Managerial Accounting Tools for Business Decision Making, 6th Edition solution manual by Ace Test Banks

Managerial Accounting Tools for Business Decision Making, 6th Edition BY Weygandt, Kimmel, Kieso

CHAPTER 1 Managerial Accounting ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Do It!

Exercises

*1.

Explain the distinguishing features of managerial accounting.

1, 2, 3

*2.

Identify the three broad functions of management.

4, 5, 6, 7, 8

2, 3

*3.

Define the three classes of manufacturing costs.

11, 12

4, 5, 7

*4.

Distinguish between product and period costs.

*5.

Explain the difference between a merchandising and a manufacturing income statement.

9, 14

*6.

Indicate how cost of goods manufactured is determined.

15, 16, 17, 18

8, 10, 11

*7.

Explain the difference between a merchandising and a manufacturing balance sheet.

10, 19, 20, 21

*8.

Identify trends in managerial accounting.

22, 23, 24 25, 26

A Problems

B Problems

2, 3, 4, 5, 6

1A, 2A

1B, 2B

3, 4, 5, 7, 13

1A, 2A

1B, 2B

8, 12, 13, 14, 15, 17

3A, 4A, 5A

3B, 4B, 5B

8, 9, 10, 11, 3A, 4A, 5A 12, 13, 14, 15, 16, 17

3B, 4B, 5B

14, 15, 16, 17

3B, 4B

3A, 4A

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter.

1-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

1-2

Description

Difficulty Level

Time Allotted (min.)

Classify manufacturing costs into different categories and compute the unit cost.

Simple

20–30

Classify manufacturing costs into different categories and compute the unit cost.

Simple

20–30

Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet.

Moderate

30–40

Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet.

Moderate

30–40

Prepare a cost of goods manufactured schedule and a correct income statement.

Moderate

30–40

Classify manufacturing costs into different categories and compute the unit cost.

Simple

20–30

Classify manufacturing costs into different categories and compute the unit cost.

Simple

20–30

Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet.

Moderate

30–40

Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet.

Moderate

30–40

Prepare a cost of goods manufactured schedule and a correct income statement.

Moderate

30–40

1-3

Learning Objective * 1. Explain the distinguishing features of managerial accounting.

Knowledge

* 2. Identify the three broad functions of management.

* 3. Define the three classes of manufacturing costs.

Q1-11

* 4. Distinguish between product and period costs. * 5. Explain the difference between a merchandising and a manufacturing income statement. * 6. Indicate how cost of goods manufactured is determined.

* 7. Explain the difference between a merchandising and a manufacturing balance sheet. * 8. Identify trends in managerial accounting.

Broadening Your Perspective

Q1-19

Comprehension Q1-1 BE1-1 Q1-2 DI1-1 Q1-3 E1-1 Q1-4 Q1-8 Q1-5 BE1-2 Q1-6 BE1-3 Q1-7 DI1-1 Q1-12 DI1-2 BE1-4 E1-2 BE1-5 E1-3 BE1-7 E1-6 Q1-13 E1-3 BE1-6 DI1-2 Q1-9 Q1-14 E1-15 E1-15

Q1-10 Q1-20 Q1-21 Q1-22 Q1-23 Q1-24 Q1-25 BYP1-4

E1-15

Application

Analysis

E1-4 E1-5

P1-1A P1-2A P1-1B

P1-2B

E1-4 E1-5 E1-7 E1-8 E1-12 E1-13 Q1-15 Q1-16 Q1-17 Q1-18 BE1-8 BE1-10 BE1-11 BE1-9 E1-14 E1-16

E1-13 P1-1A P1-2A E1-14 E1-17 P1-4A DI1-3 E1-8 E1-9 E1-10 E1-11 E1-12 E1-13

P1-1B P1-2B P1-4B

E1-14 E1-16 E1-17 P1-4A P1-4B

E1-17 P1-4A P1-4B

P1-3A P1-5A P1-3B E1-10 E1-11 P1-3A P1-5A P1-3B P1-5B

Synthesis

Evaluation

P1-5B

P1-3A P1-3B

Q1-26 DI1-4 E1-18 BYP1-1

BYP1-2 BYP1-3 BYP1-5 BYP1-6

BYP1-7 BYP1-8 BYP1-9

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) Disagree. Managerial accounting is a field of accounting that provides economic and financial information for managers and other internal users. (b) Joe is incorrect. Managerial accounting applies to all types of businesses—service, merchandising, and manufacturing.

(a) Financial accounting is concerned primarily with external users such as stockholders, creditors, and regulators. In contrast, managerial accounting is concerned primarily with internal users such as officers and managers. (b) Financial statements are the end product of financial accounting. The statements are prepared quarterly and annually. In managerial accounting, internal reports may be prepared as frequently as needed. (c) The purpose of financial accounting is to provide general-purpose information for all users. The purpose of managerial accounting is to provide special-purpose information for specific decisions.

Differences in the content of the reports are as follows: Financial

Managerial

• Pertains to business as a whole and is highly aggregated. • Limited to double-entry accounting and cost data. • Generally accepted accounting principles.

• Pertains to subunits of the business and may be very detailed. • Extends beyond double-entry accounting system to any relevant data. • Standard is relevance to decisions.

In financial accounting, financial statements are verified annually through an independent audit by certified public accountants. There are no independent audits of internal reports issued by managerial accountants. 4.

Budgets are prepared by companies to provide future direction. Because the budget is also used as an evaluation tool, some managers try to game the budgeting process by underestimating their division’s predicted performance so that it will be easier to meet their performance targets. On the other hand, if the budget is set at unattainable levels, managers sometimes take unethical actions to meet targets to receive higher compensation or in some cases to keep their jobs.

Linda should know that the management of an organization performs three broad functions: (1) Planning requires management to look ahead and to establish objectives. (2) Directing involves coordinating the diverse activities and human resources of a company to produce a smooth-running operation. (3) Controlling is the process of keeping the company’s activities on track.

Disagree. Decision making is not a separate management function. Rather, decision making involves the exercise of good judgment in performing the three management functions explained in the answer to question five above.

Employees with line positions are directly involved in the company’s primary revenue generating operating activities. Examples would include plant managers and supervisors, and the vice president of operations. In contrast, employees with staff positions are not directly involved in revenuegenerating operating activities, but rather serve in a support capacity to line employees. Examples include employees in finance, legal, and human resources.

1-4

Questions Chapter 1 (Continued) 8.

CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating results and its financial condition and that the company maintains an adequate system of internal controls. In addition, the composition of the board of directors and audit committees receives more scrutiny, and penalties for misconduct have increased.

The differences between income statements are in the computation of the cost of goods sold as follows: Manufacturing company:

Beginning finished goods inventory plus cost of goods manufactured minus ending finished goods inventory = cost of goods sold.

Merchandising company:

Beginning merchandise inventory plus cost of goods purchased minus ending merchandise inventory = cost of goods sold.

10.

The difference in balance sheets pertains to the presentation of inventories in the current asset section. In a merchandising company, only merchandise inventory is shown. In a manufacturing company, three inventory accounts are shown: finished goods, work in process, and raw materials.

11.

Manufacturing costs are classified as either direct materials, direct labor, or manufacturing overhead.

12.

No, Mel is not correct. The distinction between direct and indirect materials is based on two criteria: (1) physical association and (2) the convenience of making the physical association. Materials which cannot be easily associated with the finished product are considered indirect materials.

13.

Product costs, or inventoriable costs, are costs that are a necessary and integral part of producing the finished product. Period costs are costs that are identified with a specific time period rather than with a salable product. These costs relate to nonmanufacturing costs and therefore are not inventoriable costs.

14.

A merchandising company has beginning merchandise inventory, cost of goods purchased, and ending merchandise inventory. A manufacturing company has beginning finished goods inventory, cost of goods manufactured, and ending finished goods inventory.

15.

(a) (b)

16.

Raw materials inventory, beginning ....................................................................... Raw materials purchases ....................................................................................... Total raw materials available for use ...................................................................... Raw materials inventory, ending ............................................................................ Direct materials used ....................................................................................

$ 12,000 170,000 182,000 (15,000) $167,000

17.

Direct materials used ............................................................................................. Direct labor used.................................................................................................... Total manufacturing overhead ............................................................................... Total manufacturing costs .............................................................................

$240,000 220,000 180,000 $640,000

18.

(a) (b)

$666,000 $634,000

19.

The order of listing is finished goods inventory, work in process inventory, and raw materials inventory.

1-5

X = total cost of work in process. X = cost of goods manufactured.

Total cost of work in process ($26,000 + $640,000)...................................... Cost of goods manufactured ($666,000 – $32,000) ......................................

Questions Chapter 1 (Continued) 20. The products differ in how each are consumed by the customer. Services are consumed immediately; the product is not put into inventory. Meals at a restaurant are the best example where they are consumed immediately by the customer. There could be a long lead time before the product is consumed in a manufacturing environment. 21. Yes, product costing techniques apply equally well to manufacturers and service companies. Each needs to keep track of the cost of production or services in order to know whether it is generating a profit. The techniques shown in this chapter, to accumulate manufacturing costs to determine manufacturing inventory, are equally useful for determining the cost of services. 22. The value chain refers to all activities associated with providing a product or service. For a manufacturer, these include research and development, product design, acquisition of raw materials, production, sales and marketing, delivery, customer relations, and subsequent service. 23. An enterprise resource planning (ERP) system is an integrated software system that provides a comprehensive, centralized resource for information. Its primary benefits are that it replaces the many individual systems typically used for receivables, payables, inventory, human resources, etc. Also, it can be used to get information from, and provide information to, the company’s customers and suppliers. 24. In a just-in-time inventory system, the company has no extra inventory stored. Consequently, if some units that are produced are defective, the company will not have enough units to deliver to customers. 25. The balanced scorecard is called “balanced” because it strives to not over emphasize any one performance measure, but rather uses both financial and non-financial measures to evaluate all aspects of a company’s operations in an integrated fashion. 26. Activity-based costing is an approach used to allocate overhead based on each product’s relative use of activities in making the product. Activity-based costing is beneficial because it results in more accurate product costing and in more careful scrutiny of all activities in the value chain.

1-6

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1-1 Financial Accounting

Managerial Accounting

Primary users

External users

Internal users

Types of reports

Financial statements

Internal reports

Frequency of reports Quarterly and annually

As frequently as needed

Purpose of reports

General-purpose

Special-purpose information for specific decisions

Content of reports

Generally accepted accounting principles

Relevance to decisions

Verification process

Annual audit by certified public accountant

No independent audits

BRIEF EXERCISE 1-2 One implication of SOX was to clarify top management’s responsibility for the company’s financial statements. CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating results and its financial condition. In addition, top managers must certify that the company maintains an adequate system of internal controls to safeguard the company’s assets and ensure accurate financial reports. Also, more attention is now paid to the composition of the company’s board of directors. In particular, the audit committee of the board of directors must be comprised entirely of independent members (that is, non-employees) and must contain at least one financial expert. Finally, to increase the likelihood of compliance with these and other new rules, the penalties for misconduct were substantially increased. BRIEF EXERCISE 1-3 (a) 1. Planning. (b) 2. Directing. (c) 3. Controlling.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

1-7

BRIEF EXERCISE 1-4 (a) (b) (c) (d)

DM DL MO MO

Frames and tires used in manufacturing bicycles. Wages paid to production workers. Insurance on factory equipment and machinery. Depreciation on factory equipment.

BRIEF EXERCISE 1-5 (a) (b) (c) (d) (e) (f) (g) (h)

Direct materials. Direct materials. Direct labor. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct materials. Manufacturing overhead.

BRIEF EXERCISE 1-6 (a) (b) (c) (d) (e) (f)

Product. Period. Period. Period. Product. Product.

BRIEF EXERCISE 1-7

Direct Materials (a) (b) (c) (d)

1-8

Product Costs Direct Factory Labor Overhead X

X X X

BRIEF EXERCISE 1-8 (a) Direct materials used ........................................................... Direct labor............................................................................ Total manufacturing overhead............................................. Total manufacturing costs ...........................................

$180,000 209,000 208,000 $597,000

(b) Beginning work in process .................................................. Total manufacturing costs ................................................... Total cost of work in process .......................................

$ 25,000 597,000 $622,000

BRIEF EXERCISE 1-9 RUIZ COMPANY Balance Sheet December 31, 2014 Current assets Cash................................................................... Accounts receivable ......................................... Inventories Finished goods.......................................... Work in process ........................................ Raw materials ............................................ Prepaid expenses ............................................. Total current assets ..........................

$ 62,000 200,000 $91,000 87,000 73,000

251,000 38,000 $551,000

BRIEF EXERCISE 1-10 Direct Materials Used (1) (2) (3)

Direct Labor Used

$81,000 $144,000

1-9

Factory Overhead

Total Manufacturing Costs $151,000

BRIEF EXERCISE 1-11 Total Manufacturing Costs (1) $151,000* (2) (3)

Work in Process (January 1)

Work in Process (December 31)

Cost of Goods Manufactured $189,000

$123,000 $58,000

*$40,000 + $61,000 + $50,000 (data from BE 1-10) SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 1-1 1. 2. 3. 4. 5. 6.

False False False True True True

DO IT! 1-2 Period costs: Advertising Salaries of sales representatives Product costs: Blank CDs (DM) Depreciation of CD image burner (MO) Salary of factory manager (MO) Factory supplies used (MO) Paper inserts for CD cases (DM) CD plastic cases (DM) Salaries of factory maintenance employees (MO) Salaries of employees who burn music onto CDs (DL)

1-10

DO IT! 1-3 FISHEL COMPANY Cost of Goods Manufactured Schedule For the Month Ended April 30 Work in process, April 1 ................................ Direct materials .............................................. Raw materials, April 1 ............................... $ 10,000 Raw materials purchases .......................... 98,000 Total raw materials available for use........ 108,000 Less: Raw materials, April 30 .................. 14,000 Direct materials used ................................ $ 94,000 Direct labor ..................................................... 80,000 Manufacturing overhead ................................ 180,000 Total manufacturing costs ............................ Total cost of work in process ........................ Less: Work in process, April 30 ................... Cost of goods manufactured ........................ DO IT! 1-4 1. 2. 3. 4. 5. 6.

f a c d e b

1-11

5,000

354,000 359,000 3,500 $355,500

SOLUTIONS TO EXERCISES EXERCISE 1-1 1. False. Financial accounting focuses on providing information to external users. 2. True. 3. False. Preparation of budgets is part of managerial accounting. 4. False. Managerial accounting applies to service, merchandising and manufacturing companies. 5. True. 6. False. Managerial accounting reports are prepared as frequently as needed. 7. True. 8. True. 9. False. Financial accounting reports must comply with generally accepted accounting principles. 10. False. Managerial accountants are expected to behave ethically, and there is a code of ethical standards for managerial accountants. EXERCISE 1-2 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

(b) (c) (c) (c) (a) (b) (c) (c) (c) (a)

Direct labor.* Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct labor. Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials.

*or sometimes (c), depending on the circumstances

1-12

EXERCISE 1-3 (a) Materials used in product ...... DM Depreciation on plant .......... MOH Property taxes on store.....Period Labor costs of assembly line workers ........................... DL Factory supplies used ......... MOH

Advertising expense .............. Period Property taxes on plant ............ MOH Delivery expense .................... Period Sales commissions ................ Period Salaries paid to sales clerks ... Period

(b) Product costs are recorded as a part of the cost of inventory because they are an integral part of the cost of producing the product. Product costs are not expensed until the goods are sold. Period costs are recognized as an expense when incurred.

EXERCISE 1-4 (a) Factory utilities ....................................................................... Depreciation on factory equipment ...................................... Indirect factory labor .............................................................. Indirect materials.................................................................... Factory manager’s salary ...................................................... Property taxes on factory building ....................................... Factory repairs ....................................................................... Manufacturing overhead ........................................................

$ 15,500 12,650 48,900 80,800 8,000 2,500 2,000 $170,350

(b) Direct materials ...................................................................... Direct labor ............................................................................. Manufacturing overhead ........................................................ Product costs .........................................................................

$137,600 69,100 170,350 $377,050

(c) Depreciation on delivery trucks............................................ Sales salaries ......................................................................... Repairs to office equipment .................................................. Advertising ............................................................................. Office supplies used .............................................................. Period costs ...........................................................................

1-13

3,800 46,400 1,300 15,000 2,640 $ 69,140

EXERCISE 1-5 1. 2.

3. 4.

(a) (c)

5. 6.

(b)* (d)

7. 8.

(a) (b)

9. 10.

*or sometimes (c), depending on the circumstances. EXERCISE 1-6 1. (b) 2. (c) 3. (a) 4. (c) 5. (c) 6. (c) 7. (c) 8. (c) 9. (c) 10. (c)

EXERCISE 1-7 (a)

(b)

1-14

Delivery service (product) costs: Indirect materials Depreciation on delivery equipment Dispatcher’s salary Gas and oil for delivery trucks Drivers’ salaries Delivery equipment repairs Total

$ 5,400 11,200 5,000 2,200 16,000 300 $40,100

Period costs: Property taxes on office building CEO’s salary Advertising Office supplies Office utilities Repairs on office equipment Total

$ 870 12,000 3,600 650 990 180 $18,290

EXERCISE 1-8 (a) Work-in-process, 1/1 ............................... Direct materials used .............................. Direct labor .............................................. Manufacturing overhead Depreciation on plant ....................... Factory supplies used ..................... Property taxes on plant ................... Total manufacturing overhead ............... Total manufacturing costs...................... Total cost of work-in-process ................ Less: ending work-in-process ................ Cost of goods manufactured ..................

$ 12,000 $120,000 110,000 $60,000 23,000 14,000 97,000

(b) Finished goods, 1/1 ................................. Cost of goods manufactured ................. Cost of goods available for sale............. Less: Finished goods, 12/31.................. Cost of goods sold ..................................

327,000 339,000 15,500 $323,500 $ 60,000 323,500 383,500 45,600 $337,900

EXERCISE 1-9 Total raw materials available for use: Direct materials used ....................................................... Add: Raw materials inventory (12/31) ........................... Total raw materials available for use ..............................

$190,000 22,500 $212,500

Raw materials inventory (1/1): Total raw materials available for use: Direct materials used ....................................................... Add: Raw materials inventory (12/31) ........................... Total raw materials available for use .............................. Less: Raw materials purchases ...................................... Raw materials inventory (1/1) ..........................................

$190,000 22,500 212,500 158,000 $ 54,500

Total cost of work in process: Cost of goods manufactured ........................................... Add: Work in process (12/31) .......................................... Total cost of work in process ..........................................

$530,000 81,000 $611,000

1-15

EXERCISE 1-9 (Continued) Total manufacturing costs: Total cost of work in process ................................. Less: Work in process (1/1) .................................... Total manufacturing costs ...................................... Direct labor: Total manufacturing costs ...................................... Less: Total overhead ............................................... Direct materials used .................................... Direct labor ...............................................................

$611,000 210,000 $401,000

$401,000 $122,000 190,000

312,000 $ 89,000

EXERCISE 1-10 A + $57,000 + $46,500 = $195,650 A = $92,150

$252,500 – $11,000 = F F = $241,500

$195,650 + B = $221,500 B = $25,850

$130,000 + G + $102,000 = $253,700 G = $21,700

$221,500 – C = $185,275 C = $36,225

$253,700 + H = $337,000 H = $83,300

$68,400 + $86,000 + $81,600 = D D = $236,000

$337,000 – $70,000 = I I = $267,000

$236,000 + $16,500 = E E = $252,500 Additional explanation to EXERCISE 1-10 solution: Case A (a) Total manufacturing costs ...................................... Less: Manufacturing overhead ............................... Direct labor .................................................... Direct materials used ...............................................

1-16

$195,650 $46,500 57,000

103,500 $ 92,150

EXERCISE 1-10 (Continued) (b) Total cost of work in process ................................. Less: Total manufacturing costs ............................ Work in process (1/1/14)..........................................

$221,500 195,650 $ 25,850

(c) Total cost of work in process ................................. Less: Cost of goods manufactured ........................ Work in process (12/31/14)......................................

$221,500 185,275 $ 36,225

Case B (d) Direct materials used .............................................. Direct labor............................................................... Manufacturing overhead ......................................... Total manufacturing costs ......................................

$ 68,400 86,000 81,600 $236,000

(e) Total manufacturing costs ...................................... Work in process (1/1/14).......................................... Total cost of work in process .................................

$236,000 16,500 $252,500

(f)

$252,500 11,000 $241,500

Total cost of work in process ................................. Less: Work in process (12/31/14) ........................... Cost of goods manufactured ..................................

Case C (g) Total manufacturing costs ...................................... Less: Manufacturing overhead .............................. Direct materials used ................................... Direct labor...............................................................

$253,700 $102,000 130,000

232,000 $ 21,700

(h) Total cost of work in process ................................. Less: Total manufacturing costs ............................ Work in process (1/1/14)..........................................

$337,000 253,700 $ 83,300

(i)

$337,000 70,000 $267,000

Total cost of work in process ................................. Less: Work in process (12/31/14) ........................... Cost of goods manufactured ..................................

1-17

EXERCISE 1-11 (a) (a) $127,000 + $140,000 + $87,000 = $354,000 (b) $354,000 + $33,000 – $360,000 = $27,000 (c) $450,000 – ($200,000 + $132,000) = $118,000 (d) $40,000 + $470,000 – $450,000 = $60,000 (e) $255,000 – ($80,000 + $100,000) = $75,000 (f)

$255,000 + $60,000 – $80,000 = $235,000

(g) $288,000 – ($70,000 + $75,000) = $143,000 (h) $288,000 + $45,000 – $270,000 = $63,000 (b)

COLAW COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2014 Work in process, January 1 ............................... Direct materials ................................................... Direct labor .......................................................... Manufacturing overhead .................................... Total manufacturing costs.......................... Total cost of work in process ............................ Less: Work in process inventory, December 31 ............................................ Cost of goods manufactured .............................

1-18

$ 33,000 $127,000 140,000 87,000 354,000 387,000 27,000 $360,000

EXERCISE 1-12 (a)

CEPEDA CORPORATION Cost of Goods Manufactured Schedule For the Month Ended June 30, 2014 Work in process, June 1............................. Direct materials used ................................. Direct labor.................................................. Manufacturing overhead Indirect labor ....................................... Factory manager’s salary ................... Indirect materials ................................ Maintenance, factory equipment ........ Depreciation, factory equipment ........ Factory utilities.................................... Total manufacturing overhead ..... Total manufacturing costs ......................... Total cost of work in process .................... Less: Work in process, June 30 ............... Cost of goods manufactured .....................

(b)

$ 3,000 $20,000 40,000 $4,500 3,000 2,200 1,800 1,400 400 73,300 76,300 3,800 $72,500

CEPEDA CORPORATION Income Statement (Partial) For the Month Ended June 30, 2014 Sales revenue ......................................................... Cost of goods sold Finished goods inventory, June 1 ................. Cost of goods manufactured [from (a)] ........... Cost of goods available for sale .................... Less: Finished goods inventory, June 30 .... Cost of goods sold ......................... Gross profit .............................................................

13,300

1-19

$92,100 $ 5,000 72,500 77,500 7,500 70,000 $22,100

EXERCISE 1-13 (a) MARKS CONSULTING Schedule of Cost of Contract Services Provided For the Month Ended August 31, 2014 Supplies used (direct materials) ................................... $ 1,200 Salaries of professionals (direct labor) ........................ 15,600 Service overhead: Utilities for contract operations ............................... $1,400 Contract equipment depreciation ............................ 900 Insurance on contract operations ........................... 800 Janitorial services for professional offices............. 400 Total overhead .................................................... 3,500 Cost of contract services provided ......................... $20,300 (b) The costs not included in the cost of contract services provided would all be classified as period costs. As such, they would be reported on the income statement under administrative expenses. EXERCISE 1-14 (a) Work-in-process, 1/1 .............................. Direct materials Materials inventory, 1/1 ................... $ 21,000 Materials purchased ........................ 150,000 Materials available for use .............. 171,000 Less: Materials inventory, 12/31..... 30,000 Direct materials used ............................. $141,000 Direct labor ............................................. 220,000 Manufacturing overhead ........................ 180,000 Total manufacturing costs ..................... Total cost of work-in-process................ Less: Work-in-process, 12/31 ................ Cost of goods manufactured .................

1-20

$ 13,500

541,000 554,500 17,200 $537,300

EXERCISE 1-14 (Continued) AIKMAN COMPANY Income Statement (Partial) For the Year Ended December 31, 2014 (b) Sales revenue ....................................... Cost of goods sold Finished goods, 1/1 ........................ Cost of goods manufactured ........ Cost of goods available for sale .... Less: Finished goods, 12/31 ......... Cost of goods sold .......... Gross profit ............................................

$910,000 $ 27,000 537,300 564,300 21,000 543,300 $366,700

AIKMAN COMPANY (Partial) Balance Sheet December 31, 2014 (c) Current assets Inventories Finished goods .............................................. Work in process ............................................ Raw materials .................................................

$21,000 17,200 30,000

$68,200

(d) In a merchandising company’s income statement, the only difference would be in the computation of cost of goods sold. Beginning and ending finished goods would be replaced by beginning and ending merchandise inventory, and cost of goods manufactured would be replaced by purchases. In a merchandising company’s balance sheet, there would be one inventory account (merchandise inventory) instead of three. EXERCISE 1-15 1. 2. 3. 4. 5. 6. 7. 8. .

(a) (a) (a), (c) (b) (a) (a) (a) (b), (c) 1-21

9. 10. 11. 12. 13. 14. 15. 16.

(a) (a), (b) (b) (b) (a) (a) (a) (a)

EXERCISE 1-16 (a)

ROBERTS COMPANY Cost of Goods Manufactured Schedule For the Month Ended June 30, 2014 Work in process inventory, June 1 ................. $ 5,000 Direct materials Raw materials inventory, June 1 ............ $ 9,000 Raw materials purchases........................ 54,000 Total raw materials available for use ........ 63,000 Less: Raw materials inventory, June 30 .... 13,100 Direct materials used .............................. 49,900 Direct labor ..................................................... 47,000 Manufacturing overhead Indirect labor............................................ $5,500 Factory insurance.................................... 4,000 Machinery depreciation........................... 4,000 Factory utilities ........................................ 3,100 Machinery repairs .................................... 1,800 Miscellaneous factory costs ................... 1,500 Total manufacturing overhead ......... 19,900 Total manufacturing costs ............................ 116,800 Total cost of work in process ....................... 121,800 Less: Work in process inventory, June 30 ...... 7,000 Cost of goods manufactured ........................ $114,800

(b)

ROBERTS COMPANY (Partial) Balance Sheet June 30, 2014 Current assets Inventories Finished goods ........................................... Work in process .......................................... Raw materials .............................................

1-22

$ 8,000 7,000 13,100

$28,100

EXERCISE 1-17 (a) Raw Materials account: (5,000 – 4,650) X $10 = $3,500 Work in Process account: (4,600 X 10%) X $10 = $4,600 Finished Goods account: (4,600 X 90% X 30%) X $10 = $12,420 Cost of Goods Sold account: (4,600 X 90% X 70%) X $10 = $28,980 Selling Expenses account: 50 X $10 = $500 Proof of cost of head lamps allocated (5,000 X $10 = $50,000) Raw materials Work in process Finished goods Cost of goods sold Selling expenses Total (b) To:

$ 3,500 4,600 12,420 28,980 500 $50,000

Chief Accountant

From:

Student

Subject:

Statement Presentation of Accounts

Two accounts will appear in the income statement. Cost of Goods Sold will be deducted from net sales in determining gross profit. Selling expenses will be shown under operating expenses and will be deducted from gross profit in determining net income. Sometimes, the calculation for Cost of Good Sold is shown on the income statement. In these cases, the balance in Finished Goods inventory would also be shown on the income statement. The other accounts associated with the head lamps are inventory accounts which contain end-of-period balances. Thus, they will be reported under inventories in the current assets section of the balance sheet in the following order: finished goods, work in process, and raw materials. EXERCISE 1-18 (a) (b) (c) (d)

3. 4. 2. 1.

Balanced scorecard Value chain Just-in-time inventory Activity-based costing

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

1-23

1-24 .

(a) Cost Item

$ 9,000 1,500 $75,000 900 $

300

$53,000 800 1,100 5,700 400

000,000 $75,000

000,000 $53,000

$ 75,000 53,000 20,100 $148,100

Production cost per helmet = $148,100/10,000 = $14.81.

1,500 $20,100

14,000 10,000 000,000 $25,100

SOLUTIONS TO PROBLEMS

(b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost

Period Costs

PROBLEM 1-1A

Rent on factory equipment Insurance on factory building Raw materials Utility costs for factory Supplies for general office Wages for assembly line workers Depreciation on office equipment Miscellaneous materials Factory manager’s salary Property taxes on factory building Advertising for helmets Sales commissions Depreciation on factory building

Direct Materials

Product Costs Direct Manufacturing Labor Overhead

1-25

(a)

(1) (2) (3) (4) (5)

$90,000 $ 4,900 7,500 3,000 1,300 $9,500 00_0,000 $111,000

000,000 $90,000

650 750 $18,100

$74 X 1,500 = $111,000. $12 X 5 X 1,500 = $90,000. $5 X 1,500 = $7,500. $7,800/12 = $650. $9,000/12 = $750.

(b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost

Period Costs

$111,000 90,000 18,100 $219,100

Production cost per system = $219,100/1,500 = $146.07. (rounded)

00,000 $9,500

PROBLEM 1-2A

Cost Item Raw materials (1) Wages for workers (2) Rent on equipment Indirect materials (3) Factory supervisor’s salary Janitorial costs Advertising Depreciation on factory building (4) Property taxes on factory building (5)

Direct Materials $111,000

Product Costs Direct Manufacturing Labor Overhead

PROBLEM 1-3A

(a) Case 1 A = $9,600 + $5,000 + $8,000 = $22,600 $22,600 + $1,000 – B = $17,000 B = $22,600 + $1,000 – $17,000 = $6,600 $17,000 + C = $20,000 C = $20,000 – $17,000 = $3,000 D = $20,000 – $3,400 = $16,600 E = ($24,500 – $2,500) – $16,600 = $5,400 F = $5,400 – $2,500 = $2,900 Case 2 G + $8,000 + $4,000 = $16,000 G = $16,000 – $8,000 – $4,000 = $4,000 $16,000 + H – $3,000 = $22,000 H = $22,000 + $3,000 – $16,000 = $9,000 (I – $1,400) – K = $7,000 (I – $1,400) – $22,800 = $7,000 I = $1,400 + $22,800 + $7,000 = $31,200 (Note: Item I can only be solved after item K is solved.) J = $22,000 + $3,300 = $25,300 K = $25,300 – $2,500 = $22,800 $7,000 – L = $5,000 L = $2,000

1-26

PROBLEM 1-3A (Continued) (b)

CASE 1 Cost of Goods Manufactured Schedule Work in process, beginning ................................. Direct materials ..................................................... Direct labor............................................................ Manufacturing overhead ...................................... Total manufacturing costs ........................... Total cost of work in process .............................. Less: Work in process, ending ........................... Cost of goods manufactured ...............................

(c)

$ 1,000 $9,600 5,000 8,000 22,600 23,600 6,600 $17,000

CASE 1 Income Statement Sales revenue ....................................................... Less: Sales discounts ......................................... Net sales ................................................................ Cost of goods sold Finished goods inventory, beginning .......... Cost of goods manufactured........................ Cost of goods available for sale .................. Less: Finished goods inventory, ending .... Cost of goods sold ................................ Gross profit ........................................................... Operating expenses ............................................. Net income ............................................................

$24,500 2,500 $22,000 3,000 17,000 20,000 3,400 16,600 5,400 2,500 $ 2,900

CASE 1 (Partial) Balance Sheet Current assets Cash ............................................................... Receivables (net)........................................... Inventories Finished goods ...................................... Work in process..................................... Raw materials ........................................ Prepaid expenses.......................................... Total current assets ..............................

1-27

$ 4,000 15,000 $3,400 6,600 600

10,600 400 $30,000

PROBLEM 1-4A

(a)

CLARKSON COMPANY Cost of Goods Manufactured Schedule For the Year Ended June 30, 2014 Work in process, July 1, 2013 ............ Direct materials Raw materials inventory, July 1, 2013 .............................. Raw materials purchases ........... Total raw materials available for use ...................................... Less: Raw materials inventory, June 30, 2014 ................... Direct materials used .................. Direct labor .......................................... Manufacturing overhead Plant manager’s salary ............... Factory utilities ............................ Indirect labor ............................... Factory machinery depreciation ... Factory property taxes ................ Factory insurance ....................... Factory repairs ............................ Total manufacturing overhead........................... Total manufacturing costs ................. Total cost of work in process ............ Less: Work in process, June 30........ Cost of goods manufactured .............

1-28

$ 19,800 $ 48,000 96,400 144,400 39,600 $104,800 139,250 58,000 27,600 24,460 16,000 9,600 4,600 1,400 141,660 385,710 405,510 18,600 $386,910

PROBLEM 1-4A (Continued) (b)

CLARKSON COMPANY (Partial) Income Statement For the Year Ended June 30, 2014 Sales revenues Sales revenue ............................................. Less: Sales discounts............................... Net sales ..................................................... Cost of goods sold Finished goods inventory, July 1, 2013 ............................................. Cost of goods manufactured..................... Cost of goods available for sale ............... Less: Finished goods inventory, June 30, 2014 ................................. Cost of goods sold ............................. Gross profit ................................................

(c)

$534,000 4,200 $529,800 96,000 386,910 482,910 75,900 407,010 $122,790

CLARKSON COMPANY (Partial) Balance Sheet June 30, 2014 Assets Current assets Cash ............................................................ Accounts receivable .................................. Inventories Finished goods ................................... Work in process.................................. Raw materials ..................................... Total current assets ....................

1-29

$ 32,000 27,000 $75,900 18,600 39,600

134,100 $193,100

PROBLEM 1-5A

(a)

PHILLIPS COMPANY Cost of Goods Manufactured Schedule For the Month Ended October 31, 2014 Work in process, October 1 .............. Direct materials Raw materials inventory, October 1 ................................ $ 18,000 Raw materials purchases ............................... 264,000 Total raw materials available for use ..................................... 282,000 Less: Raw materials inventory, October 31 ....................... 29,000 Direct materials used ................. Direct labor ......................................... Manufacturing overhead Factory facility rent .................... 60,000 Depreciation on factory equipment ............................... 31,000 Indirect labor .............................. 28,000 Factory utilities* ......................... 9,000 Factory insurance** .................... 4,800 Total manufacturing overhead.......................... Total manufacturing costs ................ Total cost of work in process ........... Less: Work in process, October 31..... Cost of goods manufactured ............ **$12,000 X 75% = $9,000 **$ 8,000 X 60% = $4,800

1-30

$ 16,000

$253,000 190,000

132,800 575,800 591,800 14,000 $577,800

PROBLEM 1-5A (Continued) (b)

PHILLIPS COMPANY Income Statement For the Month Ended October 31, 2014 Sales revenue ................................................... Cost of goods sold Finished goods inventory, October 1 ...... Cost of goods manufactured.................... Cost of goods available for sale .............. Less: Finished goods inventory, October 31 ..................................... Cost of goods sold ............................ Gross profit ....................................................... Operating expenses Advertising expense ................................. Selling and administrative salaries .......... Depreciation expense—sales equipment .............................................. Insurance expense** ................................. Utilities expense* ...................................... Total operating expenses ................. Net income ........................................................ **$12,000 X 25% **$ 8,000 X 40%

1-31

$780,000 $ 30,000 577,800 607,800 45,000 562,800 217,200 90,000 75,000 45,000 3,200 3,000 216,200 $ 1,000

1-32 .

(a) Cost Item

(b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost

Period Costs

$ 1,500 5,500 8,000 4,000 700 6,000 3,000 $25,000 800 200 $54,000 000,000 $25,000

000,000 $54,000

$25,000 54,000 19,500 $98,500

Production cost per motorcycle helmet = $98,500/1,000 = $98.50

2,000 $19,500

500 000,000 $12,700

PROBLEM 1-1B

Maintenance costs on factory building Factory manager’s salary Advertising for helmets Sales commissions Depreciation on factory building Rent on factory equipment Insurance on factory building Raw materials Utility costs for factory Supplies for general office Wages for assembly line workers Depreciation on office equipment Miscellaneous materials

Direct Materials

Product Costs Direct Manufacturing Labor Overhead

(a)

(1) (2) (3) (4) (5)

$75,000 $ 1,300 7,500 3,500 1,400 $8,000 000,000 $57,500

000,000 $75,000

$23 X 2,500 = 57,500. $15 X 2 X 2,500 = $75,000. $3 X 2,500 = $7,500. $8,400/12 = $700. $9,600/12 = $800.

(For Instructor Use Only)

(b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost

Period Costs

$ 57,500 75,000 15,200 $147,700

Production cost per racket = $147,700/2,500 = $59.08

700 800 $15,200

00,000 $8,000

PROBLEM 1-2B

Weygandt, Managerial Accounting, 6/e, Solutions Manual

Direct Materials $57,500

Product Costs Direct Manufacturing Labor Overhead

1-33

PROBLEM 1-3B

(a) Case A A = $6,300 + $3,000 + $6,000 = $15,300 $15,300 + $1,000 – B = $15,800 B = $15,300 + $1,000 – $15,800 = $500 $15,800 + C = $18,300 C = $18,300 – $15,800 = $2,500 D = $18,300 – $1,200 = $17,100 E = ($22,500 – $1,500) – $17,100 = $3,900 F = $3,900 – $2,700 = $1,200 Case B G + $4,000 + $5,000 = $16,000 G = $16,000 – $4,000 – $5,000 = $7,000 $16,000 + H – $2,000 = $20,000 H = $20,000 + $2,000 – $16,000 = $6,000 (I – $1,200) – K = $6,000 (I – $1,200) – $22,500 = $6,000 I = $1,200 + $22,500 + $6,000 = $29,700 (Note: Item I can only be solved after item K is solved.) J = $20,000 + $5,000 = $25,000 K = $25,000 – $2,500 = $22,500 $6,000 – L = $2,200 L = $3,800

1-34

PROBLEM 1-3B (Continued) (b)

CASE A Cost of Goods Manufactured Schedule Work in process, beginning ................................ Direct materials .................................................... Direct labor........................................................... Manufacturing overhead ..................................... Total manufacturing costs .......................... Total cost of work in process ............................. Less: Work in process, ending .......................... Cost of goods manufactured ..............................

(c)

$ 1,000 $ 6,300 3,000 6,000 15,300 16,300 500 $15,800

CASE A Income Statement Sales revenue ...................................................... Less: Sales discounts ........................................ Net sales ............................................................... Cost of goods sold Finished goods inventory, beginning......... Cost of goods manufactured ...................... Cost of goods available for sale ................. Less: Finished goods inventory, ending ... Cost of goods sold ..................... Gross profit .......................................................... Operating expenses ............................................ Net income ...........................................................

$22,500 1,500 $21,000 2,500 15,800 18,300 1,200 17,100 3,900 2,700 $ 1,200

CASE A (Partial) Balance Sheet Current assets Cash ............................................................... Receivables (net)........................................... Inventories Finished goods ...................................... Work in process..................................... Raw materials ........................................ Prepaid expenses.......................................... Total current assets .............................. Copyright © 2012 John Wiley & Sons, Inc.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

$ 3,000 10,000 $ 1,200 500 700

2,400 200 $15,600

(For Instructor Use Only)

1-35

PROBLEM 1-4B

(a)

MOXIE COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2014 Work in process inventory, January 1 ................................. Direct materials Raw materials inventory, January 1 ......................... Raw materials purchases ........................ Total raw materials available for use .............. Less: Raw materials inventory, December 31 ............ Direct materials used .......... Direct labor .................................. Manufacturing overhead Plant manager’s salary ....... Indirect labor ....................... Factory utilities ................... Factory machinery depreciation ..................... Factory insurance ............... Factory property taxes ........ Factory repairs .................... Total manufacturing overhead .................. Total manufacturing costs ......... Total cost of work in process .... Less: Work in process, December 31 .................... Cost of goods manufactured .....

1-36

9,500

$ 47,000 62,500 109,500 44,200 $ 65,300 145,100 60,000 18,100 12,900 7,700 7,400 6,100 800 113,000 323,400 332,900 8,000 $324,900

PROBLEM 1-4B (Continued) (b)

MOXIE COMPANY (Partial) Income Statement For the Year Ended December 31, 2014 Sales revenues Sales revenue ............................................ Less: Sales discounts.............................. Net sales .................................................... Cost of goods sold Finished goods inventory, January 1 ............................................... Cost of goods manufactured (see schedule) ............................................... Cost of goods available for sale .............. Less: Finished goods inventory, December 31 .................................. Cost of goods sold .................. Gross profit .......................................................

(c)

$465,000 2,500 $462,500 85,000 324,900 409,900 57,800 352,100 $110,400

MOXIE COMPANY (Partial) Balance Sheet December 31, 2014 Assets Current assets Cash ........................................................... Accounts receivable ................................. Inventories Finished goods .................................. Work in process................................. Raw materials .................................... Total current assets ...................

$ 18,000 27,000 $ 57,800 8,000 44,200

Weygandt, Managerial Accounting, 6/e, Solutions Manual

110,000 $155,000

(For Instructor Use Only)

1-37

PROBLEM 1-5B

(a)

ORTIZ COMPANY Cost of Goods Manufactured Schedule For the Month Ended August 31, 2014 Work in process, August 1 .................. Direct materials Raw materials inventory, August 1 .................................... Raw materials purchases ............ Total raw materials available for use ....................... Less: Raw materials inventory, August 31 ........................... Direct materials used ................... Direct labor ........................................... Manufacturing overhead Factory facility rent ...................... Depreciation on factory equipment ................................. Indirect labor ................................ Factory utilities* ........................... Factory insurance** ...................... Total manufacturing overhead ........................... Total manufacturing costs .................. Total cost of work in process ............. Less: Work in process, August 31 ................................... Cost of goods manufactured .............. *$10,000 X 60% **$ 5,000 X 70%

1-38

$ 25,000 $ 19,500 220,000 239,500 35,000 $204,500 160,000 $ 60,000 35,000 20,000 6,000 3,500 124,500 489,000 514,000 21,000 $493,000

PROBLEM 1-5B (Continued) (b)

ORTIZ COMPANY Income Statement For the Month Ended August 31, 2014 Sales revenue ..................................................... Cost of goods sold Finished goods inventory, August 1.......... Cost of goods manufactured...................... Cost of goods available for sale ................ Less: Finished goods inventory, August 31 ......................................... Cost of goods sold .............................. Gross profit ......................................................... Operating expenses Advertising expense ................................... Selling and administrative salaries ............ Depreciation expense—sales equipment ................................................ Utilities expense* ........................................ Insurance expense** ................................... Total operating expenses ................... Net loss ...............................................................

$675,000 $ 40,000 493,000 533,000 52,000 481,000 194,000 75,000 70,000 50,000 4,000 1,500 200,500 $ (6,500)

*$10,000 X 40% **$ 5,000 X 30%

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

1-39

BYP 1-1

DECISION-MAKING AT CURRENT DESIGNS

The answers to parts (a) and (b) may vary from student to student. (a) What are the primary information needs of each manager? Mike Cichanowski, CEO, needs to know the overall financial picture of the company. He also needs to have a general picture of sales by territory and product line, and of cost per unit by product line. Diane Buswell, Controller, needs all accounting-related information. Deb Welch, Purchasing Manager, needs to know the costs of the components for each product. Bill Johnson, Sales Manager, needs to know sales by territory and product line. Dave Thill, Kayak Plant Manager, needs to know all the costs of producing each type of kayak. Rick Thrune, Production Manager for Composite Kayaks, needs to know the costs related to the composite kayak production.

1-40

BYP 1-1 (Continued)

(b) Name one special-purpose management accounting report that could be designed for each manager. Include the name of the report, the information it would contain, and how frequently it should be issued. Manager

Name of report

Information report would contain

Mike Cichanowski

Analysis of proposed new product line Companywide budget analysis

Projected revenues and expenses for a possible new product line Revenues, expenses, and net income compared to the budgeted amounts for each List of items purchased and most recent cost for each item Sales by product line and by customer Direct materials, direct labor, and manufacturing overhead costs assigned to each product line Detailed direct material and direct labor costs for the composite kayaks

Diane Buswell

Deb Welch

Purchasing History

Bill Johnson

Sales Summary

Dave Thill

Cost of Production Report

Rick Thrune

Cost of Production Report for Composite Kayaks

Weygandt, Managerial Accounting, 6/e, Solutions Manual

How frequently should it be issued? As needed and requested

Monthly

Monthly or available online Monthly or weekly Monthly or weekly

Weekly

(For Instructor Use Only)

1-41

BYP 1-1 (Continued) (c) When Diane Buswell, controller for Current Designs, reviewed the accounting records for a recent period, she noted the following items. Classify each item as a product cost or a period cost. If a cost is a product cost, note if it is a direct materials, direct labor, or manufacturing overhead item. Payee Winona Agency Bill Johnson (sales manager) Xcel Energy Winona Printing Jim Kaiser (sales representative) Dave Thill (plant manager)

Purpose

Product Costs Period Direct Direct Manufacturing Costs Materials Labor Overhead

Property insurance for the manufacturing plant Payroll–payment to sales manager Electricity for manufacturing plant Price lists for salespeople Sales commissions

X X X X X

Payroll–payment to plant manager

Dana Schultz (kayak Payroll–payment to assembler) kayak assembler Composite One Bagging film used when kayaks are assembled. It is discarded after use. Fastenal Shop supplies–brooms, paper towels, etc. Ravago

Winona County North American Composites

Polyethylene powder which is the main ingredient for the rotational molded kayaks Property taxes on manufacturing plant Kevlar fabric for composite kayaks

X X

Waste Management Trash disposal for the company office building None

1-42

Journal entry to record depreciation of manufacturing equipment

BYP 1-2

DECISION-MAKING ACROSS THE ORGANIZATION

Ending Raw Materials Inventory Beginning raw materials + Raw materials purchased = Raw materials available for use = $19,000 + $365,000 = $384,000 Raw materials available for use – Ending raw materials inventory = Direct materials used $384,000 – Ending raw materials inventory = $350,000 Ending raw materials inventory = $384,000 – $350,000 = $34,000 Ending Work in Process Inventory Direct materials + Direct labor + Manufacturing overhead = Total manufacturing costs = $350,000 + $250,000 + ($250,000 X 60%) = $750,000 Beginning work in process inventory + Total manufacturing costs = Total cost of work in process = $25,000 + $750,000 = $775,000 Cost of goods manufactured + Beginning finished goods inventory = Cost of goods available for sale Cost of goods manufactured + $38,000 = $770,000 Cost of goods manufactured = $770,000 – $38,000 = $732,000 Total cost of work in process – Ending work in process inventory = Cost of goods manufactured $775,000 – Ending work in process inventory = $732,000 Ending work in process inventory = $775,000 – $732,000 = $43,000 Ending Finished Goods Inventory Sales – Cost of goods sold = Gross profit $1,240,000 – Cost of goods sold = $1,240,000 X 40% Cost of goods sold = $1,240,000 – $496,000 = $744,000 Cost of goods available for sale – Ending finished goods inventory = Cost of goods sold $770,000 – Ending finished goods inventory = $744,000 Ending finished goods inventory = $770,000 – $744,000 = $26,000

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

1-43

BYP 1-3

MANAGERIAL ANALYSIS

Since the questions were fairly open-ended, the following are only suggested results. The class may be able to think of others, or of more items for each one. (a) Jason Dennis

Needs information on sales, perhaps by salesperson and by territory.

Peggy Groneman

Needs cost information for her department.

Dave Marley

Needs all accounting information.

Kevin Carson

Needs product cost information.

Sally Renner

Needs information on component costs and costs for her department. Income statement.

(b) Jason Dennis Peggy Groneman

None.

Dave Marley

All.

Kevin Carson

Income statement and cost of goods manufactured schedule.

Sally Renner (c) Jason Dennis

None. Sales by Territory—Detailed information, possibly by product line, issued daily or weekly.

1-44

Peggy Groneman

Cost of Computer Programs—Accumulated cost incurred for each major program used including maintenance and updates of program, issued monthly.

Dave Marley

Cost of Preparing Reports—Detailed analysis of all reports provided, their frequency, time, and estimated cost to prepare, issued monthly.

Kevin Carson

Cost of Product—Detailed cost by product line, including a comparison with estimated costs for that product. Issued as each batch of production is completed.

Sally Renner

Cost of Product Design—Accumulated total costs of each new product, issued at end of each project.

BYP 1-4

REAL-WORLD FOCUS

The factors that affect the cost of products are direct materials, direct labor, and manufacturing overhead. The percentage increase of total cost of products sold to net sales of 1.7% during the year appears to be entirely due to net increases in costs. The current year events and their possible impact on the three manufacturing cost elements are as follows: Operational problems at a major furnace. The principal effect is on manufacturing overhead due to higher maintenance costs. The problems may also have resulted in higher direct labor costs and higher direct materials because of the malfunctioning of the furnace. Higher downtime and costs and expenses associated with capital improvement projects. Higher downtime causes higher indirect labor. Costs associated with capital improvement projects impact product costs through depreciation which is part of manufacturing overhead. Increases in labor and other manufacturing costs. The increases in labor resulted in higher direct labor costs. The increases in indirect labor costs and in other manufacturing costs resulted in higher manufacturing overhead. Reduced fixed costs. Fixed costs such as insurance and rent are classified as manufacturing overhead. Thus, this factor reduced overhead costs during the year. Productivity and efficiency gains. This factor could have resulted in reductions of both direct material and direct labor costs.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

1-45

BYP 1-5

REAL-WORLD FOCUS

(a) The IMA has more than 60,000 members. These members include business leaders, managers, and decision makers in accounting and finance. (b) Student and Associate members receive most of the benefits of Regular membership at a significant savings. • Unique access to the professional designation, the Certified Management Accountant (CMA) • Specialized learning opportunities • Educational assistance, grants, educational competitions • Around-the-Clock Networking • Career management resources (c) The answer to this question will vary by school.

1-46

BYP 1-6

COMMUNICATION ACTIVITY

Ms. Shelly Phillips President Phillips Company Dear Shelly: As you requested, I corrected the income statement for October from the information you gave me. The corrected statement is enclosed and it shows that you actually earned net income of $1,000 for October. I also noticed that you did not have a cost of goods manufactured schedule, so I prepared one for you. The income statement your assistant accountant prepared was not correct for two primary reasons. First, product costs were not separated from selling and administrative expenses. Second, and more importantly, the reported net loss did not reflect changes in inventories. This had the effect of treating these costs as expenses rather than assets. A reconciliation of the reported net loss of $23,000 to net income of $1,000 is as follows: Net loss as reported ..................................................... Increase (decrease) in inventories Raw materials ($29,000 – $18,000)....................... $11,000 Work in process ($14,000 – $16,000) ................... (2,000) Finished goods ($45,000 – $30,000) .................... 15,000 Total increase ................................................ Net income as corrected ..............................................

$(23,000)

(24,000 $ (1,000

The changes in raw materials and work in process inventories are reported in the cost of goods manufactured schedule. You will see, for example, that the cost of direct materials used was $253,000, not $264,000 as reported by your accountant in the income statement. The difference is the change in raw materials inventories. Similarly, you will see that the $2,000 decrease in work in process inventories increases total manufacturing costs of $575,800 to produce cost of goods manufactured of $577,800. The change in finished goods inventories is reported in the income statement. Notice that the change of $15,000 is subtracted from cost of goods manufactured of $577,800 to produce cost of goods sold of $562,800.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

1-47

BYP 1-6 (Continued) I have also modified the form of the income statement to recognize the distinction between product costs (cost of goods sold) and period costs (operating expenses) as required by generally accepted accounting principles. Thanks for letting me help. If I can be of further assistance, don’t hesitate to call. I hope you find a replacement for your controller soon. Sincerely,

1-48

BYP 1-7

ETHICS CASE

(a) The stakeholders in this situation are: • • • •

The users of Newton Industries’ financial statements. Steve Morgan, controller. The vice-president of finance. The president of Newton Industries.

(b) The ethical issues in this situation pertain to the adherence to sound and acceptable accounting principles. Intentional violation of generally accepted accounting principles in order to satisfy a practical short-term personal or company need and thus create misleading financial statements would be unethical. Selecting one acceptable method of accounting and reporting among other acceptable methods is not necessarily unethical. (c) Ethically, the management of Newton Industries should be trying to report the financial condition and results of operations as fairly as possible; that is, in accordance with GAAP. Steve should inform management what is acceptable accounting and what is not. The basic concept to be supported in this advertising cost transaction is matching costs and revenues. Normally, advertising costs are expensed in the period in which they are incurred because it is very difficult to associate them with specific revenues.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

1-49

BYP 1-8

ALL ABOUT YOU

Student responses will vary. We have provided some basic examples that may represent common responses. (a) Individuals must often make purchase decisions which involve choosing between an item that has a more expensive initial purchase price, but is expected to either last longer, or provides some form of cost savings. The question that the individual faces is whether the cost savings or additional benefit justifies the additional initial cost. For example, more expensive dishwashers and refrigerators also tend to be more energy efficient. The labels on these appliances provide information regarding the energy savings which can be used to make a break-even evaluation. (b) In order to increase control over their financial situation and reduce the probability of financial hardship, all people should prepare personal budgets. Preparation of a personal budget requires the individual to plan for the future and to prioritize expenditures. (c) Companies employ the balanced scorecard as a mechanism to ensure that their financial goals are consistent with their efforts. Use of the balanced scorecard requires clear articulation of goals, priorities, and strategies. By employing these same techniques in their everyday life, individuals can be better assured that they will expend effort on those things that really matter to them, rather than wasting efforts on less important distractions. (d) Capital budgeting involves financial evaluation of long-term assets. Companies routinely make capital budgeting decisions, but so do individuals. The purchase of a home or car is a decision that has implications for your finances for many subsequent years. Buying a house or car is a very personal decision, influenced by many personal, nonfinancial, preferences. However, these decisions should also be subjected to a financial evaluation using capital budgeting techniques to ensure that the choice makes good economic sense.

1-50

BYP 1-9

CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: This is a difficult decision. While the direct costs of outsourced tax return preparation may in fact be lower, you must also consider other issues: Will the accuracy of the returns be as high? Will your relationships with your customers suffer due to the loss of direct contact? Will customers resent having their personal information shipped overseas? While you may not want to lay off six employees, you also don’t want to put your firm at risk by not remaining competitive. Perhaps one solution would be to outsource the most basic tasks, and then provide training to the six employees so they can perform higher-skilled services such as tax planning. Many of the techniques that you learn in the remaining chapters of this text will help you evaluate the merits of your various options.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

1-51

CHAPTER 2 Job Order Costing ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Do It!

Exercises

A Problems

B Problems

5, 6, 7, 8

1, 2

1, 2, 3, 4, 6, 7, 8, 9, 11

1A, 2A, 3A, 5A

1B, 2B, 3B, 5B

Explain the nature and importance of a job cost sheet.

9, 10, 11, 12

3, 4, 5

1, 2, 3, 6, 7, 8, 10, 12

1A, 2A, 3A, 5A

1B, 2B, 3B, 5B

Indicate how the predetermined overhead rate is determined and used.

13, 14, 15

6, 7

2, 3, 5, 6, 7, 8, 11, 12, 13

1A, 2A, 3A, 4A, 5A

1B, 2B, 3B, 4B, 5B

Prepare entries for jobs completed and sold.

8, 9

2, 3, 6, 7, 8, 9, 10, 11

1A, 2A, 3A, 5A

1B, 2B, 3B, 5B

Distinguish between under- and overapplied manufacturing overhead.

17, 18

4, 5, 12, 13

1A, 2A, 4A, 5A

1B, 2B, 4B, 5B

2-1

Learning Objectives

Questions

Explain the characteristics and purposes of cost accounting.

1, 2, 3, 4

Describe the flow of costs in a job order costing system.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

2-2

Description

Difficulty Level

Time Allotted (min.)

Prepare entries in a job order cost system and job cost sheets.

Simple

30−40

Prepare entries in a job order cost system and partial income statement.

Moderate

30−40

Prepare entries in a job order cost system and cost of goods manufactured schedule.

Simple

30−40

Compute predetermined overhead rates, apply overhead, and calculate under- or overapplied overhead.

Simple

20−30

Analyze manufacturing accounts and determine missing amounts.

Complex

30−40

Prepare entries in a job order cost system and job cost sheets.

Simple

30−40

Prepare entries in a job order cost system and partial income statement.

Moderate

30−40

Prepare entries in a job order cost system and cost of goods manufactured schedule.

Simple

30−40

Compute predetermined overhead rates, apply overhead, and calculate under- or overapplied overhead.

Simple

20−30

Analyze manufacturing accounts and determine missing amounts.

Complex

30−40

2-3

Learning Objective

Knowledge

1. Explain the characteristics and purposes of cost accounting.

Comprehension Q2-1 Q2-2

Application

Analysis

Synthesis

Evaluation

Q2-3 Q2-4

2. Describe the flow of costs in a job order costing system.

Q2-5 Q2-7 Q2-8

Q2-6 BE2-1

BE2-2 DI2-1 E2-1 E2-2 E2-3

E2-6 E2-7 E2-8 E2-9 E2-11

P2-1A P2-3A P2-1B P2-3B E2-4

P2-2A P2-5A P2-2B P2-5B

3. Explain the nature and importance of a job cost sheet.

Q2-11 Q2-12

Q2-9 Q2-10

BE2-3 BE2-4 BE2-5 DI2-2 E2-1 E2-2

E2-3 E2-6 E2-7 E2-8 E2-10 E2-12

P2-1A P2-3A P2-1B P2-3B

P2-2A P2-5A P2-2B P2-5B

4. Indicate how the predetermined overhead rate is determined and used.

Q2-15

Q2-13 Q2-14

BE2-6 BE2-7 DI2-2 E2-2 E2-3 E2-6

E2-7 E2-8 E2-11 E2-12 E2-13 P2-1A

P2-3A P2-4A P2-1B P2-3B P2-4B

E2-5 P2-2A P2-5A P2-2B P2-5B

5. Prepare entries for jobs completed and sold.

Q2-16 BE2-9

BE2-8 DI2-3 E2-2 E2-3 E2-6

E2-7 E2-8 E2-9 E2-10 E2-11

P2-1A P2-3A P2-1B P2-3B

P2-2A P2-5A P2-2B

P2-5B

6. Distinguish between under- and overapplied manufacturing overhead.

Q2-17 Q2-18 BE2-10

E2-12 E2-13 P2-1A

P2-4A P2-1B P2-4B

DI2-4 E2-4 E2-5 P2-2A

P2-5A P2-2B P2-5B

Broadening Your Perspective

BYP2-4 BYP2-5 BYP2-6

BYP2-1

BYP2-3

BYP2-2 BYP2-7 BYP2-8 BYP2-9

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) Cost accounting involves the measuring, recording, and reporting of product costs. A cost accounting system consists of manufacturing cost accounts that are fully integrated into the general ledger of a company. (b) An important feature of a cost accounting system is the use of a perpetual inventory system that provides immediate, up-to-date information on the cost of a product.

(a) The two principal types of cost accounting systems are: (1) job order cost system and (2) process cost system. Under a job order cost system, costs are assigned to each job or batch of goods; at all times each job or batch of goods can be separately identified. A job order cost system measures costs for each completed job, rather than for set time periods. Under a process cost system, product-related costs are accumulated by or assigned to departments or processes for a set period of time. Job order costing lends itself to specific, special-order manufacturing or servicing while process costing is better suited to similar, largevolume products and continuous process manufacturing. (b) A company can use both types of systems. For example, General Motors uses process costing for standard model cars and job order costing for custom-made vehicles.

A job order cost system is most likely to be used by a company that receives special orders, or custom builds, or produces heterogeneous items or products; that is, the product manufactured or the service rendered is tailored to the customer or client’s requests, needs, or situation. Examples of industries that use job order systems are custom home builders, commercial printing companies, motion picture companies, construction contractors, repair shops, accounting and law firms, hospitals, shipbuilders, and architects.

A process cost system is most likely to be used by manufacturing firms with continuous production flows usually found in mass production, assembly line, large-volume, uniform, or relatively similar product industries. Companies producing appliances, chemicals, pharmaceuticals, rubber and tires, plastics, cement, petroleum, and automobiles utilize process cost systems.

The major steps in the flow of costs in a job order cost system are: (1) accumulating the manufacturing costs incurred and (2) assigning the accumulated costs to work done.

The three inventory control accounts and their subsidiary ledgers are: Raw materials inventory—materials inventory records. Work in process inventory—job cost sheets. Finished goods inventory—finished goods records.

The source documents used in accumulating direct labor costs are time tickets and time cards.

Disagree. Entries to Manufacturing Overhead are also made at the end of an accounting period. For example, there will be adjusting entries for factory depreciation, property taxes, and insurance.

The source document for materials is the materials requisition slip and the source document for labor is the time ticket. The entries are: Materials Work in Process Inventory Manufacturing Overhead Raw Materials Inventory

2-4

Labor XX XX XX

Work in Process Inventory Manufacturing Overhead Factory Labor

XX XX XX

Questions Chapter 2 (Continued) 10.

The purpose of a job cost sheet is to record the costs chargeable to a specific job and to determine the total and unit costs of the completed job.

11.

The source documents for charging costs to specific jobs are materials requisition slips for direct materials, time tickets for direct labor, and the predetermined overhead rate for manufacturing overhead.

12.

The materials requisition slip is a business document used as an authorization to issue materials from inventory to production. It is approved and signed by authorized personnel so that materials may be removed from inventory and charged to production, to specific jobs, departments, or processes. The materials requisition slip is the basis for posting to the materials inventory records and to the job cost sheet.

13.

Disagree. Actual manufacturing overhead cannot be determined until the end of a period of time. Consequently, there could be a significant delay in assigning overhead and in determining the total cost of the completed job.

14.

The relationships for computing the predetermined overhead rate are the estimated annual overhead costs and an expected activity base such as direct labor hours. The rate is computed by dividing the estimated annual overhead costs by the expected annual operating activity.

15.

At any point in time, the balance in Work in Process Inventory should equal the sum of the costs shown on the job cost sheets of unfinished jobs. Alternatively, posting to Work in Process Inventory may be compared with the sum of the postings to the job cost sheets for each of the manufacturing cost elements.

16.

Jane is incorrect. There is a difference in computing total manufacturing costs. In job order costing, manufacturing overhead applied is used, whereas in Chapter 1, actual manufacturing overhead is used.

17.

Underapplied overhead means that the overhead assigned to work in process is less than the overhead incurred. Overapplied overhead means that the overhead assigned to work in process is greater than the overhead incurred. Manufacturing Overhead will have a debit balance when overhead is underapplied and a credit balance when overhead is overapplied.

18.

Under- or overapplied overhead is not closed to Income Summary. The balance in Manufacturing Overhead is eliminated through an adjusting entry. Under- or overapplied overhead generally is considered to be an adjustment of Cost of Goods Sold.

2-5

Work in Process Inventory (4) Direct (7) Cost of commaterials used pleted jobs (5) Direct labor used (6) Overhead applied

Cost of Goods Sold (8) Cost of goods sold

Key to Entries: Accumulation 1. Purchase raw materials 2. Incur factory labor 3. Incur manufacturing overhead Manufacturing Overhead (3) Depreciation (6) Overhead Insurance applied Repairs (4) Indirect materials used (5) Indirect labor used

Assignment 4. Raw materials are used 5. Factory labor is assigned 6. Overhead is applied 7. Completed goods are recognized 8. Cost of goods sold is recognized

SOLUTIONS TO BRIEF EXERCISES

Factory Labor (2) Factory labor (5) Factory labor incurred used

Finished Goods Inventory (7) Cost of com(8) Cost of goods pleted jobs sold

BRIEF EXERCISE 2-1

2-6 Raw Materials Inventory (1) Purchases (4) Materials used

BRIEF EXERCISE 2-2 Jan. 31 31

Raw Materials Inventory ...................................... Accounts Payable.........................................

4,000

Factory Labor ....................................................... Factory Wages Payable................................ Employer Payroll Taxes Payable .................

6,000

Manufacturing Overhead ..................................... Utilities Payable ............................................

2,000

4,000 5,200 800 2,000

BRIEF EXERCISE 2-3 Jan. 31

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

3,000 600 3,600

BRIEF EXERCISE 2-4 Jan. 31

Work in Process Inventory .................................. Manufacturing Overhead ..................................... Factory Labor ...............................................

5,200 800 6,000

BRIEF EXERCISE 2-5

Date 1/31 1/31

Job 1 Direct Materials 900

Direct Labor 2,200

Date 1/31 1/31

2-7

Date 1/31 1/31 Job 3 Direct Materials 700

Job 2 Direct Materials 1,400

Direct Labor 1,400

Direct Labor 1,600

BRIEF EXERCISE 2-6 Overhead rate per direct labor cost is 180%, or ($900,000 ÷ $500,000). Overhead rate per direct labor hour is $18, or ($900,000 ÷ 50,000). Overhead rate per machine hour is $9, or ($900,000 ÷ 100,000). BRIEF EXERCISE 2-7 Jan. 31

Feb. 28

Mar. 31

Work in Process Inventory ............................. Manufacturing Overhead ($40,000 X 80%) ....................................

32,000

Work in Process Inventory ............................. Manufacturing Overhead ($30,000 X 80%) ....................................

24,000

Work in Process Inventory ............................. Manufacturing Overhead ($50,000 X 80%) ....................................

40,000

32,000

24,000

40,000

BRIEF EXERCISE 2-8 Mar. 31 31 31

Finished Goods Inventory .............................. Work in Process Inventory......................

50,000

Cash ................................................................. Sales Revenue .........................................

35,000

Cost of Goods Sold ......................................... Finished Goods Inventory.......................

20,000

50,000 35,000 20,000

BRIEF EXERCISE 2-9

2-8

Service Contracts in Process ......................... Operating Overhead ........................................ Service Salaries and Wages ...................

24,000 8,000

Service Contracts in Process ......................... Operating Overhead ................................

6,000

32,000 6,000

BRIEF EXERCISE 2-10 Dec. 31

Dec. 31

Shimeca Company Cost of Goods Sold ......................................... Manufacturing Overhead ........................

1,200

Garcia Company Manufacturing Overhead ................................ Cost of Goods Sold .................................

