can sublease space and realize cash lease revenues. The current facility was acquired 10 years ago at a cost of $500,000. Current after-tax operating data: Annual cash contribution margin Annual cash fixed costs

$100,000 $15,000

New facility (after-tax) operating data: Cost of new facility Annual cash contribution margin Annual cash fixed costs Sublease revenue per year

$1,220,000 $400,000 $60,000 $30,000

Management understands that the alternatives of expanding versus not expanding into a new facility are mutually exclusive. Use the net present value method to analyze whether the company should purchase a new facility with an estimated useful life of 20 years or continue to use its current facility. Sporty’s cost of capital is 8%. Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: Net Cash Annuity Factor Flows n = 20, i = 8% Present value of increase in CM Present value of increase in fixed costs Present value of increase in sublease revenue Less: Initial investment Net present value

$300,000 –$45,000 $30,000

Present Value

9.818 $2,945,400 9.818 –$441,810 9.818 $294,540 –$1,220,000 $1,578,130

7. On December 31, 2022, CC is considering launching a new product line and entering a new market. ●

The new product line would require an infrastructure cost today of $240,000.

●

The anticipated contribution margin from the new product per year is as follows: Year 1 $175,000 Year 2 $196,000

Year 3 Year 4

$220,500 $231,000

●

CC anticipates making an additional investment of $60,000 (cash expenditure) toward the end of 2025.

●

Yearly additional support costs for the product related to promotion, accounting, and systems work are estimated at $20,000 per year.

●

The cost of capital (minimum desired rate of return) for the new product is 10%.

a. Identify the relevant items Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: The relevant items include: ● Infrastructure cost of the new product line ● Additional investment in 2025 ● Contribution margin of the new product line ● Additional support costs ● Cost of capital

b. Using the template, determine the annual cash flows and net present value.

Date

Analysis If Cash Flows Are Before Tax Annual Relevant Items Cash Flow

2022 2023 2024 2025 2026

PV Present Factor Value 1 0.909 0.826 0.751 0.683 NPV =

Difficulty: Moderate Time on task: 6 minutes 42

Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution:

Date

2022 2023 2024 2025 2026

Analysis If Cash Flows Are Before Tax Relevant Items Annual PV Present Cost of Contrib Additiona Cash Additional Factor Value Infrastru ution l Support Flow Investment cture Margin Costs (240,000) (240,000) (240,000) 1 175,000 (20,000) 155,000 0.909 140,895 196,000 (20,000) 176,000 0.826 145,376 (60,000) 220,500 (20,000) 140,500 0.751 105,516 231,000 (20,000) 211,000 0.683 144,113 295,900 NPV =

c. Presented below is the after-tax net present value analysis if the cash flows listed before are “before tax.” Compare the NPV below to your analysis in (b).

Relevant Items Annual Additional P.V. Present Cost of Additional Contributi Depreciati Date Cash Support Factor Value Infrastruc Investme on Margin on Tax Flow Costs ture nt Savings 2022 2023 2024 2025 2026

(240,000)

(18,000)

122,500 137,200 154,350 161,700

(14,000) (14,000) (14,000) (14,000)

(240,000) 16,800 125,300 22,500 145,700 8,100 130,450 3,900 151,600

(240,000) 1 113,898 0.909 120,348 0.826 97,968 0.751 103,543 0.683 NPV = 195,757

Difficulty: Difficult Time on task: 7 minutes Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: 43

The NPV in part (b) is $100,143 higher than in part (c).

d. Determine the payback period from the template assuming that the cash flows are before taxes. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Homework Solution: 2.79 years Date

Annual Cash Flow

2022 2023 2024 2025 2026

(240,000) 125,300 145,700 130,450 151,600

Balance (240,000) (114,700) 31,000

= 2 years + (114,700/145,700) = 2.79 years

e. What other factors would you consider relevant? Difficulty: Easy Time on task: 4 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Many other factors would be considered relevant in determining whether the company should launch a new product line and enter a new market. ● Is there enough customer demand for the product to support the projected sales? ● How good are the estimates of the future contribution margin? ● Will there be any decrease in quality in other product lines?

8. Cool for School Corporation is a manufacturer of smart boards and plans to purchase new equipment for its manufacturing process. After contacting the appropriate vendors, the purchasing department received differing terms and options from each vendor. The Engineering Department has determined that each vendor’s equipment is substantially identical to the others, and each has a useful life of 10 years. In addition, the estimated required year-end maintenance costs will be $2,000 per year for the first 3 years, $3,000 per year for the next 4 years, and $4,000 per year for the last 3 years. Following is each vendor’s competitive bid: Vendor A: $35,000 cash at time of delivery and 10 year-end payments of $10,000 each. Vendor A offers a maintenance plan, under which it will take care of all required year-end maintenance, for a one-time cost of $5,000. Vendor B: $9,000 semi-annual payments for 10 years, with an initial down payment of $15,000. Vendor B will perform all year-end maintenance for the next 10 years at no extra charge. Vendor C: Full cash price of $130,000. Assume the following: ● Both Vendor A and Vendor B will be able to perform the required year-end maintenance. ● Cool for School’s cost of funds is 10%.

a. From which vendor should the equipment be purchased? Support your answer with a quantitative analysis. Difficulty: Difficult Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Vendor A because it requires the least total expenditure.

Initial Investment PV of future cash flows PV of all expenditures

Vendor A Vendor B Vendor C (40,000) (15,000) (130,000) (61,450) (112,158) (17,225) (101,450) (127,158) (147,225)

Vendor A: The initial investment is $35,000 plus $5,000 maintenance contract. PV FCF is calculated as a PV annuity of $10,000 n = 10, i = 10%. Vendor B: The initial investment is the down payment of $15,000. PV FCF is calculated as the PV annuity of $9,000, n = 20, i = 5% as the payments are made twice a year (number of periods doubled and interest rate halved).

Vendor C: The initial investment is the total cost of $130,000. PV FCF is calculated as the PV of the uneven cash payments for maintenance. It can be calculated using annuity factors or as a single sum for 10 years. b. List some tangible benefits or feasibility factors that Cool for School should include in the analysis. Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Following are some tangible benefits of feasibility factors that Cool for School should consider in its analysis. This list is not comprehensive. ● Could Cool for School handle the year-end maintenance tasks in house? ● Does this new equipment fit with the strategic plans for Cool for School? ● What kind of training will be required to operate the new equipment? ● How responsive are the vendors? Will they be able to respond as quickly as possible to any and all maintenance issues?

9. At the beginning of 2022, Auner Company is considering whether to continue to make a product or to buy the finished product from a supplier. The following data have been gathered: ●

Expected sales (in units) for the next 4 years are as follows: ○ 2022: 40,000 ○ 2023: 46,000 ○ 2024: 54,000 ○ 2025: 47,000

●

If the company continues to make the product, it will have to invest now in some robotic equipment for $700,000. Given the rapid advances in technology, management anticipates only a $35,000 salvage value for the investment in 4 years. Management estimates that the robotic equipment will last 4 years.

●

With the new robotic equipment, the variable product costs (direct materials, direct labor, and variable overhead) are expected to drop from the current $20 per unit to $14.80 per unit. The outside supplier has quoted $21 per unit. The relevant analysis is $21 – $14.80 = $6.20 per unit. The $20 current cost is irrelevant since that will not be the amount in the future.

●

Of the applied annual fixed overhead, only $36,000 per year would be eliminated if Auner Company stops making the product. If the company makes the product, the company will incur extra net cash costs annually as follows: 0.7 × 36,000 = $25,200

●

Annual corporate salaries are $42,000. All executives are expected to remain with the company regardless of whether Auner Company buys the product from the outside supplier.

●

Auner Company’s cost of capital is 10%. Assume that, unless specified, all annual cash flows and tax payments are at year-end.

●

The tax rate is 30%.

●

The robotic equipment can be depreciated using an accelerated method that will result in higher tax cash savings. Tax savings are calculated by multiplying the annual allowed depreciation deductions by the tax rate. Management has calculated the cash tax savings from depreciation as follows: $67,368 in year 1, $90,720 in year 2, $28,476 in year 3, and $12,936 in year 4.

●

Since the robotic equipment will be fully depreciated in 4 years, the entire salvage value will be taxed at 30%; the net cash benefit will be 0.7 × $35,000 = $24,500.

●

The annual estimated product cash savings of making versus buying are: ○ Year 1: 40,000 × $6.20 × 0.7 = $173,600 ○ Year 2: 46,000 × $6.20 × 0.7 = $199,640 ○ Year 3: 54,000 × $6.20 × 0.7 = $234,360 ○ Year 4: 47,000 × $6.20 × 0.7 = $203,980

●

Management has provided the following analyses: Deprecia Extra tion Annual Salvage Cost PV Present Year Cost Overhead Cash Cash Value Savings Factor Value If Make Tax Flows Savings 0 –700,000 — –700,000 1 –700,000 67,368 215,768 0.909 196,133 1 — 173,600 –25,200 90,720 265,160 0.826 219,022 2 — 199,640 –25,200 28,476 237,636 0.751 178,465 3 — 234,360 –25,200 12,936 216,216 0.683 147,676 4 24,500 203,980 –25,200 Net present value $41,295

a. Based on the net present value, should the company make the investment in the robotic equipment? Difficulty: Easy Time on task: 4 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Quiz Solution: Yes. The company should make the investment in the robotic equipment because NPV is positive.

b. What is the payback period? Difficulty: Easy Time on task: 4 minutes Objective: LO3 AACSB: Application of knowledge Assignment: Quiz Solution: The payback period is just under 3 years as shown by the waterfall chart presented in the problem. Specifically, the payback period is 2.89 years as calculated below. Presenting the cash flows in the form of a chart provides a quick and easy way to identify if the payback period occurs within the estimated life of 48

the investment. The waterfall chart also facilitates discussion with individuals who are more visually oriented. Year 0 1 2 3 4

Annual Cash Flows –700,000

215,768 265,160 237,636 216,216

Balance –700,000 –484,232 –219,072

18,564

= 2 years + 18,564 / 216,216 = 2.92 years

c. Is the internal rate of return higher, lower, or the same as the cost of capital for this decision? Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Quiz Solution: Higher. The NPV is a positive value, which indicates that the investment (IRR) has a higher return than the cost of capital (NPV).

d. Discuss three intangible costs and benefits that management should consider. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Quiz Solution: Some intangible costs and benefits that should be considered: ● Impact on customer satisfaction ● Ability to expand product lines ● Risk of vendor having access to information

e. Discuss three feasibility factors that management should consider. Difficulty: Moderate Time on task: 2 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Quiz Solution: Feasibility factors that management should consider include, but are not limited to: ● Do the employees have the skills to operate robotic equipment? ● Does Auner seek to expand into robotics? ● Is this a product that Auner identifies as a core competency and will continue to produce over the next 10 years? ● Could the vendor increase the cost per unit in the future? 10. The following articles provide some insight into the current and emerging trends and considerations in capital investment decisions. Select one of the articles from the list below. ● ●

●

“Tervis selling Sarasota County headquarters”, News-Press, https://www.newspress.com/story/news/local/2020/06/02/tervis-selling-sarasota-county-headquarters/3124243001/ “Tech Data Enters Definitive Agreement to Be Acquired by Funds Managed by Affiliates of Apollo Global Management for $130 Per Share in Cash” by Business Wire https://www.businesswire.com/news/home/20191113005349/en/Tech-Data-Enters-DefinitiveAgreement-Acquired-Funds “Preparing Florida for Blockchain - Is Now the Time?” by The Florida Technology Council, http://fltechcouncil.org/images/up/file/Preparing%20Florida%20for%20Blockchain%20%E2%80%93 %20Is%20Now%20the%20Time%20%20-%20Published%201-31-2019.pdf

a. Write a one-paragraph summary of the selected article. Make sure to cite your sources and paraphrase the article with minimal use of direct quotations. If direct quotes are used, make sure to provide attribution. Difficulty: Moderate Time on task: 12 minutes Objective: LO6 AACSB: Written and oral communication Assignment: None Solution: Recall that capital investments become critical for a company to achieve long-term growth, increase its market share and competitive position, and maintain profitability. Students’ responses will vary based on the article selected but the paragraph should be a summary of the article and not a copy and paste exercise.

b. Identify three observations that were interesting or unknown prior to reading the article. Difficulty: Moderate Time on task: 8 minutes Objective: LO6 AACSB: Reflective thinking Assignment: None Solution: Students’ responses will vary based on the article selected but responses should be their opinion and not a copy and paste from the provided articles.

Chapter 10 End of Chapter with Solutions Discussion Questions 1. Describe the benefits of budgeting to a company. Difficulty: Easy Time on task: 5 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution: Budgets offer the following benefits: ● Planning by applying management’s strategic goals and objectives, summarized in a cohesive document of financial performance targets of profits and resources needed to meet the goals. ● Control of performance by providing standards and a plan of operations against which to compare actual performance. ● Communication and coordination, so that all departments and managers understand the overall direction, goals, and performance targets that will be used to coordinate the day-to-day operations at the lower levels. ● Employee motivation so that employees become an integral part of setting realistic and attainable performance targets and creating operational plans that are achievable and align with the organization’s goals.

2. Explain why objectives need to be quantifiable to provide value to management in the budgeting process. Difficulty: Easy Time on task: 7 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution:

Quantifiable objectives are valuable to management because they are measurable, with deadlines for achievement, and because they include information that can be used to evaluate the company’s performance and progress toward the goals specified in the comprehensive master budget plan.

3. Distinguish between short-term and long-term objectives. Provide two examples of each for a car manufacturer. Difficulty: Moderate Time on task: 7 minutes Objective: LO 1 AACSB: Reflective thinking Assignment: Test Solution: A short-term objective focuses on immediate performance improvements and is measured and evaluated on a timely basis. A long-term objective focuses more on what the company can do now to put the company in a better position in the future—several years from now. For a car manufacturer, short-term objectives could include increasing sales through increased advertising and reducing production costs through better production coordination. Long-term objectives for a manufacturer might include developing a better product mix of sales and product features by conducting surveys to determine customer preferences and having fewer warranty-related costs by providing better engineering.

4. Describe the role and responsibilities of the budget committee and the budget director. Difficulty: Easy Time on task: 5 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution: A budget committee, which is composed of top executives of the various departments within the organization, ensures that the budget is prepared with specific guidelines. These guidelines are communicated to the managers who are preparing their respective budgets. Any conflicts among the departmental budgets regarding their own goals or the organization’s goals are then resolved, 2

and the budget package is completed and promptly submitted to upper-level management for final approval. Once approved, the final budget is communicated to middle- and lower-level managers and serves as a written expectation of performance. The budget director, with a finance or accounting background, is the member of the budget committee who is responsible for developing the many schedules and statements that make up the master budget. The director often provides the various managers with useful historical data to assist in their estimates for the coming period, makes computations based on their estimates, and combines the individual budgets into a complete and integrated master budget package. 5. Most companies do not view “participatory budgeting” as a positive and feasible concept. Do you agree? If you do not agree, explain the benefits offered by participatory budgeting. Be specific. Difficulty: Moderate Time on task: 5 minutes Objective: LO 1 AACSB: Reflective thinking Assignment: Homework Solution: I do not agree. Participatory budgeting, when it includes proper full input from lower-level managers who are familiar with operations and review from higher management, usually leads to budgets that are more accurate and realistic, higher employee motivation, and more acceptance of the results if the budget targets are not achieved.

6. A master budget should be prepared annually by top management and revised monthly or even weekly by middle- and lower-level managers so that the numbers are up to date. Do you agree? If you do not agree, explain why not. Be specific. Difficulty: Moderate Time on task: 5 minutes Objective: LO 1, LO 7 AACSB: Reflective thinking Assignment: Test

Solution: I do not agree. A budget is usually prepared annually, but includes detailed information designed to assist middle- and lower-level managers in different areas of the organization in planning and running the day-to-day operations. Because detailed information is needed, a company will typically prepare monthly budgets, which are then aggregated to produce quarterly budgets and the annual budget. Companies that are heavily automated could even revise budgets on a daily basis; however, the constant updating might produce too much information that surpasses any benefit.

7. Manufacturers often set production budgets as follows: expected costs of producing the estimated units to be sold plus desired ending inventory less beginning inventory of finished units. Extra inventory can be expensive, so why would companies plan to have additional units in ending inventory? Difficulty: Difficult Time on task: 7 minutes Objective: LO 3 AACSB: Reflective thinking Assignment: Homework Solution: Companies normally keep a small amount of inventory on hand at the end of every period to be used as a buffer in case the actual amount sold exceeds the budgeted amount, or in case problems arise in the production process. Having extra units on hand, otherwise known as safety stock, can prevent a possible loss in sales from a demand that is greater than anticipated.

8. If a company has clear measurable short-term objectives, then it can ignore long-term objectives because the future is so unpredictable. Do you agree? If you do not agree, explain why not. Be specific. Difficulty: Moderate Time on task: 7 minutes Objective: LO 1 AACSB: Reflective thinking Assignment: Homework Solution: 4

I do not agree. Companies need both short-term objectives and long-term objectives. Long-term planning is vital for the overall viability of the organization. Actions can and should be taken today to ensure the company achieves its longterm objectives, such as proper profits, employee participation, customer satisfaction, and adequate cash flows. With proper assumptions and modeling tools, companies can apply scenario analysis to forecast possible amounts of both sales with selling prices and units of sales and both variable and fixed costs of production, selling, and administrative expenses in the future.

9. The sales budget is the cornerstone of the master budget. What are some of the factors that a software developer considers in a sales budget for the year? Difficulty: Difficult Time on task: 7 minutes Objective: LO 3 AACSB: Application of knowledge Assignment: Homework Solution: Factors that a software developer would use in a sales budget include preferences from surveys, competition, quality of sales personnel, production capacity, planned production improvements, technology trends and developments, regulations, research results, training, and mix of products.

10. If a college dean overestimates enrollment so as to have more resources allocated to that particular college, are his or her actions unethical? Discuss. Difficulty: Moderate Time on task: 5 minutes Objective: LO 7 AACSB: Ethical understanding and reasoning Assignment: Quiz Solution: The IMA’s Statement of Ethical Professional Practice Standards listed in Chapter 1 include competence, credibility, confidentiality, and integrity. A college dean would have sufficient background to know that submitting incorrect information is wrong. As such, they would violate the competence standard. Moreover, if the

numbers submitted are intentionally incorrect so that the dean would have more resources, the dean would violate the credibility and integrity standards.

11. Manufacturers often budget to have extra direct materials in an effort to protect against unexpected delays in production from equipment downtime, defective materials or delays in materials arriving, labor errors, supplier strikes, or even difficulty of predicting sales. Do you agree with such a policy? If you do not agree, explain why not. Be specific. Difficulty: Moderate Time on task: 5 minutes Objective: LO 3 AACSB: Reflective thinking Assignment: Homework Solution: I agree. As with the production budget, keeping a small inventory of direct materials on hand can prevent lost production time or lost sales that can result from unexpected delays in production, equipment downtime, or higher-thanexpected demand. Managers need to estimate what the cost is and balance the need for adequate production and sales with the extra costs of carrying the direct materials.

12. If the direct labor budget is combined with the manufacturing overhead budget, the result is the same as the cost of goods sold budget. Do you agree? If you do not agree, explain why not. Be specific. Difficulty: Easy Time on task: 3 minutes Objective: LO 3 AACSB: Application of knowledge Assignment: Homework Solution: I do not agree. The cost of goods sold budget includes the direct materials, direct labor, and manufacturing overhead expected costs for the budgeted units to be sold.

13. Contrast a rolling forecast with the master budget. Discuss the potential advantages of a rolling forecast. Difficulty: Moderate Time on task: 7 minutes Objective: LO 6 AACSB: Application of knowledge Assignment: Homework Solution: A rolling forecast involves constantly updating the data for the number of periods covered, such as 12 months. As a month passes and the actual results are known, the forecast is updated to include the 12-month period, beginning with the new month. This differs from a traditional master budget, which is usually prepared on an annual basis and is not updated throughout the year (it is static). With a rolling forecast, management can continually reevaluate its goals, objectives, and performance targets; react to trends; and make timely, wellinformed decisions.

14. Why is there a need for a combined cash budget if the company has already prepared the income statement? Difficulty: Moderate Time on task: 5 minutes Objective: LO 4 AACSB: Reflective thinking Assignment: Homework Solution: The income statement reports performance for a period of time: all sales made (whether cash or credit) and all costs incurred on an accrual basis. Management needs to plan for the amount and timing of all cash sources and needs to have an adequate cash balance, including any desired minimum balance on hand: for cash inflows and outflows from operations, investing activities, and financing activities.

15. What are some of the major differences between a cash receipts and disbursements budget and a budget income statement?

Cash Receipts and Disbursements

Income Statement

Cash Receipts and Disbursements

Income Statement

Sales

Cash sales, collections from credit sales (including from previous credit sales)

All sales just for this period

Cost of Goods Sold

Payments for direct materials, direct labor, and cash manufacturing overhead expenses

Cost of materials, direct labor, and manufacturing overhead for this period’s unit sales

Selling and Administrative

Excludes depreciation; just cash expenses

All costs incurred this period for selling and administrative expenses

Sales Cost of Goods Sold Selling and Administrative Investing Financing

Difficulty: Difficult Time on task: 7 minutes Objective: LO 4 AACSB: Reflective thinking Assignment: Homework Solution:

Investing

Cash receipts from sales and cash payments for purchase of long-term assets

Depreciation; gains and losses from the sale of longterm assets

Financing

Cash receipts from borrowing and cash payments from repayment of debt

Interest cost for this period on outstanding debt

16. Why do companies compile a budget balance sheet? Difficulty: Easy Time on task: 3 minutes Objective: LO 4 AACSB: Application of knowledge Assignment: Homework Solution: A balance sheet reflects the expected ending balance for each account that is an asset, an obligation, or equity. It is important to understand the relationships between these accounts, such as expected current assets for liquidity.

17. Flexible budgets are synonymous with rolling budgets. Do you agree? Discuss if you disagree. Difficulty: Easy Time on task: 5 minutes Objective: LO 6 AACSB: Application of knowledge Assignment: Quiz Solution: I do not agree. A flexible budget is a budget that changes as a result of a change in activity level. A flexible budget calculates what costs and income “should be” in relation to changes in sales volume, and can also be very helpful to management when trying to anticipate how a change in sales will affect profitability and cash flows. A rolling forecast constantly updates the data for the number of periods covered, such as 12 months. As a month passes and the actual results are

known, the forecast is updated to include the 12-month period, beginning with the new month.

18. What is the difference in the master budget for a manufacturer versus the master budget for a merchandiser? Difficulty: Easy Time on task: 5 minutes Objective: LO 6 AACSB: Application of knowledge Assignment: Homework Solution: Although a merchandising company also prepares a master budget, their budgeting process is less complex because the master budget has fewer components than a master budget for a manufacturer. A merchandising company generates revenues by reselling products that were purchased from someone else; it will not have to budget for any manufacturing costs. Therefore, the company’s operating budgets are simplified because the production budget, the direct materials budget, the direct labor budget, and the manufacturing overhead budget are not necessary. A merchandising company will instead have to complete a purchases budget.

19. Discuss whether operational or nonfinancial data should be considered in the budgeting process. Difficulty: Hard Time on task: 7 minutes Objective: LO 7 AACSB: Analytical thinking Assignment: Homework Solution: Operational and nonfinancial data should be considered in addition to financial data throughout the budgeting process. The operational and nonfinancial data should come from sources inside and outside the organization to provide a

comprehensive view of the factors affecting the organization over the budget period.