900

1,200

900

SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 2-1 (a) Raw Materials Inventory ............................................ Accounts Payable ............................................... (Purchases of raw materials on account)

16,000

(b) Factory Labor ............................................................. Factory Wages Payable ...................................... Employer Payroll Taxes Payable........................ (To record factory labor costs)

40,000

(c) Manufacturing Overhead .......................................... Accumulated Depreciation—Buildings.............. Utilities Payable ................................................... Prepaid Property Taxes ...................................... (To record overhead costs)

15,000

2-9

16,000

31,000 9,000

9,500 3,100 2,400

DO IT! 2-2 The three summary entries are: Work in Process Inventory ($7,200 + $9,000) .................. Raw Materials Inventory ............................................ (To assign materials to jobs)

16,200

Work Process Inventory ($4,000 + $8,000) ...................... Factory Labor ............................................................. (To assign labor to jobs)

12,000

Work in Process Inventory ($5,200 + $9,800) .................. Manufacturing Overhead .......................................... (To assign overhead to jobs)

15,000

16,200

12,000

15,000

DO IT! 2-3 Finished Goods Inventory ................................................ Work in Process Inventory ........................................ (To record completion of Job 310, costing $60,000 and Job 312, costing $50,000)

110,000

Accounts Receivable ........................................................ Sales Revenue ......................................................... (To record sale of Job 312)

90,000

Cost of Goods Sold ........................................................... Finished Goods Inventory ......................................... (To record cost of goods sold for Job 312)

50,000

110,000

90,000

50,000

DO IT! 2-4 Manufacturing overhead applied = 130% X $85,000 = $110,500 Underapplied manufacturing overhead = $115,000 – $110,500 = $4,500

2-10

SOLUTIONS TO EXERCISES EXERCISE 2-1 (a) Factory Labor .......................................................... Factory Wages Payable .................................. Employer Payroll Taxes Payable ................... Employer Fringe Benefits Payable ................

80,000

(b) Work in Process Inventory ($80,000 X 85%) ......... Manufacturing Overhead........................................ Factory Labor ..................................................

68,000 12,000

66,000 8,000 6,000

80,000

EXERCISE 2-2 (a) May 31

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

10,400 800

Work in Process Inventory .................... Manufacturing Overhead ....................... Factory Labor .................................

12,500 1,200

Work in Process Inventory ($12,500 X 60%) .................................. Manufacturing Overhead ............... Finished Goods Inventory ..................... Work in Process Inventory ............

11,200

13,700 7,500 7,500 7,540 7,540

($2,000 + $2,500 + $1,900 + $1,140*)

*$1,900 X 60% (b) May 1 Balance 31 31 31 May 31 Balance

2-11

Work in Process Inventory 3,500 May 31 10,400 12,500 7,500 26,360

7,540

EXERCISE 2-2 (Continued)

Job No. 430 431

Beginning Work in Process $1,500 0 $1,500

Job Cost Sheets Direct Direct Manufacturing* Material Labor Overhead $3,500 $ 3,000 $1,800 4,400 7,600 4,560 $7,900 $10,600 $6,360

Total $ 9,800 16,560 $26,360

*Direct labor X .60 EXERCISE 2-3 (a) 1.

$16,100, or ($5,000 + $6,000 + $5,100).

2. Last year 85%, or ($5,100 ÷ $6,000); this year 80% (either $6,400 ÷ $8,000 or $3,200 ÷ $4,000). (b) Jan. 31

31 31 31

Work in Process Inventory....................... Raw Materials Inventory ...................

8,000

Work in Process Inventory....................... Factory Labor ....................................

12,000

Work in Process Inventory....................... Manufacturing Overhead ..................

9,600

Finished Goods Inventory........................ Work in Process Inventory ...............

45,700

EXERCISE 2-4 (a) + $50,000 + $42,500 = $145,650 (a) = $53,150 $145,650 + (b) = $201,500 (b) = $55,850 $201,500 – (c) = $192,300 (c) = $9,200

2-12

8,000 12,000 9,600 45,700

EXERCISE 2-4 (Continued) [Note: The instructions indicate that manufacturing overhead is applied on the basis of direct labor cost, and the rate is the same in all cases. From Case A, a student should note the overhead rate to be 85%, or ($42,500 ÷ $50,000).] (d) = .85 X $140,000 (d) = $119,000 $83,000 + $140,000 + $119,000 = (e) (e) = $342,000 $342,000 + $15,500 = (f) (f) = $357,500 $357,500 – $11,800 = (g) (g) = $345,700 [Note: (h) and (i) are solved together.] (i) = .85(h) $63,150 + (h) + .85(h) = $213,000 1.85(h) = $149,850 (h) = $81,000 (i) = $68,850 (j) = $213,000 + $18,000 (j) = $231,000 $231,000 – (k) = $222,000 (k) = $9,000 EXERCISE 2-5 (a) $2.60 per machine hour ($325,000 ÷ 125,000). (b) ($342,000) – ($2.60 x 130,000 Machine Hours) $342,000 – $338,000 = $4,000 underapplied (c) Cost of Goods Sold ................................................... Manufacturing Overhead ...................................

2-13

4,000 4,000

EXERCISE 2-6 (a) (1) The source documents are: Direct materials—Materials requisition slips. Direct labor—Time tickets. Manufacturing overhead—Predetermined overhead rate. (2) The predetermined overhead rate is 125% of direct labor cost. For example, on July 15, the computation is $550 ÷ $440 = 125%. The same result is obtained on July 22 and 31. (3) The total cost is: Direct materials ............................................................ Direct labor ................................................................... Manufacturing overhead ..............................................

$4,700 1,360 1,700 $7,760

The unit cost is $3.10 ($7,760 ÷ 2,500). (b) July 31

Finished Goods Inventory ............................ Work in Process Inventory ...................

7,760

Raw Materials Inventory ................................................ Accounts Payable ..................................................

46,300

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

29,200 6,800

Factory Labor ................................................................. Factory Wages Payable ......................................... Employer Payroll Taxes Payable...........................

55,900

Work in Process Inventory ............................................ Manufacturing Overhead ............................................... Factory Labor .........................................................

50,000 5,900

7,760

EXERCISE 2-7 1. 2.

2-14

46,300

36,000 51,000 4,900

55,900

EXERCISE 2-7 (Continued) 5. 6. 7. 8. 9.

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

80,500

Depreciation Expense ........................................... Accumulated Depreciation—Building ..........

8,100

Work in Process Inventory ($50,000 X 150%) ...... Manufacturing Overhead ...............................

75,000

Finished Goods Inventory..................................... Work in Process Inventory ............................

88,000

Accounts Receivable ............................................. Sales Revenue ................................................

103,000

Cost of Goods Sold ............................................... Finished Goods Inventory .............................

75,000

80,500 8,100 75,000 88,000 103,000 75,000

EXERCISE 2-8 1.

Raw Materials Inventory ........................................ Accounts Payable ..........................................

192,000

Factory Labor ......................................................... Factory Wages Payable .................................

87,300

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

153,530 4,470

Work in Process Inventory.................................... Manufacturing Overhead....................................... Factory Labor .................................................

80,000 7,300

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

49,500

2-15

192,000 87,300

158,000

87,300 49,500

EXERCISE 2-8 (Continued) 4.

Manufacturing Overhead ....................................... Accumulated Depreciation—Equipment ......

14,550

Depreciation Expense ........................................... Accumulated Depreciation—Building...........

14,300

Work in Process Inventory .................................... Manufacturing Overhead (90% X $80,000) ..........................................

72,000

Finished Goods Inventory ..................................... Work in Process Inventory ............................

240,930

14,550

14,300

72,000

240,930

Computation of cost of jobs finished:

Job A20 A21 A23

Direct Materials $35,240 42,920 39,270

Direct Labor $18,000 22,000 25,000

Manufacturing Overhead $16,200 19,800 22,500

Total $ 69,440 84,720 86,770 $240,930

EXERCISE 2-9 (a)

MANTLE COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2014 Work in process, May 1 ........................................ Direct materials used............................................ Direct labor ............................................................ Manufacturing overhead applied ......................... Total manufacturing costs............................ Total cost of work in process .............................. Less: Work in process, May 31 ........................... Cost of goods manufactured ...............................

2-16

$ 14,700 $62,400 50,000 40,000 152,400 167,100 17,900 $149,200

EXERCISE 2-9 (Continued) (b)

MANTLE COMPANY (Partial) Income Statement For the Month Ended May 31, 2014 Sales revenue .................................................... Cost of goods sold Finished goods, May 1 ............................... Cost of goods manufactured..................... Cost of goods available for sale ............... Less: Finished goods, May 31.................. Cost of goods sold ............................. Gross profit ........................................................

(c)

$210,000 $ 12,600 149,200 161,800 9,500 152,300 $ 57,700

MANTLE COMPANY (Partial) Balance sheet May 31, 2014 Current assets: Finished goods inventory .......................... Work in process inventory ........................ Raw materials inventory ............................

$ 9,500 17,900 7,100

$34,500

EXERCISE 2-10 (a) Work in Process Inventory April 30 $ 9,300 (#10, $5,200 + #11, $4,100) May 31 $18,600 (#11, $8,000 + #13, $4,700 + #14, $5,900) June 30 $ 9,500 (#14, $5,900 + $3,600) (b) Finished Goods Inventory April 30 $ 1,200 (#12) May 31 $ 9,600 (#10) June 30 $19,200 (#11, $10,000 + #13, $9,200) (c) Gross Profit Month May June July .

2-17

Job Number 12 10 11/13

Sales $ 1,500 12,000 24,000

Cost of Goods Sold $ 1,200 9,600 19,200

Gross Profit $ 300 2,400 4,800

EXERCISE 2-11 (a) 1

(b) 2. 3. 5.

2-18

Supplies ............................................ Accounts Payable......................

1,500

Service Contracts in Process .......... Operating Overhead ......................... Supplies .....................................

720 480

Service Contracts in Process .......... Operating Overhead ......................... Service Salaries and Wages .....

48,000 12,000

Operating Overhead ......................... Cash ...........................................

40,000

1,500

1,200

60,000

40,000

Service Contracts in Process ($48,000 X 90%).............................. Operating Overhead ..................

43,200

Cost of Completed Service Contracts........................................ Service Contracts in Process ...

75,000

Service Contracts in Process 720 75,000 48,000 43,200 16,920

43,200

75,000

(6)

EXERCISE 2-12 (a) Direct materials Auditor labor costs Applied overhead Total cost

Lynn $ 600 5,400 3,600 $9,600

Brian $ 400 6,600 4,400 $11,400

Mike $ 200 3,375 2,250 $5,825

(b) The Lynn job is the only incomplete job, therefore, $9,600. (c) Actual overhead Applied overhead Balance

$11,000 (DR) 10,250 (CR) $ 750 (DR)

EXERCISE 2-13 (a) Predetermined overhead rate = Estimated overhead ÷ Estimated decorator hours = $920,000 ÷ 40,000 decorator hours = $23 per decorator hour (b) Service Contracts in Process (40,500 hrs X $23) ...... 931,500 Operating Overhead...................................... 931,500 (c)

Actual overhead Applied overhead Balance

2-19

$942,800 931,500 $ 11,300 underapplied

SOLUTIONS TO PROBLEMS PROBLEM 2-1A

(a) $980,000 ÷ $700,000 direct labor costs = 140% of direct labor costs (b) See solution to part (e) for job cost sheets (c) Raw Materials Inventory ............................................ Accounts Payable ..............................................

90,000

Factory Labor ............................................................. Factory Wages Payable ..................................... Employer Payroll Taxes Payable.......................

70,000

Manufacturing Overhead ........................................... Accounts Payable .............................................. Accumulated Depreciation—Equipment .......... Raw Materials Inventory .................................... Factory Labor .....................................................

72,000

(d) Work in Process Inventory ........................................ Raw Materials Inventory ($10,000 + $39,000 + $30,000) .......................

79,000

Work in Process Inventory ........................................ Factory Labor ($5,000 + $25,000 + $20,000) ..........................

50,000

Work in Process Inventory ........................................ Manufacturing Overhead ................................... ($50,000 X 140% of direct labor costs)

70,000

90,000 54,000 16,000 16,000 19,000 17,000 20,000

79,000

50,000

See solution to part (e) for postings to job cost sheets.

2-20

70,000

PROBLEM 2-1A (Continued) (b)&(e) Job Cost Sheets Job No. 50 Date Direct Materials Direct Labor Manufacturing Overhead Beg. $20,000 $12,000 *$16,000* Jan. 10,000 5,000 * 7,000* $30,000 $17,000 *$23,000* Cost of completed job Direct materials .............................................................. Direct labor ..................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................

$30,000 17,000 23,000 $70,000

*$5,000 X 140% Job No. 51 Date Direct Materials Jan. $39,000 $39,000

Direct Labor $25,000 $25,000

Manufacturing Overhead **$35,000** **$35,000**

Cost of completed job Direct materials .............................................................. Direct labor ..................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................

$39,000 25,000 35,000 $99,000

**$25,000 X 140% Job No. 52 Date Direct Materials Jan. $30,000 ***$20,000 X 140%

2-21

Direct Labor $20,000

Manufacturing Overhead ***$28,000***

PROBLEM 2-1A (Continued)

(f)

Finished Goods Inventory ...................................... Work in Process Inventory ($70,000 + $99,000) ......................................

169,000

Cost of Goods Sold ................................................ Finished Goods Inventory ($90,000 + $70,000) ......................................

160,000

Accounts Receivable .............................................. Sales Revenue ($122,000 + $158,000) ............

280,000

(g) Beginning balance Cost of completed jobs 50 and 51 Ending balance

Finished Goods Inventory 90,000 160,000 169,000 99,000

169,000

160,000 280,000

Cost of jobs 49 and 50 sold

The balance in this account consists of the cost of completed Job No. 51 which has not yet been sold. (h) Manufacturing Overhead Actual Applied 72,000 70,000 2,000 The balance in the Manufacturing Overhead account is underapplied.

2-22

PROBLEM 2-2A

(a) 1/1

12/31

Work in Process Inventory Balance (1) 128,400 Completed work (5) (c) Direct materials (2) 131,000 Direct labor (3) 139,000 Manufacturing overhead (4) 166,800 Balance 179,000

(1)

Job 7640 Job 7641

$ 77,800 50,600 $128,400

(3)

Job 7640 Job 7641 Job 7642

$ 36,000 48,000 55,000 $139,000

(2)

Job 7640 Job 7641 Job 7642

$ 30,000 43,000 58,000 $131,000

(4)

Job 7640 Job 7641 Job 7642

$ 43,200 57,600 66,000 $166,800

(5) (a) Job 7640 Beginning balance ................................................. Direct materials...................................................... Direct labor ............................................................ Manufacturing overhead .......................................

(b) Job 7641 Beginning balance ................................................. Direct materials...................................................... Direct labor ............................................................ Manufacturing overhead .......................................

(c) Total cost of completed work Job 7640 ................................................................ Job 7641 ................................................................

386,200

2-23

$ 77,800 30,000 36,000 43,200 $187,000

$ 50,600 43,000 48,000 57,600 $199,200

$187,000 199,200 $386,200

PROBLEM 2-2A (Continued) Work in process balance .............................................

$179,000

Unfinished job No. 7642 ..............................................

$179,000 (a)

(a) Current year’s cost Direct materials ................................ Direct labor....................................... Manufacturing overhead .................

$ 58,000 55,000 66,000 $179,000

(b) Actual overhead costs Incurred on account .............................................. Indirect materials................................................... Indirect labor ......................................................... Depreciation .......................................................... Applied overhead costs Job 7640 ................................................................. Job 7641 ................................................................. Job 7642 .................................................................

Actual overhead ............................................................ Applied overhead .......................................................... Overapplied overhead .................................................. Manufacturing Overhead .............................................. 6,800 Cost of Goods Sold ............................................... (c) Sales revenue (given) ........................................ Cost of goods sold Add: Job 7638 ................................................... Job 7639 ................................................... Job 7641 ................................................... Less: Overapplied overhead ........................... Gross profit .......................................................

2-24

$120,000 14,000 18,000 8,000 $160,000 $ 43,200 57,600 66,000 $166,800 $160,000 166,800 $ 6,800

6,800 $530,000

$ 87,000 92,000 199,200 378,200 6,800

371,400 $158,600

PROBLEM 2-3A

(a) (i) Raw Materials Inventory ............................................ Accounts Payable ..............................................

4,900 4,900

Factory Labor ............................................................. Cash ....................................................................

4,400

Manufacturing Overhead........................................... Accumulated Depreciation—Equipment .......... Accounts Payable ..............................................

1,100

(ii) Work in Process Inventory........................................ Manufacturing Overhead........................................... Raw Materials Inventory ....................................

4,900 1,500

Work in Process Inventory........................................ Manufacturing Overhead........................................... Factory Labor .....................................................

3,200 1,200

Work in Process Inventory ($3,200 X 1.25) .............. Manufacturing Overhead ...................................

4,000

(iii) Finished Goods Inventory......................................... Work in Process Inventory ................................

13,840

Job

Direct Materials

Direct Labor

Manufacturing Overhead*

Total Costs

Gannon Rosenthal Linton

$1,700 1,300 2,200

$1,160 900 1,780

$1,450 1,125 2,225

$ 4,310 3,325 6,205 $13,840

4,400 700 400

6,400

4,400 4,000 13,840

*125% X direct labor amount

Cash............................................................................ Sales revenue .....................................................

18,900

Cost of Goods Sold ................................................... Finished Goods Inventory .................................

13,840

2-25

18,900 13,840

PROBLEM 2-3A (Continued) (b) 6/1

6/30

Work in Process Inventory Balance 5,540 June Completed work Direct materials 4,900 Direct labor 3,200 Overhead applied 4,000 Balance 3,800

13,840

$3,800

Job: Koss (Direct materials $2,000 + Direct labor $800 + Manufacturing overhead $1,000) .................................

$3,800

(d)

STELLAR INC. Cost of Goods Manufactured Schedule For the Month Ended June 30, 2014 Work in process, June 1 .......................................... Direct materials used ............................................... Direct labor ............................................................... Manufacturing overhead applied ............................ Total manufacturing costs............................... Total cost of work in process ................................. Less: Work in process, June 30............................. Cost of goods manufactured ..................................

2-26

$ 5,540 $4,900 3,200 4,000 12,100 17,640 3,800 $13,840

PROBLEM 2-4A

(a) Department D: Department E: Department K:

$1,200,000 ÷ $1,500,000 = 80% of direct labor cost. $1,500,000 ÷ 125,000 = $12.00 per direct labor hour. $900,000 ÷ 120,000 = $7.50 per machine hour.

(b) Manufacturing Costs Direct materials Direct labor Overhead applied Total

D $140,000 120,000 96,000* $356,000

Department E $126,000 110,000 132,000** $368,000

K $ 78,000 37,500 78,000*** $193,500

D $99,000 96,000 $ 3,000

Department E $124,000 132,000 $ (8,000)

K $79,000 78,000 $ 1,000

*$120,000 X 80% **11,000 X $12.00 ***10,400 X $7.50 (c) Manufacturing Overhead Incurred Applied Under (over) applied

2-27

PROBLEM 2-5A

(a) $5,600

($16,850 + $7,975 – $19,225).

(b) $36,000

[$9,750 + $15,000 + (75% X $15,000)]. (Given in other data).

($16,850 – $1,900).

(d) $6,600

($8,800 X 75%).

(e) $12,200

[Given in other data—$3,800 + $4,800 + (75% X $4,800)].

(f)

($36,000 + $14,950 + $8,800 + $6,600 – $12,200).

$54,150

(g) $5,000

(Given in other data).

(h) $54,150

(See (f) above).

(i)

$55,150

($5,000 + $54,150 – $4,000).

(j)

$4,000

(Given in other data).

(k) $12,025

(Equal to factory labor incurred).

(l)

($12,025 – $8,800).

$3,225

(m) $6,600

($6,370* + $230) or (Same as (d)).

*$1,900 + $3,225 + $1,245

2-28

PROBLEM 2-1B

(a) $440,000 ÷ 20,000 direct labor hours = $22 per direct labor hour (b) See solution to part (e) for job cost sheets (c) Raw Materials Inventory ............................................ Accounts Payable ..............................................

45,000

Factory Labor ............................................................. Employer Payroll Taxes Payable ...................... Factory Wages Payable .....................................

33,500

Manufacturing Overhead........................................... Accumulated Depreciation—Equipment .......... Accounts Payable .............................................. Raw Materials Inventory .................................... Factory Labor .....................................................

42,500

(d) Work in Process Inventory........................................ Raw Materials Inventory ($5,000 + $17,000 + $13,000) ..........................

35,000

Work in Process Inventory........................................ Factory Labor ($3,000 + $12,000 + $9,000) .......

24,000

Work in Process Inventory........................................ Manufacturing Overhead (200 + 800 + 600) X $22 per hour ...................

35,200

45,000 7,500 26,000 12,000 11,000 10,000 9,500

35,000 24,000

See solution to part (e) for postings to job cost sheets.

2-29

35,200

PROBLEM 2-1B (Continued) (e)

Job Cost Sheets Job No. 25 Date Direct Materials Beg. $10,000 Jan. 5,000 $15,000

Direct Labor $6,000 3,000 $9,000

Manufacturing Overhead *$ 9,000* * 4,400* *$13,400*

Cost of completed job Direct materials.............................................................. Direct labor .................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................

$15,000 9,000 13,400 $37,400

*$22 X 200 direct labor hours Job No. 26 Date Direct Materials Jan. $17,000 $17,000

Direct Labor $12,000 $12,000

Manufacturing Overhead **$17,600** **$17,600**

Cost of completed job Direct materials.............................................................. Direct labor .................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................

$17,000 12,000 17,600 $46,600

**$22 X 800 direct labor hours

Job No. 27 Date Direct Materials Jan.

Direct Labor

Manufacturing Overhead

$9,000

***$13,200***

$13,000

***$22 X 600 direct labor hours

2-30

PROBLEM 2-1B (Continued)

(f)

Finished Goods Inventory..................................... Work in Process Inventory ($37,400 + $46,600) .....................................

84,000

Accounts Receivable ............................................ Sales Revenue ($63,000 + $74,000) ...............

137,000

Cost of Goods Sold ............................................... Finished Goods Inventory ($42,000 + $37,400) .....................................

79,400

(g) Beginning balance Direct materials Direct labor Manufacturing overhead Ending balance

Work in Process 25,000 84,000 35,000 24,000 35,200 35,200

84,000 137,000

79,400

Cost of completed jobs 25 and 26

The balance in this account consists of the current costs assigned to Job No. 27: Direct Materials ................................................................ Direct Labor ...................................................................... Manufacturing Overhead ................................................. Total costs assigned ................................................

$13,000 9,000 13,200 $35,200

(h) Manufacturing Overhead Actual Applied 42,500 35,200 7,300 The balance in the Manufacturing Overhead account is underapplied.

2-31

PROBLEM 2-2B

(a) 1/1

12/31

Work in Process Inventory Balance (1) 111,000 Completed work (5) (c) Direct materials (2) 97,000 Direct labor (3) 144,000 Manufacturing overhead (4)180,000 Balance 188,000

(1)

Job 7650 Job 7651

$ 63,000 48,000 $111,000

(3)

Job 7650 Job 7651 Job 7652

$ 36,000 40,000 68,000 $144,000

(2)

Job 7650 Job 7651 Job 7652

$ 32,000 30,000 35,000 $ 97,000

(4)

Job 7650 Job 7651 Job 7652

$ 45,000 50,000 85,000 $180,000

(5) (a) Job 7650 Beginning balance ................................................. Direct materials ...................................................... Direct labor............................................................. Manufacturing overhead .......................................

(b) Job 7651 Beginning balance ................................................. Direct materials ...................................................... Direct labor............................................................. Manufacturing overhead .......................................

(c) Total cost of completed work Job 7650 ................................................................. Job 7651 .................................................................

2-32

344,000

$ 63,000 32,000 36,000 45,000 $176,000

$ 48,000 30,000 40,000 50,000 $168,000

$176,000 168,000 $344,000

PROBLEM 2-2B (Continued) Work in process balance ...............................................

$188,000

Unfinished job No. 7652 .................................................

$188,000 (a)

(a) Current year’s cost Direct materials........................... Direct labor ................................. Manufacturing overhead ............

$ 35,000 68,000 85,000 $188,000

(b) Actual overhead costs Incurred on account .............................................. Indirect materials ................................................... Indirect labor .......................................................... Depreciation ........................................................... Applied overhead costs Job 7650.................................................................. Job 7651.................................................................. Job 7652..................................................................

Actual overhead ............................................................ Applied overhead .......................................................... Underapplied overhead ................................................. Cost of Goods Sold ....................................................... 2,500 Manufacturing Overhead ....................................... (c) Sales revenue (given) ....................................... Cost of goods sold Add: Job 7648 .................................................. Job 7649 .................................................. Job 7650 .................................................. Add: Underapplied overhead .......................... Gross profit .......................................................

2-33

$135,000 12,000 16,000 19,500 $182,500 $ 45,000 50,000 85,000 $180,000 $182,500 180,000 $ 2,500 2,500 $490,000

$ 93,000 62,000 176,000 331,000 2,500

333,500 $156,500

PROBLEM 2-3B

(a) (i) Raw Materials Inventory ........................................... Accounts Payable .............................................

4,000 4,000

Factory Labor ............................................................ Cash ...................................................................

7,000

Manufacturing Overhead .......................................... Cash ...................................................................

1,400

(ii) Work in Process Inventory ....................................... Manufacturing Overhead .......................................... Raw Materials Inventory ...................................

5,300 1,500

Work in Process Inventory ....................................... Manufacturing Overhead .......................................... Factory Labor ....................................................

5,000 2,000

Work in Process Inventory ($5,000 X .70) ......................................................... Manufacturing Overhead .................................. (iii) Finished Goods Inventory ........................................ Work in Process Inventory ............................... Job

Direct Materials

Direct Labor

Manufacturing Overhead*

Total Costs

Stiner Alton Herman

$3,000 2,600 3,200

$2,400 2,200 2,100

$1,680 1,540 1,470

$ 7,080 6,340 6,770 $20,190

7,000 1,400

6,800

7,000 3,500 3,500 20,190 20,190

*70% of direct labor amount

2-34

Cash ........................................................................... Sales Revenue (3 X $12,000) ............................

36,000

Cost of Goods Sold .................................................. Finished Goods Inventory ................................

20,190

36,000 20,190

PROBLEM 2-3B (Continued) (b) 5/1

5/31

Work in Process Inventory Balance 12,200 5/31 Completed work Direct materials 5,300 Direct labor 5,000 Overhead applied 3,500 Balance 5,810

20,190

$5,810

Job: Smith (Direct materials $1,900 + Direct labor $2,300 + Manufacturing overhead $1,610) .....................................

$5,810

(d)

ROBERT PEREZ COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2014 Work in process, May 1 ........................................... Direct materials used .............................................. Direct labor............................................................... Manufacturing overhead applied ............................ Total manufacturing costs .............................. Total cost of work in process ................................. Less: Work in process, May 31 .............................. Cost of goods manufactured ..................................

2-35

$12,200 $5,300 5,000 3,500 13,800 26,000 5,810 $20,190

PROBLEM 2-4B

(a) Department A: Department B: Department C:

$720,000 ÷ $600,000 = 120% of direct labor cost. $640,000 ÷ 40,000 = $16.00 per direct labor hour. $900,000 ÷ 150,000 = $6.00 per machine hour.

(b) Manufacturing Costs Direct materials Direct labor Overhead applied Total

A $ 92,000 48,000 57,600 * $197,600

Department B $ 86,000 35,000 56,000 ** $177,000

C $ 64,000 50,400 75,600 *** $190,000

A $60,000 57,600 $ 2,400

Department B $60,000 56,000 $ 4,000

C $72,100 75,600 $ (3,500)

*$48,000 X 120% **3,500 X $16 ***12,600 X $6.00 (c) Manufacturing Overhead Incurred Applied Under (over) applied

2-36

PROBLEM 2-5B

(a) $88,900

($80,000 + $8,900).

(b) $20,500

[($19,000 + $90,400) – $88,900 (See (a))].

(Given in Other data—$19,000 + $8,200).

(d) $90,000

($117,000 manufacturing overhead applied ÷ 130%).

(e) $117,000

(Manufacturing overhead applied).

(f)

[$27,200 + $80,000 + $90,000 + $117,000 – $5,450 (See (g))].

$308,750

(g) $5,450

[$2,000 + $1,500 + ($1,500 X 130%)].

(h) $145,000

(Given in Other data).

(i)

$308,750

(Same as (f)).

(j)

$315,750

[$145,000 + $308,750 – $138,000 (Given in Other data)].

(k) $138,000

(Given in Other data).

(l)

[$90,000 (See (d)) + $16,000].

$106,000

(m) $106,000

(Same as (l)).

(n) $95,100

[$117,000 + $3,000 (Given in Other data) – $8,900 – $16,000].

2-37

BYP 2-1

DECISION-MAKING AT CURRENT DESIGNS

Cost for one kayak: Direct Materials Polyethylene powder Finishing kit

54 pounds @ $1.50 per pound 1 kit @ $170

Direct Labor More skilled Less skilled

2 hours @ $15 per hour 3 hours @ $12 per hour

81 170 30 36

Manufacturing overhead 150% of direct labor costs 150% * $66 Total cost for one kayak

99 $ 416

Cost for order of 20 kayaks $416 per kayak * 20 kayaks

$8,320

2-38

BYP 2-2

DECISION-MAKING ACROSS THE ORGANIZATION

(a) The manufacturing cost element that is responsible for the fluctuating unit costs is manufacturing overhead. Manufacturing overhead is being included as incurred rather than being applied on a predetermined basis. Direct materials and direct labor are not the cause as they have the same unit cost per batch in each quarter. (b) The solution is to apply overhead using a predetermined overhead rate based on a relevant basis of production activity. Based on actual overhead incurred and using batches of product TC-1 as the activity base, the overhead rate is $16,000 per batch [($105,000 + $153,000 + $97,000 + $125,000) ÷ 30]. Another approach would be to use direct labor cost as the relevant basis to apply overhead on a predetermined basis. For example, a rate of 133 1/3% of direct labor cost ($480,000 ÷ $360,000) could be used. Either approach will provide the same result. (c) The quarterly results using a predetermined overhead rate based on batches produced are as follows: Quarter Costs Direct materials Direct labor Manufacturing overhead Applied ($16,000 X batches) Total (a)

1 $100,000 60,000

2 3 $220,000 $ 80,000 132,000 48,000

4 $200,000 120,000

80,000 $240,000

176,000 64,000 $528,000 $192,000

160,000 $480,000

Production in batches (b)

$ 48,000

Unit cost (per batch) (a) ÷ (b)

(Note: The unit cost of a batch remains the same in each quarter. Both sales and production should be pleased with this solution to fluctuating unit costs.)

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

2-39

BYP 2-3

MANAGERIAL ANALYSIS

(a) Work in Process Inventory ............................. Raw Materials Inventory..........................

25,000 25,000

(b) If not corrected, the balance sheet is affected. Cash is understated and Raw Materials Inventory is overstated. 2.

(a) Sales Bonus Expense ..................................... Cash .........................................................

12,000 12,000

(b) Both the income statement and the balance sheet are affected. In the income statement, Sales Bonus Expense is understated, Income Tax Expense is overstated, and net income is overstated. The error causes the underapplied overhead to be overstated or the overapplied overhead to be understated. This affects Cost of Goods Sold, since the over- or underapplied balance is closed out to Cost of Goods Sold. The error in Cost of Goods Sold also has an effect on Retained Earnings. Also, Retained Earnings is overstated because of the overstatement of net income, and Income Taxes Payable is overstated. 3.

(a) Factory Labor .................................................. Factory Wages Payable........................... Employer Payroll Taxes Payable ............

120,000 102,000 18,000

(b) If not corrected, both the income statement and the balance sheet are affected. On the income statement, Cost of Goods Sold is understated and Wages Expense is overstated. On the balance sheet, Cash, Factory Wages Payable, and Employer Payroll Taxes Payable are understated.

2-40

BYP 2-3 (Continued) 4.

(a) Manufacturing Overhead ................................. Raw Materials Inventory ..........................

3,000 3,000

(b) Both the income statement and balance sheet are affected. If units that were in process during the month have been sold, then in the income statement Cost of Goods Sold is overstated, Income Tax Expense is understated, and net income is understated. This causes the Retained Earnings and Income Taxes Payable in the balance sheet to be understated. Also the error causes underapplied overhead to be understated or overapplied overhead to be overstated. This affects Cost of Goods Sold, since the over- or underapplied balance is closed out to Cost of Goods Sold. The error in Cost of Good Sold also has an affect on Retained Earnings.

2-41

BYP 2-4

REAL-WORLD FOCUS

(a) The advantages of job order costing include the following: 1.

Accurate costing results because actual costs of direct materials and direct labor are assigned to each job.

A comparison of actual costs with costs estimated in the company’s bid provides a basis for controlling job costs and improving operating efficiency.

Cost data on specific jobs may be useful to management in bidding on similar jobs in the future.

Accurate costs are assigned to work in process and finished goods inventories.

Job costing enables management to assess the relationship of the cost of goods sold for each job to the sales price of each job. The reciprocal of this relationship is the gross profit on each job. Improving these relationships is an important factor in increasing net income.

(b) Products in job order costing are usually custom-made to customer specifications so that a sale is assured prior to the start of the manufacturing process. Specific products include cruise ships, presidential limousines, buildings, homes, wedding invitations, and graduation and birth announcements. Products in process costing are relatively homogeneous such as boxes of cereal, bottles and cans of soda, jars of peanut butter, quarts of motor oil, and automobiles. The manufacture of the product is continuous to ensure that adequate inventories of finished products are available at all times.

2-42

BYP 2-5

REAL-WORLD FOCUS

(a) Candidates for the CMA or CFM Certificate must complete two continuous years of professional experience in management accounting or financial management. This requirement may be completed prior to or within seven years of passing the examination. (b) CMAs, CFMs, and candidates who have completed the CMA and/or the CFM examination but have not yet met the experience requirement, are required to maintain their proficiency in the fields of management accounting and financial management. This includes knowledge of new concepts and techniques as well as their application in the management accounting and financial management professions. The objective is to maintain the professional competence of the individual and to enhance one’s ability to perform job-related requirements. Persons who have retired need not meet continuing education requirements. The continuing requirement is 30 hours per year and at least 2 of those hours must be ethics-related. A broad range of subjects may be included in the programs for which hours of credit will be given. The subjects should be related to the topics covered on the CMA/CFM examination and/or to an individual’s job responsibilities. Illustrative of the subjects that may qualify are: all aspects of accounting, financial management, business applications of mathematics and statistics, computer science, economics, management, production, marketing, business law, and organizational behavior.

2-43

BYP 2-6

COMMUNICATION ACTIVITY

Williams Company Date Nancy Kopay 123 Cedar Lane Altoona, Kansas 66651 Dear Ms. Kopay: Thank you for your prompt payment! I am very glad that you found the cost information helpful. Thank you also for your questions about our overhead costs. We do try to provide our customers with as much information as possible, but we cannot give detailed information on overhead costs. The cost of providing such information is prohibitive. You asked why we do not use actual overhead costs when we bill our customers. We estimate overhead costs, rather than use actual costs, for several reasons. One of the most important reasons for you is that we could not prepare bills in a timely manner if we had to use actual overhead. We would have to wait until we were billed for such things as electricity and telephone service. A second reason is that some costs we include in overhead are only payable once or twice a year, such as insurance and taxes. When we use an estimated rate, we are able to allow for those costs. A third reason is that some costs are fixed, which means that they stay the same in dollar amount from month to month. This category includes items such as rent. If we billed you based on our actual costs, you would be billed a higher amount if your work was done during a slow time (because we would have fewer jobs to spread the costs over). An estimated overhead rate allows us to level out these costs.

2-44

BYP 2-6 (Continued) I hope this answers some of your questions. I’m glad you are interested in our company and that you took the time to write. I am sending a copy of our annual report under separate cover. It contains some details on the information you asked about. Thanks again for your letter and for having Williams make your new cabinets! Sincerely, Student

2-45

BYP 2-7

ETHICS CASE

(a) The stakeholders in this situation are:  Alice Reiley, controller for LRF Printing.  The president of LRF Printing.  The customers of LRF Printing.  The competitors of LRF Printing. (b) Padding cost-plus contracts is both unethical and illegal. Alice is faced with an ethical dilemma. She will be in trouble with the president if she doesn’t follow his directive, and she will be committing an unethical act if she does follow his instructions. (c) Alice should continue to accurately account for cost-plus contracts and, if challenged by the president, she should say that she is doing her very best to charge each and every legitimate cost to the cost-plus contracts. Let the president perform the unethical act if he continues to persist in padding costs.

2-46

BYP 2-8

ALL ABOUT YOU

(a) Your chances of success in small business are increased if you have the following characteristics: You are a self-starter, you get along with many different kinds of people, you are good at making decisions, you have physical and emotional stamina, you are well organized, you have a strong desire to succeed and you will receive family support during the start up phase. (b) The top ten reasons why businesses fail as cited in the books Small Business Management by Michael Ames, and The Do it Yourself Business Book by Gustav Berle are: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

2-47

Lack of experience Insufficient capital (money) Poor location Poor inventory management Over-investment in fixed assets Poor credit arrangements Personal use of business funds Unexpected growth Competition Low sales

BYP 2-9

CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: The situation presented is a difficult one because you are presently receiving some help for free. It would seem that the best strategy is to price your services based on what it would cost you to do the landscape business without any free help. In the long run, it is going to be impossible to continue unless you can cover these costs. In addition, if you underprice your services today, your customers may expect your prices will remain as low in the future. That probably cannot happen, given that your costs will increase substantially after the first two years. However, we should note that it is not unusual to start a small business with some assets available to you. Then, as your business grows, you acquire additional assets to meet your needs. After all, you may need a low price to get started, and as you gain experience you will be able to charge more or become more efficient. So what to do? Let’s address your old truck first. You should treat the truck as an asset owned by your business. Put it on your books at its fair value, and depreciate it over a reasonable life. This will result in an overhead charge. You need to cover the cost of that truck, as you will have to buy another one some day. The land, barn, and your mother’s services are a little more difficult. If you rented the land and barn and if you paid an assistant, all of these costs would be charged to overhead. (The assistant would be indirect labor.) You are currently getting all these services for free. This is a good situation now, and you may need this situation early in your business to help you get started. But you should recognize that even if you run your business profitably for the first two years, you may have problems beginning in the third year. Thus, it would seem prudent to establish a budget based on both scenarios for the first two years. If you can charge based on your expected costs in the future, do so. If that is not realistic, because you need to establish yourself and get more experience, then charge less. But be sure from the start to cover a reasonable amount of your costs, or the business does not make sense for you financially.

2-48

CHAPTER 3 Process Costing ASSIGNMENT CLASSIFICATION TABLE A Problems

B Problems

2, 4

4, 9

3, 5, 6, 7, 8, 9, 10, 11, 13, 14, 15

2A, 3A, 4A, 5A, 6A

2B, 3B, 4B, 5B, 6B

8, 9, 14, 15, 18

5, 6, 7, 8

3, 5, 6, 7, 8, 9, 2A, 3A, 10, 11, 13, 14, 4A, 5A 15, 16, 17, 18, 19

2B, 3B, 4B, 5B

16, 17, 19

7, 12, 13

2A, 3A, 4A, 5A, 6A

2B, 3B, 4B, 5B, 6B

16, 17, 18, 19, 20

Learning Objectives

Questions

* 1.

Understand who uses process cost systems.

* 2.

Brief Exercises

Do It!

Exercises

1, 2, 20

Explain the similarities and differences between job order cost and process cost systems.

2, 3, 4, 5

* 3.

Explain the flow of costs in a process cost system.

* 4.

Make the journal entries to assign manufacturing costs in a process cost system.

6, 7

1, 2, 3

* 5.

Compute equivalent units.

10, 11, 12, 13

* 6.

Explain the four steps necessary to prepare a production cost report.

* 7.

Prepare a production cost report.

**8.

Compute equivalent units 21, 22 using the FIFO method.

10, 11, 12

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix*to the chapter.

3-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Journalize transactions.

Moderate

20–30

Complete four steps necessary to prepare a production cost report.

Simple

30–40

Complete four steps necessary to prepare a production cost report.

Simple

30–40

Assign costs and prepare production cost report.

Moderate

20–30

Determine equivalent units and unit costs and assign costs.

Moderate

20–30

Compute equivalent units and complete production cost report.

Moderate

15–25

*7A*

Determine equivalent units and unit costs and assign costs for processes; prepare production cost report.

Moderate

30–40

Journalize transactions.

Moderate

20–30

Complete four steps necessary to prepare a production cost report.

Simple

30–40

Complete four steps necessary to prepare a production cost report.

Simple

30–40

Assign costs and prepare production cost report.

Moderate

20–30

Determine equivalent units and unit costs and assign costs.

Moderate

20–30

Compute equivalent units and complete production cost report.

Moderate

15–25

*7B

Determine equivalent units and unit costs and assign costs for processes; prepare production cost report.

Moderate

30–40

3-2

3-3

Learning Objective

Knowledge Comprehension

* 1. Understand who uses process cost Q3-1 systems. Q3-2 * 2. Explain the similarities and differences Q3-2 between job order cost and process Q3-3 cost systems. * 3. Explain the flow of costs in a process Q3-6 cost system. * 4. Make the journal entries to assign Q3-6 manufacturing costs in a process cost system. * 5. Compute equivalent units. Q3-10 Q3-11

E3-1 Q3-20 Q3-4 Q3-5 E3-1

* 6. Explain the four steps necessary to prepare a production cost report.

Q3-8

Q3-9

* 7. Prepare a production cost report.

Q3-16 Q3-17 Q3-19

*8. Compute equivalent units using the FIFO method.

Broadening Your Perspective

BYP3-4

Application

Analysis

Synthesis

Evaluation

DI3-1 DI3-1

E3-3 P3-1A Q3-7 BE3-1 BE3-2 Q3-12 Q3-13 BE3-4 BE3-9 DI3-3 E3-3 E3-5 E3-6 E3-7 E3-8 Q3-14 Q3-15 Q3-18 BE3-5 BE3-6 BE3-7 BE3-8 DI3-4 E3-3 E3-5 E3-6 BE3-11 DI3-4 E3-7 E3-11 E3-13 Q3-21 Q3-22 BE3-10 BE3-11 BYP3-1

P3-1B BE3-3 DI3-2 E3-2 E3-9 E3-10 E3-11 E3-13 E3-14 E3-15 P3-2A P3-3A P3-4A

E3-4 P3-1A P3-1B P3-5A P3-6A P3-2B P3-3B P3-4B P3-5B P3-6B

E3-7 E3-8 E3-9 E3-10 E3-11 E3-13 E3-14 E3-15 E3-16 E3-17

E3-18 E3-19 P3-2A P3-3A P3-4A P3-5A P3-2B P3-3B P3-4B P3-5B

P3-2A P3-3A P3-4A P3-5A P3-6A BE3-12 E3-16 E3-17 E3-18

P3-2B P3-3B P3-4B P3-5B P3-6B E3-19 E3-20 P3-7A P3-7B

P3-1A P3-1B P3-1A P3-1B P3-2A P3-3A P3-2B P3-3B

P3-2A P3-3A P3-2B P3-3B

BYP3-2 BYP3-3 BYP3-7

BYP3-5

BYP3-6

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) (b) (c) (d)

Process cost. Process cost. Job order. Job order.

The primary focus of job order cost accounting is on the individual job. In process cost accounting, the primary focus is on the processes involved in producing homogeneous products.

The similarities are: (1) all three manufacturing cost elements—direct materials, direct labor, and overhead—are the same; (2) the accumulation of the costs of materials, labor, and overhead is the same; and (3) the flow of costs is the same.

The features of process cost accounting are: (1) separate work in process accounts for each process, (2) production cost reports, (3) product costs computed for each accounting period, and (4) unit costs computed based on total manufacturing costs.

Sam is correct. The flow of costs is the same in process cost accounting as in job order cost accounting. The method of assigning costs, however, is significantly different.

(a) (1) Materials are charged to production on the basis of materials requisition slips. (2) Labor is usually charged to production on the basis of the payroll register or departmental payroll summaries. (b) The criterion used in assigning overhead to processes is to identify the activity that “drives” or causes the cost. In many companies this activity is machine time, not direct labor.

The entry to assign overhead to production is: July 31

Work in Process—Machining .................................................... Work in Process—Assembly ..................................................... Manufacturing Overhead ...................................................

15,000 12,000 27,000

To prepare a production cost report, four steps are followed: (a) compute the physical unit flow, (b) compute equivalent units of production, (c) compute unit production costs, and (d) prepare a cost reconciliation schedule.

Physical units to be accounted for consist of units in process at the beginning of the period plus units started (or transferred) into production during the period. Units accounted for consist of units completed and transferred out during the period plus units in process at the end of the period.

10.

Equivalent units of production measure the work done during the period, expressed in fully completed units.

11.

Equivalent units of production are the sum of: (1) units completed and transferred out and (2) equivalent units of ending work in process.

12.

Units started into production were 9,600, or (9,000 + 600).

3-4

Questions Chapter 3 (Continued)

13. Units transferred out Work in process 500 X 100% 500 X 20% Total equivalent units 14. Units transferred out were 3,200* Units to be accounted for Work in process (beginning) Started into production Total units Units accounted for Completed and transferred out Work in process (ending) Total units *3,500 – 300

Equivalent Units Materials Conversion Costs 12,000 12,000 500 12,500

100 12,100

500 3,000 3,500 3,200* 300 3,500

15. (a) (b)

The cost of the units transferred out is $112,000, or (14,000 X $8). The cost of the units in ending inventory is $8,500, or [(2,000 X $3) + (500 X $5)].

16. (a) (b)

Ann is incorrect. The report is an internal report for management. There are four sections in a production cost report: (1) number of physical units, (2) equivalent units determination, (3) unit costs, and (4) cost reconciliation schedule.

17. The production cost report provides the basis for evaluating: (1) the productivity of a department, (2) whether unit and total costs are reasonable, and (3) whether current performance is meeting planned objectives. 18. The per unit conversion cost is $11.25. [Conversion costs = $6,000 – $2,400 = $3,600. Equivalent units for conversion costs are 320 (800 X 40%); $3,600 ÷ 320 = $11.25.] 19. Operations costing is similar to process costing in that standardized methods are used to manufacture the product. At the same time, the product may have some customized individual features that require the use of a job order cost system. 20. In deciding which system to use, a cost-benefit tradeoff occurs. In a job order system, detailed information related to the cost of the product is involved. The cost of implementing this system is often expensive. In a process cost system, an average cost of the product will suffice and therefore the cost to implement is less. In summary, the cost of implementing the system must be balanced against the benefits provided from the additional information. *21. Units transferred out were 2,800 (2,000 + 800). *22. (a) (b)

3-5

The cost of the units transferred out is $120,000 (12,000 X $10). The cost of the units in ending inventory is $9,500 [(2,000 X $3) + (500 X $7)].

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 3-1 Mar. 31 31

Raw Materials Inventory ................................. Accounts Payable ....................................

45,000

Factory Labor .................................................. Wages Payable ........................................

60,000

45,000 60,000

BRIEF EXERCISE 3-2 Mar. 31

Work in Process—Assembly Department ..... Work in Process—Finishing Department ...... Raw Materials Inventory ..........................

24,000 21,000

Work in Process—Assembly Department ..... Work in Process—Finishing Department ...... Factory Labor ...........................................

35,000 25,000

45,000

60,000

BRIEF EXERCISE 3-3 Mar. 31

Work in Process—Assembly Department ($35,000 X 200%) ......................................... Work in Process—Finishing Department ($25,000 X 200%) ......................................... Manufacturing Overhead.........................

70,000 50,000 120,000

BRIEF EXERCISE 3-4

January March July

Materials 45,000 (35,000 + 10,000) 48,000 (40,000 + 8,000) 61,000 (45,000 + 16,000)

a. 10,000 X 40% b. 8,000 X 75% c. 16,000 X 25%

3-6

Conversion Costs 39,000 (35,000 + 4,000a) 46,000 (40,000 + 6,000b) 49,000 (45,000 + 4,000c)

BRIEF EXERCISE 3-5 Total materials costs $36,000 Total conversion costs $54,000 Unit materials cost $3.60

Equivalent units of materials 10,000

Equivalent units of conversion costs 12,000

Unit conversion cost $4.50

Unit materials cost $3.60

Unit conversion cost $4.50

Total manufacturing cost per unit $8.10

BRIEF EXERCISE 3-6 Assignment of Costs Transferred out Transferred out Work in process, 4/30 Materials Conversion costs Total costs

Equivalent Units

Unit Cost

40,000

$11

5,000 2,000

$ 4 $ 7

$440,000

$20,000 14,000

34,000 $474,000

BRIEF EXERCISE 3-7 Total materials costs $16,000 Total conversion *costs* $47,500 *$29,500 + $18,000

3-7

Equivalent units of materials 20,000

Equivalent units of conversion costs 19,000

Unit materials cost $.80

Unit conversion cost $2.50

BRIEF EXERCISE 3-8 Costs accounted for Transferred out Work in process Materials Conversion costs Total costs

(18,000 X $3.30) (2,000 X $.80) (1,000* X $2.50)

$59,400 $1,600 2,500

4,100 $63,500

*2,000 X 50% BRIEF EXERCISE 3-9

Units transferred out Work in process, November 30 Materials (7,000 X 100%) Conversion costs (7,000 X 40%) Total equivalent units

(a) Materials 8,000

(b) Conversion Costs 8,000

7,000 2,800 10,800

15,000

*BRIEF EXERCISE 3-10 Costs to Be Assigned Assignment of Costs

Equivalent Units

Unit Cost

Total Costs Assigned

Transferred out Work in process, 3/1 Started and completed

0 30,000

$ 0 $18

Work in process, 3/31 Materials Conversion costs

5,000 2,000

$ 6 $12

0 540,000 540,000

$594,000

3-8

$ 30,000 24,000

54,000 $594,000

*BRIEF EXERCISE 3-11 Equivalent Units Conversion Materials Costs Units accounted for Completed and transferred out Work in process, March 1 Started and completed Work in process, March 31 Total units

-030,000 5,000 35,000

-030,000 2,000 32,000

SANDERSON COMPANY (Partial) Production Cost Report For the Month Ended March 31 COSTS Materials Unit costs Total costs (a) Equivalent units (b) Unit costs (a) ÷ (b) Costs to be accounted for In process, March 1 Costs in March Total costs Costs accounted for Transferred out In process, March 1 Started and completed (30,000 units X $18) In process, March 31 Materials (5,000 X $6) Conversion costs (2,000 X $12) Total costs

$210,000* 35,000 $ 6

*35,000 equivalent units X $6 per unit **32,000 equivalent units X $12 per unit

3-9

Conversion Costs

Total

$384,000** $594,000 32,000 $ 12 $ 18 $ 0 594,000 $594,000 $

0 540,000

$ 30,000 24,000

54,000 $594,000

*BRIEF EXERCISE 3-12 Total materials costs 1 $75,0001 1

Equivalent units of materials 20,000

Unit materials cost $3.75

Unit conversion cost $2.00

$8,000 + $67,000 = $75,000

Total conversion costs 2 $38,0002 2

Equivalent units of conversion costs 19,000

$20,000 + $18,000 SOLUTIONS FOR DO IT! REVIEW EXERCISES

DO IT! 3-1 1. 2. 3. 4.

False False True False

DO IT! 3-2 Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Raw Materials Inventory ............................................. (To record materials used)

10,000 28,000

Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Factory Labor .............................................................. (To assign factory labor to production)

8,000 36,000

Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Manufacturing Overhead ............................................ (To assign overhead to production)

12,000 54,000

3-10

38,000

44,000

66,000

DO IT! 3-2 (Continued) Work in Process—Packaging ............................................ Work in Process—Mixing ........................................... (To record transfer of units to the Packaging Department)

21,000

Finished Goods Inventory ................................................. 106,000 Work in Process—Packaging .................................... (To record transfer of units to finished goods)

21,000

106,000

DO IT! 3-3 (a) Since materials are entered at the beginning of the process, the equivalent units of ending work in process are 12,000. 20,000 units + 12,000 units = 32,000 equivalent units of production for materials. (b) Since ending work in process is only 70% complete as to conversion costs, the equivalent units of ending work in process for conversion costs are 8,400 (70% X 12,000 units). 20,000 units + 8,400 units = 28,400 equivalent units of production for conversion costs. DO IT! 3-4 (a) 0 (Work in process, March 1) + 26,000* (Started into production) = 26,000 *22,000 + 4,000 (b) Equivalent units of production: Units transferred out ................. Work in process, March 31 ....... Total ............................................

3-11

Materials 22,000 4,000 26,000

Conversion 22,000 1,600 (4,000 X 40%) 23,600

DO IT! 3-4 (Continued) (c) Cost reconciliation schedule Costs accounted for Transferred out (22,000 X $18) ............ Work in process, March 31 Materials (4,000 X $10) ................. Conversion costs (1,600 X $8) ..... Total costs ..................................................

3-12

$396,000 $40,000 12,800

52,800 $448,800

SOLUTIONS TO EXERCISES EXERCISE 3-1 1. True. 2. True. 3. False. Companies that produce soft drinks and computer chips would use process cost accounting. 4. False. In a job order cost system, costs are tracked by individual jobs. 5. False. Job order costing and process costing track the same three manufacturing cost elements. 6. True. 7. True. 8. False. In a process cost system, multiple work in process accounts are used. 9. False. In a process cost system, costs are summarized in a production cost report for each department. 10. True. EXERCISE 3-2 April 30

3-13

Work in Process—Cooking .............................. Work in Process—Canning .............................. Raw Materials Inventory ...........................

21,000 9,000

Work in Process—Cooking .............................. Work in Process—Canning .............................. Factory Labor ............................................

8,500 7,000

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

31,500 25,800

Work in Process—Canning .............................. Work in Process—Cooking ......................

53,000

30,000

15,500

57,300 53,000

EXERCISE 3-3 (a) Work in process, May 1 Started into production Total units to be accounted for Less: Transferred out Work in process, May 31 (b) and (c) Units transferred out Work in process, May 31 300 X 100% 300 X 40%

Work in process, May 1 Costs added Total costs Equivalent units Unit costs

400 1,400 1,800 1,500 300 Equivalent Units Materials Conversion Costs 1,500 1,500 300 1,800

120 1,620

Direct Materials $2,040 5,160 $7,200 1,800 $4.00

Conversion Costs $1,550 4,120* $5,670 1,620 $3.50

*$2,740 + $1,380 (d) Transferred out (1,500 X $7.50) (e) Work in process Materials (300 X $4.00) Conversion costs (120 X $3.50)

3-14

$11,250 $ 1,200 420 $ 1,620

EXERCISE 3-4 1. 2. 3.

7. 8. 9.

Raw Materials Inventory .......................................... Accounts Payable ............................................

62,500

Factory Labor ........................................................... Wages Payable .................................................

60,000

Manufacturing Overhead......................................... Cash .................................................................. Accounts Payable ............................................

70,000

Work in Process—Cutting....................................... Work in Process—Assembly .................................. Raw Materials Inventory ..................................

15,700 8,900

Work in Process—Cutting....................................... Work in Process—Assembly .................................. Factory Labor ...................................................

33,000 27,000

Work in Process—Cutting (1,680 X $18) ................ Work in Process—Assembly (1,720 X $18) ............ Manufacturing Overhead .................................

30,240 30,960

Work in Process—Assembly .................................. Work in Process—Cutting ...............................

67,600

Finished Goods Inventory....................................... Work in Process—Assembly ...........................

134,900

Cost of Goods Sold ................................................. Finished Goods Inventory ...............................

150,000

Accounts Receivable ............................................... Sales Revenue ..................................................

200,000

3-15

62,500 60,000 40,000 30,000

24,600

60,000

61,200 67,600 134,900 150,000 200,000

EXERCISE 3-5 (a)

January

May

Units to be accounted for Beginning work in process Started into production Total units

0 11,000 11,000

0 23,000 23,000

Units accounted for Transferred out Ending work in process Total units

9,000 2,000 11,000

16,000 7,000 23,000

(b)

(1) January March May July

Materials

(2)

11,000 ( 9,000 + 2,000) 15,000 (12,000 + 3,000) 23,000 (16,000 + 7,000) 11,500 (10,000 + 1,500)

Conversion Costs 10,200 ( 9,000 + 1,200) 12,900 (12,000 + 900) 21,600 (16,000 + 5,600) 10,600 (10,000 + 600)

EXERCISE 3-6 (a) Units transferred out Work in process, July 31 3,000 X 100% 3,000 X 60% Total equivalent units

(1) Materials

(2) Conversion Costs

12,000

3,000 15,000

1,800 13,800

(b) Materials: $45,000 ÷ 15,000 = $3.00 Conversion costs: ($16,200 + $18,300) ÷ 13,800 = $2.50 Costs accounted for Transferred out (12,000 X $5.50) Work in process, July 31 Materials (3,000 X $3.00) Conversion costs (1,800 X $2.50) Total costs

3-16

$66,000 $9,000 4,500

13,500 $79,500

EXERCISE 3-7 RICHARDS FURNITURE COMPANY Sanding Department Production Cost Report For the Month Ended March 31, 2014

Quantities

Physical Units

Units to be accounted for Work in process, March 1 Started into production Total units

0 12,000 12,000

Units accounted for Transferred out Work in process, March 31 Total units

9,000 3,000 12,000

Equivalent Units Conversion Materials Costs

9,000 3,000 12,000

9,000 600 9,600

Costs

Materials

Conversion Costs

Unit costs Total cost Equivalent units Unit costs (a) ÷ (b)

$33,000 12,000 $2.75

$60,000* 9,600 $6.25

Costs to be accounted for Work in process, March 1 Started into production Total costs

(3,000 X 20%)

Total $93,000 $9.00

0 93,000 $93,000

Cost Reconciliation Schedule Costs accounted for Transferred out (9,000 X $9.00) Work in process, March 31 Materials (3,000 X $2.75) Conversion costs (600 X $6.25) Total costs

*$24,000 + $36,000

3-17

$81,000 $8,250 3,750

12,000 $93,000

EXERCISE 3-8 (a)

(1)

Units transferred out Work in process, April 30 1,000 X 100% 1,000 X 40%

(2) Conversion Costs 17,000

Materials 17,000 1,000 18,000

400 17,400

Materials $900,000(1) 18,000 $ 50

Conversion Costs $435,000(2) 17,400 $ 25

(b) Total cost Equivalent units Unit costs (1)

$100,000 + $800,000

(2)

$ 70,000 + $365,000

$50,000 10,000

(a) Materials: 34,000* + 6,000 = 40,000 Conversion costs: 34,000* + (6,000 X 40%) = 36,400 *40,000 – 6,000 (b) Materials: $72,000/40,000 = $1.80 Conversion costs: ($81,000 + $101,000)/36,400 = $5.00 (c) Transferred out: 34,000 X $6.80 = $231,200 Ending work in process:

3-18

$1,275,000

EXERCISE 3-9

Materials (6,000 X $1.80) Conversion costs (2,400 X $5.00) Total

Total $1,335,000

= =

$10,800 12,000 $22,800

60,000 $1,335,000

EXERCISE 3-10 (a) Beginning work in process Units started into production

Units transferred out Ending work in process

Physical Units 20,000 164,000 184,000

Equivalent Units

Conversion Materials Costs 160,000 160,000 24,000 14,400 (60% X 24,000) 184,000 174,400

160,000 24,000 184,000

(b) Costs incurred Equivalent units Unit costs

Materials $101,200 184,000 $0.55

Conversion Costs $348,800 174,400 $2.00

(c) Assignment of costs: Transferred out (160,000 X $2.55) Ending work in process Materials (24,000 X $.55) Conversion costs (14,400 X $2.00) Total costs

Work in process, September 1 Units started into production Units transferred out Work in process, September 30

3-19

$2.55 $408,000

$13,200 28,800

EXERCISE 3-11 (a)

Total $450,000

Physical Units 1,600 38,400 40,000 35,000 5,000 40,000

42,000 $450,000

EXERCISE 3-11 (Continued)

Units transferred out Work in process 5,000 X 100% 5,000 X 10%

Equivalent Units Materials Conversion Costs 35,000 35,000 5,000 500 35,500

40,000 (b)

Materials Work in process, September 1 Direct materials

$ 20,000

Costs added to production during September Total materials cost

177,200 $197,200

$197,200 ÷ 40,000 = $4.93 (Materials cost per unit) Conversion Costs Work in process, September 1 Conversion costs

$ 43,180

Costs added to production during September Conversion costs ($125,680 + $257,140) Total conversion costs

382,820 $426,000

$426,000 ÷ 35,500 = $12.00 (Conversion cost per unit) (c) Costs accounted for Transferred out (35,000 X $16.93) Work in process, September 30 Materials (5,000 X $4.93) Conversion costs (500 X $12.00) Total costs

3-20

$592,550 $24,650 6,000

30,650 $623,200

EXERCISE 3-12 To:

David Skaros

From:

Student

Re:

Ending inventory

The reason for any confusion related to your department’s ending inventory quantity stems from the fact that the quantity can be measured in two different ways, depending on what the information is used for. The ending inventory quantity can be measured in physical units or equivalent units. Physical units are actual units present without regard to the stage of completion. Your department’s ending inventory in physical units is at least double the amount reported as equivalent units. Equivalent units measure the work done on the physical units, expressed in terms of fully completed units. Therefore, if your ending inventory contains 4,000 units which are 50% complete, that is equivalent to having 2,000 completed units at month end. Therefore, the ending inventory could be expressed as containing 4,000 physical units or 2,000 equivalent units. I hope this clears up any misunderstandings. Please contact me if you have any further questions.

3-21

EXERCISE 3-13 THORPE COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, February 1 Started into production Total units

15,000 45,000 60,000

Units accounted for Transferred out Work in process, February 28 Total units

49,000 11,000 60,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

49,000 11,000 60,000

49,000 2,200 51,200

Materials

Conversion Costs

(a) $198,000(1) (b) 60,000 $3.30

$128,000(2) 51,200 $2.50

Costs to be accounted for Work in process, February 1 Started into production Total costs

(11,000 X 20%)

Total $326,000 $5.80

$ 32,175 293,825 $326,000

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (49,000 X $5.80) Work in process, February 28 Materials (11,000 X $3.30) Conversion costs (2,200 X $2.50) Total costs (1)

$18,000 + $180,000 $14,175 + $52,380 + $61,445

(2)

3-22

$284,200 $36,300 5,500

41,800 $326,000

EXERCISE 3-14 (a)

Containers in transit, April 1 Containers loaded Total containers

0 1,200 1,200

Containers off-loaded Containers in transit, April 30 Total containers

850 350 1,200

(b) Containers off-loaded Containers in transit, April 30 Total equivalent units *350 x 40% = 140 **350 x 20% = 70

Equivalent Units Physical Direct Conversion Units Materials Costs 850 850 850 350 140* 70** 990 920

EXERCISE 3-15 (a) Applications transferred out Work in process, September 30 Equivalent units

Materials 800 200* 1,000

Conversion Costs 800 120** 920

*100 + 900 – 800 = 200 **200 X 60% = 120 (b) Materials: $5,500 ÷ 1,000 = $5.50 Conversion costs: $25,300* ÷ 920 = $27.50 Costs accounted for: Transferred out (800 X $33.00) Work in process, September 30 Materials (200 X $5.50) Conversion costs (120 X $27.50) Total costs *($3,960 + $12,000 + $9,340)

3-23

$26,400 $1,100 3,300

4,400 $30,800

*EXERCISE 3-16

(a)

Physical Units

Applications completed: Work in process, September 1 Started and completed Work in process, September 30 Total units

Equivalent Units Conversion Materials Costs

100 700 200 1,000

0 700 200 900

60 700 120 880

(b) Materials: $4,500 ÷ 900 = $5.00 Conversion costs: $21,340* ÷ 880 = $24.25 *($12,000 + $9,340) Costs accounted for: Applications completed: Work in process, September 1 Conversion costs (60 x $24.25) Started and completed (700 x $29.25) Work in process, September 30: Materials (200 x $5.00) Conversion costs (120 x $24.25) Total costs

$4,960 1,455

$ 6,415 20,475 1,000 2,910

$26,890 3,910 $30,800*

*Total costs to be accounted for: $1,000 + $3,960 + $4,500 + $12,000 + $9,340 = $30,800

3-24

*EXERCISE 3-17 (a) (1) Materials: Production Data

Physical Units

Materials Added This Period

Equivalent Units

Work in process, August 1 Started and completed Work in process, August 31 Total

0 8,000 2,000 10,000

0 100% 100%

0 8,000 2,000 10,000

(2) Conversion Costs: Production Data

Physical Units

Work Added This Period

Equivalent Units

Work in process, August 1 Started and completed Work in process, August 31 Total

0 8,000 2,000 10,000

0 100% 40%

0 8,000 800 8,800

(b) Unit costs are: Materials Conversion costs Total

$45,000 ÷ 10,000 = $4.50 $30,800* ÷ 8,800 = 3.50 $8.00

*$14,700 + $16,100 Costs to Be Assigned

Assignment of Costs

Total Costs Assigned

Total mfg. costs Transferred out Work in process, August 1 $75,800 (1) Started and completed

0 8,000

$0 $8

Work in process, August 31 Materials Conversion costs

2,000 800

$4.50 $ 9,000 $3.50 2,800

(1) $45,000 + $14,700 + $16,100.

Equivalent Unit Units Cost

3-25

$ 0 64,000

$64,000

11,800 $75,800

*EXERCISE 3-18 (a) (1) Materials Work in process, September 1 Started and completed Work in process, September 30 Total (2) Conversion Costs Work in process, September 1 Started and completed Work in process, September 30 Total (b) Materials Conversion costs

(c)

Costs to Be Assigned Total mfg. costs

*$207,200*

Physical Units

Materials Added This Period Q 0% 100%

Equivalent Units

1,000 12,000

100%

1,000 10,000

Physical Units

Work Added This Period

Equivalent Units

2,000 9,000

80% 100%

1,600 9,000

1,000 12,000

40%

400 11,000

Unit Cost

Total Costs Assigned

2,000 9,000

0 9,000

$ 60,000 ÷ 10,000 = $ 6 $132,000 ÷ 11,000 = 12 $18

Assignment of Costs

Equivalent Units

Transferred out Work in process, 9/1 0 Conversion costs 1,600 Started and completed 9,000 Total costs transferred out Work in process, 9/30 Materials 1,000 Conversion costs 400 Total costs

$ 0 $12 $18

$15,200 19,200

$ 6 $12

$6,000 4,800

$ 34,400 162,000 196,400

10,800 $207,200

*Work in process, September 1, $15,200 + materials costs $60,000 + labor and overhead costs $132,000.