Exercises 1. Fancy Runners manufactures and sells table runners for an average price of $18.00. Other facts are as follows: ● Materials cost $12 per runner. ● The company projects 16,000 runners to be sold in August, 40,000 in September, and 30,000 in October. ● The company wishes to have inventory of runners equal to 15% of next month's sales in units. ● Conversion costs (direct labor and overhead) are budgeted at $30,000 for September. What are the budgeted total production costs for September?

Difficulty: Moderate Time on task: 7 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Test Solution: Analyze September inventory to determine production’s needs for direct materials:

September Inventory

Beginning: 0.15 (40,000) = 6,000 units X = Production = 38,500 units

Sell 40,000 units

Ending: 0.15 (30,000) = 4,500 units Sept Current month (September) sales in units

40,000

+ Desired ending inventory: 0.15 × next month, October (30,000 units)

4,500

Need

44,500

– Beginning inventory = last month, August end inventory: 0.15 (40,000)

6,000

Units needed to produce

38,500

Budgeted September Production Costs Direct materials: 38,500 × $12 Conversion costs Total September budgeted production costs

$462,000 30,000 $492,000

2. Match the following terms with the descriptions provided below by placing the letter of the term in front of the description: a. Manufacturing overhead budget b. Budgetary slack c. Budget committee d. Top-down budgeting approach e. Master budget f. Sales budget g. Objectives h. Participatory budgeting i. Strategic plan j. Combined cash budget k. Direct materials budget l. Rolling forecast m. Flexible budget Letter

Description Budget that changes as a result of changes in activity Schedule of materials needed in production Document that predicts sales revenue for the upcoming period Process of developing a plan in which all levels of management assume an active role Document that establishes the company’s direction, performance, strategic targets, financial targets, and how the company plans to execute its strategy in the current economic and competitive environment

Results that management wants to achieve Tool used to coordinate and communicate management’s plan and to guide the company to achieve the expected financial results Approach to budgeting in which upper-level management develops financial projections and communicates those expectations to middleand lower-level managers Cross-functional group of executives from various departments that participates in preparing the master budget and its components Amount that managers understate for estimated revenues or overstate for estimated expenses Schedule of all indirect costs of production (both variable and fixed costs) Depicts anticipated cash receipts and disbursements as well as the beginning cash balance to reflect anticipated ending cash balance Planning tool whereby although the number of periods is the same, the months and data are updated continuously Difficulty: Easy Time on task: 5 minutes Objective: LO vary by item as shown below a. Manufacturing overhead budget LO 3 b. Budgetary slack LO 7 c. Budget committee LO 1 d. Top-down budgeting approach LO 1 e. Master budget LO 1 f. Sales budget LO 3 g. Objectives LO 1 h. Participatory budgeting LO 1 i. Strategic plan LO 1 j. Combined cash budget LO 4 k. Direct materials budget LO 3 l. Rolling forecast LO 6 m. Flexible budget LO 6 AACSB: Application of knowledge Assignment: Quiz Solution:

Letter

Description

Budget that changes as a result of changes in activity

Schedule of materials needed in production

Document that predicts sales revenue for the upcoming period

Process of developing a plan in which all levels of management assume an active role

Document that establishes the company’s direction, performance, strategic targets, financial targets, and how the company plans to execute its strategy in the current economic and competitive environment

Results that management wants to achieve

Tool used to coordinate and communicate management’s plan and to guide the company to achieve the expected financial results

Approach to budgeting in which upper-level management develops financial projections and communicates those expectations to middleand lower-level managers

Cross-functional group of executives from various departments that participates in preparing the master budget and its components

Amount that managers understate for estimated revenues or overstate for estimated expenses

Schedule of all indirect costs of production (both variable and fixed costs)

Depicts anticipated cash receipts and disbursements as well as the beginning cash balance to reflect anticipated ending cash balance

Planning tool whereby although the number of periods is the same, the months and data are updated continuously

3. The accounts receivable balance on June 30 is $12,000. Total sales for July are estimated to be $90,000. Sales are typically 10% cash and 90% credit sales. Of the credit sales, 40% is collected in the month of sale and the other 60% in the subsequent month. a. What are the total cash collections budgeted for July? Difficulty: Moderate Time on task: 5 minutes

Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution: Budgeted July Cash Collections Cash sales, July: $90,000 × 10% = $9,000

$9,000

Credit sales, July: $90,000 × 90% = $81,000 Collections from same-month credit sales, July: $81,000 × 40%

$32,400

Collections from prior-month credit sales, June, in accounts receivable

$12,000

Total budgeted July operating cash inflows – cash collections

$53,400

b. What amount would be reported as accounts receivable at the end of July? Difficulty: Moderate Time on task: 3 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution: Accounts receivable balance, July 31: $81,000 July credit sales × 60% not collected = $48,600 c. The company is contemplating offering a 3% discount for credit sales collected in the same month as a sale is made. Management anticipates that the collection of credit sales would change as follows: 70% in the same month and 30% in the next month. Calculate total cash collections for July with the proposed change. Difficulty: Difficult Time on task: 7 minutes Objective: LO 3 AACSB: Analytical thinking

Assignment: Homework Solution: Cash sales, July: $90,000 × 10%

$9,000

Credit sales, July: $90,000 × 90% = $81,000 Collections from same-month credit sales, July: $81,000 × 70% × 97%*

$54,999

Collections from prior-month credit sales, June, in accounts receivable

$12,000

Total budgeted July operating cash inflows – cash collections

$75,999

* Since the company gave a 3% discount of the 100% collections in the same month, keep only 97%. 4. Identify each of the following statements as either T (True) or F (False). a. Objectives can be either measurable with a deadline for achievement or long-term subjective ideals that other companies in the industry currently have. b. The strategic plan serves as the foundation for the company’s actions and financial results. c. For maximum accuracy, budgets should be based on the previous period’s actual amounts plus a certain across-the-board percentage increase to compensate for risk and uncertainty. d. The production budget, also known as the budgeted schedule of cost of goods sold, gives the purchase payments for a given period. e. When companies use participatory budgeting, they automatically eliminate budgetary slack. f.

Disadvantages of a top-down budgeting approach are that upper-level management may lack detailed pertinent knowledge of facts that affect specific departments and set unrealistic expectations that can create morale problems.

g. The master budget consists of both operating and financial budgets. h. Companies may use a combination of both top-down and participatory budgeting to achieve better results. i.

The following are all advantages of budgeting: better planning and ability to make decisions on alternative courses of action; provide standards against which to compare

performance; communication and coordination tools within departments; empowerment of employees to achieve realistic results. j.

A minimum balance of finished goods inventory is kept so that no sales are lost if actual demand is greater than expected sales.

k. Ideally, budgets should be prepared completely by the company president and given to middle- and lower-level managers. l.

Both the past and budgeted balance sheets contain historical data.

m. The master budget is concerned with the planning of operations rather than the controlling of operations. n. Depreciation and cost of goods sold are items that appear on the income statement because they are expenses, but do not show up on the statement of cash receipts and disbursements. o. The payment made for purchases of materials, rather than the direct materials used in production, is the amount found on the budgeted statement of cash receipts and disbursements. p. If a one-year insurance policy is purchased and paid for on April 1, and a quarterly statement of cash receipts and disbursements is prepared from April 1 to June 30, the full one-year amount will appear as a negative item. q. If a company has high budgeted sales and low budgeted cost of goods sold, a high positive ending cash balance can be assured. r.

If a cash deficiency is expected during a month, a loan should be arranged at the beginning of the month to ensure adequate funds during the month.

s. If $80,000 in salaries is to be paid and $20,000 is accrued, the cash flow operating budget will include $80,000, but the budgeted income statement will list $100,000 as an expense. t.

The purchasing manager should revise budgeted direct materials and direct labor prices weekly so that actual comparisons made later yield no differences.

u. In preparing the sales forecast, factors considered could include improvements that will reduce non–value-added activities relative to materials, labor, overhead, and selling and administrative costs, as well as quality, time, expected economic conditions, competitor reactions, and customer satisfaction. v. If there were no supplies to begin the year, $11,000 of supplies purchases is projected, and $2,000 is estimated to be on hand at the end of the month, the budgeted income statement should include $9,000 for operating expenses.

Difficulty: Moderate Time on task: 10 minutes Objective: LO 1: a, b, c, f, h, i, k, m LO 2: g LO 3: d, j, u, v LO 4: l, n, o, p, q, r, s LO 6: t LO 7: e AACSB: Application of knowledge Assignment: All except e: Homework e only: Test Solution: a. F b. T c. F d. F e. F f. T g. T h. T

i. T j. T k. F l. T m. T n. T o. T p. T

q. r. s. t. u. v.

F T T F T T

5. For each of the following items, select for the current period only one financial document that best describes where the item would appear: a. b. c.

Budgeted statement of cash receipts and cash disbursements Income statement Balance sheet Document

Item Amount not collected from credit sales Total sales Amount collected from credit sales and cash sales Cost of goods sold Amount of safety stock ending inventories of raw materials and of finished goods Amount paid to suppliers from last month’s credit purchase of materials

Amount that remains unpaid from credit purchases of finished goods this period Amount of supplies purchased but not used Amount of insurance used in this period, but acquired in the last period Amount of salaries for work done in this period, even though some remains unpaid Amount of salaries that were paid for work done in the last period but not paid in that period Depreciation expense Equipment purchased through long-term financing Amount of debt taken out in the last period that has not been repaid

Difficulty: Easy Time on task: 7 minutes Objective: LO 4 for all a and c items, LO 3 for all b items AACSB: Application of knowledge Assignment: Homework Solution: Document

Item

Amount not collected from credit sales

Total sales

Amount collected from credit sales and cash sales

Cost of goods sold

Amount of safety stock ending inventories of raw materials and of finished goods

Amount paid to suppliers from last month’s credit purchase of materials

Amount that remains unpaid from credit purchases of finished goods this period

Amount of supplies purchased but not used

Amount of insurance used in this period, but acquired in the last period

Amount of salaries for work done in this period, even though some remains unpaid

Amount of salaries that were paid for work done in the last period but not paid in that period

Depreciation expense

Equipment purchased through long-term financing

Amount of debt taken out in the last period that has not been repaid

6. Pine Company manufactures end tables that sell for $125 per table. Budgeted unit sales for the next six months are as follows: July

10,000

August

18,000

September

25,000

October

20,000

November

16,000

December

30,000

a. Prepare a sales budget for the third quarter of the calendar year covering July, August, and September. b. Prepare a sales budget for July, August, and September if the sales price is instead $200 per table.

Difficulty: Easy Time on task: 5 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution:

Data

July

August

September

Total Sales

Budgeted units to be sold

10,000

18,000

25,000

53,000

a) Sales at $125

$1,250,000

$2,250,000

$3,125,000

$6,625,000

b) Sales at $200

$2,000,000

$3,600,000

$5,000,000

$10,600,000

7. The following sales budget information is known for East Company, which sells wall hangings for $20 per unit: July

$20,000

August

$28,000

September

$40,000

October

$50,000

November

$30,000

December

$60,000

Also known: ● 30% of the sales are cash sales. ● Credit sales are collected as follows: 60% in the same month and the rest in the following month.

a. Prepare a schedule of cash collections for September, October, and November. Difficulty: Moderate Time on task: 5 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: Data

August

September

October

November

Budgeted units to be sold

1,400

2,000

2,500

1,500

𝘅 $12 per unit

$20

Total sales

$28,000

$40,000

$50,000

$30,000

Cash sales: 30%

$8,400

$12,000

$15,000

$9,000

Credit sales: 70%

$19,600

$28,000

$35,000

$21,000

Collection, same-month credit sales: 60%

$16,800

$21,000

$12,600

Collection, last-month credit sales: 40%

$7,840

$11,200

$14,000

$36,640

$47,200

$35,600

Total cash collections: Cash sales + Collections from credit sales

b. Prepare a schedule of cash collections for September, October, and November assuming the following: 20% cash and 80% credit sales; collection of credit sales: 75% in the same month and 20% in the following month. Assume that 5% of sales are simply never collected. Difficulty: Difficult Time on task: 7 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: Cash sales: 20%

$5,600

$8,000

$10,000

$6,000

Credit sales: 80%

$22,400

$32,000

$40,000

$24,000

Collection, same-month credit sales: 75%

$24,000

$30,000

$18,000

Collection, last-month credit sales: 20%

$4,480

$6,400

$8,000

Total cash collections: cash sales + collections from credit sales

$36,480

$46,400

$32,000

c. Compare your answers in parts (a) and (b). Prompt collections and cash sales maximize cash flows. Managers can compare collections to terms of their credit sales and industry metrics and pay structures for salespeople. What are some actions that managers can take to “speed up” collections? Be specific. Difficulty: Difficult Time on task: 5 minutes

Objective: LO 6 AACSB: Reflective thinking Assignment: Homework Solution: To speed up collections, company management can offer discounts and give incentives to salespeople. Companies can also hold salespeople accountable for uncollected amounts if they continue to sell to poorpaying customers. 8. Identify which items you would include in a budgeted cash flow statement and budgeted income statement for yourself for the next month. Be sure to consider cash receipts from your salary, contributions from your parents or scholarships, planned payments for books, gasoline, rent, credit card and car loan payments, clothes, food, phone and computer monthly plans, discretionary leisure items such as planned entertainment, taxes, savings, and so on. a. Classify the costs, as much as possible, as variable, fixed (committed or discretionary), or mixed. Difficulty: Moderate Time on task: 7 minutes Objective: LO 4 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers will vary. Variable costs could include meals (unless on a meal plan, which would then be fixed), variable charges for cell plans, some entertainment, and gasoline. Fixed costs could include rent, tuition, books for the semester, insurance for a car, a clothing discretionary allowance, and phone monthly fees.

b. What differences do you see between your income statement and your cash flow statement? Difficulty: Moderate Time on task: 5 minutes Objective: LO 4 23

AACSB: Reflective thinking Assignment: Homework Solution: The income statement would report revenues as earned and costs as incurred. For example, if the student has worked at the end of the period, but will not get paid until the next period, the amount will be included on the income statement but not on the cash flow statement. Scholarships should be included each month. Similarly, many costs will be amortized: Each month, the student should recognize a portion of the costs such as semester tuition, depreciation on cars, furniture, or a computer, but include those costs on the cash flow statement only in the month that payment is actually made.

c. Try to list amounts for each cash inflow or outflow, even if the amounts are just estimates. State the assumptions underlying the estimates. Difficulty: Moderate Time on task: 5 minutes Objective: LO 4 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers will vary for the previously listed items or other items.

d. What accounts and amounts would you have in a budgeted balance sheet as of the beginning of the budgeted month? Difficulty: Moderate Time on task: 5 minutes Objective: LO 4 AACSB: Application of knowledge Assignment: Homework Solution:

Students’ answers will vary. Assets should include cash, clothes, furniture, car, prepaid tuition plan, books, phone, and furniture. Liabilities could include outstanding amounts on credit cards, student tuition loans, and car loans. Equity would be the difference between the assets and the liabilities.

e. What benefits could you derive from preparing a budgeted income statement, budgeted statement of cash receipts and disbursements, and budgeted balance sheet? Difficulty: Easy Time on task: 3 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution: The discipline of actually planning expenditures to match cash receipts is a great benefit. Moreover, the budgeted numbers could serve as a benchmark against which to compare actual results.

9. Select a small business or service line that you would like to own and operate. Research what the annual operating, investing, and finance inflows and outflows would be if you operated such a business in your area. Some possible references include the following: www.sba.gov: Information on estimating startup costs as well as writing a business plan. www.business.gov: Information on 10 steps for starting a business. www.sbinformation.about.com: Description of the top 10 small business expenses, along with tips on how to manage them. www.startupnation.com: Example of costs associated with starting a service-oriented business. www.homebusiness.about.com: Information related to running a business based out of the home.

a. Describe the business and what the top 10 costs would be. Difficulty: Difficult

Time on task: 15 minutes Objective: LO 4 AACSB: Application of knowledge Assignment: Homework Solution: Students’ answers will vary depending on the industry and link chosen.

b. Describe the relevant information that you gathered as if you were writing a one-page business plan to get financing from a lender. Give the business’s goals, identified opportunities, and challenges. Difficulty: Difficult Time on task: 45 minutes Objective: LO 1 AACSB: Written and oral communication Assignment: Homework Solution: Students’ answers will vary depending on the industry and link chosen.

10. The following information is known for Eskew Company: ●

A four-month insurance policy will be purchased on October 1 for $800.

●

Salaries of $5,000 will be paid on October 1 for the period from October 1 to December 22 and accrued for $1,000 on December 31.

●

Dividends in the amount of $2,250 are expected to be declared on December 10 but not paid.

●

Total sales during the fourth quarter are projected to be $17,000, of which $11,000 is expected to be collected.

a. What amount would appear on the cash disbursements budget for operating activities for the quarter ended December 31? Difficulty: Easy

Time on task: 3 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Quiz Solution: Four-month insurance of $800 and salaries of $5,000, totaling $5,800.

b. What amount would appear on the cash disbursements budget for financing and investing activities for the quarter ended December 31? Difficulty: Easy Time on task: 3 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Quiz Solution: None, because the dividends will not be paid.

c. What amount would appear on the cash receipts budget for the quarter ended December 31? Difficulty: Easy Time on task: 3 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Quiz Solution: $11,000 from collection of sales d. What net amount would appear on the budgeted quarterly income statement on December 31? Difficulty: Moderate

Time on task: 3 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Quiz Solution: Revenues: Sales Expenses: Insurance $600 + Salaries $6,000 Operating Income

$17,000 –

$6,600 $10,400

11. Review the Statement of Ethical Professional Practice Standards promulgated by the Institute of Management Accounting (IMA): competence, confidentiality, credibility, and integrity. Now consider these five independent budgeting situations: i.

The technology team intentionally padded the budget so that they would get a bonus for spending less than budgeted.

ii.

To meet the gross margin target, some fixed manufacturing overhead was listed as administrative operating costs. Total costs on the budgeted income statement are correct.

iii.

To avoid alarming the controller, the budgeting director used a much lower interest rate cost than was quoted by the bank. The finance director believes that interest rates will drop; otherwise, a new, very promising product may not get approval.

iv.

The sales team is paid an extra commission for the percentage increase in sales from previous periods. The marketing director underestimated the sales for this period and suggested to the sales team that they encourage customers to defer some purchases until next period so that the salespeople would get a higher commission.

Since her bonus is based on income, the accounting manager suggested to the chief operating officer to defer scheduled maintenance on equipment.

a. Identify for each situation if one of the IMA Standards was violated. Discuss the standard and be specific. b. Give your recommendation.

Difficulty: Difficult

Time on task: 10 minutes Objective: LO 3 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: a. For i, ii, iii, and iv, the credibility, competence, and integrity standards are violated because the employees have sufficient training and background to know the numbers are incorrect and the motivation is self-gain. For v, maintenance may be considered a discretionary item, so the numbers may not be incorrect, if the company needs the cash. However, the following standards would still be violated: integrity, because the motivation is self-gain and the risks of deferring maintenance were not presented; and competence, because the accounting manager knew that she should fully disclose the merits of deferring the maintenance costs. b. Better training is needed—perhaps using such scenarios to explain to employees the policies and the nature of unethical and unprofessional behavior. Clearer written policies for unethical behavior should be developed as part of a code of ethics that employees agree to follow.

12. You have been given the following annual 2023 cash flow projections for Expert House Cleaners: Cleaning supplies

$48,000

Salaries of cleaning staff (paid per hour)

$200,000

Administrative costs (salary of manager, office rent, insurance, license)

$96,000

Utilities, car

$18,000

Advertising, other

$2,400

Other information: ● The company charges an average fee of $2,000 per customer (house) monthly. ● The company currently has 240 customers.

a. Which costs appear to be variable, fixed, or perhaps mixed? Difficulty: Easy 29

Time on task: 7 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution: Variable: cleaning supplies, salaries that are paid per hour Fixed: administrative costs of salary of manager, office rent, insurance, license Mixed: utilities for car

b. Which costs are more subject to changes in the economy or other factors outside the company versus under the control of management inside the company? Difficulty: Difficult Time on task: 5 minutes Objective: LO 1 AACSB: Reflective thinking Assignment: Homework Solution: All of the fixed costs to some extent correlate with the economy regarding the fees that are charged; the company may have some discretion in deciding how much it wants to spend. Advertising may be more discretionary and under the control of management, compared to the external costs charged for rent, insurance, and the license.

c. What other information would you like to know how to properly prepare a budget? Difficulty: Easy Time on task: 3 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution:

Past results, future expectations of customer preferences, quality of the product, possible product improvements, and planned initiatives such as technology upgrades equipment replacement.

d. For this part, assume that all costs other than supplies and salaries of cleaning staff are fixed. What is the total cost function? Round to the nearest dollar, if necessary. Difficulty: Difficult Time on task: 5 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution: Variable costs =

$248,000 240

Total costs =

Fixed cost $116,000 + variable costs $1,033 × number of customers

= $1,033 per customer

e. How many more customers would the company have to budget to acquire if it wants to generate a $28,000 operating income? Difficulty: Difficult Time on task: 5 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Test Solution: Fixed costs + Income Contribution margin

= Number of customers

→

Fixed costs $116,400 + Income $28,000 Contribution margin $2,000 – $1,033

= 150 customers

13. Mindy Copper saw a budget for the home delivery business in which all costs were calculated as a percentage of revenues. She has asked you for clarification. Specifically, she would like your opinion on whether the costs should be budgeted as variable versus fixed costs. Difficulty: Moderate Time on task: 5 minutes Objective: LO 2 AACSB: Reflective thinking Assignment: Quiz Solution: Costs can be budgeted by their accounts (such as cost of goods sold, salaries, rent, insurance, depreciation, and utilities) that will appear on the income statement. For internal planning purposes, they may also be budgeted by their cost behavior (fixed [will not change with changes in volume] versus variable [will change with expected changes in volume]). Budgeting by cost behavior is useful to analyze how income will change if there is a change in output sales.

14. Several components of the master budget are listed as follows: ● Direct materials budget ● Cost of goods sold budget ● Production budget ● Budgeted balance sheet ● Manufacturing overhead budget ● Sales budget ● Budgeted income statement ● Cash receipts and disbursements (combined cash budget) a. Briefly describe what each particular budget includes. Difficulty: Easy Time on task: 10 minutes Objective: LO 3 = Direct materials budget, cost of goods sold budget, production budget, manufacturing overhead budget, sales budget, and budgeted income statement LO 4 = Budgeted balance sheet, cash receipts and disbursements (combined cash budget) AACSB: Application of knowledge

Assignment: Test Solution: Direct materials budget: estimated cost of materials needed for production plus desired ending balance of direct materials less beginning balance of direct materials Cost of goods sold budget: estimated costs of direct materials, direct labor, and manufacturing overhead for budgeted units to be produced and sold Production budget: estimated units to be produced in a given period to meet expected sales and to include a minimum amount of ending inventory Budgeted balance sheet: the ending balance of assets, liabilities, and equity accounts as of a certain date Manufacturing overhead budget: expected costs of fixed and variable indirect manufacturing costs (e.g., insurance, utilities, depreciation, indirect labor, rent) Sales budget: estimated sales for a given period Budgeted income statement: expected revenues and expected costs for a given period Cash receipts and disbursements: anticipated beginning balance of cash plus expected cash receipts from operations, investing, and financing activities, less expected cash payments for suppliers, operating expenses, investing, and financing activities

b. Give the proper order in which these budgets are prepared. Difficulty: Easy Time on task: 3 minutes Objective: LO 2 AACSB: Application of knowledge Assignment: Test Solution: Sales budget, production budget, direct materials budget, manufacturing overhead budget, cost of goods sold budget, budgeted income statement, cash receipts and disbursements budget, budgeted balance sheet

15. The following information is known about Marilyn Company: ● ● ● ● ● ●

The company anticipates sales of 20,000 units in July. The company plans to have 3,000 units at the end of July as desired ending inventory. 1,400 units are on hand at the beginning of July. Each unit requires 2 direct labor hours at $8 per hour. Each unit requires 3 feet of direct materials at $3 per foot. The company does not keep a surplus of materials on hand. Manufacturing overhead costs are applied at $12 per unit produced.

a. How many units must be produced in July? Difficulty: Easy Time on task: 3 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution:

Finished Goods Inventory—July BB 1,400 Produce x = 21,600

Sell 20,000

EB 3,000

July Expected units to be sold

20,000

Ending inventory

+ 3,000

Needed

23,000

Beginning inventory units

– 1,400

Units to produce

21,600

b. What are the budgeted prime costs (direct materials and direct labor) for July? Difficulty: Easy

Time on task: 5 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution: Direct materials

21,600 units × 3 feet × $3 per foot =

$194,400

Direct labor

21,600 units × 2 hours × $8 per hour =

$345,600

Budgeted prime costs

direct materials + direct labor =

$540,000

c. What are the total budgeted manufacturing costs for July? Difficulty: Easy Time on task: 5 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution: Direct materials

21,600 units × 3 feet × $3 per foot =

$194,400

Direct labor

21,600 units × 2 hours × $$8 per hour =

$345,600

Manufacturing overhead

21,600 units × $12 per unit =

$259,200

Total budgeted manufacturing costs

$799,200

16. Find an article that discusses the budgeting process. Write a one-page summary of the article that includes discussion of the relevant internal and external factors and risks. Make sure to cite your sources. Difficulty: Moderate Time on task: 20 minutes Objective: LO2 AACSB: Written and oral communication

Assignment: Homework Solution: Students’ responses will vary based on the article selected but the paragraph should be a summary of the article and not a copy and paste exercise. If students struggle to identify an article, suggest looking for articles related to government and non-profits.

Problems 1. The following information is known about Premiere Suits, which sells tailored, hand-detailed suits and provides alteration and tailoring services: ● ● ● ● ● ● ●

● ● ● ● ●

●

The cash balance on November 1, 2022, is $40,000. The company's policy is to have on hand 10% of the suits estimated to be sold in the next month. The company wishes to keep 20% of next month's direct materials needs for production of suits. It takes 4 yards of direct materials for each premier finished suit; each yard costs $10. All purchases of materials are paid in cash. The budgeted direct salaries cost for the suits in November is $300,000, of which $39,600 is projected to apply to the alterations service revenue line. Budgeted total costs other than direct materials and alterations for November are $482,000. The factory overhead component is $310,000 (which includes $30,000 of depreciation) and the selling and administrative period expenses (of which $15,000 is for depreciation) are $172,000. All costs except for depreciation are paid as incurred. November taxes are anticipated to be $89,500 and interest will be $15,300. Both will be paid in November. The average suit sells for $275. Sales were 5,000 suits in October and are expected to be 6,000 in November, 8,000 in December, and 7,000 in January, 2023. Cash sales are expected to be 10%, and the rest of sales will be on credit. Of the credit sales, 80% are expected to be collected in the month of sale and the rest in the month following the sale. Alteration services revenue is projected to be $58,000 in November (all cash collected).

a. What are the budgeted production costs for November? b. What is the budgeted inventory of direct materials on November 30? c. What is the budgeted gross margin for November?

d. What is the budgeted net income for November? What is the benefit of analyzing items of income? e. What are the expected operating cash receipts from the suits for November? f.

What is the expected cash balance on November 30?

Difficulty: Difficult Time on task: 30 minutes Objective: LO 3 (a, b, c, d) and LO 4 (e, f) AACSB: Analytical thinking Assignment: Homework Solution:

Finished Goods Inventory—October BB 0.1 (5,000) = 500 Produce x = 5,100

Sell 5,000 suits

EB 0.1 (6,000) = 600

Finished Goods Inventory—November BEB October = BB November 600 P Produce 6,200

Sell 6,000 suits

EB 0.1 (8,000) = 800

October

November December

Expected units to be sold

5,000

6,000

8,000

Ending inventory: 10% next month’s sales units

+ 600

+ 800

+700

Needed

5,600

6,800

8,700

Beginning inventory units

– 500

– 600

– 800

Units to produce

5,100

6,200

7,900

Solution to Problem 1.a.:

Production Cost Schedule

November

Units produced

6,200 units

Direct materials to be issued to production: 6,200 suits × 4 yards × $10 per yard

$248,000

Direct labor: $300,000 – $39,600

$260,400

Manufacturing overhead

$310,000

Total

$818,400

Production cost per suit: $818,400 ÷ 6,200 suits = $132

Solution to 1.b.: October Direct Materials Inventory

November Direct Materials Inventory

BB 0.2 (24,800) =4,080 Buy x = 21,280 yards

EB October = BB November 4,960 5,100 × 4 = 20,400 yards

Buy x = 26,160 yards

EB 0.2 (24,800) = 4,960

6,200 × 4 = 24,800 yards

EB 0.2 (7,900 × 4) = 6,320

Purchases of materials at $10 per yard: October Production

November

$204,000

$248,000

+ Ending inventory

49,600

63,200

Materials needed

$253,600

$311,200

– Beginning inventory

– 40,800

– 49,600

Purchase

$212,800

$261,600

Solution to 1.c.: Sales: 6,000 at $275

$1,650,000

Cost of goods sold: 6,000 at $132

– $792,000

Gross margin

$858,000

Solution to 1.d.: Sales: 6,000 at $275

$1,650,000

Cost of goods sold: 6,000 at $132

– 792,000

Gross margin

$858,000

Selling and administrative expenses: Salaries

$39,600

Other selling and administrative expenses

172,000

– 211,600

Operating income

$646,400

Other revenue – alterations services

+ 58,000

Income before interest and taxes

$704,400

Interest and taxes: $89,500 + $15,300

– 104,800

Net income

$599,600

It is useful to track and compare budgeted amounts against actual amounts, to establish trends for the period, and to compare the various sources of income against the effort and to compare operating and nonoperating costs.

Solution to 1.e.: October Total sales: suits at $275

5,000 × $275 = $1,375,000

Cash sales: 0.1 (sales) Credit sales: 0.9 (sales)

November 6,000 × $275 = $1,650,000 0.1 (1,650,000) = $165,000

0.9 (1,375,000) = $1,237,500

0.9 (1,650,000) = $1,485,000

Collections of credit sales: From same month, November: 80% From last month, October: 20% Budgeted cash operating inflows

0.8 (1,485,000) = $1,188,000 0.2 (1,237,500) = $247,500 $1,600,500

Solution to 1.f.: November Cash Financial Master Budget

Beginning balance

$40,000

Operating cash inflows (from e above):

Operating cash outflows:

Cash sales

Payment for November purchases $261,600

$165,000

Collection of November credit sales 1,188,000

Payment for salaries

300,000

Collection of October credit sales Alteration revenues

247,500 58,000

Cash other expenses

** 541,800

Total cash inflows from operations $1,658,500

Total cash outflows

$1,103,400

Available cash

Needed cash

$1,103,400

$1,698,500

Ending balance: $1,698,500 – $1,103,400 = $595,100 ** $482,000 – $45,000 depreciation + $89,500 taxes + $15,300 interest = $541,800 November 30 estimated cash balance: $40,000 beginning + $1,658,500 budgeted cash operating inflows – $1,103,400 budgeted cash outflows = $595,100

2. Custom Windows has budgeted annual unit quarterly sales and production data as follows: Sales

● ●

30,000 units at $90

Beginning inventory, finished goods

5,000 units

Desired ending inventory, finished goods

4,000 units

Beginning inventory, direct materials

3,000 pounds

Desired ending inventory, direct materials

1,700 pounds

Each unit requires 2 pounds of direct materials at a standard cost of $10 per pound. Payments for purchases of materials are 60% in the same month and 40% in the next month.

a. How many units should be produced for the quarter? b. How many pounds should be purchased for the quarter? c. What is the cost of purchases for the quarter?

d. The vendor for direct materials has offered the company a 2% discount if the company pays in the same month as the purchase. Describe the analysis that the company should undertake to decide whether to accept the discount offer from the supplier. Difficulty: Moderate Time on task: 15 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution 2.a.: Quarter Finished Goods Inventory BB 5,000 units a) Produce = 29,000 units

30,000 units sell

EB 4,000 units

Unit sales

30,000 units

+ Ending inventory

+ 4,000 units

Units needed

34,000 units

– Beginning units

– 5,000 units

Units to produce

29,000 units

Solution to 2.b.: Quarter Direct Materials Inventory BB 3,000 pounds c) Buy x = 56,700 pounds

29,000 × 2 = 58,000 pounds

EB 1,700 pounds

Pounds for production: 29,000 × 2

58,000 pounds

+ Ending inventory

+ 1,700 pounds

Pounds needed

59,700 pounds

– Beginning pounds

– 3,000 pounds

Pounds to buy

56,700 pounds

Solution to 2.c.: 56,700 pounds × $10 = $567,000 Solution to 2.d.: Managers should compare the 2% savings to the opportunity cost of what the company could have earned during the days that it had to pay earlier.

3. Tourist Trinkets, Inc. had a $70,000 cash balance on July 1. Other facts are as follows: ● ● ● ● ● ● ● ● ● ● ●

Half of all sales are on credit. Of the credit sales, 75% are collected in the same month and 25% in the next month. Sales for June were $125,000, and expected sales are $160,000 in July and $130,000 in August. Desired ending inventory is 15% of next month's sales in units at the end of each month. The gross margin percentage is 40%. Payments to suppliers are made 70% in the same month as purchases are made and 30% in the following month. Total monthly fixed selling and administrative costs are $25,000; of this amount, depreciation expense is $10,000. All cash expenses are paid in the month incurred. Variable selling and administrative costs are $2.00 per unit and paid in the month incurred. The sales price is $16 per unit. The company plans to buy a small parcel of land at the end of July for $15,000.

a. What were purchases in June and what are expected purchases in July? Difficulty: Moderate Time on task: 7 minutes Objective: LO 5 AACSB: Analytical thinking Assignment: Quiz Solution:

Finished Goods Inventory—June

Finished Goods Inventory—July

BB 0.15(75,000) = $11,250

BBB July = EB June

a) Buy x = $78,150

COGS = 0.6 (125,000) = $75,000

EB 0.15 (96,000) = $14,400

$14,400

COGS = 0.6 (160,000) =

a) Buy x = $93,300

$96,000

EB 0.15 (130,000) = $11,700

June

July

Cost of current sales

$75,000

$96,000

+ Ending inventory

+ 14,400

+ 11,700

Needed

$89,900

$107,700

Beginning inventory

– 11,250

– 14,400

Purchases

$78,150

$93,300

b. What is the budgeted cost of goods sold for July? Difficulty: Moderate Time on task: 3 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Quiz Solution: Cost of goods sold for July: 60% of $160,000 sales = $96,000 that would be reported as an expense on the July income statement.

c. What is the budgeted income before taxes for July? Difficulty: Difficult Time on task: 7 minutes Objective: LO 3 AACSB: Analytical thinking

Assignment: Quiz Solution: Sales

$160,000

Cost of goods sold

– 96,000

Gross margin

$64,000

= $160,000 ÷ $16 = 10,000 units

Selling and administrative expenses: Variable $2 (10,000 units)

$20,000

Fixed

25,000 – 45,000

Operating income

$19,000

d. What are budgeted cash collections for July? Difficulty: Easy Time on task: 5 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Quiz Solution: Cash collections for July: Cash sales for July + Collection of credit sales from July and June credit sales: Cash sales: 50% of $160,000 July sales

$80,000

Collection of credit sales, same month: 75% (July credit sales of $80,000)

60,000

Collection of credit sales, previous month: 25% (June credit sales of $62,500)

15,625

July cash receipts from operations

$155,625

e. What are budgeted payments to suppliers in July?

Difficulty: Easy Time on task: 5 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: July payment to suppliers:

Payments for purchases, same month: 0.7 (July $93,300 purchases)

$65,310

Payments for purchases, previous month: 0.3 (June $78,150 purchases)

23,445

July payment to suppliers – operating cash outflow

$88,755

What is the budgeted ending cash balance as of July 31? Difficulty: Moderate Time on task: 7 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: July Cash Financial Master Budget

Beginning balance $70,000 Operating cash inflows (from d above):

Operating cash outflows (from e above):

Cash sales $80,000

Payment for July purchases $65,310

Collection of July credit sales 60,000

Payment for June purchases 23,445

Collection of June credit sales 15,625

Cash operating expenses 35,000

Total cash inflows from operations 155,625

Total cash operating outflows $123,755 Investing cash outflows: Planned purchase of land $15,000

Available cash $225,625

Needed cash $138,755

Ending balance: $225,625 – $138,755 = $86,870 ** Cash operating expenses: variable $20,000 + fixed ($25,000 – $10,000 depreciation = $15,000) = $35,000 Ending cash balance: $70,000 beginning + $155,625 budgeted cash operating inflows – $123,755 budgeted cash operating outflows – $15,000 planned cash investing = $86,870 g. What is the budgeted balance of accounts receivable on July 31? Difficulty: Moderate Time on task: 3 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: July 31, accounts receivable balance: July credit sales not collected: 25% ($80,000) = $20,000

h. What is the budgeted balance of accounts payable on July 31? Difficulty: Moderate Time on task: 3 minutes Objective: LO 4 AACSB: Analytical thinking

Assignment: Homework Solution: July 31, accounts payable balance: July credit purchases not paid: 0.3 x $93,300 = $27,990

4. Modern Notes, Inc. had a $47,000 cash balance on May 1. The following information was also gathered: ● ● ● ● ● ● ●

Half of all sales are on credit. Of the credit sales, 80% are collected in the same month, 10% are collected in the next month, and 10% are uncollectible. Sales for April were $100,000, and expected sales are $110,000 in May and $140,000 in June. The company wishes to have half of next month's sales in units available at the end of each month. The gross margin percentage is 40%. Of the production costs, the depreciation expense (part of fixed overhead) is $5,000 per month. The selling and administrative costs (all variable) are $1.00 per unit. The unit sales price is $10 per unit sold. All the cash costs of production and the selling and administrative salaries are paid in the month incurred

a. How many units will be produced in May? Difficulty: Easy Time on task: 5 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution: April Budgeted sales

May

$100,000 $110,000

Budgeted unit sales: Monthly sales ÷ $10

10,000

11,000

Desired ending inventory: 50% next month’s

5,500

7,000

Finished Goods Inventory—April

June $140,000 14,000

Finished Goods Inventory—May

BB 5,000 units Produce = 10,500

EB April = BB May 5,500 10,000 units

EB 5,500 units

Produce = 12,500

11,000 units

EB 7,000 units

April

May

Expected units to be sold

10,000

11,000

Ending inventory: 50% next month’s units

+ 5,500

+ 7,000

Needed

15,500

18,000

Beginning inventory units

– 5,000

– 5,500

Units to produce

10,500

12,500

b. What is the budgeted ending cash balance as of May 31? Difficulty: Moderate Time on task: 15 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: Since gross margin is 40% of sales, cost of goods sold each month equals 60% of sales: 0.6($10 sales price) = $6 per unit.

Cash inflows: Cash sales in May + Collection of credit sales from May and April credit sales Cash sales: 50% of $110,000 May sales

$55,000

Collection of credit sales, same month: 0.8 (May credit sales of $55,000)

44,000

Collection of credit sales, previous month: 0.1 (April credit sales of $50,000)

5,000

May cash receipts from operations

$104,000

May cash production costs: ($6 × 12,500 units produced) – $5,000 depreciation = $70,000 May Cash Financial Master Budget

Beginning balance $47,000 Operating cash inflows:

Operating cash outflows:

Cash sales $55,000

May production costs $70,000

Collection of May credit sales 44,000

Cash selling expense: 11,000

Collection of April credit sales 5,000

Total cash operating outflows $81,000

$1 (11,000)

Total cash inflows from operations 104,000 Available cash $151,000

Needed cash $81,000

Ending balance: $151,000 – $81,000 = $70,000

5. Verde is a retailer whose fiscal year ends on June 30. The following data are provided for Verde’s operations: Cash Sales

Credit Sales

Actual: May

$80,000

$500,000

Actual: June

90,000

600,000

Projected: July

115,000

700,000

Projected: August

300,000

400,000

Projected: September

240,000

600,000

Other Information: ● Credit sales are collected as follows: 60% during the month of sale, 40% in the next month. ● The gross profit ratio on merchandise inventory is 30% of the sales price. The company’s policy is to have 5% of the next month's sales in units (safety stock) available 49

each month. All purchases are on credit: 60% are paid in the same month as the purchase and the remaining 40% in the following month.

a. Give the amount to be reported as the ending cash balance for the combined cash budget for July. b. Give the amount to be reported as gross margin on the budgeted income statement for July.

Difficulty: Moderate Time on task: 20 minutes Objective: LO 5 (b) and LO 4 (a) AACSB: Analytical thinking Assignment: Homework Solution:

Finished Goods Inventory—June

Finished Goods Inventory—July

BB 0.05(483,000) = $24,150 Buy x = $487,375

BBB July = EB June

COGS = 0.7 (690,000) = $483,000

EB0 0.05 (570,500) = $28,525

COGS = 0.7 (815,000) = $570,500

$28,525 Buy x = 566,475 EB 0.05 (700,000 × 0.7) =

$24,500

June

July

Cost of current sales

$483,000

$570,500

+ Ending inventory

+ 28,525

+ 24,500

Needed

$511,525

$595,000

– Beginning inventory

– 24,150

– 28,525

Purchases

$487,375

$566,475

Solution to 5.a.: July cash inflow

Cash sales

$115,000

Collections from July credit sales: 0.6 ($700,000)

420,000

Collections from June credit sales: 0.4 ($600,000)

240,000

Total July cash inflows

$775,000

July cash outflow Payments for July purchases: 0.6 ($566,475)

339,885

Payments for June purchases: 0.4 ($487,375)

194,950

Total July cash outflows

$534,835

Solution to 5.b.: July income statement Sales

$815,000

– Cost of goods sold

570,500

Gross margin

$244,500

6. Quality Cases, a small company that provides services and makes protective cases for phones and tablets, has gathered data to prepare a master budget. Assume the following data for Quality Cases: Month

Unit Sales

Total Sales

Cash Sales

Credit Sales

May (past – actual) $12.50/unit

32,000

$400,000

$10,000

$390,000

June (forecasted) $12.50/unit

36,000

$450,000

$15,000

$435,000

July (forecasted) $12.50/unit

39,200

$490,000

$18,000

$472,000

Other information: ● The collection policy for credit sales is as follows: 25% in the month of sale; 75% in the subsequent month. The company is aware that some credit sales may not be collected, but believes that amount to be negligible because the salespeople will not sell to customers that do not pay on credit. ● The gross profit ratio is 45% of sales. The inventory policy is to have 5% of the next month’s sales in units (safety stock) available at the end of each month. All purchases are on credit. Seventy percent is paid in the same month of purchase; the remainder is paid in the month following the purchase.

● ●

● ● ●

Selling and administrative salaries for June total $64,000 and will be paid in June. Accrued salaries from May of $8,000 will be paid in June. Existing buildings and equipment have a combined cost of $140,000, a useful life of 7 years, and no salvage value. Equipment with a cost of $12,000 is projected to be bought toward the end of June with cash. Land with a book value of $16,000 is projected to be sold for $13,000 in June. Rent, insurance, and advertising total $11,500 per month (paid at the end of each month). The cash balance on June 1 was $10,000. The June scheduled debt payment of $4,400 includes $400 of interest. The interest expense relates to a $72,000 note payable. For simplicity, ignore income taxes. The desired minimum cash balance is $20,000.

a. Calculate budgeted June cash receipts from operations (cash sales and collections of credit sales). Difficulty: Easy Time on task: 5 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Test Solution: June cash inflow Cash sales

$15,000

Collections from June credit sales: 0.25 ($435,000)

108,750

Collections from July credit sales: 0.75 ($390,000)

292,500

Total June cash inflows

$416,250

b. Calculate budgeted June inventory purchases (a template follows to assist with the analysis).

May Inventory BB

June Inventory BB

COGS

Buy x

Difficulty: Moderate Time on task: 7 minutes Objective: LO 5 AACSB: Analytical thinking Assignment: Test Solution:

Finished Goods Inventory—May BB 0.05(220,000) = $11,000 Buy x = $221,375

COGS = 0.55 (400,000) = $220,000

EB 0.05 (247,500) = $12,375

Finished Goods Inventory—June BBB July = EB June $12,375 Buy x = $248,600

COGS = 0.55 (450,000) = $247,500

EB 0.05 (490,000 × 0.55) = $13,475

May

June

Cost of current sales

$220,000

$247,500

+ Ending inventory

+ 12,375

+ 13,475

Needed

$232,375

$260,975

– Beginning inventory

– 11,000

– 12,375

Purchases

$221,375

$248,600

c. Calculate payments to suppliers in June. Difficulty: Easy Time on task: 5 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution:

Payments for June purchases: 0.7 ($248,600)

$174,020

Payments for May purchases:0.3 ($221,375)

66,413

Total cash outflows

$240,433

d. Prepare a June income statement. Difficulty: Difficult Time on task: 9 minutes Objective: LO 5 AACSB: Analytical thinking Assignment: Homework Solution: Quality Cases Income Statement For Month of June Sales

$450,000

Cost of goods sold

– 247,500

Gross margin

$202,500

Selling and administrative expenses Salaries

$64,000

Depreciation (140,000 ÷ 7) 1/12 (rounded to nearest dollar)

1,667

Rent, insurance, advertising

11,500

Operating Income

77,167 $125,333

Other revenues, expenses Loss on sale of land ($16,000 – $13,000) Interest expense

$3,000 400

3,400

Income before taxes

$121,933

e. Calculate the budgeted June cash flow statement (a template follows to assist with the analysis). June Master Budget: Cash Beginning balance

Operating cash inflows:

Operating cash outflows:

Cash sales

Payment for this month’s purchases

Collection of credit sales: this month

Payment for last month’s purchases

Collection of credit sales: previous month

Cash operating expenses:

Total cash operating inflows

Total cash operating outflows

Investing and financing cash inflows:

Investing and financing cash outflows:

Sale of long-term assets

Purchase of long-term assets

Issuing stock, planned borrowings

Planned payment of loans, dividends

Total cash inflows from Investing and financing

Total cash outflows Investing and financing

Available cash

Needed Cash

Excess: Available > Need / Repay debt, invest

Deficit: Need > Available/ Arrange financing

Difficulty: Moderate Time on task: 7 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: June Cash Financial Master Budget

Beginning balance $10,000 Operating cash inflows:

Operating cash outflows:

Cash sales $15,000 Collection of June credit sales 108,750

Payment for June purchases $174,020 Payment for May purchases 66,413

Collection of May credit sales 292,500

Cash operating expenses 83,500

Total cash inflows from operations 416,250

Total cash operating outflows $323,933

Cash investing inflow: sale of land 13,000

Investing cash outflow: equipment 12,000 Financing cash outflow 4,400

Available cash $439,250

Needed cash $340,333

Ending balance: $439,250 – $340,333 = $98,917

7. Refer to the data provided in Problem 6, but assume that the number of units expected to be sold will equal the number of units expected to be produced. Also assume that Quality Cases manufactures the product rather than buys the finished units. As such, the company would need a schedule of production costs (direct materials, direct labor, overhead). Data include the following facts: ● ●

●

Each unit is projected to sell for $12.50. Assume the same unit sales and total sales provided earlier. Cost per unit is estimated at $7.50 as follows: Direct materials: 1/2 pound at $3.00 per pound

$1.50

Direct labor: 1/4 hour at $10 per hour

2.50

Variable overhead (indirect materials, indirect labor, electricity)

1.10

Fixed overhead $864,000 annual cost ÷ 360,000 annual expected production

2.40

The fixed overhead is applied to each unit as it is produced at the rate of $2.40; the monthly budget would consist of the same amount for depreciation, supervisory and administrative fixed salaries, property taxes, insurance, and so on.