3-26

*EXERCISE 3-19 (a) Work in process, March 1 Started into production Total units to be accounted for Less: Transferred out Work in process, March 31

800 1,200 2,000 1,500 500

(b) Materials: Physical Materials Added Equivalent Production Data Units This Period Units Work in process, March 1 800 %100 0 Started and completed 700 100% 700 Work in process, March 31 500 100% 500 Total 2,000 1,200 Unit cost = $6,600 ÷ 1,200 = $5.50. (c) Conversion costs: Physical Production Data Units Work in process, March 1 800 Started and completed 700 Work in process, March 31 500 Total 2,000

Work Added This Period 70% 100% 40%

Equivalent Units 560 700 200 1,460

Unit cost = $2,500 + $1,150 = $3,650 ÷ 1,460 = $2.50. (d) In process, March 1 ......................................................... Conversion costs (560 X $2.50) ...................................... Total cost..........................................................................

$3,680 1,400 $5,080

(e) 700 X ($5.50 + $2.50) = $5,600. (f)

Materials (500 X $5.50) .................................................... Conversion costs (200 X $2.50) ...................................... Total cost of work in process, March 31 ........................

3-27

$2,750 500 $3,250

*EXERCISE 3-20 MAJESTIC COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2014

Quantities

Physical Units (Step 1)

Units to be accounted for Work in process, February 1 Started into production Total units

15,000 64,000 79,000

Units accounted for Completed and transferred out Work in process, February 1 Started and completed Total Work in process, February 28 Total units

15,000 39,000* 54,000 25,000 79,000

Equivalent Units Conversion Materials Costs (Step 2)

0 39,000 39,000 25,000 64,000

13,500 (15,000 X 90%) 39,000 52,500 5,000 (25,000 X 20%) 57,500

*(64,000 – 25,000)

Costs Unit costs (Step 3) Costs in February Equivalent units Unit costs (a) ÷ (b) Costs to be accounted for Work in process, February 1 Started into production Total costs

3-28

Materials (a) $192,000 (1) (b) 64,000 $3.00

Conversion Costs

Total

$103,500 (2) $295,500 57,500 $1.80 $4.80

$ 32,175 295,500 $327,675

*EXERCISE 3-20 (Continued) Cost Reconciliation Schedule Costs accounted for (Step 4) Transferred out Work in process, February 1 Costs to complete beginning work in process Conversion costs (13,500 X $1.80) Total costs Units started and completed (39,000 X $4.80) Total costs transferred out Work in process, February 28 Materials (25,000 X $3.00) Conversion costs (5,000 X $1.80) Total costs

$32,175

24,300

(1) Cost of materials added $57,000 plus costs transferred in $135,000. (2) Labor $35,100 plus overhead $68,400.

3-29

$ 56,475 187,200 $243,675 75,000 9,000

84,000 $327,675

SOLUTIONS TO PROBLEMS PROBLEM 3-1A

1. 2.

3. 4.

5. 6.

7. 8. 9.

3-30

Raw Materials Inventory .................................. Accounts Payable ....................................

300,000

Work in Process—Mixing ................................ Work in Process—Packaging ......................... Raw Materials Inventory ..........................

210,000 45,000

Factory Labor ................................................... Wages Payable .........................................

258,900

Work in Process—Mixing ................................ Work in Process—Packaging ......................... Factory Labor ...........................................

182,500 76,400

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

810,000

Work in Process—Mixing (28,000 X $24)........ Work in Process—Packaging (6,000 X $24) ................................................. Manufacturing Overhead .........................

672,000

300,000

255,000 258,900

258,900 810,000

144,000 816,000

Work in Process—Packaging ......................... Work in Process—Mixing ........................

979,000

Finished Goods Inventory ............................... Work in Process—Packaging ..................

1,315,000

Accounts Receivable ....................................... Sales Revenue ..........................................

2,500,000

Cost of Goods Sold ......................................... Finished Goods Inventory .......................

1,604,000

979,000 1,315,000 2,500,000 1,604,000

PROBLEM 3-2A

(a) Physical units Units to be accounted for Work in process, June 1 Started into production Total units

0 22,000 22,000

Units accounted for Transferred out Work in process, June 30 Total units

20,000 2,000 22,000

(b) Equivalent units Units transferred out Work in process, June 30 2,000 X 100% 2,000 X 40% Total equivalent units (c) Materials Conversion costs Total unit cost

Materials 20,000

Conversion Costs 20,000

2,000 800 20,800

22,000 Unit Costs $9.00 ($198,000 ÷ 22,000) $8.00 ($166,400* ÷ 20,800) $17.00 ($9.00 + $8.00)

*$53,600 + $112,800 (d) Costs accounted for Transferred out (20,000 X $17.00) Work in process, June 30 Materials (2,000 X $9.00) Conversion costs (800 X $8.00) Total costs

3-31

$340,000 $18,000 6,400

24,400 $364,400

PROBLEM 3-2A (Continued) (e)

ROSENTHAL COMPANY Molding Department Production Cost Report For the Month Ended June 30, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, June 1 Started into production Total units

0 22,000 22,000

Units accounted for Transferred out Work in process, June 30 Total units

20,000 2,000 22,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

20,000 2,000 22,000

20,000 800 (2,000 X 40%) 20,800

Materials

Conversion Costs

(a) $198,000 (b) 22,000 $9.00

$166,400 20,800 $8.00

Costs to be accounted for Work in process, June 1 Started into production Total costs

Total $364,400 $17.00

$ 0 364,400 $364,400

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (20,000 X $17.00) Work in process, June 30 Materials (2,000 X $9.00) Conversion costs (800 X $8.00) Total costs

3-32

$340,000 $18,000 6,400

24,400 $364,400

PROBLEM 3-3A

(a) (1) Physical units T12 Tables

C10 Chairs

Units to be accounted for Work in process, July 1 Started into production Total units

0 19,000 19,000

0 16,000 16,000

Units accounted for Transferred out Work in process, July 31 Total units

16,000 3,000 19,000

15,500 500 16,000

(2) Equivalent units

Units transferred out Work in process, July 31 (3,000 X 100%) (3,000 X 60%) Total equivalent units

Units transferred out Work in process, July 31 (500 X 100%) (500 X 80%) Total equivalent units

3-33

T12 Tables Conversion Materials Costs 16,000 16,000 3,000 19,000

1,800 17,800

C10 Chairs Conversion Materials Costs 15,500 15,500 500 16,000

400 15,900

PROBLEM 3-3A (Continued) (3) Unit costs

Materials ($380,000 ÷ 19,000) ($288,000 ÷ 16,000) Conversion costs ($338,200(a) ÷ 17,800) ($206,700(b) ÷ 15,900) Total (a)

C10 Chairs $18

19 $39

13 $31

$234,200 + $104,000

(b)

(4)

T12 Tables $20

$110,000 + $96,700

T12 Tables Costs accounted for Transferred out (16,000 X $39) Work in process Materials (3,000 X $20) Conversion costs (1,800 X $19) Total costs

$624,000 $60,000 34,200

94,200 $718,200

C10 Chairs Costs accounted for Transferred out (15,500 X $31) Work in process Materials (500 X $18) Conversion costs (400 X $13) Total costs

3-34

$480,500 $9,000 5,200

14,200 $494,700

PROBLEM 3-3A (Continued) (b)

SEAGREN INDUSTRIES INC. Cutting Department—Plant 1 Production Cost Report For the Month Ended July 31, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, July 1 Started into production Total units

0 19,000 19,000

Units accounted for Transferred out Work in process, July 31 Total units

16,000 3,000 19,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

16,000 3,000 19,000

16,000 1,800 (3,000 X 60%) 17,800

Materials

Conversion Costs

(a) $380,000 (b) 19,000 $ 20

$338,200 17,800 $ 19

Costs to be accounted for Work in process, July 1 Started into production Total costs

Total $718,200 $

0 718,200 $718,200

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (16,000 X $39) Work in process, July 31 Materials (3,000 X $20) Conversion costs (1,800 X $19) Total costs

3-35

$624,400 $60,000 34,200

94,200 $718,200

PROBLEM 3-4A

(a) Physical Units Units to be accounted for Work in process, November 1 Started into production Total units

35,000 660,000 695,000

Units accounted for Transferred out Work in process, November 30 Total units

670,000 25,000 695,000

Equivalent Units Conversion Materials Costs

670,000 25,000 695,000

670,000 10,000* 680,000

*25,000 X 40% Materials cost Beginning work in process Added during month Total Equivalent units Cost per unit

Conversion costs

79,000 1,589,000 $1,668,000

$ 48,150 563,850 $612,000

695,000

680,000

$2.40

$.90

($225,920 + $337,930)

(b) Costs accounted for Transferred out (670,000 X $3.30) Work in process, November 30 Materials (25,000 X $2.40) Conversion costs (10,000 X $.90) Total costs

3-36

$2,211,000 $60,000 9,000

69,000 $2,280,000

PROBLEM 3-4A (Continued) (c)

RIVERA COMPANY Assembly Department Production Cost Report For the Month Ended November 30, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, November 1 Started into production Total units

35,000 660,000 695,000

Units accounted for Transferred out Work in process, November 30 Total units

670,000 25,000 695,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

670,000 25,000 695,000

670,000 10,000 (25,000 X 40%) 680,000

Materials

Conversion Costs

(a) $1,668,000 (b) 695,000 $2.40

$612,000 680,000 $.90

Costs to be accounted for Work in process, November 1 Started into production Total costs

Total $2,280,000 $3.30

$ 127,150 2,152,850 $2,280,000

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (670,000 X $3.30) Work in process, November 30 Materials (25,000 X $2.40) Conversion costs (10,000 X $.90) Total costs

3-37

$2,211,000 $60,000 9,000

69,000 $2,280,000

PROBLEM 3-5A

(a) (1) Physical Units Units to be accounted for Work in process, July 1 Started into production Total units

500 1,250 1,750

Units accounted for Transferred out Work in process, July 31 Total units

1,150 600 1,750

Equivalent Units Conversion Materials Costs

1,150 600 1,750

1,150 240* 1,390

*600 X 40% (2)

Materials cost

Conversion costs

Beginning work in process Added during month Total

$ 750 2,400 $3,150

$ 600 2,875 $3,475

Equivalent units

1,750

1,390

Cost per unit

$1.80

$2.50

($1,580 + $1,295)

(3) Costs accounted for Transferred out (1,150 X $4.30) Work in process, July 31 Materials (600 X $1.80) Conversion costs (240 X $2.50) Total costs

3-38

$4,945 $1,080 600

1,680 $6,625

PROBLEM 3-5A (Continued) (b)

MORSE COMPANY Basketball Department Production Cost Report For the Month Ended July 31, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, July 1 Started into production Total units

500 1,250 1,750

Units accounted for Transferred out Work in process, July 31 Total units

1,150 600 1,750

Costs Unit costs (Step 3) Costs in July Equivalent units Unit costs (a) ÷ (b)

(a) (b)

1,150 600 1,750

1,150 240 1,390

Materials

Conversion Costs

$3,150 1,750 $1.80

$3,475 1,390 $2.50

Costs to be accounted for Work in process, July 1 Started into production Total costs

Total $6,625 $4.30

$1,350 5,275 $6,625

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (1,150 X $4.30) Work in process, July 31 Materials (600 X $1.80) Conversion costs (240 X $2.50) Total costs

3-39

$4,945 $1,080 600

1,680 $6,625

PROBLEM 3-6A

(a) Computation of equivalent units:

Units accounted for Transferred out Work in process, October 31 (60% materials, (40% conversion costs) Total units

Physical Units

Equivalent Units Conversion Materials Costs

120,000

50,000 170,000

30,000 150,000

20,000 140,000

Computation of October unit costs Materials: $240,000 ÷ 150,000 equivalent units = $1.60 Conversion cost: $105,000 ÷ 140,000 equivalent units = .75 Total unit cost, October $2.35

(b) Cost Reconciliation Schedule Costs accounted for Transferred out (120,000 X $2.35) Work in process, October 31 Materials (30,000 X $1.60) Conversion costs (20,000 X $0.75) Total costs

3-40

$282,000 $48,000 15,000

63,000 $345,000

*PROBLEM 3-7A

(a) Bicycles (1) Equivalent units—Materials Materials Added This Period

Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total

200 950 (1,250 – 300) 300 1,450

Equivalent Units

0%* 100% 100%

0 950 300 1,250

*All materials are added at the beginning of the production process

Equivalent units—Conversion Conversion Added This Period

Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total

200 950 (1,250 – 300) 300 1,450

Equivalent Units

20% (1 – .8) 100% 40%

40 950 120 1,110

(2) Unit costs Costs in March (a) Equivalent units (b) Unit costs (a) ÷ (b)

Materials $50,000 1,250 $ 40

Conversion **$55,500** 1,110 $ 50

**Direct Labor $25,500 + Manufacturing Overhead $30,000

3-41

*PROBLEM 3-7A (Continued) (3) Assignment of costs to units transferred out and in process Costs to Be Assigned Total mfg. costs ***$124,780***

Assignment of Costs Transferred out Work in process, March 1 Conversion Started and completed Total costs transferred out Work in process, March 31 Materials Conversion costs Total costs

Equivalent Unit Units Cost

40 950

$50 $90

Total Costs Assigned $19,280 2,000 85,500 $106,780

300 120

$40 $50

12,000 6,000

18,000 $124,780

***Work in process, March 1, $19,280 + Materials $50,000 + Labor $25,500 + Overhead $30,000

Tricycles (1) Equivalent units—Materials Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total

100 740 (800 – 60) 60 900

Materials Added This Period *

0%* 100% 100%

Equivalent Units 0 740 60 800

*All materials are added at the beginning of the production process

Equivalent units—Conversion Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total

3-42

100 740 (800 – 60) 60 900

Conversion Added This Period 25% (1 – .75) 100% 25%

Equivalent Units 25 740 15 780

*PROBLEM 3-7A (Continued) (2) Unit costs Costs in March (a) Equivalent units (b) Unit costs (a) ÷ (b)

Materials $30,400 800 $ 38

Conversion $35,100** 780 $ 45

**Direct Labor $15,100 + Manufacturing Overhead $20,000 (3) Assignment of costs to units transferred out and in process Costs to Be Assigned

Assignment of Costs

Total mfg. costs Transferred out Work in process, March 1 ***$71,625*** Conversion Started and completed Total costs transferred out Work in process, March 31 Materials Conversion costs Total costs

Equivalent Unit Units Cost

25 740

$45 $83

Total Costs Assigned $ 6,125 1,125 61,420 $68,670

60 15

$38 $45

2,280 675

2,955 $71,625

***Work in process, March 1, $6,125 + Materials $30,400 + Labor $15,100 + Overhead $20,000

3-43

*PROBLEM 3-7A (Continued) (b)

RONDELI COMPANY Production Cost Report—Bicycles For the Month Ended March 31

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, March 1 Started into production Total units

200 1,250 1,450

Units accounted for Completed and transferred out Work in process, March 1 Started and completed Work In process, March 31 Total units

200 950 300 1,450

0 950 300 1,250

Costs

Materials

Conversion Costs

Unit costs (Step 3) Costs in March (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

$50,000 1,250 $ 40

$ 55,500 1,110 $ 50

Costs to be accounted for Work in process, March 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out Work in process, March 1 Conversion costs to complete beginning inventory (40 X $50) Started and completed (950 X $90) Work in process, March 31 Materials (300 X $40) Conversion costs (120 X $50) Total costs

*($50,000 + $25,500 + $30,000)

3-44

$ 19,280 105,500* $124,780

$19,280 2,000 85,500 12,000 6,000

$106,780

18,000 $124,780

40 950 120 1,110 Total $105,500 $

PROBLEM 3-1B

1. 2.

3. 4.

5. 6.

7. 8. 9.

Raw Materials Inventory ............................................. Accounts Payable ...............................................

25,000

Work in Process—Blending ....................................... Work in Process—Packaging .................................... Raw Materials Inventory .....................................

18,930 9,140

Factory Labor .............................................................. Wages Payable ....................................................

25,770

Work in Process—Blending ....................................... Work in Process—Packaging .................................... Factory Labor ......................................................

15,320 10,450

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

36,500

Work in Process—Blending (900 X $28) ................... Work in Process—Packaging (300 X $28) ................. Manufacturing Overhead ....................................

25,200 8,400

Work in Process—Packaging .................................... Work in Process—Blending ...............................

44,940

Finished Goods Inventory.......................................... Work in Process—Packaging .............................

67,490

Accounts Receivable .................................................. Sales Revenue .....................................................

90,000

Cost of Goods Sold .................................................... Finished Goods Inventory ..................................

62,000

3-45

25,000

28,070 25,770

25,770 36,500

33,600 44,940 67,490 90,000 62,000

PROBLEM 3-2B

(a) Physical units Units to be accounted for Work in process, January 1 Started into production Total units

0 50,000 50,000

Units accounted for Transferred out Work in process, January 31 Total units

47,500 2,500 50,000

(b) Equivalent units Units transferred out Work in process, January 31 2,500 X 100% 2,500 X 40% Total equivalent units (c) Materials Conversion costs Total manufacturing

Materials 47,500 2,500

1,000 48,500

50,000

Unit Costs $10.20 ($510,000 ÷ 50,000) $ 5.00 ($242,500 ÷ 48,500) $15.20 ($10.20 + $5.00)

(d) Costs accounted for Transferred out (47,500 X $15.20) .................. Work in process, January 31 Materials (2,500 X $10.20) ..................... Conversion costs (1,000 X $5.00) ........... Total costs .......................................

3-46

Conversion Costs 47,500

$722,000 $25,500 5,000

30,500 $752,500

PROBLEM 3-2B (Continued) (e)

STEINER CORPORATION Molding Department Production Cost Report For the Month Ended January 31, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, January 1 Started into production Total units

0 50,000 50,000

Units accounted for Transferred out Work in process, January 31 Total units

47,500 2,500 50,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

47,500 2,500 50,000

47,500 1,000 (2,500 X 40%) 48,500

Materials

Conversion Costs

(a) $510,000 (b) 50,000 $10.20

$242,500 48,500 $5.00

Costs to be accounted for Work in process, January 1 Started into production Total costs

Total $752,500 $15.20

0 752,500 $752,500

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (47,500 X $15.20) Work in process, January 31 Materials (2,500 X $10.20) Conversion costs (1,000 X $5.00) Total costs

3-47

$722,000 $25,500 5,000

30,500 $752,500

PROBLEM 3-3B

(a) (1) Physical units R12 Refrigerators

F24 Freezers

Units to be accounted for Work in process, June 1 Started into production Total units

0 20,000 20,000

Units accounted for Transferred out Work in process, June 30 Total units

16,000 4,000 20,000

17,500 2,500 20,000

(2) Equivalent units

Units transferred out Work in process, June 30 (4,000 X 100%) (4,000 X 75%) Total equivalent units

Units transferred out Work in process, June 30 (2,500 X 100%) (2,500 X 60%) Total equivalent units

3-48

R12 Refrigerators Conversion Materials Costs 16,000 16,000 4,000 20,000

3,000 19,000

F24 Freezers Conversion Materials Costs 17,500 17,500 2,500 20,000

1,500 19,000

PROBLEM 3-3B (Continued) (3) Unit costs

Materials ($840,000 ÷ 20,000) ($720,000 ÷ 20,000) Conversion costs ($665,000(a) ÷ 19,000) ($551,000(b) ÷ 19,000) Total (a)

F24 Freezers $36

35 $77

29 $65

$245,000 + $420,000

(b)

(4)

R12 Refrigerators $42

$259,000 + $292,000

R12 Refrigerators Costs accounted for Transferred out (16,000 X $77) ............. Work in process Materials (4,000 X $42) ................... Conversion costs (3,000 X $35) ............................... Total costs ..............................

$1,232,000 $168,000 105,000

273,000 $1,505,000

F24 Freezers Costs accounted for Transferred out (17,500 X $65) .............. Work in process Materials (2,500 X $36) ................... Conversion costs (1,500 X $29) ............................... Total costs ..............................

3-49

$1,137,500 $90,000 43,500

133,500 $1,271,000

PROBLEM 3-3B (Continued) (b)

BORMAN CORPORATION Stamping Department—Plant A Production Cost Report For the Month Ended June 30, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, June 1 Started into production Total units

0 20,000 20,000

Units accounted for Transferred out Work in process, June 30 Total units

16,000 4,000 20,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

16,000 4,000 20,000

16,000 3,000 19,000

Materials

Conversion Costs

(a) $840,000 (b) 20,000 $ 42

$665,000 19,000 $ 35

Costs to be accounted for Work in process, June 1 Started into production Total costs

(4,000 X 75%)

Total $1,505,000 $

0 1,505,000 $1,505,000

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (16,000 X $77) Work in process, June 30 Materials (4,000 X $42) Conversion costs (3,000 X $35) Total costs

3-50

$1,232,000 $168,000 105,000

273,000 $1,505,000

PROBLEM 3-4B

(a) Physical Units Units to be accounted for Work in process, October 1 Started into production Total units

25,000 435,000 460,000

Units accounted for Transferred out Work in process, October 31 Total units

425,000 35,000 460,000

Equivalent Units Conversion Materials Costs

425,000 35,000 460,000

425,000 14,000* 439,000

*35,000 X 40% Materials cost Beginning work in process Added during month Total Equivalent units Cost per unit

Conversion costs

29,000 1,006,000 $1,035,000

$ 16,500 246,900 $263,400

460,000

439,000

$2.25

$.60

($138,900 + $108,000)

(b) Costs accounted for Transferred out (425,000 X $2.85) Work in process, October 31 Materials (35,000 X $2.25) Conversion costs (14,000 X $.60) Total costs

3-51

$1,211,250 $78,750 8,400

87,150 $1,298,400

PROBLEM 3-4B (Continued) (c)

LUXMAN COMPANY Assembly Department Production Cost Report For the Month Ended October 31, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, October 1 Started into production Total units

25,000 435,000 460,000

Units accounted for Transferred out Work in process, October 31 Total units

425,000 35,000 460,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

425,000 35,000 460,000

425,000 14,000 (35,000 X 40%) 439,000

Materials

Conversion Costs

(a) $1,035,000 (b) 460,000 $2.25

$263,400 439,000 $.60

Costs to be accounted for Work in process, October 1 Started into production Total costs

Total $1,298,400 $2.85

$ 45,500 1,252,900 $1,298,400

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (425,000 X $2.85) Work in process, October 31 Materials (35,000 X $2.25) Conversion costs (14,000 X $.60) Total costs

3-52

$1,211,250 $78,750 8,400

87,150 $1,298,400

PROBLEM 3-5B

(a) (1) Physical Units Units to be accounted for Work in process, May 1 Started into production Total units

500 2,000 2,500

Units accounted for Transferred out Work in process, May 31 Total units

1,700 800 2,500

Equivalent Units Conversion Materials Costs

1,700 800 2,500

1,700 320* 2,020

*800 X 40% (2) Beginning work in process Added during month Total Equivalent units Cost per unit

Materials cost

Conversion costs

$15,000 50,000 $65,000

$18,000 52,700 $70,700

2,500

2,020

$26

$35

($19,020 + $33,680)

(3) Costs accounted for Transferred out (1,700 X $61) Work in process, May 31 Materials (800 X $26) Conversion costs (320 X $35) Total costs

3-53

$103,700 $20,800 11,200

32,000 $135,700

PROBLEM 3-5B (Continued) (b)

SWINN COMPANY Bicycle Department Production Cost Report For the Month Ended May 31, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, May 1 Started into production Total units

500 2,000 2,500

Units accounted for Transferred out Work in process, May 31 Total units

1,700 800 2,500

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

(a) (b)

1,700 800 2,500

1,700 320 2,020

Materials

Conversion Costs

$65,000 2,500 $26

$70,700 2,020 $35

Costs to be accounted for Work in process, May 1 Started into production Total costs

(800 X .40)

Total $135,700 $61

$ 33,000 102,700 $135,700

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (1,700 X $61) Work in process, May 31 Materials (800 X $26) Conversion costs (320 X $35) Total costs

3-54

$103,700 $20,800 11,200

32,000 $135,700

PROBLEM 3-6B

(a) Computation of equivalent units:

Units accounted for Transferred out Work in process, March 31 (60% materials, (20% conversion costs) Total units

Physical Units

Equivalent Units Conversion Materials Costs

66,000

20,000 86,000

12,000 78,000

4,000 70,000

Computation of March unit costs Materials: $156,000 ÷ 78,000 equivalent units = Conversion cost: $98,000 ÷ 70,000 equivalent units = Total unit cost, March

$2.00 1.40 $3.40

(b) Cost Reconciliation Schedule Costs accounted for Transferred out (66,000 X $3.40).................... Work in process, March 31 Materials (12,000 X $2.00) ....................... Conversion costs (4,000 X $1.40) ........... Total costs ......................................................

3-55

$224,400 $24,000 5,600

29,600 $254,000

*PROBLEM 3-7B

(a) Basketballs (1) Equivalent units—Materials Materials Added This Period

Physical Units Work in process, August 1 Started and completed Work in process, August 31 Total

500 1,400 (2,000 – 600) 600 2,500

Equivalent Units

0%* 100% 100%

0 1,400 600 2,000

*All materials are added at the beginning of the production process

Equivalent units—Conversion Conversion Added This Period

Physical Units Work in process, August 1 Started and completed Work in process, August 31 Total

500 1,400 (2,000 – 600) 600 2,500

Equivalent Units

40% (1 – .6) 100% 50%

200 1,400 300 1,900

(2) Unit costs Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

Materials $1,600 2,000 $.80

Conversion **$2,280** 1,900 $1.20

**Direct Labor $1,280 + Manufacturing Overhead $1,000

3-56

*PROBLEM 3-7B (Continued) (3) Assignment of costs to units transferred out and in process Costs to Be Assigned

Assignment of Costs

Total mfg. costs Transferred out Work in process, August 1 ***$5,005*** Conversion Started and completed Total costs transferred out Work in process, August 31 Materials Conversion costs Total costs

Equivalent Unit Units Cost

200 1,400

Total Costs Assigned

$1,125 1.20 240 2.00 2,800 $4,165

600 300

.80 1.20

480 360

840 $5,005

***Work in process, August 1, $1,125 + Materials $1,600 + Labor $1,280 + Overhead $1,000

Soccer balls (1) Equivalent units—Materials Physical Units Work in process, August 1 Started and completed Work in process, August 31 Total

200 1,850 (2,000 – 150) 150 2,200

Materials Added This Period *

0%* 100% 100%

Equivalent Units 0 1,850 150 2,000

*All materials are added at the beginning of the production process

Equivalent units—Conversion Physical Units Work in process, August 1 Started and completed Work in process, August 31 Total

3-57

200 1,850 (2,000 – 150) 150 2,200

Conversion Added This Period

Equivalent Units

20% (1 – .8) 40 100% 1,850 70% 105 1,995

*PROBLEM 3-7B (Continued) (2) Unit costs Costs in August (a) Equivalent units (b) Unit costs (a) ÷ (b)

Materials $2,800 2,000 $1.40

Conversion $2,394** 1,995 $1.20

**Direct Labor $1,000 + Manufacturing Overhead $1,394 (3) Assignment of costs to units transferred out and in process Costs to Be Assigned

Assignment of Costs

Total mfg. costs Transferred out Work in process, August 1 ***$5,644*** Conversion Started and completed Total costs transferred out Work in process, August 31 Materials Conversion costs Total costs

Equivalent Unit Units Cost

40 1,850

$1.20 $2.60

Total Costs Assigned $ 450 48 4,810 $5,308

150 105

$1.40 $1.20

210 126

336 $5,644

***Work in process, August 1, $450 + Materials $2,800 + Labor $1,000 + Overhead $1,394

3-58

*PROBLEM 3-7B (Continued) (b)

HOLIDAY COMPANY Production Cost Report—Basketballs For the Month Ended August 31

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, August 1 Started into production Total units

500 2,000 2,500

Units accounted for Completed and transferred out Work in process, August 1 Started and completed Work in process, August 31 Total units

500 1,400 600 2,500

0 1,400 600 2,000

200 1,400 300 1,900

Costs

Materials

Conversion Costs

Total

Unit costs (Step 3) Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

$1,600 2,000 $.80

$2,280 1,900 $1.20

Costs to be accounted for Work in process, August 1 Started into production Total costs Cost Reconciliation Schedule Costs accounted for Transferred out Work in process, August 1 Conversion costs to complete beginning inventory (200 X $1.20) Started and completed (1,400 X $2.00) Work in process, August 31 Materials (600 X $.80) Conversion costs (300 X $1.20) Total costs *($1,600 + $1,280 + $1,000)

3-59

$1,125 3,880* $5,005

$1,125 240 2,800 480 360

$4,165

840 $5,005

$3,880 $2.00

BYP 3-1

DECISION-MAKING AT CURRENT DESIGNS

CURRENT DESIGNS Fabrication Department Production Cost Report For the Month Ended April 30, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, April 1 Started into production Total units

30 72 102

Units accounted for Transferred out Work in process, April 30 Total units

67 35 102

Costs Unit costs (Step 3) Total cost* Equivalent units Unit costs [(a) ÷ (b)]

67 7 (35 X 20%) 74

Materials

Conversion Costs

(a) $25,900 (b) 74 $ 350

$48,600 81 $ 600

Costs to be accounted for Work in process, April 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (67 X $950) Work in process, April 30 Materials (7 X $350) Conversion costs (14 X $600) Total costs

*Material costs = $8,400 + $17,500 Conversion costs = $9,000 + $39,600

3-60

67 14 (35 X 40%) 81

Total $74,500 $

950

$17,400 57,100 $74,500

$63,650 $ 2,450 8,400

10,850 $74,500

BYP 3-2

DECISION-MAKING ACROSS THE ORGANIZATION

(a) The unit cost suggests that Joe took the highest total costs and divided these costs by the units started into production. The highest total costs would be the total costs charged to the Mixing Department ($88,000 + $573,000 + $765,000) divided by the units started during July (100,000 gallons), which results in a per unit cost of $14.26 ($1,426,000 ÷ 100,000). (b) The principal errors made by Joe were: (1) he did not compute equivalent units of production; (2) he did not use the weighted-average costing method; and (3) he did not assign costs to ending work-in-process.

3-61

BYP 3-2 (Continued) (c)

FLORIDA BEACH COMPANY Mixing Department Production Cost Report For the Month Ended July 31, 2014

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, July 1 Started into production Total units

8,000 100,000 108,000

Units accounted for Transferred out Work in process, July 31 Total units

103,000 5,000 108,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

103,000 5,000 108,000

103,000 1,000 (5,000 X 20%) 104,000

Materials

Conversion Costs

(a) $594,000 (b) 108,000 $5.50

$832,000 104,000 $8.00

Costs to be accounted for Work in process, July 1 Started into production Total costs

Total $1,426,000 $13.50

$ 88,000 1,338,000 $1,426,000

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (103,000 X $13.50) Work in process, July 31 Materials (5,000 X $5.50) Conversion costs (1,000 X $8.00) Total costs

3-62

$1,390,500 $27,500 8,000

35,500 $1,426,000

BYP 3-3

MANAGERIAL ANALYSIS

(a) The unit cost of materials is $150 ($450,000 ÷ 3,000). (b) The materials cost of the goods transferred out is $375,000 (2,500 X $150). Conversion costs, therefore, are $225,000 ($600,000 – $375,000), and per unit conversion cost is $90 ($225,000 ÷ 2,500). (c) There are 500 units in ending work-in-process inventory (3,000 started – 2,500 transferred out). The materials cost is $75,000 (500 X $150). Thus, the conversion costs in the inventory are $36,000 ($261,000 – $225,000). $36,000 divided by $90 per unit conversion cost equals 400 equivalent units or 80% (400 ÷ 500) complete.

3-63

BYP 3-4

REAL-WORLD FOCUS

(a) The outer shell of the paintballs is made from a mixture that includes water, sweeteners, food ingredients, and most importantly, gelatin. All of the ingredients used to make paintballs are food grade, biodegradable products. The “paint” filling inside a paintball is comprised of the same inert ingredient used in cough syrup, as well as crayon wax. After mixing the gelatin and other materials, the mixture is heated, and then spread on rolling drums which create thin gelatin ribbons. Each of the ribbons then passes over a rotating die. The dies are designed so that they can form round capsules. The dies press against each other as they rotate. As the dies meet, both shells are filled with paint, which is injected into the area between the sheets. The two halves then seal as they press against each other to form a filled capsule. Once the capsules are sealed they drop out of the machine to become paintballs. They pass along a conveyor belt to a tumble drier, then onto a drying rack. Once they are dry, they go into a counting machine, then into a packing machine which packs exactly the correct number of balls into each container. (b) Materials: water, sweeteners, food ingredients, gelatin, “cough syrup material”, crayon wax, and food coloring. Labor: People would be needed run the various machines. Overhead: Depreciation and maintenance of the various machines. It would appear that overhead would be by far the highest cost because the process is very automated. Machines are needed for mixing the gelatin, heating it, rolling it into ribbons, making the capsules, filling the capsules, sorting and drying the capsules, counting the capsules and packing them. (c) This would appear to be a perfect situation for the use of process costing. Paintballs are a high volume product, and the paintballs are very homogenous. While there may be some differences in various types of paintballs that would merit keeping track of specific costs to make the various types, the primary method of cost determination would be process costing.

3-64

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

BYP 3-5

COMMUNICATION ACTIVITY

To:

Diane Barone, Regional Sales Manager

From:

Student, Accounting Manager

Re:

Production Cost Reports

Diane, congratulations again on your promotion! It’s going to be great working with you. It kind of reminds me of our days at Dairy-Freeze after school (although this work is more fun, and it certainly pays better!). I’ll try to clear up some of the questions you raised in your email. Here in the Snack Foods Division we use process costing rather than the job order system that Special Projects uses. The reason for this is that we produce all our products in a more or less continuous process, even when we run occasional special orders. You see, all our workers are assigned a particular part of the process to control. One might be in charge of making sure the mixing machines work properly, while another verifies the weight of the finished products. Whichever job a worker is assigned, he or she stays with it to completion, or at least the completion of that particular process. That’s different from what you had in Special Projects, where workers moved from job to job. That’s why we don’t usually track the orders separately. Our special orders are for various quantities of the foods we produce, so only the Packing Department needs to be concerned with the particular set of products shipped to the particular customer—which is its ordinary concern anyway. Your next question was about what an equivalent unit is. Well, you know already that Special Projects bids on various jobs, and then costs are recorded when the jobs are complete. The costs accumulated on jobs that aren’t complete are reflected in Work in Process inventory. We in Snack Foods can’t use that method for a simple reason—we produce our products in huge batches that we keep going fairly continuously. Or, in other words, we don’t have a “job” that we can record as “complete.” A batch may contain enough of our product to fill thirty or more orders, so we may have thirty or more “jobs” in each batch. One job may happen to be filled from two batches. Since the cost of each batch is about the same, it isn’t worth keeping track of separately.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

3-65

BYP 3-5 (Continued) At the end of the month, we need to record what we finished and what still remains undone. Equivalent units are the way we measure the amount of work we have done on our work in process. It’s kind of like comparing the contents of 4-ounce cups with the contents of 12-ounce cups. It doesn’t make sense to compare by counting the number of cups you have. You need to find out how many ounces you have in one set; then you can get a meaningful comparison with the ounces you have in the other set. We compare by the number of “units” of materials or labor that are required to finish a product completely. If it requires 12 ounces of flour and 15 minutes of labor for a finished bag of pretzels, for example, then the 12 ounces and 15 minutes are “finished equivalents.” If we have enough pretzels to fill 30 bags, but we’ve only spent 5 minutes (or 1/3 of the total required) of labor on them at the end of the month, we could have used the same amount of time and completely finished 10 bags. Thus, we have the “equivalent” of 10 bags worth of labor. Your last question is the easiest to answer. You get four reports because we use four processes here in Snack Foods Division. Each process has to report its status at the end of every month. It’s kind of like we have four miniature factories, each reporting “completion” of a certain number of products. The products from one department are used as raw materials for other departments, so we have a chain of reports. Notice that the units and costs transferred out of Process 1 are the same as the units and costs transferred in to Process 2, and so on. I hope this helps. Call, write, or email me any time!

3-66

BYP 3-6

ETHICS CASE

(a) The stakeholders in this situation are:    

Jan Wooten, molding department head. Tony Ferneti quality control inspector. Customers of R. B. Dillman Company. The department manager of the assembly department.

(b) Tony is placed in an ethical dilemma. He can offend his department head by disregarding Jan’s instructions and lose the support of his supervisor, and maybe lose his job. He can follow Jan’s instructions and be in violation of company policy. He can also report Jan’s instructions to supervisors (plant superintendent or vice-president of production). The company should make the position of quality control inspector responsible to someone other than the department head. Tony should not report to Jan.

3-67

BYP 3-7

CONSIDERING CORPORATE SOCIAL RESPONSIBILITY

(a) Some of the costs that the company now faces include: • Monetary damages: The company paid $21.4 million in fines as a result of an OSHA investigation; $1.6 billion to compensate those affected by the accident; and $1 billion to repair and update its refinery (plus an additional $250 million to install safety valves) • Bad publicity • Lost sales • Cost of cleaning up the affected area including transporting workers to the site; housing workers near the site; per diem for cleanup workers; safety equipment for the workers • Transportation and storage/disposal fees for any contaminants removed from the area • Legal fees associated with lawsuits/settlements • Reimburse the Coast Guard for any oil containment equipment provided • Possible air/water testing for an extensive time following the accident (b) Some steps that the company could have taken to reduce the environmental failure costs include: • • • •

Install up to date safety equipment Increase the frequency and efficacy of inspections Increase maintenance on older facilities Be responsive to and investigate thoroughly complaints by neighbors and regulators • Invest in research to discover safer means of boosting octane • Locate plants further away from population centers to the extent possible

3-68

CHAPTER 4 Activity-Based Costing ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Do It!

Exercises

A Problems

B Problems

1, 2

1, 2, 3, 4, 5, 6, 12, 13

1A, 3A, 4A, 5A

1B, 3B, 4B, 5B

1A, 2A, 3A, 4A, 5A

1B, 2B, 3B, 4B, 5B

1A, 5A

1B, 5B

Learning Objectives

Questions

*1.

Recognize the difference between traditional costing and activity-based costing.

1, 2, 3, 4, 5

*2.

Identify the steps in the development of an activitybased costing system.

*3.

Know how companies identify the activity cost pools used in activity-based costing.

*4.

Know how companies identify and use cost drivers in activity-based costing.

6, 10, 11, 12

*5.

Understand the benefits and limitations of activity-based costing.

13, 14, 15

*6.

Differentiate between value-added and nonvalue-added activities.

8, 16, 17

8, 9

12, 13, 14

*7.

Understand the value of using activity levels in activity-based costing.

10, 11, 12

15, 16

*8.

Apply activity-based costing to service industries.

9, 10

*9.

Explain just-in-time (JIT) processing.

7, 8

3, 4, 5, 6, 7, 12

1, 3, 4, 5, 6, 8, 9, 10, 11, 12, 13

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

4-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

4-2

Description

Difficulty Level

Time Allotted (min.)

Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non-value-added.

Moderate

35–45

Assign overhead to products using ABC and evaluate decision.

Moderate

25–35

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

35–45

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

40–50

Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.

Moderate

35–45

Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non-value-added.

Moderate

35–45

Assign overhead to products using ABC and evaluate decision.

Moderate

25–35

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

35–45

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

40–50

Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.

Moderate

35–45

4-3

Learning Objective

Knowledge Comprehension

*1. Recognize the difference Q4-1 between traditional costing and Q4-2 activity-based costing. Q4-3 Q4-4 Q4-5 DI4-1

Application BE4-1 BE4-2 E4-1 E4-2

*2. Identify the steps in the development of an activitybased costing system.

Q4-7 DI4-1

*3. Know how companies identify the activity cost pools used in activity-based costing.

Q4-9

E4-7

*4. Know how companies identify and use cost drivers in activity-based costing.

Q4-6 Q4-10 Q4-11 Q4-12

BE4-3 BE4-4 BE4-5 BE4-6 BE4-7 BE4-12 DI4-2

*5. Understand the benefits and limitations of activity-based costing.

Q4-13 Q4-14 Q4-15

E4-11

*6. Differentiate between valueadded and non-value-added activities.

Q4-8 Q4-16 Q4-17

BE4-8 BE4-9 DI4-3

*7. Understand the value of using activity levels in activity-based costing.

Q4-19

*8. Apply activity-based costing to Q4-18 service industries. *9. Explain just-in-time (JIT) processing. Broadening Your Perspective

DI4-4

E4-12 E4-13 P4-1A P4-4A

P4-5A P4-1B P4-4B P4-5B

E4-1 E4-2 E4-3 E4-4 E4-5 E4-6

Synthesis

Evaluation

P4-3A P4-4A P4-5A P4-3B P4-4B P4-5B

E4-8

E4-1 E4-4 E4-5 E4-11

E4-12 E4-13 P4-1A P4-2A P4-4A P4-5A

P4-1B P4-2B P4-3B P4-4B P4-5B

DI4-2 E4-1 E4-3 E4-4 E4-5 E4-6 E4-8

E4-12 E4-13

P4-1A

P4-1B

BE4-8 BE4-9 E4-14

BE4-10 BE4-11 BE4-12 BE4-9 BE4-10

Analysis

E4-9 E4-10 P4-3A P4-4A P4-5A P4-3B P4-4B P4-5B

P4-4B

E4-15 E4-16 P4-5A P4-5B

BE4-10 E4-17 E4-18 DI4-3 P4-5A

P4-5B

P4-5A

P4-5B

Q4-20 BYP4-1 BYP4-3

BYP4-4 BYP4-7

BYP4-2 BYP4-5 BYP4-8

BYP4-3 BYP4-6

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

Direct labor is a valid basis for allocating overhead when: (a) direct labor constitutes a significant part of total product cost, and (b) there is a high correlation between direct labor and changes in the amount of overhead costs.

The amount of direct labor in many industries has greatly decreased, due to advances in computerized systems, technological innovation, global competition and automation. Total overhead costs resulting from depreciation on expensive equipment and machinery, utilities, repairs, and maintenance have significantly increased. Many companies now use machine hours as the basis on which to allocate overhead in an automated manufacturing environment.

In many automated manufacturing environments, machine hours is a more relevant basis on which to allocate overhead.

Under a traditional volume-based costing system where overhead cost is allocated on the basis of units of output, the high-volume product will undoubtedly absorb more overhead than the lowvolume product.

The principal differences are: (1) Primary focus (2) Bases of allocation

Activity-Based Costing Activities performed in making products Multiple cost drivers

Traditional Costing Units of production Single unit-level base

Activity-based overhead rates are computed using the following formula: Estimated Overhead per Activity Expected Use of Cost Drivers per Activity

The four steps involved in developing an ABC system are: 1. Identify and classify the major activities involved in the manufacture of specific products, and allocate manufacturing overhead costs to appropriate cost pools. 2. Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool. 3. Compute the overhead rate for each cost driver. 4. Assign manufacturing overhead costs for each cost pool to products, using the overhead rates (cost per driver).

A value-added/non-value-added activity flowchart is based on a systematic analysis of all the activities (resource-consuming actions and transactions) performed to manufacture a product or render a service. The flowchart documents each activity and the time involved in each activity. The flow chart also documents management’s proposed reengineering of the manufacturing process.

An activity cost pool is the overhead cost attributed to a distinct type of activity.

10.

A cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed.

4-4

Questions Chapter 4 (Continued)

11.

A cost driver is accurate and appropriate if it measures the actual consumption of the activity in manufacturing a product or rendering a service and the data relating to the cost driver is available and easily obtained.

12.

The formula for assigning activity cost pools to products is: Activity-based overhead rate X Expected use of cost drivers per product

13.

The primary benefit of ABC is more accurate product costing. This results from using more cost pools and enhanced control over overhead costs, and leads to better management decisions.

14.

The limitations of ABC are: (a) increased costs that accompany multiple-activity cost pools and cost drivers and (b) the necessity still to allocate some costs arbitrarily.

15.

ABC is the superior costing system when: (1) product lines differ greatly in volume and manufacturing complexity; (2) product lines are numerous, diverse, and require differing degrees of support services; (3) overhead costs constitute a significant portion of total costs; (4) the manufacturing process or the number of products has changed significantly; and (5) data from the existing system is being ignored.

16.

Basic ABC has been enhanced by identifying activities as value-added and non-value-added.

17.

Identifying non-value-added activities highlights for managers the activities that should be reduced or eliminated because they are not essential and they add no value to the product.

18.

The overall objective of ABC in service firms is no different than for manufacturing companies; that is, improved costing of services rendered (by job, service, contract, or customer). The general approach to costing is the same—analyze operations, identify activities, assign overhead costs to activity cost pools, and identify and use cost drivers to assign the cost pools to the services.

19.

Greater accuracy in cost allocation is achieved by recognizing the four levels of activity. Some activities are affected (driven) by changes in the number of units produced, while other activities are affected only by changes in the number of batches or the number of products, and some, facility-level activities, are unaffected by changes in either units, batches, or products produced.

*20. (a) Just-in-time processing has a just-in-time philosophy and a pull approach to eliminate inventory. It is dedicated to having the right amount of materials, parts, or products just as they are needed. (b) There are three important elements in JIT processing: (1) A company must have dependable suppliers who are willing to deliver on short notice exact quantities of raw materials according to precise quality specifications. (2) A multiskilled workforce must be developed. (3) A total quality control system must be established.

4-5

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4-1

(a)

Estimated annual overhead costs = Predetermined overhead rate Expected annual operating activity $1,000,000 = $10 per direct labor hour 100,000

(b)

92,000 direct labor hours X $10 = $920,000 overhead applied

(c)

If the manufacturing process is complex, then multiple allocation bases can result in more accurate product-cost computations. In such situations, managers need to consider an overhead cost allocation method that uses multiple bases. That method is activitybased costing.

BRIEF EXERCISE 4-2 Under ABC, overhead costs are shifted from the high-volume products to the low-volume products. This shift results in more accurate costing for two reasons: 1. Low-volume products often require more special handling, such as more machine setups and inspections, than high-volume products. Thus, the low-volume product frequently is responsible for more overhead costs per unit than is a high-volume product. 2. Assigning overhead using ABC will usually increase the cost per unit for low-volume products. Therefore, a traditional overhead allocation such as direct labor hours is usually a poor cost driver for assigning overhead costs to low-volume products. As a result, for Finney, one of the products (Product RX3) may have been low volume and therefore may have more overhead costs assigned to it under an ABC system.

4-6

BRIEF EXERCISE 4-3 An appropriate cost driver for each activity is: Activity Materials handling Machine setups Factory machine maintenance Factory supervision Quality control

Cost Driver Number of requisitions Number of setups Machine hours used Number of employees Number of inspections

BRIEF EXERCISE 4-4 (a) (b) (c) (d) (e) (f) (g)

Number of parts or assemblies Number of setups Number of employees Number of inspections Number of purchase orders Machine hours Square footage occupied

BRIEF EXERCISE 4-5 Machine setups Machining Inspections

$150,000 ÷ 2,500 = $60 per setup $325,000 ÷ 25,000 = $13 per machine hour $ 87,500 ÷ 1,750 = $50 per inspection

BRIEF EXERCISE 4-6 Activity Cost Pool Designing Sizing and cutting Stitching and trimming Wrapping and packing

4-7

Estimated Expected Use of Overhead ÷ Cost Drivers per Activity = $ 450,000 4,000,000 1,440,000 336,000

10,000 designer hours 160,000 machine hours 80,000 labor hours 32,000 finished units

Activity-Based Overhead Rates $45.00 per designer hour $25.00 per machine hour $18.00 per labor hour $10.50 per finished unit

BRIEF EXERCISE 4-7 Estimated Expected Use of Overhead ÷ Cost Drivers per Activity =

Activity Cost Pool Ordering and receiving Etching Soldering

Cost Drivers 11,000 orders 50,000 machine hours 500,000 labor hours

90,000 480,000 1,760,000

12,000 orders 60,000 machine hours 440,000 labor hours

Activity-Based Overhead Rates $7.50 per order $8.00 per machine hour $4.00 per labor hour

Overhead Total Overhead Rates = Applied $7.50 $ 82,500 $8.00 400,000 $4.00 2,000,000 $2,482,500

BRIEF EXERCISE 4-8 (a) (b) (c) (d) (e) (f)

Non-value-added Value-added Non-value-added Non-value-added Non-value-added Value-added

BRIEF EXERCISE 4-9 Value-added Activities (1) Designing and drafting (3) On-site supervision (5) Consultation with client

Hours 2.5 2.0 1.5 6.0

Non-value-added Activities (2) Staff meetings (4) Lunch (6) Entertaining a prospective client

Hours 1 1 2 4

4-8

BRIEF EXERCISE 4-10 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Batch- or unit-level Unit-level Unit-level Batch- or unit-level Facility-level Batch- or product-level Batch- or product-level Unit-level Facility-level Batch-level

BRIEF EXERCISE 4-11 (a) (b) (c) (d) (e) (f) (g) (h)

Facility-level Unit-level Product-level Unit-level Batch-level Batch-level Product-level Facility-level

BRIEF EXERCISE 4-12 (a) Product design

(b)

$40,000 = $4,000 per product change 10

Machining

$300,000 = $2 per machine hour 150,000

Material handling

$100,000 = $1,000 per set up 100

Product design—product-level Machining—unit-level Material handling—batch-level

4-9

SOLUTIONS TO DO IT! REVIEW EXERCISES

DO IT! 4-1 1. 2. 3. 4. 5.

True False False True True

DO IT! 4-2 (a) Computations of activity-based overhead rates per cost driver: Activity Cost Pools Machine setup Machining Packing

Estimated Overhead $ 16,000 110,000 30,000 $156,000

Expected Use of Cost Activity-Based Drivers per Activity Overhead Rates 40 setups $400 per setup 5,000 machine hours $ 22 per machine hr. 500 orders $ 60 per order

(b) Assignment of each activity’s overhead cost to products using ABC: BC113

AD908

Expected Use of Cost Activity Cost Drivers per Activity-Based Cost Pools Product Overhead Rates Assigned Machine setup 25 $400 $10,000 Machining 1,000 $ 22 22,000 Packing 150 $ 60 9,000 Total assigned costs $41,000

Expected Use of Activity-Based Cost Drivers per Overhead Cost Product Rates Assigned 15 $400 $ 6,000 4,000 $ 22 88,000 350 $ 60 21,000 $115,000

(c) Computation of overhead cost per unit: Total costs assigned (a) Total units produced (b) Overhead cost per unit (a) ÷ (b)

4-10

BC113 $41,000 3,000 $13.67

AD908 $115,000 1,500 $76.67

DO IT! 4-2 (Continued) (d) These computations show that the total overhead assigned to Product AD908 is more than two and a half times that assigned to BC113. On a per unit basis, the overhead assigned to AD908 is close to six times that assigned to each BC113. DO IT! 4-3 1. 2. 3. 4. 5.

NVA VA NVA VA VA

DO IT! 4-4 (a) (b) (c) (d) (e) (f) (g) (h)

unit-level product-level facility-level batch-level unit-level batch-level facility-level unit-level

4-11

SOLUTIONS TO EXERCISES EXERCISE 4-1 (a)

Estimated overhead = Predetermined overhead rate Direct labor costs $270,000 = 180% of direct labor cost $50,000 + $100,000

(b) Activity cost pools Machining Machine setup

Cost drivers Machine hours Set up hours

Estimated overhead $170,000 100,000

Activity-based overhead rates Machining: Machine setup: $170,000 $100,000 = $85 per machine hour = $200 per setup hour 1,000 + 1,000 400 + 100 (c) Traditional costing $50,000 X 180% $100,000 X 180%

Standard $90,000 $90,000

Activity-based costing Machining: 1,000 X $85 1,000 X $85 Machine setup: 100 X $200 400 X $200

$180,000 $180,000

$85,000 $85,000

20,000 $105,000

4-12

Custom

80,000 $165,000

EXERCISE 4-2 (a)

Traditional costing system

Sales Costs Operating income (b)

Product 540X

Product 137Y

Product 249S

$180,000 55,000 $125,000

$160,000 50,000 $110,000

$70,000 15,000 $55,000

Product 540X

Product 137Y

Product 249S

$180,000 50,000 $130,000

$160,000 35,000 $125,000

$70,000 35,000 $35,000

Activity-based costing system

Sales Costs Operating income (c) Product 540X:

($130,000 – $125,000) ÷ $125,000 = 4.00%

Product 137Y

($125,000 – $110,000) ÷ $110,000 = 13.64%

Product 249S

($35,000 – $55,000) ÷ $55,000 = (36.36%)

(d) These costs are similar probably because the cost drivers are essentially the same; that is, they are based on a unit volume concept.

4-13

EXERCISE 4-3 (a)

Activity cost pools

Cost drivers

Estimated overhead

Cutting

Machine hours

$360,000

Design

Number of setups

630,000

Activity-based overhead rates Cutting $360,000 = $1.80 per machine hour 200,000

Design $630,000 = $420 per setup 1,500 Wool

Activity-based costing Cutting 100,000 X $1.80 100,000 X $1.80

$180,000 $180,000

Design 1,000 X $420 500 X $420 Total cost allocated

420,000 210,000 $390,000

$600,000

(b) Estimated overhead = $990,000 Direct labors hours 450,000

= $2.20 per direct labor hour

Wool Traditional costing 225,000 X $2.20 225,000 X $2.20

Cotton

$495,000 $495,000

The wool product line is allocated $105,000 ($600,000 – $495,000) more overhead cost when an activity-based costing system is used. As a result, the cotton product line is allocated $105,000 ($495,000 – $390,000) less.

4-14

EXERCISE 4-4 (a) Direct labor hours for car wheels (40,000 X 1) = 40,000 Direct labor hours for truck wheels (10,000 X 3) = 30,000 Total direct labor hours 70,000 $770,000 (total estimated overhead) 70,000 (total direct labor hours)

= $11 per direct labor hour.

Overhead assigned Car wheels Truck wheels Total overhead

(40,000 X $11) (30,000 X $11)

(b)

Expected Use of Cost Drivers

ABC Overhead = Rate

Activity Cost Pool

Estimated Overhead

Setting up machines Assembling Inspection

$220,000 280,000 270,000

Activity Cost Pools

Car Wheels Expected Use Activity-Based of Cost Driver Overhead per Product X Rates =

(c)

Setting up machines Assembling Inspection Total cost assigned

= $440,000 = 330,000 $770,000

4-15

200 40,000 100

1,000 70,000 1,200

$220 $ 4 $225

Cost Assigned $ 44,000 160,000 22,500 $226,500

EXERCISE 4-4 (Continued) (c)

Truck Wheels

Activity Cost Pools Setting up machines Assembling Inspection Total cost assigned

Expected use of Cost Driver X per Product 800 30,000 1,100

ActivityBased Overhead Rates $220 $ 4 $225

Cost Assigned $176,000 120,000 247,500 $543,500

(d)

Assuming that the cost drivers are a reasonable representation of what is occurring in the two product lines, it seems appropriate to switch to activity-based costing. By using this system, more accurate cost information is developed which should lead to better allocation of resources and pricing decisions in the future.

4-16

EXERCISE 4-5 (a) Activity Cost Pools Estimated Overhead Scheduling and travel $105,000 Setup time $ 70,000 Supervision $ 60,000

Expected use ÷ of Cost Drivers = ABC Overhead Rates 1,500 $ 70.00 700 $100.00 $400,000* $ .15

*$100,000 + $300,000 Commercial Activity Cost Pools Scheduling and travel Setup time Supervision Total assigned costs

Expected use of Cost Drivers per Product X ABC Overhead Rates = 1,000 $ 70.00 450 $100.00 $100,000 $ .15

Cost Assigned $ 70,000 45,000 15,000 $130,000

Residential Activity Cost Pools Scheduling and travel Setup time Supervision Total assigned costs

Expected use of Cost Drivers per Product X ABC Overhead Rates = 500 $ 70.00 250 $100.00 $300,000 $ .15

(b) Revenues Direct material costs Direct labor costs Overhead costs Operating income (loss)

(c)

Commercial $300,000 $ 30,000 100,000 130,000

260,000 $ 40,000

Cost Assigned $ 35,000 25,000 45,000 $105,000 Residential $480,000

$ 50,000 300,000 105,000

455,000 $ 25,000

4-17

EXERCISE 4-6 (a) Traditional costing: $260,000 ÷ 2,500 (800 + 1,700) hours = $104 per direct labor hour (1) One mobile safe: 800 hours X $104 = $83,200 $83,200 ÷ 200 = $416 each (2) One walk-in safe: 1,700 hours X $104 = $176,800 $176,800 ÷ 50 = $3,536 each (b) Activity-based costing: (1) Material handling costs $160,000 ÷ 500 (300 + 200) moves = $320 per move (a) One mobile safe: 300 moves X $320 = $96,000 $96,000 ÷ 200 = $480 each (b) One walk-in safe: 200 moves X $320 = $64,000 $64,000 ÷ 50 = $1,280 each (2) Purchasing activity costs $100,000 ÷ 800 (450 + 350) orders = $125 per order (a) One mobile safe: 450 orders X $125 = $56,250 $56,250 ÷ 200 = $281.25 each (b) One walk-in safe: 350 orders X $125 = $43,750 $43,750 ÷ 50 = $875 each

4-18

EXERCISE 4-6 (Continued) (c) The total amount of overhead allocated to each unit of the two products under the two allocation approaches is:

Mobile safe Walk-in safe

Traditional Costing $ 416 $3,536

Activity-Based Costing ** $761.25** $ 2,155**

**$480 + $281.25 **$1,280 + $875 EXERCISE 4-7 The following activities might be identified at Quik Prints Company from your analysis of its operations and a discussion with the owner-manager, Terry Morton. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

4-19

Hiring and training personnel Purchasing supplies and materials Selling, promoting, and marketing Billing and collecting Designing Offset printing Copying Faxing Collating Cutting and folding Maintenance and repairs Delivery Accounting

EXERCISE 4-8 Budgeted Costs

Activity Cost Pool

Cost Driver

Engineering design Engineering prototypes

Engineering

Engineering hours

Depreciation, machinery Electricity, machinery

Machinery

Machine hours

Machine setup

Number of setups

Inspections Tests

Quality control

Number of tests or inspections

Depreciation, plant Insurance, plant Property taxes Oil, heating Electricity, plant lighting

Factory utilities

Square feet or Machine hours

Machine maintenance wages

Maintenance

Machine setup, indirect labor Machine setup, indirect materials

Number of machines or Machine hours

EXERCISE 4-9 The following cost drivers might be used to assign overhead: 1. 2. 3. 4. 5. 6. 7. 8.

Labor hours Labor hours Labor hours Gallons of chemicals Number of cartfuls or labor hours Number of cartfuls Gallons of juice Gallons of juice

4-20

9. 10. 11. 12. 13. 14. 15.

Gallons of wine or months of aging Number of bottles Number of bottles Number of boxes Number of shipments Number of gallons processed Number of gallons processed

EXERCISE 4-10 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Number of engineering change orders; hours of designing Number of orders processed Number of parts in stock Weight of material; number of boxes or cartons Employee turnover; number of employees hired Machine hours; direct labor hours Number of employees; number of parts; direct labor hours Number of employees Book or market value of assets Cost of goods manufactured, direct labor hours; number of employees Machine hours; number of machines Gallons of paint; number of appliances

11. 12.

EXERCISE 4-11 (a) The overhead rates are: Activity Cost Pools

Expected Use Estimated of Cost Drivers Activity-Based Overhead ÷ per Activity = Overhead Rates

Materials handling Machine setups Quality inspections

$40,000 27,500 27,000

1,000 500 600

$40 55 45

(b) The assignment of the overhead costs to products is as follows: Instruments Gauges Cost Driver Number Cost Number Cost Requisitions ($40) 400 $16,000 600 $24,000 Machine setups ($55) 200 11,000 300 16,500 Inspections ($45) 200 9,000 400 18,000 Total costs assigned (a) $36,000 $58,500 Units produced (b) Overhead cost per Unit (a) ÷ (b)

4-21

50 $

720

300 $

195

Cost Assigned $40,000 27,500 27,000 $94,500

EXERCISE 4-11 (Continued) (c)

MEMO To:

President, Major Instrument, Inc.

From:

Student

Re:

Benefits of activity-based costing (ABC)

ABC focuses on the activities performed in producing a product. Overhead costs are assigned to products based on cost drivers that measure the activities performed on the product. The primary benefit of ABC is more accurate and meaningful product costing. This improved cost data can lead to reduced costs as managers become more aware of the underlying causes of cost incurrence. Thus, control over costs is enhanced. The improved cost data should also lead to better management decisions. More accurate product costing should contribute to setting selling prices which will help achieve desired profitability levels. In addition, it should be helpful in deciding whether to make or buy a product part or component, and sometimes even whether to eliminate a product.

4-22

EXERCISE 4-12 (a) (1) Traditional product costing system: $400,000 X .70 = $280,000 Selling costs assigned in March to the “high intensity” product line. (2) Activity-based costing system:

Activity Cost Pools Sales commissions Advertising—TV/Radio Advertising—Newspaper Catalogs Cost of catalog sales Credit and collection Total assigned cost for March

ActivityBased Cost Drivers Overhead Overhead Cost Used X Rates = Assigned $900,000 250 2,000 60,000 9,000 $900,000

$.05 $300 $10 $2.50 $1.00 $.03

$ 45,000 75,000 20,000 150,000 9,000 27,000 $326,000

(b) As compared to ABC, traditional costing grossly undercosts the selling costs assigned to the “high intensity” product line. The difference of $46,000 ($326,000 – $280,000) in the month of March is a 14.1% understatement. (c) All six activities, as selling activities, are non-value-added activities.

4-23

EXERCISE 4-13 (a) 1.

Traditional product costing system: Quality-control overhead costs assigned in June to the low-calorie dessert line are $11,050 ($65,000 X .17).

Activity-based costing system:

Activity Cost Pools Inspections of material received In-process inspections FDA certification Total assigned cost for June

ActivityBased Cost Drivers Overhead Overhead Cost Used X Rate = Assigned 6,000 10,000 420

$ .80 $ .33 $12.00

$ 4,800 3,300 5,040 $13,140

(b) As compared to ABC, the traditional costing system undercosts the quality-control overhead cost assigned to the low-calorie dessert product line by $2,090 ($13,140 – $11,050) in the month of June. That is a 15.9% understatement. (c) All three activities, as quality-control related activities, are non-valueadded activities.

4-24

EXERCISE 4-14 Value-Added Activities Writing contracts and letters Taking depositions Contemplating legal strategy Litigating a case in court

Hours 1.5 1.0 1.0 2.5 6.0

Non-Value-Added Activities Attending staff meetings Doing research Traveling to/from court Eating lunch Entertaining a prospective client

Hours 0.5 1.0 1.0 1.0 1.5 5.0

Questionable Classifications Writing contracts is value-added; writing letters may be value-added if related to a specific case or it may be non-value-added if it is billing a client or collecting receivables. Research may be value-added if it is unique, related to a specific case, and is billable. Research may be non-value-added if it is something the attorney should already have known and is not billable to the client.

4-25

EXERCISE 4-15 Activity Cost Pools Engineering Machinery Machine setup Quality control Factory utilities Maintenance

Activity Level Product-level Unit-level Batch-level Depends on frequency. Could be unit, batch, or product-level Facility-level Facility-level

EXERCISE 4-16 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

4-26

Facility-level activity Product-level activity Batch-level activity Product-level activity Product-level activity Batch-level activity Facility-level activity Batch-level or unit-level activity Unit-level activity Unit-level activity

SOLUTIONS TO PROBLEMS PROBLEM 4-1A

(a) Computation of unit costs—traditional costing. Products Manufacturing Costs

Home Model

Commercial Model

$18.50 19.00 * 24.26* $61.76

$26.50 19.00 * 24.26* $69.76

Direct materials Direct labor Overhead Total unit cost *$16.17 X 1.5 = $24.26

(b) Estimated Overhead ÷

Activity Cost Pool Receiving Forming Assembling Testing Painting Packing and shipping

70,350 150,500 412,300 51,000 52,580 820,750 $1,557,480

Expected Use of Cost Drivers

Activity-Based Overhead Rate

335,000 Pounds 35,000 Machine hours 217,000 Parts 25,500 Tests 5,258 Gallons 335,000 Pounds

$ .21 per pound $ 4.30 per machine hour $ 1.90 per part $ 2.00 per test $10.00 per gallon $ 2.45 per pound

Activity Cost Pool

Receiving 215,000 Forming 27,000 Assembling 165,000 Testing 15,500 Painting 3,680 Packing and shipping 215,000 Total costs assigned (a) Units produced

4-27

45,150 116,100 313,500 31,000 36,800 526,750 $1,069,300

120,000 8,000 52,000 10,000 1,578 120,000

$ .21 $ 4.30 $ 1.90 $ 2.00 $10.00 $ 2.45

$ 25,200 34,400 98,800 20,000 15,780 294,000 $488,180

54,000

(b)

Overhead cost per unit [(a) ÷ (b)]

$ .21 $ 4.30 $ 1.90 $ 2.00 $10.00 $ 2.45

Commercial Model ActivityExpected Based Use of Overhead Cost Drivers X Rates = Assigned

19.80

10,200 $

47.86

PROBLEM 4-1A (Continued) (d) ABC Manufacturing Costs Direct materials Direct labor Overhead Total cost per unit

Home Model $18.50 19.00 19.80 $57.30

Commercial Model $26.50 19.00 47.86 $93.36

(e)

Activity Receiving Forming Assembling Testing Painting Packing and shipping

Value- vs. Non-Value-Added Non-value-added Value-added Value-added Non-value-added Value-added Value-added

(f)

(1) Activity-based costing shows the commercial model absorbs nearly 21/2 ($47.86 ÷ $19.80) times as much overhead per unit as the home model. (2) The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal at $24.26 but rather $19.80 for the home model and $47.86 for the commercial model. Under traditional costing, the margin of error on the commercial model was almost 100%, an understatement of $23.60 on an assignment of $24.26. These distorted overhead assignments have likely led to overpricing the home model and underpricing the commercial model.