● ●

The company wishes to have 15% of the next month’s direct materials available at the end of each month. Direct materials inventory purchases are bought all on credit; half are paid in the month of purchase and half are paid in the following month.

a. Prepare a budgeted manufacturing production cost schedule for June. May and July have been provided as a guide. Production Cost Schedule

May

June

July

Units produced and sold

32,000

39,200

Direct materials to be issued at $1.50

$48,000

$58,800

Direct labor at $2.50

$80,000

$98,000

Variable overhead at $1.10

$35,200

$43,120

Fixed overhead budget $864,000 ÷ 12 months

$72,000

Total Difficulty: Moderate Time on task: 7 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Test Solution: Production Cost Schedule

May

June

July

Units produced and sold

32,000

36,000

39,200

Direct materials to be issued at $1.50

$48,000

$54,000

$58,800

Direct labor at $2.50

$80,000

$90,000

$98,000

Variable overhead at $1.10

$35,200

$39,600

$43,120

Fixed overhead budget $864,000 ÷ 12 months

$72,000

Total

$235,200

$255,600

$271,920

b. What are the planned purchases of direct materials for May and June?

May DM Inventory

June DM Inventory

Beg

Beg Issue to production

Issue to production

Buy x

End

Difficulty: Easy Time on task: 5 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Test Solution: May DM Inventory BB 0.15(48,000) = $7,200 Buy x = $49,980

June DM Inventory EB May = BB June

Issue to production $48,000

EB 0.15 (54,000) = $9,180

= $9,180 Buy x = $53,640

Issue to production $54,000

EB 0.15 (58,800) = $8,820

May

June

Materials for production

$48,000

$54,000

+ Ending inventory

+ 9,180

+ 8,820

Needed

$57,180

$62,820

Beginning inventory

– 7,200

– 9,180

Purchase

$49,980

$53,640

c. What are the planned payments to suppliers for June? Difficulty: Easy

Time on task: 5 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Test Solution: Payment for June purchases: ½ ($53,640)

$26,820

Payment for May purchases: ½ ($49,980)

24,990

Total payment to suppliers

$51,810

d. Describe (without actually calculating) which numbers would change if the company instead produced 37,000 units in June (sensitivity analysis)? Difficulty: Difficult Time on task: 5 minutes Objective: LO 6 AACSB: Reflective thinking Assignment: Test Solution: The production costs would have been calculated for 37,000 units and direct materials would have been purchased to accommodate the production of 37,000 units.

8. Beisswanger Company is preparing a master budget for 2023. Relevant data pertaining to its sales and production budgets are as follows: ● Sales for the year are expected to total $1,200,000. Quarterly sales, as a percentage of total sales, are expected to be 20%, 25%, 30%, and 25%, respectively. ● The sales price is expected to be $50 per unit for the first three quarters and $60 per unit for the fourth quarter and later. Sales in the first quarter of 2024 are expected to be 10% higher than the budgeted volume for the first quarter of 2023. ● Of all sales, 10% are cash sales and the remaining 90% in each quarter are credit sales. Of the credit sales, 50% are collected in the same quarter as the sale is made, 40% are collected in the following quarter, and 10% are deemed to be uncollectible. ● The accounts receivable balance at 1/1/23 was $200,000 before uncollectible sales were written off. ● Management desires to maintain an ending finished goods inventory each quarter that represents 25% of the next quarter’s budgeted sales volume.

● ● ●

Each unit is purchased from the vendor at $10 per unit, and all units are purchased on credit. Of the inventory purchased each quarter, 60% of the credit purchase is paid for within the same quarter and 40% is paid in the following quarter. The balance in accounts payable as of 1/1/23 was $75,000.

a. Prepare a sales and cash collections budget for 2023. Difficulty: Difficult Time on task: 20 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: Quarter 1: 20%

Quarter 2: 25%

Quarter 3: 30%

Quarter 4: 25%

$240,000

$300,000

$360,000

$300,000

4,800

6,000

7,200

5,000

Cost of goods sold: $10 × units

$48,000

$60,000

$72,000

$50,000

Cash sales: 10%

$24,000

$30,000

$36,000

$30,000

Credit sales: 90%

$216,000

$270,000

$324,000

$270,000

Collection credit sales, same month (50%)

$108,000

$135,000

$162,000

$135,000

Collection credit sales, previous month (40%)

$200,000

$86,400

$108,000

$129,600

$332,000

$251,400

$306,000

$294,600

2021 Sales $1,200,000 Units: sales ÷ sales price

Total operating cash inflows

b. Prepare a purchases and cash disbursements budget for 2023. Difficulty: Moderate Time on task: 20 minutes Objective: LO 4 AACSB: Analytical thinking

Assignment: Homework Solution:

Quarter 1 Inventory BB $12,000 Buy x = $51,000

Quarter 2 Inventory BB $15,000

COGS $48,000

EB $15,000

Buy x = $63,000 EB $18,000

Quarter 3 Inventory BB $18,000 Buy x = $66,500

COGS $60,000

Quarter 4 Inventory BB $12,500

COGS $72,000

EB $12,500

Buy x = $50,700

COGS $50,000

EB 0.25($52,800) = $13,200

Quarter 1

Quarter 2

Quarter 3

Quarter 4

Payments for purchases, same quarter: 60%

$30,600

$37,800

$39,900

$30,420

Payments for purchases, last quarter: 40% (* except for beginning accounts payable, quarter 1)

*$75,000

$20,400

$25,200

$26,600

Total payments to suppliers

$105,600

$58,200

$65,100

$57,020

Quarter 3

Quarter 4

c. What is the gross margin for each quarter? Difficulty: Easy Time on task: 5 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: Quarter 1

Quarter 2

Sales

$240,000

$300,000

$360,000

$300,000

Cost of goods sold

$48,000

$60,000

$72,000

$50,000

Gross margin

$192,000

$240,000

$288,000

$250,000

9. Denisco Doughnuts has applied for a loan with a local bank. The bank has requested a budgeted balance sheet as of May 31, 2023. The controller of Denisco has assembled the following information: ● ● ● ● ● ● ● ● ● ● ● ● ●

May 31 inventory balance: $19,355 May payments of inventory paid for in cash: $5,400 May payments of accounts payable and accrued liabilities from April: $8,000 May 31 accounts payable balance: $11,845 April 30 furniture and fixtures: $34,200, with accumulated depreciation of $27,880 April 30 owner’s equity: $26,390 May depreciation expense: $750 Cost of goods sold: 40% of sales Other May expenses, including income taxes: $5,200, paid in cash April 30 cash balance: $13,200 May budgeted sales: $16,400 May 31 accounts receivable balance: 25% of May sales May cash receipts: $18,500

Prepare a budgeted balance sheet for Denisco Doughnuts. Difficulty: Difficult Time on task: 25 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution: Balance Sheet: Assets = Liabilities + Equity Denisco Doughnuts Budgeted Balance Sheet Assets

Liabilities and Stockholders’ Equity

Current Assets

Liabilities

Cash

$13,100

Accounts Payable

$11,845

Accounts Receivable

4,100

Inventory

19,355

Current Assets

Total Liabilities

$11,845

Equity $36,555

Stock and Retained Earnings

30,280

Property, Plant, and Equipment: Furniture, fixtures

$34,200

– Accum Deprec

28,630

Total Assets ● ● ● ●

5,570 $42,125

Total Liabilities and Equity

$42,215

Cash: $13,200 + $18,500 – $5,400 – $8,000 – $5,200 = $13,100 Accounts receivable: 0.25 ($16,400) = $4,100 Accumulated depreciation: $27,880 + $750 = $28,630 Income: Sales

$16,400

Cost of goods sold: 0.4 (sales)

– 6,560

Gross margin

$9,840

Operating expenses: Depreciation Expense

$750

Other expenses

5,200

Total operating expenses

5,950

Income ●

$3,890

Equity: $26,390 + $3,890 = $30,280

10. The following information has been compiled for Quilliam Company. The company is in the office paper products industry. ●

Projected cash and credit sales schedule: Month

Cash Sales

Credit Sales

Total Sales

September

$4,000

$390,000

$394,000

October

$5,000

$420,000

$425,000

November ● ●

● ● ●

● ● ● ●

$7,000

$438,000

$445,000

Collection policy for credit sales: 30% in month of sale; 60% in subsequent month. Remaining 10% are uncollectible and written off 2 months after sale. There is a 1% cash discount on the 30% credit sales collected in the month of sale. Gross profit ratio is 40% of sales. The inventory policy is to have 10% of the next month’s sales in units (safety stock) available at the end of each month. All purchases are on credit. Half are paid in the same month that the purchase is made, and the other half in the month following the purchase. Selling and administrative salaries for September of $63,000 will be paid in October. Accrued salaries from September of $12,000 will also be paid in October. Buildings have a useful life of 8 years and a cost of $128,000. Equipment has a useful life of 4 years and a cost of $80,000. Land with a book value of $15,000 is projected to be sold for $12,000 in October. Cash will be used to buy a 3-month insurance policy on October 1 for $10,500. Supplies of $1,100 will be purchased on October 15. Supplies on January 31 were $1,700 and are projected to be $300 on October 28. Rent per month (paid at the end of each month) is $9,000. Advertising costs for October (will be paid) are expected to be $10,000. Unearned revenue from January of $1,400 will be earned in October. Cash dividends of $3,800 were declared in October and will be paid on October 10. Stock with a par value of $500 is projected to be issued in October for $7,000. The cash balance on September 30 was $4,000. The October scheduled debt payment of $18,000 includes $10,000 of interest. For simplicity, ignore taxes and the minimum desired cash balance.

The following budgets have been prepared and are given here: ● October operating cash budget, including cash receipts and cash disbursements ● October income statement ● October partial financial budget: cash flow from investing and financing activities October budgeted cash receipts from operations: October cash sales

$5,000

Collections from same month (October) credit sales: (420,000 × 0.3 × 0.99)

124,740

Collections from last month (September) credit sales: (390,000 × 0.6)

234,000

Total cash operating cash inflows

$363,740

Inventory budgeted purchases and payments of accounts payable:

September Inventory BB 23,640

October Inventory BB 25,500

COGS 236,400

COGS 255,000

Buy x

EB 25,500

EB 26,700

September

October

COGS

394,000 × 0.6

425,000 × 0.6

Beginning balance

236,400 × 0.1

255,000 × 0.1

236,400 + 25,500 – 23,640 = $238,260

255,000 + 26,700 – 25,500 = $256,200

Purchases

October budgeted payments to suppliers= ½ (256,200 + 238,260) = $247,230 Other budgeted operating cash outflows: Budgeted investing and financing activities: Salaries

$75,000

Issuance of stock

$7,000

Supplies

1,100

Payment of dividends

(3,800)

Insurance

10,500

Sale of land

12,000

Rent and advertising

19,000

Debt payment

(8,000)

Interest

10,000

Investing and Financing

$7,200

Total other operating outflows

$115,600

Ending budgeted cash balance: $4,000 + $363,740 – $247,230 – $115,600 + $7,200 = $12,110 October budgeted income statement: Net sales*

$423,230

Supporting schedule of S, G,& A expenses:

Cost of goods sold

(255,000)

Salaries

$63,000 2,500

Gross profit

$168,230

Supplies**

Selling, general, and administrative expenses

133,000

Insurance***

Operating income

$35,230

Rent and advertising

19,000

Depreciation****

3,000

Other items:

3,500

Loss on sale of land

($3,000)

Credit losses*****

Interest expense

(10,000)

Total S, G, & A

Other revenue

1,400

Income

42,000 $133,000

(11,600) $23,630

* Net sales = 425,000 – (0.01 × 420,000 × 0.3) = $423,230 ** Supplies = 1,700 + 1,100 – 300 = 2,500 *** Insurance= 10,500 ÷ 3 **** Depreciation = 1/12 ((128,000 ÷ 8) + (80,000 ÷ 4)) ***** Credit losses = 420,000 × 0.1

a. Analyze all of the budgets and supporting calculations. How should the company use this information? Difficulty: Difficult Time on task: 10 minutes Objective: LO 7 AACSB: Reflective thinking Assignment: Homework Solution: The company should use the information to properly plan how to meet its specific objectives, goals, and financial targets for performance in the period. What are the period targeted income levels, cash balances, required payments for operations, and both investing and financing activities? Additionally, with the use of spreadsheets, the managers can modify the assumptions and data to consider many different potential scenarios (“what if”): ● What if total sales vary because of changes in consumer preferences, changes in technology, consumer preferences, the economy in general, or competition? ● What if the cash discount were increased or fewer sales were made on credit? ● What if the company could avoid some of the operating costs or increase its operational efficiency?

● ● ● ● ●

What if the company kept a different amount of safety stock on hand? What if the company does not sell the land or sells the land for less? What if the company wishes to have more cash on hand? What if the company pays more of the debt? What if new recycling/sustainability regulations are enacted that increase costs?

Management can also use the budget to compare its expected performance to the actual results at the end of the period and analyze any differences. Visual tools such as charts are very helpful. Then, managers can evaluate the budget to make decisions about whether to change credit policies, pricing of products, mix of products, levels of automation versus direct labor, outsourcing, and so on. b. What other information would be useful if you were the chief financial officer of the company? Difficulty: Difficult Time on task: 5 minutes Objective: LO 7 AACSB: Reflective thinking Assignment: Homework Solution: Some additional items include the following: how previous budgeted sales and actual sales compared; industry trends; quality initiatives and customer satisfaction; ratings on websites; new risks from the economy, industry, or competition; management-identified opportunities; needed equipment replacements; changes in labor regulations; new ideas from managers; supply chain changes for suppliers or logistics (transportation). c. This chapter focuses primarily on the manual preparation of the master budget. Technologies such as RPA, Blockchain, 5G, and SAP HANA allow for online real-time reporting. Identify the costs and benefits of moving to an automated budgeting process. Difficulty: Difficult Time on task: 5 minutes Objective: LO 7 AACSB: Reflective thinking

Assignment: Homework Solution: Automating the budgeting and reporting processes improves the quality of managerial decision making as data is available immediately instead after the general ledger close process is completed at the end of every month. This allows managers to respond more quickly to changes in the business and macro-economic environment. However, this technology can be expensive and the benefits may not outweigh the costs for all organizations. Further, budgets (output) are only as good as the data input into the system and the processing that occurs for both manual and automated processing. Therefore, controls must be established to ensure that error or manipulation does not occur within the budgeting process.

13. The following articles provide some insight into the macro-level factors affecting organizations as the result of the COVID-19 pandemic. Select one of the articles from the list below. ●

● ●

“As consumers keep adapting, how will your business keep changing with them?” EY, https://www.ey.com/en_gl/consumer-products-retail/future-consumer-index-keep-upchanging-consumer “Health Care Industry Outlook,” RSM, https://rsmus.com/what-we-do/industries/healthcare/industry-outlook-health-care.html “How Finance & Accounting Can Rise in Uncertain Times,” Blackline, https://www.blackline.com/resources/ondemand/how-finance-accounting-can-rise-inuncertain-times/

a. Write a one-paragraph summary of the selected article. Make sure to cite your sources and paraphrase the article with minimal use of direct quotations. If direct quotes are used make sure to provide attribution. Difficulty: Moderate Time on task: 12 minutes Objective: LO7 AACSB: Written and oral communication Assignment: None Solution: Students’ responses will vary based on the article selected but the paragraph should be a summary of the article and not a copy and paste exercise. If students struggle to identify an appropriate article, suggest looking for articles related to government and nonprofits.

Commented [LB1]: [AU: Because the students have to choose between the 3 articles linked to the problem, it would be helpful to include an answer key that summarizes the articles for the instructor.] Commented [JC2R1]: We have a question in to the MAL team on how to handle open ended questions such as these. If this can be included, we will include a solution for each of the three articles. 2nd email was sent to the team today (8/5) for clarification

b. Identify three changes or considerations that should be made to an organization’s budgeting process as a result of the COVID-19 pandemic. Difficulty: Moderate Time on task: 8 minutes Objective: LO7 AACSB: Reflective thinking Assignment: None Solution: Students’ responses will vary based on the article selected but responses should be their opinion and not a copy and paste from the provided articles.

Chapter 11 End of Chapter with Solutions Discussion Questions 1. In the input-process-output model for standard costing, the inputs are the standard costs. What information is used to establish the standard price for direct materials and direct labor? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Quiz Solution: Standard costs are determined by analyzing historical costs and evaluating all operating activities. The standard price for direct materials is usually determined by a purchasing agent. The purchasing agent is responsible for acquiring raw materials at the right quantity and quality required for production. The standard price should be the best price available given the desired quality, including any quantity discounts. The standard direct labor rates are determined typically by labor contracts negotiated between management and workers, taking into consideration the workers’ skills and seniority.

2. What information is used to establish the standard quantity of materials and labor to be used in production for the current period? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution:

Standard costs are determined by analyzing historical costs and evaluating all operating activities. The direct materials quantity standards are determined by the engineering department, production managers, or other supervisors based on the materials needed for production given the quality of the employees and the efficiency of the machinery used in production. The direct labor quantity standards are determined by the engineering department or the production department after conducting time studies to determine what an average worker under continuing normal conditions accomplishes.

3. In a responsibility accounting system, who is assigned responsibility for explaining the price and the quantity variances for direct materials and direct labor? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Text Solution: In a responsibility accounting system, the following individuals are assigned responsibility for the price and quantity variances for direct materials and direct labor: ● Direct materials price variance: purchasing agent ● Direct materials quantity variance: production manager or supervisor ● Direct labor price variance: production manager or supervisor ● Direct labor quantity variance: production manager or supervisor

4. Because actual costs have already happened (sunk costs), there is no point in analyzing variances. Do you agree? If you do not agree, explain why not. Difficulty: Difficult Time on task: 5 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution:

No, I do not agree. Historical costs provide useful information on prior performance. However, historical costs should not be the only input when establishing standards for the upcoming year. Management should also consider changes to operating activities including supply chain logistics, capacity, available labor, and the impact of standards.

5. All unfavorable variances should be investigated, and all favorable variances should not be investigated because the costs will always outweigh the benefits. Do you agree? If you do not agree, explain why not. Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: No, I do not agree. All material variances should be investigated to determine the cause of the variance. A favorable variance is just as important as an unfavorable variance. For example, a favorable direct materials price variance could indicate that the purchasing manager is purchasing lower-quality materials that could result in internal failure costs of rework or scrap during production or external failure costs after the product reaches the customer.

6. The organization’s long-term practical capacity should be used to create the flexible budget for the period. Do you agree? If you do not agree, explain why not. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: No, I do not agree. The flexible budget should be based on actual activity for the period, not what the practical capacity should be.

7. The price variance for fixed overhead represents the savings or extra cost if production personnel are efficient. Do you agree? If you do not agree, explain why not. Difficulty: Difficult Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: No, I do not agree. The price variance for fixed overhead could reflect how well management developed estimated overhead rate(s) at the beginning of the year or if actual costs varied from expected costs.

8. Standard costs should be based on the assumption of ideal (maximum efficiency) conditions to hold production and purchasing employees accountable. Do you agree? If you do not agree, explain why not. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: No, I do not agree. An ideal standard represents what it should cost to produce a unit of production when conditions are perfect and operations are running at peak efficiency. Although ideal standards might provide a goal for employees, they are often unrealistic and can demotivate some employees because the goals are not achievable. Currently attainable or practical standards should be used instead, as they provide allowances for normal and acceptable imperfections in the production process. These standards are more realistic expectations of what should be accomplished under normal operating conditions.

9. The sum of the price and quantity variances for variable overhead equals the flexible budget variance for variable overhead. Do you agree? If you do not agree, explain why not. Difficulty: Moderate

Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Yes, I agree. The sum of the price variance and the quantity variance equals the total flexible budget variance.

10. The only reason a company would use a standard costing system is for planning and control purposes. Do you agree? If you do not agree, explain why not. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: No, I do not agree. By carefully setting standards in a standard costing system, a company is better prepared to identify whether inefficiencies or non–value-added activities exist and can strive to reduce or eliminate them. Also, a standard cost system simplifies the recording of product costs because all production costs are initially entered as standard costs.

11. Describe the contents of a flexible budget in a standard costing system for a manufacturer. Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: To prepare a flexible budget, a company uses standard costs. A standard cost is a predetermined estimate of what the company believes a cost should be. Examples of standard costs for a manufacturer are direct materials, direct labor, and overhead.

12. Describe the information contained in a performance report that a company using a standard costing system would prepare. Difficulty: Moderate Time on task: 5 minutes Objective: LO2, LO7 AACSB: Analytical thinking Assignment: Quiz Solution: To evaluate performance, the activity variance report and the revenue and spending variances report can be combined into a performance report. The performance report will contain key data regarding activity levels, the static budget, the flexible budget, actual costs, and variances. The company may also include this information within a dashboard that updates automatically and allows the user to interact with it.

13. If a company spends less on materials than the master budget, management is working efficiently and should not investigate the variances. Do you agree? If you do not agree, explain why not. Difficulty: Difficult Time on task: 7 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Text Solution: No, I do not agree. Management should calculate a flexible budget based on actual sales volume (activity) to determine what the budgeted amounts should be, given the actual production and sales. The company should then compare actual costs with the flexible budget. It may have spent less on materials than the master budget estimated because fewer items were produced, not because the cost per item was lower.

14. Variances only list the amounts over or under budget; they do not explain the causes of the problems. Do you agree? Explain. Difficulty: Moderate

Time on task: 5 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: Yes, I agree. Variances can be caused by many different factors. It is important for management to find the underlying cause of each variance and to understand how the variances might be related. For example, materials price variance may be due to the company’s ability to purchase materials for a lower cost.

15. Give three reasons why a direct labor unfavorable variance may occur. Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Direct labor variances can result from poor scheduling, poorly trained employees, equipment inefficiencies, downtime outside the employee’s control, or inappropriate pay rates.

16. Basing bonuses only on favorable purchasing and production variances could encourage employees in the short run to act in a manner that does not promote goal congruence (is best for the company). Do you agree? Explain. Difficulty: Difficult Time on task: 7 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Yes, I agree. Variances can be caused by many different factors, including some that are not under the control of the department affected by the variance in the short term. For example, the purchasing department may show a favorable direct materials price variance because it

was able to purchase materials for a lower cost. However, these materials may end up being of lower quality, such that a higher quantity is required to produce goods than was used previously. In this case, the production department will have an unfavorable direct materials quantity variance. It is important for management to utilize variances as one component of evaluating performance and determining compensation.

17. Discuss the different types of responsibility centers. Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: Cost center: Managers responsible only for cost control would be responsible for a cost center. Examples of cost centers are operations within a factory or administrative functions such as human resources or the corporate accounting department. Managers in these areas are responsible for minimizing costs while meeting the expectations of the company. Revenue center: In a revenue center, managers are responsible only for generating revenues. These managers are held accountable for increasing sales or the company’s market share, but have little or no responsibility for the costs the center incurs to generate the sales. Profit center: A profit center manager is held responsible for both generating sales and controlling costs, thereby managing profits. Investment center: Managers of an investment center are responsible for generating revenues, controlling costs, and efficiently using the company’s equipment and other longterm assets to help the company generate a profit.

18. How is the concept of “management by exception” used with standard costing? Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Analytical thinking

Assignment: Homework Solution: Under a management by exception philosophy, only the significant variances (from standard costing) are identified and analyzed. The company defines what it considers to be a “significant variance,” which can be stated in terms of a dollar amount, a percentage of the standard, or a statistical limit. Management by exception points managers toward the critical problems that need to be addressed.

19. What is a balanced scorecard report, and how is it useful to management? Difficulty: Easy Time on task: 3 minutes Objective: LO6, LO7 AACSB: Analytical thinking Assignment: Quiz Solution: The balanced scorecard is a performance measurement system that recognizes both financial and nonfinancial measures when evaluating a company’s performance. These measures are integrated with the company’s strategy to develop an action plan to meet the company’s objectives. Additionally, it helps the company determine if it is meeting its operational and financial goals. The balanced scorecard may be presented using an interactive and dynamic dashboard.

20. If a company spends more money on appropriate prevention and appraisal costs, it should realize lower internal and external failure costs of quality in future periods. Do you agree? Explain. Difficulty: Moderate Time on task: 5 minutes Objective: LO6 AACSB: Analytical thinking Assignment: Text Solution: Yes, I agree. If a company spends money on prevention and appraisal costs, then ideally it will spend less time and money reworking products (internal failure costs) or responding to deficiencies once customers receive the products (external failure costs).

Exercises 1. For each of the following items, select the term that best fits the description: a. price variance b. efficiency variance c. flexible budget d. profit center e. balanced scorecard f. management by exception g. performance report h. currently attainable standards i. standard costs j. volume variance k. data dashboard i. Report that includes a comparison with the master budget, a flexible budget for actual production and sales, as well as variances for revenues and costs ii. A report of what costs should be based on different levels of activity iii. Focus is placed on identifying and analyzing significant variances iv. Measures the dollar cost that should be paid for inputs (product costs) needed in production v. Difference between actual and standard prices for actual materials purchased (direct materials variance) or actual hours (direct labor variances) vi. Difference between actual and standard hours allowed (direct labor variances) or quantities of materials for units produced (direct materials variances) measured at standard rates vii. Difference between budgeted and applied fixed overhead viii. Performance management system that recognizes both financial and nonfinancial measures when evaluating a company’s performance ix. Organizational unit in which the manger is responsible for generating revenue and controlling costs x. Realistic expectations of what should be accomplished under normal production conditions xi. Visual information tools designed to track, analyze, and display key metrics and data points for management

Difficulty: Easy Time on task: 1 minute each Objective: varies, see chart below AACSB: Reflective thinking Assignment: Homework

Solution: varies, see chart below # 1i 1 ii 1 iii 1 iv 1v

1 vi

Question Report that includes a comparison with the master budget, a flexible budget for actual production and sales, as well as variances for revenues and costs A report of what costs should be based on different levels of activity Focus is placed on identifying and analyzing significant variances Measures the dollar cost that should be paid for inputs (product costs) needed in production Difference between actual and standard prices for actual materials purchased (direct materials variance) or actual hours (direct labor variances) Difference between actual and standard hours allowed (direct labor variances) or quantities of materials for units produced (direct materials variances) measured at standard rates

1 vii Difference between budgeted and applied fixed overhead Performance management system that recognizes both 1 viii financial and nonfinancial measures when evaluating a company’s performance Organizational unit in which the manger is responsible for 1 ix generating revenue and controlling costs Realistic expectations of what should be accomplished under 1x normal production conditions Visual information tools designed to track, analyze, and display 1 xi key metrics and data points for management

Solution LO g

2. Identify each statement as True or False. a. In the performance report, the flexible budget costs for the units produced are compared to the actual costs to produce those units. Difficulty: Moderate Time on task: 2 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Homework Solution: True.

b. The term “flexible budget” is used for the standard rate per input unit and standard quantity per input unit, and the term “standard costs” is used for total standard costs. Difficulty: Moderate Time on task: 2 minutes Objective: LO1 AACSB: Analytical thinking Assignment: Test Solution: False. The flexible budget is a budget that changes as a result of a change in activity level. The standard cost is typically referred as the per-unit estimated amount. c. Responsibility accounting deals with assigning blame for the unfavorable variances and rewarding managers who report favorable variances. Difficulty: Difficult Time on task: 3 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: False. Responsibility accounting does not deal with assigning blame but rather with identifying the root cause of variances. As variances are detected, the managers of responsibility centers detect the cause of the variance, and then use this information to make changes or improvements to the processes. Root causes of production problems may include inappropriate procedures, supplier logistics issues, poor training, poor scheduling, insufficient capacity, bottlenecks, and machinery problems. d. The activity variance, a measure of effectiveness, can be calculated by multiplying the budgeted contribution margin per unit by the difference between units expected to be sold and actual units sold. Difficulty: Moderate Time on task: 2 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Quiz Solution:

False. An activity variance represents the difference in units expected to be produced and sold and the actual units produced and sold. e. Ideal standards are developed through the participation of all levels of management; they are ideal because they motivate employees in a positive manner. Difficulty: Easy Time on task: 2 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: False. An ideal standard represents what it should cost to produce a unit of production when conditions are perfect and operations are running at peak efficiency. Although ideal standards might provide a goal for employees, they are often unrealistic and can demotivate some employees because the goals are not achievable. f.

A price variance (rate variance or spending variance) is computed for each of the four product costs: direct materials, direct labor, variable overhead, and fixed overhead. Difficulty: Easy Time on task: 1 minute Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: True.

A quantity variance (efficiency variance) is computed for each of the four product costs: direct materials, direct labor, variable overhead, and fixed overhead. Difficulty: Easy Time on task: 1 minute Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: False. There is no efficiency variance for fixed overhead.

h. Production supervisors are usually responsible for both the price and quantity variances for direct materials and direct labor. Difficulty: Easy Time on task: 1 minute Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: False. The purchasing manager, not the production supervisor, is responsible for price variances for direct materials. i.

The master budget is often called the static budget and is prepared before the budget period begins for the expected original level of output. Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Reflective thinking Assignment: Quiz Solution: True.

For product costing, under a standard costing system, actual costs are assigned to ending inventory and variances are never closed to cost of goods sold. Difficulty: Moderate Time on task: 2 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: False. The variances between the standard costs and the actual costs are either recorded as expenses on the income statement as cost of goods sold or recorded as part of the work in process or finished goods inventory accounts if the inventory has not been sold.

k. There is never a quantity (efficiency) variance for fixed overhead. Difficulty: Moderate Time on task: 2 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Text Solution: True. l.

When an efficiency variance is calculated for fixed overhead, the variance is always unfavorable if the direct labor efficiency variance is unfavorable and overhead is based on machine hours. Difficulty: Difficult Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: False. If overhead is based on machine hours, the direct labor efficiency variance is not related, because it is based on direct labor hours.

3. Identify each statement as True or False. a. Having a bonus based on the direct materials purchase price variance can motivate purchasing department personnel to buy inferior goods. Difficulty: Moderate Time on task: 2 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: True.

b. A master budget is typically a long-range strategic plan covering two years. Master budgets provide an accurate control number to evaluate performance and award bonuses.

Difficulty: Easy Time on task: 1 minute Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: False. The master budget is often called the static budget and is prepared before the budget period begins for the expected original level of output. A master budget is only as good as the assumptions used to develop it. c. Government agencies should compare actual results against flexible budgets for actual services provided to properly determine efficiency. Difficulty: Moderate Time on task: 2 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: True. d. The balanced scorecard attempts to provide a more comprehensive picture of a company’s goals by including both financial and nonfinancial measures of performance and relating the performance measures to the strategic goals of the company. Difficulty: Easy Time on task: 1 minute Objective: LO6 AACSB: Reflective thinking Assignment: Homework Solution: True. e. In today’s manufacturing environment, which features a significant amount of automation, standard cost systems should emphasize understanding sources of non–value-added activities related to materials, labor, and especially indirect production costs (overhead). Difficulty: Moderate Time on task: 2 minutes

Objective: LO5 AACSB: Application of knowledge Assignment: Homework Solution: True.

The difference between available capacity and used capacity is known as the fixed overhead spending variance. Difficulty: Difficult Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: False. Idle capacity is the cause of fixed overhead volume variance.

g. All unfavorable variances should be investigated because they can be controlled by management. Cost-benefit concerns imply that management should not waste time on analyzing any favorable variances. Difficulty: Moderate Time on task: 2 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Quiz Solution: False. Management should focus on investigating all significant variances, favorable or unfavorable, and not simply follow up on unfavorable variances. h. Redesigning processes to achieve lower defects and forging relations with the right suppliers are examples of prevention activities. Difficulty: Moderate Time on task: 2 minutes Objective: LO5 AACSB: Analytical thinking

Assignment: Homework Solution: True. i.

Carrying costs of inventory, waiting time, and costs of moving inventory are theoretically non–valueadded costs that can be eliminated. Difficulty: Moderate Time on task: 2 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Quiz Solution: True.

Companies should focus on the lowest quoted initial purchase cost from suppliers and reward purchasing managers for achieving large favorable price variances. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: False. Purchasing materials of inferior quality could increase the quantity of materials required to produce products, thereby causing an unfavorable direct materials quantity variance.

k. Activity-based management can be used to determine which non–value-added activities can be eliminated and how to better function in a competitive environment. Difficulty: Easy Time on task: 2 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: True.

4. Plastic Imitations produced 1,000 units during November. Normal activity for the company is 1,200 units per month. The budgeted fixed overhead was $4,800 and the actual fixed overhead for November was $4,600. a. What was the price variance for fixed overhead for Plastic Imitations for November? Difficulty: Easy Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Fixed OH spending variance = (Actual fixed OH – Budgeted fixed OH) Fixed OH spending variance = $4,600 – $4,800 Fixed OH spending variance = $200 Favorable

b. What was the volume variance for fixed overhead for Plastic Imitations in November? Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Budgeted fixed OH rate per unit = $4,800 ÷ $1,200 units = $4 per unit Fixed OH volume variance = Budgeted fixed OH – Applied fixed OH Fixed OH volume variance = $4,800 – (1,000 units produced × $4 per unit) Fixed OH volume variance = $800 Unfavorable

5. Tasteful Art uses standard costs and flexible budgets for control and product costing. Two hours of work is required per finished unit. The fixed overhead rate per hour is $1.20. During March, the company produced 40,000 units. Tasteful Art reported a favorable $4,800 volume variance and a $2,000 unfavorable spending variance for fixed overhead for March.

a. What was the fixed overhead applied for product costing (i.e., the applied fixed overhead)? Difficulty: Moderate

Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Fixed OH applied = Units produced × Hours per unit × Rate per hour Fixed OH applied = 40,000 units × 2 hours × $1.20 Fixed OH applied = $96,000 b. What was the amount of budgeted fixed overhead for March? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Fixed OH volume variance = Budgeted fixed OH – Applied fixed OH $4,800 F = Budgeted fixed OH – $96,000 Budgeted fixed OH = $91,200 c. What was the actual fixed overhead? Difficulty: Difficult Time on task: 7 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Fixed OH spending variance = Actual – Budgeted $2,000 U = Actual – $91,200 Actual = $93,200 d. What were the standard hours applied to production? Difficulty: Moderate

Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Fixed volume variance = (Budgeted hours – Standard hours) × Fixed OH rate $4,800 F = ((40,000 units × 2 hours) – Standard hours) × $1.20 Standard hours = 84,000

6. The performance report for Smart Pens included the following variances for direct materials: price variance, $10,200 favorable; flexible budget (total) variance, $7,200 favorable. The materials purchased and used were 17,000 lb. For the 5,000 units produced, the standards were 3 lb per unit at $1.50 per pound.

a. What was the actual price paid per pound? Difficulty: Moderate Time on task: 5 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Quiz Solution: DM price variance = (AP – SP) × AQ $10,200 F = (AP – $1.50) × 17,000 $0.60F = AP – $1.50 AP = $0.90

b. What was the efficiency variance? Difficulty: Easy Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: Flexible budget variance = DM price variance – DM efficiency variance

$10,200 F = $7,200 F – DM efficiency variance DM efficiency variance = $3,000 F c. What are some possible reasons the actual pounds of materials used differed from the pounds allowed per the flexible budget of units produced? Difficulty: Difficult Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: The use of more pounds of materials during production than was budgeted could be caused by lower-quality materials used in production that resulted in more rework, machine inefficiencies leading to rework, workers lacking training, or changes in processes.

7. The performance report of Custom Jewelry included the following variances for direct labor: price (rate) variance, $4,000 favorable; quantity (efficiency) variance, $14,000 unfavorable. For each finished unit, the standard hourly direct labor rate was $7. The actual hours were 5,000 because 1.25 actual hours is required for each of the 4,000 finished units.

a. What was the actual rate per hour? Difficulty: Moderate Time on task: 3 minutes each Objective: LO3 AACSB: Analytical thinking Assignment: Quiz Solution: Direct labor rate variance = (Actual rate – Standard rate) × Actual hours $4,000 F = (AR – $7) × 5,000 hours $0.80 F = AR – $7.00 Actual rate = $6.20 b. What were the standard direct labor hours allowed for production? Difficulty: Moderate Time on task: 3 minutes each

Objective: LO3 AACSB: Analytical thinking Assignment: Quiz Solution: Direct labor quantity variance = (Actual hours – Standard hours) × Standard rate $14,000 U = (5,000 – SH) × $7 $2,000 U = 5,000 – SH Standard hours = 3,000 c. Since the price (rate) variance was favorable and the quantity (efficiency) variance unfavorable, can the production supervisor conclude that unskilled workers caused the hours to be higher than the allowed hours for the flexible budget of actual units produced? Discuss. Difficulty: Moderate Time on task: 3 minutes each Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: Many factors can lead to variances. The production supervisor should perform an investigation to determine the root causes of variances. Contributing factors could include: the use of unskilled workers who incur more hours than allowed, labor rates decreased, or additional hours are required to perform work. These outcomes could be caused by equipment malfunction, material bottlenecks, delays in the supply chain, and use of inferior materials. 8. As part of the management by exception philosophy, Luggage Manufacturing gives bonuses based on positive variances with respect to the following: i. Using less materials than allowed in the flexible budget ii. Using less labor hours than allowed in the flexible budget iii. Lower than budgeted amount for costs of quality in the prevention and appraisal categories iv. Lower variable costs per the flexible budget than variable costs per the master budget due to lower production v. Lower fixed costs applied than budgeted

a. For each of these items, identify whether management may be unintentionally creating bad incentives and a poor performance system.

Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: i. Yes. ii. Yes. iii. Yes. iv. Yes. v. Yes.

b. Choose one of the items and discuss how an unethical supervisor could act in a manner contrary to the Institute of Management Accountants’ Statement of Ethical Professional Practice Standards (competence, credibility, integrity, and confidentiality). Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: i. This metric could incentivize using less materials than required during production, resulting in higher defects. ii. This metric could incentivize using less labor than required during production, resulting in higher defects. iii. This metric could incentivize skipping routine maintenance to save costs, resulting in higher internal failure and external failure costs. iv. This metric could result in reducing production levels instead of meeting customer demand. v. This metric could result in management underestimating the capacity.

c. Discuss additional metrics that could be used in a balanced scorecard report to assess quality. Indicate in what quadrant those metrics would be found. Difficulty: Moderate Time on task: 5 minutes Objective: varies, see chart below

AACSB: Application of knowledge Assignment: Homework Solution: Additional nonfinancial metrics that Luggage Manufacturing could implement to assess quality include, but are not limited to: ● Employee satisfaction ratings (learning and growth) ● Employee training hours (learning and growth) ● Number of defects (internal business) ● Number of failed quality tests (internal business) ● Customer satisfaction ratings (customer)

9. The balanced scorecard is a performance measurement system that recognizes both financial and nonfinancial measures when evaluating a company’s performance. The balanced scorecard consists of four quadrants: learning and growth, internal business process, customer, and financial. a. Indicate in which quadrant of the balanced scorecard each of the following performance measures would appear. i. ii. iii. iv. v. vi. vii. viii. ix. x. xi. xii.

Cycle processing time New patents pending Employee skill level Return on investment Scrap and spoilage Secret shopper ratings Customer retention metrics Budgets and performance reports Employee satisfaction ratings Rework cost Number of new customers Budget and variances report

Difficulty: Easy Time on task: 3 minutes Objective: LO6 AACSB: Analytical thinking Assignment: Homework Solution: i. Internal business ii. Learning and growth iii. Learning and growth iv. Financial

v. vi. vii. viii. ix. x. xi. xii.

Internal business Customer Customer Financial Learning and growth Internal business Customers Financial

b. Which of these metrics would be nonfinancial (not reported in dollar terms) but still useful and understandable by management? Difficulty: Easy Time on task: 3 minutes Objective: LO6 AACSB: Analytical thinking Assignment: Homework Solution: Nonfinancial metrics include: i. Cycle processing time ii. New patents pending iii. Employee skill level v. Scrap and spoilage vi. Secret shopper ratings vii. Customer retention metrics ix. Employee satisfaction ratings xi. Number of new customers

c. Which of these metrics would be considered lead indicators? Difficulty: Moderate Time on task: 3 minutes Objective: LO6 AACSB: Analytical thinking Assignment: Homework Solution: A lead indicator is a measure that helps predict future performance. Lead indicators include: ii. New patents pending

iii. Employee skill level vi. Secret shopper ratings ix. Employee satisfaction ratings

10. Costs of quality fall into four main categories: prevention, appraisal, internal failure, or external failure. a. Indicate for each of the costs whether it should be classified as a prevention, internal failure, appraisal, or external failure cost. i. ii. iii. iv. v. vi. vii. viii.

Cancelled sales due to customer dissatisfaction Product recalls Training programs Inspection of raw materials Machine downtime because of improper maintenance Seminar with suppliers to discuss ways to reduce costs Audits of financial statements Rework of defective products

Difficulty: Easy Time on task: 5 minutes Objective: LO5 AACSB: Analytical thinking Assignment: Homework Solution: i. External failure ii. External failure iii. Prevention iv. Appraisal v. Internal failure vi. Prevention vii. Appraisal viii. Internal failure

b. For a company like Publix, whose mission “is to be the premier quality food retailer in the world,” on which categories would you expect it to spend more money? How does this compare to a company like Walmart, whose mission is to “save people money so they can live better”? Difficulty: Moderate Time on task: 3 minutes

Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: I would expect Publix to spend more money in the prevention and appraisal categories, as the company is focused on ensuring that the customer receives the highest-quality product. I would expect Walmart to spend less in the prevention and appraisal categories, leading to higher internal and external failure costs.

11. Morra is the new manager of the parking division of a small college; her division is set up as a profit center. Morra has responsibility for control of the costs and for revenues generated by parking fines and decal permit sales. To increase revenues, the parking division has emphasized issuing parking fines for all violations, even when the lot is vacant.

a. Discuss the merits of the parking division set up as a profit center. Difficulty: Moderate Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: There is some merit of assigning responsibility for the parking division to both generate revenues and control costs. However, the parking division personnel may upset customers by issuing parking fines, especially when the lot is vacant and customers are not taking up other spaces.

b. If you were Morra, would you think that too much emphasis was being placed on generating a profit for the parking division and that perhaps the division should be measured on other performance measures? Be specific in what you would suggest instead (any other metrics, responsibility center changes, or other sources of revenues or means to control costs). Difficulty: Difficult Time on task: 7 minutes Objective: LO5 AACSB: Application of knowledge

Assignment: Homework Solution: It depends on whether Morra has the ability to control costs within the parking division. If she can control costs, then she should be held accountable for those costs. If not, the parking division should be a revenue center, and held accountable for generating revenue. One performance metric could be the number of new parking decals issued per term.

12. Purchasing Company budgeted $100,000 of factory overhead cost to manufacture 5,000 units in 2022. At the end of 2022, management asked production why only 4,000 units were produced and the factory sat idle, incurring heavy fixed costs and a high volume variance. Production responded that the sales team projected lower sales units and there was considerable extra inventory from previous periods, so it did not make sense to overproduce.

a. Did the plant manager do a good job in controlling factory overhead costs or does the explanation for the high-volume variance make sense? Difficulty: Difficult Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: The explanation makes sense to minimize inventory carrying costs and costs of inventory obsolescence.

b. In such a situation, how would you recommend dealing with the idle facilities? For example, should production still produce more units? Should production be outsourced because of the unpredictability of sales? Difficulty: Difficult Time on task: 5 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution:

I would recommend that production find another use of the idle facilities. Potentially, production could lease out the facility to another company to manufacture its products. Additionally, production could manufacture a different product as long as there is customer demand for it. Production should also ensure proper communication with the sales team to ensure that the projected production and projected sales are consistent and congruent.

13. Actual weekly payroll costs for direct labor for installations of Easy Applications were $10,500 for 500 hours. The standard was 2 hours per installation. The direct labor standard cost was $18 per hour. Actual installations were 235 units. a. What was the direct labor rate (price) variance? Difficulty: Easy Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Actual rate = $10,500 ÷ 500 hours = $21/hour Direct labor rate variance = (Actual rate – Standard rate) × Actual hours Direct labor rate variance = ($21 – $18) × 500 Direct labor rate variance = $1,500 U

b. What was the direct labor efficiency (quantity) variance? Difficulty: Easy Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Standard hours = 2 hours per installation × 235 installations Standard hours = 470 hours Direct labor efficiency variance = (Actual hours – Standard hours) × Standard rate Direct labor efficiency variance = (500 hours – 470 hours) × $18 Direct labor efficiency variance = $540 U

c. What is the total direct labor variance? Difficulty: Easy Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Total direct labor variance = Direct labor rate variance + Direct labor efficiency variance Total direct labor variance = $1,500 U + $540 U Total direct labor variance = $1,940 U

d. What could be some reasons for the direct labor efficiency (quantity) variance? Difficulty: Easy Time on task: 3 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: An unfavorable direct labor efficiency variance could be caused by: ● Poor scheduling ● Poorly trained employees ● Equipment inefficiencies ● Machine downtime

14. Fill in the diagram below. Actual Cost Direct Materials Variances

Direct Labor Variances

Direct materials price variance Actual Cost

Standard Cost

Direct materials quantity variance Standard Cost

Direct labor rate variance Actual Cost Variable Overhead Variances

Fixed Overhead Variances

Direct labor efficiency variance Standard Cost

Variable overhead price variance

Variable overhead quantity variance

Fixed overhead spending variance

Fixed overhead volume variance

Difficulty: Easy Time on task: 4 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution:

Direct Materials Variances

Direct Labor Variances

Actual Cost

Standard Cost

(AP – SP)AQ purchased

(AQ – SQ)SP

Direct materials price variance Actual Cost

Standard Cost

(AR – SR)AH

(AH – SH)SR

Direct labor rate variance

Variable Overhead Variances

Fixed Overhead Variances

Direct materials quantity variance

Direct labor efficiency variance

Actual Cost

Standard Cost

(AR – SR)AH

(AH – SH)SR

Variable overhead rate variance

Actual Fixed Overhead –

Variable overhead efficiency variance

Budgeted Fixed Overhead – Applied

Budgeted Fixed Overhead Fixed overhead spending variance

Fixed Overhead Fixed overhead volume variance

15. Find an article that discusses the role of the balanced scorecard within organizations. Write a one-page summary of the article. Make sure to cite your sources. Difficulty: Moderate Time on task: 20 minutes Objective: LO7 AACSB: Written and oral communication Assignment: None Solution: Students’ responses will vary based on the article selected but should include some discussion on one or more aspects of the balanced scorecard and its use within organizations.

Problems 1. Contemporary Tableware manufactures dishes and cutlery. The production supervisor has noted that the direct labor efficiency variance has decreased over the last three quarters as follows: ● ● ●

Quarter 1 $40,000 unfavorable Quarter 2 $34,000 unfavorable Quarter 3 $21,000 unfavorable

The supervisor is pleased that the variance has decreased but has asked for an analysis. In particular, the supervisor is interested if problems with direct materials or the machines contributed to the labor issues in terms of rework, which remains a problem to maintain the output quality. Upon further analysis, the following report is produced, summarizing the percentages per quarter of the variance attributed to various issues.