4-28

PROBLEM 4-2A

(a) The allocation of total manufacturing overhead using activity-based costing is as follows:

Overhead Rate Purchase orders @ $30 Machine setups @ $50 Machine hours @ $40 Inspections @ $25 Total assigned costs (a)

Royale Drivers Cost Used Assigned

Majestic Drivers Cost Used Assigned

17,000 5,000 75,000 11,000

23,000 13,000 45,000 17,000

$ 510,000 250,000 3,000,000 275,000 $4,035,000

Units produced (b) Cost per unit (a) ÷ (b)

$ 690,000 650,000 1,800,000 425,000 $3,565,000

25,000 $

161.40

Total Overhead $1,200,000 900,000 4,800,000 700,000 $7,600,000

10,000 $

356.50

(b) The cost per unit and gross profit of each model under ABC costing were: Direct materials Direct labor Manufacturing overhead Total cost per unit

Royale $ 700.00 120.00 161.40 $ 981.40

Majestic $ 420.00 100.00 356.50 $ 876.50

Sales price per unit Cost per unit Gross profit

$1,600.00 981.40 $ 618.60

$1,300.00 876.50 $ 423.50

(c) Management’s future plans for the two television models are not sound. Under ABC costing, the Royale model is $195.10 ($618.60 – $423.50) per unit more profitable than the Majestic model. If any product should be phased out, it is the Majestic. But, by applying ABC and activity-based management analysis, Schultz may determine how to reduce the costs of producing the Majestic model.

4-29

PROBLEM 4-3A

(a) Predetermined overhead rate using machine hours: $852,000 ÷ 100,000 hrs. = $8.52 per machine hour (b) Manufacturing cost per stairway under traditional costing: Direct materials ............................................................... Direct labor ...................................................................... Overhead (14,500 X $8.52) .............................................. Total cost of 250 stairs............................................

$ 103,600 112,000 123,540 $ 339,140

Cost per stairway ($339,140 ÷ 250) ................................

$1,356.56

(c) Manufacturing cost per stairway under activity-based costing: Computation of Activity-Based Overhead Rates Activity Cost Pools Purchasing Handling materials Production Setting up machines Inspecting Inventory control Utilities

Estimated Expected Use of Cost Overhead ÷ Drivers per Activity = $ 69,000 82,000 210,000 95,000 90,000 126,000 180,000 $852,000

600 Orders 8,000 Moves 100,000 D/L Hours 1,250 Setups 6,000 Inspections 168,000 Components 90,000 Sq. ft.

Activity-Based Overhead Rate $115 per order $10.25 per move $2.10 per D/L hour $76 per setup $15 per inspection $.75 per component $2.00 per sq. ft.

Assignment of Overhead to Order of 250 Stairs Activity Cost Pools

Expected Use of Cost Drivers

Purchasing 60 Orders Handling materials 800 Moves Production 5,000 D/L Hours Setting up machines 100 Setups Inspecting 450 Inspections Inventory control 16,000 Components Utilities 8,000 Sq. ft. Total overhead assigned

4-30

Activity-Based X Overhead Rates = Cost Assigned $115 $10.25 $2.10 $76 $15 $.75 $2.00

$ 6,900 8,200 10,500 7,600 6,750 12,000 16,000 $67,950

PROBLEM 4-3A (Continued) Total manufacturing cost per stairway under ABC: Direct materials ...................................................................... Direct labor............................................................................. Overhead ................................................................................ Total cost of 250 stairs ..................................................

$ 103,600 112,000 67,950 $ 283,550

Total cost per stairway ($283,550 ÷ 250) ..............................

$1,134.20

(d) The difference between the traditional cost and the activity-based cost per unit, $1,356.56 versus $1,134.20, is not great in amount but $222.36 ($1,356.56 – $1,134.20) is 19.6% of the more correct ABC cost per unit. Activity-based costing is the preferable costing system for setting prices because the real costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity cost drivers under ABC than the single cost driver used with the traditional volumebased system.

4-31

PROBLEM 4-4A

(a) Computation of unit costs—traditional costing Overhead cost per direct labor hour is $1,241,660 ÷ (150,000 + 27,000) = $7.015 Products CoolDay LiteMist $0.400 $1.200 0.500 0.900 0.351* 0.631** $1.251 $2.731

Manufacturing Costs Direct materials Direct labor Overhead *$7.015 X .05 **$7.015 X .09 (b) Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment

(c)

Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment Total costs assigned (a) Liters produced

4-32

Estimated Expected Use Overhead ÷ of Cost Drivers = $ 145,860 396,000 270,000 189,000

6,600 6,600,000 900,000 900,000

240,800 $1,241,660

800

CoolDay Expected ActivityUse of Based Cost Overhead Cost Drivers X Rates = Assigned 6,000 $22.10 $132,600 3,000,000 $ 0.06 180,000 600,000 $ 0.30 180,000 600,000 $ 0.21 126,000 350

$301

105,350 $723,950

Activity-Based Overhead Rates $22.10 per cart $ 0.06 per month $ 0.30 per bottle $ 0.21 per bottle $301 per inspection

LiteMist Expected ActivityUse of Based Cost Overhead Cost Drivers X Rates = Assigned 600 $22.10 $ 13,260 3,600,000 $ 0.06 216,000 300,000 $ 0.30 90,000 300,000 $ 0.21 63,000 450

$301

135,450 $517,710

(b)

3,000,000

300,000

Overhead cost per liter [(a) ÷ (b)]

$0.241

$1.726

PROBLEM 4-4A (Continued) (d) Manufacturing Costs Direct materials Direct labor Overhead

(e) To:

Products CoolDay LiteMist $0.400 $1.200 0.500 0.900 0.241 1.726 $1.141 $3.826

Mr. Jack Eller

From:

Student

Subject:

Product costs using traditional approach versus ABC

The memorandum covers the following points:

ABC allocates overhead costs as a function of each product’s use of cost drivers. Thus, ABC results in overhead allocation that more closely approximates each product’s generation of overhead costs.

Traditional approaches that allocate costs as a function of volume tend to be biased toward allocating too much overhead to high volume, simple products, and too little to low volume, complex products. This is because the actual incurrence of overhead costs is rarely correlated with labor costs.

In the case of the Benton Corporation, the LiteMist product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When overhead costs were allocated using labor rates, too much overhead was allocated to the high volume CoolDay product. This reduced the apparent profitability of this product.

4-33

PROBLEM 4-5A

(a) Computation of assigned overhead under traditional costing (“direct labor dollars” appears in the first line of the schedule of overhead data): Predetermined overhead rate X direct labor dollars Overhead assigned to audit: Overhead assigned to tax:

.40 X $1,050,000 = $420,000 .40 X $750,000 = $300,000

(b) (1) Computation of activity-based overhead rates:

Activity Cost Pools Employee training Typing and secretarial Computing Facility rental Travel

Estimated Overhead ÷

Expected Use of Cost Drivers per Activity

$216,000 76,200 204,000 142,500 81,300 $720,000

$1,800,000 Direct labor dollars 2,500 Reports/forms 60,000 Minutes 40 Employees Direct

Activity-Based Overhead Rates

$.12 per DL dollar $30.48 per report/form $3.40 per minute $3,562.50 per employee Direct

(2) Assignment of overhead to audit and tax services:

Activity Cost Pools Employee training Typing and secretarial Computing Facility rental Travel Overhead costs assigned

4-34

Audit Expected ActivityUse of Based Cost Overhead Cost Driver X Rate = Assigned

Tax Expected ActivityUse of Based Cost Overhead Cost Driver X Rate = Assigned

$1,050,000 800 25,000 22 56,000

$750,000 1,700 35,000 18 25,300

$.12 $30.48 $3.40 $3,562.50 Direct

$126,000 24,384 85,000 78,375 56,000 $369,759

$.12 $30.48 $3.40 $3,562.50 Direct

$ 90,000 51,816 119,000 64,125 25,300 $350,241

PROBLEM 4-5A (Continued) (c) Overhead is assigned to the two service lines as follows:

Traditional costing ABC Difference

Audit $420,000 369,759 $ 50,241

Tax $300,000 350,241 $ 50,241

The $50,241 difference for audits is 12% lower under ABC costing, while the $50,241 difference for tax is 16.7% higher under ABC costing. Clearly, ABC costing should be used to determine the relative profitability of each service.

4-35

PROBLEM 4-1B

(a) Computation of unit costs—traditional costing. VideoPlus, Inc. Products Manufacturing Costs Direct materials Direct labor Overhead Total unit cost

Standard Model

Deluxe Model

$11 18 * 15* $44

$42 18 * 15* $75

*$7.50 X 2 = $15

(b)

VideoPlus, Inc. Activity Cost Pool Purchasing Receiving Assembling Testing Finishing Packing and shipping

Estimated Overhead ÷

Expected Use of Cost Drivers =

$ 126,000 30,000 444,000 115,000 140,000 195,000 $1,050,000

400 Orders 20,000 Pounds 74,000 Parts 23,000 Tests 70,000 Units 80,000 Pounds

(c)

$315.00 per order $ 1.50 per pound $ 6.00 per part $ 5.00 per test $ 2.00 per unit $ 2.4375 per pound

VideoPlus, Inc.

Activity Cost Pool Purchasing Receiving Assembling Testing Finishing Packing and shipping Total costs assigned

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Activity-Based Overhead Rate

Standard Model Expected Use of Overhead Cost Drivers X Rates = Assigned 100 4,000 20,000 10,000 20,000 18,000

$315.00 $ 1.50 $ 6.00 $ 5.00 $ 2.00 $ 2.4375

$ 31,500 6,000 120,000 50,000 40,000 43,875 $291,375

Deluxe Model Expected Use of Overhead Cost Drivers X Rates = Assigned 300 16,000 54,000 13,000 50,000 62,000

$315.00 $ 1.50 $ 6.00 $ 5.00 $ 2.00 $ 2.4375

$ 94,500 24,000 324,000 65,000 100,000 151,125 $758,625

Units produced

20,000

50,000

Overhead cost per unit

$14.57

$15.17

PROBLEM 4-1B (Continued) (d)

VideoPlus, Inc. ABC Manufacturing Costs Direct materials Direct labor Overhead Total cost per unit

Standard Model $11.00 18.00 14.57 $43.57

Deluxe Model $42.00 18.00 15.17 $75.17

(e)

Activity Purchasing Receiving Assembling Testing Finishing Packing and shipping

Value- vs. Non-value-added Non-value-added Non-value added Value-added Non-value-added Value-added Value-added

(f)

(1) Activity-based costing shows the standard model absorbs about the same overhead per unit as the deluxe model. (2) The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products in this case is close to the equal amounts assigned by traditional costing. In many cases, ABC costing will provide a significant difference as overhead is allocated in a manner that better reflects cause and effect. In some situations, however, traditional costing can be a good approximation.

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PROBLEM 4-2B

(a) The allocation of total manufacturing overhead using activity-based costing is as follows: Elite Overhead Rate Purchase orders @ $31 Machine setups @ $29 Machine hours @ $31 Inspections @ $89 Total assigned costs (a)

Drivers Used

Cost Assigned

11,250 11,000 40,000 2,750

$ 348,750 319,000 1,240,000 244,750 $2,152,500

Preferred Drivers Cost Used Assigned 13,750 9,000 60,000 2,250

$ 426,250 261,000 1,860,000 200,250 $2,747,500

Units produced (b)

20,000

10,000

Cost per unit (a) ÷ (b)

$107.63

$274.75

Total Overhead $ 775,000 580,000 3,100,000 445,000 $4,900,000

(b) The cost per unit and gross profit of each model under ABC costing were: Direct materials Direct labor Manufacturing overhead Total cost per unit

Elite $ 600.00 100.00 107.63 $ 807.63

Preferred $ 320.00 80.00 274.75 $ 674.75

Sales price per unit Cost per unit Gross profit

$1,400.00 807.63 $ 592.37

$1,100.00 674.75 $ 425.25

(c) Management’s future plans for the two home theater systems are not sound. Under ABC costing, the Elite system is $167.12 per unit more profitable than the Preferred system. If any product should be phased out, it is the Preferred. But, by applying ABC and activity-based management analysis, Kinnard may determine how to reduce the costs of producing the Preferred system.

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PROBLEM 4-3B

(a) Predetermined overhead rate using materials cost: $550,000 ÷ $500,000 = 110% of materials cost (b) Manufacturing cost per armoire under traditional costing: Direct materials ............................................................... Direct labor...................................................................... Overhead (5,200 X 110%) ............................................... Total cost of 12 armoires ........................................

5,200 3,500 5,720 $ 14,420

Cost per armoire ($14,420 ÷ 12) .....................................

$1,201.67

(c) Manufacturing cost per armoire under activity-based costing: Computation of Activity-Based Overhead Rate Activity Cost Pools Purchasing Handling materials Production Setting up machines Inspecting Inventory control Utilities

Estimated Overhead ÷

Total Estimated Drivers

$ 45,000 50,000 130,000 85,000 60,000 80,000 100,000 $550,000

500 Orders 5,000 Moves 65,000 D/L Hours 1,000 Setups 4,000 Inspections 40,000 Components 50,000 Sq. ft.

Activity-Based Overhead Rate $90 per order $10 per move $ 2 per D/L hour $85 per setup $15 per inspection $ 2 per component $ 2 per sq. ft.

Assignment of Overhead to Order of 12 armoires Activity Cost Pools

Expected Use of Drivers

Purchasing 3 Orders Handling materials 32 Moves Production 200 D/L Hours Setting up machines 4 Setups Inspecting 20 Inspections Inventory control 640 Components Utilities 320 Sq. ft. Total overhead assigned

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Activity-Based X Overhead Rate = Cost Assigned $90 $10 $ 2 $85 $15 $ 2 $ 2

$ 270 320 400 340 300 1,280 640 $3,550

PROBLEM 4-3B (Continued) Total manufacturing cost per armoire under ABC: Direct materials ...................................................................... Direct labor ............................................................................. Overhead ................................................................................ Total cost of 12 armoires ...............................................

5,200 3,500 3,550 $ 12,250

Total cost per armoire ($12,250 ÷ 12) ...................................

$1,020.83

(d) The difference between the traditional cost and the activity-based cost per unit, $1,201.67 versus $1,020.83, is not great in amount but $180.84 or ($1,201.67 – $1,020.83) is 17.7% of the more correct ABC cost per unit. Activity-based costing is the preferable costing system for setting prices because the real costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity cost drivers under ABC than the single cost driver used with the traditional volume-based system.

4-40

PROBLEM 4-4B

(a) Computation of unit costs—traditional costing Overhead cost per labor hour is $1,150,000 ÷ (30,000 + 20,000) =$23 Products Valley Fresh Merando Valley $1.35 $3.60 0.75 1.50 1.15* 2.30** $3.25 $7.40

Manufacturing Costs Direct materials Direct labor Overhead *$23 X .05 **$23 X .10 (b) Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment

Estimated Overhead

Expected Use of Cost Drivers

$ 146,000 420,000 210,000 140,000

8,000 3,000,000 1,400,000 1,400,000

234,000 $1,150,000

1,040

(c) Activity Cost Pool Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment Total costs assigned (a) Liters produced

Activity-Based Overhead Rates $ 18.25 per cart $ 0.14 per month $ 0.15 per bottle $ 0.10 per bottle $225.00 per inspection

Valley Fresh

Merando Valley

Expected Use of Overhead Cost Drivers X Rates = Assigned 6,000 $ 18.25 $109,500 600,000 $ 0.14 84,000 600,000 $ 0.15 90,000 600,000 $ 0.10 60,000

Expected Use of Overhead Cost Drivers X Rates = Assigned 2,000 $ 18.25 $ 36,500 2,400,000 $ 0.14 336,000 800,000 $ 0.15 120,000 800,000 $ 0.10 80,000

240

$225.00

54,000 $397,500

800

$225.00

180,000 $ 752,500

(b)

600,000

200,000

Overhead cost per gallon [(a) ÷ (b)]

$0.663

$3.763

4-41

PROBLEM 4-4B (Continued) (d) Manufacturing Costs Direct materials Direct labor Overhead

(e) To:

Products Valley Fresh Merando Valley $1.350 $3.600 0.750 1.500 0.663 3.763 $2.763 $8.863

Mr. Frankie Merando

From:

Student

Subject:

Product costs using traditional approach versus ABC

The memorandum covers the following points:

4-42

In the case of the Merando Corporation, the Merando Valley product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When overhead costs were allocated using labor rates, too much overhead was allocated to the high volume Valley Fresh product. This reduced the apparent profitability of this product.

PROBLEM 4-4B (Continued) d.

The total cost of the two products under the two approaches was as follows:

Traditional approach ABC

Valley Fresh $3.25

Merando Valley $7.40

$2.763

$8.863

Therefore, the relative profitability of the two products should be determined using ABC costing.

4-43

PROBLEM 4-5B

Computation of activity-based overhead rates:

Activity Cost Pool Employee training Typing and secretarial Computing Facility rental Travel

Estimated Overhead ÷

Total Expected Use of Cost Drivers

$120,000 60,000 130,000 100,000 70,000 $480,000

$1,600,000 Direct labor dollars 2,000 Reports/forms 40,000 Minutes 25 Employees Direct

Activity Cost Pool Employee training Typing and secretarial Computing Facility rental Travel Overhead assigned

$.075 per DL dollar $30 per report/form $3.25 per minute $4,000 per employee Direct

Assignment of overhead to corporate and individual services: Corporate

4-44

Activity-Based Overhead Rates

Individual

Expected Use of Driver

Overhead Rate

Cost Assigned

$900,000 500 17,000 14 48,000

$.075 $30 $3.25 $4,000 Direct

$ 67,500 15,000 55,250 56,000 48,000 $241,750

Expected Use of Driver

Overhead Rate

Cost Assigned

$700,000 1,500 23,000 11 22,000

$.075 $30 $3.25 $4,000 Direct

$ 52,500 45,000 74,750 44,000 22,000 $238,250

PROBLEM 4-5B (Continued) (c) Overhead is assigned to the two service lines as follows:

Traditional costing ABC Difference

Corporate $270,000 241,750 $ 28,250

Individual $210,000 238,250 ($ 28,250)

ABC allocates $28,250 of overhead that had been assigned to the Corporate department to the Individual department. Since ABC costing usually provides more accurate results, it should be used to determine the relative profitability of each service.

4-45

BYP 4-1

DECISION-MAKING AT CURRENT DESIGNS

(a) Directly assigned Remaining amount ($832,000) allocated 50% to each product line Total Number of units Cost assigned per unit

Composite $ 28,000

Rotomolded $ 40,000

$416,000 $444,000 1,000 $ 444.00

$416,000 $456,000 4,000 $ 114.00

Composite $ 28,000

Rotomolded $ 40,000

$374,400* $402,400 1,000 $ 402.40

$457,600** $497,600 4,000 $ 124.40

(b) Directly assigned Remaining amount ($832,000) allocated based on direct labor costs Total Number of units Cost assigned per unit

*Overhead rate = $832,000 ÷ ($234,000 + $286,000) = $160% of direct labor cost Composite: 160% X $234,000 = 374,400. **Using overhead rate calculated in* Rotomolded: 160% X $286,000 = $457,600

4-46

BYP 4-1 (Continued) (c) Activity Cost Pools Design Prototypes Molds Supervision Curing time

Estimated Overhead $121,100 152,000 188,500 180,000 190,400

Expected Use of Cost Drivers 4 8 13 24 17,000

Composite Activity Cost Pool Design Prototypes Molds Supervision Curing time Total amount allocated Directly assigned Total cost (a) Number of units (b) Cost assigned per unit (a) ÷ (b)

Activity-Based Overhead Rates $30,275 per model $19,000 per prototype $14,500 per mold $7,500 per employee $11.20 per day Rotomolded

Expected Expected Use of Overhead Cost Use of Overhead Cost Drivers Rates Assigned Drivers Rates Assigned 3 $30,275 $ 90,825 1 $30,275 $ 30,275 6 $19,000 114,000 2 $19,000 38,000 12 $14,500 174,000 1 $14,500 14,500 12 $ 7,500 90,000 12 $ 7,500 90,000 15,000 $ 11.20 168,000 2,000 $ 11.20 22,400 636.825

195,175

28,000 $664,825

40,000 $235,175

1,000

4,000

$ 664.83

58.79

(d) Activity based costing assigns significantly more costs to the composite kayaks. Since the cost is divided into pools and each pool is allocated using a cost driver that is related to those particular costs, it provides a more accurate way to allocate the costs. Current Designs would need to weigh the additional costs of implementing an ABC system against the benefits that it provides.

4-47

BYP 4-2

DECISION-MAKING ACROSS THE ORGANIZATION

The following activities and cost drivers might be submitted: (a) Activities Laundering Housekeeping Dietary Computing information technology Nursing care Surgery Clinical lab Imaging (X-ray, etc.) Pharmacy Emergency room Maintenance Billing and collecting

4-48

(b) Cost Drivers Pounds of linen Square footage; number of beds Number of meals Minutes of computer usage; or number of work stations Number of patients Number of procedures or operations Number of tests Number of images Number of prescriptions Number of cases or patients Square footage Number of invoices

BYP 4-3

MANAGERIAL ANALYSIS

(a) Computation of activity-based overhead rate:

Activity Cost Pools

Total Estimated Overhead ÷

Expected Use of Cost Drivers Per Activity

Market analysis Product design Product development Prototype testing

$1,050,000 2,350,000 3,600,000 1,400,000

15,000 Hours 2,500 Designs 90 Products 500 Tests

Activity-Based Overhead Rates $ 70 per hour $ 940 per design $40,000 per product $ 2,800 per test

(b) Charges to in-house manufacturing department: In-House Manufacturing Department

Activity Cost Pools

Activity-Based Cost Drivers Used X Overhead Rates = Cost Assigned

Market analysis 1,800 Hours Product design 280 Designs Product development 10 Products Prototype testing 92 Tests Total overhead assigned

$ 70 $ 940 $40,000 $ 2,800

$ 126,000 263,200 400,000 257,600 $1,046,800

Activity Cost Pools

Activity-Based Cost Drivers Used X Overhead Rates = Cost Assigned

Market analysis 800 Hours Product design 178 Designs Product development 3 Products Prototype testing 70 Tests Total overhead assigned

4-49

$ 70 $ 940 $40,000 $ 2,800

$ 56,000 167,320 120,000 196,000 $539,320

BYP 4-3 (Continued) (d) Activity-based costing permits the company to identify its R&D costs by the activities that cause the costs; that is, ABC allows closer scrutiny of the causes for cost incurrences; hence, greater control. By charging in-house manufacturing departments for their fair share of the company’s R&D costs, these departments may exert their own control over such costs. Activity-based costing allows Ideal to compile realistic costs for bidding and charging outside users of its R&D department’s services.

4-50

BYP 4-4

REAL-WORLD FOCUS

(a) Some of the benefits of ABC for the financial services industry include: Identification of the most profitable customers More accurate product and service pricing Increased product profitability Well-organized process costs (b) Three things that the company’s original costing method did not take into account were: (1) The same servicing and administrative expenses were applied equally to all accounts, including fixed and adjustable rate mortgages. (2) No consideration was given to “seasoning”, that is, the amount of time a loan had been on the books. (3) It did not take credit quality into account. (c) Some of the cost drivers used under the new approach were: Average number of accounts that were at least 60 days delinquent. Average number of accounts outstanding. Average number of bankrupt accounts plus the average number of real estate owned accounts.

4-51

BYP 4-5

REAL-WORLD FOCUS

(a) According to the authors, “ABC loses power in large-scale operations, and can be difficult to implement and maintain.” They suggest, though, that ABC should not be abandoned but, rather, improved because it provides many potential benefits. They cite as benefits that ABC “has helped many companies identify important cost- and profit-enhancement opportunities through repricing of unprofitable customer relationships, process improvement on the shop floor, lower-cost product designs, and rationalized product variety.” (b) One way to estimate practical capacity is to simply use a rule of thumb, such as practical capacity is 80 to 85% of theoretical capacity. The authors suggest that estimates for people be put at the lower end of the range and for machines at the upper end of the range. A more systematic approach would be to review past activity levels during a month where a high level of orders was processed with a high degree of success. The authors say that it is not important to be extremely precise, as long as you are within 5 to 10% of the actual number. (c) After practical capacity is determined in terms of total time available, the cost per unit of time is determined by dividing the total cost of that capacity by the total capacity in units of time. This results in a cost per unit of time. Next, managers determine the amount of time it takes to carry out each type of activity. Then the cost per time unit can be multiplied by the time it takes to perform each activity so that the cost of the activity is determined. This then enables the company to assign costs to the activities performed for specific customers or in making specific products.

4-52

BYP 4-5 (Continued) (d) One of the primary benefits of the report provided by “ABC, the TimeDriven Way” is that it highlights the difference between capacity supplied and capacity used. This enables management to evaluate its effectiveness in its use of the company’s resources and to evaluate decisions regarding increasing or decreasing capacity. As an example, the authors discuss the experience of Lewis-Goetz, a hose and belt fabricator. It found that one of its plants was operating at only 27% of capacity. It was able to use this information in making decisions regarding how it planned to meet the production requirements of a very large order it was anticipating for later in the year.

4-53

BYP 4-6

ETHICS CASE

(a) The stakeholders (parties affected by Curtis’s and Ed’s actions) in this case are: • Curtis as cost accountant. • Ed and all personnel employed in the production of the Supercut Model of lawn tractor. • Hi-Power Mower management. • Hi-Power Mower owners (stockholders). • The stakeholder group may be expanded to include Hi-Power Mower’s suppliers and customers. (b) The objective of cost accounting is to provide useful, accurate information for decision making by managers. Ed is coercing Curtis to massage the data to save the product line and, thus, Ed’s job. Ed is advocating knowingly providing false data, deceiving management, and jeopardizing Curtis’s job. (c) Curtis is a management accountant employed by Hi-Power Mower Company. His first job responsibility is to his employer to: (1) communicate information fairly and objectively and (2) disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. Curtis’s obligation is to provide management with timely, truthful information.

4-54

BYP 4-7

ALL ABOUT YOU

(a) The three main tools for time management for students are: Term calendar—records quizzes, exams, project due dates and other major events. Weekly schedule—records your scheduled time for learning for each course. Daily to do list—lists the tasks that must be accomplished each day in order to identify priorities. (b) Studies show that students are most inclined to waste time during the morning and afternoon. Your brain is best prepared for learning during day-light hours. Therefore, it is important to schedule your time so that you tackle your most difficult topics during daylight hours. (c) Many students resent time management practices because they think they will be constraining. In fact, time management practices can be liberating because they help you to get control of your life so that you have more time to devote to those things that are really important to you. (d) Goal setting is important because if you have clearly defined goals you will be more likely to accomplish those things that are important to you. Good goals are clearly defined, with as much detail as possible. They also should be realistic. To help you develop your goals, you should discuss your goals and objectives with a mentor or advisor.

4-55

BYP 4-8

CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: In part, the response to this question depends on how broadly you apply the term “value-added activity” when looking at one’s life. For example, some value-added activities relate to goals and objectives for school and work. It is important to try to manage your time effectively to maximize your chance of achieving these objectives. But it is also important to identify the other things in life that are important. These would include time with friends, family, your health, and hobbies and activities that you value. When identifying personal value-added activities, it is important to identify all the things, school-related and otherwise, that matter most to you. In applying the activity-based concepts that you learned in this chapter to your life, try to eliminate the non-value-added activities that reduce your ability to focus on those aspects of life that are really important to you.

4-56

CHAPTER 5 Cost-Volume-Profit ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Do It!

Exercises

A Problems

B Problems

Distinguish between variable and fixed costs.

1, 2, 3, 6

1, 2, 3, 4, 5, 6

1A, 6A

1B, 6B

Explain the significance of the relevant range.

4, 5

Explain the concept of mixed costs.

6, 7, 8

1, 3, 4, 5

List the five components of cost-volume-profit analysis.

Indicate what contribution margin is and how it can be expressed.

10, 11, 17

6, 7

8, 9, 10, 11, 12, 13, 17

1A, 2A, 3A, 4A, 5A, 6A

1B, 2B, 3B, 4B, 5B, 6B

Identify the three ways to determine the break-even point.

12, 13, 14

8, 9

3, 4

8, 9, 10, 11, 12, 13, 14, 16, 17

1A, 2A, 3A, 4A, 5A

1B, 2B, 3B, 4B, 5B

Give the formulas for determining sales required to earn target net income.

10, 12

14, 15, 17

2A, 5A, 6A

2B, 5B, 6B

Define margin of safety, and give the formulas for computing it.

16, 17

2A, 4A, 5A, 6A

2B, 4B, 5B, 6B

5-1

1, 2

1, 3, 4, 5, 6 7

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

5-2

Description

Difficulty Level

Time Allotted (min.)

Determine variable and fixed costs, compute break-even point, prepare a CVP graph, and determine net income.

Simple

20–30

Prepare a CVP income statement, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income.

Moderate

30–40

Compute break-even point under alternative courses of action.

Simple

20–30

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

Moderate

20–30

Compute contribution margin, fixed costs, break-even point, sales for target net income, and margin of safety ratio.

Moderate

20–30

Determine contribution margin ratio, break-even point, and margin of safety.

Moderate

20–30

Determine variable and fixed costs, compute break-even point, prepare a CVP graph, and determine net income.

Simple

20–30

Prepare a CVP income statement, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income.

Moderate

30–40

Compute break-even point under alternative courses of action.

Simple

20–30

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

Moderate

20–30

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

Moderate

20–30

Determine contribution margin ratio, break-even point, and margin of safety.

Moderate

20–30

5-3 Learning Objective * 1. Distinguish between variable and fixed costs.

Knowledge Comprehension E5-4

Application

Analysis

Q5-1 Q5-2 Q5-3 Q5-6

BE5-1 E5-5 E5-1 E5-2 DI5-1

E5-3 E5-6 P5-1A P5-1B

* 2. Explain the significance of the relevant range.

Q5-4 Q5-5

E5-2

BE5-2

* 3. Explain the concept of mixed costs. E5-4 E5-5

Q5-6 Q5-7 BE5-1

* 4. List the five components of cost-volume-profit analysis.

Q5-9

E5-7

DI5-1 Q5-8 E5-1 BE5-4 BE5-5

DI5-2 BE5-3 E5-5 E5-3 E5-6 P5-1A

Synthesis

Evaluation P5-6A P5-6B

P5-1B

* 5. Indicate what contribution margin is and how it can be expressed.

Q5-10

Q5-11 Q5-17 BE5-6 BE5-7 E5-8 E5-9

E5-10 E5-11 E5-12 E5-13 E5-17

BE5-6 P5-1A P5-2A P5-1B P5-2B

P5-3A P5-3B P5-4A P5-5A P5-6A P5-4B

* 6. Identify the three ways to determine the break-even point.

Q5-12 Q5-14

Q5-13 BE5-8 BE5-9 DI5-3 DI5-4 E5-8 E5-9

E5-10 E5-11 E5-12 E5-13 E5-14 E5-17

E5-16 P5-1A P5-2A P5-1B P5-2B

P5-3A P5-4A P5-3B P5-4B P5-5A P5-5B

* 7. Give the formulas for determining sales required to earn target net income.

Q5-16 BE5-10 BE5-12 DI5-4

E5-12 P5-2A E5-14 P5-2B E5-15 E5-17

P5-5A P5-6A P5-5B P5-6B

* 8. Define margin of safety, and give the formulas for computing it.

Q5-15 BE5-11 DI5-4

E5-17 E5-16 P5-2A P5-2B

BYP5-4

BYP5-1 BYP5-2

Broadening Your Perspective

BYP5-6

P5-5A P5-5B

P5-4A P5-6A P5-4B BYP5-5

BYP5-3 BYP5-7 BYP5-8

P5-5B P5-6B

P5-6B

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) Cost behavior analysis is the study of how specific costs respond to changes in the level of activity within a company. (b) Cost behavior analysis is important to management in planning business operations and in deciding between alternative courses of action.

(a) The activity index identifies the activity that causes changes in the behavior of costs. Once the index is determined, it is possible to classify the behavior of costs in response to changes in activity levels into three categories: variable, fixed, or mixed. (b) Variable costs may be defined in total or on a per-unit basis. Variable costs in total vary directly and proportionately with changes in the activity level. Variable costs per unit remain the same at every level of activity.

Fixed costs remain the same in total regardless of changes in the activity level. In contrast, fixed costs per unit vary inversely with activity. As volume increases, fixed costs per unit decline and vice versa.

(a) The relevant range is the range of activity over which a company expects to operate during the year. (b) Disagree. The behavior of both fixed and variable costs are linear only over a certain range of activity. CVP analysis is based on the assumption that both fixed and variable costs remain linear within the relevant range.

This is true. Most companies operate within the relevant range. Within this range, it is possible to establish a linear (straight-line) relationship for both variable and fixed costs. If a relevant range cannot be established, segregation of costs into fixed and variable becomes extremely difficult.

Apartment rent is fixed because the cost per month remains the same regardless of how much Adam uses the apartment. Rent on a Hertz rental truck is a mixed cost because the cost usually includes a per day charge (a fixed cost) plus an activity charge based on miles driven (a variable cost).

For CVP analysis, mixed costs must be classified into their fixed and variable elements. One approach to the classification of mixed costs is the high-low method.

Variable cost per unit is $1.30, or [($165,000 – $100,000) ÷ (90,000 – 40,000)]. At any level of activity, fixed costs are $48,000 per month [$165,000 – (90,000 X $1.30)].

No. Only two of the basic components of cost-volume-profit (CVP) analysis, unit selling prices and variable cost per unit, relate to unit data. The other components, volume, total fixed costs, and sales mix, are not based on per-unit amounts.

10.

There is no truth in Faye’s statement. Contribution margin is sales less variable costs. It is the revenue that remains to cover fixed costs and to produce income (profit) for the company.

11.

Contribution margin is $14 ($40 – $26). The contribution margin ratio is 35% ($14 ÷ $40).

5-4

Questions Chapter 5 (Continued) 12.

Disagree. Knowledge of the break-even point is useful to management in deciding whether to introduce new product lines, change sales prices on established products, and enter new market areas.

13.

$26,000 ÷ 25% = $104,000

14.

(a) The break-even point involves the plotting of three lines over the full range of activity: the total revenue line, the total fixed cost line, and the total cost line. The break-even point is determined at the intersection of the total revenue and total cost lines. (b) The break-even point in units is obtained by drawing a vertical line from the break-even point to the horizontal axis. The break-even point in sales dollars is obtained by drawing a horizontal line from the break-even point to the vertical axis.

15.

Margin of safety is the difference between actual or expected sales and sales at the break-even point. 1,250 X $12 = $15,000; $15,000 – $13,200 = $1,800; $1,800 ÷ $15,000 = 12%.

16.

At break-even sales, the contribution margin is equal to the fixed costs. The contribution margin ratio is: = 36% The sales volume to achieve net income of $90,000 is as follows: = $750,000

17.

PACE COMPANY CVP Income Statement Sales ................................................................................................. Variable expenses Cost of goods sold ($600,000 X .70) .......................................... Operating expenses ($200,000 X .70)........................................ Total variable expenses ..................................................... Contribution margin ...........................................................................

5-5

$900,000 $420,000 140,000 560,000 $340,000

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1 Indirect labor is a variable cost because it increases in total directly and proportionately with the change in the activity level. Supervisory salaries is a fixed cost because it remains the same in total regardless of changes in the activity level. Maintenance is a mixed cost because it increases in total but not proportionately with changes in the activity level.

BRIEF EXERCISE 5-2 VARIABLE COST Relevant Range $10,000

$10,000

8,000

6,000

4,000

2,000

2,000 0

80 100

Activity Level

5-6

FIXED COST Relevant Range

80 100

Activity Level

BRIEF EXERCISE 5-3

$60,000 Total Cost Line

COST

45,000

Variable Cost Element

30,000

15,000 Fixed Cost Element 0

500

1,000

1,500

2,000

2,500

Direct Labor Hours

BRIEF EXERCISE 5-4 High Low Difference $15,000 – $13,500 = $1,500 8,500 – 7,500 = 1,000 $1,500 ÷ 1,000 = $1.50—Variable cost per mile.

Total cost Less: Variable costs 8,500 X $1.50 7,500 X $1.50 Total fixed costs

High $15,000

Low $13,500

12,750 $ 2,250

11,250 $ 2,250

The mixed cost is $2,250 plus $1.50 per mile.

5-7

BRIEF EXERCISE 5-5 High Low Difference $66,100 – $32,000 = $34,100 40,000 – 18,000 = 22,000 $34,100 ÷ 22,000

= $1.55 per unit.

Total cost Less: Variable costs 40,000 X $1.55 18,000 X $1.55 Total fixed costs

Activity Level High Low $66,100 $32,000 62,000 000,000 $ 4,100

27,900 $ 4,100

BRIEF EXERCISE 5-6 1.

(a) (b)

$288 = ($640 – $352) 45% ($288 ÷ $640)

$207 = ($300 – $93) 31% ($93 ÷ $300)

(e) (f)

$1,300 = ($325 ÷ 25%) $975 ($1,300 – $325)

BRIEF EXERCISE 5-7 RADIAL INC. CVP Income Statement For the Quarter Ended March 31, 2014 Sales .................................................................................. Variable costs ($920,000 + $70,000 + $86,000) ............... Contribution margin ......................................................... Fixed costs ($440,000 + $45,000 + $98,000) .................... Net income ........................................................................

5-8

$2,400,000 1,076,000 1,324,000 583,000 $ 741,000

BRIEF EXERCISE 5-8 (a) $520Q – $286Q – $163,800 = $0 $234Q = $163,800 Q = 700 units (b) Contribution margin per unit $234, or ($520 – $286) X = $163,800 ÷ $234 X = 700 units BRIEF EXERCISE 5-9 Contribution margin ratio = [($300,000 – $180,000) ÷ $300,000] = 40% Required sales in dollars = $170,000 ÷ 40% = $425,000

BRIEF EXERCISE 5-10 If variable costs are 70% of sales, the contribution margin ratio is ($1 – $0.70) ÷ $1 = .30. Required sales in dollars = ($195,000 + $75,000) ÷ .30 = $900,000 BRIEF EXERCISE 5-11 Margin of safety = $1,000,000 – $840,000 = $160,000 Margin of safety ratio = $160,000 ÷ $1,000,000 = 16% BRIEF EXERCISE 5-12 Contribution margin per unit $1.60 is ($6.00 – $4.40) Required sales in units = ($480,000 + $1,500,000) ÷ $1.60 = 1,237,500.

5-9

SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 5-1 Variable costs: Indirect labor, direct labor, and direct materials. Fixed costs: Property taxes and depreciation. Mixed costs: Utilities and maintenance. DO IT! 5-2 ($18,580 – $16,200) ÷ (10,500 – 8,800) = $1.40 per unit $18,580 – ($1.40 X 10,500 units) = $3,880 or $16,200 – ($1.40 X 8,800) = $3,880

(a)

Variable cost: Fixed cost:

(b)

Total cost to produce 9,200 units: $3,880 + ($1.40 X 9,200) = $16,760

DO IT! 5-3 (a)

The formula is $250Q – $170Q – $140,000 = 0. Therefore, 80Q = $140,000, and the breakeven point in units is 1,750 ($140,000 ÷ $80).

(b)

The contribution margin per unit is $80 ($250 – $170). The formula therefore is $140,000 ÷ $80, and the breakeven point in units is 1,750.

DO IT! 5-4 (a)

CM per unit = Unit selling price – Unit variable costs $12 = $30 – $18 CM ratio = CM per unit/Unit selling price 40% = $12/$30 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio = $220,000 ÷ 40% = $550,000

5-10

DO IT! 5-4 (Continued) (b)

Margin of safety

Actual sales – Break-even sales Actual sales $800,000 – $550,000 = $800,000 =

= (c)

31.25%

Sales – Variable costs – Fixed costs = Net income $30Q – $18Q = $220,000 + $140,000 $12Q = $360,000 Q = 30,000 units 30,000 units X $30 = $900,000 required sales

5-11

SOLUTIONS TO EXERCISES EXERCISE 5-1 (a) The determination as to whether a cost is variable, fixed, or mixed can be made by comparing the cost in total and on a per-unit basis at two different levels of production. Variable Costs Fixed Costs Mixed Costs

Vary in total but remain constant on a per-unit basis. Remain constant in total but vary on a per-unit basis. Contain both a fixed element and a variable element. Vary both in total and on a per-unit basis.

(b) Using these criteria as a guideline, the classification is as follows: Direct materials Direct labor Utilities EXERCISE 5-2 (a)

5-12

Variable Variable Mixed

Rent Maintenance Supervisory salaries

Fixed Mixed Fixed

EXERCISE 5-2 (Continued) (b) The relevant range is 3,000 – 8,000 units of output since a straight-line relationship exists for both direct materials and rent within this range. (c)

Variable cost per unit Within the relevant range (3,000 – 8,000 units)

= =

Cost Units $15,000* 5,000*

$3 per unit

*Any costs and units within the relevant range could have been used to calculate the same unit cost of $3. (d) Fixed cost within the relevant range (3,000 – 8,000 units)

$8,000

EXERCISE 5-3 (a) Maintenance Costs: =

Total costs Less: Variable costs 700 X $6 300 X $6 Total fixed costs

= $6 variable cost per machine hour 700 Machine Hours $4,900

300 Machine Hours $2,500

4,200 $ 700

1,800 $ 700

Thus, maintenance costs are $700 per month plus $6 per machine hour.

5-13

EXERCISE 5-3 (Continued) (b)

$5,000 Total Cost Line

$4,900

COSTS

$4,000

$3,000 Variable Cost Element $2,000

$1,000 $ 700 Fixed Cost Element 0 100 200 300 400 500 600 700 Machine Hours

EXERCISE 5-4 1. Wood used in the production of furniture. 2. Fuel used in delivery trucks. 3. Straight-line depreciation on factory building. 4. Screws used in the production of furniture. 5. Sales staff salaries. 6. Sales commissions. 7. Property taxes. 8. Insurance on buildings. 9. Hourly wages of furniture craftsmen. 10. Salaries of factory supervisors. 11. Utilities expense. 12. Telephone bill.

5-14

Variable. Variable. Fixed. Variable. Fixed. Variable. Fixed. Fixed. Variable. Fixed. Mixed. Mixed.

EXERCISE 5-5 (a) Maintenance Costs: = $.50 variable cost per machine hour

Activity Level Total cost Less: Variable costs 8,000 X $.50 3,500 X $.50 Total fixed costs

High $5,000

Low $2,750

4,000 00,000 $1,000

1,750 $1,000

Thus, maintenance costs are $1,000 per month plus $.50 per machine hour. (b)

$5,000 Total Cost Line

COSTS

$4,000

Variable Cost Element

$3,000

$2,000

$1,000 Fixed Cost Element 0

2,000

4,000

6,000

Machine Hours

5-15

8,000

EXERCISE 5-6 (a)

Cost Direct materials Direct labor Utilities Property taxes Indirect labor Supervisory salaries Maintenance Depreciation

(b)

Fixed

Variable X X

Mixed X

X X X X X

Fixed costs

= $1,000 + $1,900 + $2,400 + $300 + $200 = $5,800

Variable costs to produce 3,000 units = $7,500 + $18,000 + $4,500 = $30,000 Variable cost per unit

= $30,000/3,000 units = $10 per unit

Variable cost portion of mixed cost

= Total cost – Fixed portion

Utilities: Variable cost to produce 3,000 units = $2,100 – $300 = $1,800 Variable cost per unit

= $1,800/3,000 units = $.60 per unit

Maintenance: Variable cost to produce 3,000 units = $1,100 – $200 = $900 Variable cost per unit

= $900/3,000 units = $.30 per unit

Cost to produce 5,000 units = (Variable costs per + Fixed cost unit X 5,000 units) = (($10 + $.60 + $.30) X 5,000) + $5,800 = $54,500 + $5,800 = $60,300 5-16

EXERCISE 5-7 MEMO To:

Jim Taylor

From:

Student

Re:

Assumptions underlying CVP analysis

CVP analysis is a useful tool in analyzing the effects of changes in costs and volume on a company’s profits. However, there are some assumptions which underline CVP analysis. When these assumptions are not valid, the results of CVP analysis may be inaccurate. The five assumptions are: 1. The behavior of both costs and revenues is linear throughout the relevant range of the activity index. 2. All costs can be classified accurately as either fixed or variable. 3. Changes in activity are the only factors that affect costs. 4. All units produced are sold. 5. When more than one type of product is sold, the sales mix will remain constant. If you want further explanation of any of these assumptions, please contact me. EXERCISE 5-8 (a) Contribution margin per lawn

$60 – ($12 + $10 + $2)

Contribution margin per lawn

$36

Contribution margin ratio

$36 ÷ $60 = 60%

Fixed costs = $1,400 + $200 + $2,000 = $3,600 Break-even point in lawns = $3,600 ÷ $36 = 100 (b) Break-even point in dollars = 100 lawns X $60 per lawn = $6,000 per month OR Fixed costs ÷ Contribution margin ratio = $3,600 ÷ .60 = $6,000 per month

5-17

EXERCISE 5-9 1.

Contribution margin per room

$60 – ($11 + $28)

Contribution margin per room

$21

Contribution margin ratio

$21 ÷ $60 = 35%

Fixed costs = $6,200 + $1,100 + $1,000 + $100 = $8,400 Break-even point in rooms = $8,400 ÷ $21 = 400 2.

Break-even point in dollars

= 400 rooms X $60 per room = $24,000 per month

OR Fixed costs ÷ Contribution margin ratio = $8,400 ÷ .35 = $24,000 per month EXERCISE 5-10 (a) Contribution margin in dollars: Sales = 560 X $120 =

$67,200 Variable costs = $67,200 X .60 = 40,320 Contribution margin $26,880

Contribution margin per unit: Contribution margin ratio:

(b) Break-even sales in dollars: Break-even sales in units:

5-18

$120 – $72 ($120 X 60%) = $48. $48 ÷ $120 = 40%.

= $52,560. = 438.

EXERCISE 5-11 (a) 1. Contribution margin ratio is: $27,000 = 75% $36,000 Break-even point in dollars = 2. Round-trip fare =

$15,000 = $20,000 75%

$36,000 = $25 1,440 fares

Break-even point in fares = $20,000 = 800 fares $25 (b) At the break-even point fixed costs and contribution margin are equal. Therefore, the contribution margin at the break-even point would be $15,000. EXERCISE 5-12 (a) Unit contribution margin =

= = $1.60 Variable cost per unit

= Unit selling price – Unit contribution margin = $5.00 – $1.60 = $3.40

OR = 70,000 X $5.00 = 70,000X + $112,000 = where X = Variable cost per unit = Variable cost per unit = $3.40 Contribution margin ratio = $1.60 ÷ $5.00 = 32%

5-19

EXERCISE 5-12 (Continued) (b) Fixed costs ÷ Contribution margin ratio = Break-even sales in dollars Fixed costs ÷ .32 = $420,000 = $134,400 ($420,000 X.32) Since fixed costs were $112,000 in 2013, the increase in 2014 is $22,400 ($134,400 – $112,000). EXERCISE 5-13 (a)

CANNES COMPANY CVP Income Statement For the Month Ended September 30, 2014 Sales (600 video game consoles) .................. Variable costs ................................................. Contribution margin ....................................... Fixed costs ...................................................... Net income ......................................................

(b)

Per Unit $400 275 $125

Sales = Variable costs + Fixed costs $400X = $275X + $52,000 $125X = 52,000 X = 416 units

(c)

CANNES COMPANY CVP Income Statement For the Month Ended September 30, 2014

Sales (416 video game consoles)................... Variable costs .................................................. Contribution margin ........................................ Fixed costs ...................................................... Net income .......................................................

5-20

Total $240,000 165,000 75,000 52,000 $ 23,000

Total $166,400 114,400 52,000 52,000 $ –0–

Per Unit $400 275 $125

EXERCISE 5-14 (a) Units sold in 2013 =

= 13,000 units

(b) Units needed in 2014 =

= 13,867 units (rounded)

*$210,000 + $52,000 = $262,000

(c)

= 13,000 units, where X = new selling price $832,000 = 13,000X – $1,170,000 $2,002,000 = 13,000X X = $154

EXERCISE 5-15 1.

Unit sales price = $400,000 ÷ 5,000 units = $80 Increase selling price to $88, or ($80 X 110%). Net income = $440,000 – $210,000 – $90,000 = $140,000.

Reduce variable costs to 45% of sales. Net income = $400,000 – $180,000 – $90,000 = $130,000.

Alternative 1, increasing selling price, will produce the highest net income.

5-21

EXERCISE 5-16 (a)

$3,200

Sales Line

2,800

DOLLARS (000)

2,400

Break-even Point

Total Cost Line

2,000 1,600 1,200 800 Fixed Cost Line 400 100 200 300 400 500 600 700 800 Number of Units (in thousands)

(b) 1.

Break-even sales in units: $4X = $2.50X + $600,000 $1.50X = $600,000 X = 400,000 units

Break-even sales in dollars: X = .625X + $600,000 .375X = $600,000 X = $1,600,000 or $600,000 ÷ 37.5%

5-22

Margin of safety in dollars: $2,000,000 – $1,600,000 = $400,000 Margin of safety ratio: $400,000 ÷ $2,000,000 = 20%

EXERCISE 5-17 (a) Contribution ratio = Contribution margin ÷ Sales ($40 – $16) ÷ $40 = 60% (b) Break-even in dollars: $19,500 ÷ 60% = $32,500 (c) Margin of safety = (2,600 X $40) – $32,500 = $71,500 $71,500 ÷ $104,000 = 68.75% (d) Current contribution margin $40 – $16 = $24 Total contribution margin is $24 X 2,600 = $62,400 30% increase in contribution margin is $62,400 X 30% = $18,720 Total increase in sales required: $18,720 ÷ 60% = $31,200

5-23

SOLUTIONS TO PROBLEMS PROBLEM 5-1A (a) Variable costs (per haircut) Barbers’ commission Barber supplies Utilities Total variable cost per haircut

(b) $10.00X = $5.00X + $6,000 $ 5.00X = $6,000 X = 1,200 haircuts

DOLLARS (000)

(c)

$4.50 .30 .20 $5.00

Fixed costs (per month) Barbers’ salaries Manager’s extra salary Advertising Rent Utilities Magazines Total fixed

1,200 haircuts X $10 = $12,000

Sales Line

Total Cost Line Break-even Point

12 9 6

Fixed Cost Line

300

600

900 1,200 1,500 1,800

Number of Haircuts

(d) Net income = $17,000 – [($5.00 X 1,700) + $6,000] = $2,500

5-24

$4,000 500 200 1,100 175 25 $6,000

PROBLEM 5-2A (a)

JORGE COMPANY CVP Income Statement (Estimated) For the Year Ending December 31, 2014 Sales .............................................................. Variable expenses Cost of goods sold ................................ Selling expenses ................................... Administrative expenses ...................... Total variable expenses ................ Contribution margin ..................................... Fixed expenses Cost of goods sold ................................ Selling expenses ................................... Administrative expenses ...................... Total fixed expenses ..................... Net income ....................................................

$1,800,000 $1,170,000 * 70,000 20,000 1,260,000 540,000 280,000 65,000 60,000 405,000 $ 135,000

*Direct materials $430,000 + direct labor $360,000 + variable manufacturing overhead $380,000. (b) Variable costs = 70% of sales ($1,260,000 ÷ $1,800,000) or $.35 per bottle ($.50 X 70%). Total fixed costs = $405,000. 1.

$.50X = $.35X + $405,000 $.15X = $405,000 X = 2,700,000 units

2,700,000 X $.50 = $1,350,000

= ($1,800,000 – $1,350,000) ÷ $1,800,000 = 25%

(d) Required sales X=

5-25

= $1,950,000

PROBLEM 5-3A

(a) Sales were $2,500,000, variable expenses were $1,700,000 (68% of sales), and fixed expenses were $900,000. Therefore, the break-even point in dollars is: = $2,812,500 (b) 1.

The effect of this alternative is to increase the selling price per unit to $6 ($5 X 120%). Total sales become $3,000,000 (500,000 X $6). Thus, the contribution margin ratio changes to 43% [($3,000,000 – $1,700,000) ÷ $3,000,000]. The new break-even point is: = $2,093,023 (rounded)

The effects of this alternative are to change total fixed costs to $810,000 ($900,000 – $90,000) and to change the contribution margin to 27% [($2,500,000 – $1,700,000 – $125,000) ÷ $2,500,000]. The new break-even point is: = $3,000,000

Alternative 1 is the recommended course of action because it has a lower break-even point.

5-26

PROBLEM 5-4A

(a) Current break-even point: $40X = $24X + $270,000 (where X = pairs of shoes) $16X = $270,000 X = 16,875 pairs of shoes New break-even point:

$38X = $24X + ($270,000 + $24,000) $14X = $294,000 X = 21,000 pairs of shoes

(b) Current margin of safety ratio = = 16% (rounded)

New margin of safety ratio

= = 13% (rounded)

(c)

BARGAIN SHOE STORE CVP Income Statement

Sales (20,000 X $40) Variable expenses (20,000 X $24) Contribution margin Fixed expenses Net income

Current

New

$800,000 480,000 320,000 270,000 $ 50,000

$912,000 576,000 336,000 294,000 $ 42,000

(24,000 X $38) (24,000 X $24)

The proposed changes will raise the break-even point 4,125 units. This is a significant increase. Margin of safety is 3% lower and net income is $8,000 lower. The recommendation is to not accept the proposed changes.

5-27

PROBLEM 5-5A

(a) (1) Sales

Current Year $1,500,000

Variable costs Direct materials Direct labor Manufacturing overhead ($350,000 X .70) Selling expenses ($250,000 X .40) Administrative expenses ($270,000 X .20) Total variable costs Contribution margin

511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000

Sales

Current Year $1,500,000 X 1.1

Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin

511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000

X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1

Projected Year $1,650,000 562,100 319,000 269,500 110,000 59,400 1,320,000 $ 330,000

(2) Fixed Costs Current Year Manufacturing overhead ($350,000 X .30) $105,000 Selling expenses ($250,000 X .60) 150,000 Administrative expenses ($270,000 X .80) 216,000 Total fixed costs $471,000

5-28

Projected year $105,000 150,000 216,000 $471,000

PROBLEM 5-5A (Continued) (b) Unit selling price = $1,500,000 ÷ 100,000 = $15 Unit variable cost = $1,200,000 ÷ 100,000 = $12 Unit contribution margin = $15 – $12 = $3 Contribution margin ratio = $3 ÷ $15 = .20 Break-even point in units = Fixed costs ÷ Unit contribution margin 157,000 units = $471,000 ÷ $3 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio $2,355,000 = $471,000 ÷ .20

(c) Sales dollars required for = (Fixed costs + Target net income) ÷ Contribution margin ratio target net income $3,355,000

($471,000

$200,000)

.20

(d) Margin of safety = (Expected sales – Break-even sales) ÷ Expected sales ratio 29.8%

5-29

($3,355,000

–

$2,355,000)

$3,355,000

PROBLEM 5-6A

(a) 1.

Let variable selling and administrative expenses = VSA Sales – Variable cost of goods sold – VSA = Contribution Margin $1,200,000 – ($400,000 + $500,000 + $50,000 + VSA) = $180,000 VSA = $70,000

Let fixed manufacturing overhead = FMO Sales – Variable cost of goods sold – FMO = Gross profit $1,200,000 – ($400,000 + $500,000 + $50,000 + FMO) = $180,000 FMO = $70,000

Let fixed selling and administrative expenses = FSA Contribution margin ratio = $180,000 ÷ $1,200,000 = 15% Contribution margin at break-even = $1,300,000 X 15% = $195,000 At break-even, Contribution margin = Fixed costs (FSA + FMO) $195,000 = FSA + $70,000 FSA = $125,000

(b) Incremental sales = $1,200,000 X 25% = $300,000 Incremental contribution margin = $300,000 X 15% = $45,000 The maximum increased advertising expenditure would be equal to the incremental contribution margin earned on the increased sales, which is $45,000. The other fixed costs are irrelevant to this decision, because they would be incurred whether or not the advertising expenditure is increased.

5-30

PROBLEM 5-1B

(a) Variable costs (per haircut) Barbers’ commission $3.00 Rent .60 Barber supplies .40 Total variable $4.00

Fixed costs (per month) Barbers’ salaries $7,500* Rent 700 Depreciation 400 Utilities 300 Advertising 100 Total fixed $9,000 *($1,500 X 3) + $3,000

(b) $10X = $4X + $9,000 $6X = $9,000 X = 1,500 haircuts

(c)

1,500 haircuts X $10 = $15,000

Break-even Point

Total Cost Line

DOLLARS (000)

Sales Line

12 Fixed Cost Line

9 6 3

300

600

900

1,200 1,500 1,800

Number of Haircuts

(d) Net income = $18,000 – [($4.00 X 1,800) + $9,000] = $1,800

5-31

PROBLEM 5-2B (a)

ALL FRUTE COMPANY CVP Income Statement (Estimated) For the Year Ending December 31, 2014 Sales ....................................................... Variable expenses Cost of goods sold ......................... Selling expenses ............................ Administrative expenses ............... Total variable expenses ......... Contribution margin .............................. Fixed expenses Cost of goods sold ......................... Selling expenses ............................ Administrative expenses ............... Total fixed expenses .............. Net income .............................................

$2,500,000 $1,080,000 (1) 80,000 40,000 1,200,000 1,300,000 380,000 250,000 150,000 780,000 $ 520,000

(1) Direct materials $360,000 + direct labor $450,000 + variable manufacturing overhead $270,000. (b) Variable costs = 48% of sales ($1,200,000 ÷ $2,500,000) or $.24 per bottle ($.50 X 48%). Total fixed costs = $780,000. 1.

$.50X = $.24X + $780,000 $.26X = $780,000 X = 3,000,000 units (breakeven)

3,000,000 X $.50 = $1,500,000

= ($2,500,000 – $1,500,000) ÷ $2,500,000 = 40%

(d) Required sales X= 5-32

= $2,700,000

PROBLEM 5-3B

(a) Sales were $1,800,000 and variable expenses were $1,170,000, which means contribution margin was $630,000 and CM ratio was 35%. Fixed expenses were $840,000. Therefore, the breakeven point in dollars is: = $2,400,000 (b) 1.

The effect of this alternative is to increase the selling price per unit to $37.50 ($30 X 125%). Total sales become $2,250,000 (60,000 X $37.50). Thus, the contribution margin ratio changes to 48% [($2,250,000 – $1,170,000) ÷ $2,250,000]. The new breakeven point is: = $1,750,000

The effects of this alternative are to change total fixed costs to $660,000 ($840,000 – $180,000) and to change the contribution margin to .30 [($1,800,000 – $1,170,000 – $90,000) ÷ $1,800,000]. The new breakeven point is: = $2,200,000

The effects of this alternative are: (1) variable and fixed cost of goods sold become $675,000 each, (2) total variable costs become $915,000 ($675,000 + $125,000 + $115,000), and (3) total fixed costs are $1,095,000 ($675,000 + $355,000 + $65,000). The new breakeven point is: X = ($915,000 ÷ $1,800,000)X + $1,095,000 X = .51X + $1,095,000 .49X = $1,095,000 X = $2,234,694 (rounded)

Alternative 1 is the recommended course of action using breakeven analysis because it has the lowest breakeven point.

5-33

PROBLEM 5-4B

(a) Current break-even point: $30X = $12X + $216,000 (where X = pairs of shoes) $18X = $216,000 X = 12,000 pairs of shoes New break-even point:

$27X = $12X + ($216,000 + $18,000) $15X = $234,000 X = 15,600 pairs of shoes

(b) Current margin of safety ratio = = 40% New margin of safety ratio

= = 35%

*$30 X $90 (c)

COSTLESS SHOE STORE CVP Income Statement

Sales (20,000 X $30) Variable expenses (20,000 X $12) Contribution margin Fixed expenses Net income

Current

New

$600,000 240,000 360,000 216,000 $144,000

$648,000 288,000 360,000 234,000 $126,000

(24,000 X $27) (24,000 X $12)

No, the changes should not be made because net income will be lower than the net income currently earned. In addition, the break-even point would be higher by 3,600 units and the margin of safety ratio would decrease from 40% to 35%. 5-34

PROBLEM 5-5B

(a) (1) Sales

Current Year $1,800,000

Variable costs Direct materials Direct labor Manufacturing overhead ($480,000 X .40) Selling expenses ($400,000 X .30) Administrative expenses ($484,000 X .50) Total variable costs Contribution margin

456,000 250,000 192,000 120,000 242,000 1,260,000 $ 540,000

Sales

Current Year $1,800,000 X 1.2

Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin

456,000 250,000 192,000 120,000 242,000 1,260,000 $ 540,000

(2) Fixed Costs Manufacturing overhead ($480,000 X .60) Selling expenses ($400,000 X .70) Administrative expenses ($484,000 X .50) Total fixed costs

5-35

X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2

Projected Year $2,160,000 547,200 300,000 230,400 144,000 290,400 1,512,000 $ 648,000

Current Year $288,000 280,000 242,000 $810,000

Projected Year $288,000 280,000 242,000 $810,000

PROBLEM 5-5B (Continued) (b) Unit selling price = $1,800,000 ÷ 100,000 = $18.00 Unit variable cost = $1,260,000 ÷ 100,000 = $12.60 Unit contribution margin = $18.00 – $12.60 = $5.40 Contribution margin ratio = $5.40 ÷ $18.00 = .30 Break-even point in units = Fixed costs ÷ Unit contribution margin 150,000 units = $810,000 ÷ $5.40 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio $2,700,000 = $810,000 ÷ .30 (c)

Sales dollars required for = (Fixed costs + Target net income) ÷ Contribution margin ratio target net income $3,410,000 = ($810,000 + $213,000) ÷ .30

(d)

Margin of safety = (Expected sales – Break-even sales) ÷ Expected sales ratio 21*% = ($3,410,000 – $2,700,000) ÷ 3,410,000

*(Rounded) (e) (1)

5-36

Sales

$1,800,000

Variable costs Direct materials Direct labor ($250,000 – $100,000) Manufacturing overhead ($480,000 X .10) Selling expenses ($400,000 X .80) Administrative expenses ($484,000 X .50) Total variable costs Contribution margin

456,000 150,000 48,000 320,000 242,000 1,216,000 $ 584,000

PROBLEM 5-5B (Continued) (2) Contribution margin ratio = $584,000 ÷ $1,800,000 = .32 (Rounded) (3) Break-even point in dollars = $754,000 ÷ .32 = $2,356,250 Fixed costs Manufacturing overhead ($480,000 X .90) Selling expenses ($400,000 X .20) Administrative expenses ($484,000 X .50) Total fixed costs

$432,000 80,000 242,000 $754,000

The break-even point in dollars declined from $2,700,000 to $2,356,250. This means that overall the company’s risk has declined because it doesn’t have to generate as much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission based approach to compensate its sales staff, the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) and reduced its variable direct labor cost, both of which would increase the break-even point.

5-37

PROBLEM 5-6B

(a) 1.

Let variable selling and administrative expenses = VSA Sales – Variable cost of goods sold – VSA = Contribution Margin $2,000,000 – ($600,000 + $700,000 + $200,000 + VSA) = $150,000 VSA = $350,000

Let fixed manufacturing overhead = FMO Sales – Variable cost of goods sold – FMO = Gross profit $2,000,000 – ($600,000 + $700,000 + $200,000 + FMO) = $400,000 FMO = $100,000

Let fixed selling and administrative expenses = FSA Contribution margin ratio = $150,000 ÷ $2,000,000 = 7.50% Contribution margin at break-even = $2,400,000 X 7.50% = $180,000 At break-even, Contribution margin = Fixed costs (FSA + FMO) $180,000 = FSA + $100,000 FSA = $80,000

(b) Incremental sales = $2,000,000 X 15% = $300,000 Incremental contribution margin = $300,000 X 7.50% = $22,500 The maximum increased advertising expenditure would be equal to the incremental contribution margin earned on the increased sales, which is $22,500. The other fixed costs are irrelevant to this decision, because they would be incurred whether or not the advertising expenditure is increased.

5-38

BYP 5-1

DECISION-MAKING AT CURRENT DESIGNS

(a) $250 + $100 + $170 + $420 + $400 = $1,340 total variable costs (b) Contribution margin per unit = $2,000 – $1,340 = $660 (c) $359,700* ÷ $660 = 545 units *$119,700 ÷ $240,000 (d) ($359,700 + $270,600) ÷ $660 = 955 units (e) Actual (expected) sales = $2,000 X 1,000 = $2,000,000 Break-even sales = $2,000 X 545 = $1,090,000 Margin of safety in dollars = $2,000,000 – $1,090,000 = $910,000 Margin of safety ratio = $910,000 ÷ $2,000,000 = 45.5%

5-39

BYP 5-2

DECISION-MAKING ACROSS THE ORGANIZATION

(a) (1)

Capital-Intensive

Fixed manufacturing costs Incremental selling expenses Total fixed costs Selling price Variable costs Direct materials Direct labor Variable overhead Selling expenses Contribution margin

(2) $2,524,000 502,000 $3,026,000 $32.00

$5.00 6.00 3.00 2.00

Total fixed costs (1)

16.00 $16.00 $3,026,000

Labor-Intensive

Fixed manufacturing costs Incremental selling expenses Total fixed costs Selling price Variable costs Direct materials Direct labor Variable overhead Selling expenses Contribution margin

$1,550,000 502,000 $2,052,000 $32.00

$5.50 8.00 4.50 2.00

Total fixed costs (1)

20.00 $12.00 $2,052,000

Contribution margin per unit (2)

$16.00

Contribution margin per unit (2)

$12.00

Break-even in units (1) ÷ (2)

189,125

Break-even in units (1) ÷ (2)

171,000

(b) Creative Ideas Company would be indifferent between the two manufacturing methods at the volume (X) where total costs are equal. $16X + $3,026,000 = $20X + $2,052,000 $4X = $974,000 X = 243,500 units (c) Creative Ideas should employ the capital-intensive manufacturing method if annual sales are expected to exceed 243,500 units and the labor-intensive manufacturing method if annual sales are not expected to exceed 243,500 units. The labor-intensive method is more profitable for sales up to 243,500 units because the fixed costs are lower. The capital-intensive method is more profitable for sales above 243,500 units because its contribution margin is higher.

5-40

BYP 5-3

MANAGERIAL ANALYSIS

(a) The variable costs per unit are: Cost of goods sold ($600,000 ÷ 240,000) ..................... Selling expenses ($117,600 ÷ 240,000) ........................ Administrative expenses ($60,000 ÷ 240,000) ............. Total........................................................................ Fixed costs are: Cost of goods sold ($800,000 X .25) ............................ Selling expenses ($280,000 X .58) ................................ Administrative expenses ($150,000 X .60) ...................