The company changed suppliers in Quarter 3 because, despite penalty clauses for late deliveries and the poor quality of materials, the workers complained that the inferior and late materials resulted in rework, breakdown of machines, worker frustration, and even idle time for workers on the lines.

a. Could waiting until the next quarter to perform routine maintenance of equipment affect the direct labor efficiency variance? Which other equipment-related items affect the direct labor efficiency? b. Should workers simply be fired because the direct labor efficiency variance remains about the same? c. How could the amount of the training or the type of training impact the direct labor efficiency variance? Which other factors related to the workers could affect the direct labor efficiency?

d. Besides changing suppliers, what else can the company do to ensure the quality of the direct materials?

Difficulty: Easy Time on task: 3 minutes each Objective: LO4 AACSB: Application of knowledge Assignment: Homework Solution: # Question 1a Could waiting until the next quarter to perform routine maintenance of equipment affect the direct labor efficiency variance? Which other equipment-related items affect the direct labor efficiency? 1b Should workers simply be fired because the direct labor efficiency variance remains about the same?

Solution Yes, deferring routine maintenance could result in unexpected breakdowns,causing employees to remain idle while machinery is being repaired.

No, workers should not be fired because the direct labor efficiency variance remains the same. An analysis should look at whether the problem is a need for more training, machine improvement, or issues with materials. Standards should be established based on practical or currently attainable standards. Therefore, meeting the standards should be acceptable. 1c How could the amount of the training Yes, the amount of training could impact the or the type of training impact the direct direct labor efficiency variance. The more labor efficiency variance? Which other training that employees receive, the greater factors related to the workers could skills that those employees will have to affect the direct labor efficiency? complete their tasks, resulting in greater efficiency. 1d Besides changing suppliers, what else The company could perform inspections of can the company do to ensure the materials as they arrive to make sure that the quality of the direct materials? appropriate quality is provided by the vendor.

2. Suvaranat shows the following budgeted and actual data for the current fiscal year:

Master Budget Units Sales

8,000 $120,000

Flexible Budget 9,000 $135,000

Actual Income Statement 9,000 $136,500

Variable costs Fixed costs Operating income

$56,000 $50,000 $14,000

$63,000 $50,000 $22,000

$66,000 $52,000 $18,500

a. Was the company effective in reaching its goals? Support your position with numbers. Difficulty: Moderate Time on task: 5 minutes each Objective: LO2 AACSB: Reflective thinking Assignment: Test Solution: The company’s effectiveness, or how well the company has attained its objectives as set forth in the master budget, is assessed by comparing the static budget with the flexible budget. In terms of the differences between the static and flexible budgets, it appears as if the company was effective in reaching its goals: 9,000 units versus 8,000 units. b. Was the company efficient in reaching its goals? Support your position with numbers. Difficulty: Moderate Time on task: 5 minutes each Objective: LO2 AACSB: Reflective thinking Assignment: Test Solution: The company’s efficiency, or how well the company used its inputs to produce its outputs, can be assessed by comparing the flexible budget to the actual results. In terms of the differences between the flexible budget and actual results, it appears as if the company was inefficient in reaching its goals. ● Revenue: $1,500 F ● Variable costs: $3,000 U ● Fixed costs: $2,000 U ● Operating Income: $3,500 U

c. What was the revenue price variance? Difficulty: Moderate

Time on task: 5 minutes each Objective: LO2 AACSB: Analytical thinking Assignment: Test Solution: The revenue price variance is $1,500 F ($136,500 actual sales versus $135,000 flexible budget sales).

d. Prepare a flexible budget for 10,000 units, assuming that such a level of production and sales is within the same relevant range. Difficulty: Moderate Time on task: 5 minutes each Objective: LO2 AACSB: Analytical thinking Assignment: Test Solution: Flexible Budget Units Sales Variable costs Fixed costs Operating income

Calculation

Given 10,000 ($120,000 / 8,000) x 10,000 $150,000 ($56,000 / 8,000) x 10,000 $70,000 $50,000 Don’t change based on production $150,000 - $70,000 - $50,000 $30,000

3. Sparkle Clean uses a standard cost system to apply factory overhead costs to units of toothpaste produced. The following facts are known: ● ● ● ● ● ●

Both variable and fixed factory overhead costs are applied using standard machine hours allowed for the 90,000 units actually produced this year as follows: 90,000 units × ½ hour each = 45,000 hours. A practical capacity of 50,000 machine hours was used to develop the overhead rate for the expected 100,000 units and the budgeted fixed overhead costs of $75,000. The budgeted variable overhead rate is $1 per unit. Actual machine hours were 44,000. Actual fixed overhead costs for the year were $77,000. Actual variable overhead cost per unit was $1.10.

a. What is the budgeted fixed overhead rate per unit?

b. What was the fixed overhead spending variance for the year? c. What was the fixed overhead volume variance for the year? d. What was the variable overhead flexible budget variance? Difficulty: Moderate Time on task: 4 minutes each Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: #

Question

What is the budgeted fixed 3a overhead rate per unit? What was the fixed overhead 3b spending variance for the year? What was the fixed overhead 3c volume variance for the year?

Solution

$75,000 ÷ 100,00 units = $0.75

Fixed OH spending variance = Actual fixed OH – Budgeted fixed OH Fixed OH spending variance = $77,000 – $75,000 Fixed OH spending variance = $2,000 U Fixed OH volume variance = Budgeted fixed OH – Applied fixed OH Fixed OH volume variance = $75,000 – ($0.75 × 90,000 units) Fixed OH volume variance = $75,000 – $67,500 Fixed OH volume variance = $7,500 U

Flexible budget = Actual variable OH cost – Flexible budget variable What was the OH variable Flexible budget = (44,000 machine hours × $1.10) – ($1.00 × 3d overhead flexible 45,000 hours) budget variance? Flexible budget = $48,400 – 45,000 Flexible budget = $3,400 U

4. The Trendsetter Company produces fashionable clothing. It had the following standard costs for the month of May 2022: ● ● ● ●

Direct materials per unit: 5 yards at $6.00 per yard Direct labor per unit: ¼ hour at $16.00 per hour Variable overhead per unit: ¼ hour at $4.00 per hour Fixed overhead: $24,000

Also known: ● The master budget called for the production and sale of 16,000 dresses in May. ● Actual production and sales were 12,000 dresses. ● The company purchased 68,000 yards of materials at $5.60 per yard. ● Actual direct labor costs were $57,600 for 3,200 hours. ● Only 64,000 yards was used in production. ● Actual variable overhead costs were $13,200. ● Normal activity was 4,000 direct labor hours. ● Actual fixed overhead was $22,200.

a. Prepare a flexible budget to compute the total product cost at 12,000 units and at 15,000 units. Difficulty: Easy Time on task: 5 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Homework Solution: Flexible Budget Cost Information Units Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total Product Cost

12,000 $360,000 48,000 12,000 24,000 $444,000

15,000 $450,000 60,000 15,000 24,000 $549,000

b. Calculate the direct materials price variance and the direct materials quantity variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Direct materials price variance = (AP – SP)AQ purchased Direct materials price variance = ($5.60 – $6)68,000 lb Direct materials price variance = $27,200 F

SQ = standard DM per unit × number of units produced SQ = 5 yards per dress × 12,000 dress SQ = 60,000 yards Direct materials quantity variance = (AQ used – SQ)SP Direct materials quantity variance = (64,000 – 60,000)$6 Direct materials quantity variance = $24,000 U

c. Calculate the direct labor rate and direct labor efficiency variances. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Direct labor actual rate = Actual direct labor cost ÷ Number of actual direct labor hours (DLH) Direct labor actual rate = $57,600 ÷ 3,200 DLH Direct labor actual rate = $18 per DLH Direct labor rate variance = (AR – SR)AH Direct labor rate variance = ($18 – $16)3,200 hours Direct labor rate variance = $6,400 U Direct labor efficiency variance = (AH – SH)SH Direct labor efficiency variance = (3,200 – 3,000)$16 Direct labor efficiency variance = $3,200 U

d. Calculate all of the variances for variable overhead. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: AR = Total actual variable cost ÷ Total actual hours AR = $13,200 ÷ 3,200

AR = $4.13 Variable OH rate variance = (AR – SR)AH Variable OH rate variance = ($4.13 – $4)3,200 hours Variable OH rate variance = $416 U Variable OH efficiency variance = (AH – SH)SR Variable OH efficiency variance = (3,200 – 3,000)$4 Variable OH efficiency variance = $800 U

e. Calculate all of the variances for fixed overhead. Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: Fixed OH spending variance = Actual fixed OH – Budgeted fixed OH Fixed OH spending variance = $22,200 – $24,000 Fixed OH spending variance = $1,800 F Applied fixed OH rate = Budgeted fixed OH ÷ Normal number of units Applied fixed OH rate = $24,000 ÷ 16,000 units Applied fixed OH rate = $1.50 Fixed OH volume variance = Budgeted fixed OH – Applied fixed OH Fixed OH volume variance = $24,000 – ($1.50 × 12,000 units) Fixed OH volume variance = $6,000 F

Prepare a performance report for the direct labor and variable overhead for the 12,000 units produced. Use the following headings: Actual Costs, Flexible Budget Costs, Flexible Budget Variance, Rate/Spending Variance, Quantity/Efficiency Variance. Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework

Solution: Actual Costs Direct labor Variable manufacturing overhead

57,600 13,200

Flexible Budget Costs 48,000 12,000

Flexible Quantity/ Rate/Spending Budget Efficiency Variance Variance Variance 9,600 U $6,400 U $3,200 U $1,200 U $416 U $800 U

5. The Clement Co. uses a flexible budget and standard costs; it applies overhead on the basis of standard labor hours. The following information is known for Clement Co.:

Actual

Standard

Direct labor

30,000 hours at $10.50 per hour

2 hours per unit at $11 per hour

Variable overhead

30,000 hours at $27 per hour

2 hours per unit at $25 per hour

Direct materials

130,000 lb purchased at $0.51 per lb 125,000 lb used

8 lb per unit at $0.50 per lb

Fixed overhead Actual production

Practical capacity 14,000 units 12,900 units

a. Calculate the direct materials price variance. b. Calculate the direct materials quantity variance. c. Calculate the direct labor rate variance. d. Calculate the direct labor efficiency variance. e. Calculate the variable overhead rate variance. f.

Calculate the variable overhead efficiency variance.

g. What is the amount of standard costs of direct materials allowed in the flexible budget for the 12,900 units produced? h. What is the amount of standard costs of direct labor allowed in the flexible budget for the 12,900 units produced?

Difficulty: Moderate

Time on task: 3 minutes Objective: LO3 AACSB: Analytical thinking Assignment: Homework Solution: #

Question

Solution

Calculate the Direct materials price variance = (AP – SP)AQ purchased 5a direct materials Direct materials price variance = ($0.51 – $0.50)130,000 lb price variance. Direct materials price variance = $1,300 U Standard quantity = Standard pounds allowed per unit × Number of units produced Calculate the Standard quantity = 8 lb per unit × 12,900 units direct materials Standard quantity = 103,200 lb 5b quantity variance. Direct materials quantity variance = (AQ used – SQ)SP Direct materials quantity variance = (125,000 – 103,200)$0.50 Direct materials quantity variance = $10,900 U Calculate the 5c direct labor rate variance.

Calculate the direct labor 5d efficiency variance.

Calculate the variable 5e overhead rate variance.

Calculate the variable 5f overhead efficiency variance.

Direct labor rate variance = (AR – SR)AH Direct labor rate variance = ($10.50 – $11)30,000 hours Direct labor rate variance = $15,000 F Standard hours = Standard hours allowed per unit × Number of units produced Standard hours = 2 hours per unit × 12,900 units Standard hours = 25,800 hours Direct labor efficiency variance = (AH – SH)SR Direct labor efficiency variance = (30,000 – 25,800)$11 Direct labor efficiency variance = $46,200 U Variable OH rate variance = (AR – SR)AH Variable OH rate variance = ($27 – $25)30,000 hours Variable OH rate variance = $60,000 U Standard hours = Standard hours allowed per unit × Number of units produced Standard hours = 2 hours per unit × 12,900 units Standard hours = 25,800 hours Variable OH efficiency variance = (AH – SH)SR Variable OH efficiency variance = (30,000 – 25,800)$25 Variable OH efficiency variance = $105,000 U

What is the amount of Standard cost of direct materials = 8 lb per unit × $0.50 per lb × 12,900 5g standard costs units of direct Standard cost of direct materials = $51,600 materials

allowed in the flexible budget for the 12,900 units produced? What is the amount of standard costs of direct labor Standard cost of direct labor = 2 hours per unit × $11 per hour × 12,900 5h allowed in the units flexible budget Standard cost of direct labor = $283,800 for the 12,900 units produced?

6. Give all of the journal entries for direct materials, direct labor, and variable overhead for Problem 5. Difficulty: Difficult Time on task: 6 minutes Objective: Appendix AACSB: Analytical thinking Assignment: Homework Solution: Direct Materials Price Variance Raw Materials Inventory Direct Materials Price Variance Accounts Payable Direct Materials Quantity Variance Work in Process Inventory Direct Materials Quantity Variance Raw Materials Inventory Direct Labor Variance Work in Process Inventory Direct Labor Efficiency Variance Direct Labor Rate Variance Wages Payable Variable Overhead Variance Work in Process Inventory Overhead

$65,000 $1,300 $66,300 $51,600 $10,900 $62,500 $283,800 $46,200 $15,000 $315,000 $645,000

Variable OH Rate Variance Variable OH Efficiency Variance

$60,000 $105,000 Various Accounts

$810,000

7. The Farr Quality Bathroom Tile Company has developed the following standards for one of its products: Materials 3 feet × $9 per foot Direct labor 2 hours × $11 per hour Variable manufacturing overhead 2 hours × $4 per hour Total standard variable cost per unit

$27 22 8 $57

The company produced 1,200 units and sold all of the units at the budgeted sales price of $85. Additional information is as follows for June: Materials purchased Materials used Direct labor Actual variable manufacturing overhead

4,000 feet at purchase price of $40,000 3,900 feet 2,300 hours for total payroll of $24,150 $9,660

a. Calculate the direct materials price variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: AP = Total cost of direct materials purchased ÷ Number of feet AP = $40,000 ÷ 4,000 feet AP = $4 per foot Direct materials price variance = (AP – SP)AQ purchased Direct materials price variance = ($4 – $9)4,000 feet Direct materials price variance = $20,000 F

b. Calculate the direct materials quantity variance. Difficulty: Moderate

Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: Standard quantity = Standard pounds allowed per unit × Number of units produced Standard quantity = 3 feet per unit × 1,200 units Standard quantity = 3,600 feet Direct materials quantity variance = (AQ used – SQ)SP Direct materials quantity variance = (3,900 – 3,600)$9 Direct materials quantity variance = $27,000 U

c. Calculate the direct labor rate variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: AR = Total cost of direct labor ÷ Number of actual hours AR = $24,150 ÷ 2,300 hours AR = $10.50 per DLH Direct labor rate variance = (AR – SR)AH Direct labor rate variance = ($10.50 – $11)2,300 hours Direct labor rate variance = $1,150 F

d. Calculate the direct labor efficiency variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution:

Standard hours = Standard hours allowed per unit × Number of units produced Standard hours = 2 hours per unit × 1,200 units Standard hours = 2,400 hours Direct labor efficiency variance = (AH – SH)SR Direct labor efficiency variance = (2,300 – 2,400)$11 Direct labor efficiency variance = $1,100 F

e. Calculate the variable overhead rate variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: Variable OH actual rate = Actual variable OH cost ÷ Number of actual direct labor hours (DLH) Variable OH actual rate = $9,660 ÷ 2,300 DLH Variable OH actual rate = $4.20 per DLH Variable OH rate variance = (AR – SR)AH Variable OH rate variance = ($4.20 – $4.00)2,300 hours Variable OH rate variance = $460 U

Calculate the variable overhead efficiency variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Quiz Solution: Standard hours = Standard hours allowed per unit × Number of units produced Standard hours = 2 hours per unit × 1,200 units Standard hours = 2,400 hours Variable OH efficiency variance = (AH – SH)SR Variable OH efficiency variance = (2,300 – 2,400)$4

Variable OH efficiency variance = $400 F

g. If the company has a policy of investigating all variances that exceed $2,000 (both favorable and unfavorable), which variances would the company investigate? Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Quiz Solution: The company would investigate the direct materials price and quantity variances.

8. The Mazdiak Company has converted to an activity-based costing (ABC) system, as discussed in Chapter 4. Accordingly, the company prepares a flexible budget based on the four activity costs for indirect production costs (factory overhead):

Unit-level support costs (e.g., electricity, maintenance) Batch-level support costs (setups, handling, and inspections)

$4 per machine hour $600 per batch

Product-level support costs (design changes)

$3,000 per change

Facilities-level support costs (factory depreciation, insurance, and taxes)

$50,000 per month

Activity levels for the company for August were 10,000 units with 5,000 machine hours, 40 batches, and 3 design changes.

a. What would be the total flexible budget for the month of August? Difficulty: Easy Time on task: 5 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Homework Solution:

Unit-level support costs Batch-level support costs Product-level support costs Facilities-level support costs Total indirect production costs

Flexible Budget August 20,000 $24,000 $9,000 $50,000 $103,000

b. By using an activity-based budget and tracking actual indirect production costs (overhead) by activities, would Mazdiak be able to better identify non–value-added costs as candidates for improvements? Discuss. Be specific. Difficulty: Moderate Time on task: 3 minutes Objective: LO5 AACSB: Reflective thinking Assignment: Homework Solution: Yes. Management can use the variance information that has been calculated not only to identify problems but also to begin examining the activities being performed in these areas that might potentially be causing these variances. After identifying the activities being performed, management can work with managers from across the organization to determine how the activities can be improved or become more efficient, or which activities are not adding value to the processes but are adding to the costs and, therefore, could be eliminated. For example, could very expensive design changes be avoided by having the proper design? Or could setups, handling, and inspections be streamlined?

9. Holtje sells hammocks to many different retail outlets, and has gathered the following information for the period: Flexible Budget Price/Rate Quantity/Efficiency Volume Variance Variance Variance Variance Direct materials $57,700 U * $39,000 U * $18,700 U * Direct labor $6,000 U * $18,000 F * Variable overhead $14,850 F * $7,200 F * Fixed overhead $4,000 F * $12,000 U * * U = unfavorable, F = favorable. Product Cost

Additional information:

● ● ● ● ●

Planned production was 3,000 units, but only 2,700 units were produced. Direct materials: 130,000 feet of materials were purchased at $2.50 per foot, for a total cost of $325,000. The company uses a just-in-time system, so it used all 130,000 feet purchased. Direct labor: The standard time per unit was 5 hours at $12 per hour. The total actual payroll was $168,000. Variable overhead: The flexible budget was based on 5 standard direct labor hours at $5 per hour. Fixed overhead: Actual cost was $116,000.

Solve for the missing information. The direct materials information is shown as an example. Solution to part a provided as example for requirements c through i: Direct material price variance = (AP – SP)AQ purchased $39,000 U = ($2.50 – SP)130,000 $0.30 U = $2.50 – SP SP = $2.20 For standard rate = $39,000 ÷ 130,000 = difference between actual and standard rate = $0.30. Since the variance is unfavorable, the actual rate of $2.50 is $0.30 higher than the standard of $2.20. Direct materials quantity variance = (AQ used – SQ)SP $18,700 F = (130,000 – SQ)$2.20 8,500 F = 130,000 – SQ SQ = 138,500 For standard feet per flexible budget = $18,700 ÷ $2.20 = difference between actual and standard quantity of feet = 8,500 feet. The variance is favorable, so the standard feet allowed for the units produced in the flexible budget was 8,500 more than the 138,000 feet used = 138,500.

a. Given the purchase price variance, what was the standard rate per foot of materials, and how many feet of material were allowed per the flexible budget? b. What was the direct labor rate variance? c. How many standard direct labor hours were allowed per the flexible budget for actual production? d. Given the direct labor efficiency, how many actual hours were worked? e. What was the actual direct labor rate per hour? f.

How much was the fixed overhead budget amount?

Difficulty: Difficult Time on task: 5 minutes Objective: LO4 AACSB: Reflective thinking

Assignment: Homework Solution: #

Question

9a Given the purchase price variance, what was the standard rate per foot of materials, and how many feet of material were allowed per the flexible budget?

9b What was the direct labor rate variance? 9c How many standard direct labor hours were allowed per the flexible budget for actual production? 9d Given the direct labor efficiency, how many actual hours were worked? 9e What was the actual direct labor rate per hour? 9f How much was the fixed overhead budget amount?