$2.50 .49 .25 $3.24 $200,000 162,400 90,000 $452,400

The break-even points are: X = ($3.24 ÷ $5.00) X + $452,400 X = .65X + $452,400 .35X = $452,400 X = $1,292,571 (rounded) $5.00X = $3.24X + $452,400 $1.76X = $452,400 X = 257,045 units (rounded) (b) Variable unit cost of goods sold = $2.75 ($600,000 ÷ 240,000 = $2.50; $2.50 + $.25) Sales volume = 300,000 units (240,000 X 125%) Total sales = 300,000 X $5.25 = $1,575,000 Net income computation: Sales ....................................................... Variable expenses Cost of goods sold (300,000 X $2.75) ......................... Selling expenses (300,000 X $.49) ........................... Administrative expenses (300,000 X $.25) ........................... Total variable expenses.......... Contribution margin ...............................

5-41

$1,575,000 $825,000 147,000 75,000 1,047,000 528,000

BYP 5-3 (Continued) Fixed expenses Cost of goods sold ........................ Selling expenses............................ Administrative expenses............... Total fixed expenses .............. Net income .............................................

$200,000 162,400 90,000 452,400 $ 75,600

X = ($1,047,000 ÷ $1,575,000)X + $452,400 X = .66X + $452,400 .34X = $452,400 X = $1,330,588 (rounded) Profits and the break-even point would both increase. (c) Sales [384,000 (1) X ($5.00 – $.25)] ............... Variable expenses Cost of goods sold (384,000 X $2.50)................................. Selling expenses (384,000 X $.59) ......... Administrative expenses (384,000 X $.25) .................................. Total variable expenses ................. Contribution margin ...................................... Fixed expenses Cost of goods sold ................................. Selling expenses ($162,400 + $40,000) ........................... Administrative expenses ....................... Total fixed expenses ...................... Net income .....................................................

$1,824,000 $960,000 226,560 96,000 1,282,560 541,440 $200,000 202,400 90,000 492,400 $ 49,040

(1) Sales volume = 240,000 X 160% = 384,000 X = ($1,282,560 ÷ $1,824,000)X + $492,400 X = .70X + $492,400 .30X = $492,400 X = $1,641,333 Profits and the break-even point would both increase. (d) Peri’s plan should be accepted. It produces a higher net income and a lower break-even point than Paul’s plan.

5-42

BYP 5-4

REAL-WORLD FOCUS

(a) Sweeteners and packaging are a variable cost to Coca-Cola because their use is directly proportional to the amount of product produced. If the unit cost of a variable cost item increases, the contribution margin will decline. This will lead to a decline in net income unless the company can increase its selling price, increase the number of units it sells, or reduce other costs. (b) This description makes the marketing expenditures sound like they are a variable cost, since it suggests that they vary with the amount of units sold. However, unlike variable costs, the relationship of marketing costs is not directly proportional to sales, since other factors also influence units sold. Thus, it is not a pure variable cost. However, it is also not a fixed cost, in that there usually is a relationship between marketing expenditures and sales. For CVP purposes, it might best be handled as a mixed cost, having both a fixed and variable component. (c) The first measure, gallon shipments of concentrates and syrups, is the activity index, since it best reflects the company’s production and sales activity at the wholesale level, its primary line of business. The second measure, unit cases of finished product, indicates the amount of activity by Coke’s primary customers, the bottlers. Coke also keeps track of this since it provides information about what is happening at the retail level.

5-43

BYP 5-5

REAL-WORLD FOCUS

(a) Barnes and Noble has 1,362 stores with a total of 18.8 million square feet. That is a huge investment in fixed costs that have very little value in an e-book environment. (b) Barnes and Noble’s big advantage (which enabled it to put lots of small independent book sellers out of business), was that each of its superstores had 150,000 books in stock. However, that is no longer as impressive when you consider that booksellers’ websites now give you access to millions of e-book titles which can be downloaded directly to e-readers. (c) The authors say that the arrival of Apple’s iPad has huge implications for e-books. ITunes has more than 125 million customers. They represent a very wide potential audience for e-books. (d) Barnes and Nobel earns about $12.50 on a $25 hardcover book. The same book, as an e-book, would sell for $12.99 and Barnes and Noble would earn $3.90. Obviously they can’t afford this decline unless they can dramatically reduce their fixed costs. (e) Barnes and Noble was one of the first companies to have an e-reader, called the Rocket e-book. However, it abandoned its e-reader in 2003 because sales of e-books had been very low. Four years later Amazon introduced its Kindle e-reader, which has been hugely popular. A second mistake was that Barnes and Noble was very slow to upgrade its website to encourage the sale of e-books. Again, Amazon was more than happy to fill the void.

5-44

BYP 5-6

COMMUNICATION ACTIVITY

To:

My Roommate

From:

Your Roommate

Subject:

Cost-Volume-Profit Questions

In response to your request for help, I provide you the following: (a) The mathematical formula for break-even sales is: Break-even Sales = Variable Costs + Fixed Costs Break-even sales in dollars is found by expressing variable costs as a percentage of unit selling price. For example, if the percentage is 70%, the break-even formula becomes X = .70X + Fixed Costs. The answer will be in sales dollars. Break-even sales in units is found by using unit selling price and unit variable costs in the formula. For example, if the selling price is $300 and variable costs are $210, the break-even formula becomes $300X = $210X + Fixed Costs. The answer will be in sales units. (b) The formulas for contribution margin per unit and contribution margin ratio differ as shown below: Unit Selling Price – Unit Variable Costs = Contribution Margin per Unit Contribution Margin per Unit ÷ Unit Selling Price = Contribution Margin Ratio You can see that CM per Unit is used in computing the CM ratio. (c) When contribution margin is used to determine break-even sales, total fixed costs are divided by either the contribution margin ratio or contribution margin per unit. Using the CM ratio results in determining the break-even point in dollars. Using CM per unit results in determining the break-even point in units.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

5-45

BYP 5-6 (Continued) The formula for determining break-even sales in dollars is: Fixed Costs ÷ Contribution Margin Ratio = Break-even Sales in Dollars The formula for determining break-even sales in units is: Fixed Costs ÷ Contribution Margin per Unit = Break-even Sales in Units I hope this memo answers your questions.

5-46

BYP 5-7

ETHICS CASE

(a) The stakeholders in this situation are:  Scott Bestor, accountant of Westfield Company.  The dislocated personnel of Westfield.  The senior management who made the decision. (b) Scott is hiding an error and is knowingly deceiving the company’s management with inaccurate data. (c) Scott’s alternatives are:  Keep quiet.  Confess his mistake to management. The students’ recommendations should recognize the practical aspects of the situation but they should be idealistic and ethical. If the students can’t be totally ethical when really nothing is at stake, how can they expect to be ethical under real-world pressures?

5-47

BYP 5-8

ALL ABOUT YOU

(a)

The variable gasoline cost of going one mile in the hybrid car would be $0.09 ($3.60/40). The variable gasoline cost of going one mile in the traditional car would be $0.12 ($3.60/30).

(b)

The savings per mile of driving the hybrid vehicle would be $0.03 ($0.12 – $0.09).

(c)

In order to break even on your investment, you would need to drive 150,000 miles. This is determined by dividing the additional fixed cost of $4,500 by the cost savings per mile of $0.03.

(d)

There are many other factors that you would want to consider in your analysis. For example, do the vehicles differ in their expected repair bills, insurance costs, licensing fees, or ultimate resale value. Also, some states and some employers offer rebates for the purchase of hybrid vehicles. In addition, your decision might be influenced by non-financial factors, such as a desire to reduce emissions.

5-48

CHAPTER 6 Cost-Volume-Profit Analysis: Additional Issues ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

A Problems

B Problems

1A, 2A

1B, 2B

1, 2, 3, 4, 5

1A, 2A, 6A

1B, 2B, 6B

6, 7, 8, 9, 10

11, 12, 13

12, 13, 14

14, 15, 16

5A, 6A

5B, 6B

16, 17, 18

17, 18, 19

7A, 8A

7B, 8B

Discuss net income effects under absorption costing versus variable costing.

19, 20, 21, 22

7A, 8A

7B, 8B

*8.

Discuss the merits of absorption versus variable costing for management decision making.

6-1

Learning Objectives

Questions

Do It!

Describe the essential features of a cost-volume-profit income statement.

1, 2, 3, 4

1, 2, 3, 4, 5, 6

Apply basic CVP concepts.

2, 4, 5, 6

1, 2, 3, 4, 5, 6

Explain the term sales mix and its effects on break-even sales.

7, 8, 9

7, 8, 9, 10

Determine sales mix when a company has limited resources.

10, 11

11, 15

Understand how operating leverage affects profitability.

12, 13, 14, 15, 16

*6.

Explain the difference between absorption costing and variable costing.

*7.

Exercises

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

6-2

Description

Difficulty Level

Time Allotted (min.)

Compute break-even point under alternative courses of action.

Moderate

20–30

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

Moderate

20–30

Determine sales mix with limited resources.

Simple

10–15

Determine break-even sales under alternative sales strategies and evaluate results.

Moderate

20–30

Compute degree of operating leverage and evaluate impact of operating leverage on financial results.

Moderate

20–30

Determine contribution margin, break-even point, target sales, and degree of operating leverage.

Moderate

20–30

*7A

Prepare income statements under absorption costing and variable costing for a company with beginning inventory, and reconcile differences.

Moderate

20–30

*8A

Prepare absorption and variable costing income statements and reconcile differences between absorption and variable costing income statements when sales level and production level change. Discuss relative usefulness of absorption costing versus variable costing.

Moderate

20–30

Compute break-even point under alternative courses of action.

Moderate

20–30

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

Moderate

20–30

Determine sales mix with limited resources.

Simple

10–15

Determine break-even sales under alternative sales strategies and evaluate results.

Moderate

20–30

Compute degree of operating leverage and evaluate impact of operating leverage on financial results.

Moderate

20–30

Determine contribution margin, break-even point, target sales, and degree of operating leverage.

Moderate

20–30

*7B

Prepare income statements under absorption costing and variable costing for a company with beginning inventory, and reconcile differences.

Moderate

20–30

*8B

Moderate

20–30

6-3

Learning Objective

Knowledge Comprehension

Application

Analysis

*1.

Describe the essential features Q6-1 of a cost-volume-profit income Q6-3 statement.

Q6-2 Q6-4

BE6-2 BE6-3 BE6-4 BE6-5 BE6-6

*2.

Apply basic CVP concepts.

Q6-2 Q6-4 Q6-5 Q6-6

BE6-2 BE6-3 BE6-4 BE6-5 BE6-6 DI6-2 E6-1

E6-2 E6-3 E6-4 E6-5 P6-1A P6-2A P6-4A

P6-6A BE6-1 P6-1B P6-1A P6-2B P6-2A P6-4B P6-6A P6-6B P6-1B P6-2B

P6-6B

*3.

Explain the term sales mix and Q6-7 its effects on break-even sales. Q6-8

Q6-8 Q6-9

BE6-7 DI6-3 BE6-8 E6-6 BE6-9 E6-7 BE6-10 E6-8

E6-9 E6-6 E6-10 E6-7 P6-4A E6-8 P6-4B P6-4A

P6-4B

*4.

Determine sales mix when a Q6-11 company has limited resources.

Q6-10

BE6-11 E6-11 BE6-15 E6-12 DI6-4 E6-13

P6-3A E6-11 P6-3B E6-12 E6-13

P6-3A P6-3B

*5.

Understand how operating leverage affects profitability.

Q6-14

Q6-16 E6-14 P6-6A E6-14 BE6-12 E6-15 P6-5B E6-15 BE6-13 E6-16 E6-16 BE6-14 P6-5A P6-5A

P6-6A P6-5B P6-6B

**6.

Explain the difference between absorption costing and variable costing.

Q6-17

BE6-16 E6-18 P6-7B E6-18 BE6-17 E6-19 P6-8B E6-19 BE6-18 P6-7A P6-7A E6-17 P6-8A P6-8A

P6-7B P6-8B

*7.

Discuss net income effects under absorption costing versus variable costing.

Q6-19 Q6-22 Q6-20 Q6-21

Q6-19 P6-7A P6-8B P6-7A BE6-19 P6-8A P6-8A E6-18 P6-7B P6-7B

P6-8B

**8.

Discuss the merits of absorption versus variable costing for management decision making.

Q6-18

Broadening Your Perspective

Q6-12 Q6-13 Q6-15

BYP6-7

Synthesis

Evaluation

DI6-1 BE6-1 P6-1A P6-1A P6-2A P6-2A P6-1B P6-1B P6-2B P6-2B

P6-8A P6-8B

BYP6-4 BYP6-5

BYP6-1 BYP6-2

BYP6-6 BYP6-9

BYP6-3 BYP6-8 BYP6-10

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

CVP or cost-volume-profit analysis is the study of the effects of changes in costs and volume on a company’s profit.

Managers use CVP analysis to make decisions involving break-even point, sales required to reach a target net income, margin of safety, the most profitable sales mix, allocation of limited resources, and operating leverage.

Both types of income statements report the same amount of net income. But the format used to reach net income differs. A traditional income statement’s format consists of: Sales revenue – cost of goods sold = gross profit; Gross profit – selling and administrative expenses = net income. A CVP income statement’s format consists of: Sales revenue – variable expenses = contribution margin; Contribution margin – fixed expenses = net income.

The CVP income statement isolates variable costs from fixed costs while the traditional income statement does not. The CVP format indicates contribution margin in total and frequently on a per unit basis as well. This format facilitates calculation of break-even point and target net income. It also highlights how changes in sales volume or cost structure affect net income.

WHEAT COMPANY CVP Income Statement Sales ........................................................................................................ Variable costs ($500,000 X .75) + ($200,000 X .75) ................................. Contribution margin ..................................................................................

$900,000 525,000 $375,000

If the selling price is reduced but variable and fixed costs remain unchanged, the break-even point will increase.

Sales mix is the relative percentage of each product sold when a company sells more than one product. Sales mix changes the calculation of the break-even point because the fixed costs must be divided by the weighted-average unit contribution margin.

The 150,000-mile tire has a higher unit contribution margin, that is, each tire sold covers a larger amount of fixed costs. Therefore, if the sales mix shifts away from the 150,000-mile tire to the 50,000-mile tire, the company will have to sell more total tires in order to break-even.

If a company has many products, the break-even point is calculated using sales information for divisions or product lines, rather than individual products. The weighted-average contribution margin ratio is computed by multiplying the sales mix percentage of each product line by the contribution margin ratio of each product line, and then summing the results. Total break-even sales in dollars is then calculated by dividing the company’s total fixed costs by the weightedaverage contribution margin ratio. Finally, to determine the amount of sales generated by each product line at the break-even point, multiply the total break-even sales by the sales mix percentage of each product line.

6-4

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

Questions Chapter 6 (Continued) 10. Contribution margin per unit of limited resource is determined by dividing the contribution margin per unit of the product by the number of units of the limited resource required to produce the product. 11. The theory of constraints is a specific approach used to identify and manage constraints to achieve the company’s goals. According to this theory, a company must continually identify its constraints and find ways to reduce or eliminate them, where appropriate. Examples of constraints would be production bottlenecks or poorly trained workers. 12. Cost structure refers to the relative proportion of fixed costs versus variable costs that a company incurs. Companies that rely heavily on fixed costs will have higher break-even points. 13. Operating leverage refers to the extent to which a company’s net income reacts to a given change in sales. A company can increase its operating leverage by increasing its reliance on fixed costs. 14. Typically manual labor is considered a variable cost. Depreciation on factory equipment is a fixed cost. Therefore, if a company replaces manual labor with automated factory equipment it will increase its operating leverage, and increase its break-even point. 15. The degree of operating leverage is a measure of a company’s relative operating leverage. It is calculated by dividing the contribution margin by net income at a particular level of sales. 16. Pine’s degree of operating leverage of 8 versus Fir’s measure of 4 tells us that Pine will experience twice (8 ÷ 4) the increase (or decrease) in net income for a given increase (decrease) in sales as Fir. *17. Under absorption costing, both variable and fixed manufacturing costs are considered to be product costs. Under variable costing, only variable manufacturing costs are product costs and fixed manufacturing costs are expensed when incurred. *18. (a)

(b)

The rationale for variable costing centers on the purpose of fixed manufacturing costs, which is to have productive facilities available for use. Since these costs are incurred whether a company operates at zero or 100% capacity, it is argued that they should be expensed when they are incurred. Variable costing is useful in product costing internally by management and it is useful in controlling manufacturing costs. Variable costing cannot be used for financial reporting purposes because it does not follow generally accepted accounting principles.

*19. One way to compute the difference is as follows: Ending inventory 8,500

X Fixed manufacturing overhead cost per unit X $5

= $42,500

Absorption costing will report a $42,500 higher net income than variable costing because a portion of the fixed manufacturing overhead costs are deferred in inventory.

6-5

Questions Chapter 6 (Continued) *20. If production equals sales in any given period, the net incomes under both methods will be equal. In this case, there is no increase in the ending inventory. So fixed manufacturing overhead costs in the current period are not deferred to future periods through the ending inventory. *21. If production is greater than sales, absorption costing net income will be greater than variable costing net income. Absorption costing net income is higher because some of the fixed manufacturing overhead costs will be deferred in the inventory account until the products are sold. *22. In the long run, neither method will produce a higher net income amount. Over a long period of time, sales can never exceed production, nor production exceed sales by significant amounts. For this reason, over the lifetime of a corporation, variable costing and absorption costing will tend to yield the same net income amounts.

6-6

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 1.

(a) (b)

$70 = ($250 – $180) 28% ($70 ÷ $250)

$200 = ($500 – $300) 60% ($300 ÷ $500)

(e) (f)

$1,100 = ($330 ÷ 30%) $770 ($1,100 – $330)

BRIEF EXERCISE 6-2 HAMBY INC. Income Statement For the Quarter Ended March 31, 2014 Sales........................................................................ Variable expenses Cost of goods sold ......................................... Selling expenses............................................. Administrative expenses................................ Total variable expenses .......................... Contribution margin ............................................... Fixed expenses Cost of goods sold ......................................... Selling expenses............................................. Administrative expenses................................ Total fixed expenses ............................... Net income ..............................................................

$2,000,000 $760,000 95,000 79,000 934,000 1,066,000 600,000 60,000 66,000 726,000 $ 340,000

BRIEF EXERCISE 6-3 Contribution margin ratio = [($250,000 – $175,000) ÷ $250,000] = 30% Required sales in dollars = $120,000 ÷ 30% = $400,000

6-7

BRIEF EXERCISE 6-4 (a) $400Q = $250Q + $210,000 + $0 $150Q = $210,000 Q = 1,400 units (b) Contribution margin per unit $150, or ($400 – $250) X = $210,000 ÷ $150 X = 1,400 units BRIEF EXERCISE 6-5 X = .60X + $210,000 + $60,000 .40X = $270,000 X = $675,000 BRIEF EXERCISE 6-6 Margin of safety = $1,200,000 – $960,000 = $240,000 Margin of safety ratio = $240,000 ÷ $1,200,000 = 20% BRIEF EXERCISE 6-7 Model A12 B22 C124

6-8

Sales Mix Percentage 60% 15% 25%

Unit Contribution Margin $10 ($50 – $40) $30 ($100 – $70) $100 ($400 – $300)

Weighted-Average Unit Contribution Margin $ 6.00 4.50 25.00 $35.50

BRIEF EXERCISE 6-8 Total break-even = ($213,000 ÷ $35.50*) = 6,000 units *Computed in BE 6-7 Sales Units Units of A12 = .60 X 6,000 = 3,600 Units of B22 = .15 X 6,000 = 900 Units of C124 = .25 X 6,000 = 1,500 6,000 BRIEF EXERCISE 6-9 (a)

(b)

Weighted-average contribution = margin ratio

(.30 X .20) + (.50 X .20) + ( .20 X .45) = .25

Total break-even point = in dollars

($440,000 ÷ .25) = $1,760,000

Birthday $1,760,000 X .30 = $ 528,000 Standard tapered $1,760,000 X .50 = 880,000 Large scented $1,760,000 X .20 = 352,000 $1,760,000 BRIEF EXERCISE 6-10 (a)

Sales Mix Bedroom Division $500,000 ÷ $1,250,000 = .40 Dining Room Division $750,000 ÷ $1,250,000 = .60

(b)

Weight-average contribution = $575,000 = .46 margin ratio $1,250,000 OR Contribution Margin Ratio Bedroom Division($275,000 ÷ $500,000) = .55 Dining Room Division($300,000 ÷ $750,000) = .40 Weighted-average contribution margin ratio = (.55 X .40) + (.40 X .60) = .46

6-9

BRIEF EXERCISE 6-11

Contribution margin per unit (a) Machine hours required (b) Contribution margin per unit of limited resource [(a) ÷ (b)]

Product A $12.0 2 $ 6

Product B $15 3 $ 5

BRIEF EXERCISE 6-12 Degree of operating leverage (old) =

$200,000 ÷ $40,000 = 5

Degree of operating leverage (new) =

$240,000 ÷ $40,000 = 6

If Sam’s sales change, the resulting change in net income will be 1.2 times (6 ÷ 5) higher with the new machine than under the old system. BRIEF EXERCISE 6-13 Break-even point in dollars: Logan Co. $60,000 ÷ ($120,000 ÷ $200,000) = $100,000

Morgan Co. $90,000 ÷ ($150,000 ÷ $200,000) = $120,000

Morgan Company’s cost structure relies much more heavily on fixed costs than that of Logan Co. As result, Morgan has a higher contribution margin ratio of .75 ($150,000 ÷ $200,000) versus .60 ($120,000 ÷ $200,000), for Logan Co. Morgan also has much higher fixed costs to cover. Its break-even point is therefore higher than that of Logan Co. BRIEF EXERCISE 6-14 Degree of operating leverage = Contribution margin ÷ Net income Montana Corp. 1.6 = Contribution margin ÷ $50,000 Contribution margin = $50,000 X 1.6 = $80,000 APK Co. 5.4 = Contribution margin ÷ $50,000 Contribution margin = $50,000 X 5.4 = $270,000

6-10

BRIEF EXERCISE 6-15

Contribution margin per unit (a) Machine hours required (b) Contribution margin per unit of limited resource [(a) ÷ (b)]

Product 1 $ 42 .15 $280

Product 2 $ 35 .10 $350

Product 2 has a higher contribution margin per limited resource, even though it has a lower contribution margin per unit. Given that machine hours are limited to 2,000 per month, Ger Corporation should produce Product 2. *BRIEF EXERCISE 6-16 Variable Costing Direct materials Direct labor Variable manufacturing overhead Total product costs

$14,400 25,600 32,400 $72,400

*BRIEF EXERCISE 6-17 Absorption Costing Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total product costs

$14,400 25,600 32,400 12,000 $84,400

*BRIEF EXERCISE 6-18 (a) Absorption Costing ....... Direct materials................................................................ Direct labor ...................................................................... Variable manufacturing overhead .................................. Fixed manufacturing overhead ($128,000 ÷ 8,000) ........ Total manufacturing cost per unit ..................................

6-11

$20 14 15 16 $65

*BRIEF EXERCISE 6-18 (Continued) (b) Variable Costing Direct materials ............................................... Direct labor...................................................... Variable manufacturing overhead ................. Total manufacturing cost per unit .................

$20 14 15 $49

*BRIEF EXERCISE 6-19 MEMO To:

Chief financial officer

From:

Student

Re:

Absorption and variable costing

Under absorption costing, fixed manufacturing overhead is a product cost, while under variable costing, fixed manufacturing overhead is a period cost (expensed as incurred). Since units produced (50,000) exceeded units sold (48,000) last month, income under absorption costing will be higher than under variable costing. Some fixed overhead (2,000 units X $4 = $8,000) will be assigned to ending inventory and therefore not expensed under absorption costing, whereas all fixed overhead is expensed under variable costing. Therefore, absorption costing net income will be higher than variable costing net income by $8,000.

6-12

SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 6-1 AMANDA INC. Income Statement For the Month Ended January 31, 2014 Sales (10,000 units).......................................... Variable expenses Cost of goods sold..................................... Selling expenses ........................................ Administrative expenses ........................... Total variable expenses ...................... Contribution margin Fixed expenses Cost of goods sold..................................... Selling expenses ........................................ Administrative expenses ........................... Total fixed expenses ........................... Net income .......................................................

$400,000 $184,000 40,000 16,000 240,000 160,000 $ 70,000 30,000 50,000 150,000 $ 10,000

Contribution margin per unit: $160,000 ÷ 10,000 units = $16 per unit. Contribution margin ratio: $160,000 ÷ $400,000 = 40% or $16 ÷ $40 = 40%. DO IT! 6-2 (a)

Break-even point in units is 7,500 units ($150,000 ÷ $20). Break-even point in sales dollars is $375,000 ($150,000 ÷ .40*). The margin of safety in dollars is $75,000 ($450,000 – $375,000). *$20 ÷ $50.

(b) Break-even point in units is 8,333 units (rounded) ($150,000 ÷ $18*). Break-even point in sales dollars is $400,000 ($150,000 ÷ .375**). The margin of safety in dollars is $118,400 ($518,400*** – $400,000). *$50 – (.04 X $50) – 30 = $18. **$18 ÷ $48 = .375 ***9,000 + (.20 X 9,000) = 10,800 units, 10,800 units X $48 = $518,400

6-13

DO IT! 6-2 (Continued) The increase in the break-even point from $375,000 to $400,000 indicates that management should not implement the proposed change while the increase in the margin of safety from $75,000 to $118,400 indicates that management should implement the proposed change. Since the expected 20% increase in sales volume will result in a contribution margin of $194,400 (10,800 X $18) which is only $14,400 more than the current amount, management should be cautious before reducing unit prices. DO IT! 6-3 (a)

The sales mix percentages as a function of units sold is: Basic 750 ÷ 1,500 = 50%

Basic Plus 450 ÷ 1,500 = 30%

Premium 300 ÷ 1,500 = 20%

(b) The weighted-average unit contribution margin is: [.50 X ($250 – $195)] + [.3 X ($400 – $288)] + [.20 X ($800 – $416)] = $137.90.

(c)

The break-even point in units is: $165,480 ÷ $137.90 = 1,200 units.

(d) The break-even units to produce for each product are: Basic: 1,200 units X 50% = 600 units Basic Plus 1,200 units X 30% = 360 units Premium: 1,200 units X 20% = 240 units 1,200 units DO IT! 6-4 (a)

The Best binoculars have the highest contribution margin per unit. Thus, ignoring any manufacturing constraints, it would appear that the company should shift toward production of more Best units.

6-14

DO IT! 6-4 (Continued) (b) The contribution margin per unit of limited resource is calculated as:

Contribution margin per unit Limited resource consumed per unit

(c)

Good $40 .5 = $80

Better Best $150 $420 1.5 = $100 6 = $70

The Better binoculars have the highest contribution margin per unit of limited resource, even though they do not have the highest contribution margin per unit. Given the resource constraint, any additional capacity should be used to make Better binoculars.

6-15

SOLUTIONS TO EXERCISES EXERCISE 6-1 (a)

Contribution margin per room = Contribution margin per room = Contribution margin ratio =

$60 – ($8 + $37) $15 $15 ÷ $60 = 25%

Fixed costs = $8,800 + $2,400 + $1,500 + $800 = $13,500 Break-even point in rooms = $13,500 ÷ $15 = 900 2.

Break-even point in dollars

= =

900 rooms X $60 per room $54,000 per month

OR Fixed costs ÷ Contribution margin ratio = $13,500 ÷ .25 = $54,000 per month (b)

Margin of safety in dollars: Planned activity = 50 rooms per day X 30 days = 1,500 rooms per month Expected rental revenue = 1,500 rooms X $60 = $90,000 Margin of safety in dollars = $90,000 – $54,000 = $36,000

Margin of safety ratio:

$36,000 = 40% $90,000

EXERCISE 6-2 (a)

Contribution margin in dollars: Sales = 4,000 X $30 =

$120,000 Variable costs = $120,000 X .75 = 90,000 Contribution margin $ 30,000

Contribution margin per unit: Contribution margin ratio:

6-16

$30 – $22.50 ($30 X 75%) = $7.50. $7.50 ÷ $30 = 25%.

EXERCISE 6-2 (Continued) (b) Break-even sales in dollars:

= $67,200.

Break-even sales in units:

= 2,240.

$120,000 – $67,200 = $52,800. $52,800 ÷ $120,000 = 44%.

EXERCISE 6-3 Current selling price = $310,000 ÷ 5,000 units Current selling price = $62 1.

Increase selling price to $68.20 ($62 X 110%). Net income = $341,000* – $210,000 – $75,000 = $56,000. *($68.20 X 5,000)

Reduce variable costs to 58% of sales. Net income = $310,000 – $179,800** – $75,000 = $55,200. **($310,000 X .58)

Reduce fixed costs to $55,000 ($75,000 – $20,000). Net income = $310,000 – $210,000 – $55,000 = $45,000.

Alternative 1, increasing unit sales price, will produce the highest net income.

6-17

EXERCISE 6-4 (a) 1. Contribution margin ratio is:

$30,000 = 62.5% $48,000

Break-even point in dollars =

$20,250 = $32,400 62.5%

2. Round-trip fare =

$48,000 = $120 400 fares

Break-even point in fares =

$32,400 = 270 fares $120

(b) At the break-even point fixed costs and contribution margin are equal. Therefore, the contribution margin at the break-even point would be $20,250. (c) Fare revenue ($108* X 500**) Variable costs ($18,000 X 1.20) Contribution margin Fixed costs Net income

$54,000 21,600 32,400 20,250 $12,150

Yes, the fare decrease should be implemented because net income increases to $12,150. *$120 – (.10 X $120) **400 + 100 EXERCISE 6-5 (a)

HALL COMPANY CVP Income Statement For the Year Ended December 31, 2014

Sales (60,000 X $26) ...................................... Variable costs (60,000 X $12) ........................ Contribution margin (60,000 X $14) .............. Fixed costs..................................................... Net income .....................................................

6-18

Total $1,560,000 720,000 840,000 500,000 $ 340,000

Per Unit $26 12 $14

EXERCISE 6-5 (Continued) (b)

HALL COMPANY CVP Income Statement For the Year Ended December 31, 2014

Sales [(60,000 X 105%) X $24.50*] ................ Variable costs (63,000 X $9.00**) .................. Contribution margin (63,000 X $15.50)......... Fixed costs ($500,000 + $150,000) ............... Net income .....................................................

Total $1,543,500 567,000 976,500 650,000 $ 326,500

Per Unit $24.50 9.00 $15.50

*$26.00 – ($3 X 50%) = $24.50. **$12.00 – ($12 X 25%) = $9.00. EXERCISE 6-6

Lawnmowers Weed-trimmers Chainsaws

Sales Mix Percentage 20% 50% 30%

Contribution Margin Per Unit $30 $20 $40

Weighted-Average Contribution Margin $ 6 10 12 $28

Total break-even sales in units = $4,200,000 ÷ $28 = 150,000 units

Lawnmowers Weed-trimmers Chainsaws Total units

6-19

Total Sales Mix Break-even Sales Percentage in Units 20% X 150,000 = 50% X 150,000 = 30% X 150,000 =

Sales Units Needed Per Product 30,000 units 75,000 units 45,000 units 150,000 units

EXERCISE 6-7 (a)

Oil changes Brake repair

Sales Mix Percentage 70% 30%

Contribution Margin Ratio 20% 60%

Weighted-Average Contribution Margin Ratio .14 .18 .32

Total break-even sales in dollars = $16,000,000 ÷ .32 = $50,000,000

Oil changes Brake repair Total sales

Sales Mix Percentage 70% X 30% X

Total Break-even Sales in Dollars $50,000,000 $50,000,000

= =

Sales Dollars Needed Per Product $35,000,000 15,000,000 $50,000,000

(b) Sales to achieve target net income = ($80,000 + $60,000) ÷ .32 = $437,500

Oil changes Brake repair Total sales

Sales Mix Total Percentage Sales Needed 70% X $437,500 = 30% X $437,500 =

Sales Dollars Needed Per Product Per Store $306,250 131,250 $437,500

EXERCISE 6-8 (a)

Mail pouches and small boxes Non-standard boxes

Sales Mix Percentage

Contribution Margin Ratio

Weighted-Average Contribution Margin Ratio

80%

20%

.16

20%

70%

.14 .30

Total break-even sales in dollars = $12,000,000 ÷ .30 = $40,000,000 6-20

EXERCISE 6-8 (Continued) Total Breakeven Sales in Dollars

Sales Mix Percentage Mail pouches and small boxes Non-standard boxes Total sales

Sales Dollars Needed Per Product

80%

$40,000,000

$32,000,000

20%

$40,000,000

8,000,000 $40,000,000

(b)

Mail pouches and small boxes Non-standard boxes

Sales Mix Percentage

Contribution Margin Ratio

Weighted-Average Contribution Margin Ratio

40%

20%

.08

60%

70%

.42 .50

Total break-even sales in dollars = $12,000,000 ÷ .50 = $24,000,000 Total Breakeven Sales in Dollars

Sales Mix Percentage Mail pouches and small boxes Non-standardized boxes Total sales

Sales Dollars Per Product

40%

$24,000,000

$ 9,600,000

60%

$24,000,000

14,400,000 $24,000,000

EXERCISE 6-9 (a) Weighted-average unit contribution margin = ($40 X .30) + ($20 X .60) + ($60 X .10) = $30 Break-even point in units = $630,000 ÷ $30 = 21,000 (b) Shoes (21,000 X .30) = 6,300 pairs of shoes Gloves (21,000 X .60) = 12,600 pairs of gloves Range-finders (21,000 X .10) = 2,100 range-finders

6-21

EXERCISE 6-9 (Continued) (c) Shoes: 6,300 X $40 = $252,000 Gloves: 12,600 X $20 = 252,000 Range-finders: 2,100 X $60 = 126,000 Total contribution margin 630,000 Fixed costs 630,000 Net income $ 0 EXERCISE 6-10 (a) Sales mix percentage iPad division: $600,000 ÷ ($600,000 + $400,000) = .60 iPod division: $400,000 ÷ ($600,000 + $400,000) = .40 Contribution margin ratio: iPad division: $180,000 ÷ $600,000 = .30 iPod division: $140,000 ÷ $400,000 = .35 (b)

Weighted-average contribution = $320,000 = .32 OR margin ratio $1,000,000 Weighted-average contribution margin ratio = (.60 X .30) + (.40 X .35) = .32

(c) Break-even point in dollars = $120,000 ÷ .32 = $375,000 (d) Sales dollars needed at break-even point for each division iPad division: $375,000 X .60 = $225,000 iPod division: $375,000 X .40 = $150,000 EXERCISE 6-11 (a) A Contribution margin per unit (a) Machine hours required (b) Contribution margin per unit of limited resource (a) ÷ (b)

5 2 $2.50

Product B $ $

2 1 2

C $

3 2 $1.50

(b) Product A should be manufactured because it results in the highest contribution margin per machine hour. 6-22

EXERCISE 6-11 (Continued) (c) 1. Machine hours (a) (1,500 ÷ 3) Contribution margin per unit of limited resource (b) Total contribution margin [(a) X (b)]

Product A B 500 500 $ 2.50 $1,250

$ 2 $1,000

C 500 $1.50 $ 750

The total contribution margin = ($1,250 + $1,000 + $750) = $3,000. 2. Machine hours (a) Contribution margin per unit of limited resource (b) Total contribution margin [(a) X (b)]

Product A 1,500 $ 2.50 $3,750

EXERCISE 6-12 (a) Product D: $30 ÷ $10 = 3.0 hours per unit Product E: $80 ÷ $10 = 8.0 hours per unit Product F: $35 ÷ $10 = 3.5 hours per unit (b) Selling price Variable costs Contribution margin Direct labor hours per unit Contribution margin per direct labor hour

D $200 125 75 ÷ 3.0

Product E $ 300 160 140 ÷ 8.0

F $250 180 70 ÷ 3.5

$ 25

$17.50

$ 20

(c) Product D should be produced because it generates the highest contribution margin per direct labor hour. Total direct labor hours available Contribution margin per direct labor hour Total contribution margin

6-23

Product D 2,000 X $25 $50,000

EXERCISE 6-13 (a)

Product Basic Deluxe $40 $ 52 20 22 $20 $ 30 .5 .8

Selling price per unit Variable costs per unit Contribution margin per unit (a) Machine hours required (b) Contribution margin per machine hour (a) ÷ (b)

$40

$37.50

(b) The Basic product should be manufactured because it results in the higher contribution margin per machine hour. (c) 1. Machine hours allocated X Contribution margin per machine hour Contribution margin 2. Machine hours allocated X Contribution margin per machine hour Contribution margin

Basic 500

Deluxe 500

Total 1,000

$40 $20,000

$37.50 $18,750

$38,750

Basic 1,000

Deluxe –0–

Total 1,000

$40 $40,000

$37.50 –0–

$40,000

EXERCISE 6-14 (a) Armstrong Contador

Contribution Margin $260,000 $450,000

÷ ÷ ÷

Net Income $100,000 $100,000

Degree of Operating = Leverage = 2.60 = 4.50

Interpretation: Contador has a higher degree of operating leverage. Its earnings would increase (decrease) by a greater amount than Armstrong if each experienced an equal increase (decrease) in sales.

6-24

EXERCISE 6-14 (Continued) (b) Sales Variable costs Contribution margin Fixed costs Net income

Armstrong Company $550,000** 264,000** 286,000** 160,000** $126,000**

Contador Company $550,000*** 55,000*** 495,000*** 350,000*** $145,000***

*$500,000 X 1.1 **$240,000 X 1.1 ***$ 50,000 X 1.1 (c) Each company experienced a $50,000 increase in sales. However, because of Contador’s higher operating leverage, it experienced a $45,000 ($145,000 – $100,000) increase in net income while Armstrong experienced only a $26,000 ($126,000 – $100,000) increase. This is what we would have expected, since Contador’s degree of operating leverage exceeds that of Armstrong. EXERCISE 6-15 (a)

Manual system Computerized system

Contribution Margin ÷ $300,000 ÷ $900,000

Net Income $250,000

= =

Degree of Operating Leverage 1.20

$250,000

3.60

(b) The computerized system would produce profits that are 3.0 times (3.60 ÷ 1.20) as much as the manual system. With a $150,000 increase in sales, net income would increase $30,000 ($280,000 – $250,000) under the manual system and $90,000 ($340,000 – $250,000) under the computerized system.

6-25

EXERCISE 6-15 (Continued) Manual System $1,650,000 1,320,000* 330,000 50,000 $ 280,000

Sales Variable costs Contribution margin Fixed costs Net income

Computerized System $1,650,000 660,000** 990,000 650,000 $ 340,000

*($1,200,000 ÷ $1,500,000) X $1,650,000 **($600,000 ÷ $1,500,000) X $1,650,000 (c) (Actual Sales

–

Break-even Sales)

Actual Sales

Margin of Safety Ratio

($1,500,000

–

$250,000*)

$1,500,000

.83

($1,500,000

–

$1,083,333**)

$1,500,000

.28

Manual system Computerized system

*$ 50,000 ÷ ($300,000 ÷ $1,500,000) **$650,000 ÷ ($900,000 ÷ $1,500,000) The manual system could weather the greater decline in sales before reaching the break-even point. Under the manual system sales could drop 83% before suffering a loss, while sales under the computerized system could only decline by 28% before suffering a loss. EXERCISE 6-16 (a) Contribution Margin ÷ Traditional Yams $ 80,000 ÷ Auto-Yams $240,000 ÷

Net Income $50,000 $50,000

= = =

Degree of Operating Leverage 1.60 4.80

Auto-Yams, which relies more heavily on fixed costs, has the higher degree of operating leverage, 4.8 versus 1.60. That means for every dollar of increase (decrease) in sales, Auto-Yams will generate 3 (4.80 ÷ 1.60) times more (less) in contribution margin and net income.

6-26

EXERCISE 6-16 (Continued) (b) % Change in Sales X

Degree of Operating Leverage

% Change in Net Income

15% decrease: Traditional Yams Auto-Yams

(15%) (15%)

X X

1.60 4.80

= =

(24.0%) (72.0%)

10% increase: Traditional Yams Auto-Yams

10% 10%

X X

1.60 4.80

= =

16.0% 48.0%

(c) There are several possible answers that could be given. For example, if the candied Yams business is fairly stable, Auto-Yams might be the choice, because they will generate the higher contribution margin and net income. If, however, sales swing widely from year to year, Traditional Yams might be chosen because they will provide the more stable contribution margin and net income. Finally, if the investment banker is a risk taker, she might choose Auto-Yams in spite of year to year sales swings. EXERCISE 6-17 (a) Unit Cost Direct materials Direct labor Variable manufacturing overhead Manufacturing cost per unit

6-27

$ 7.50 2.45 5.80 $15.75

EXERCISE 6-17 (Continued) (b) FELDE COMPANY Income Statement For the Year Ended December 31, 2014 Variable Costing Sales (80,000 lures X $25) Variable cost of goods sold (80,000 lures X $15.75) Variable selling and administrative expenses (80,000 lures X $3.90) Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net Income (loss)

$2,000,000 $1,260,000 312,000

1,572,000 428,000

225,000 240,100

465,100 $ (37,100)

(c) Unit Cost Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($225,000 ÷ 90,000) Manufacturing cost per unit

$ 7.50 2.45 5.80 2.50 $18.25

(d) FELDE COMPANY Income Statement For the Year Ended December 31, 2014 Absorption Costing Sales (80,000 lures X $25) $2,000,000 Cost of goods sold (80,000 lures X $18.25) 1,460,000 Gross profit 540,000 Variable selling and administrative expenses (80,000 lures X $3.90) $312,000 Fixed selling and administrative expenses 240,100 552,100 Net Income $ (12,100)

6-28

*EXERCISE 6-18 (a) Direct materials used Direct labor incurred Variable manufacturing overhead Variable manufacturing costs

$ 79,000 30,000 21,500 $130,500

Variable manufacturing cost per unit = $130,500 ÷ 9,000 = $14.50 per unit Finished goods inventory cost = (9,000 – 8,200 units) X $14.50 = $11,600 (b) Absorption costing would show a higher net income because a portion of the fixed costs are deferred to future periods. The following computation indicates that finished goods inventory will be $4,000 higher under absorption costing which will cause its net income to be $4,000 higher. Direct materials used Direct labor incurred Variable manufacturing overhead Fixed manufacturing overhead Total manufacturing costs

$ 79,000 30,000 21,500 45,000 $175,500

Total manufacturing costs per unit = $175,500 ÷ 9,000 = $19.50 per unit Finished goods inventory cost = (9,000 – 8,200 units) X $19.50 = $15,600 Inventory (absorption costing) Inventory (variable costing)

$15,600 11,600 $ 4,000

*EXERCISE 6-19 (a)

6-29

Utility Expense Kilowatt Hourly Variable X = hours Charge Utilities

Months in a year

500

$0.40

Months in a year

Monthly Fee

Fixed Utilities

$1,500

= $18,000

$2,400

*EXERCISE 6-19 (Continued) Variable Costing Labor: Crate builders Material: Wood Variable Overhead: Utilities Nails Total manufacturing costs

$38,000 54,000 2,400 350 $94,750

(b) Absorption Costing Labor: Crate builders Material: Wood Variable overhead: Utilities Nails Fixed overhead: Utilities Rent Total manufacturing costs

$ 38,000 54,000 2,400 350 18,000 21,400 $134,150

(c) The entire difference in costs between the two methods is due to the fact that fixed overhead is included as part of manufacturing costs only under the absorption costing method. This difference amounts to $39,400 ($18,000 + $21,400).

6-30

SOLUTIONS TO PROBLEMS PROBLEM 6-1A (a) Sales were $2,000,000 and variable expenses were $1,100,000, which means contribution margin was $900,000 and CM ratio was .45. Fixed expenses were $1,035,000. Therefore, the break-even point in dollars is: $1,035,000 = $2,300,000 .45 (b) 1.

The effect of this alternative is to increase the selling price per unit to $31.25 ($25 X 125%). Total sales become $2,500,000 (80,000 X $31.25). Thus, contribution margin ratio changes to 56% [($2,500,000 – $1,100,000) ÷ $2,500,000]. The new break-even point is: $1,035,000 = $1,848,214 (rounded) .56

The effects of this alternative are: (1) fixed costs decrease by $160,000, (2) variable costs increase by $100,000 ($2,000,000 X 5%), (3) total fixed costs become $875,000 ($1,035,000 – $160,000), and the contribution margin ratio becomes .40 [($2,000,000 – $1,100,000 – $100,000) ÷ $2,000,000]. The new break-even point is: $875,000 = $2,187,500 .40

The effects of this alternative are: (1) variable and fixed cost of goods sold become $734,000 each, (2) total variable costs become $884,000 ($734,000 + $92,000 + $58,000), (3) total fixed costs are $1,251,000 ($734,000 + $425,000 + $92,000) and the contribution margin ratio becomes .558 [($2,000,000 – $884,000) ÷ $2,000,000]. The new break-even point is: $1,251,000 = $2,241,935 (rounded) .558

Alternative 1 is the recommended course of action using break-even analysis because it has the lowest break-even point. .

6-31

PROBLEM 6-2A

(a) (1) Sales

Current Year $1,500,000

511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000

Sales

Current Year $1,500,000 X 1.1

Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin

511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000

X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1

Projected Year $1,650,000 562,100 319,000 269,500 110,000 59,400 1,320,000 $ 330,000

(2) Fixed Costs Current Year Manufacturing overhead ($350,000 X .30) $105,000 Selling expenses ($250,000 X .60) 150,000 Administrative expenses ($270,000 X .80) 216,000 Total fixed costs $471,000

6-32

Projected year $105,000 150,000 216,000 $471,000

PROBLEM 6-2A (Continued) (b) Unit selling price = $1,500,000 ÷ 100,000 = $15 Unit variable cost = $1,200,000 ÷ 100,000 = $12 Unit contribution margin = $15 – $12 = $3 Contribution margin ratio = $3 ÷ $15 = .20 Break-even point in units 157,000 units

= Fixed costs = $471,000

÷ ÷

Unit contribution margin $3.00

Break-even point in dollars $2,355,000

= Fixed costs = $471,000

÷ ÷

Contribution margin ratio .20

+ Target net income) ÷ Contribution margin ratio

$3,355,000 =

($471,000

$200,000)

(d) Margin of safety = (Expected sales ratio 29.8%

($3,355,000

.20

– Break-even sales)

÷ Expected sales

–

$2,355,000)

(e) (1) Sales Variable costs Direct materials Direct labor ($290,000 – $104,000) Manufacturing overhead ($350,000 X .30) Selling expenses ($250,000 X .90) Administrative expenses ($270,000 X .20) Total variable costs Contribution margin

6-33

Current Year $1,500,000 511,000 186,000 105,000 225,000 54,000 1,081,000 $ 419,000

$3,355,000

PROBLEM 6-2A (Continued) Fixed cost Manufacturing overhead ($350,000 X .70) Selling expenses ($250,000 X .10) Administrative expenses ($270,000 X .80) Total fixed costs

$245,000 25,000 216,000 $486,000

(2) Contribution margin ratio = $419,000 ÷ $1,500,000 = .28 (rounded) (3) Break-even point in dollars = $486,000 ÷ .28 = $1,735,714 (rounded) The break-even point in dollars declined from $2,355,000 to $1,735,714. This means that overall the company’s risk has declined because it doesn’t have to generate as much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission-based approach to compensate its sales staff the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) which would increase the break-even point.

6-34

PROBLEM 6-3A

(a) Selling price Less: Variable costs Contribution margin per unit

Economy $30 14 $16

Product Standard $50 15 $35

Deluxe $100 46 $ 54

Ignoring the machine time constraint, the Deluxe product should be produced because it has the highest contribution margin per unit. (b) Contribution margin per unit (a) Machine hours required (b) Contribution margin per limited resource (a)/(b)

Economy $16 .5

Product Standard $ 35 .8

Deluxe $ 54 1.6

$32

$43.75

$33.75

(c) If additional machine hours become available, the additional time should be used to produce the Standard product since it has the highest contribution margin per machine hour.

6-35

PROBLEM 6-4A (a)

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 15% 50% 10% 25%

Total sales required to achieve target net income =

Appetizers Main entrees Desserts Beverages

X X X X X

Contribution Margin Ratio 50% 25% 50% 80%

= = = = =

Weighted-Average Contribution Margin Ratio .075 .125 .050 .200 .450

( $1,053,000 + $117,000 ) ÷ .45 = $2,600,000

Sales Mix Percentage 15% 50% 10% 25%

X X X X X

Total Sales Needed $2,600,000 $2,600,000 $2,600,000 $2,600,000

= = = = =

Sales from Each Product $ 390,000 1,300,000 260,000 650,000 $2,600,000

(b)

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 25% 25% 10% 40%

Total sales required to achieve target net income = *$1,053,000 + $585,000

6-36

X X X X X

Contribution Margin Ratio 50% 10% 50% 80%

= = = = =

Weighted-Average Contribution Margin Ratio .125 .025 .050 .320 .520

( $1,638,000* + $117,000) ÷ .52 = $ 3,375,000

PROBLEM 6-4A (Continued) Thus, sales would have to increase by $775,000 ($3,375,000 – $2,600,000) to achieve the target net income. This increase in sales is driven by the increase in fixed costs. The sales of each product line would be:

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 25% 25% 10% 40%

X X X X X

Total Sales Needed $3,375,000 $3,375,000 $3,375,000 $3,375,000

= = = = =

Sales from Each Product $ 843,750 843,750 337,500 1,350,000 $3,375,000

(c)

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 15% 50% 10% 25%

X X X X X

Contribution Margin Ratio 50% 10% 50% 80%

= = = = =

Weighted-Average Contribution Margin Ratio .075 .050 .050 .200 .375

The weighted-average contribution margin ratio computed in part (a) was 45%. With the contribution margin ratio on entrees falling to 10%, that average will now be 37.5% as shown previously. Applying this to the new fixed costs of $1,638,000 and target net income of $117,000 we get: Total sales required to achieve target net income

Appetizers Main entrees Desserts Beverages

($1,638,000 + $117,000) ÷ .375 = $ 4,680,000

Sales Mix Percentage 15% 50% 10% 25%

X X X X X

Total Sales Needed $4,680,000 $4,680,000 $4,680,000 $4,680,000

= = = = =

Sales from Each Product $ 702,000 2,340,000 468,000 1,170,000 $4,680,000

Relative to parts (a) and (b), the total required sales for (c) would increase. It appears that the least risky approach would be for Phil to switch to the new sales mix, but not to incur the additional fixed costs of expanding operations. If the switch in sales mix appears to be successful, then it may be appropriate for him to incur the additional fixed costs necessary for expansion of operations. .

6-37

PROBLEM 6-5A (a) To determine the break-even point in dollars we must first calculate the contribution margin ratio for each company.

Viejo Company Nuevo Company

Contribution Margin ÷ $220,000 ÷ $320,000 ÷

Sales $500,000 $500,000

Viejo Company Nuevo Company

Fixed Costs $180,000 $280,000

Contribution Margin Ratio .44 .64

Viejo Company Nuevo Company

(Actual Sales ($500,000 ($500,000

– – –

÷ ÷ ÷

Break-even Sales) $409,091) $437,500)

÷ ÷ ÷

Contribution Margin = Ratio = .44 = .64 Break-even Point = in Dollars = $409,091 = $437,500

Actual Sales $500,000 $500,000

= = =

Margin of Safety Ratio .182 .125

(b)

Viejo Company Nuevo Company

Contribution Margin ÷ $220,000 ÷ $320,000 ÷

Net Income $40,000 $40,000

Degree of Operating = Leverage = 5.5 = 8.0

Because Nuevo Company relies more heavily on fixed costs, it has a higher degree of operating leverage. This means that its net income will be more sensitive to changes in sales. For a given change in sales, the change in net income will be 1.45 (8.0 ÷ 5.5) times higher for Nuevo Company than for Viejo Company. (c) Sales Variable costs Contribution margin Fixed costs Net income *$500,000 X 1.2 **$280,000 X 1.2 ***$180,000 X 1.2

6-38

Viejo Company $600,000* 336,000** 264,000 180,000 $ 84,000

Nuevo Company $600,000 216,000*** 384,000 280,000 $104,000

PROBLEM 6-5A (Continued) (d) Sales Variable costs Contribution margin Fixed costs Net income (Loss)

Viejo Company $400,000* 224,000** 176,000 180,000 ($ 4,000)

Nuevo Company $400,000 144,000*** 256,000 280,000 ($ 24,000)

*$500,000 X .80 **$280,000 X .80 ***$180,000 X .80 (e) In part (b) the degree of operating leverage of Nuevo Company was higher than that of Viejo Company, telling us that the net income of Nuevo Company was more sensitive to changes in sales than that of Viejo Company. In part (c) we see that a 20% increase in sales increased the net income of Nuevo Company by $64,000 ($104,000 – $40,000), while the net income of Viejo Company increased by only $44,000 ($84,000 – $40,000). However, in part (d) we see that a 20% decrease in sales resulted in a $64,000 ($40,000 + $24,000) decline in net income for Nuevo Company, while Viejo Company’s net income only declined by $44,000 ($40,000 + $4,000). The increased risk caused by higher operating leverage is also seen in part (a). Nuevo Company has a higher break-even point, and a lower margin of safety ratio than Viejo Company. Thus, while operating leverage can be very beneficial for a company that expects its sales to increase, it can also significantly increase a company’s risk.

6-39

PROBLEM 6-6A

(a) Reformat the income statement to CVP format. All amount are in $000s. Sales ........................................................ Variable costs ($31,500 + $13,500) ......... Contribution margin ................................ Less: Fixed costs ($8,610 + $10,260) .... Operating income....................................

$75,000 45,000 30,000 18,870 $11,130

Contribution margin ratio = $30,000 ÷ $75,000 = 40% Break-even point = $18,870 ÷ 40% = $47,175 (b) If a hired workforce replaces sales agents, commissions will be reduced to 8% of sales, or $6,000; but fixed costs will increase by $7,500. Sales ........................................................ Variable costs ($31,500 + $6,000) ........... Contribution margin ................................ Less: Fixed costs ($18,870* + $7,500) ... Operating income....................................

$75,000 37,500 37,500 26,370 $11,130

*($8,610 + $10,260) Contribution margin ratio = $37,500 ÷ $75,000 = 50% Break-even point = $26,370 ÷ 50% = $52,740 (c) Operating leverage = contribution margin ÷ operating income (1) Current situation: from part (a) $30,000 ÷ $11,130 = 2.70 (2) Proposed situation: from part (b) $37,500 ÷ $11,130 = 3.37

6-40

PROBLEM 6-6A (Continued) The calculations indicate that at a sales level of $75 million, a percentage change in sales and contribution margin will result in 2.70 times that percentage change in operating income if Bonita continues to use sales agents. If they choose to employ their own, the change in operating income will be 3.37 times the percentage change in sales. The higher contribution margin per dollar of sales and higher fixed costs from Bonita employing their own agents gives them more operating leverage. This will result in greater benefits (increases in operating income) if revenues increase, but greater risks (decreases in operating income) if revenues decline. (d) The sales level at which operating incomes will be identical is called the point of indifference. This would be when the cost of the network of agents (18% of sales) is exactly equal to the cost of paying employees 8% commission along with additional fixed costs of $7.5 million. None of the other costs is relevant, because they will not change between alternatives. Let the sales volume = S 18% X S = (8% X S) + $7,500,000 .18S = .08S + $7,500,000 .10S = $7,500,000 S = $75,000,000

6-41

*PROBLEM 6-7A

(a)

GARDNER COMPANY Income Statement For the Year Ended December 31, 2013 Variable Costing Sales (2,500 tons X $2,000) ......................... Variable cost of goods sold Inventory, January 1 ............................ Variable cost of goods manufactured [4,000 tons X ($2,000 X .15)] ............ Variable cost of goods available for sale .............................................. Inventory, December 31 [1,500 tons X ($2,000 X .15)] ............ Variable cost of goods sold ................. Variable selling expenses [2,500 tons X ($2,000 X .10)] ............ Contribution margin .................................... Fixed manufacturing overhead ................... Fixed administrative expenses ................... Net income ...................................................

6-42

$5,000,000 $

–0–

1,200,000 1,200,000 450,000 750,000 500,000 2,000,000 500,000

1,250,000 3,750,000 2,500,000 $1,250,000

*PROBLEM 6-7A (Continued) GARDNER COMPANY Income Statement For the Year Ended December 31, 2014 Variable Costing Sales (4,000 tons X $2,000) ........................... Variable cost of goods sold Inventory, January 1 .............................. Variable cost of goods manufactured [2,500 tons X ($2,000 X .15)] .............. Variable cost of goods available for sale ................................................ Inventory, December 31 ......................... Variable cost of goods sold .................. Variable selling expenses [4,000 tons X ($2,000 X .10)] .............. Contribution margin ...................................... Fixed manufacturing overhead ..................... Fixed administrative expenses ..................... Net income ..................................................... (b)

$8,000,000 $ 450,000 750,000 1,200,000 –0– 1,200,000 800,000 2,000,000 500,000

2,500,000 $3,500,000

GARDNER COMPANY Income Statement For the Year Ended December 31, 2013 Absorption Costing Sales (2,500 tons X $2,000) ...................... Cost of goods sold Inventory, January 1 ......................... Cost of goods manufactured............ Cost of goods available for sale ...... Inventory, December 31 .................... Cost of goods sold ............................ Gross profit ............................................... Variable selling expenses [2,500 tons X ($2,000 X .10)] ................. Fixed administrative expenses ................ Net income ................................................

$5,000,000 $ –0– 3,200,000 (1) 3,200,000 1,200,000 (2) 2,000,000 3,000,000 500,000 500,000

(1) 4,000 X [($2,000 X .15) + ($2,000,000 ÷ 4,000)] (2) 1,500 X [($2,000 X .15) + ($2,000,000 ÷ 4,000)] .

2,000,000 6,000,000

6-43

1,000,000 $2,000,000

*PROBLEM 6-7A (Continued) GARDNER COMPANY Income Statement For the Year Ended December 31, 2014 Absorption Costing Sales (4,000 tons X $2,000) .................. Cost of goods sold Inventory, January 1 ..................... Cost of goods manufactured ........ Cost of goods available for sale ... Inventory, December 31 ................ Cost of goods sold ........................ Gross profit ........................................... Variable selling expenses [4,000 tons X ($2,000 X .10)] ............. Fixed administrative expenses ............ Net income ............................................

$8,000,000 $1,200,000 2,750,000 (1) 3,950,000 –0– 3,950,000 4,050,000 800,000 500,000

1,300,000 $2,750,000

(1) 2,500 X [($2,000 X .15) + ($2,000,000 ÷ 2,500)] (c) The variable costing and the absorption costing net income can be reconciled as follows: 2013

2014

Variable costing net income $1,250,000 $3,500,000 Fixed manufacturing overhead expensed with variable costing $2,000,000 $2,000,000 Less: Fixed manufacturing overhead expensed with absorption costing (1,250,000)(1) (2,750,000)(2) Difference 750,000 (750,000) Absorption costing net income $2,000,000 $2,750,000

(1)

In 2013, with absorption costing $1,250,000

of the

fixed manufacturing overhead is expensed as part of cost of goods sold, and $750,000 is included in the ending inventory.

(2)

In 2014, with absorption costing $2,750,000 of fixed manufacturing overhead is expensed as part of cost of goods sold. This includes the fixed manufacturing overhead for 2014 of $2,000,000 plus $750,000 of fixed manufacturing overhead from 2013 that was included in the beginning inventory for 2014.

6-44

*PROBLEM 6-7A (Continued) (d) Income parallels sales under variable costing as seen in the increase in net income in 2014 when 1,500 additional units were sold. In contrast, under absorption costing, income parallels production as seen in the higher net income in 2013 when production exceeded sales by 1,500 tons.

6-45

*PROBLEM 6-8A (a) DILITHIUM BATTERIES DIVISION Income Statement For the Year Ended December 31, 2014 Absorption Costing _______________________________________________________________

Sales (60,000 units X $30) Cost of goods sold (60,000 units X $21) Gross profit Variable selling and administrative expenses (60,000 units x $2) Fixed selling and administrative expenses Net income

60,000 Produced $1,800,000 1,260,000 540,000

90,000 Produced $1,800,000 (60,000 X $18)

1,080,000 720,000

120,000

50,000 $ 370,000

50,000 $ 550,000

(b) DILITHIUM BATTERIES DIVISION Income Statement For the Year Ended December 31, 2014 Variable Costing _______________________________________________________________

Sales (60,000 units X $30) Variable cost of goods sold (60,000 units X $12) Variable selling and administrative expenses (60,000 units X $2) Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net income

6-46

60,000 Produced $1,800,000

90,000 Produced $1,800,000

720,000

120,000 960,000 540,000

50,000 $ 370,000

*PROBLEM 6-8A (Continued) (c) If the company produces 90,000 units, but only sells 60,000 units, then 30,000 units will remain in ending inventory. Under absorption costing these 30,000 units will each include $6 of fixed manufacturing overhead—a total of $180,000. However, under variable costing, fixed manufacturing overhead is expensed when incurred. This accounts for the $180,000 difference ($550,000 – $370,000) in net income. This is summarized as: Net income under absorption costing Less: Fixed manufacturing overhead included in ending inventory (30,000 units X $6) Net income under variable costing

$550,000 180,000 $370,000

(d) Variable costing has a number of advantages over absorption costing for decision making and evaluation purposes. (1) The use of variable costing is consistent with cost-volume-profit and incremental analysis. (2) Net income computed under variable costing is unaffected by changes in production levels. Note that, under variable costing the company’s net income is $370,000 no matter what the level of production is. (3) Net income computed under variable costing is closely tied to changes in sales levels (not production levels), and therefore provides a more realistic assessment of the company’s success or failure during a period. (4) The presentation of fixed and variable cost components on the face of the variable costing income statement makes it easier to identify these costs and understand their effect on the business. Under absorption costing, the allocation of fixed costs to inventory makes it difficult to evaluate the impact of fixed costs on the company’s results.

6-47

PROBLEM 6-1B

(a) Sales were $2,400,000 and variable expenses were $1,536,000, which means contribution margin was $864,000 and CM ratio was .36. Fixed expenses were $936,000. Therefore, the break-even point in dollars is: $936,000 = $2,600,000 .36 (b) 1.

The effect of this alternative is to increase the selling price per unit to $15 ($12 X 125%). Total sales become $3,000,000 (200,000 X $15). Thus, contribution margin changes to 48.8% [($3,000,000 – $1,536,000) ÷ $3,000,000]. The new break-even point is: $936,000 = $1,918,033 (rounded) .488

The effects of this alternative are: (1) fixed costs decrease by $120,000, (2) variable costs increase by $144,000 ($2,400,000 X 6%), (3) total fixed costs become $816,000 ($936,000 – $120,000), and the contribution margin becomes .30 [($2,400,000 – $1,536,000 – $144,000) ÷ $2,400,000]. The new break-even point is: $816,000 = $2,720,000 .30

The effects of this alternative are: (1) variable and fixed cost of goods sold become $594,400 and $891,600, (2) total variable costs become $1,060,400 ($594,400 + $356,000 + $110,000), (3) total fixed costs are $1,411,600 ($891,600 + $325,000 + $195,000) and the contribution margin becomes .5582 [($2,400,000 – $1,060,400) ÷ $2,400,000]. The new break-even point is: $1,411,600 = $2,529,749 (rounded) .558

Alternative 1 is the recommended course of action using break-even analysis because it has the lowest break-even point.

6-48

PROBLEM 6-2B

(a) (1) Sales

Current Year $1,000,000

Variable costs Direct materials Direct labor Manufacturing overhead ($240,000 X .20) Selling expenses ($200,000 X .30) Administrative expenses ($250,000 X .30) Total variable costs Contribution margin

327,000 190,000 48,000 60,000 75,000 700,000 $ 300,000

Sales

Current Year $1,000,000 X 1.2

Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin

327,000 190,000 48,000 60,000 75,000 700,000 $ 300,000

X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2

Projected Year $1,200,000 392,400 228,000 57,600 72,000 90,000 840,000 $ 360,000

(2) Fixed Costs Current Year Manufacturing overhead ($240,000 X .80) $192,000 Selling expenses ($200,000 X .70) 140,000 Administrative expenses ($250,000 X .70) 175,000 Total fixed costs $507,000

6-49

Projected year $192,000 140,000 175,000 $507,000

PROBLEM 6-2B (Continued) (b) Unit selling price = $1,000,000 ÷ 40,000 = $25.00 Unit variable cost = $700,000 ÷ 40,000 = $17.50 Unit contribution margin = $25.00 – $17.50 = $7.50 Contribution margin ratio = $7.50 ÷ $25 = .30 Break-even point in units 67,600 units

= Fixed costs = $507,000

÷ ÷

Unit contribution margin $7.50

Break-even point in dollars $1,690,000

= Fixed costs = $507,000

÷ ÷

Contribution margin ratio .30

+ Target net income) ÷ Contribution margin ratio

$2,090,000 =

($507,000

$120,000)

(d) Margin of safety = (Expected sales ratio 19.1%

($2,090,000

.30

– Break-even sales)

÷ Expected sales

–

$1,690,000)

(e) (1) Sales Variable costs Direct materials Direct labor ($190,000 – $90,000) Manufacturing overhead ($240,000 X .10) Selling expenses ($200,000 X .80) Administrative expenses ($250,000 X .30) Total variable costs Contribution margin Fixed cost Manufacturing overhead ($240,000 X .90) Selling expenses ($200,000 X .20) Administrative expenses ($250,000 X .70) Total fixed costs

6-50

Current Year $1,000,000 327,000 100,000 24,000 160,000 75,000 686,000 $ 314,000 $ 216,000 40,000 175,000 $ 431,000

$2,090,000

PROBLEM 6-2B (Continued) (2) Contribution margin ratio = $314,000 ÷ $1,000,000 = .314 (3) Break-even point in dollars = $431,000 ÷ .314 = $1,372,611 (rounded) The break-even point in dollars declined from $1,690,000 to $1,372,611. This means that overall the company’s risk has declined because it doesn’t have to generate so much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission-based approach to compensate its sales staff the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) and reduced its variable direct labor cost, both of which would increase the break-even point.

6-51

PROBLEM 6-3B

(a) Selling price Less: Variable costs Contribution margin per unit

Economy $270 144 $126

Product Standard $450 260 $190

Deluxe $650 430 $220

Economy $126 .6

Product Standard $ 190 .8

Deluxe $ 220 1.1

$210

$237.50

200

(c) If additional machine hours become available, the additional time should be used to produce the Standard product since it has the highest contribution margin per machine hour.