Solution Direct material price variance = (AP – SP)AQ purchased $39,000 U = ($2.50 – SP)130,000 $0.30 U = $2.50 – SP SP = $2.20 For standard rate = $39,000 ÷ 130,000 = difference between actual and standard rate = $0.30. Since the variance is unfavorable, the actual rate of $2.50 is $0.30 higher than the standard of $2.20. Direct materials quantity variance = (AQ used – SQ)SP $18,700 F = (130,000 – SQ)$2.20 8,500 F = 130,000 – SQ SQ = 138,500 For standard feet per flexible budget = $18,700 ÷ $2.20 = difference between actual and standard quantity of feet = 8,500 feet. The variance was favorable, so the standard feet allowed for the units produced in the flexible budget was 8,500 more than the 138,000 feet used = 138,500. Total variance = Rate variance + Efficiency variance $6,000 U = Rate variance + $18,000 F Rate variance = $24,000 U Standard hours = Standard hours allowed per unit × Number of units produced Standard hours = 5 hours per unit × 2,700 units Standard hours = 13,500 hours Direct labor efficiency variance = (AH – SH)SR $18,000 F = (AH – 13,500)$12 1,500 F = AH – 13,500 AH = 12,000 hours Total direct labor cost = AH × AR $168,000 = 12,000 hours × AR AR = $14 per hour Fixed OH spending variance = Actual fixed OH – Budgeted fixed OH $4,000 F = $116,000 – Budgeted fixed OH Budgeted fixed OH = $120,000

10. Trendy Corporation manufactures a basic line of ground cover with the following standard unit costs: Direct materials (6 lb × $13 per yard)

$78

Direct labor (4 hours × $15 per hour)

Factory overhead (Variable, Fixed)

12.50, 37.50

Total standard cost per unit of output

$188

The following information pertains to the month of December: Actual direct labor (2,800 hours)

$39,200

Actual factory overhead (of which $7,100 is variable overhead)

$31,500

Standards are based on normal monthly production of 700 units of output. The company actually produced 750 units in December.

a. Calculate the standard direct labor hours allowed per the flexible budget for variable overhead. Difficulty: Moderate Time on task: 4 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Standard hours = Standard hours allowed per unit × Number of units produced Standard hours = 4 hours per unit × 750 units Standard hours = 3,000 hours

b. Calculate the variable overhead efficiency variance. Difficulty: Moderate Time on task: 5 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Homework Solution: Variable OH efficiency variance = (AH – SH)SR

Variable OH efficiency variance = (2,800 – 3,000)$12.50 Variable OH efficiency variance = $2,500 F

c. Calculate the fixed overhead spending variance. Difficulty: Difficult Time on task: 7 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Total actual OH = Actual fixed OH + Actual variable OH $31,500 = Actual fixed OH + $7,100 Actual fixed OH = $24,400 Budgeted fixed OH = Applied fixed OH rate × Budgeted units Budgeted fixed OH = $37.50 × 700 Budgeted fixed OH = $26,250 Fixed OH spending variance = Actual fixed OH – Budgeted fixed OH Fixed OH spending variance = $24,400 – $26,250 Fixed OH spending variance = $1,850 F

d. Calculate the fixed overhead volume variance. Difficulty: Difficult Time on task: 7 minutes Objective: LO4 AACSB: Reflective thinking Assignment: Homework Solution: Fixed OH volume variance = Budgeted fixed OH – Applied fixed OH Fixed OH volume variance = $26,250 – (750 units × $37.50) Fixed OH volume variance = $26,250 – $28,125 Fixed OH volume variance = $1,875 F

11. Crispin Company uses a standard-cost system. The standard direct materials cost per unit is $20, consisting of 4 lb at $5 per lb. The standard direct labor cost per unit is $40, consisting of 2 hours at $20 per hour. The following represents a monthly flexible factory overhead budget for different levels of production within the relevant range of 10,000 units to 25,000 units: Flexible budget cost information: Units Standard direct labor hours allowed Variable manufacturing overhead Fixed manufacturing overhead Direct materials Direct labor

14,000 22,000 28,000 44,000 $42,000 $66,000 $300,000 $300,000 $280,000 $440,000 $560,000 $880,000

25,000 50,000 $75,000 $300,000 $500,000 $1,000,000

Additional information for the current period: ● Variable manufacturing overhead consists of supplies, indirect labor, and other incidentals such as maintenance; it is allocated based on direct labor hours. ● Fixed overhead consists of supervision and other fixed production salaries, factory property taxes and insurance, depreciation, and other fixed factory costs. ● The fixed overhead rate is based on practical (normal) capacity of 20,000 units. ● The company produced and sold 18,000 units. ● Actual direct labor costs were $805,000, consisting of 35,000 hours worked at an average rate of $23 per direct labor hour. ● Direct materials purchased were 56,000 lb at $7 per lb. Pounds used in production were 53,000. ● Actual manufacturing overhead included variable overhead of $55,500 and fixed overhead of $309,000.

a. Create a flexible budget for the 18,000 units produced and sold. Difficulty: Moderate Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Text Solution: Units Standard direct labor hours allowed Variable manufacturing overhead Fixed manufacturing overhead Direct materials Direct labor

18,000 36,000 $54,000 $300,000 $360,000 $720,000

b. Calculate the direct materials price variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Text Solution: Direct materials price variance = (AP – SP)AQ purchased Direct materials price variance = ($7 – $5)56,000 lb Direct materials price variance = $112,000 U

c. Calculate the direct materials quantity variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Text Solution: Standard quantity = Standard pounds allowed per unit × Number of units produced Standard quantity = 4 lb per unit × 18,000 units Standard quantity = 72,000 lb Direct materials quantity variance = (AQ used – SQ)SP Direct materials quantity variance = (53,000 – 72,000)$5 Direct materials quantity variance = $95,000 F

d. Calculate the direct labor rate variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Text Solution:

Direct labor rate variance = (AR – SR)AH Direct labor rate variance = ($23 – $20)35,000 hours Direct labor rate variance = $105,000 U

e. Calculate the direct labor efficiency variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Text Solution: Standard hours = Standard hours allowed per unit × Number of units produced Standard hours = 2 hours per unit × 18,000 units Standard hours = 36,000 hours Direct labor efficiency variance = (AH – SH)SR Direct labor efficiency variance = (35,000 – 36,000)$20 Direct labor efficiency variance = $20,000 F

Calculate the variable overhead rate variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Text Solution: Variable OH actual rate = Actual variable OH cost ÷ Number of actual direct labor hours (DLH) Variable OH actual rate = $55,500 ÷ 35,000 DLH Variable OH actual rate = $1.59 per DLH Variable OH standard rate = Standard variable OH cost at 18,000 units ÷ Standard direct labor hours allowed at 18,000 units Variable OH standard rate = $54,000 ÷ 36,000 DLH Variable OH standard rate = $1.50 Variable OH rate variance = (AR – SR)AH

Variable OH rate variance = ($1.59 – $1.50)35,000 hours Variable OH rate variance = $3,150 U

g. Calculate the variable OH efficiency variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Text Solution: Standard hours = Standard hours allowed per unit × Number of units produced Standard hours = 2 hours per unit × 18,000 units Standard hours = 36,000 hours Variable OH efficiency variance = (AH – SH)SR Variable OH efficiency variance = (35,000 – 36,000)$1.50 Variable OH efficiency variance = $1,500 F

h. Calculate the fixed overhead spending variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking Assignment: Text Solution: Fixed OH spending variance = Actual fixed OH – Budgeted fixed OH Fixed OH spending variance = $309,000 – $300,000 Fixed OH spending variance = $9,000 U

Calculate the fixed overhead volume variance. Difficulty: Moderate Time on task: 3 minutes Objective: LO4 AACSB: Analytical thinking

Assignment: Text Solution: Budgeted fixed OH rate = Budgeted fixed OH ÷ Normal number of units Budgeted fixed OH = $15 Fixed OH volume variance = Budgeted fixed OH – Applied fixed OH Fixed OH volume variance = $300,000 – ($15 × 18,000) Fixed OH volume variance = $30,000 F

Discuss how management could summarize the variances into a meaningful report that would be helpful for further action. Difficulty: Easy Time on task: 3 minutes Objective: LO5 AACSB: Application of knowledge Assignment: Text Solution: Management could include all all the variances on one page and highlight in red and green colors the favorable and unfavorable variances. Alternatively, management could prepare graphics similar to those provided in the textbook showing the breakout of total variance into price and quantity variances. Price Variance

Efficiency Variance

Direct materials

$112,000 U

$95,000 F

Direct labor

$105,000 U

$20,000 F

Variable manufacturing overhead

$3,150 U

$1,500 F

Fixed manufacturing overhead

$9,000 U

$30,000 F

12. Young, Inc., manufactures cardboard boxes. Young has shared the most recent performance report with you as follows:

Analysis Units sold Revenues Variable costs

Master Budget

Sales Volume Variances

Flexible Budget

Income Statement

10,300 @ $50? @ $28?

100 ? ?

10,200 $510,000 $285,600

10,200 $530,400 $336,600

Flexible Budget Variances ? $20,400 F $51,000 U

Contribution margin Fixed costs Operating income

@$22? $104,400 $122,200

? 0 $2,200 U

? $104,400 $120,000

? $110,000 ?

? $5,600 U ?

a. What are the master budget revenues? Difficulty: Easy Time on task: 2 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Homework Solution: Master budget revenue = Master budget sales price × Master budget number of units sold Master budget revenue = $50 per unit × 10,300 units Master budget revenue = $515,000

b. What are the master budget variable costs? Difficulty: Easy Time on task: 2 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Homework Solution: Master budget variable costs (VC) = Master budget VC × Master budget number of units sold Master budget variable costs (VC) = $28 per unit × 10,300 units Master budget variable costs (VC) = $288,400

c. What is the master budget contribution margin? Difficulty: Easy Time on task: 2 minutes Objective: LO2 AACSB: Analytical thinking

Assignment: Homework Solution: Master budget revenue - Master budget VC Contribution margin

$515,000 (calculated in part a) – 288,400 (calculated in part b) $226,600

d. The measure of ineffectiveness is the contribution margin lost from the units not produced and sold as expected (the sales volume contribution margin amount). What is that amount of effectiveness or ineffectiveness for Young, Inc., and of what relevance is it to the company? Difficulty: Difficult Time on task: 5 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Sales volume variance is 100 units (the company expected to produce and sell 10,300 but produced and sold only 10,200 units). Contribution margin per unit = Master budget sales revenue per unit – Master budget VC per unit Contribution margin per unit = $50 per unit – $28 per unit Contribution margin per unit = $22 per unit Total ineffectiveness = Sales volume variance × CM per unit Total ineffectiveness = 100 units × $22 per unit Total ineffectiveness = $2,200 U

e. What is the contribution margin flexible budget variance? Difficulty: Easy Time on task: 2 minutes Objective: LO2 AACSB: Analytical thinking Assignment: Homework Solution: Contribution margin flexible variance = Revenue flexible budget variance – Variable cost flexible budget variance Contribution margin flexible variance = $20,400 F – $51,000 U

Contribution margin flexible variance = $30,600 U

Was Young efficient? Support your answer with numbers. Difficulty: Moderate Time on task: 3 minutes Objective: LO2 AACSB: Reflective thinking Assignment: Homework Solution: Analysis

Units sold Revenues Variable costs Contribution margin Fixed costs Operating income

Master Budget

Sales Volume Variances

Flexible Budget

Income Statement

10,300 515,000 288,400 226,000 $104,400 $122,200

100 U 5,000 U 2,880 F 2,200 U 0 $2,200 U

10,200 $510,000 $285,600 226,000 $104,400 $120,000

10,200 $530,400 $336,600 193,000 $110,000 83,800

Flexible Budget Variances $20,400 F $51,000 U 30,600 U $5,600 U 36,200 U

No. The flexible budget variance for contribution margin was unfavorable. Breaking down the variance into revenue and variable cost components reveals that the company generated more revenue per unit than expected, but this was offset by higher variable costs per unit than expected.

g. If the company were to break down the variable costs flexible budget variance into rate and efficiency variances for the product costs such as direct materials and direct labor, what insights could the company gain? Difficulty: Moderate Time on task: 3 minutes Objective: LO3 AACSB: Reflective thinking Assignment: Homework Solution: By breaking the variable flexible budget variance costs down into rate and efficiency variances, the company would be better able to identify the cause of the unfavorable variance. Is it due to more hours worked than expected? Is the cost of direct materials more than expected?

13. Variances are insufficient performance metrics since they represent past historical/sunk costs; promote short-term thinking; represent mainly lag indicators; do not shed light on the source of the problem or how to correct issues; compare to budgets that may not have been appropriately set; are a one-dimensional view. The following articles provide some insight into the airline industry and the balanced scorecard. ●

●

“The Key To Management: A Balanced Scorecard” Forbes, https://www.forbes.com/2008/04/29/small-business-management-ent-mangecx_gm_0429genemarksmetric.html#71046a705e17 “Balanced scorecard based performance measurement of European airlines using a hybrid multicriteria decision making approach under the fuzzy environment,” Hasan Dincer, Ümit Hacıoğlu, and Serhat Yüksel (Aug 2017), Journal of Air Transport Management, https://www.sciencedirect.com/science/article/abs/pii/S0969699717300091 “Here’s Why So Many Planes Are Still Flying, Nearly Empty,” Intelligencer, https://nymag.com/intelligencer/2020/04/heres-why-so-many-planes-are-still-flying-nearlyempty.html?utm_source=pocket-newtab “Air travel faces continued turbulence,” BBC, https://www.bbc.com/news/uk-scotland-scotlandbusiness-52212510

After reading the referenced materials for the balanced scorecard and airlines industry and in light of the retooling that will be needed when we emerge from the current lockdown as well as the discussions of the costs of quality: a. Create a revised balanced scorecard for a hypothetical airline. b. List and discuss appropriate costs of quality (prevention, appraisal, internal failure, and external failure) for your hypothetical airline. c. Discuss other information you would add to the analysis and what information you would visually report. Difficulty: Difficult Time on task: 20 minutes Objective: LO7 AACSB: Written and oral communication Assignment: None Solution: Students’ responses will vary.

Chapter 12 End of Chapter with Solutions Discussion Questions

1. Distinguish among the three most common comparative financial statement techniques. Difficulty: Easy Time on task: 7 minutes Objective: LO 2, 3, 4 AACSB: Application of knowledge Assignment: Homework Solution: The three most common comparative financial statement techniques are vertical analysis, horizontal analysis, and ratio analysis. A horizontal analysis compares the financial statements of an organization across time periods. This type of analysis helps to evaluate the company’s performance from year to year, by comparing the current year’s results against those of a prior year. A vertical analysis compares the relationship of each item on the financial statement to a base amount. The base amount is considered 100%, and every other line item on that financial statement is compared to its base. Financial statement ratios analyze relationships between different financial statement accounts. Ratios can be classified into the following categories: liquidity, efficiency, solvency, profitability, and stock investment.

2. Describe the purpose of each of the four main financial statements. Difficulty: Moderate Time on task: 5 minutes Objective: LO 1

AACSB: Application of knowledge Assignment: Homework Solution: The income statement measures a company’s financial performance over a specific period of time. It reports income and expenses from both operating activities and nonoperating activities. The statement of retained earnings measures how much income has been generated and retained by the company. This statement reconciles the changes in the retained earnings account for the period by starting with the beginning balances and adding any profits or subtracting any losses or dividends to determine the balance in retained earnings for the end of the accounting period, with the ending balance reported on the balance sheet. The balance sheet reports the financial position of a company as of a certain date, which includes its assets, liabilities, and equity. The statement of cash flows presents information on the sources and uses of cash for a given accounting period.

3. Are the following ratios useful in assessing the liquidity position of a company: return on stockholders’ equity, current ratio, inventory turnover? Discuss. Difficulty: Easy Time on task: 4 minutes Objective: LO 4 AACSB: Application of knowledge Assignment: Test Solution: No, only the current ratio is useful in assessing the liquidity position of a company. Return on stockholders’ equity is useful in assessing profitability, and inventory turnover is useful in assessing efficiency.

4. A high current ratio is not always desirable. Do you agree? Discuss. Difficulty: Difficult Time on task: 7 minutes Objective: LO 4 AACSB: Reflective thinking

Assignment: Test Solution: Yes, I agree. A high current ratio indicates that there are significantly more current assets than current liabilities at a certain point in time. A high current ratio is desirable; however, too high of a current ratio could indicate that the company is not appropriately investing cash in long-term assets that can generate higher returns or is paying down long-term debt that has a high cost of debt.

5. A cash flow statement is very valuable in assessing a company’s debt paying ability. Do you agree? Discuss. Difficulty: Difficult Time on task: 8 minutes Objective: LO 1 and 4 AACSB: Reflective thinking Assignment: Quiz Solution: Yes, I agree. The cash flow statement provides valuable information to assess a company’s debt paying ability. The statement of cash flows presents information on the sources and uses of cash for a given accounting period and provides the change in cash during the period. In addition to the cash flow statement, solvency ratios provide additional data in assessing a company’s debt paying ability (e.g., debt ratio and times-interest earned ratio),

6. The income statement reports assets and liabilities as of a point in time. Do you agree with this statement? Discuss. Difficulty: Easy Time on task: 5 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution:

No, I do not agree. The income statement measures a company’s financial performance over a specific period of time in terms of revenues and expenses. The balance sheet reports the financial position of a company as of a point in time and includes its assets, liabilities, and equity.

7. Accounts receivable turnover gives indication of time needed to convert receivables into cash. A high turnover ratio indicates a very ineffective credit department with low paying customers and very restrictive credit policies. Do you agree? Discuss. Difficulty: Moderate Time on task: 6 minutes Objective: LO 4 AACSB: Reflective thinking Assignment: Quiz Solution: No, I do not agree. A low accounts receivable turnover could indicate that the company needs to reconsider its credit granting policies.

8. For inventory turnover, the higher the turnover, the more rapidly the inventory is sold. The ratio may be distorted if a company carries a lot of obsolete inventory. A high ratio could indicate possible stock-outs. Do you agree? Discuss. Difficulty: Difficult Time on task: 9 minutes Objective: LO 4 AACSB: Reflective thinking Assignment: Homework Solution: Yes, I agree. The higher the inventory turnover ratio, the more rapidly the inventory is sold. If the company has a lot of obsolete inventory that is not selling, this could cause a lower inventory turnover ratio resulting from inventory on hand that is not selling. Also, a high inventory turnover ratio could be an indication of possible stock-outs as it indicates the company has a low inventory on hand balance and might not be carrying enough inventory to meet demand.

9. All of the following are assets: Accounts Payable, Inventory, Retained Earnings, and Accounts Receivable. If not, explain where the items that are not assets should be included. Difficulty: Difficult Time on task: 6 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Test Solution: Inventory and Accounts Receivable are types of assets; specifically, they are current assets. Retained Earnings is a type of equity account and Accounts Payable is a liability account, specifically, a current liability.

10. XN suggests that having the highest amount of cash flows from operating activities is generally better than cash flows from investing or financing activities. Do you agree? Discuss. Difficulty: Difficult Time on task: 5 minutes Objective: LO 1 AACSB: Reflective thinking Assignment: Quiz Solution: Yes, I agree. Higher cash flows from operating activities is generally better than cash flows from investing or financing activities. Cash flows from operations represent the cash sources and uses from day-to-day operations of the business and generally are indicative of future sustainable positive cash flows. High investing cash inflows represent increases in cash related to the sale of longterm assets or collection of loans. High financing inflows represent issuance of stock or borrowing of money from creditors. Neither of these cash sources (investing or financing) is sustainable or expected to happen each year.

11. Past financial information and ratios are all that is necessary to evaluate the performance of a company. Supplier, employee, and customer relationships; innovation; time to process; scrap; and yields are just vague qualitative concepts that are not relevant because they are difficult to quantify from general ledger accounts into meaningful data. Do you agree? Discuss. Difficulty: Moderate Time on task: 5 minutes Objective: LO 5 AACSB: Application of knowledge Assignment: Homework Solution: No, I do not agree. To thoroughly evaluate a company’s performance, users of financial information must also understand and evaluate other qualitative information like supplier, employee, and customer relationships; innovation; time to process; scrap; and yields that impacts a company’s results. This information can come from structured or unstructured data either internal or external to the company (i.e., Big Data).

12. Describe how the IPO model can be integrated with data analytics. Difficulty: Moderate Time on task: 6 minutes Objective: LO 5 AACSB: Information technology Assignment: Homework Solution: The IPO model can be used as a framework when designing and executing data analytics. Once the company has defined its information needs, decisions will be made on how to gather the information (inputs), process this information (processes), and analyze the information (outputs) to help management make better decisions and add value to the organization. The specific data to be gathered and output to be analyzed will vary based on the information needs of the company’s internal and external stakeholders.

13. The IMA identified six areas that a managerial accountant needs in order to remain relevant in today’s business environment. These areas include strategy, planning and performance, reporting and control, technology and analytics, business acumen and operations, leadership, and professional ethics and values. Based on your coursework to date, describe how your education has prepared you to be successful in each of these areas and identify any areas that you still need to improve upon. Difficulty: Easy Time on task: 6 minutes Objective: LO 6 AACSB: Application of knowledge Assignment: Homework Solution: This question requires students to provide their opinion on IMA’s identified core competencies. Answers may vary based on students’ responses to their different educational experiences.

Exercises 1. Select the letter of the description that best fits each ratio or analysis. Choose from: a. reports all amounts as percentages of a base amount b. prepared to show the relationship of each item on the financial statement to a base amount c. measure a company’s ability to pay its long-term debts d. current assets less current liabilities e. process of comparing a company’s results to that of another competitor or against industry averages f. cash, short-term investments, and net accounts receivable divided by current liabilities g. expanded form of horizontal analysis that allows financial statement users to compare several years of information against a base year, to see the percentage change over time h. measure how efficiently the company is operating i. measures the company’s ability to pay for its current obligations with its current assets j. analyzes the financial statements of an organization across time periods k. calculated to assess how well a company is performing l. measures how quickly a company can collect cash from its credit customers m. calculates how much of a company’s assets are financed with debt n. measures how well a company is utilizing its assets to earn a profit o. measures how many times a company can sell its average inventory in a given period

p. calculates the ratio of total stockholders’ equity to the number of common shares outstanding q. calculates a company’s ability to pay its interest expense from its income r. amount of net income earned for each share of the company’s average common stock outstanding s. measure a company’s ability to pay its short-term obligations as they become due t. compares the market price of each share to the earnings per share 1.____ times interest earned 2.____ common size financial statement 3. ___ earnings per share 4. ____ vertical analysis 5. ___ horizontal analysis 6. _____ accounts receivable turnover ratio 7. ____ benchmarking 8. ____ quick ratio (acid test) 9. ____ inventory turnover ratio 10. ___ return on total assets ratio 11. ___ working capital 12. ___ book value per share of common stock 13. ___ trend percentages 14. ___ debt ratio 15. ___ current ratio 16. ___ liquidity ratios 17. ____ price/earnings ratio 18. ___ solvency ratios 19. ____ efficiency ratios 20. ____ profitability ratios

Difficulty: Easy Time on task: 7 minutes Objective: LO 2 (#5, #13), 3 (#2, #4, #7), 4 (all others) AACSB: Application of knowledge Assignment: Quiz Solution: 1. q 2. a 3. r 4. b 5. j

6. l 7. e 8. f 9. o 10. n 11. d 12. p 13. g 14. m 15. i 16. s 17. t 18. c 19. h 20. k

2. Match each of the following decisions to the phase of the IPO model the decision relates to. 1. 2. 3. 4. 5. 6.

What type of system should be used to analyze captured data? How frequently is the information provided to decision makers? What type of data should be analyzed? Where is the data being captured and stored? In what format should information be provided to decision makers? Is artificial intelligence needed to collect and analyze unstructured data?

Difficulty: Easy Time on task: 7 minutes Objective: LO 5 AACSB: Application of knowledge Assignment: Quiz Solution: 1. Process 2. Output 3. Input 4. Input 5. Output 6. Process

3. What would be the effect of each of the following transactions on each of the following ratios? An example is provided for you. Example: Collect $10,000 on outstanding accounts receivable. Increase, Decrease or No Effect Current ratio

No effect

Quick ratio

No effect

The current ratio is calculated as current assets divided by current liabilities. Collecting on accounts receivable results in an increase in cash and a decrease in accounts receivable. Both are current asset accounts; therefore, the net effect of the cash collection is zero on the current ratio. The quick (acid-test) ratio is similar to the current ratio except certain current assets are excluded. If you struggle with the accounts, another way to solve the problem is to come up with your own values, plug the values into the ratio equation, and compare the results prior to and subsequent to the activity. Required: On December 30, the company had cash of $300,000, a current ratio of 1.5:1 and a quick ratio of .5:1. On December 31, all cash was used to reduce accounts payable. Increase, Decrease or No Effect Current ratio Quick ratio Difficulty: Moderate Time on task: 5 minutes Objective: LO 4 AACSB: Reflective thinking Assignment: Homework Solution: Increase, Decrease or No Effect Current ratio

Increase

Quick ratio

Decrease

Explanation assuming total current assets were $1,500,000, quick assets are $500,000, and current liabilities are $1,000,000. Current Ratio: Before: 1,500,000/1,000,000 = 1.5 After $300,000 payment: (1.500,000 - 300,000)/(1,000,000 - 300,000) = 1.7 Quick ratio: Before: 500,000/1,000,000 = .5 After $300,000 payment: (500,000 - 300,000)/(1,000,000 - 300,000) = .28 4. Mariah Company is currently preparing an income statement budget for 2023. Mariah, the owner of Mariah Company, requests assistance with analyzing results of operations in 2022. a. In 2022, Mariah Company had net income of $500, representing 10% of all sales. What were total sales? Difficulty: Easy Time on task: 2 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution: A common-size income statement or the return on sales ratio can be used to calculate total sales. Net income as % of sales = Net income/Total sales 10% = $500/Total Sales Total Sales x 10% = $500 Total Sales = $5,000 b. If total sales are $5,000 and one-fourth of all sales were cash sales, what were credit sales? Difficulty: Easy Time on task: 2 minutes Objective: LO 1 AACSB: Analytical thinking Assignment: Homework Solution:

If total sales are 100%, cash sales represent 25% of all sales, then 75% of all sales must be on credit. Mathematically, to calculate the total credit sales, multiply the total sales times 75% or $5,000 x 75% = $3,750.