6-52

PROBLEM 6-4B (a)

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 15% 60% 10% 15%

Total sales required to achieve target net income =

Appetizers Main entrees Desserts Beverages

X X X X X

Contribution Margin Ratio 60% 25% 40% 80%

= = = = =

Weighted-Average Contribution Margin Ratio .09 .15 .04 .12 .40

( $352,000 + $176,000 ) ÷ .40 = $1,320,000

Sales Mix Percentage 15% 60% 10% 15%

X X X X X

Total Sales $1,320,000 $1,320,000 $1,320,000 $1,320,000

X X X X X

Contribution Margin Ratio 60% 10% 50% 80%

= = = = =

Sales from Each Product $ 198,000 792,000 132,000 198,000 $1,320,000

(b)

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 25% 40% 10% 25%

Total sales required to achieve target net income = *$352,000 X 1.5

6-53

= = = = =

Weighted-Average Contribution Margin Ratio .15 .04 .05 .20 .44

( $528,000* + $176,000) ÷ .44 = $1,600,000

PROBLEM 6-4B (Continued) Thus, sales would have to increase by $280,000 ($1,600,000 – $1,320,000) to achieve the target net income. This increase in sales is driven by the increase in fixed costs. The sales of each product line would be:

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 25% 40% 10% 25%

X X X X X

Total Sales Needed $1,600,000 $1,600,000 $1,600,000 $1,600,000

= = = = =

Sales Dollars Per Product $ 400,000 640,000 160,000 400,000 $1,600,000

(c)

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 15% 60% 10% 15%

Contribution X Margin Ratio X 60% X 10% X 50% X 80%

= = = = =

Weighted-Average Contribution Margin Ratio .09 .06 .05 .12 .32

The weighted-average contribution margin ratio computed in part (a) was 40%. With the contribution margin ratio on entrees falling to 10%, that average will now be 32% as shown above. Applying this to the new fixed costs of $528,000 and target net income of $176,000 we get: Total sales required to achieve target net income

Appetizers Main entrees Desserts Beverages

6-54

($528,000 + $176,000) ÷ .32 = $2,200,000

Sales Mix Percentage 15% 60% 10% 15%

X X X X X

Total Sales Needed $2,200,000 $2,200,000 $2,200,000 $2,200,000

= = = = =

Sales from Each Product $ 330,000 1,320,000 220,000 330,000 $2,200,000

PROBLEM 6-4B (Continued) Relative to parts (a) and (b), the total required sales for (c) would increase. It appears that the least risky approach would be for Michael to switch to the new sales mix, but not to incur the additional fixed costs of expanding operations. If the switch in sales mix appears to be successful, then it may be appropriate for him to incur the additional fixed costs necessary for expansion of operations.

6-55

PROBLEM 6-5B

(a) To determine the break-even point in dollars we must first calculate the contribution margin ratio for each company.

Lyte Company Darke Company

Contribution Margin ÷ $400,000 ÷ $800,000 ÷

Lyte Company Darke Company

Fixed Costs ÷ $200,000 ÷ $600,000 ÷

Contribution Margin Ratio .40 .80

Sales = $1,000,000 = $1,000,000 =

Contribution Margin Ratio = .40 = .80 =

Break-even Point in Dollars $500,000 $750,000 Margin of Safety

(Actual Sales

–

Break-even Sales)

Actual Sales

Ratio

Lyte Company

($1,000,000

–

$500,000)

$1,000,000

.50

Darke Company

($1,000,000

–

$750,000)

$1,000,000

.25

(b)

Lyte Company Darke Company

Contribution Net Margin ÷ Income = $400,000 ÷ $200,000 = $800,000 ÷ $200,000 =

Degree of Operating Leverage 2.00 4.00

Because Darke Company relies more heavily on fixed costs, it has a higher degree of operating leverage. This means that its net income will be more sensitive to changes in sales. For a given change in sales, the change in net income will be 2.0 (4.00 ÷ 2.00) times higher for Darke Company than for Lyte Company.

6-56

PROBLEM 6-5B (Continued) (c) Sales Variable costs Contribution margin Fixed costs Net income

Lyte Company $1,300,000* 780,000** 520,000 200,000 $ 320,000

Darke Company $1,300,000 260,000*** 1,040,000 600,000 $ 440,000

Lyte Company $700,000* 420,000** 280,000 200,000 $ 80,000

Darke Company $700,000 140,000*** 560,000 600,000 ($ 40,000)

*$1,000,000 X 1.3 **$600,000 X 1.3 ***$200,000 X 1.3 (d) Sales Variable costs Contribution margin Fixed costs Net income *$1,000,000 X .70 **$600,000 X .70 ***$200,000 X .70 (e) In part (b) the degree of operating leverage of Darke Company was higher than that of Lyte Company, telling us that the net income of Darke Company was more sensitive to changes in sales than that of Lyte Company. In part (c) we see that a 30% increase in sales increased the net income of Darke Company by $240,000 ($440,000 – $200,000), while the net income of Lyte Company increased by only $120,000 ($320,000 – $200,000). However, in part (d) we see that a 30% decrease in sales resulted in a $240,000 ($40,000 + $200,000) decline in net income for Darke Company, while Lyte Company’s net income only declined by $120,000 ($200,000 – $80,000). The increased risk caused by higher operating leverage is also seen in part (a). Darke Company has a higher break-even point, and a lower margin of safety ratio than Lyte Company. Thus, while operating leverage can be very beneficial for a company that expects its sales to increase, it can also significantly increase a company’s risk.

6-57

PROBLEM 6-6B

(a) Reformat the income statement to CVP format. All amount are in $000s. Sales .................................................................. Variable costs ($58,500 + $19,500) ................... Contribution margin .......................................... Less: Fixed costs ($11,000 + $10,000) ............ Operating income..............................................

$120,000 78,000 42,000 21,000 $ 21,000

Contribution margin ratio = $42,000 ÷ $120,000 = 35% Break-even point = $21,000 ÷ 35% = $60,000 (b) If a hired workforce replaces sales agents, commissions will be reduced to 10% of sales, or $12,000; but fixed costs will increase by $12,000. Sales .................................................................. $120,000 Variable costs ($58,500 + $12,000) ................... 70,500 Contribution margin .......................................... 49,500 Less: Fixed costs ($21,000* + $12,000) ........... 33,000 Operating income.............................................. $ 16,500 *($11,000 + $10,000) Contribution margin ratio = $49,500 ÷ $120,000 = 41.25% Break-even point = $33,000 ÷ 41.25% = $80,000 (c) Operating leverage = contribution margin ÷ operating income (1) Current situation: from part (a) $42,000 ÷ $21,000 = 2.00 (2) Proposed situation: from part (b) $49,500 ÷ $16,500 = 3.00

6-58

PROBLEM 6-6B (Continued) The calculations indicate that at a sales level of $120 million, a percentage change in sales and contribution margin will result in 2.00 times that percentage change in operating income if Peaches continues to use sales agents. If they choose to employ their own, the change in operating income will be 3.00 times the percentage change in sales. The higher contribution margin per dollar of sales and higher fixed costs from Peaches employing their own agents gives them more operating leverage. This will result in greater benefits (increases in operating income) if revenues increase, but greater risks (decreases in operating income) if revenues decline. (d) The sales level at which operating incomes will be identical is called the point of indifference. This would be when the cost of the network of agents (16.25% of sales) is exactly equal to the cost of paying employees 10% commission along with additional fixed costs of $12.0 million. None of the other costs is relevant, because they will not change between alternatives. Let the sales volume = S 16.25% X S = (10% X S) + $12,000 .1625S = .10S + $12,000 .0625S = $12,000 S = $192,000

6-59

*PROBLEM 6-7B

(a)

FAB COMPANY Income Statement For the Year Ended December 31, 2013 Variable Costing Sales (400,000 yards X $2.50) ...................... Variable cost of goods sold Inventory, January 1 ............................. Variable cost of goods manufactured [500,000 yards X $2.50 X 30%] .......... Variable cost of goods available for sale ............................................... Inventory, December 31 [100,000 yards X $2.50 X 30%] .......... Variable cost of goods sold .................. Variable selling expenses [400,000 yards X $2.50 X 10%] .......... Contribution margin ..................................... Fixed manufacturing overhead .................... Fixed administrative expenses .................... Net income ....................................................

6-60

$1,000,000 $ –0– 375,000 375,000 75,000 300,000 100,000 400,000 100,000

400,000 600,000 500,000 $ 100,000

*PROBLEM 6-7B (Continued) FAB COMPANY Income Statement For the Year Ended December 31, 2014 Variable Costing Sales (500,000 yards X $2.50) .................... Variable cost of goods sold Inventory, January 1 ........................... Variable cost of goods manufactured [400,000 yards X $2.50 X 30%]........ Variable cost of goods available for sale ............................................. Inventory, December 31 ...................... Variable cost of goods sold ............... Variable selling expenses [500,000 yards X ($2.50 X 10%)] ..... Contribution margin ................................... Fixed manufacturing overhead .................. Fixed administrative expenses .................. Net income .................................................. (b)

$1,250,000 $ 75,000 300,000 375,000 –0– 375,000 125,000 400,000 100,000

500,000 $ 250,000

FAB COMPANY Income Statement For the Year Ended December 31, 2013 Absorption Costing Sales (400,000 yards X $2.50) .................. Cost of goods sold Inventory, January 1 ......................... Cost of goods manufactured............ Cost of goods available for sale Inventory, December 31 .................... Cost of goods sold ............................ Gross profit ............................................... Variable selling expenses [400,000 yards X ($2.50 X .10)] ............. Fixed administrative expenses ................ Net income ................................................

$1,000,000 $ –0– 775,000 (1) 775,000 155,000 (2) 620,000 380,000 100,000 100,000

(1) 500,000 X [($2.50 X 30%) + ($400,000 ÷ 500,000)] (2) 100,000 X [($2.50 X 30%) + ($400,000 ÷ 500,000)] .

500,000 750,000

6-61

200,000 $ 180,000

*PROBLEM 6-7B (Continued) FAB COMPANY Income Statement For the Year Ended December 31, 2014 Absorption Costing Sales (500,000 yards X $2.50) .............. Cost of goods sold Inventory, January 1 ..................... Cost of goods manufactured ........ Cost of goods available for sale... Inventory, December 31 ................ Cost of goods sold ........................ Gross profit ........................................... Variable selling expenses [500,000 yards X ($2.50 X .10)] ......... Fixed administrative expenses ............ Net income ............................................

$1,250,000 $ 155,000 700,000 (1) 855,000 –0– 855,000 395,000 125,000 100,000

225,000 $ 170,000

(1) 400,000 X [($2.50 X 30%) + ($400,000 ÷ 400,000)] (c) The variable costing and the absorption costing income from operations can be reconciled as follows: 2013 Variable costing net income Fixed manufacturing overhead expensed with variable costing Less: Fixed manufacturing overhead expensed with absorption costing Difference Absorption costing income

2014

$100,000

$250,000

$400,000

(320,000)(1)

(480,000)(2) 80,000 $180,000

(1)

In 2013, with absorption costing $320,000

(80,000) $170,000

the fixed manufacturing overhead is expensed as part of cost of goods sold, and $80,000 is included in the ending inventory.

(2)

In 2014, with absorption costing $480,000 of fixed manufacturing overhead is expensed as part of cost of goods sold. This includes the fixed manufacturing overhead for 2014 of $400,000 plus $80,000 of fixed manufacturing overhead from 2013 that was included in the beginning inventory for 2014.

6-62

*PROBLEM 6-7B (Continued) (d) Income parallels sales under variable costing as seen in the increase in net income in 2014 when 100,000 additional units were sold. In contrast, under absorption costing, income parallels production as seen in the higher net income in 2013 when production exceeded sales by 100,000.

6-63

*PROBLEM 6-8B (a) ELECTRICOIL DIVISION Income Statement For the Year Ended December 31, 2014 Absorption Costing

Sales (200,000 units X $9) Cost of goods sold (200,000 units X $5.50) Gross profit Variable selling and administrative expenses (200,000 units X $0.40) Fixed selling and administrative expenses Net income

200,000 Produced $1,800,000

250,000 Produced $1,800,000

1,100,000 (200,000 X $5.00) 1,000,000 700,000 800,000 80,000

80,000

15,000 $ 605,000

15,000 $ 705,000

(b) ELECTRICOIL DIVISION Income Statement For the Year Ended December 31, 2014 Variable Costing _______________________________________________________________ 200,000 250,000 Produced Produced Sales (200,000 units X $9) $1,800,000 $1,800,000 Variable cost of goods sold (200,000 units X $3) 600,000 600,000 Variable selling and administrative expenses (200,000 units X $0.40) 80,000 80,000 Contribution margin 1,120,000 1,120,000 Fixed manufacturing overhead 500,000 500,000 Fixed selling and administrative expenses 15,000 15,000 Net income $ 605,000 $ 605,000 6-64

*PROBLEM 6-8B (Continued) (c) If the company produces 250,000 units, but only sells 200,000 units, then 50,000 units will remain in ending inventory. Under absorption costing these 50,000 units will each include $2.00 of fixed manufacturing cost—a total of $100,000. However, under variable costing, fixed manufacturing cost is expensed when incurred. This accounts for the $100,000 difference ($705,000 – $605,000) in net income. This is summarized as: Net income under absorption costing Less: Fixed manufacturing cost included in ending inventory Net income under variable costing

$705,000 100,000 $605,000

(d) Variable costing has a number of advantages over absorption costing for decision making and evaluation purposes. (1) The use of variable costing is consistent with cost-volume-profit and incremental analysis: (2) Net income computed under variable costing is unaffected by changes in production levels. Note that, under variable costing the company’s net income is $605,000 no matter what the level of production is. (3) Net income computed under variable costing is closely tied to changes in sales levels (not production levels), and therefore provides a more realistic assessment of the company’s success or failure during a period. (4) The presentation of fixed and variable cost components on the face of the variable costing income statement makes it easier to identify these costs and understand their effect on the business. Under absorption costing, the allocation of fixed costs makes it difficult to evaluate the impact of fixed costs on the company’s results.

6-65

BYP 6-1

DECISION-MAKING AT CURRENT DESIGNS

(a) Rotomolded Kayaks (($950 – $570) X .80)

Composite Kayaks = (($2,000 – $1,340) X .20)

Weighted Average Unit Contribution Margin $436

(b) Break-even Sales = $820,000 ÷ $436 = 1,881 units Break-even Sales Distribution:

Rotomolded Kayaks = 1,881 X 80% = 1,505 units Composite Kayaks = 1,881 X 20% = 376 units

Composite Kayaks ($660 X .30)

Weighted-Average CM/Unit $464

Required Sales in Units = ($820,000 + $2,000,000) ÷ $464 = 6,078 units Break-even Sales Distribution:

Rotomolded Kayaks = 6,078 X 70% = 4,255 units Composite Kayaks = 6,078 X 30% = 1,823 units

(d) CVP Income Statement

Sales Variable Costs Contribution Margin Fixed Costs Net Income *($570 ÷ $950) X $2,000,000

6-66

Rotomolded $2,000,000 1,200,000* 800,000 660,000 $ 140,000

Composite $1,000,000 670,000** 330,000 160,000 $ 170,000

**($1,340 ÷ $2,000) X $1,000,000

BYP 6-1 (Continued) (e) Degree of Operating Leverage Rotomolded Kayaks = $800,000 ÷ $140,000 = 5.71 Composite Kayaks = $330,000 ÷ $170,000 = 1.94 At a sales mix of 2/3 to 1/3, the degree of operating leverage is nearly three times as high for the rotomolded kayaks as it is for the composite kayaks. This means that the company’s net income will respond more quickly to a change in the sales of rotomolded kayaks than to composite kayaks. For example, an increase in sales of the rotomolded kayaks will increase the company’s net income at a faster rate than an increase in the sales of the composite kayaks. This result will differ depending on what sales mix assumption is made.

6-67

BYP 6-2

DECISION-MAKING ACROSS THE ORGANIZATION

(a) Sales (10,000 seats X $500) Variable costs (10,000 seats X $200) Contribution margin Fixed costs Net income

$5,000,000 2,000,000 3,000,000 2,000,000 $1,000,000

(b) Contribution margin ratio = $3,000,000 ÷ $5,000,000 = .60 Break-even point in dollars = $2,000,000 ÷ .60 = $3,333,333 Margin of safety ratio = ($5,000,000 – $3,333,333) ÷ $5,000,000 = .333 Degree of operating leverage = $3,000,000 ÷ $1,000,000 = 3.0 (c) Sales (10,000 seats X $500) Variable costs (10,000 seats X $ 100) Contribution margin Fixed costs Net income

$5,000,000 1,000,000 4,000,000 3,000,000 $1,000,000

(d) Contribution margin ratio = $4,000,000 ÷ $5,000,000 = .80 Break-even point in dollars = $3,000,000 ÷ .80 = $3,750,000 Margin of safety ratio = ($5,000,000 – $3,750,000) ÷ $5,000,000 = .25 Degree of operating leverage = $4,000,000 ÷ $1,000,000 = 4.00 (e) By automating its manufacturing process the company will replace some of its variable costs with fixed costs. This shift toward more fixed costs will increase its break-even point from $3,333,333 to $3,750,000 and reduce its margin of safety from 33.3% to 25%. This means that under the old system sales could fall by 33.3% percent before the company would operate at a loss, whereas under the automated system they could only fall by 25%. Both of these findings suggest that the company would be riskier with the automated system. However, the company’s degree of operating leverage would increase from 3.0 to 4.00. This means that with a change in sales, the change in net income would be 1.33 (4 ÷ 3) times higher under the automated system. This would be good if the company expects sales to increase, but would be bad if the company’s sales fall.

6-68

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

BYP 6-3

(a)

MANAGERIAL ANALYSIS

The contribution margin ratios under each approach are: Current approach Automated approach

$500,000/$2,000,000 = .25 $1,000,000/$2,000,000 = .50

This means that for every dollar of sales, net income goes up by 25 cents under the current approach, but by $.50 under the automated approach. (b)

The break-even points in sales dollars under each approach are: Current approach Automated approach

$380,000/.25 $800,000/.50

= =

$1,520,000 $1,600,000

This shows that, under the automated approach, the company’s sales would have to be 5.26% higher just to break-even. (c)

At the current level of sales, the margin of safety ratio under each approach is: Current approach Automated approach

($2,000,000 – $1,520,000)/$2,000,000 ($2,000,000 – $1,600,000)/$2,000,000

= .24 = .20

The company has a low margin of safety under either approach. Under the current approach sales could drop 24% before the company would be operating at a loss. Under the automated approach the company’s sales could drop by 20% before it would be operating at a loss. (d)

The degree of operating leverage under each approach at the current level of sales is: Current approach Automated approach

$500,000/$120,000 $1,000,000/$200,000

= =

4.17 5.00

This means that for a 10% drop in sales net income would drop by 41.7 percent for the current approach, but 50% for the automated approach. Recall, however, that at the current level of sales the company makes considerably more money using the automated approach.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

6-69

BYP 6-3 (Continued) (e)

In order to solve for the sales level where net income would be equal under either approach, set the two CVP equations equal to each other and solve for sales: Sales – ((1 – .75) X Sales) – $380,000 = Sales – ((1 – .5) X Sales) – $800,000 (.25 X Sales) – $380,000 = (.5 X Sales) – $800,000 (.25 X Sales) = $420,000 Sales = $1,680,000

When sales are equal to $1,680,000 the company would make the same amount of income under either approach. Current approach Automated approach

$1,680,000 – [(1 – .25) X $1,680,000] – $380,000 = $40,000 $1,680,000 – [(1 – .5) X $1,680,000] – $800,000 = $40,000

(f)

Based upon this numeric analysis it would appear that the decision to purchase the automated system would be a good decision. The current level of sales far exceeds the break-even point, and, unless sales were to fall all the way to $1,680,000, the company would be better off under the automated system. However, there are many difficult issues that should also be considered. Not-the-least of these is the decision to lay-off 15 employees, many of whom have likely been with the company for a long time. Also, the company should carefully evaluate whether the automated system will be able to attain the same level of quality as the skilled employees. Perhaps the automated system would be more appropriate for some of the painting work, while skilled labor would be more appropriate for other painting work.

6-70

BYP 6-4

REAL-WORLD FOCUS

(a) ($ in millions)

Sales Variable costs Contribution margin

Consumer Products $1,031.8 610.0 $ 421.8

Pet Products $ 837.3 350.0 $ 487.3

Soup and Infant-Feeding Products $ 302.0 100.0 $ 202.0

Contribution margin ÷ Sales Contribution margin ratio

$ 421.8 1,031.8 40.9%

$ 487.3 837.3 58.2%

$ 202.0 302.0 66.9%

Division sales ÷ Total sales Sales mix percentage

$1,031.8 2,171.1 47.5%

$ 837.3 2,171.1 38.6%

$ 302.0 2,171.1 13.9%

(b)

Consumer products Pet products Soup and infant-feeding products Break-even point in dollars

Consumer products Pet products Soup and infantfeeding products Total sales *Sales are rounded

6-71

Weighted-Average Sales Mix Contribution Contribution Percentage X Margin Ratio = Margin Ratio 47.5% 40.9% .194 38.6% 58.2% .225 13.9%

66.9%

.093 .512

$860,300,000 ÷ .512 = $1,680,273,438 Sales Mix Sales from Percentage X Total Sales = Each Product* 47.5% X $1,680,273,438 = $ 798,129,883 38.6% X $1,680,273,438 = 648,585,547 13.9%

X $1,680,273,438 =

233,558,008 $1,680,273,438

BYP 6-5

REAL-WORLD FOCUS

(a) The four primary product lines are FedEx Express (provides express transportation); FedEx Ground (small package ground delivery); FedEx Freight (regional, less-than-truckload freight service); and FedEx Services (Kinkos). The key factors affecting operating results are the volumes of shipments transported through networks; the mix of services purchased by customers; the prices obtained for services; ability to manage cost structure for capital expenditures and operating expenses; and ability to match operating costs to shifting volumes. (b) FEDEX GROUND Income Statement For the Year Ended May 31, 2008 Variable Costing (In Millions) ____________________________________________________________ Revenues ...................................................... $ 6,751 Variable costs: Salaries and employee benefits ............. $1,073 Purchased transportation ...................... 2,691 Fuel .......................................................... 201 Maintenance and repairs ........................ 145 Intercompany charges ............................ 658 4,768 Contribution margin................................ 1,983 Fixed costs: Rentals ..................................................... 189 Depreciation and amortization ............... 305 Other ........................................................ 753 1,247 Net income ................................................... $ 736

6-72

Contribution Margin $1,983

÷ ÷

Revenues $6,751

= =

Contribution Margin Ratio 29.4%

Fixed Costs $1,247

÷ ÷

Contribution Margin Ratio .294

= =

Break-even Point in Dollars $4,241.5 million

BYP 6-5 (Continued) (c) (i) 2008

2006

FedEx Express FedEx Ground FedEx Freight FedEx Services Total

$24,421 ÷ $38,244 = 63.9% 6,751 ÷ $38,244 = 17.6% 4,934 ÷ $38,244 = 12.9% 2,138 ÷ $38,244 = 5.6% $38,244

$21,446 ÷ $32,485 = 66.0% 5,306 ÷ $32,485 = 16.3% 3,645 ÷ $32,485 = 11.2% 2,088 ÷ $32,485 = 6.4% $32,485

FedEx Express FedEx Ground FedEx Freight FedEx Services

2008 7.8% 10.9% 6.7% (41.7%)*

2006 8.2% 13.3% 13.3% ____

(ii)

*$(891) ÷ $2,138 (iii) In part (ii) we see that in all divisions the company’s operating margins declined. We also see in part (ii) that in 2006 FedEx Express had the lowest operating margin (8.2%), and FedEx Services had the lowest in 2008 (–41.7%) while FedEx Ground had the highest (13.3% and 10.9%). In part (i) we see that the company shifted its sales mix percentage down in FedEx Express (66.0% to 63.9%) and FedEx Services (6.4% and 5.6%) but increased its sales mix percentage for FedEx Ground (16.3% to 17.6%) and FedEx Freight (11.2% to 12.9%). Thus, during this period two of the company’s divisions became more profitable, and the company successfully shifted its sales mix so that more of its revenue came from its more profitable divisions.

6-73

BYP 6-6

REAL-WORLD FOCUS

(a) Smart Balance relies very heavily on outsourcing. It keeps it employees and investments in fixed assets to a minimum. As a consequence it has very low fixed costs. (b) The company keeps new-product development and marketing in house. (c) The potential advantage of having very low fixed costs is that the company has a lower break-even point. It can be profitable at relatively low volumes of sales and therefore it has less potential for financial failure. (d) The potential disadvantage of this approach is that its low fixed costs means that the company has low operating leverage. If the company’s sales increase significantly, it would not enjoy the same increase in profitability as a company that was producing its own goods.

6-74

BYP 6-7

COMMUNICATION ACTIVITY

MEMO To:

Bjorn Borg—CEO

From:

Student

Re:

Best use of limited resources

I share your concern, that, since we are operating at full capacity, we need to ensure that our product mix maximizes our profitability. The decision of how to best utilize our limited productive resources is one of the most important decisions we face. We currently make two different anchors, a traditional fishing anchor, and a high-end yacht anchor. The contribution margin per unit produced of the yacht anchor is three times that of the fishing anchor, thus one might logically assume that we should shift our production toward producing the yacht anchor. However, this assumption ignores an element that is critical to the decision. In order to make a proper decision, we would need to know the contribution margin per unit of limited resource that each product produces. While the yacht anchor has a very high contribution margin, it also consumes considerably more productive resources. I propose that a study be done to determine exactly how much of the limited productive resource is consumed by one unit of each of the two anchor types. In addition, at the same time that this study is being undertaken, I propose that the marketing department undertake a study of the demand for each anchor type. This is important so that we don’t produce anchors that we can’t sell. Finally, a shift in our product mix would maximize our profitability at our current level of productive capacity. However, we should also consider a more long-term solution to our production constraints. Since we have been operating at, or near full capacity for two years, it would seem appropriate to undertake a study of whether an acquisition of additional plant equipment would be appropriate.

6-75

*BYP 6-8

ETHICS CASE

(a) The division’s net income increased by $225,000 ($525,000 – $300,000). This represents a 75% increase over the previous year ($225,000 ÷ $300,000). Thus Brett’s bonus would be 75 X $5,000 = $375,000. (b) In 2013 the number of units produced and sold were equal. When this occurs variable costing and absorption costing provide the same results. Thus, in 2013, net income under variable costing would have been $300,000. In 2014, units produced exceeded units sold by 5,000 units. However, net income under variable costing is not impacted by the number of units produced. Since the number of units sold did not change from 2013 to 2014, and the selling price, variable cost per unit, and total fixed costs didn’t change, the division’s net income in 2014 would equal its 2013 income of $300,000. (c) In part (b) it was determined that the division’s net income would have been $300,000 in 2014 under variable costing. Since this is the same as 2013 net income, Brett would not receive a bonus. (d) If Brett intentionally overproduced inventory in order to increase his bonus, then his actions were unethical. Overproduction of inventory increases the company’s costs related to inventory, such as storage, handling, waste and theft. Based on the information provided we can’t actually determine Brett’s motives. He may have believed that just-in-time inventory was causing the company to lose sales due to “stock-outs.” If that was the case, there would be options available to the company other than totally giving up on just-in-time practices. In order to eliminate any potential conflicts of interest between Brett and the company, and to ensure that his actions are in the best interest of the company, the company could begin preparing variable costing income statements to supplement its absorption costing statements for the purpose of calculating bonuses. This would eliminate any incentive Brett might have to over-produce, as well as providing useful information for other internal management decision making.

6-76

BYP 6-9

(a)

ALL ABOUT YOU

Using a common equation for CVP analysis, Sales = Variable Costs + Fixed Costs + Net Income, and substituting the information provided, and knowing that at break-even, net income = $0, ($26 X 300) = Variable Costs + ($4,000 + $1,460) + $0 $7,800 = Variable Costs + $5,460 + $0 $2,340 = Variable Costs (in total) or $7.80 (variable costs/member/month) = $2,340 ÷ 300

(b)

To find the sales required to reach a target net income, contribution margin must be calculated. Contribution Margin = Sales – Variable Costs Contribution Margin = $7,800 – $2,340 Contribution Margin = $5,460 Contribution Margin per Unit = $5,460/300 memberships = $18.20 Contribution Margin Ratio = $5,460/$7,800 = 70% To compute the sales required to reach a target net income of $3,640. Required Sales in Units = (Fixed Costs + /Contribution Margin Target Net Income) per Unit Required Sales in Units = ($5,460 + $3,640)/$18.20 Required Sales in Units = 500 memberships Required Sales in Dollars = 500 memberships X $26 = $13,000 Using the contribution margin ratio, Required Sales in Dollars = (Fixed Costs + Target Net Income)

/Contribution Margin Ratio

Required Sales in Dollars = ($5,460 + $3,640)/70% Required Sales in Dollars = $13,000 (c)

Answers will vary. Suggested examples include franchise fees, employee wages, utilities, supplies, and maintenance.

(d)

Answers will vary.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

6-77

BYP 6-10 CONSIDERING CORPORATE SOCIAL RESPONSIBILITY

Discussion Guide: If reduction of greenhouse gas emissions is a goal, then one step toward attainment of that goal is to assign a cost to greenhousegas emissions. One approach that is currently being used is the buying and selling of carbon-emission rights. As companies buy and sell emission rights, the price of polluting becomes a tangible factor in the formulations that will be used to make future energy-source decisions. This approach has been effective in addressing similar issues, such as the reduction of sulfur emissions. However, as suggested in the “No” response, many believe that, to be effective and fair, an enforceable international agreement on such an approach would be necessary. In the United States, companies currently participate on a voluntary basis; in some other countries, participation is required. Another factor to consider in these decisions is the timing of conversion to new technology. A gradual conversion to new technologies as existing power plants reach the end of their productive lives would be far less costly than a rapid conversion to new technologies that required scrapping existing plants before they are fully depreciated. Decisions about which plants to replace and when to replace them will require careful cost-benefit analyses.

6-78

CHAPTER 7 Incremental Analysis ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

A Problems

B Problems

Identify the steps in management’s decisionmaking process.

1, 2

Describe the concept of incremental analysis.

3, 4

1, 17

Identify the relevant costs in accepting an order at a special price.

2, 3, 4, 18

Identify the relevant costs in a make-or-buy decision.

6, 7

5, 6, 7, 8, 18

Identify the relevant costs in determining whether to sell or process materials further.

8, 9, 10

5, 6

9, 10, 11, 12, 18

Identify the relevant costs to be considered in repairing, retaining or replacing equipment.

13, 14, 18

Identify the relevant costs in deciding whether to eliminate an unprofitable segment.

15, 16, 17, 18

7-1

Do It!

Exercises

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

7-2

Description

Difficulty Level

Time Allotted (min.)

Use incremental analysis for special order and identify nonfinancial factors in the decision.

Simple

20–30

Use incremental analysis related to make or buy, consider opportunity cost, and identify nonfinancial factors.

Moderate

30–40

Determine if product should be sold or processed further.

Moderate

30–40

Compute gain or loss, and determine if equipment should be replaced.

Moderate

30–40

Prepare incremental analysis concerning elimination of divisions.

Moderate

30–40

Use incremental analysis for special order and identify nonfinancial factors in the decision.

Simple

20–30

Use incremental analysis related to make or buy, consider opportunity cost, and identify nonfinancial factors.

Moderate

30–40

Determine if product should be sold or processed further.

Moderate

30–40

Compute gain or loss, and determine if equipment should be replaced.

Moderate

30–40

Prepare incremental analysis concerning elimination of divisions.

Moderate

20–30

7-3 Learning Objective

Knowledge Comprehension

*1.

Identify the steps in management’s BE7-1 decision-making process.

Q7-1 Q7-2

E7-1

*2.

Describe the concept of incremental analysis.

Q7-3 Q7-4

E7-1

*3.

Identify the relevant costs in accepting an order at a special price.

*4.

Identify the relevant costs in a make-or-buy decision.

*5.

Identify the relevant costs in determining whether to sell or process materials further.

*6.

Identify the relevant costs to be considered in repairing, retaining or replacing equipment.

*7.

Identify the relevant costs in deciding whether to eliminate an unprofitable segment.

Broadening Your Perspective

Application

Analysis

Synthesis

Evaluation

BE7-2

E7-17

Q7-5

BE7-3 DI7-1

E7-2 E7-3 E7-4

E7-18 P7-1A P7-1B

Q7-6 Q7-7

BE7-4 DI7-2

E7-5 E7-6 E7-7 E7-8

E7-18 P7-2A P7-2B

BE7-5 BE7-6 DI7-3

E7-9 E7-10 E7-11 E7-12

E7-18 P7-3A P7-3B

Q7-11

BE7-7

E7-13 E7-14 E7-18

P7-4A P7-4B

Q7-12

BE7-8 DI7-4

E7-15 E7-16 E7-17

E7-18 P7-5A P7-5B

Q7-8 Q7-9 Q7-10

BYP7-1 BYP7-4 BYP7-5

BYP7-2

BYP7-8 BYP7-9

BYP7-3 BYP7-6 BYP7-7

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

The following steps are frequently involved in management’s decision-making process: (1) Identify the problem and assign responsibility. (2) Determine and evaluate possible courses of action. (3) Make a decision. (4) Review results of the decision.

My roommate is incorrect. Accounting contributes to the decision-making process at Steps 2 and 4. Prior to the decision, accounting provides relevant revenue and cost data for each course of action. Following the decision, internal reports are prepared to show the actual impact of the decision.

Disagree. Incremental analysis involves the identification of financial data that change under alternative courses of action.

In incremental analysis, the important point to consider is whether costs will differ (change) between the two alternatives. As a result, sometimes (1) variable costs do not change under the alternative courses of action and (2) fixed costs do change.

The relevant data in deciding whether to accept an order at a special price are the incremental revenues to be obtained compared to the incremental costs of filling the special order.

The manufacturing costs that are relevant in the make-or-buy decision are those that will change if the parts are purchased.

Opportunity cost may be defined as the potential benefit that may be obtained by following an alternative course of action. Opportunity cost is relevant in a make-or-buy decision when the facilities used to make the part can be used to generate additional income.

The decision rule in a decision to sell a product or to process it further is: Process further as long as the incremental revenue from the additional processing exceeds the incremental processing costs.

Joint products are products that are produced from a single raw material and a common production process. An accounting issue related to joint products is how to allocate the joint costs incurred during the production process that creates the joint products.

10.

Joint costs are irrelevant to a sell-or-process-further decision because they are sunk costs and will not change whether the decision is to sell the existing product or process it further. Therefore, joint costs are ignored in this decision.

11.

A sunk cost is a cost that cannot be changed by any present or future decision. Sunk costs, such as the book value of an old piece of equipment, therefore, are not relevant in a decision to retain or replace equipment.

12.

Net income will be lower if an unprofitable product line is eliminated when the product line is producing a positive contribution margin and its fixed costs cannot be avoided or reduced.

7-4

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1 The correct order is: 1. 2. 3. 4.

Identify the problem and assign responsibility. Determine and evaluate possible courses of action. Make a decision. Review results of the decision.

BRIEF EXERCISE 7-2

Revenues Costs Net income

Alternative A $160,000 100,000 $ 60,000

Alternative B $180,000 125,000 $ 55,000

Net Income Increase (Decrease) ($ 20,000) (25,000) ($ 5,000)

Alternative A is better than Alternative B.

BRIEF EXERCISE 7-3

Revenues Costs—Variable manufacturing Shipping Net income

Reject Order $0 0 0 $0

The special order should be accepted. *3,000 X $25 **3,000 X $20 ***3,000 X $ 2

7-5

Accept Order $75,000* 60,000** 6,000*** $ 9,000

Net Income Increase (Decrease) ($ 75,000) ( (60,000) ( (6,000) ($ 9,000)

BRIEF EXERCISE 7-4

Variable manufacturing costs Fixed manufacturing costs Purchase price Total annual cost

Make $50,000 30,000 –0– $80,000

Buy $ –0– 30,000 60,000 $90,000

Net Income Increase (Decrease) $ 50,000 0 (60,000) ($(10,000)

The decision should be to make the part. BRIEF EXERCISE 7-5

Sales price per unit Cost per unit Variable Fixed Total Net income per unit

Sell $62.00

Process Further $70.00

Net Income Increase (Decrease) $8.00

36.00 10.00 46.00 $16.00

43.00 10.00 53.00 $17.00

( (7.00) 0 ( (7.00) $1.00

The bookcases should be processed further because the incremental revenues exceed incremental costs by $1.00 per unit. BRIEF EXERCISE 7-6 The allocated joint costs are irrelevant to the sell or process further decisions. If AB1 is processed further, the company will earn incremental revenue of $50,000 ($150,000 – $100,000) and only incur incremental costs of $45,000. Therefore, the company should process AB1 further and sell AB2. If XY1 is processed further, the company will earn incremental revenue of $35,000 ($130,000 – $95,000) but will incur incremental costs of $50,000. Therefore, the company should sell XY1 rather than process it further.

7-6

BRIEF EXERCISE 7-7

Variable manufacturing costs for 4 years New machine cost Sell old machine Total

Retain Equipment

Replace Equipment

Net 4-Year Income Increase (Decrease)

$3,000,000 (30,000)

$2,500,000 300,000 (30,000) $2,770,000

($ 500,000 ((300,000) 30,000 $ 230,000

$3,000,000

The old factory machine should be replaced. BRIEF EXERCISE 7-8

Sales Variable costs Contribution margin Fixed costs Net income

Continue $200,000 180,000 20,000 30,000 ($ (10,000)

Eliminate $ –0– –0– ( –0– 20,000) $(20,000)

Net Income Increase (Decrease) $(200,000) (180,000) (20,000) ( 10,000) $ (10,000)

The Big Bart product line should be continued because $20,000 of contribution margin will not be realized if the line is eliminated. This amount is greater than the $10,000 savings of fixed costs. SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 7-1

Revenues Costs Net income

Reject $ –0– $ –0– $ –0–

Accept $180,000 138,000* $ 42,000

Net Income Increase (Decrease) $180,000 (138,000) $ 42,000

*(6,000 X $20) + (6,000 X $3) Given the results of the above analysis, Maize Company should accept the special order. .

7-7

DO IT! 7-2 (a)

Direct materials Direct labor Variable manufacturing costs Fixed manufacturing costs Purchase price Total cost

Net Income Increase (Decrease) $ 30,000 42,000

Make $ 30,000 42,000

Buy $ –0– –0–

45,000

–0–

45,000

60,000 –0– $177,000

45,000 162,000 $207,000

15,000 (162,000) $ (30,000)

Given the results of the above analysis, Rubble Company will incur $30,000 of additional costs if it buys the switches. (b)

Total cost Opportunity cost Total cost

Make $177,000 34,000 $211,000

Buy $207,000 –0– $207,000

Net Income Increase (Decrease) $(30,000) 34,000 $ 4,000

Yes, the answer is different: The analysis shows that net income will be increased by $4,000 if Rubble Company purchases the switches. DO IT! 7-3

Sales per unit Cost per unit Variable Fixed Total Net income per unit

Sell $75

Process Further $100

Net Income Increase (Decrease) $25

$40 10 $50

$ 57 13 $ 70

($17) (3) ($20)

$25

$ 30

$ 5

The tables should be processed further and Mesa Verde should finish the tables because the incremental revenues exceed incremental costs by $5 per unit. 7-8

DO IT! 7-4

Sales Variable costs Contribution margin Fixed costs Net income

Continue $500,000 370,000 130,000 150,000 $ (20,000)

Eliminate $ 0 0 0 38,000 $(38,000)

Net Income Increase (Decrease) $(500,000) 370,000 (130,000) 112,000 $ (18,000)

The analysis indicates that Gator should not eliminate the gloves and mittens line because net income would decrease $18,000.

7-9

SOLUTIONS TO EXERCISES EXERCISE 7-1 1. 2. 3. 4. 5. 6. 7. 8. 9.

False. The first step in management’s decision-making process is “identify the problem and assign responsibility”. False. The final step in management’s decision-making process is to review the results of the decision. True. False. In making business decisions, management ordinarily considers both financial and nonfinancial information. True. True. False. Costs that are the same under all alternative courses of action do not affect the decision. False. When using incremental analysis, either costs or revenues or both will change under alternative courses of action. False. Sometimes variable costs will not change under alternative courses of action, but fixed costs will.

EXERCISE 7-2 (a)

Revenues ($4.80) Materials ($0.50) Labor ($1.50) Variable overhead ($1.00) Fixed overhead Sales commissions Net income

Reject Order $ –0– –0– –0– –0– –0– –0– $ –0–

Accept Order $24,000 (2,500) (7,500) (5,000) (6,000) –0– $ 3,000

Net Income Increase (Decrease) $24,000 (2,500) (7,500) (5,000) (6,000) –0– $ 3,000

(b) As shown in the incremental analysis, Gruden should accept the special order because incremental revenue exceeds incremental expenses by $3,000. (c) It is assumed that sales of the golf discs in other markets would not be affected by this special order. If other sales were affected, Gruden would have to consider the lost sales in making the decision. Second, if Gruden is operating at full capacity, it is likely that the special order would be rejected.

7-10

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

EXERCISE 7-3 (a)

Revenues (15,000 X $7.60) Cost of goods sold Operating expenses Net income

Reject Order $0 0 0 $0

Accept Order $114,000 78,000 (1) 30,000 (2) $ 6,000

Net Income Increase (Decrease) ($114,000) ( (78,000) ( (30,000) ($ 6,000)

(1) Variable cost of goods sold = $2,600,000 X 70% = $1,820,000. Variable cost of goods sold per unit = $1,820,000 ÷ 350,000 = $5.20 Variable cost of goods sold for the special order = $5.20 X 15,000 = $78,000.

(2) Variable operating expenses = $840,000 X 75% = $630,000 $630,000 ÷ 350,000 = $1.80 per unit 15,000 X $1.80 = $27,000 $27,000 + $3,000 = $30,000 (b) As shown in the incremental analysis, Leno Company should accept the special order because incremental revenues exceed incremental expenses by $6,000. EXERCISE 7-4

Revenues Variable costs: Direct materials Direct labor Variable overhead Total variable costs Net income

Reject Order $0

Accept Order $1,187,500 (1)

Net Income Increase (Decrease) $1,187,500

0 0 0 0 $0

500,000 187,500 250,000 937,500 $ 250,000

(500,000) (187,500) (250,000) (937,500) $ 250,000

(1) [($2.00 + $0.75 + $1.00 + $1.00) X 250,000] Klean Fiber should accept the Army’s offer since it would increase net income by $250,000.

7-11

EXERCISE 7-5 (a)

Direct materials (30,000 X $4.00) Direct labor (30,000 X $5.00) Variable overhead costs ($150,000 X 70%) Fixed manufacturing costs Purchase price (30,000 X $12.75) Total annual cost

Make $120,000 150,000

0 0

Net Income Increase (Decrease) $ 120,000 150,000

105,000 45,000 0 $420,000

0 45,000 382,500 $427,500

105,000 0 ( (382,500) ($ (7,500)

Buy

(b) No, Schopp Inc. should not purchase the shades. As indicated by the incremental analysis, it would cost the company $7,500 more to purchase the lamp shades. (c) Yes, by purchasing the lamp shades, a total cost saving of $17,500 will result as shown below.

Total annual cost (above) Opportunity cost Total cost

Make $420,000 25,000 $445,000

Buy $427,500 0 $427,500

Net Income Increase (Decrease) $ (7,500) (25,000) $(17,500)

EXERCISE 7-6 (a) 1.

Direct materials Direct labor Variable overhead Fixed overhead Purchase price Total annual cost

Make Buy $1,000,000 $ –0– 800,000 –0– 120,000 –0– 600,000 195,000 0 2,300,000 $2,520,000 $2,495,000

Net Income Increase (Decrease) $ 1,000,000 800,000 120,000 405,000 (2,300,000) $ 25,000

Yes. The offer should be accepted as net income will increase by $25,000.

7-12

EXERCISE 7-6 (Continued) 2.

Direct materials Direct labor Variable overhead Fixed overhead Opportunity cost Purchase price Totals

Make $1,000,000 800,000 120,000 600,000 405,000 0 $2,925,000

Buy $

0 0 0 600,000 0 2,300,000 $2,900,000

Net Income Increase (Decrease) $ 1,000,000 800,000 120,000 0 405,000 (2,300,000) $ 25,000

Yes. The offer should be accepted as net income would be $25,000 more. (b) Qualitative factors include the possibility of laying off those employees that produced the robot and the resulting poor morale of the remaining employees, maintaining quality standards, and controlling the purchase price in the future. EXERCISE 7-7 (a) Direct materials Direct labor Variable overhead Purchase price Total unit cost

Make Sails $100 80 35 0 $215

Buy Sails $ 0 0 0 250 $250

Net Income Increase (Decrease) $ 100 80 35 (250) $ (35)

Gibbs should be making the sails, because they could save $35 per unit or $42,000. The president was including the fixed overhead cost in the calculation. Variable overhead = Total overhead ($100) – Fixed overhead ($78,000 ÷ 1,200) = $35. This amount has been allocated, so Gibbs will incur the cost whether or not they make the sails. This is an example of an irrelevant cost, because it does not differ between the two alternatives.

7-13

EXERCISE 7-7 (Continued) (b)

The best decision would be to rent out the space as shown below. The differential savings would be $77,000 – $42,000 = $35,000.

(Based on 1,200 units) Manufacturing cost Purchase price Opportunity cost Total annual cost (c)

Per Unit $215 $250

Make Sails $258,000 0 77,000 $335,000

Buy Sails $ 0 300,000 0 $300,000

Net Income Increase (Decrease) $ 258,000 (300,000) 77,000 $ 35,000

Qualitative factors to consider would be (1) whether Gibbs will be able to exercise control over the future price of the product (2) whether Gibbs will be able to exercise control over the quality of the product and (3) the potential for interruptions in the supply of the product.

EXERCISE 7-8 (a) Direct materials Direct labor Material handling Variable overhead Purchase price Total unit cost

Make IMC2 $ 65.00 45.00 6.50 72.00* 0 $188.50

Buy IMC2 $ 0 0 0 0 200.00 $200.00

Net Income Increase (Decrease) $ 65.00 45.00 6.50 72.00 (200.00) $ (11.50)

*Variable overhead = 60% X ($126.50 – 6.50) The unit should not be purchased from the outside vendor, as the per unit cost would be $11.50 greater than if they made it.

7-14

EXERCISE 7-8 (Continued) (b)

In order for Innova to make an accurate decision, they would have to know the opportunity cost of manufacturing the other product. As determined in (a), purchasing the product from outside would cost $11,500 more (1,000 X $11.50). Innova would have to increase their contribution margin by more than $11,500 through the manufacture of the other product, before it would be economical for them to purchase the IMC2 from the outside vendor.

(c)

Qualitative factors to consider would be (1) quality of the component (2) on-time delivery, and (3) reliability of the vendor.

EXERCISE 7-9

Sales per unit Costs per unit Direct materials Direct labor Total Net income per unit

Sell (Basic Kit) $30

Process Further (Stage 2 Kit) ( )$35( )

Net Income Increase (Decrease) $(5)

$14 0 $14

( ) $ 7 (1) ( ) 9 (2) ( ) $16 ( )

$(7) (9) $(2)

$16

( ) $19 ( )

$(3)

(1) The cost of materials decreases because Rachel can make two Stage 2 Kits from the materials for a basic kit. (2) The total time to make the two kits is one hour at $18 per hour or $9 per unit.

7-15

EXERCISE 7-9 (Continued) Rachel should carry the Stage 2 Kits. The incremental revenue, $5, exceeds the incremental processing costs, $2. Thus, net income will increase by processing the kits further. EXERCISE 7-10 (a)

Sales ($60,000 + $15,000 + $55,000) Joint costs Net income

$ 130,000 (100,000) $ 30,000

(b) Sales ($190,000 + $35,000 + $215,000) Joint costs Additional costs ($100,000 + $30,000 + $150,000) Net income

$ 440,000 (100,000) (280,000) $ 60,000

Incremental revenue Incremental costs Incremental profit (loss) (1)

Product 10 Product 12 Product 14 $ 130,000 $ 20,000 $ 160,000 (100,000) (30,000) (150,000) $ 30,000 $(10,000) $ 10,000

Sales value after further processing – Sales value @ split-off point

Products 10 and 14 should be processed further and product 12 should be sold at the split-off point. (d) Sales ($190,000 + $15,000 + $215,000) Joint costs Additional costs ($100,000 + $150,000) Net income

$ 420,000 (100,000) (250,000) $ 70,000

Net income is $10,000 ($70,000 – $60,000) higher in (d) than in (b) because product 12 is not processed further, thereby increasing overall profit $10,000.

7-16

EXERCISE 7-11 To determine whether each of the three joint products should be sold as is, or processed further, we must determine the incremental profit or loss that would be earned by each. The allocated joint costs are irrelevant to the decision since these costs will not change whether or not the products are sold as is or processed further.

Incremental revenue Incremental cost Incremental profit (loss)

Larco $100,000* (110,000) $ (10,000)

Marco $100,000** (85,000) $( 15,000

Narco $395,000*** (250,000) $145,000

From this analysis we see that Marco and Narco should be processed further because the incremental revenue exceeds the incremental costs, but Larco should be sold as is. *$300,000 – $200,000

**$400,000 – $300,000

***$800,000 – $405,000

EXERCISE 7-12 (a)

The costs that are relevant in this decision are the incremental revenues and the incremental costs associated with processing the material past the split-off point. Any costs incurred up to the split-off point are sunk costs, and therefore, irrelevant to this decision.

(b)

Revenue after further processing: Product D—$60,000 (4,000 units X $15.00 per unit) Product E—$97,200 (6,000 units X $16.20 per unit) Product F—$45,200 (2,000 units X $22.60 per unit) Revenue at split-off: Product D—$40,000 (4,000 units X $10.00 per unit) Product E—$69,600 (6,000 units X $11.60 per unit) Product F—$38,800 (2,000 units X $19.40 per unit) Incremental revenue Incremental cost Increase (decrease) in profit

D $20,000 (14,000) $ 6,000

E $27,600 (20,000) $ 7,600

F $ 6,400 (9,000) $(2,600)

Products D and E should be processed further. (c)

The decision would remain the same. It does not matter how the joint costs are allocated because joint costs are irrelevant to this decision.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

7-17

EXERCISE 7-13 (a)

Cost Accumulated depreciation Book value Sales proceeds Loss on sale

$100,000 (25,000*) 75,000 40,000 $ 35,000

*One year’s depreciation: ($100,000 – $0) ÷ 4 years (b)

Annual operating costs New scanner cost Old scanner salvage Total

Retain Scanner $315,000* $315,000

Replace Scanner $225,000** 110,000 (40,000) $295,000

Net Income Increase (Decrease) $ 90,000 (110,000) 40,000 $ 20,000

*(3 years X $105,000) **[3 years X ($105,000 – $30,000)] Yes. Benson Hospital should replace the old scanner because it will result in a savings of $20,000 over the next four years. (c)

7-18

As shown in (a) above, replacing the old scanner will result in reporting a loss of $35,000. Reluctance to report losses of this nature is the usual reason for not recognizing that a poor decision was made in the past. The remaining book value of the old scanner ($75,000) is a sunk cost. It will be deducted in the future, if the scanner is retained, or written off now if it is replaced. However, if it is replaced now, that cost will be partially offset by the salvage value that Dyno is willing to pay ($40,000).

EXERCISE 7-14

Operating costs New machine cost Salvage value (old) Total

Retain Machine $125,000 (1) 0 0 $125,000

Replace Machine ($100,000) (2) ( 25,000) ( (6,000) ($119,000)

Net Income Increase (Decrease) ($ 25,000 ( (25,000) ( 6,000 ($ 6,000

(1) $25,000 X 5. (2) $20,000 X 5. The current machine should be replaced. The incremental analysis shows that net income for the five-year period will be $6,000 higher by replacing the current machine. EXERCISE 7-15

Sales Variable costs Cost of goods sold Operating expenses Total variable Contribution margin Fixed costs Cost of goods sold Operating expenses Total fixed Net income (loss)

Net Income Increase (Decrease) $(100,000)

Continue $100,000)

Eliminate $( 0)

( 61,000) (26,000) (87,000) (13,000)

( ( ( (

0) 0) 0) 0)

(61,000) (26,000) (87,000) (13,000)

(15,000) (24,000) (39,000) $(26,000)

(15,000) (24,000) (39,000) $(39,000)

( 0) ( 0) ( 0) $ (13,000)

Judy is incorrect. The incremental analysis shows that net income will be $13,000 less if the Huron Division is eliminated. This amount equals the contribution margin that would be lost through discontinuing the division. (Note: None of the fixed costs can be avoided.)

7-19

EXERCISE 7-16 (a)

$30,000 + $70,000 – $40,000 = $60,000

(b)

Tingler $300,000 150,000 150,000 142,500* $ 7,500

Sales Variable expenses Contribution margin Fixed expenses Net income

Shocker $500,000 200,000 300,000 267,500** $ 32,500

Total $800,000 350,000 450,000 410,000 $ 40,000

*$30,000 + [($300,000 ÷ $800,000) X $300,000] **$80,000 + [($500,000 ÷ $800,000) X $300,000] (c)

As shown in the analysis above, Cawley should not eliminate the Stunner product line. Elimination of the line would cause net income to drop from $60,000 to $40,000. The reason for this decrease in net income is that elimination of the product line would result in the loss of $55,000 of contribution margin while saving only $35,000 of fixed expenses.

EXERCISE 7-17 Calculation of contribution margin per unit: Selling price per unit Less: variable costs/unit Contribution margin/unit

C $95 50 $45

D $75 40 $35

E $115 40 $ 75

Fixed costs = $22 X (9,000 + 20,000) = $638,000 Company profit with Products C and D: Units sold Sales revenue Less: Variable costs Contribution margin Less: Fixed costs Net income 7-20

C 9,000

D 20,000

Total

$855,000 450,000 $405,000

$1,500,000 800,000 $ 700,000

$2,355,000 $1,250,000 1,105,000 638,000 $ 467,000

EXERCISE 7-17 (Continued) Company profit with Products C and E: Units sold Sales revenue Less: Variable costs Contribution margin Less: Fixed costs Net income

C 9,900*

E 10,000

Total

$940,500 495,000 $445,500

$1,150,000 400,000 $ 750,000

$2,090,500 895,000 1,195,500 638,000 $ 557,500

*Product C sales increase by 10%, (9,000 X 110%) Yes they should introduce Product E since net profit would increase by $90,500 ($557,500 – $467,000). EXERCISE 7-18 1. Irrelevant. Unavoidable costs will be incurred regardless of the decision made. 2. Relevant. 3. Irrelevant. This is a sunk cost and all sunk costs are irrelevant. 4. Irrelevant. These are sunk costs. 5. Relevant. 6. Relevant. 7. Relevant. 8. Relevant. 9. Irrelevant. If there is no change in the direct materials charge regardless of the decision made, the cost is irrelevant. 10. Relevant.

7-21

7-22

SOLUTIONS TO PROBLEMS PROBLEM 7-1A

(a)

Revenues (10,000 X $27) Cost of goods sold Selling and administrative expenses Net income

Reject Order $0 0

Accept Order $270,000 220,000 (1)

Net Income Increase (Decrease) $ 270,000 ( (220,000)

0 $0

20,000 (2) $ 30,000

( (20,000) $ 30,000

(1) Variable costs = $3,600,000 – $960,000 = $2,640,000; $2,640,000 ÷ 120,000 units = $22.00 per unit; 10,000 X $22.00 = $220,000. (2) Variable costs = $405,000 – $225,000 = $180,000; $180,000 ÷ 120,000 units = $1.50 per unit; 10,000 X ($1.50 + $0.50) = $20,000. (b) Yes, the special order should be accepted because net income will increase by $30,000. (c) Unit selling price = $22.00 (variable manufacturing costs) + $2.00 variable selling and administrative expenses + $4.00 net income = $28. (d) Nonfinancial factors to be considered are: (1) possible effect on domestic sales, (2) possible alternative uses of the unused plant capacity, and (3) ability to meet customer’s schedule for delivery without increasing costs.

7-23

PROBLEM 7-2A

(a) Make CISCO Direct materials (8,000 X $4.80) Direct labor (8,000 X $4.30) Indirect labor (8,000 X $.43) Utilities (8,000 X $.40) Depreciation Property taxes Insurance Purchase price Freight and inspection (8,000 X $.35) Receiving costs Total annual cost

$38,400

Buy CISCO $

Net Income Increase (Decrease)

($38,400)

34,400

( 34,400)

3,440 3,200 3,000 700 1,500 0

0 0 900 200 600 80,000

( 3,440) ( 3,200) ( 2,100) ( 500) ( 900) ( (80,000)

0 0 $84,640

2,800 1,300 $85,800

( (2,800) ( (1,300) ($ (1,160)

(b) The company should continue to make CISCO because net income would be $1,160 less if CISCO were purchased from the supplier. (c) The decision would be different. Because of the opportunity cost of $3,000, net income will be $1,840 higher if CISCO is purchased as shown below: Net Income Increase Make CISCO Buy CISCO (Decrease) Total annual cost $84,640 $85,800 $(1,160) Opportunity cost 3,000 0 (3,000) Total cost $87,640 $85,800 $(1,840) (d) Nonfinancial factors include: (1) the adverse effect on employees if CISCO is purchased, (2) how long the supplier will be able to satisfy the Shatner Manufacturing Company’s quality control standards at the quoted price per unit, and (3) whether the supplier will deliver the units when they are needed by Shatner.

7-24

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

PROBLEM 7-3A

(a) (1)

Table Cleaner Not Processed Further Sales: FloorShine (600,000 ÷ 30) X $20 Table Cleaner (300,000 ÷ 25) X $18 Total revenue Costs: CDG Additional costs of FloorShine Total costs Gross profit

(2)

$400,000 216,000 $616,000 210,000 240,000 450,000 $166,000

Table Cleaner Processed Further Sales: FloorShine Table Stain Remover (300,000 ÷ 25) X $14 Table Polish (300,000 ÷ 25) X $14 Total revenue Costs: CDG Additional costs of FloorShine TCP Total costs Gross profit

$400,000 168,000 168,000 $736,000 210,000 240,000 100,000 550,000 $186,000

(3) If the table cleaner is processed further overall company profits will be $20,000 higher. Therefore, management made the wrong decision by choosing to not process table cleaner further.

7-25

PROBLEM 7-3A (Continued) (b) Incremental revenue Incremental costs Totals

Don’t Process Table Cleaner Further $216,000 0 $216,000

Process Table Cleaner Further $336,000 100,000 $236,000

Net Income Increase (Decrease) $120,000 (100,000) $ 20,000

When trying to decide if the table cleaner should be processed further into TSR and TP, only the relevant data need be considered. All of the costs that occurred prior to the creation of the table cleaner are sunk costs and can be ignored. The decision should be made by comparing the incremental revenue from further processing to the incremental costs.

7-26

PROBLEM 7-4A (a)

Cost Accumulated depreciation Book value Sales proceeds Loss on sale

$120,000 (24,000*) 96,000 (25,000) $ 71,000

*$120,000 ÷ 5 years = $24,000 (b) (1) Revenues ($240,000 X 4 yrs.) Less costs: Variable costs ($35,000 X 4) Fixed costs ($23,000 X 4) Selling & administrative Depreciation Net income

Retain Old Elevator $960,000 $140,000 92,000 116,000* 96,000

444,000 $516,000

*($29,000 X 4) (2) Revenues Less costs: Variable costs ($10,000 X 4) Fixed costs ($8,500 X 4) Selling and administrative Depreciation Operating income Less: Loss on old elevator Net income

Replace Old Elevator $960,000 $ 40,000 34,000 116,000 160,000

350,000 610,000 71,000 $539,000

7-27

Retain Replace Old Elevator Old Elevator $140,000 $ 40,000 92,000 34,000 160,000 (25,000) $232,000 $209,000 .

Net Income Increase (Decrease) $ 100,000 58,000 (160,000) 25,000 $ 23,000

PROBLEM 7-4A (Continued) (d)

MEMO

TO: Ron Richter FROM: Student SUBJECT: Relevant Data for Decision to Replace Old Elevator When deciding whether or not to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $71,000 loss that would be experienced if we replace the old elevator with the newer model is related to a sunk cost, namely the cost of the old elevator. Sunk costs are irrelevant in decision making. The loss occurs when comparing the book value of the old elevator to the cash proceeds that would be received. The book value of $96,000 would be deducted as depreciation expense over the next four years if the elevator were retained. If the elevator is replaced with the newer model, the book value will be expensed in the current year, less the cash proceeds received on disposal. Therefore, the $96,000 book value will be expensed under either alternative, making it irrelevant.

7-28

PROBLEM 7-5A

(a) Sales Variable costs Cost of goods sold Selling and administrative Total variable expenses Contribution margin

Division I $250,000

Division II $200,000

150,000 30,000 180,000 ($ 70,000)

172,800 42,000 214,800 $ (14,800)

(b) (1) Division I

Continue

Eliminate

Net Income Increase (Decrease)

Contribution margin (above) Fixed costs Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations

$(70,000)

(50,000) (45,000) (95,000) $(25,000)

(25,000) (22,500) (47,500) $(47,500)

25,000 22,500 47,500 $(22,500)

(2) Division II

Continue

Eliminate

Net Income Increase (Decrease)

Contribution margin (above) Fixed costs Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations

$(14,800)

$14,800

(19,200 ( 18,000 ( 37,200 $(52,000)

( 9,600) ( 9,000) (18,600) $(18,600)

( 9,600 9,000 18,600 $33,400

Division II should be eliminated as its negative contribution margin is $14,800. Income from operations would increase $33,400 if Division II is eliminated. Division I should be continued because it is producing positive contribution margin of $70,000. Income from operations will decrease $22,500 by discontinuing this division.

7-29

PROBLEM 7-5A (Continued) (c)

GUTIERREZ COMPANY CVP Income Statement For the Quarter Ended March 31, 2014 Divisions Sales Variable costs Cost of goods sold Selling and administrative Total variable costs Contribution margin Fixed costs Cost of goods sold (1) Selling and administrative (2) Total fixed costs Income (loss) from operations

III

Total

$250,000

$500,000

$450,000

$1,200,000

150,000

240,000

187,500

577,500

30,000

90,000

180,000 70,000

270,000 230,000

217,500 232,500

667,500 532,500

53,200

63,200

65,700

182,100

48,000

33,000

23,000

104,000

101,200

96,200

88,700

286,100

$(31,200) $133,800

$143,800

$ 246,400

(1) Division’s fixed cost of goods sold plus 1/3 of Division II’s unavoidable fixed cost of goods sold [$192,000 X (100% – 90%) X 50% = $9,600]. Each division’s share is $3,200. (2) Division’s fixed selling and administrative expense plus 1/3 of Division II’s unavoidable fixed selling and administrative expenses [$60,000 X (100% – 70%) X 50% = $9,000]. Each division’s share is $3,000. (d) Income from operations with Division II of $213,000 (given) plus incremental income of $33,400 from eliminating Division II = $246,400 income from operations without Division II.

7-30

PROBLEM 7-1B

(a)

Revenues (10,000 X $30) Cost of goods sold Selling and administrative expenses Net income

Reject Order $0 0

Net Income Accept Increase Order (Decrease) $300,000 $ 300,000 240,000 (1) ( (240,000)

0 $0

25,000 (2) ( (25,000) $ 35,000 $ 35,000

(1) Variable costs = $3,060,000 – $900,000 = $2,160,000; $2,160,000 ÷ 90,000 units = $24 per unit; 10,000 X $24 = $240,000. (2) Variable costs = $360,000 – $180,000 = $180,000; $180,000 ÷ 90,000 units = $2.00 per unit; 10,000 X ($2.00 + $0.50) = $25,000. (b) Yes, the special order should be accepted because net income will be increased by $35,000. (c) Unit selling price = $24 (variable manufacturing costs) + $2.50 (variable selling and administrative expenses) + $5.50 (net income) = $32.00. (d) Nonquantitative factors to be considered are: (1) possible effect on domestic sales, (2) possible alternative uses of the unused plant capacity, and (3) ability to meet customer’s schedule for delivery without increasing costs.

7-31

PROBLEM 7-2B

(a) Make FIZBE Direct materials (5,000 X $4.75) Direct labor (5,000 X $4.60) Indirect labor (5,000 X $.45) Utilities (5,000 X $.35) Depreciation Property taxes Insurance Purchase price Freight and inspection (5,000 X $.30) Receiving costs Total annual cost

Buy FIZBE

$23,750 23,000 2,250 1,750 2,000 700 1,500 0

0 0 0 0 900 200 600 56,000

0 0 $54,950

1,500 500 $59,700

Net Income Increase (Decrease) ($ 23,750 ( 23,000 ( 2,250 ( 1,750 ( 1,100 ( 500 ( 900 ( (56,000) ( (1,500) (500) ($ (4,750)

(b) The company should continue to make FIZBE because net income would be $4,750 less if FIZBE were purchased from the supplier. (c) The decision would be different. Because of the opportunity cost of $6,000, net income will be $1,250 higher if FIZBE is purchased as shown below:

Total annual cost Opportunity cost Total cost

Make FIZBE $54,950 6,000 $60,950

Buy FIZBE $59,700 0 $59,700

Net Income Increase (Decrease) $(4,750) 6,000 $ 1,250

(d) Nonfinancial factors include: (1) the adverse effect on employees if FIZBE is purchased, (2) how long the supplier will be able to satisfy the Gill Corporation’s quality control standards at the quoted price per unit, and (3) will the supplier deliver the units when they are needed by Gill? 7-32

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

PROBLEM 7-3B (a) (1)

General-Purpose Cleaner Not Processed Further Sales ShineBrite (750,000 ÷ 25) X $15 $450,000 General-Purpose Cleaner (250,000 ÷ 20) X $20 250,000 Total revenue $700,000 Costs NPR 200,000 Additional costs for ShineBrite 300,000 Total costs 500,000 Gross profit $200,000

(2)

General-Purpose is Processed Further Sales ShineBrite (750,000 ÷ 25) X $15 Premium Cleaner (250,000 ÷ 20) X $16 Premium Stain Remover (250,000 ÷ 20) X $16 Total revenue Costs NPR Additional costs for ShineBrite PST Total costs Gross profit

$450,000 200,000 200,000 $850,000 200,000 300,000 140,000 640,000 $210,000

(3) If the general-purpose cleaner is processed further overall company profits will be $10,000 higher. Therefore, management made the wrong decision by choosing to not process the general-purpose cleaner further.

7-33

PROBLEM 7-3B (Continued) (b) Incremental revenue Incremental costs Totals

Don’t Process G-P Cleaner Further $250,000 0 $250,000

Process G-P Cleaner Further $400,000 140,000 $260,000

Net Income Increase (Decrease) $150,000 (140,000) $ 10,000

When trying to decide if the general-purpose cleaner should be processed further into PC and PSR, only the relevant data need be considered. All of the costs that occurred prior to the creation of the general-purpose cleaner are sunk costs and can be ignored. The decision should be made by comparing the incremental revenue from further processing to the incremental costs.

7-34

PROBLEM 7-4B

(a)

Cost Accumulated depreciation Book value Sales proceeds Loss on sale

$210,000 (42,000*) 168,000 (58,000) $110,000

*$210,000 ÷ 5 years = $42,000 (b) (1)

Retain Old Equipment $1,440,000

Revenues ($360,000 X 4 yrs.) Less costs: Variable costs Fixed costs Selling & administrative Depreciation Net income

$200,000 120,000 180,000 168,000

(2)

668,000 $ 772,000 Replace Old Equipment $1,440,000

Revenues Less costs: Variable costs Fixed costs Selling and administrative Depreciation Operating income Less: Loss on old equipment Net income

$ 48,000 20,000 180,000 250,000

498,000 942,000 110,000 $ 832,000

(c)

Variable costs Fixed costs New equipment cost Salvage on old .

7-35

Retain Old Equipment $200,000 120,000

Replace Old Equipment $ 48,000 20,000 250,000

Net Income Increase (Decrease) $152,000 100,000 (250,000)

(58,000)

58,000

equipment Totals

7-36

$320,000

$260,000

$ 60,000

PROBLEM 7-4B (Continued) (d)

MEMO

TO: Gene Simmons FROM: Student SUBJECT: Relevant Data for Decision to Replace Old Equipment When deciding whether or not to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $110,000 loss that would be experienced if we replace the old equipment with the newer equipment is related to a sunk cost, namely the cost of the old equipment. Sunk costs are irrelevant in decision making. The loss occurs when comparing the book value of the old equipment to the cash proceeds that would be received. The book value of $168,000 would be deducted as depreciation expense over the next four years if the equipment were retained. If the equipment is replaced with the newer model the book value will be expensed in the current year, less the cash proceeds received on disposal. Therefore, the $168,000 book value will be expensed under either alternative, making it irrelevant.

7-37

PROBLEM 7-5B

(a) Sales Variable expenses Cost of goods sold Selling and administrative Total variable expenses Contribution margin

Division III $310,000

Division IV $170,000

189,000 45,000 234,000 $ 76,000

140,400 49,000 189,400 ($ (19,400)

(b) (1) Division III

Continue

Eliminate

Net Income Increase (Decrease)

Contribution margin (above) Fixed expenses Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations

$ 76,000

$(76,000)

81,000 30,000 111,000 ($(35,000)

(40,500 15,000 55,500 $(55,500)

40,500 15,000 55,500 $(20,500) Net Income Increase (Decrease)

(2) Division IV

Continue

Eliminate

Contribution margin (above) Fixed expenses Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations

$(19,400)

$19,400

(15,600) 21,000) 36,600) $(56,000)

7,800 10,500 18,300 $(18,300)

7,800 10,500 18,300 $37,700

Division III should be continued as contribution margin ($76,000) is greater than the savings in fixed costs ($55,500) that would result from elimination. Therefore, income from operations would decrease $20,500 if Division III is eliminated. Division IV should be eliminated because it is producing negative contribution margin ($19,400). Income from operations will increase $37,700 by discontinuing this division. 7-38

PROBLEM 7-5B (Continued) (c)

PANDA COMPANY CVP Income Statement For the Quarter Ended March 31, 2014 Divisions Sales Variable expenses Cost of goods sold Selling and administrative Total variable expenses Contribution margin Fixed expenses Cost of goods sold (1) Selling and administrative (2) Total fixed expenses Income (loss) from operations

III

Total

$510,000

$400,000

$310,000

$1,220,000

210,000

200,000

189,000

599,000

24,000

40,000

45,000

109,000

234,000 276,000

240,000 160,000

234,000 76,000

708,000 512,000

92,600

52,600

83,600

228,800

39,500

43,500

33,500

116,500

132,100 $143,900

96,100 $ 63,900

117,100 345,300 $ (41,100 ) $ 166,700

(1) Division’s fixed cost of goods sold plus 1/3 of Division IV’s unavoidable fixed cost of goods sold [$156,000 X (100% – 90%) X 50% = $7,800]. Each division’s share is $2,600. (2) Division’s fixed selling and administrative expenses plus 1/3 of Division IV’s unavoidable fixed selling and administrative expenses [$70,000 X (100% – 70%) X 50% = $10,500]. Each division’s share is $3,500. (d) Income from operations with Division IV of $129,000 (given) plus incremental income of $37,700 from eliminating Division IV = $166,700 income from operations without Division IV.

7-39

BYP 7-1

DECISION-MAKING AT CURRENT DESIGNS

Situation #1 (a) Current Designs should accept the special order based on the following calculations:

Revenues Costs Net Income

Reject Order $0 0 $0

Accept Order $25,000* (19,000)** $ 6,000

Net Income Increase (Decrease) $25,000 (19,000) $ 6,000

*(100 X $250) **(($80 + $60 + $20) X 100) + ($1,000 + $2,000) (b) Assuming that Current Designs is currently operating with excess capacity, it should accept the order based on the calculations shown in part (a). If Current Designs is currently operating at full capacity, it would have to weigh its options. If it displaced production of regular kayaks in order to fill this order, it would have to consider the opportunity costs associated with this decision. The opportunity cost, when operating at full capacity, would be the lost contribution margin from regular sales given up in order to fulfill the special order. Alternatively, rather than reject the special order, it might consider temporarily expanding the plant’s capacity by adding an additional production shift to handle the special order. If this option were considered, it would have to identify all additional incremental costs (for example, overtime pay) that would be incurred.

7-40

BYP 7-1 (Continued) Situation #2 (a) Current designs should not replace the Rotomold oven based on the following calculations:

Variable manufacturing costs New oven cost Proceeds from scrapping old oven Total

Retain Oven $110,500* 0 0 $110,500

Replace Oven $ 97,500** 250,000 (10,000) $337,500

Net Income Increase (Decrease) $ 13,000 (250,000) 10,000 ($ 227,000)

*(17,000 therms/year X $0.65/therm X 10 years) **(15,000 therms/year X $0.65/therm X 10 years)

(b) Even with the cost of natural gas increasing at a faster than expected rate, Current Designs still should not replace the Rotomold oven as the rate increase does not cover the cost of the new oven based on the following calculations:

Variable manufacturing costs New oven cost Proceeds from scrapping old oven Total

Retain Oven $144,500* 0 0 $144,500

*(17,000 therms/year X $0.85/therm X 10 years) **(15,000 therms/year X $0.85/therm X 10 years)

7-41

Replace Oven $127,500** 250,000 (10,000) $367,500

Net Income Increase (Decrease) $ 17,000 (250,000) 10,000 ($ 223,000)

BYP 7-1 (Continued) Situation #3 (a) Current Designs should make the seats based on the following calculations:

Direct materials Direct labor Variable manufacturing costs Fixed manufacturing costs Purchase price ($50 X 3,000) Total annual cost

Make $ 60,000 45,000 36,000 20,000 0 $161,000

Buy $

0 0 0 15,000 150,000 $165,000

Net Income Increase (Decrease) $ 60,000 45,000 36,000 5,000 (150,000) ($ 4,000)

(b) When the opportunity cost of $20,000 is considered, Current Designs should buy the seats based on the following calculations:

Total annual cost Opportunity cost Total cost

7-42

Make $161,000 20,000 $181,000

Buy $165,000 0 $165,000

Net Income Increase (Decrease) ($ 4,000) 20,000 $16,000

BYP 7-2

DECISION-MAKING ACROSS THE ORGANIZATION

Sales Costs and expenses Cost of goods sold Selling expenses Administrative expenses Purchase price Total costs and expenses Net income (1) (2) (3) (4) (5)

Retain Purchase Old Machine New Machine $6,000,000 (1) $6,600,000 (2)

Net Income Increase (Decrease) ($ 600,000

4,500,000 (3) 900,000 500,000 — 5,900,000 $ 100,000

( (120,000) ( (90,000) ( (65,000) ( (150,000) ( (425,000) ($ 175,000

4,620,000 (4) 990,000 565,000 150,000 (5) 6,325,000 $ 275,000

12,000 X $100 X 5 years = $6,000,000. $6,000,000 X 110% = $6,600,000. $6,000,000 X (100% – 25%) = $4,500,000. $6,600,000 X (100% – 30%) = $4,620,000. $140,000 + $4,000 + $6,000 = $150,000.

The new machine should be purchased. The incremental analysis shows that net income will increase from $100,000 to $275,000 over the five years with the new machine.

7-43

BYP 7-3

MANAGERIAL ANALYSIS

(a)

$ 14.50

Buy— TransTech $ 14.50

$ 14.50

2.00 0.80 0.60 3.00 0.50 0 — 6.90 $ 7.60 $38,000

0 0 0 0 0 10.00 1.00* 11.00 $ 3.50 $17,500

0 0 0 0 0 5.00 1.00 6.00 $ 8.50 $42,500

Make Sales Revenue Variable Manufacturing Cost: Circuit Board Plastic Case Alarms (4 @ $.15 each) Labor Overhead Purchase Cost Fixed Manufacturing Cost: Total Manufacturing Cost Profit per Unit Total Profit

Buy— Omega

*The $5,000 cost that will continue to be incurred, even if the product is not manufactured, divided by the 5,000 units. The company will make the most profit if the clocks are purchased from Omega Company. The company will make $4,500 less if the clocks are manufactured by MiniTek. The company will make $25,000 less if the clocks are purchased from Trans-Tech. (b) There are several important nonfinancial factors described in the case. Other factors might be identified as well. The factors described are: The company is having serious difficulty manufacturing the clocks. Therefore, it would probably be willing to have someone else manufacture the clocks, even if it cost more to do so. The most promising company appears to be Omega; however, there is a serious question about Omega’s ability to remain in business. However, the company could purchase just this one order from Omega, and then continue to search for another manufacturer, or stop manufacturing the clocks. Trans-Tech’s stringent requirements for preferred customer status, in the form of large sales requirements, appear to limit the possibilities for MiniTek to use it as a supplier. However, if MiniTek does desire to continue to offer the clocks because of their popularity, then perhaps Trans-Tech could be used in the future. 7-44

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

BYP 7-3 (Continued) (c) Many answers are possible, depending upon each student’s assessment of the seriousness of the issues mentioned in (b). One answer would be: The company should use Omega to manufacture the Kmart order. After that, the company should not offer the clocks any longer. Especially since the clocks are no longer very profitable, it does not seem like a good idea to keep spending money to modify the process.

7-45

BYP 7-4

REAL-WORLD FOCUS

(a) Before building the special-order new ceiling fans, company management must consider the effect of the new lines on current production capacity, existing and available channels of distribution, the effect on manufacturing efficiency, the effect on sales of current lines of product, and the supply of materials and labor. (b) Incremental analysis would provide a financial comparison of income with the special-order ceiling fans to income without the special orders.

7-46

BYP 7-5

REAL-WORLD FOCUS

(a) The types of outsourcing services that the company provides assistance on are: Information technology outsourcing, finance and accounting, human resource outsourcing, business process outsourcing, procurement, and call centers. (b) Insourcing means to take work that is currently being performed by an outside service provider back in-house. For example, collections of accounts receivable might currently be performed by a collection agency, and you might decide to establish a collection group within your company. (c) Some of the benefits of insourcing include: • Greater control over resources • Greater ability to control intellectual property • Increased visibility of accountability within the organization

7-47

BYP 7-6

COMMUNICATION ACTIVITY

To:

Preston Thiese—Plant Manager

From:

Hank Jewel—Production Manager

I have spent considerable time thinking about the dilemma created by the new PDD1130 machine. Clearly, it is far superior to our existing machine. There is no question that it would save us tremendous amounts of money. I hope I am not overstepping my bounds here, but I just reviewed a chapter in my managerial accounting text on incremental analysis which has made me think we need to reconsider this decision. The key to incremental analysis is identifying relevant costs. Relevant costs are those costs that vary depending on the course of action taken. In our situation, a relevant cost would be the savings that we would experience were we to purchase the new machine. The book value of the existing machine is not a relevant cost since it would not be changed by purchasing or not purchasing the new machine. Costs incurred in the past that do not change are referred to as sunk costs. Sunk costs are irrelevant to incremental analysis. I would really like to lay out an analysis of our options to decide the proper course of action. I am concerned that by using the old machine for a couple of years the profitability of the plant could be impacted negatively.

7-48

BYP 7-7

ETHICS CASE

(a) Many factors need to be considered when determining whether to close a division. The loss of jobs can have a devastating impact on a community and on the morale of remaining employees. From a financial perspective, closing a division that is reporting losses will not necessarily increase the reported net income of the company. The reason: if fixed costs that have been allocated to a division that is closed are reallocated to the remaining divisions, the company’s net income might actually decrease. This sounds like it would most likely be the case at Peters. (b) It is not unusual to reevaluate fixed cost allocations periodically. However, the allocation should be based on the underlying economics of the situation rather than the motives of individuals. (c) Blake should explain to the board of directors that the change in income is due to a reallocation and that closing the plumbing division is not advisable. In this case, being honest is not only the ethical thing to do, but it will also maximize the company’s net income.

7-49

BYP 7-8

ALL ABOUT YOU

(a) Chronic homelessness is defined as being on the streets for a year or more. (b) Homelessness costs cities money because the chronic homeless have frequent jail time, shelter costs, emergency room visits and hospital stays. Some costs per city per homeless person are: New York $40,000; Dallas $50,000; San Diego $150,000. (c) The first step is to try to identify the size of the problem by doing street counts. From this count, benchmarks can be set, enabling a reward system for meeting goals. Next is to identify what the homeless people want. What do they think they need to help them address their problem? They typically want adequate housing with some privacy. (d) It has been estimated that in New York this approach costs about $22,000 per year. New York has documented an 88% success rate (defined as not returning to the streets for five years). (e) In terms of incremental analysis, two alternatives are to either continue with the current situation, with the costs presented in part (b) or to implement the approach outlined in part (d). From a purely financial perspective the approach in (d) appears to have significant merit. Also (d) does not even take into account the intangible benefits of improving the quality of life for this segment of the population.

7-50

BYP 7-9

CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: This is a very difficult decision. All of the evidence suggests that your short-term and long-term prospects will be far greater with some form of post–high-school degree. Because of this, we feel strongly that you should make every effort to continue your education. Many of the discussions provided in this text present ideas on how to get control of your individual financial situation. We would encourage you to use these tools to identify ways to reduce your financial burden in order to continue your education. We also want to repeat that even taking only one course a semester is better than dropping out. Your instructors and advisors frequently provide advice to students who are faced with the decision about whether to continue with their education. If you are in this situation, we would encourage you to seek their advice since the implications of this decision can be long-lasting.

7-51

CHAPTER 8 Pricing ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Do It!

Exercises

1. Compute a target cost when the market determines a product price.

1, 2

1, 2, 3

2. Compute a target selling price using cost-plus pricing.

3, 4, 5, 6, 7, 8

2, 3, 4, 5

3. Use time-and-material pricing to determine the cost of services provided.

9, 10

4. Determine a transfer price using the negotiated, costbased, and market-based approaches.

11, 12, 13, 14, 15, 16, 17

7, 8, 9

5. Explain issues involved in transferring goods between divisions in different countries.

*6. Determine prices using absorption-cost pricing and variable-cost pricing.

19, 20

10, 11

A Problems

B Problems

3, 4, 5, 6, 7

1A, 2A

1B, 2B

8, 9, 10

11, 12, 13, 14, 15, 16, 17

4A, 5A, 6A 4B, 5B, 6B

18, 19, 20

7A, 8A

7B, 8B

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter.

8-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Use cost-plus pricing to determine various amounts.

Simple

20–30

Use cost-plus pricing to determine various amounts.

Simple

20–30

Use time-and-material pricing to determine bill.

Simple

20–30

Determine minimum transfer price with no excess capacity and with excess capacity.

Moderate

20–30

Determine minimum transfer price with no excess capacity.

Moderate

20–30

Determine minimum transfer price under different situations.

Moderate

20–30

*7A*

Compute the target price using absorption-cost pricing and variable-cost pricing.

Moderate

30–40

*8A*

Compute various amounts using absorption-cost pricing and variable-cost pricing.

Complex

40–50

Use cost-plus pricing to determine various amounts.

Simple

20–30

Use cost-plus pricing to determine various amounts.

Simple

20–30

Use time-and-material pricing to determine bill.

Simple

20–30

Determine minimum transfer price with no excess capacity and with excess capacity.

Moderate

20–30

Determine minimum transfer price with no excess capacity.

Moderate

20–30

Determine minimum transfer price under different situations.

Moderate

20–30

*7B*

Compute the target price using absorption-cost pricing and variable-cost pricing.

Moderate

30–40

*8B*

Compute various amounts using absorption-cost pricing and variable-cost pricing.

Complex

40–50

8-2

8-3

Learning Objective

Knowledge

Comprehension

Application

*1. Compute a target cost when the Q8-1 market determines a product price.

Q8-2 BE8-1

DI8-1 E8-1 E8-2

E8-3

*2. Compute a target selling price using cost-plus pricing.

Q8-3 Q8-5

Q8-6

Q8-4 Q8-7 Q8-8 BE8-2 BE8-3 BE8-4 BE8-5 DI8-2 E8-3

E8-4 E8-5 E8-6 E8-7 P8-1A P8-2A P8-1B P8-2B

*3. Use time-and-material pricing to determine the cost of services provided.

Q8-10

Q8-9

BE8-6 DI8-3 E8-8 E8-9

E8-10 P8-3A P8-3B

*4. Determine a transfer price using Q8-13 the negotiated, cost-based, and Q8-15 market-based approaches. Q8-16

Q8-11 Q8-12 Q8-14 Q8-17

*5. Explain issues involved in transferring goods between divisions in different countries.

Q8-18

*6. Determine prices using absorption-cost pricing and variable-cost pricing.

Broadening Your Perspective

Q8-19

BE8-7 BE8-8 BE8-9 DI8-4 E8-11 E8-12 E8-13 E8-14 E8-15

Q8-20 BE8-10 BE8-11 E8-18 E8-19 BYP8-5

Analysis

Synthesis

Evaluation

E8-16 E8-17 P8-4A P8-5A P8-6A P8-4B P8-5B P8-6B

E8-20 P8-7A P8-8A P8-7B P8-8B BYP8-1 BYP8-6 BYP8-7

BYP8-3 BYP8-4 BYP8-8

BYP8-2

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

The first type of pricing environment is where the company is a price taker; that is, the company does not set the price, but instead the price is set by a competitive market. In the second type of situation, the company sets the price. This happens most often when the product is specially made for a customer or there are few or no other producers capable of manufacturing a similar item.

A company focuses on target cost when it cannot influence the market price. The target cost is determined by subtracting the desired profit per unit from the market-determined selling price.

The basic formula to determine the target selling price in cost-plus pricing is: Target selling price = Cost + (Markup percentage X Cost)

The basic formula to determine the target selling price in cost-plus pricing is: Target selling price = Cost + (Markup percentage X Cost) $23.40 = $18 + (30% X $18)

The basic formula to compute the markup percentage is: Markup percentage =

Desired ROI per unit Total unit cost

Some of the factors that affect a company’s desired ROI are competitive and market conditions, political and legal issues, and other relevant risk factors.

Total cost base per unit, excluding selling and administrative expenses ......................... Selling and administrative expenses per unit .................................................................. Total unit cost .................................................................................................................

$60 15 $75

The markup percentage is computed as follows: $6 = 8% $75 8.

Variable cost per unit ...................................................................................................... Fixed cost per unit .......................................................................................................... Desired ROI per unit ....................................................................................................... Target selling price .........................................................................................................

$16 9 6 $31

The markup percentage is: $6 = 24% $25 9.

Time-and-material pricing is most often used in service industries. It involves two pricing rates, one for the labor used on a job, while the other involves the materials used. Each typically has a profit rate factored into it.

10.

The material loading charge is a fee added to each bill to cover the costs of purchasing, receiving, handling, and storing materials, plus any desired profit margin on the materials themselves. The material loading charge is expressed as a percentage of the total estimated costs of parts and materials for the year.

8-4

Questions Chapter 8 (Continued) *11.

A transfer price is the price used to record the transfer of goods or services between two divisions in the same company. Setting a fair transfer price is important because an improper price will benefit one division while hurting the other.

*12.

The objective of an appropriate transfer price is to maximize the return to the whole company and not cause divisional performance to decline.

*13.

The three approaches for determining transfer prices are: (1) Negotiated transfer prices (2) Cost-based transfer prices (3) Market-based transfer prices

*14.

When a cost-based transfer price is used, the exchange of goods between divisions is recorded by using the costs incurred by the selling division. This may either be the variable costs or the variable costs with an additional markup to cover fixed costs. The primary advantage of this approach is that it is relatively simple to use. The disadvantage is that it understates the selling division’s contribution to the company’s total contribution margin. Finally, it reduces the selling division’s incentive to control cost.

*15.

The general formula for determining the minimum transfer price that the selling division should be willing to accept is: Minimum transfer price = Variable cost + Opportunity cost

*16.

When determining the minimum transfer price, the opportunity cost is the contribution margin that would be received if the goods were sold externally.

*17.

A company is likely to use a negotiated transfer price rather than a market-based price when the selling division has excess capacity, and is therefore eager to expand production, or when a market price does not exist (e.g., for a special order).

*18.

A company with divisions in different countries will set the transfer price so that more profit is allocated to the division located in the country with the lower tax rate. This is improper. The proper (and legal) treatment is to base the transfer price on the market value of the goods transferred.

*19.

The absorption-cost approach defines the cost base as manufacturing cost. Therefore, it excludes variable and fixed selling and administrative costs.

*20.

The markup percentage using variable-cost pricing would be: $3 + $9 = 75% $16

8-5

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 In order to obtain a profit of $15 per drive, Voorhees must set its target cost at $30 per drive ($45 – $15). It will then need to form a design team that will design a product that will meet quality specifications without exceeding the target cost.

BRIEF EXERCISE 8-2 Direct materials ....................................................................................... Direct labor .............................................................................................. Variable manufacturing overhead .......................................................... Fixed manufacturing overhead .............................................................. Variable selling and administrative expenses ....................................... Fixed selling and administrative expenses ........................................... Total unit cost ..................................................................................

$12 8 6 14 4 12 $56

Total unit cost + (Markup percentage X Total unit cost) = Target selling price $56 + (30% X $56) = $72.80

BRIEF EXERCISE 8-3 ROI per unit = =

(Total investment X Desired ROI percentage) Number of units ($10,000,000 X 16%) = $32 50,000

BRIEF EXERCISE 8-4 The markup percentage would be: $30 = 18.75% $36 + $24 + $18 + $40 + $14 + $28

8-6

BRIEF EXERCISE 8-5 The markup percentage is equal to Desired ROI per unit divided by total unit cost. The desired ROI per unit is computed as follows: Desired ROI per unit =

$1,500,000 X 24% =$36 10,000 units

The total unit cost is computed as follows: Total unit cost =

$1,100,000 + $100,000 =$120 10,000 units

The markup percentage is computed as follows: Desired ROI per unit $36 = = 30% Total unit cost $120 BRIEF EXERCISE 8-6 Rooney’s total bill would equal: (10.5 hours X $42) + $700 + ($700 X 40%) = $1,421 BRIEF EXERCISE 8-7 The minimum transfer price is equal to the division’s variable cost plus its opportunity cost. The opportunity cost is equal to its contribution margin on goods sold to external parties. Thus, the minimum transfer price in this case is: Minimum transfer price = $20 + ($45 – $20) = $45. BRIEF EXERCISE 8-8 If the division has excess capacity, then its opportunity cost is zero. In this case, the minimum transfer price is: Minimum transfer price = $20 + $0 = $20. .

8-7

BRIEF EXERCISE 8-9 The minimum transfer price is equal to the division’s variable cost plus its opportunity cost. In this case the minimum transfer price is: Minimum transfer price = $24 + ($45 – $20) = $49.

*BRIEF EXERCISE 8-10 The markup percentage using the absorption-cost approach is calculated by including only manufacturing costs in the cost base. Therefore, all costs related to selling and administration are excluded from the cost base and added back in the numerator. Markup percentage =

$30 + ($14 + $28) = 61.02% $36 + $24 + $18 + $40

*BRIEF EXERCISE 8-11 The markup percentage using variable-cost pricing is calculated by including only variable costs in the cost base. Therefore, all fixed costs are excluded from the cost base and added back in the numerator. Markup percentage =

$30 + ($40 + $28) = 106.52% $36 + $24 + $18 + $14

SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 8-1 The desired profit for this new product line is $360,000 ($2,000,000 X 18%) Each filter must result in $.36 of profit ($360,000/1,000,000 units) Market price – Desired profit = Target cost per unit $3 – $.36 = $2.64 per unit

8-8

DO IT! 8-2 Direct materials ............................................................... Direct labor ...................................................................... Variable manufacturing overhead ................................. Fixed manufacturing overhead ...................................... Variable selling and administrative expenses .............. Fixed selling and administrative expenses ................... Total unit costs ..........................................................

$18 9 5 6 3 7 $48

Total unit cost + (Total unit cost X Markup percentage) = Target selling price $48 + ($48 X 30%) = $62.40 DO IT! 8-3

Repair-technicians’ wages Fringe benefits Overhead

Total Cost / $120,000 40,000 50,000 $210,000

Total Hours = 5,000 5,000 5,000 5,000

Profit margin Rate charged per hour of labor Materials cost .............................................. Materials loading charge ($80 X 60%) ........ Total materials cost.....................................

$ 80 48 $128

Cost of dishwasher repair Labor costs ($62 X 1.5) ....................... Materials cost ...................................... Total repair cost ..........................................

$ 93 128 $221

Per Hour Charge $24 8 10 $42 20 $62

DO IT! 8-4 (a)

Minimum transfer price = Variable cost + $2.80 = $2.80 ($3 – $.20) +

Opportunity cost $0

(b)

Minimum transfer price = Variable cost + $7.80 = $2.80 ($3 – $.20) +

Opportunity cost $5 ($8 – $3)

8-9

SOLUTIONS TO EXERCISES EXERCISE 8-1 (a)

The target cost formula is: Target cost = Market price – Desired profit. In this case, the market price is $20 and the desired profit is $6 (30% X $20). Therefore the target cost is $14 ($20 – $6).

(b)

Target costing is particularly helpful when a company faces a competitive market. In this case, the price is affected by supply and demand, so no company in the industry can affect price. Therefore to earn a profit, companies must focus on controlling costs.

EXERCISE 8-2 The following formula may be used to determine return on investment Investment $8,000,000

X X

ROI percentage = Return on investment 20% = $1,600,000

Return on investment per unit is then $16 ($1,600,000 ÷ 100,000) The target cost is therefore $74 computed as follows: Target cost = Market price – Desired profit $74 = $90 – $16 EXERCISE 8-3 (a)

(1) In this case the selling price would be $120 ($100 + [$100 X 20%]). The problem with the $120 is that it is unlikely that Hannon will be able to sell any All-Body suits at that price. Market research seems to indicate that it will sell for only $100. (2) One way that Hannon might consider manufacturing the All-Body swimsuit is if it has excess capacity and therefore manufacturing the All-Body will not affect fixed costs. Thus if the company can cover its variable costs, it might want to sell at the $100 level.

(b)

In this case, the amount would be the selling price of $100.

8-10

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

EXERCISE 8-3 (Continued) (c)

The highest acceptable cost would be the target cost. The target cost is $80 as shown below: Target cost = Market price – Desired profit $80 = $100 – $20

EXERCISE 8-4 (a) Total cost per unit: Per Unit Direct materials .......................................................................... $17 Direct labor................................................................................. 8 Variable manufacturing overhead ............................................ 11 Fixed manufacturing overhead ($300,000/30,000) ................................................................... 10 Variable selling and administrative expenses ......................... 4 Fixed selling and administrative expenses ($150,000/30,000) ................................................................... 5 $55 (b) Target selling price = $55 + (40% X $55) = $77 EXERCISE 8-5 (a) Total cost per unit: Per Unit Direct materials .......................................................................... $ 7 Direct labor................................................................................. 9 Variable manufacturing overhead ............................................ 15 Fixed manufacturing overhead ($3,000,000/500,000) .............................................................. 6 Variable selling and administrative expenses ......................... 14 Fixed selling and administrative expenses ($1,500,000/500,000) .............................................................. 3 $54 (b) Desired ROI per unit = (25% X $26,000,000)/500,000 = $13

8-11

EXERCISE 8-5 (Continued) (c) Markup percentage using total cost per unit: $13 $54

= 24.07%

(d) Target selling price = $54 + ($54 X 24.07%) = $67 EXERCISE 8-6 (a)

Total cost per session: Direct materials ................................................. Direct labor ........................................................ Variable overhead.............................................. Fixed overhead ($950,000 ÷ 1,000) ................... Variable selling & administrative expenses..... Fixed selling & administrative expenses ($500,000 ÷ 1,000) .......................................... Total cost per session ...............................

Per Session $ 20 400 50 950 40 500 $1,960

(b)

Desired ROI per session = (20% X $2,352,000) ÷ 1,000 = $470.40

(c)

Mark-up percentage on total cost per session = $470.40 ÷ $1,960 = 24%

(d)

Target price per session = $1,960 + ($1,960 X 24%) = $2,430.40

EXERCISE 8-7 (a) Fixed manufacturing overhead per unit =

$1,800,000 = $600 per unit 3,000

Fixed selling and administrative = $324,000 = $108 per unit expenses per unit 3,000 (b) Desired ROI per unit =

8-12

20% X $51,000,000 = $3,400 per unit 3,000

EXERCISE 8-7 (Continued) (c) Direct materials .......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Fixed manufacturing overhead ................................................. Variable selling and administrative expenses ......................... Fixed selling and administrative expenses ............................. Total cost per unit...................................................................... Desired ROI per unit .................................................................. Target selling price ....................................................................

Per Unit $ 380 290 72 600 55 108 1,505 3,400 $4,905

EXERCISE 8-8 (a)

Total Cost Hourly labor rate for repairs Technician’s wages and benefits Overhead costs Office employee’s salary and benefits Other overhead

Total Per Hour ÷ Hours = Charge

$228,000 ÷

7,600

$30

38,000 ÷ 15,200 ÷ $281,200 ÷

7,600 7,600 7,600

= = =

5 2 37 30 $67

Profit margin Rate charged per hour of labor

(b)

Total Material Invoice Cost, Material Loading Parts and Loading Charges ÷ Materials = Percentage Overhead costs Parts manager’s salary and benefits Office employee’s salary and benefits Other overhead Profit margin Material loading percentage

8-13

$42,500 9,000 51,500 24,000 $75,500

÷ ÷ ÷

$400,000 $400,000 $400,000

= = =

12.875% 6.000% 18.875% 20.000% 38.875%

EXERCISE 8-8 (Continued) (c) Job: Pace Corporation—Rebuild spot welder Labor charges 40 hours @ $67 ........................................... Material charges Cost of parts and materials ........................ Material loading charge (38.875% X $2,000) ...................................

$2,680.00 $2,000.00 777.50

2,777.50

Total price of labor and material ..........

$5,457.50

EXERCISE 8-9 (a)

Total Cost Hourly labor rate for repairs Technician’s wages and benefits Overhead costs Office employee’s salary and benefits Other overhead

Total Per Hour ÷ Hours = Charge

$150,000 ÷

6,250

$24.00

28,000 ÷ 15,000 ÷ $193,000 ÷

6,250 6,250 6,250

= = =

4.48 2.40 30.88 38.00 $68.88

Profit margin Rate charged per hour of labor

(b)

8-14

$34,000 15,000 49,000

$700,000

7.00%

42,000 $91,000

÷ ÷

$700,000 $700,000

6.00% 13.00% 100.00% 113.00%

EXERCISE 8-9 (Continued) (c) Job: Buil Builders Labor charges 80 hours @ $68.88 ................................

$ 5,510.40

Material charges Cost of parts and materials.................. Material loading charge (113% X $40,000) ...............................

$40,000.00 45,200.00

85,200.00

Total price of labor and material ...

$90,710.40

EXERCISE 8-10 (a)

Total Cost Hourly labor rate: Restorers’ wages and fringes Overhead costs: Administrative salaries & fringes Other overhead costs Total hourly cost

Total Hours ÷

$270,000 ÷

12,000 =

$22.50

54,000 ÷

12,000 =

4.50

24,000 ÷ $348,000 ÷

12,000 = 12,000 =

2.00 $29.00

Profit margin = Hourly rate – total hourly cost = $70.00 – $29.00 = $41.00

8-15

Hourly = Charge

EXERCISE 8-10 (Continued) (b) Material Loading Charges Overhead costs: Purchasing agent’s salary and fringes Administrative salaries and fringes Other overhead costs Total

Total Invoice Cost, Parts & ÷ Materials

Material Loading = Percentage

$ 67,500 21,960 89,460 ÷

$1,260,000

7.10%

77,490 ÷ $166,950 ÷

$1,260,000 $1,260,000

= =

6.15% 13.25%

Material loading charge (with profit) Material loading charge (without profit) Profit margin on materials (c) Labor charges: 150 hours @ $70 Material charges: Cost of parts & materials Material loading charge ($60,000 X 83.25%) Total price of labor and materials

83.25% 13.25% 70.00% $ 10,500 $60,000 49,950

109,950 $120,450

EXERCISE 8-11 (a)

The minimum transfer price is: Minimum transfer price = Variable cost + opportunity cost Given that the Small Motor Division has excess capacity, the minimum transfer price is the variable cost of $9.00 per unit.

(b)

Given no excess capacity, the minimum transfer price is $30, which is its variable cost plus the lost contribution margin.

8-16

EXERCISE 8-11 (Continued) (c)

The level of capacity plays a significant role in determining the appropriate transfer price. If a division has no excess capacity, why should it sell its product below a selling price it can obtain in an outside market? Conversely, if it has excess capacity, as long as it receives more than its variable cost, it has a net gain.

EXERCISE 8-12 (a) As indicated, FrameBody has excess capacity and therefore should be willing to accept any price that equals or exceeds its variable cost. 1.

The effect on Cycle Division is as follows:

Selling price Variable cost of goods sold Body frame Other variable costs Contribution margin

Purchase from FrameBody $2,200

Present Situation $2,200 $300 900

1,200 $1,000

$280 900

1,180 $1,020

In this case, Cycle Division makes $20 ($1,020 – $1,000) more per cycle sold and therefore if it sells 1,000 cycles, it makes an additional $20,000. 2.

The effect on FrameBody is that it makes $10 on each frame sold as shown below: Selling price to Cycle Division Variable cost

$280 270 $ 10

Thus the FrameBody Division gains $10,000 ($10 X 1,000). 3.

8-17

As a result, the overall income for Ayala increases $30,000 ($20,000 from Cycle Division and $10,000 from FrameBody).

EXERCISE 8-12 (Continued) (b) 1.

The answer would not change from (a)(1). Cycle Division would gain $20,000 if it purchased the frames from FrameBody.

However, FrameBody would incur a loss of $70,000 as computed below: Selling price to outside buyer Selling price to Cycle Division Lost contribution margin per cycle Number of cycles Lost contribution margin

350 280 $ 70 X 1,000 $70,000

The effect on the overall income to Ayala is a net loss of $50,000 as shown below: Cycle Division gain Frame Body loss Overall loss

$20,000 70,000 ($50,000)

EXERCISE 8-13 (a) The minimum transfer price that Venetian should accept is: Minimum transfer price = ($35 – $4) + ($86 – $35) = $82 (b) The lost contribution margin per unit to the company is: Contribution margin lost by Venetian [($86 – $35) – $4] ....... Increased contribution margin to vehicle division ($80 – $35) ................................................. Net loss in contribution margin...............................................

$47 45 $ 2

Total lost contribution margin is $2 X 200,000 units = $400,000 (c) If management insists that it wants Venetian to provide the stereo units, and Venetian is operating at full capacity, then it must be willing to pay the minimum transfer price for those units. Otherwise it will be penalizing the managers of Venetian by not giving them adequate credit for their contribution to the corporation’s contribution margin.

8-18

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

EXERCISE 8-14 The minimum transfer price on this special order would be: Minimum transfer price = ($140 – $6) + ($50 – $29) = $155. Since the $160 price offered by the Bathtub Division exceeds this minimum price, the offer should probably be accepted. However, given that the division is operating at full capacity, it should give some consideration to the chance that it may anger existing customers if it has to turn away business. EXERCISE 8-15 (a) Minimum transfer price = ($130 – $6) + $0 = $124 (b) Minimum transfer price = ($130 – $6) + ($162 – $130) = $156 (c) No. By forcing the Appraisal Department to accept the $150 per appraisal price, management is penalizing the Appraisal department. If the department was allowed to sell its services to outside customers, it could earn $32 ($162 – $130) in contribution margin per appraisal. Forcing them to sell their services internally would allow them to earn only $26 ($150 – $124) in contribution margin. A loss of $6 per appraisal or a total of $7,200 (1,200 X $6) would result. EXERCISE 8-16 (a) The minimum transfer price for Division B would be variable costs, which are $6 per unit ($7, variable cost – $1, variable selling expense). The maximum price would be the external price paid by Division A, which is $10 per unit. (b) Minimum transfer price = variable costs + opportunity cost Variable costs = $6 (as in (a)) Opportunity cost = (($7 – $5) X 15,000) ÷ 10,000 = $3 Therefore the minimum transfer price should be $9 ($6 + $3) The maximum price would still be the external price paid by Division A, which is $10 per unit.

8-19

EXERCISE 8-16 (Continued) (c) Minimum transfer price = variable costs + opportunity cost Variable costs = $6.00 (as in (a)) Opportunity cost = (($12 – $7) X 5,000) ÷ 15,000 = $1.67 Therefore the minimum transfer price should be $7.67 ($6 + $1.67) The maximum price would still be the external price paid by Division A, which is $10 per unit. EXERCISE 8-17 (a) Sales Less: Costs Variable costs Transfer costs Total costs Contribution to income

Division A $1,500

Division B $2,400

Total Company $3,900

$1,050 0 $1,050 $ 450

$1,200 1,500 $2,700 $ (300)

$2,250 1,500 $3,750 $ 150

(b) The opportunity cost is the market price. Transfers should be made at market prices less any avoidable costs. In the current situation, it would appear that no transfers would be made. (c) (i) (ii)

Maintain price, no transfers (500 X $1,500) – ($500 X $1,050) = $225,000 Cut price, no transfers (1,000 X $1,200) – ($1,000 X $1,050) = $150,000

(iii) Maintain price and transfers (500 X $2,400) + (500 X $1,500) – $1,650,000* = $300,000 *(500 X $2,250) + (500 X $1,050) The firm is better off by maintaining the current market price for Division A’s product and transferring 500 units to Division B. A transfer price within the range of $1,050 to $1,200 would be needed to motivate both divisional managers to engage in the transfers. An optimal transfer price cannot be determined from the information given (even with full information, the best transfer price in the range may not be determinable). 8-20

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

*EXERCISE 8-18 (a) Cost per unit: Direct materials .......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Fixed manufacturing overhead ($3,000,000/500,000) .............. Variable selling and administrative expenses ......................... Fixed selling and administrative expenses ($1,500,000/500,000) ..............................................................

Per Unit $ 7 9 15 6 14 3 $54

(b) Desired ROI per unit = (25% X $26,000,000)/500,000 = $13 (c) Absorption-cost pricing markup percentage

(d) Variable-cost pricing markup percentage

$13 + ($6 + $3) = 48.89% ($7 + $9 + $15 + $14)

$13 + ($14 + $3) = 81.08% ($7 + $9 + $15 + $6)

*EXERCISE 8-19 (a) The cost base of absorption-cost pricing includes only manufacturing costs. All selling and administrative costs are excluded from the cost base and are added back in the numerator of the markup percentage. Absorption-cost pricing markup percentage

$20 + ($9 + $11) = 50% ($20 + $25 + $14 + $21)

(b) The cost base of variable-cost pricing includes only variable costs. All fixed costs are excluded from the cost base and are added back in the numerator of the markup percentage. Variable-cost pricing markup percentage

8-21

$20 + ($21 + $11) = 76.47% ($20 + $25 + $14 + $9)

*EXERCISE 8-20 (a) Fixed manufacturing $1,800,000 = = $600 per unit overhead per unit 3,000 Fixed selling and administrative $324,000 = = $108 per unit expenses per unit 3,000

(b) Desired ROI per unit =

(c)

20% X $51,000,000 = $3,400 per unit 3,000

Absorption-cost pricing $3,400 + ($55 + $108) = = 265.499% markup percentage $380 + $290 + $72 + $600 Target selling price = $1,342 + ($1,342 X 265.499%) = $4,905

(d) Variable-cost pricing markup percentage

$3,400 + ($600 + $108) = 515.433% $380 + $290 + $72 + $55

Target selling price = $797 + ($797 X 515.433%) = $4,905

8-22

SOLUTIONS TO PROBLEMS PROBLEM 8-1A

(a) Direct materials .......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Variable selling and administrative expenses ......................... Variable cost per unit ................................................................

Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit

$20 40 10 5 $75

Total Budgeted Cost Costs ÷ Volume = Per Unit $1,440,000 ÷ 80,000 = $18 960,000 ÷ $2,400,000 ÷

80,000 80,000

= =

Variable cost per unit ................................................................ Fixed cost per unit ..................................................................... Total cost per unit......................................................................

12 $30 $ $

75 30 105

(b) Total cost per unit...................................................................... Markup ........................................................................................ Desired ROI per unit ..................................................................

$ 105 X 30% $ 31.50

(c) Total cost per unit...................................................................... Desired ROI per unit .................................................................. Target selling price ....................................................................

$105.00 31.50 $136.50

(d) Variable cost per unit ......... Fixed cost per unit .............. Total cost per unit...............

8-23

$ 75 40 $115

(same as above) ($1,440,000 + $960,000) ÷ 60,000

PROBLEM 8-2A

(a) Direct materials ......................................................................... Direct labor ................................................................................ Variable manufacturing overhead ........................................... Variable selling and administrative expenses ........................ Variable cost per unit ...............................................................

Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit

$ 50 26 20 19 $115

Total Budgeted Cost Costs ÷ Volume = Per Unit $ 600,000 ÷ 50,000 = $12 400,000 ÷ $1,000,000 ÷

50,000 50,000

= =

Variable cost per unit ............................................................... Fixed cost per unit .................................................................... Total cost per unit ..................................................................... Desired ROI per unit =

25% X $1,000,000 = $5 50,000

Markup percentage =

$5 $135

8 $20 $115 20 $135

= 3.70%

Total cost per unit ..................................................................... Desired ROI per unit ................................................................. Target selling price ................................................................... (b) Variable cost per unit .............................................

$135 5 $140

$115 (same as (a))

Total Budgeted Cost Costs ÷ Volume = Per Unit $ 600,000 ÷ 40,000 = $15

Fixed manufacturing overhead Fixed selling and administrative expenses 400,000 ÷ Fixed cost per unit $1,000,000 ÷

8-24

40,000 40,000

10 $25

PROBLEM 8-2A (Continued) Variable cost per unit ................................................................ Fixed cost per unit ..................................................................... Total cost per unit...................................................................... Desired ROI per unit = Markup percentage =

25% X $1,000,000 = $6.25 40,000

$6.25 = 4.46% $140

Total cost per unit...................................................................... Desired ROI per unit .................................................................. Target selling price ....................................................................

8-25

$115 25 $140

$140.00 6.25 $146.25

PROBLEM 8-3A

(a) Computation of time charge rate Total Cost Hourly labor rate for repairs Shop employees’ wages and benefits Overhead costs Office employee’s salary and benefits Other overhead Total Profit margin Rate charged per hour of labor

Total Per Hour ÷ Hours = Charge

$108,000 ÷ 5,000 =

$21.60

23,500 ÷ 5,000 = 26,000 ÷ 5,000 = $157,500 ÷ 5,000 =

4.70 5.20 31.50 5.00 $36.50

(b) Computation of material loading charge Material Material Loading Total Invoice Cost, Loading Charges ÷ Parts and Materials = Percentage Overhead costs Parts manager’s salary and benefits Office employee’s salary and benefits Other overhead Total Profit margin Material loading percentage

8-26

$25,400 13,600 39,000 ÷ 16,000 ÷ $55,000 ÷

$100,000 100,000 100,000

= = =

39% 16% 55% 30% 85%

PROBLEM 8-3A (Continued) (c) Price quotation for time and material JOSE’S ELECTRONIC REPAIR SHOP Time and Material Price Quotation January 5, 2014 Job: Fix big screen TV set Labor charges: 5 hours @ $36.50 .................... Material charges Cost of parts and materials......................... Material loading charge (85% X $200) ........ Total price of labor and material.......................

8-27

$182.50 $200 170

370.00 $552.50

PROBLEM 8-4A

(a) Assuming no available capacity, the printing operation’s variable cost is $0.004 per page and its opportunity cost is $0.006 ($0.01 – $0.004) per page. The minimum transfer price would be $0.01 ($0.004 + $0.006). Therefore, the printing operation would not accept the internal transfer price of $0.007. (b) Assuming that the printing operation has available capacity, the printing operation’s variable cost is $0.004 and its opportunity cost is $0. The minimum transfer price would be $0.004 ($0.004 + $0). Therefore, in this case, the printing operation should accept the offer to print internally. The $0.007 transfer price would provide a contribution margin of $0.003 ($0.007 – $0.004) per page. Depending on its bargaining strength, the printing operation might want to ask for a transfer price higher than $0.007, since the company is saving money at any price below the $0.009 price that the line pays to outside printers. (c) The advantages of having all of the company’s printing done internally include: (1) ensuring that the company’s quality expectations are met, (2) ensuring that all projects are completed on a timely basis, and (3) ensuring that jobs are scheduled in a manner consistent with the company’s priorities. The primary disadvantages of forcing the printing operation to print internal work when it doesn’t feel it is in its best interest are: (1) the division manager loses control over the division’s performance, resulting in a loss of morale, and (2) the profitability of the division, as well as the company as a whole, will decline. (d) The printing operation would lose: ($0.01 – $0.007) X 500 pages X 1,500 copies

= ($2,250)

Business Books would save: ($0.009 – $0.007) X 500 pages X 1,500 copies = Overall loss to the company as a whole

8-28

1,500

= ($ 750)

PROBLEM 8-5A

(a) The minimum transfer price is based on the variable cost of units transferred internally, plus the opportunity cost of units sold externally. The variable cost of internal sales would be $10 ($14.50 – $4.50). The opportunity cost would be $8 ($22.50 – $14.50). Therefore, the minimum transfer price would be $18 ($10 + $8). Since the $20 transfer price offered by the Board Division exceeds this minimum transfer price, the Chip Division should sell the chip internally. Since it is already at capacity, it probably needs to consider the implications to its existing customers. (b) If the Chip Division rejects the offer, each division will suffer a loss of contribution margin, as well as the company as a whole. The amount of this loss is calculated as: Lost contribution margin by Board Division: Cost of buying externally, per chip Cost of buying internally, per chip Increased cost, resulting in lower unit contribution margin Number of units purchased Total lost contribution margin

$22 20 2 X 30,000

Lost contribution margin by Chip Division: Unit contribution margin on internal sales ($20 – $10) $10 Unit contribution margin on external sales ($22.50 – $14.50) 8 Lost unit contribution margin 2 Number of units sold X 30,000 Total lost contribution margin Overall lost contribution margin for the company

8-29

$ 60,000

60,000 $120,000

PROBLEM 8-6A

(a) Assuming no available capacity, and that the number of new units produced would be equal to the number of standard units forgone, variable cost of the special pager would be $80 ($50 + $30) and the opportunity cost would be $45 ($95 – $50). Therefore, the minimum transfer price would be $125 ($80 + $45). Since this is higher than the $105 transfer price, the CD Division should reject the offer. (b) Assuming no available capacity, and that in order to produce the 12,000 special pagers, 16,000 standard pagers would be forgone, the minimum variable cost would be ($50 + $30) or $80 and the opportunity cost would be: Total contribution margin on standard pagers ($95 – $50) X 16,000 = = $60 Number of special pagers 12,000

Therefore, the minimum transfer price would be $140 [($50 + $30) + $60]. Since the $150 transfer price being offered exceeds the minimum transfer price of $140, the CD Division should accept the offer. (c) Assuming that the CD Division has available capacity, variable cost would be $80 ($50 + $30) and the opportunity cost would be zero. Therefore, the minimum transfer price would be $80 ($80 + $0). Since the $100 transfer price being offered exceeds the $80 minimum transfer price, the offer should be accepted.

8-30

*PROBLEM 8-7A

(a) Absorption-cost pricing: Computation of unit manufacturing cost and target selling price Direct materials ......................................................................... Direct labor................................................................................ Variable manufacturing overhead ........................................... Fixed manufacturing overhead ($1,200,000 ÷ 80,000) ............ Unit manufacturing cost ................................................... Markup: 50% X $85.00 ............................................................. Target selling price ...................................................................

$ 20.00 40.00 10.00 15.00 85.00 42.50 $127.50

The markup of $42.50 per unit must cover selling and administrative expenses (variable and fixed) plus provide a desired return on investment. (b) Variable-cost pricing: Computation of total variable cost and target selling price Direct materials ......................................................................... Direct labor................................................................................ Variable manufacturing overhead ........................................... Variable selling and administrative expenses ........................ Unit total variable cost ...................................................... Markup: 70% X $75 .................................................................. Target selling price ...................................................................

$ 20.00 40.00 10.00 5.00 75.00 52.50 $127.50

The markup of $52.50 per unit must cover fixed manufacturing and fixed selling and administrative costs plus provide a desired return on investment.

8-31

*PROBLEM 8-8A

Absorption-cost pricing (a) Step one—Computation of unit manufacturing cost: Direct materials ........................................................................ Direct labor ............................................................................... Variable manufacturing overhead .......................................... Fixed manufacturing overhead ($120,000 ÷ 4,000) ................ Total manufacturing cost.................................................

Per Unit $100 70 20 30 $220

Step two—Computation of markup percentage to provide a 25% ROI: Markup [(25% X $1,016,000) ÷ 4,000] + [$10 + ($102,000 ÷ 4,000)] $99 = = = 45% Percentage $220 $220

(b) Step three—Computation of target price: Target price: $220 + [45% X $220) = $319 Proof of 25% ROI under absorption-cost pricing: ANDERSON WINDOWS INC. Budgeted Absorption-Cost Income Statement (Tinted Window) Revenues (4,000 units X $319) ........................................ Cost of goods sold (4,000 units X $220) ......................... Gross profit ...................................................................... Selling and administrative expenses [(4,000 units X $10) + $102,000] .................................. Net income ....................................................................... Desired ROI =

$254,000 = 25% $1,016,000

Markup percentage = *$220 X 4,000

8-32

$254,000 + $142,000 = 45% *$880,000*

$1,276,000 880,000 396,000 142,000 $ 254,000

*PROBLEM 8-8A (Continued) Variable-cost pricing (c) Step one—Computation of unit variable cost: Direct materials ...................................................................... Direct labor............................................................................. Variable manufacturing overhead ........................................ Variable selling and administrative expenses ............................................................................ Total variable cost..........................................................

Per Unit $100 70 20 10 $200

Step two—Computation of markup percentage to provide a 25% ROI: Markup [(25% X $1,016,000) ÷ 4,000] + [($120,000 + $102,000) ÷ 4,000] $119 = = = 59.50% Percentage $200 $200

(d) Step three—Computation of target price: Target price: $200 + (59.5% X $200) = $319 Proof of 25% ROI under variable-cost pricing: ANDERSON WINDOWS INC. Budgeted Variable-Cost Income Statement (Tinted Window) Revenue (4,000 units X $319) ............................ Variable costs (4,000 units X $200) .................. Contribution margin .......................................... Fixed costs Fixed manufacturing overhead costs........... Fixed selling and administrative expenses.... Net income ......................................................... Desired ROI =

8-33

$120,000 102,000

$254,000 = 25% $1,016,000

Markup percentage =

$1,276,000 800,000 476,000

$222,000 + $254,000 = 59.5% $800,000

222,000 $ 254,000

*PROBLEM 8-8A (Continued) (e) Both absorption-cost pricing and variable-cost pricing are used because they have differing merits. Absorption-cost pricing, especially when it includes full or all costs, is preferred by some because in the long-run all costs plus a normal profit margin must be covered. Using only variable costs, as the variable-cost pricing does, is thought to encourage decision makers to set too low a price in order to boost sales. Also, absorption-cost pricing is preferred because of its convenience. Absorption-cost data is more readily provided by most companies’ financial and cost accounting systems. The accounts and numbers used to prepare financial reports can be used for absorption-cost pricing. Variable-cost pricing is preferred by some, even though the basic accounting data is less accessible, because it is more consistent with cost-volume-profit analysis. In addition, it can be used in pricing special orders since it shows the incremental cost of one more unit or one more order. Variable-cost pricing also avoids arbitrary allocation of common fixed costs to individual product lines.

8-34

PROBLEM 8-1B

Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit

$ 8 14 7 6 $35

Total Budgeted Cost Costs ÷ Volume = Per Unit $2,000,000 ÷ 100,000 = $20 1,200,000 ÷ $3,200,000 ÷

100,000 = 100,000 =

12 $32 $ $

35 32 67

$ 67 X 30% $20.10

$67.00 20.10 $87.10

(d) Variable cost per unit ........... Fixed cost per unit ................ Total cost per unit.................

8-35

$35 40 $75

(same as above) ($2,000,000 + $1,200,000) ÷ 80,000

PROBLEM 8-2B

Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit

$30 20 17 8 $75

Total Budgeted Cost Costs ÷ Volume = Per Unit $2,500,000 ÷ 100,000 = $25 500,000 ÷ 100,000 $3,000,000 ÷ 100,000

= =

5 $30 $ 75 30 $105

Desired ROI per unit = 30% X $3,000,000 = $9 100,000 Markup percentage =

$9 $105

= 8.57%

$105 9 $114

$75 (same as (a))

Total Budgeted Cost Costs ÷ Volume = Per Unit $2,500,000 ÷ 80,000 = $31.25

Fixed manufacturing overhead Fixed selling and administrative expenses 500,000 ÷ Fixed cost per unit $2,900,000

8-36

80,000 80,000

6.25 $37.50

PROBLEM 8-2B (Continued) Variable cost per unit ................................................................ Fixed cost per unit ..................................................................... Total cost per unit...................................................................... Desired ROI per unit =

30% X $3,000,000 = $11.25 80,000

Markup percentage =

$11.25 = 10% $112.50

8-37

$ 75.00 37.50 $112.50

$112.50 11.25 $123.75

PROBLEM 8-3B

Total Hours

Per Hour Charge

$36,000 ÷ 2,500 =

$14.40

15,000 ÷ 2,500 = 19,000 ÷ 2,500 = $70,000 ÷ 2,500 =

6.00 7.60 28.00 5.00 $33.00

(b) Computation of material loading charge Material Loading Charges Overhead costs Parts supervisor’s salary and benefits Office employee’s salary and benefits Other overhead Total Profit margin Material loading percentage

8-38

Material Loading Percentage

Total Invoice Cost, Parts and Materials

$20,000 10,000 30,000 ÷ 15,000 ÷ $45,000 ÷

$75,000 75,000 75,000

= = =

40.00% 20.00% 60.00% 15.00% 75.00%

PROBLEM 8-3B (Continued) (c) Price quotation for time and material ARMSTRONG BIKE REPAIR SHOP Time and Material Price Quotation Job: Fix Superior Mountain bike Labor charges: 4 hours @ $33................ Material charges Cost of parts and materials................ Material loading charge (75% X $200)..................................... Total price of labor and material..............

8-39

$132.00 $200.00 150.00

350.00 $482.00

PROBLEM 8-4B

(a) Assuming no available capacity, the printing operation’s variable cost is $0.014 per page and its opportunity cost is $0.011 ($0.025 – $0.014) per page. The minimum transfer price would be $0.025 ($0.014 + $0.011). Therefore, the printing operation would not accept the internal transfer price of $0.016. (b) Assuming that the printing operation has available capacity, the printing operation’s variable cost is $0.014 and its opportunity cost is $0. The minimum transfer price would be $0.014 ($0.014 + $0). Therefore, in this case, the printing operation should accept the offer to print internally. The $0.016 transfer price would provide a contribution margin of $0.002 ($0.016 – $0.014) per page. Depending on its bargaining strength, the printing operation might want to ask for a transfer price higher than $0.016, since the company is saving money at any price below the $0.018 price that the line pays to outside printers. (c) The advantages of having all of the company’s printing done internally include: (1) ensuring that the company’s quality expectations are met, (2) ensuring that all projects are completed on a timely basis, and (3) ensuring that jobs are scheduled in a manner consistent with the company’s priorities. The primary disadvantages of forcing the printing operation to print internal work when it doesn’t feel it is in its best interest are: (1) the division manager loses control over the division’s performance, resulting in a loss of morale, and (2) the profitability of the division, as well as the company as a whole, will decline. (d) The printing operation would lose: ($0.025 – $0.016) X 64 pages X 20,000 copies = ($11,520) Winner! would save: ($0.018 – $0.016) X 64 pages X 20,000 copies = Overall loss to the company as a whole

8-40

2,560

= ($ 8,960)

PROBLEM 8-5B

(a) The minimum transfer price is based on the variable cost of units transferred internally, plus the opportunity cost of units sold externally. The variable cost of internal sales would be $0.14 ($0.18 – $0.04). The opportunity cost would be $0.12 ($0.30 – $0.18). Therefore, the minimum transfer price would be $0.26 ($0.14 + $0.12). Since the $0.26 transfer price offered by the Alto Division equals this minimum transfer price, the Peg Division would be indifferent. Since it is already at capacity, it probably needs to consider the implications to its existing customers. (b) If the Peg Division rejects the offer, the Alto division will suffer a loss of contribution margin, as well as the company as a whole. The amount of this loss is calculated as: Lost contribution margin by Alto Division: Cost of buying externally, per Peg Cost of buying internally, per Peg Increased cost, resulting in lower unit contribution margin Number of units purchased Total lost contribution margin

$0.28 0.26 0.02 X200,000

Lost contribution margin by Peg Division: Unit contribution margin on internal sales ($0.26 – $0.14) $0.12 Unit contribution margin on external sales ($0.30 – $0.18) 0.12 Lost unit contribution margin 0.00 Number of units sold X200,000 Total lost contribution margin Overall lost contribution margin for the company

8-41

$ 4,000

–0– $ 4,000

PROBLEM 8-6B

(a) Assuming no available capacity, and that the number of new units produced would be equal to the number of standard units forgone, variable cost of the special circuit board would be $50 ($30 + $20) and the opportunity cost would be $24 ($54 – $30). Therefore, the minimum transfer price would be $74 ($50 + $24). Since this is higher than the $62 transfer price, the LT Division should reject the offer. (b) Assuming no available capacity, and that in order to produce the 200,000 circuit boards, 250,000 standard circuit boards would be forgone, the minimum variable cost would be ($30 + $20) or $50 and the opportunity cost would be: Total contribution margin on circuit boards Number of circuit boards

($54 – $30) X 250,000 200,000

= $30

Therefore, the minimum transfer price would be $80 [($30 + $20) + $30]. Since the $90 transfer price being offered exceeds the minimum transfer price of $80, the LT Division should accept the offer. (c) Assuming that the LT Division has available capacity, variable cost would be $50 ($30 + $20) and the opportunity cost would be zero. Therefore, the minimum transfer price would be $50 ($50 + $0). Since the $62 transfer price being offered exceeds the $50 minimum transfer price, the offer should be accepted.

8-42

*PROBLEM 8-7B

(a) Absorption-cost pricing: Computation of unit manufacturing cost and target selling price Direct materials ......................................................................... Direct labor................................................................................ Variable manufacturing overhead ........................................... Fixed manufacturing overhead ($8,000,000 ÷ 250,000) .......... Unit manufacturing cost ................................................... Markup: 60% X $125 ................................................................ Target selling price ...................................................................

$ 50 30 13 32 125 75 $200

The markup of $75 per unit must cover selling and administrative expenses (variable and fixed) plus provide a desired return on investment. (b) Variable-cost pricing: Computation of total variable cost and target selling price Direct materials ......................................................................... Direct labor................................................................................ Variable manufacturing overhead ........................................... Variable selling and administrative expenses ........................ Unit total variable cost ...................................................... Markup: 100% X $100 .............................................................. Target selling price ...................................................................

$ 50 30 13 7 100 100 $200

The markup of $100 per unit must cover fixed manufacturing and fixed selling and administrative costs plus provide a desired return on investment.

8-43

*PROBLEM 8-8B

Absorption-cost pricing (a) Step one—Computation of unit manufacturing cost: Direct materials ........................................................................ Direct labor ............................................................................... Variable manufacturing overhead .......................................... Fixed manufacturing overhead ($1,400,000 ÷ 20,000) ........... Total manufacturing cost.................................................

Per Unit $200 100 30 70 $400

Step two—Computation of markup percentage to provide a 25% ROI: Markup [(25% X $20,000,000) ÷ 20,000] + [$20 + ($200,000 ÷ 20,000)] = = Percentage $400

$280 $400

= 70%

(b) Step three—Computation of target price: Target price: $400 + [70% X $400) = $680 Step four—Proof of 25% ROI under absorption-cost approach: GEORGIA GOULD BIKES INC. Budgeted Absorption-Cost Income Statement (Mountain Bike) Revenues (20,000 units X $680) ...................................... Cost of goods sold (20,000 units X $400) ....................... Gross profit ...................................................................... Selling and administrative expenses [(20,000 units X $20) + $200,000]................................. Net income ....................................................................... Desired ROI =

$5,000,000 = 25% $20,000,000

Markup percentage = *$400 X 20,000

8-44

$5,000,000 + $600,000 = 70% *$8,000,000*

$13,600,000 8,000,000 5,600,000 600,000 $ 5,000,000

*PROBLEM 8-8B (Continued) Variable-cost pricing (c) Step one—Computation of unit variable cost: Direct materials ...................................................................... Direct labor............................................................................. Variable manufacturing overhead ........................................ Variable selling and administrative expenses ............................................................................ Total variable cost..........................................................

Per Unit $200 100 30 20 $350

Step two—Computation of markup percentage to provide a 25% ROI: Markup [(25% X $20,000,000) ÷ 20,000] + [($1,400,000 + $200,000) ÷ 20,000] $330 = = = 94.3% Percentage $350 $350

(d) Step three—Computation of target price: Target price: $350 + (94.3% X $350) = $680 Step four—Proof of 25% ROI under variable-cost pricing: GEORGIA GOULD BIKES INC. Budgeted Variable-Cost Income Statement (Mountain Bike) Revenue (20,000 units X $680) ................... Variable costs (20,000 units X $350) ......... Contribution margin ................................... Fixed costs Manufacturing ......................................... $1,400,000 Selling and administrative ..................... 200,000 Net income .................................................. Desired ROI =

$5,000,000 = 25% $20,000,000

Markup percentage =

8-45

$1,600,000 + $5,000,000 = 94.3% $7,000,000

$13,600,000 7,000,000 6,600,000 1,600,000 $ 5,000,000

*PROBLEM 8-8B (Continued) (e) Both absorption-cost pricing and variable-cost pricing are used because they have differing merits. Absorption-cost pricing, especially when it includes full or all costs, is preferred by some because in the long-run all costs plus a normal profit margin must be covered. Using only variable costs, as the variable-cost pricing does, is thought to encourage decision makers to set too low a price in order to boost sales. Also, absorption-cost pricing is preferred because of its convenience. Absorption-cost data is more readily provided by most companies’ financial and cost accounting systems. The accounts and numbers used to prepare financial reports can be used for absorption-cost pricing. Variable-cost pricing is preferred by some, even though the basic accounting data is less accessible, because it is more consistent with cost-volume-profit analysis. In addition, it can be used in pricing special orders since it shows the incremental cost of one more unit or one more order. Variable-cost pricing also avoids arbitrary allocation of common fixed costs to individual product lines.

8-46

BYP 8-1

DECISION-MAKING AT CURRENT DESIGNS

Repair-technician’s wages Fringe benefits Overhead

Total Cost $30,000 10,000 10,000 $50,000

Total Hours 2,000 2,000 2,000 2,000

Profit margin Rate charged per hour of labor Job: Composite kayak repair Labor charges: 3 hours @ $45 Materials charges Cost of parts and materials Materials loading charge (50% X $100) Total price of labor and material

8-47

$135 $100 50

150 $285

Per Hour Charge $15 5 5 25 20 $45

BYP 8-2

DECISION-MAKING ACROSS THE ORGANIZATION

(a) Purchasing goods from within the company offers a number of advantages. (1) It cuts out the “middle man,” thus keeping all profits in the company. (2) It allows the company to have more control over the quality of its products. (3) It allows the company to have more control over the timing of production and shipments. (4) It keeps the company running closer to full capacity. (b) Frequently the buying division will be required to buy from within the company as long as the selling division can provide goods of comparable quality and price. A selling division should not normally be forced to sell to an internal division if it doesn’t want to. If top management really wants the division to sell internally, it should provide proper financial incentives to make it in the division’s best interest to sell internally. (c) The Wheel division would find this desirable. It would be able to get higher quality bearings at a cost savings of $3 per set. The Bearing division would find this very undesirable. Instead of making a profit of $14 ($36 – $22) per set, it would just be breaking even. The overall company would be worse off because it would be losing $14 per set of profit and only making $3 per set of savings. Thus, it would be $11 worse off per set. (d) One possible solution is to continue on with the current situation. As pointed out in (c), the current situation is clearly better than forcing the Bearing division to sell its high quality bearings to a division that doesn’t need the quality. A second possible solution is for the Bearing division to begin to manufacture a lower quality bearing that would be suitable for the Wheel division. Given that the Bearing division is currently operating at full capacity, this would only make sense if the Bearing division would still maintain the same profit per set. It would either have to give up business to existing customers or expand capacity.