Total Sales 100%

Cash Sales 25%

Credit Sales 75%

c. If total sales are $5,000 and gross profit represents 60% of sales, what was the cost of goods sold? Difficulty: Easy Time on task: 3 minutes Objective: LO 3 AACSB: Analytical thinking Assignment: Homework Solution: A common-size income statement or the gross margin ratio can be used to calculate COGS for Mariah Company. If total sales are 100%, gross profit represents 60% of sales, then 40% of all sales must be cost of goods sold. Mathematically, to calculate the total cost of goods sold, multiply the total sales times 40% or $5,000 x 40% = $2,000.

Total Sales 100%

COGS 40%

Gross Profit 60% d. If total sales are $5,000, COGS is $2,000, and net income is $500, what were operating expenses (assuming no other gains or losses to report)? Difficulty: Moderate Time on task: 6 minutes Objective: LO 1 AACSB: Analytical thinking Assignment: Homework Solution: The income statement is as follows: Sales - COGS Gross profit - Operating Expenses Net income To calculate the total operating expenses, plug in the known values and solve for the operating expenses. Algebraically: Sales - COGS - Operating expenses = Net Income 13

$5,000 - 2,000 - Operating expenses = $500 $3,000 - Operating expenses = $500 - Operating expenses = -$2,500 Operating expenses = $2,500 5. Morgan’s financial statement had the following balances at year end:

Cash

$120,000

Short-term investments

140,000

Accounts receivable (net)

160,000

Inventory

100,000

Prepaid expenses

30,000

Investments, property, plant and equipment

350,000

Accounts payable

75,000

Accrued expenses payable

90,000

a. What was the amount of the current assets? b. What was the amount of the current liabilities? c. What was the quick ratio? d. What was the current ratio? e. What actions could the company take to increase the quick ratio and current ratio? Difficulty: Moderate Time on task: 9 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Quiz Solution:

a. Current assets = Cash + Short-term investments + Accounts receivable (net) + Inventory + Prepaids = $120,000 + 140,000 + 160,000 + 100,000 + 30,000 = $550,000 b. Current liabilities = Accounts payable + Accrued expenses payable = $75,000 + 90,000 = $165,000 c. Quick ratio = Cash + Short‐term investments + Accounts receivable (net) ÷ Current liabilities = ($120,000 + 140,000 + 160,000) ÷ 165,000 = 420,000 ÷ 165,000 = 2.55 d. Current ratio = Current assets ÷ Current liabilities = $550,000 ÷ $165,000 = 3.33 e. To increase the quick and current ratios, the company could pay off some of its current liabilities with cash, sell long-term assets for cash, or issue long-term debt or equity for cash.

6. Whitney has working capital of $1,600. Cash is $600, merchandise inventory $1,700, and current liabilities are $1,500. The only other current account is accounts receivable. a. What is the amount of accounts receivable? b. Should receivables, inventory, and accounts payable all trend in the same direction (increase or decrease)? Explain. c. What other information would you like to know about inventory and accounts payable? Difficulty: Difficult Time on task: 11 minutes Objective: LO 4 AACSB: Analytical thinking (a), Reflective thinking (b & c) Assignment: Test Solution: a. $800. Use the working capital formula to solve for accounts receivable.

Working capital = Current assets - Current liabilities Working capital = (Cash + Accounts receivable + Merchandise inventory) - Current liabilities $1,600 = ($600 + Accounts receivable + $1,700) - $1,500 $1,600 = Accounts receivable + $800 $800 = Accounts receivable b. All of the accounts do not necessarily have to trend in the same direction. Inventory and accounts payable should trend in the same direction relating to purchasing inventory on account, and receivables and revenue should trend in the same direction relating to sales of merchandise to customers on account. c. Some additional information that might be useful in analyzing inventory and accounts payable includes: ● How long has the inventory been on hand by inventory type? ● Is any of the inventory on hand obsolete? ● Were there any inventory stockouts? ● Are there any cash discounts that we should be taking advantage of? ● What are the terms of payments with the vendor? ● What were the variances from budget? Were there deviations from plan?

7. The following information pertains to Kenia Corporation as of the beginning of the current fiscal year: Liabilities

$60,000

Stockholders’ equity

500,000

Shares of common stock issued and outstanding

10,000

Net income

30,000

On 1/1, the company had issued 2,000 shares of common stock with $10 per share market value. a. Identify the impact of a company's stock issuance on the following ratios (increase, decrease, or no effect).

Increase, Decrease, or No Effect Debt ratio Earnings per share Difficulty: Difficult Time on task: 5 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Homework Solution: Increase, Decrease, or No Effect Debt ratio

Decrease

Earnings per share

Decrease

Debt ratio = Total liabilities/Total assets Before = $60,000/(60,000 + 500,000) = $60,000/$560,000 = 0.11 After = $60,000/($560,000 + 20,000) = $60,000/$580,000 = 0.10 Earnings per share = Net income - Preferred dividends/Weighted average shares outstanding Before = ($30,000 - 0)/10,000 shares = $3 per share After = ($30,000 - 0)/(10,000 + 2,000) shares = $2.50 per share

b. Do you believe that besides ratios, other information such as customer satisfaction, quality of new products, and employee skills are needed in order to understand management’s true performance? Discuss. Difficulty: Moderate

Time on task: 2 minutes Objective: LO 5 AACSB: Reflective thinking Assignment: Test Solution: Yes, managers should also be cognizant of other qualitative factors that can affect the company’s results such as customer satisfaction, quality of new products, and employee skills. By reviewing both financial and nonfinancial measures, management ensures that any decisions made will support both the immediate and the long-term goals of the company.

8. C Company has 10-year bonds that require the company to maintain a times-interest earned ratio above 5.0. A times-interest earned ratio below 5.0 results in the C Company defaulting on the bonds and having to pay back any outstanding amount on the bonds immediately. Complete the following steps to calculate the times-interest earned ratio and determine if it meets the debt covenant for the current year. a. C Company has long-term liabilities consisting of 4%, 10-year bonds of $20,000. What is the interest expense for the year? b. Total sales were $18,000 and gross profit rate was 60%. What is gross profit? c. Based on your answer to letter b above and selling and other operating expenses of $4,900 (including $1,000 of depreciation but excluding interest expense calculated in a), what is income before taxes? d. Based on your answer in letter c above, if the tax rate is 20%, what is net income? e. What is the times-interest earned? f.

Did C Company default on the debt covenant this year? Otherwise stated, did the C Company achieve a times-interest earned ratio less than 5.0 that would require it to pay back all outstanding bonds immediately? Difficulty: Moderate Time on task: 9 minutes Objective: LO 1 (a - d), LO 4 (e & f) AACSB: Analytical thinking Assignment: Quiz

Solution: a. $800. Interest expense is calculated as Principal x Rate x Time. Interest expense: $20,000 x 4% x 12/12 = 800. b. $10,800. Gross profit is calculated by multiplying the total sales times 60%: $18,000 x 60% = $10,800. c. $5,100. Income before taxes is calculated by subtracting selling and other operating expenses from gross profit: $10,800 - 4,900 - 800 = $5,100. d. $4,080. Net income is calculated by subtracting income tax expense from income before taxes. Income tax expense is 20% of income before taxes: $1,020 ($5,100 x 20%) = $5,100 - $1,020 = $4,080. e. Times interest earned = Income from operations/Interest expense = ($5,100 + $800)/$800 = 7.4x f. No, C Company did not default on their debt covenant as their timesinterest earned ratio of 7.4x exceeded the minimum requirement of 5.0x.

9. The Institute of Management Accountants’ Statement of Ethical Professional Practice Standards include the standards: competence, confidentiality, credibility, and integrity. For each of the following scenarios, discuss whether one or more of the standards has been violated. a. The controller reclassified some of the manufacturing overhead to administrative expenses so that gross margin would be in line with last year. Net income is the same. b. The controller reclassified some of the debt due next year to long-term so that the current ratio was in line with the industry number. c. The controller included sales for inventory that had been ordered but not shipped. Without that revenue, the company would not meet the targets required on the loans. Difficulty: Moderate Time on task: 7 minutes Objective: LO 4 AACSB: Ethical understanding and reasoning Assignment: Homework Solution: Yes, the IMA Statement of Ethical Professional Practice Standards has been violated. The controller violated three standards:

●

● ●

Competence: Perform professional duties in accordance with all laws, regulations, and policies and to provide decision support information and recommendations that are accurate, clear, concise and timely. Integrity: Be honest and trustworthy at all times, no matter what the circumstance. Credibility: Present information fairly, objectively, and without bias to intended users of the information.

The correct accounting under each scenario is: ● Scenario A: manufacturing overhead should be included within inventory and expensed when sold. ● Scenario B: all debt due within the next year should be classified as a current liability. ● Scenario C: revenue should only be recorded when it satisfies all revenue recognition principles. Inventory that has been ordered but not been provided to the customer is still considered inventory and should not be recorded as revenue.

10. With respect to financial statement analysis, answer true or false for each of the following statements. a. Financial ratios illustrate financial information relationships for comparison purposes and are derived generally from the income statement, balance sheet, and cash flow statement. b. Financial ratios can only provide managers with trends because outside users such as investors and analysts do not have the training to assess progress against predetermined goals, competitors, or the overall industry. c. Financial statement analysis is required by generally accepted accounting principles and standards of ethical conduct. d. Financial statement analysis can assist in identifying areas where improvements can be made. e. Ratios are easy to calculate and use, and they provide some insight into the operations of the business. But other information can also be important, such as industry and economic trends, employee skills, customer preferences, and operational metrics. Difficulty: Difficult Time on task: 7 minutes Objective: LO 4 and LO 5 AACSB: Application of knowledge

Assignment: Test Solution: a. True b. False c. False d. True e. True 11. Using the following information, indicate the proper sections of the statement of cash flows for each of the transactions by inserting the proper letter in the spaces provided. Choose from: A. Operating Activities B. Investing Activities C. Financing Activities

Items

Sections of Cash Flow Statement

Cash income (cash revenue less cash expenses) Equipment was sold The company borrowed from the bank Dividends were paid A truck was purchased for cash Preferred stock was issued for cash Difficulty: Moderate Time on task: 5 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Quiz Solution: Items Cash income (cash revenue less cash expenses) Equipment was sold The company borrowed from the bank Dividends were paid A truck was purchased for cash Preferred stock was issued for cash

Sections of Cash Flow Statement A. Operating B. Investing C. Financing C. Financing B. Investing C. Financing

12. The following ratios are from the most recent financial statements for Company XYZ and Company ABC both operating within the same industry. a. For each ratio: (1) identify the type of ratio (liquidity, efficiency, solvency, or profitability), and (2) identify the company with the better ratio.

Ratio

(1) Type of Ratio

XYZ

ABC

Inventory turnover

4.27

5.11

Current ratio

1.00

1.25

EPS

$3.48

$6.47

Debt ratio

4.35

89.2

(2) Which Company Has the Better Ratio?

b. After evaluating the ratios above, which company would you purchase stock in: XYZ or ABC and briefly explain how you made your decision.

Difficulty: Moderate Time on task: 11 minutes Objective: LO 4 AACSB: Reflective thinking Assignment: Quiz Solution: a.

Ratio

(1) Type of Ratio

XYZ

ABC

(2) Which Company Has the Better Ratio?

Inventory turnover

Efficiency

4.27

5.11

ABC

Current ratio

Liquidity

1.00

1.25

ABC

EPS

Profitability

$3.48

$6.47

ABC

Debt ratio

Solvency

0.48

0.89

XYZ

b. From an efficiency, liquidity, and profitability standpoint, Company ABC appears to be the better investment. However, there are concerns over ABC Company’s solvency, with 89% financed using debt and almost twice as much as competitor XYZ. Additional information about ABC’s debt or the future outlook for XYZ could assist in making a better investment decision.

13. The IMA Management Accounting Competency Framework identifies six domains and core competencies management accountants must possess in order to perform their jobs effectively in today’s world of rapidly changing technologies. Match the domains listed with the respective core competencies identified. a. b. c. d. e. f.

Strategy, Planning and Performance Reporting and Control Technology and Analytics Business Acumen and Operations Leadership Professional Ethics and Values _____1. Communication skills _____ 2. Legal and regulatory requirements _____ 3. Internal controls _____ 4. Budgeting and forecasting _____ 5. Enterprise risk management _____ 6. Financial statement analysis _____ 7. Data analytics _____ 8. Decision analysis _____ 9. Data visualizations _____ 10. Industry specific knowledge _____ 12. Change management

Difficulty: Moderate Time on task: 8 minutes Objective: LO 6 AACSB: Reflective thinking Assignment: Quiz Solution: e.___1. Communication skills f.___ 2. Legal and regulatory requirements b.___ 3. Internal controls a.___ 4. Budgeting and forecasting 23

a.___ 5. Enterprise risk management b.___ 6. Financial statement analysis c ___ 7. Data analytics a.___ 8. Decision analysis c.___ 9. Data visualizations d.___ 10. Industry specific knowledge e.___ 12. Change management

Problems 1. Classify each of the following accounts as being included on the Income Statement (I/S) or Balance Sheet (B/S); if B/S, choose from the categories below. The first three are completed to illustrate. Current Asset (CA) Intangible Assets (IA) Investments (I) Current Liabilities (CL) Property, Plant, & Equipment (PPE) Accounts Accounts Payable Accounts Receivable Accumulated Depreciation Bonds Payable Buildings Cash Capital Stock

Long-Term Liabilities (LL) Stockholders’ Equity (SE)

I/S B/S x x x

B/S Category CL CA PPE

Cost of Goods Sold Equipment Gain on Sale of Land Goodwill Interest Payable Inventory Land Loss on Sale of Equipment Notes Payable – 6 months Prepaid Insurance

Rent Revenue Retained Earnings Salaries Expense Sales Trading Securities Unearned Revenue Warranty Obligation Difficulty: Moderate Time on task: 9 minutes Objective: LO 1 AACSB: Application of knowledge Assignment: Homework Solution: Accounts Accounts Payable Accounts Receivable Accumulated Depreciation Bonds Payable Buildings Cash Capital Stock Cost of Goods Sold Equipment Gain on Sale of Land Goodwill Interest Payable Inventory Land Loss on Sale of Equipment Notes Payable – 6 months Prepaid Insurance Rent Revenue Retained Earnings Salaries Expense Sales Unearned Revenue Warranty Obligation

x x x x x x x

B/S Category CL CA PPE LL PPE CA SE

PPE

X x x x

IA CL CA PPE

x x

CL CA

x x

CL CL

I/S B/S

x x

x x x

2. A company’s year-end balance sheet is shown below: Assets Cash

$300,000

Accounts receivable

480,000

Inventory

320,000

Investments

300,000

Property, plant and equipment (net)

1,000,000

Intangible assets

200,000

Total assets

$2,600,000

Liabilities and Stockholders’ Equity Current liabilities

$400,000

Long-term liabilities

550,000

Common stock

750,000

Retained earnings

900,000

Total liabilities and stockholders’ equity

$2,600,000

a. What is the debt ratio? b. What other information about the existing long-term debt would creditors and other users want to know before granting more loans? c. What additional information would investors want to know about property, plant and equipment? d. What additional information would users want to know about the common stock?

Difficulty: Moderate Time on task: 19 minutes Objective: LO 4 and LO 5 AACSB: Application of knowledge (a), analytical thinking (b - e) 26

Assignment: Homework Solution: a. Debt ratio = Total liabilities/Total assets = ($400,000 + 550,000)/$2,600,000 = 0.37 b. Other information about existing long-term debt users might be interested before granting additional loans include: ● What is the maturity date of the existing long-term debt? ● What is the interest rate of the existing long-term debt? ● What is the company’s current times-interest earned ratio? c.

Other information about property, plant and equipment include: ● What is the average useful life? ● How far are the assets into their useful lives? ● Are there any technologies that are obsolete and might require replacement before the end of the useful life?

Other information about stock include: ● What are the classes of stock? ● What were any repurchases of stock used to purchase? ● Were there any dividends declared?

3. On December 31, 2022, Madison Company had the following balances in selected asset accounts:

a. Conduct a horizontal and vertical analysis on each of the assets using the template provided. To conduct the industry horizontal analysis, compare Madison current year to

industry current year.

b. Discuss the differences in Madison’s current year inventory balance to prior year and industry inventory balances. What is one reason for the differences in inventory balance? c. Calculate Madison’s current ratio for this year, the previous year, and industry assuming current liabilities total $1,000, $1,500, and $2,500, respectively. How does Madison’s liquidity position appear? Difficulty: Easy Time on task: 9 minutes Objective: LO 2, 3, 4 AACSB: Analytical thinking (c), reflective thinking (b), application of knowledge (a) Assignment: Test Solution: a.

If students complete in Excel, the appropriate formulas are:

b. Madison’s current year inventory balance was $200 lower than prior year and $100 higher than industry. A higher inventory balance or an increase in the inventory balance could indicate lower customer demand than expected, potentially resulting in obsolescence or expectations of higher demand in the future. A lower or decrease in the inventory balance could indicate possible higher customer demand than expected, potentially resulting in stockouts or expectations of lower demand in the future.

c. Current ratio = Current assets/Current liabilities; current assets include cash, accounts receivable, inventory, and prepaid expenses Madison Current Year = (300 + 1,200 + 500 +100)/1,000 = 2.10 Madison Prior Year = (450 + 850 + 700 + 60)/1,500 = 1.37 Industry = (650 + 1,100 + 400 + 150)/2,000 = 1.53 Madison’s liquidity position through review of the current ratio has improved over prior year and is better than the industry average. A current ratio greater than 2 is ideal. If students complete in Excel, the appropriate formulas are:

4. Ildi Co. is looking to expand operations. Ildi does not have enough cash on hand to pay for the expansion and, therefore needs to borrow additional funds. Currently, Ildi has outstanding debt of $450,000, which is subject to certain debt covenants. Ildi is required to maintain a maximum debt ratio. If the debt ratio rises above the threshold, the entire debt is required to be paid back immediately (comes due). a. Ildi Co. has total debt of $450,000 and stockholders’ equity of $500,000. What is the current debt ratio? b. Based on your answer to a above and the bank stipulating that the debt ratio cannot exceed .5, what is the maximum additional amount that Ildi will be able to borrow? c. What other information could Ildi provide the bank to persuade it to lend the money? Difficulty: Difficult Time on task: 11 minutes Objective: LO 4 AACSB: Analytical thinking Assignment: Test Solution: a. Debt ratio = Total liabilities/Total assets* = 450,000/(450,000 + 500,000) = .47 * Total assets are not given but we are able to solve for total assets using the accounting equation: Assets = Liabilities + Stockholder’s equity. b. $50,000. The maximum amount Ildi will be able to borrow is $50,000. This can be solved by plugging in values into the debt ratio equation

(remember, added to the numerator and the denominator) or algebraically. c. Ildi could provide additional information to the bank on its cash flows from operations and projections on future cash collections. These pieces of information provide insight into the company’s ability to maintain positive cash flows. 5. Management’s Discussion and Analysis information (MD&A) for companies typically includes: ▪ Unusual or infrequent transactions ▪ Changes in sales due to price and volume components ▪ Anticipated changes in financing and in investment activities (internal and external) ▪ Information on acquisitions, divestitures, contingencies and commitments, segments, compensation ▪ Planned expansions: required fixed assets and infrastructure, personnel and other operating expenses, lease commitments, product life cycles, etc. Look up a public company on the internet and read its MD&A. Comment on the usefulness of this part of the financial statements. Difficulty: Difficult Time on task: 10 minutes Objective: LO 5 and LO 6 AACSB: Analytical thinking Assignment: Homework Solution: Students' answers may vary.

6. Below, you will find the balance sheet data for High Couture, Inc. for Years 2 and 1:

High Couture, Inc. Balance Sheet December 31, Year 2

December 31, Year 1

$20,000

$16,000

Assets Current Assets Cash

Marketable Securities

10,000

14,000

Accounts Receivable (net)

40,000

33,000

Merchandise Inventory

44,000

20,000

Prepaid Expenses

6,000

2,000

$120,000

$85,000

Land

$110,000

$90,000

Building

200,000

Less: Accumulated Depreciation

(60,000)

(55,000)

Equipment

210,000

180,000

Less: Accumulated Depreciation

(20,000)

(10,000)

440,000

405,000

$560,000

$490,000

Accounts Payable

$45,000

$30,000

Salaries Payable

15,000

19,000

Taxes Payable

10,000

6,000

Total Current Liabilities

$70,000

$55,000

85,000

$155,000

$140,000

Total Current Assets Property, Plant & Equipment

Total Property, Plant & Equipment

Total Assets Liabilities and Stockholders’ Equity Current Liabilities

Long-term Liabilities 12% Bonds Payable Total Liabilities Stockholders’ Equity

6% $10 Par Preferred Stock

$65,000

Common Stock ($3 Par)

72,000

69,000

Paid-in Capital in Excess of Par-Common Stock

88,000

86,000

Retained Earnings

180,000

130,000

405,000

350,000

$560,000

$490,000

Total Stockholders’ Equity

Total Liabilities and Stockholders’ Equity

High Couture, Inc Income Statement Sales (all credit)

$ 230,000

Cost of Goods Sold

125,000

Gross margin

105,000

Selling, general, and admin expenses

30,000

Operating income

75,000

Interest expense

7,800

Tax expense

4,020

Net income

$ 63,180

Also known for Year 2: Dividends declared and paid

10,000 (3,900 preferred, 6,100 common)

The market price of the stock

$10 per share

Average common shares outstanding

30,500 shares

a. Compute the following ratios for High Couture for Year 2:

1. Return on total assets 2. Return on equity 3. Earnings per share 4. Price-earnings ratio 5. Dividend yield ratio 6. Times-interest earned 7. Debt ratio 8. Current ratio 9. Quick ratio 10. Inventory turnover 11. Accounts receivable turnover

Difficulty: Moderate Time on task: 25 minutes Objective: LO 4 AACSB: Application of knowledge (a), reflective thinking (b) Assignment: Homework Solution: a.1. Return on total assets = Net income + Interest expense/Average total assets = (63,180 + 7,800 /((560,000 + 490,000)/2) = 70,980/525,000 = 0.14 a.2. Return on equity = Net income Preferred dividends declared/Average common stockholder’s equity = (63,180 - 3,100)/(((405,000 - 65,000) + (350,000 - 65,000))/2) = 60,080/((340,000 + 285,000)/2) = 60,080/312,500 = 0.19 a.3. Earnings per share = Net income Preferred dividends declared/Average common shares outstanding = ($63,180 - $3,100)/30,500 shares = $1.97 per common share a.4. Price-earnings ratio = Market price per common share/Earnings per share = $10 per share/$1.97 per share

= 5.08 a.5. Dividend yield on common stock = Dividend per share of common stock/Market price per common stock = ($6,100/30,500 shares)/$10 per share = $0.20 per share/$10 per share = 0.02 a.6. operations/Interest expense = 75,000/7,800 = 9.6

Times interest earned = Income from

a.7. assets = 155,000/560,000 = 0.28

Debt ratio = Total liabilities/Total

a.8. liabilities = 120,000/70,000 = 1.71

Current ratio = Current assets/Current

a.9. Quick ratio = (Cash + Short‐term investments + Net accounts receivable)/Current liabilities = (20,000 + 10,000 + 40,000)/70,000 = 70,000/70,000 = 1.00 a.10. Inventory turnover = COGS/Average inventory = 125,000/(44,000 + 20,000)/2 = 125,000/32,000 = 3.9 times a year or every 94 days (365 days/3.9x) a.11. Accounts receivable turnover = Net sales/Average accounts receivable = 230,000/(40,000 + 33,000)/2 = 230,000/36,500 = 6.3 times or every 58 days (365 days/6.3x)