8-48

BYP 8-3

MANAGERIAL ANALYSIS

(a) Dave must consider a number of issues in arriving at a price. First, he should gather information regarding what price people would be willing to pay for his type of service. This information could be gathered by a marketing agency. He must consider the strengths and weaknesses of his product. First, he is closer to housing, thus more convenient. Two, his service is easier, especially when compared to the “self-spray” service. Also, his service is safer for the car than the “brush” type service offered at the gas station. Furthermore, he offers a higher level of service for those interested in really taking care of their cars. He has initially decided to offer only three levels of service. He may ultimately decide to offer additional different levels of service. Often businesses will promote their least expensive service and then try to “sell the customer up” to a higher level of service when they drive in. Also, humans are creatures of habit. It would probably be wise for Dave to offer an introductory-type price in the early months in order to get people used to coming to his car wash. He may also want to offer promotions, such as coupon books, and the option of purchasing multiple washes in advance. (b) Variable cost per unit

Direct materials Direct labor Variable overhead Variable selling and administrative expenses

Basic Wash $0.30 0.00 0.10

Deluxe Wash $0.80 0.40 0.20

Premium Wash $1.10 2.40 0.20

0.10 $0.50

0.10 $1.50

0.10 $3.80

Fixed cost per unit

Fixed overhead Fixed selling and administrative expenses Fixed cost per unit

8-49

Total Budgeted Cost Costs ÷ Volume = Per Unit $117,000 45,000 $2.60 130,500

45,000

2.90 $5.50

BYP 8-3 (Continued) Computation of selling price (45,000 units)

Variable cost per unit Fixed cost per unit Total unit cost Desired ROI per unit* Selling price

Basic $0.50 5.50 6.00 1.75 $7.75

Deluxe $1.50 5.50 7.00 1.75 $8.75

Premium $ 3.80 5.50 9.30 1.75 $11.05

*($393,750 X .20) ÷ 45,000 (c) Revenues Basic 3,000 Deluxe 31,000 Premium 9,000 Total revenues Variable expenses Basic 3,000 Deluxe 31,000 Premium 9,000 Total variable expenses Contribution margin Fixed expenses ($117,000 + $130,500) Net income

X $ 7.75 = $ 23,250 X $ 8.75 = 271,250 X $11.05 = 99,450 $393,950 X $ 0.50 = $ 1,500 X $ 1.50 = 46,500 X $ 3.80 = 34,200 82,200 311,750 247,500 $ 64,250

ROI = $64,250 ÷ $393,750 = 16.32%

(d) Clearly, the basic wash does not use much of the more complex capabilities of the equipment. The equipment is expensive and the overhead related to depreciation would be a big component of the fixed cost. Therefore, the accuracy of the product cost would be significantly improved with an activity-based costing approach. It would appear that the traditional approach of overhead allocation resulted in product costs (and consequently prices) that were too high for the basic wash and too low for the premium.

8-50

BYP 8-4

REAL-WORLD FOCUS

(a) Pricing in the pharmaceutical industry is complicated by a number of factors: 1.

When a new drug is developed, it is patented. This protects the company from competition for a period of time and allows the company to charge a higher price.

The nature of the product is such that demand is relatively inelastic. If a person needs a drug that will dramatically improve his health, he will pay as much as he can afford to acquire it.

In light of 2., pharmaceutical companies must be careful not to charge so much that they are perceived as gouging their customers. If they do, the public will call for regulation and oversight of the industry by the government.

Many prescription drugs are paid for by health insurance policies. This complicates matters since it makes the user of the drug insensitive to price, but makes the ultimate payer (the insurance company) very sensitive to price. That is why insurance companies and health maintenance organizations are constantly questioning whether certain treatments and prescriptions are medically necessary.

The pharmaceutical industry is heavily regulated worldwide. However, the regulations differ significantly from country to country.

(b) Normally, if a difference exists in the price of a product across markets, that difference will be eliminated as people take advantage of the difference by shipping the goods. Eventually, the difference should be equal to the cost of transporting and selling from one market to another. However, in the pharmaceutical industry, barriers exist which allow significant differences in price to persist. For example, it is often illegal to transport prescription drugs from one country to another. Some drugs are illegal in one country and not another. Prices may also differ due to relaxed oversight in one country versus another that reduces the production costs. The extreme case of price differentiation exists when the same drug is used for humans and pets. Customers might be willing to pay $500 per dose for a critical drug for themselves, but only $50 for a pet.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

8-51

BYP 8-4 (Continued) (c) In arriving at a price for a drug, the company would need to take into account market factors as well as its costs. Ultimately, the price will be arrived at through a combination of cost-plus pricing, market considerations, and consideration of the other factors discussed in (a). When considering its costs, it will also have to consider the cost of unsuccessful research. That is, eventually, it must cover the cost of both its successful and unsuccessful research projects. In determining what the market will be willing to pay, the company must consider what other treatments are available and what those cost, and how the effectiveness of this product compares to those.

8-52

BYP 8-5

REAL-WORLD FOCUS

(a) Answers will vary. (b) One concern is the security of providing credit card information over the Internet. While most security issues related to payment have been addressed, it still remains a threat. In addition, many people have concerns about lost privacy when they give out information, such as credit information, over the Internet. (c) In the same way that sometimes consumers will choose a brick-andmortar retailer even though its prices are higher, the same is true of the Web. For brick-and-mortar stores, the reasons for this often have to do with location. It would appear that this would not be an issue with Web retailers, but in fact it can be when one takes into account the potential for having to deal with returned goods. Name recognition also is important on the Web. Studies have shown that people frequently buy books from Amazon.com even when the price of the book is lower from a different Web site. Consumers are familiar with the Amazon name and have more confidence in the process when dealing with a well-known company. (d) These shopping “robot” sites have tremendous implications for retailers. These sites make it incredibly easy for a customer to price shop. No retailer can afford to be too far out of line under these conditions. Ultimately, as people become more familiar with these sites, they will likely cut into the profit margins of retailers.

8-53

BYP 8-6

COMMUNICATION ACTIVITY

To:

Jane Fleming

From:

Student

Re:

Proposal to start business with links to businesses of relatives

The student’s memo should address the following points: 1.

In a traditional transfer pricing problem, the transactions are between divisions within the same company. In the case of related divisions, the challenge is to find a transfer price that is fair to all parties and results in equitable evaluation of division performance. In this situation, evaluation of each party’s performance isn’t a concern, but arriving at a price that is fair to all parties is.

It is similar to a transfer pricing case in that, for a variety of reasons, it would be desirable to deal with the related (in this case literally) parties. For example, quality is more assured. Some costs, such as variable marketing expenditures, are eliminated. It also avoids the awkward question, that may arise from customers, of why you chose to buy from a supplier other than your related division.

Jane should gather information regarding what she would pay to other suppliers as well as documenting other issues (perceived quality, reliability, and convenience) in addition to price. She should also develop a business plan which identifies who her competitors will be, how large the potential market is, and whether there is a need for another company such as hers in her community.

8-54

BYP 8-7

ETHICS CASE

(a) The stakeholders in this case are: • The two airlines • The flying public in the affected cities • Federal transportation regulators (b) Most small airlines can keep their costs down (and therefore have a lower break-even point) because they fly used aircraft, they pay their employees (in particular their pilots) less, and they have lower overhead costs because of smaller operations. (c) Jumbo services many different locations. If it loses money for a while on one location, it can make it up on other locations. Econo doesn’t have this luxury. This same phenomenon has been observed with large discount stores that move into a community and initially offer low prices until the local competition goes out of business. (d) If it feels that Jumbo’s actions are anti-competitive, it can take Jumbo to court. The problem is that anti-competitive behavior is difficult to prove, and legal remedies are slow. It is likely that Econo will be out of business by the time the court acts. Ironically, one possibility would have been to not offer a price that was so much below Jumbo’s. This way, it might not have caused Jumbo to act so aggressively. It also might have tried to target destinations that were not so critical to a large airline. That is, use its comparative advantage as a small airline to service regional communities. (e) Whether this is ethical behavior is difficult to say. On the one hand, it can be argued that Jumbo is simply acting to protect its interests by maintaining its market share. And it can be argued that the flying public benefited because of the lower fares. Unfortunately, the fares are only lower as long as the competitor stays in business. Cases such as this have been very difficult for regulators and the courts to resolve.

8-55

BYP 8-8

CONSIDERING YOUR COSTS AND BENEFITS

(a) A low-priced product is a product with a low initial purchase price. The authors contrast this to a low-cost product by explaining that the initial purchase price is just one of a potentially long list of costs that a company can incur when using a piece of equipment. (b) Clarus Technologies often charges significantly higher prices for its equipment when compared to competitive products. In order for the company to compete, one option would be for the company to lower its price. It has chosen instead to keep its prices high, and then to educate its customers on how its products are actually less expensive when all costs of use are considered. In effect, rather than take the market price as given, its sets its own price, and then uses incremental analysis to justify this price. (c) The five categories of costs used by the authors to evaluate the Tornado and examples of each type of cost are: a. Usual costs: Personnel and fuel savings. b. Hidden costs: Insurance rates, regulatory costs, hazardous waste disposal fees. c. Liability costs: Reduction of potential contingencies, fines and penalties. d. Less tangible costs: Value of improved image. e. Environmental focused costs: Reduced soil contamination and reduced air pollution. (d) Full-cost accounting, as developed by the EPA, looks at all costs incurred using a product over its life-cycle. It focuses on including environmental costs and benefits, as well as other “social costs of doing business” that other approaches ignore. By considering these costs when they develop their products, and then referring to these costs when they justify the price of their products, they make consideration of these issues a more common aspect of business decisions.

8-56

CHAPTER 9 Budgetary Planning ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Indicate the benefits of budgeting.

1, 2, 4

State the essentials of effective budgeting.

3, 5, 6, 7, 8

Identify the budgets that comprise the master budget.

9, 10, 11, 12, 13, 14, 15, 16

Describe the sources for preparing the budgeted income statement.

Brief Exercises

Do It!

Exercises

A Problems

B Problems

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

1, 2, 3

1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12

1A, 2A, 3A

1B, 2B, 3B

17, 18

1A, 2A, 3A, 6A

1B, 2B, 3B

Explain the principal sections of a cash budget.

19, 20

14, 15, 16, 17, 18, 19

4A, 6A

Indicate the applicability of budgeting in nonmanufacturing companies.

21, 22

3, 18, 19, 20

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

9-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

9-2

Description

Difficulty Level

Time Allotted (min.)

Prepare budgeted income statement and supporting budgets.

Simple

30–40

Prepare sales, production, direct materials, direct labor, and income statement budgets.

Simple

40–50

Prepare sales and production budgets and compute cost per unit under two plans.

Moderate

30–40

Prepare cash budget for two months.

Moderate

30–40

Prepare purchases and income statement budgets for a merchandiser.

Simple

30–40

Prepare budgeted income statement and balance sheet.

Complex

40–50

Prepare budgeted income statement and supporting budgets.

Simple

30–40

Prepare sales, production, direct materials, direct labor, and income statement budgets.

Simple

40–50

Prepare sales and production budgets and compute cost per unit under two plans.

Moderate

30–40

Prepare cash budget for two months.

Moderate

30–40

Prepare purchases and income statement budgets for a merchandiser.

Simple

30–40

9-3 Learning Objective

Knowledge Comprehension

Indicate the benefits of budgeting.

Q9-1 Q9-2

Q9-4 E9-1

State the essentials of effective budgeting.

DI9-1

Q9-3 Q9-5 Q9-6

Q9-7 Q9-8 E9-1

Identify the budgets that comprise the master budget.

DI9-1

Q9-9 Q9-10 Q9-11 E9-1

Q9-12 Q9-13 Q9-14 Q9-15 Q9-16 BE9-2 BE9-3 BE9-4 BE9-5 BE9-6

BE9-7 E9-9 DI9-2 E9-10 DI9-3 E9-11 E9-2 E9-12 E9-3 P9-1A E9-4 P9-2A E9-5 P9-1B E9-6 P9-2B E9-7 E9-8

Describe the sources for preparing the budgeted income statement.

Q9-18

Q9-17 BE9-8 DI9-4

E9-13 P9-6A P9-1A P9-1B P9-2A P9-2B

Explain the principal Q9-19 sections of a cash budget.

Q9-20 BE9-9 DI9-5 E9-14

E9-15 P9-4A E9-17 P9-6A E9-18 P9-4B E9-19

Indicate the applicability of budgeting in nonmanufacturing companies.

BE9-10 E9-3 E9-18 E9-19

E9-20 P9-5A P9-5B

Broadening Your Perspective

Q9-21 Q9-22

Application

BYP9-1

Analysis

Synthesis

BE9-1

Evaluation

P9-3A P9-3B

P9-3A P9-3B E9-16

BYP9-3 BYP9-4 BYP9-5 BYP9-6

BYP9-2

BYP9-7 BYP9-8 BYP9-9

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. (b) A budget aids management in planning because it represents the primary method of communicating agreed-upon objectives throughout the organization. Once adopted, a budget becomes an important basis for evaluating performance.

The primary benefits of budgeting are: (1) It requires all levels of management to plan ahead and to formalize goals on a recurring basis. (2) It provides definite objectives for evaluating performance at each level of responsibility. (3) It creates an early warning system for potential problems, so that management can make changes before things get out of hand. (4) It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives. (5) It results in greater management awareness of the entity’s overall operations and the impact of external factors such as economic trends. (6) It motivates personnel throughout the organization to meet planned objectives.

The essentials of effective budgeting are: (1) a sound organizational structure, (2) research and analysis, and (3) acceptance by all levels of management.

(a) Disagree. Accounting information makes major contributions to the budgeting process. Accounting provides the starting point of budgeting by providing historical data on revenues, costs, and expenses. An accountant becomes the translator of the budget and communicates the budget to all areas of responsibility. Accountants also prepare periodic budget reports that compare actual results with planned objectives and provide a basis for evaluating performance. (b) The budget itself, and the administration of the budget, are the responsibility of management.

The budget period should be long enough to provide an attainable goal under normal business conditions. The budget period should minimize the impact of seasonal and cyclical business fluctuations, but it should not be so long that reliable estimates are impossible. The most common budget period is one year.

Disagree. Long-range planning usually encompasses a period of at least five years. It involves the selection of strategies to achieve long-term goals and the development of policies and plans to implement the strategies. In addition, long-range planning reports contain considerably less detail than budget reports.

Participative budgeting involves the use of a “bottom-to-top” approach, which requires input from lower level management during the budgeting process so as to involve employees from various levels and areas within the company. The potential benefits of this approach are lower-level managers have more detailed knowledge of the specifics of their job, and thus should be able to provide better budgetary estimates. In addition, by involving lower-level managers in the process, it is more likely that they will perceive the budget as being fair and reasonable. One disadvantage of participative budgeting is that it takes more time, and thus costs more. Another disadvantage of participative budgeting is that it may enable managers to game the system through such practices as budgetary slack.

9-4

Questions Chapter 9 (Continued) 8.

Budgetary slack is the amount by which a manager intentionally underestimates budgeted revenues or overestimates budgeted expenses in order to make it easier to achieve budgetary goals. Managers may have an incentive to create budgetary slack in order to increase the likelihood of receiving a bonus, or decrease the likelihood of losing their job.

A master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period. The master budget is developed within the framework of a sales forecast.

10.

The sales budget is the starting point in preparing the master budget. An inaccurate sales budget may adversely affect net income. An overly optimistic sales budget may result in excessive inventories and a very conservative sales budget may lead to inventory shortages.

11.

The statement is false. The production budget only shows the units that must be produced to meet anticipated sales and ending inventory requirements.

12.

The required units of production are 155,000 (160,000 + 15,000 = 175,000 – 20,000 = 155,000).

13.

The desired ending direct materials units are 21,000 (64,000 + 9,000 = 73,000 – 52,000 = 21,000).

14.

Total budgeted direct labor costs are $960,000 (80,000 X .75 X $16 = $960,000).

15.

(a) Manufacturing overhead rate based on direct labor cost is 48% [$198,000 + $162,000 = $360,000; $360,000 ÷ (150,000 X 1/3 X $15/hr.) = 48%]. (b) Manufacturing overhead rate per direct labor hour is $7.20 ($360,000 ÷ 50,000).

16.

The first quarter budgeted selling and administrative expenses are $74,000 [(12% X $200,000) + $50,000]. The second quarter total is $78,800 [(12% X $240,000) + $50,000].

17.

The budgeted cost per unit of product is $46 ($10 + $20 + $16). Gross profit per unit is $19 ($65 – $46). Total budgeted gross profit is $475,000 (25,000 X $19).

18.

The supporting schedules are the budgets for sales, direct materials, direct labor, and manufacturing overhead.

19.

The three sections of a cash budget are: (1) cash receipts, (2) cash disbursements, and (3) financing. The cash budget also shows the beginning and ending cash balances.

20.

Cash collections are: January—$600,000 X 40% = $240,000. February—$600,000 X 50% = $300,000. March—$600,000 X 10% = $60,000.

21.

The formula is: Budgeted cost of goods sold plus desired ending merchandise inventory minus beginning merchandise inventory equals required merchandise purchases.

22.

In a service company, expected revenues can be obtained from expected output or expected input. The former is based on anticipated billings of clients for services provided. The latter is based on expected billable time of the professional staff.

9-5

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 Sales Budget

Production Budget

Direct Materials Budget

Direct Labor Budget

Manufacturing Overhead Budget

Operating Budgets

Budgeted Balance Sheet

Financial Budgets

Selling and Administrative Expense Budget

Budgeted Income Statement

Capital Expenditure Budget

9-6

Cash Budget

BRIEF EXERCISE 9-2 PALERMO COMPANY Sales Budget For the Year Ending December 31, 2014 Quarter Expected unit sales Unit selling price Total sales

Year

10,000

12,000

15,000

18,000

55,000

X $70 X $70 $700,000 $840,000

X $70 $1,050,000

X $70 $1,260,000

X $70 $3,850,000

BRIEF EXERCISE 9-3 PALERMO COMPANY Production Budget For the Six Months Ending June 30, 2014 Quarter Expected unit sales Add: Desired ending finished goods Total required units Less: Beginning finished goods inventory Required production units a

12,000 X .25

9-7

10,000 X .25

15,000 X .25

1 2 10,000 12,000 3,000 a 3,750 c 13,000 15,750 2,500 b 3,000 10,500 12,750

Six Months

23,250

BRIEF EXERCISE 9-4 PERINE COMPANY Direct Materials Budget For the Month Ending January 31, 2014 Units to be produced....................................................... Direct materials per unit ................................................. Total pounds required for production............................ Add: Desired ending inventory (25% X 5,000 X 2) ...... Total materials required .................................................. Less: Beginning materials inventory (4,000 X 2 X 25%).................................................. Direct materials purchases ............................................. Cost per pound ................................................................ Total cost of direct materials purchases .......................

4,000 X 2 8,000 2,500 10,500 2,000 8,500 X $6 $51,000

BRIEF EXERCISE 9-5 MIZE COMPANY Direct Labor Budget For the Six Months Ending June 30, 2014 Quarter Units to be produced Direct labor time (hours) per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost

9-8

1 5,000 X 1.6 8,000 X $15 $120,000

2 6,000 X 1.6 9,600 X $15 $144,000

Six Months

$264,000

BRIEF EXERCISE 9-6 ROCHE INC. Manufacturing Overhead Budget For the Year Ending December 31, 2014 Quarter 1 Variable costs Fixed costs Total manufacturing overhead

Year

$20,000 $25,000 $30,000 $35,000 $110,000 40,000 40,000 40,000 40,000 160,000 $60,000 $65,000 $70,000 $75,000 $270,000

BRIEF EXERCISE 9-7 NOBLE COMPANY Selling and Administrative Expense Budget For the Year Ending December 31, 2014 Quarter 1

Year

Variable expenses $22,000 $26,000 $30,000 $34,000 $112,000 Fixed expenses 40,000 40,000 40,000 40,000 160,000 Total selling and administrative expenses $62,000 $66,000 $70,000 $74,000 $272,000

BRIEF EXERCISE 9-8 NORTH COMPANY Budgeted Income Statement For the Year Ending December 31, 2014 Sales.................................................................................. Cost of goods sold (50,000 X $25) .................................. Gross profit....................................................................... Selling and administrative expenses .............................. Income before income taxes ........................................... Income tax expense ......................................................... Net income ........................................................................

9-9

$2,250,000 1,250,000 1,000,000 300,000 700,000 210,000 $ 490,000

BRIEF EXERCISE 9-9 Credit Sales January, $200,000 February, $260,000 March, $300,000

Collections from Customers January February March $150,000 $ 50,000 195,000 $ 65,000 225,000 $150,000 $245,000 $290,000

BRIEF EXERCISE 9-10 Budgeted cost of goods sold ($400,000 X 65%) ........................ Add: Desired ending inventory ($480,000 X 65% X 20%) ....... Total inventory required ............................................................. Less: Beginning inventory ($400,000 X 65% X 20%) ................ Required merchandise purchases for April ..............................

$260,000 62,400 322,400 52,000 $270,400

SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 9-1 1. 2. 3. 4. 5. 6.

Operating budgets Master budget Participative budgeting Financial budgets Sales forecast Long-range plans

DO IT! 9-2 ZELLER COMPANY Production Budget For the Six Months Ending June 30, 2014

Expected unit sales Add: Desired ending finished goods inventory Total required units Less: Beginning finished goods inventory Required production units *(29,000 X .10) 9-10

Quarter Six 1 2 Months 20,000 24,000 2,400 2,900* 22,400 26,900 2,000 2,400 20,400 24,500 44,900

DO IT! 9-3 ASH CREEK COMPANY Sales Budget For the Year Ending December 31, 2014 Quarter 1

Year

Expected unit sales 200,000 200,000 300,000 300,000 1,000,000 Unit selling price X $40 X $40 X $40 X $45 — Total sales $8,000,000 $8,000,000 $12,000,000 $13,500,000 $41,500,000

ASH CREEK COMPANY Production Budget For the Year Ending December 31, 2014 Quarter 1

Expected unit sales 200,000 200,000 Add: Desired ending finished goods units 50,000 75,000 Total required units 250,000 275,000 Less: Beginning finished goods units 50,000** 50,000 Required production units 200,000 225,000

300,000

75,000 375,000

60,000* 360,000

75,000 300,000

75,000 285,000

Year

1,010,000

*Estimated first-quarter 2015 sales volume 200,000 + (200,000 X 20%) = 240,000: 240,000 X 25%. **25% of estimated first-quarter 2014 sales units (200,000 X 25%).

9-11

DO IT! 9-3 (Continued) ASH CREEK COMPANY Direct Materials Budget For the Year Ending December 31, 2014 Quarter 1

Year

Units to be produced 200,000 225,000 300,000 285,000 Direct materials per unit X 2 X 2 X 2 X 2 Total pounds needed for production 400,000 450,000 600,000 570,000 Add: Desired ending direct materials (pounds) 45,000 60,000 57,000 *45,000 Total materials required 445,000 510,000 657,000 615,000 Less: Beginning direct materials (pounds) **40,000 45,000 60,000 57,000 Direct materials purchases 405,000 465,000 597,000 558,000 Cost per pound X $12 X $12 X $12 X $12 Total cost of direct materials purchases $4,860,000 $5,580,000 $7,164,000 $6,696,000 $24,300,000 *Estimated first-quarter 2015 production requirements 450,000 X 10% = 45,000 **10% of estimated first-quarter pounds needed for production.

DO IT! 9-4 (a)

9-12

Total unit cost: Cost Element Direct materials .............................. Direct labor ..................................... Manufacturing overhead ................ Total unit cost ........................

Quantity 2 pounds 0.3 hours 0.3 hours

Unit Cost $12.00 $15.00 $20.00

Total $24.00 4.50 6.00 $34.50

DO IT! 9-4 (Continued) (b)

ASH CREEK COMPANY Budgeted Income Statement For the Year Ending December 31, 2014 Sales (1,000,000) units from sales budget, page 9-11....... Cost of goods sold (1,000,000 X $34.50/unit) .................. Gross profit ....................................................................... Selling and administrative expenses............................... Net income ........................................................................

$41,500,000 34,500,000 7,000,000 6,000,000 $ 1,000,000

DO IT! 9-5 BATISTA COMPANY Cash Budget April Beginning cash balance ............................................................. Add: Cash receipts for April ...................................................... Total available cash .................................................................... Less: Cash disbursements in April ........................................... Excess of available cash over cash disbursements ................. Add: Financing ($20,000 – $15,000) .......................................... Ending cash balance...................................................................

$ 25,000 245,000 270,000 255,000 15,000 5,000 $ 20,000

To maintain the desired minimum cash balance of $20,000, Batista Company must borrow $5,000.

9-13

SOLUTIONS TO EXERCISES EXERCISE 9-1 MEMO To

Jim Dixon

From: Student Re:

Budgeting

I am glad Adler Company is considering preparing a formal budget. There are many benefits derived from budgeting, as I will discuss later in this memo. A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. The master budget generally consists of operating budgets such as the sales budget, production budget, direct materials budget, direct labor budget, manufacturing overhead budget, selling and administrative expense budget, and budgeted income statement; and financial budgets such as the capital expenditure budget, cash budget, and budgeted balance sheet. The primary benefits of budgeting are: 1. It requires all levels of management to plan ahead and to formalize goals on a recurring basis. 2. It provides definite objectives for evaluating performance at each level of responsibility. 3. It creates an early warning system for potential problems, so that management can make changes before things get out of hand. 4. It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives. 5. It results in greater management awareness of the entity’s overall operations and the impact of external factors such as economic trends. 6. It motivates personnel throughout the organization to meet planned objectives. In order to maximize these benefits, it is essential that budgeting take place within a sound organizational structure, so authority and responsibility for all phases of operations are clearly defined. Also, the budget should be based on research and analysis that results in realistic goals. Finally, the effectiveness of a budget program is directly related to its acceptance by all levels of management. If you want further explanation of any of these topics, please contact me. 9-14

9-15

EXERCISE 9-2

EDINGTON ELECTRONICS INC. Sales Budget For the Six Months Ending June 30, 2014

Product

Units

XQ-103 XQ-104 Totals

20,000 12,000 32,000

Quarter 1 Selling Total Price Sales $15 25

Units

$300,000 22,000 300,000 15,000 $600,000 37,000

Quarter 2 Selling Total Price Sales $15 25

$330,000 375,000 $705,000

Units 42,000 27,000 69,000

Six Months Selling Total Price Sales $15 25

$ 630,000 675,000 $1,305,000

EXERCISE 9-3

9-16 .

GARZA AND NEELY, CPAs Sales Revenue Budget For the Year Ending December 31, 2014

Dept. Auditing Tax Consulting Totals

Billable Hours 2,300 3,000 1,500

Billable Hours 8,300a 9,700b 6,000c

Quarter 1 Billable Total Rate Rev. $ 80 $184,000 90 270,000 100 150,000 $604,000

Year Billable Rate $ 80 90 100

a2,300 + 1,600 + 2,000 + 2,400 b3,000 + 2,200 + 2,000 + 2,500 c1,500 X 4

Billable Hours 1,600 2,200 1,500

Total Rev. $ 664,000 873,000 600,000 $2,137,000

Quarter 2 Billable Rate $ 80 90 100

Total Rev. 128,000 198,000 150,000 $476,000

Billable Hours 2,000 2,000 1,500

Quarter 3 Billable Total Rate Rev. $ 80 $160,000 90 180,000 100 150,000 $490,000

Billable Hours 2,400 2,500 1,500

Quarter 4 Billable Total Rate Rev. $ 80 $192,000 90 225,000 100 150,000 $567,000

EXERCISE 9-4 TURNEY COMPANY Production Budget For the Year Ending December 31, 2014 Product HD-240 Quarter Expected unit sales Add: Desired ending finished goods units(1) Total required units Less: Beginning finished goods units Required production units (1) (2)

5,000

7,000

8,000

10,000

2,800 7,800

3,200 10,200

4,000 12,000

2,500 (2) 12,500

2,000 5,800

2,800 7,400

3,200 8,800

4,000 8,500

40% of next quarter’s sales. 40% X (5,000 X 125%).

9-17

Year

30,500

EXERCISE 9-5 DALLAS INDUSTRIES Direct Materials Purchases Budget For the Quarter Ending March 31, 2014

Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials (pounds)* Total materials required Less: Beginning direct materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials purchases

January 10,000 X 2 20,000

February 8,000 X 2 16,000

March 5,000 X 2 10,000

3,200 23,200

2,000 18,000

1,600 11,600

4,000 19,200 X $2

3,200 14,800 X $2

2,000 9,600 X $2

$38,400

$29,600

$19,200

*20% of next month’s production needs. EXERCISE 9-6 (a)

HARDIN COMPANY Production Budget For the Six Months Ending June 30, 2014 Quarter Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units (1)

25% X 6,000. 25% X 7,000. (3) 25% X 5,000. (2)

9-18

Six Months

1 5,000

2 6,000

1,500 (1) 6,500 1,250 (3) 5,250

1,750 (2) 7,750 1,500 6,250 11,500

EXERCISE 9-6 (Continued) (b)

HARDIN COMPANY Direct Materials Budget For the Six Months Ending June 30, 2014 Quarter Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials (pounds) Total materials required Less: Beginning direct materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials Purchases (1) 40% X 18,750. (2) 7,200 X (3 X 40%). (3) 40% X 15,750.

1 5,250 X 3 15,750

2 6,250 X 3 18,750

7,500 (1) 23,250

8,640 (2) 27,390

Six Months

6,300 (3) 7,500 16,950 19,890 X $4 X $4

0000,000

$67,800

$79,560

$147,360

Finished goods: Sales ........................................................................ Plus: Ending inventory ........................................... Total required .............................................................. Less: beginning inventory .................................... Production required ....................................................

2,475 2,200 4,675 2,230 2,445

EXERCISE 9-7

Direct materials per unit ............................................. Units of direct material required for production ....... Plus: ending inventory ................................................ Total required .............................................................. Less: beginning inventory .................................... Purchases of direct material required ....................... Cost per unit ................................................................ Total cost of materials ................................................ The May raw material purchases would be $19,780. (a)

2,390 + 2,310 – 2,200 = 2,500; 2,500 X 2 X .50 = 2,500 2,475 + 2,200 – 2,230 = 2,445; 2,445 X 2 X .50 = 2,445

(b)

9-19

2 4,890 2,500(a) 7,390 2,445(b) 4,945 X $4 $19,780

EXERCISE 9-8 RODRIQUEZ, INC. Direct Labor Budget For the Year Ending December 31, 2014 Quarter Units to be produced Direct labor time (hours) per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost

Year

20,000

25,000

35,000

30,000

110,000

1.5

30,000

37,500

52,500

45,000

X $16 $480,000

X $16 $600,000

X $18 $945,000

X $18 $810,000

$2,835,000

EXERCISE 9-9 DONNEGAL COMPANY Production Budget For the Quarter Ending March 31, 2014 Sales in units Plus: desired ending inventory Total needs Less: beginning inventory Required production units (1)

Jan 12,000 18,000(1) 30,000 17,600 12,400

(14,000 X 100%) + (10,000 X 40%) (10,000 X 100%) + (11,000 X 40%) (3) (11,000 X 100%) + (11,000 X 40%) (2)

9-20

Feb 14,000 14,400(2) 28,400 18,000 10,400

Mar 10,000 15,400(3) 25,400 14,400 11,000

Total 36,000 15,400 51,400 17,600 33,800

EXERCISE 9-9 (Continued) DONNEGAL COMPANY Direct Labor Budget For the Quarter Ending March 31, 2014 Production in units Direct labor hours per unit Total hours needed Rate per hour Total direct labor

Jan 12,400 X 2.00 24,800 X $8.00 $198,400

Feb Mar 10,400 11,000 X 2.00 X 1.50 20,800 16,500 X $8.00 X $8.00 $166,400 $132,000

Total

$496,800

EXERCISE 9-10 ATLANTA COMPANY Manufacturing Overhead Budget For the Year Ending December 31, 2014 Quarter 1 Variable costs Indirect materials ($.80/hour) $12,000 Indirect labor ($1.20/hour) 18,000 Maintenance ($.50/hour) 7,500 Total variable 37,500 Fixed costs Supervisory salaries 35,000 Depreciation 15,000 Maintenance 12,000 Total fixed 62,000 Total manufacturing overhead $99,500 Direct labor hours Manufacturing overhead rate per direct labor hour ($443,000 ÷ 78,000)

*(10,000 X 1.5)

9-21

15,000*

Year

$ 14,400 21,600 9,000 45,000

$ 16,800 25,200 10,500 52,500

$ 19,200 28,800 12,000 60,000

$ 62,400 93,600 39,000 195,000

35,000 15,000 12,000 62,000 $107,000

35,000 15,000 12,000 62,000 $114,500

35,000 15,000 12,000 62,000 $122,000

140,000 60,000 48,000 248,000 $443,000

18,000

21,000

24,000

78,000 $5.68

EXERCISE 9-11 DUNCAN COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2014 Quarter

Six Months

Budgeted sales in units

1 20,000

2 22,000

Variable expenses (1) Sales commissions Delivery expense Advertising Total variable

$20,000* 8,000 16,000 44,000

$22,000 8,800 17,600 48,400

$ 42,000 16,800 33,600 92,400

10,000 8,000 4,200 1,500 800 500 25,000

20,000 16,000 8,400 3,000 1,600 1,000 50,000

$69,000

$73,400

$142,400

Fixed expenses Sales salaries Office salaries Depreciation Insurance Utilities Repairs expense Total fixed Total selling and administrative expenses

(1) Variable costs per dollar of sales are: Sales commissions (5%), Delivery expense (2%), and Advertising (4%). *(20,000 X $20 X 5%)

9-22

EXERCISE 9-12 (a)

FUQUA COMPANY Production Budget For the Two Months Ending February 28, 2014 _____________________________________________________________ January February Expected unit sales ............................................ 10,000 12,000 Add: desired ending finished goods inventory .................................................. 2,400* 2,600*** Total required units ............................................ 12,400 14,600 Less: beginning finished goods inventory ...... 2,000** 2,400 Required production units ................................. 10,400 12,200 *20% X next month’s expected sales or 12,000 X 20% **20% X 10,000 ***20% X 13,000

(b)

FUQUA COMPANY Direct Materials Budget For the Month Ending January 31, 2014 _____________________________________________________________ January Units to be produced ............................................................ 10,400 Direct material pounds per unit ........................................... X 4 Total pounds needed for production................................... 41,600 Add: desired pounds in ending materials inventory ......... 19,520* Total materials required ....................................................... 61,120 Less: beginning direct materials (pounds) ......................... 16,640** Direct materials purchases .................................................. 44,480 Cost per pound ..................................................................... X $2 Total cost of direct materials purchases ............................ $88,960 *(12,200 X 4) X 40%

9-23

**(10,400 X 4) X 40%

EXERCISE 9-13 (a) DALBY COMPANY Computation of Cost of Goods Sold For the Year Ending December 31, 2014 Cost of one unit of finished goods: Direct materials (2 X $5) ............................................................... Direct labor (3 X $15) .................................................................... Manufacturing overhead (3 X $5) ................................................ Total ......................................................................................

$10 45 15 $70

30,000 units X $70 = $2,100,000. (b) DALBY COMPANY Budgeted Income Statement For the Year Ending December 31, 2014 Sales (30,000 X $85) ............................................................ Cost of goods sold (see part (a)) ....................................... Gross profit ......................................................................... Selling and administrative expenses ................................ Income before income taxes .............................................. Income tax expense ($250,000 X 30%) .............................. Net income ..........................................................................

9-24

$2,550,000 2,100,000 450,000 200,000 250,000 75,000 $ 175,000

EXERCISE 9-14 DANNER COMPANY Cash Budget For the Two Months Ending February 28, 2014

Beginning cash balance .......................................... Add: Receipts Collections from customers ....................... Sale of marketable securities ..................... Total receipts ............................................... Total available cash ................................................. Less: Disbursements Direct materials............................................ Direct labor .................................................. Manufacturing overhead ............................. Selling and administrative expenses ......... Total disbursements.................................... Excess (deficiency) of available cash over cash disbursements ..................................................... Financing Add: Borrowings ..................................................... Less: Repayments ................................................... Ending cash balance ...............................................

9-25

January $ 45,000

February $ 27,500

85,000 12,000 97,000 142,000

150,000 0 150,000 177,500

50,000 30,000 19,500 15,000 114,500

75,000 45,000 23,500 20,000 163,500

27,500

14,000

0 0 $ 27,500

6,000 0 $ 20,000

EXERCISE 9-15 AARON CORPORATION Cash Budget For the Quarter Ended March 31, 2014 Beginning cash balance ........................................................... Add: Receipts Collections from customers......................................... Sale of equipment ......................................................... Total receipts .......................................................... Total available cash .................................................................. Less: Disbursements Direct materials ............................................................. Direct labor .................................................................... Manufacturing overhead .............................................. Selling and administrative expenses .......................... Purchase of securities.................................................. Total disbursements .............................................. Excess of available cash over disbursements ........................ Financing Add: Borrowings ..................................................................... Less: Repayments .................................................................... Ending cash balance ................................................................

9-26

$ 30,000 180,000 3,000 183,000 213,000 41,000 70,000 35,000 45,000 14,000 205,000 8,000 17,000 –0– $ 25,000

EXERCISE 9-16 (a)

TRENSHAW COMPANY Cash Budget For the Month Ended July 31, 2014 Beginning cash balance ............................ Add: Cash collections .............................. Total cash available ................................... Less: Cash disbursements Merchandise purchases ......... Operating expenses................ Equipment purchase .............. Total cash disbursements ......................... Excess of available cash over disbursements ................................ Add: Borrowings ....................................... Ending cash balance .................................

$45,000 90,000 $135,000 $56,200 40,800 20,000 117,000 18,000 7,000 $ 25,000

Cash disbursements of $117,000 plus the desired ending cash balance of $25,000 exceeds the $135,000 total cash available by $7,000. Therefore, Trenshaw Company will have to borrow $7,000. (b)

An advantage of cash budgeting is that it allows cash shortfalls to be predicted. If the timing of future cash shortfalls is known, arrangements to borrow funds can be made well in advance, which often means that interest rates may be more favorable than if the funds are needed on short notice.

9-27

EXERCISE 9-17 (a)

LRF COMPANY Expected Collections from Customers

March cash sales (30% X $270,000) ..................................... Collection of March credit sales [(70% X $270,000) X 10%] .................................................. Collection of February credit sales [(70% X $220,000) X 50%] .................................................. Collection of January credit sales [(70% X $200,000) X 36%] .................................................. Total collections ........................................................ (b)

18,900 77,000 50,400 $227,300

LRF COMPANY Expected Payments for Direct Materials

March cash purchases (50% X $40,000) .............................. Payment of March credit purchases [(50% X $40,000) X 40%] .................................................... Payment of February credit purchases [(50% X $36,000) X 60%] .................................................... Total payments ..........................................................

9-28

March $ 81,000

March $20,000 8,000 10,800 $38,800

EXERCISE 9-18 (a)

(1) GREEN LANDSCAPING INC. Schedule of Expected Collections From Clients For the Quarter Ending March 31, 2014 January

February

November ($80,000) .............................................. $ 8,000 December ($90,000) .............................................. 27,000 $ 9,000 January ($100,000) ............................................... 60,000 30,000 February ($120,000) .............................................. 72,000 March ($140,000)................................................... ______ _______ Total collections ............................................. $95,000 $111,000

March

Quarter $

$ 10,000 36,000 84,000 $130,000

8,000 36,000 100,000 108,000 84,000 $336,000

(2) GREEN LANDSCAPING INC. Schedule of Expected Payments for Landscaping Supplies For the Quarter Ending March 31, 2014 ________________________________________________________ January

February

December ($14,000) .............................................. $ 5,600 January ($12,000) ................................................. 7,200 $ 4,800 February ($15,000) ................................................ 9,000 March ($18,000)..................................................... Total payments ............................................... $12,800 $13,800

March

Quarter

$ 6,000 10,800 $16,800

$ 5,600 12,000 15,000 10,800 $43,400

(b) (1) Accounts receivable at March 31, 2014: ($120,000 X 10%) + ($140,000 X 40%) = $68,000 (2) Accounts payable at March 31, 2014: ($18,000 X 40%) = $7,200

9-29

EXERCISE 9-19 LAGER DENTAL CLINIC Cash Budget For the Two Quarters Ending June 30, 2014 1st Quarter Beginning cash balance ......................................... $ 30,000 Add: Receipts Collections from clients........................... 230,000 Sale of equipment .................................... 12,000 Investment interest .................................. 0 Total receipts ...................................... 242,000 Total cash available ................................................ 272,000 Less: Disbursements Professional salaries ............................... 140,000 Overhead costs ........................................ 75,000 Selling and administrative costs............. 48,000* Equipment purchase ................................ 0 Payment of income taxes ........................ 0 Total disbursements .......................... 263,000 Excess (deficiency) of cash available over cash disbursements ................................... 9,000 Financing Add: Borrowings ................................................... 16,000 Less: Repayments ................................................. 0 Ending cash balance .............................................. $ 25,000 *$50,000 – $2,000 **$70,000 – $2,000

9-30

2nd Quarter $ 25,000 380,000 0 7,000 387,000 412,000 140,000 100,000 68,000** 50,000 4,000 362,000 50,000 0 16,400 $ 33,600

EXERCISE 9-20 (a)

GRAND STORES Merchandise Purchases Budget For the Month Ending June 30, 2014 Budgeted cost of goods sold ($500,000 X 75%) .................. Add: Desired ending merchandise inventory ($600,000 X 75% X 30%) .................................................... Total ........................................................................................ Less: Beginning merchandise inventory ($375,000 X 30%)......................................................... Required merchandise purchases .......................................

(b)

135,000 510,000 112,500 $397,500

GRAND STORES Budgeted Income Statement For the Month Ending June 30, 2014 Sales ...................................................................................... Cost of goods sold (75% X $500,000) .................................. Gross profit ...........................................................................

$375,000

9-31

$500,000 375,000 $125,000

SOLUTIONS TO PROBLEMS PROBLEM 9-1A

GLENDO FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2014 Quarter Expected unit sales ..................... Unit selling price ......................... Total sales ...................................

1 30,000 X $60 $1,800,000

2 42,000 X $60 $2,520,000

Six Months 72,000 X $60 $4,320,000

GLENDO FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2014 Quarter 1 Expected unit sales ............................................ 30,000 Add: Desired ending finished goods units ......................................................... 15,000 Total required units ............................................ 45,000 Less: Beginning finished goods units ............. 8,000 Required production units ................................. 37,000

9-32

2 42,000 18,000 60,000 15,000 45,000

Six Months

82,000

PROBLEM 9-1A (Continued) GLENDO FARM SUPPLY COMPANY Direct Materials Budget—Gumm For the Six Months Ending June 30, 2014 Quarter Units to be produced .................................... Direct materials per unit ............................... Total pounds needed for production .......... Add: Desired ending direct materials (pounds) ............................................. Total materials required ............................... Less: Beginning direct materials (pounds) ............................................ Direct materials purchases .......................... Cost per pound .............................................. Total cost of direct materials purchases ..................................................

37,000 X4 148,000

45,000 X 4 180,000

10,000 158,000

13,000 193,000

9,000 149,000 X $3.80

10,000 183,000 X $3.80

$566,200

$695,400

Six Months

$1,261,600

GLENDO FARM SUPPLY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2014 Quarter Units to be produced ........................... Direct labor time (hours) per unit ........ Total required direct labor hours ........ Direct labor cost per hour.................... Total direct labor cost ..........................

9-33

1 37,000 X 1/4 9,250 X $16 $148,000

2 45,000 X 1/4 11,250 X $16 $180,000

Six Months

$328,000

PROBLEM 9-1A (Continued) GLENDO FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2014 Quarter Budgeted sales in units Variable (.15 X sales) .......................... Fixed .................................................... Total.....................................................

1 30,000

2 42,000

Six Months 72,000

$270,000 175,000 $445,000

$378,000 175,000 $553,000

$ 648,000 350,000 $998,000

GLENDO FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2014 Sales ............................................................................................. Cost of goods sold (72,000 X $34.20)* ....................................... Gross profit .................................................................................. Selling and administrative expenses ......................................... Income from operations .............................................................. Income tax expense (30%) .......................................................... Net income ...................................................................................

$4,320,000 2,462,400 1,857,600 998,000 859,600 257,880 $ 601,720

*Cost Per Bag Cost Element Direct materials Gumm .......................................... Tarr ............................................... Direct labor ...................................... Manufacturing overhead (150% of direct labor cost) ......... Total ........................................

9-34

Quantity

Unit Cost

Total

4 pounds 6 pounds 1/4 hour

$ 3.80 1.50 16.00

$15.20 9.00 4.00 6.00 $34.20

PROBLEM 9-2A

(a)

DELEON INC. Sales Budget For the Year Ending December 31, 2014 JB 50 Expected unit sales .............. 400,000 Unit selling price .................. X $20 Total sales............................. $8,000,000

(b)

JB 60 200,000 X $25 $5,000,000

000,000,0 $13,000,000

DELEON INC. Production Budget For the Year Ending December 31, 2014 JB 50 400,000

Expected unit sales .............................. Add: Desired ending finished goods units ................................ 30,000 Total required units .............................. 430,000 Less: Beginning finished goods units ........................................... 25,000 Required production units ................... 405,000

Total

9-35

JB 60 200,000 15,000 215,000 10,000 205,000

PROBLEM 9-2A (Continued) (c)

DELEON INC. Direct Materials Budget For the Year Ending December 31, 2014 JB 50 Units to be produced ...................... 405,000 Direct materials per unit ................. X 2 Total pounds needed for production.................................... 810,000 Add: Desired ending direct materials (pounds) ............... 30,000 Total materials required ................. 840,000 Less: Beginning direct materials (pounds) ............... 40,000 Direct materials purchases ............ 800,000 Cost per pound ................................ X $3 Total cost of direct materials purchases ................................... $2,400,000

(d)

Total

205,000 X 3 615,000 10,000 625,000 15,000 610,000 X $4 $2,440,000

$4,840,000

DELEON INC. Direct Labor Budget For the Year Ending December 31, 2014 JB 50 Units to be produced ...................... 405,000 Direct labor time (hours) per unit ................................................ X .4 Total required direct labor hours ............................................ 162,000 Direct labor cost per hour .............. X $12 Total direct labor cost ..................... $1,944,000

9-36

JB 60

Total

205,000

650,000

X .6

—

123,000 X $12 $1,476,000

301,000 X $10 $3,420,000

PROBLEM 9-2A (Continued) (e)

DELEON INC. Budgeted Income Statement For the Year Ending December 31, 2014

Sales ...................................... Cost of goods sold ............... Gross profit ........................... Operating expenses Selling expenses ............... Administrative expenses ....................... Total operating expenses................ Income before income taxes .................................. Income tax expense (30%) .................................. Net income ............................ (1) (2)

9-37

400,000 X $13. 200,000 X $20.

JB 50 JB 60 Total $8,000,000 $5,000,000 $13,000,000 (1) 5,200,000 4,000,000 (2) 9,200,000 2,800,000 1,000,000 3,800,000 560,000

360,000

920,000

540,000

340,000

880,000

1,100,000

700,000

1,800,000

$1,700,000

$ 300,000

2,000,000 600,000 $ 1,400,000

PROBLEM 9-3A

(a)

MARSH INDUSTRIES Sales Budget For the Year Ending December 31, 2014

Expected unit sales ................................... Unit selling price ........................................ Total sales ..................................................

Plan A Plan B 720,000 (1) 900,000 (2) X $8.40 X $7.50 (3) $6,048,000 $6,750,000

(1)

$6,400,000 ÷ $8 = 800,000 X 90% = 720,000. 800,000 + 100,000 = 900,000. (3) $8.00 – $0.50 (2)

(b)

MARSH INDUSTRIES Production Budget For the Year Ending December 31, 2014

Expected unit sales.............................................. Add: Desired ending finished goods units ...... Total required units.............................................. Less: Beginning finished goods units............... Required production units .................................. (1)

Plan A 720,000 36,000 (1) 756,000 38,000 718,000

Plan B 900,000 60,000 960,000 38,000 922,000

720,000 X 5%

(c) Variable costs = $4.30 per unit ($1.80 + $1.30 + $1.20) for both plans. Plan A Total variable costs Total fixed costs Total costs (a) Total units (b) Unit cost (a) ÷ (b)

$3,087,400 (718,000 X $4.30) 1,895,000 $4,982,400

Plan B $3,964,600 (922,000 X $4.30) 1,895,000 $5,859,600

718,000

922,000

$6.94

$6.36

The difference is due to the fact that fixed costs are spread over a larger number of units (204,000) in Plan B. 9-38

PROBLEM 9-3A (Continued) (d)

Gross Profit Plan A Sales Cost of goods sold Gross profit

$6,048,000 4,996,800 (720,000 X $6.94) $1,051,200

Plan B $6,750,000 5,724,000 (900,000 X $6.36) $1,026,000

Plan A should be accepted because it produces a higher gross profit than Plan B.

9-39

PROBLEM 9-4A

(a) (1)

Expected Collections from Customers

November ($250,000) ................................ December ($320,000) ................................ January ($360,000).................................... February ($400,000) .................................. Total collections .............................. (2)

$326,000

February $ 0 64,000 108,000 200,000 $372,000

Expected Payments for Direct Materials

December ($100,000) ................................ January ($120,000).................................... February ($125,000) .................................. Total payments ................................

9-40

January $ 50,000 96,000 180,000

January $ 40,000 72,000 .

$112,000

February $ 0 48,000 75,000 $123,000

PROBLEM 9-4A (Continued) (b)

COLTER COMPANY Cash Budget For the Two Months Ending February 28, 2014

Beginning cash balance .................................. Add: Receipts Collections from customers ............ [See Schedule (1)] Notes receivable ............................... Sale of securities .............................. Total receipts ............................ Total available cash ......................................... Less: Disbursements Direct materials ............................... [See Schedule 2] Direct labor ...................................... Manufacturing overhead ................. Selling and administrative expenses* .................................... Cash dividend .................................. Total disbursements ............... Excess (deficiency) of available cash over cash disbursements ............................ Financing Add: Borrowings ............................................ Less: Repayments .......................................... Ending cash balance .......................................

January $ 60,000

February $ 51,000

326,000

372,000

15,000 341,000 401,000

6,000 378,000 429,000

112,000

123,000

90,000 70,000

100,000 75,000

78,000 350,000

84,000 6,000 388,000

51,000

41,000

0 0 $ 51,000

9,000 0 $ 50,000

*Selling and administrative expenses less $1,000 depreciation.

9-41

PROBLEM 9-5A

(a)

LITWIN COMPANY San Miguel Store Merchandise Purchases Budget For the Months of May and June, 2014

Budgeted cost of goods sold ........................... Add: Desired ending merchandise inventory..... Total ................................................................... Less: Beginning merchandise inventory ........ Required merchandise purchases ................... (1)

May June $600,000 $630,000 (1) 94,500(2) 99,225 (3) 694,500 729,225 (4) 90,000 94,500 $604,500 $634,725

$800,000 X 105% = $840,000; $840,000 X 75% = $630,000. $630,000 X 15% = $94,500. (3) $840,000 X 105% = $882,000; $882,000 X 75% = $661,500; $661,500 X 15% = $99,225. (4) $600,000 X 15% = $90,000. (2)

9-42

PROBLEM 9-5A (Continued) (b)

LITWIN COMPANY San Miguel Store Budgeted Income Statement For the Months of May and June, 2014

Sales .................................................................. Cost of goods sold Beginning inventory.................................. Purchases .................................................. Cost of goods available for sale .............. Less: Ending inventory ............................ Cost of goods sold ............................ Gross profit ....................................................... Operating expenses Sales salaries ............................................ Advertising* ............................................... Delivery** ................................................... Sales commissions*** ............................... Rent ............................................................ Depreciation .............................................. Utilities ....................................................... Insurance ................................................... Total .................................................... Income from operations ................................... Income tax expense (30%) ............................... Net income ........................................................ *6% of sales. **3% of sales. ***5% of sales.

9-43

May $800,000

June $840,000

90,000 604,500 694,500 94,500 600,000 200,000

94,500 634,725 729,225 99,225 630,000 210,000

30,000 48,000 24,000 40,000 5,000 800 600 500 148,900 51,100 15,330 $ 35,770

30,000 50,400 25,200 42,000 5,000 800 600 500 154,500 55,500 16,650 $ 38,850

PROBLEM 9-6A

KRAUSE INDUSTRIES Budgeted Income Statement For the Year Ending December 31, 2014 Sales (8,000 X $32) .................................................. Cost of goods sold Finished goods inventory, January 1 ............. Cost of goods manufactured ($62,500 + $50,900 + $48,600) ...................... Cost of goods available for sale ..................... Finished goods inventory, December 31 (3,000 X $18) ................................................. Cost of goods sold ................................... Gross profit .............................................................. Selling and administrative expenses ..................... Income from operations .......................................... Interest expense ...................................................... Income before income taxes .................................. Income tax expense (40%) ...................................... Net income ...............................................................

9-44

$256,000 $ 15,000 162,000 177,000 54,000 123,000 133,000 75,000 58,000 3,500 54,500 21,800 $ 32,700

PROBLEM 9-6A (Continued) KRAUSE INDUSTRIES Budgeted Balance Sheet December 31, 2014 Assets Current assets Cash...................................................................... Accounts receivable ($76,800 X 40%) ................ Finished goods inventory (3,000 units X $18) ........................................... Total current assets ..................................... Property, plant, and equipment Equipment ($40,000 + $9,000) ............................. Less: Accumulated depreciation ($10,000 + $4,000) ..................................... Total assets ..................................................

$ 6,980 30,720 54,000 $91,700 $49,000 14,000

35,000 $126,700

Liabilities and Stockholders’ Equity Liabilities Notes payable ($25,000 – $8,000) ....................... Accounts payable ($8,500* + $6,500).................. Income taxes payable .......................................... Total liabilities .............................................. Stockholders’ equity Common stock ..................................................... Retained earnings ($25,000 + $32,700 – $8,000)............................ Total stockholders’ equity ........................... Total liabilities and stockholders’ equity ........................................................ *$17,000 X 50%

9-45

$17,000 15,000 5,000 $ 37,000 $40,000 49,700 89,700 $126,700

PROBLEM 9-1B

MERCER FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2014 Quarter Expected unit sales ................... Unit selling price ....................... Total sales .................................

1 40,000 X $63 $2,520,000

2 50,000 X $63 $3,150,000

Six Months 90,000 X $63 $5,670,000

MERCER FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2014 Quarter 1 Expected unit sales ............................................40,000 Add: Desired ending finished goods units .........................................................15,000 Total required units ............................................55,000 Less: Beginning finished goods units .............10,000 Required production units ................................45,000

9-46

2 50,000 20,000 70,000 15,000 55,000

Six Months

100,000

PROBLEM 9-1B (Continued) MERCER FARM SUPPLY COMPANY Direct Materials Budget—Crup For the Six Months Ending June 30, 2014 Quarter 1

Units to be produced ................................. 45,000 Direct materials per unit ............................ X 5 Total pounds needed for production ....... 225,000 Add: Desired ending direct materials (pounds) .......................................... 12,000 Total materials required ............................ 237,000 Less: Beginning direct materials (pounds) ......................................... 9,000 Direct materials purchases ....................... 228,000 Cost per pound ........................................... X $3.80 Total cost of direct materials purchases ............................................... $866,400

Six Months

55,000 X 5 275,000 15,000 290,000 12,000 278,000 X $3.80 $1,056,400

$1,922,800

MERCER FARM SUPPLY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2014 Quarter Units to be produced ......................... Direct labor time (hours) per unit ...... Total required direct labor hours ...... Direct labor cost per hour ................. Total direct labor cost ........................

9-47

1 45,000 X .25 11,250 X $12 $135,000

2 55,000 X .25 13,750 X $12 $165,000

Six Months

$300,000

PROBLEM 9-1B (Continued) MERCER FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2014 Quarter Budgeted sales in units .....................

1 40,000

2 50,000

Six Months 90,000

Variable (.10 X sales) .......................... Fixed.................................................... Total ....................................................

$252,000 150,000 $402,000

$315,000 150,000 $465,000

$567,000 300,000 $867,000

MERCER FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2014 Sales ............................................................................................ Cost of goods sold (90,000 X $40)............................................. Gross profit ................................................................................. Selling and administrative expenses ........................................ Income from operations ............................................................. Income tax expense (30%) ......................................................... Net income ..................................................................................

$5,670,000 3,600,000 2,070,000 867,000 1,203,000 360,900 $ 842,100

Cost Per Bag Cost Element Direct materials Crup ............................................ Dert ............................................. Direct labor .................................... Manufacturing overhead (100% of direct labor cost) ........ Total .......................................

9-48

Quantity

Unit Cost

Total

5 pounds 10 pounds .25 hour

$ 3.80 1.50 12.00

$19.00 15.00 3.00 3.00 $40.00

PROBLEM 9-2B

(a)

URBINA INC. Sales Budget For the Year Ending December 31, 2014 LN 35 Expected unit sales .............. 400,000 Unit selling price ................... X $25 Total sales ............................. $10,000,000

(b)

Total 000,000,0 $18,400,000

URBINA INC. Production Budget For the Year Ending December 31, 2014

Expected unit sales .............................. Add: Desired ending finished goods units ................................ Total required units .............................. Less: Beginning finished goods units ........................................... Required production units ...................

LN 40 240,000 X $35 $8,400,000

9-49

LN 35 400,000

LN 40 240,000

20,000 420,000

25,000 265,000

30,000 390,000

15,000 250,000

PROBLEM 9-2B (Continued) (c)

URBINA INC. Direct Materials Budget For the Year Ending December 31, 2014 LN 35 Units to be produced ...................... 390,000 Direct materials per unit ................. X 2 Total pounds needed for production.................................... 780,000 Add: Desired ending direct materials (pounds) ............... 50,000 Total materials required ................. 830,000 Less: Beginning direct materials (pounds) ............... 40,000 Direct materials purchases ............ 790,000 Cost per pound ................................ X $2 Total cost of direct materials purchases .................................... $1,580,000

(d)

LN 40 250,000 X 3 750,000 10,000 760,000 20,000 740,000 X $3 $2,220,000

$3,800,000

URBINA INC. Direct Labor Budget For the Year Ending December 31, 2014 LN 35 Units to be produced ...................... 390,000 Direct labor time (hours) per unit ................................................ X .5 Total required direct labor hours ............................................ 195,000 Direct labor cost per hour .............. X $12 Total direct labor cost ..................... $2,340,000

9-50

Total

LN 40

Total

250,000

550,000

.75

187,500 X $12 $2,250,000

322,500 X $10 $4,590,000

PROBLEM 9-2B (Continued) (e)

URBINA INC. Budgeted Income Statement For the Year Ending December 31, 2014 LN 35 LN 40 Total Sales ...................................... $10,000,000 $8,400,000 $18,400,000 Cost of goods sold................ 4,800,000 (1) 5,280,000 (2) 10,080,000 Gross profit ........................... 5,200,000 3,120,000 8,320,000 Operating expenses Selling expenses ............... 750,000 580,000 1,330,000 Administrative expenses........................ 420,000 380,000 800,000 Total operating expenses ................ 1,170,000 960,000 2,130,000 Income before income taxes................................... $ 4,030,000 $2,160,000 6,190,000 Income tax expense (30%) .................................. 1,857,000 Net income ............................ $ 4,333,000 (1) (2)

9-51

400,000 X $12. 240,000 X $22.

PROBLEM 9-3B

(a)

OGLEBY INDUSTRIES Sales Budget For the Year Ending December 31, 2014

Expected unit sales .................................. Unit selling price ....................................... Total sales .................................................

Plan A Plan B 760,000 (1) 950,000 (2) X $7.60 X $6.65 (3) $5,776,000 $6,317,500

(1)

800,000 X 95% = 760,000. 800,000 + 150,000 = 950,000. (3) $7.00 X 95% = $6.65. (2)

(b)

OGLEBY INDUSTRIES Production Budget For the Year Ending December 31, 2014

Plan A 760,000 90,000 850,000 70,000 780,000

Plan B 950,000 100,000 1,050,000 70,000 980,000

(c) Variable costs = $4.00 per unit ($2.00 + $1.50 + $.50) for both plans. Plan A Total variable costs Total fixed costs Total costs (a) Total units (b) Unit cost (a) ÷ (b)

$3,120,000 (780,000 X $4.00) 980,000 $4,100,000

Plan B $3,920,000 (980,000 X $4.00) 980,000 $4,900,000

780,000

980,000

$5.26

$5.00

The difference is due to the fact that fixed costs are spread over a larger number of units (200,000) in Plan B.

9-52

PROBLEM 9-3B (Continued) (d)

Gross Profit Plan A Sales Cost of goods sold Gross profit

$5,776,000 3,997,600 (760,000 X $5.26) $1,778,400

Plan B $6,317,500 4,750,000 (950,000 X $5.00) $1,567,500

Plan A should be accepted because it produces a higher gross profit than Plan B.

9-53

PROBLEM 9-4B

(a) 1.

Expected Collections from Customers

November ($200,000) .................................. December ($290,000) .................................. January ($350,000)...................................... February ($400,000) .................................... Total collections ................................ 2.

$312,500

February $ 0 43,500 87,500 240,000 $371,000

Expected Payments for Direct Materials

December ($90,000) .................................... January ($110,000)...................................... February ($120,000) .................................... Total payments ..................................

9-54

January $ 30,000 72,500 210,000

January $63,000 33,000 $96,000

February $ 0 77,000 36,000 $113,000

PROBLEM 9-4B (Continued) (b)

DERBY COMPANY Cash Budget For the Two Months Ending February 28, 2014

Beginning cash balance ................................... Add: Receipts Collections from customers .................. [See Schedule (1)] Interest receivable .................................. Sale of securities .................................... Total receipts .................................. Total available cash .......................................... Less: Disbursements Direct materials ..................................... [See Schedule 2] Direct labor ....................................... Manufacturing overhead .................. Selling and administrative expenses ....................................... Purchase of land .............................. Total disbursements ................ Excess (deficiency) of available cash over cash disbursements............................. Financing Add: Borrowings ............................................. Less: Repayments ............................................ Ending cash balance ........................................

9-55

January $ 50,000

February $ 49,500

312,500

371,000

3,000 315,500 365,500

5,000 376,000 425,500

96,000

113,000

85,000 60,000

115,000 75,000

75,000 316,000

80,000 20,000 403,000

49,500

22,500

0 0 $ 49,500

17,500 0 $ 40,000

PROBLEM 9-5B

(a)

WIDNER COMPANY Westwood Store Merchandise Purchases Budget For the Months of July and August, 2014 July August Budgeted cost of goods sold ............................. $260,000(1) $292,500 Add: Desired ending merchandise inventory ... 43,875(2) 48,750 (3) Total ..................................................................... 303,875 341,250 Less: Beginning merchandise inventory .................................................. 39,000(4) 43,875 Required merchandise purchases ..................... $264,875 $297,375 (1)

$400,000 X 65% = $260,000 $292,500 X 15% = $ 43,875. (3) $500,000 X 65% = $325,000; $325,000 X 15% = $48,750. (4) $260,000 X 15% = $ 39,000. (2)

9-56

PROBLEM 9-5B (Continued) (b)

WIDNER COMPANY Westwood Store Budgeted Income Statement For the Months of July and August, 2014

Sales ................................................................... Cost of goods sold Beginning inventory................................... Purchases ................................................... Cost of goods available for sale ............... Less: Ending inventory ............................. Cost of goods sold ..................................... Gross profit ........................................................ Operating expenses Sales salaries ............................................. Advertising* ................................................ Delivery expense** ..................................... Sales commissions*** ................................ Rent ............................................................. Depreciation ............................................... Utilities ........................................................ Insurance .................................................... Total ..................................................... Income from operations .................................... Income tax expense (30%) ................................ Net income ......................................................... *5% of sales **2% of sales ***4% of sales

9-57

July $400,000

August $450,000

39,000 264,875 303,875 43,875 260,000 140,000

43,875 297,375 341,250 48,750 292,500 157,500

50,000 20,000 8,000 16,000 3,000 700 500 300 98,500 41,500 12,450 $ 29,050

50,000 22,500 9,000 18,000 3,000 700 500 300 104,000 53,500 16,050 $ 37,450

BYP 9-1

DECISION-MAKING AT CURRENT DESIGNS CREATIVE DESIGNS Production Budget For the Year Ending December 31, 2013

Expected unit sales Add: desired ending finished goods units Total required units Less: Beginning finished goods units Required production units

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total 1,000 1,500 750 750 4,000 300* 1,300

150* 1,650

150* 900

220** 220 970 4,220

200*** 1,100

300 1,350

150 750

150 820

*(20% of next quarter’s sales) **20% X 1,100 ***given in problem

9-58

200 4,020

BYP 9-1 (Continued) CREATIVE DESIGNS Direct materials Budget For the Year Ending December 31, 2013 Units to be produced Pounds of polyethylene powder per unit Total pounds needed for production Add: desired ending inventory of powder Total pounds of powder required Less: Beginning inventory of powder Pounds of Polyethylene powder to be purchased Cost per pound Cost of polyethylene powder to be purchased Cost of required finishing kits (one kit per kayak manufactured) @$170 each Total costs for direct materials

Quarter 1

Quarter 2

Quarter 3

Quarter 4

1,100

1,350

750

820

Total 4,020 X

59,400

72,900

40,500

44,280

217,080

18,225*

10,125*

11,070*

15,930**

15,930

77,625

83,025

51,570

60,210

233,010

19,400***

18,225

10,125

11,070

19,400

58,225 $1.50

64,800 $1.50

41,445 $1.50

49,140 $1.50

213,610 $1.50

$ 87,337.50

$ 97,200.00

$ 62,167.50 $ 73,710.00

$ 320,415.00

187,000.00 $274,337.50

229,500.00 $326,700.00

127,500.00 139,400.00 $189,667.50 $213,110.00

683,400.00 $1,003,815.00

*25% of needs for next quarter **Desired ending inventory for Quarter 4 = 25% of amount needed for first quarter of 2014 production. Production for first quarter of 2014 = 1,100 + 300 – 220 = 1,180 units Desired ending inventory for Quarter 4 of 2013 = 25% *(1,180 units * 54 pounds per unit) = 15,930 pounds ***given in problem

9-59

BYP 9-1 (Continued) CREATIVE DESIGNS Direct labor Budget For the Year Ending December 31, 2013 Units to be produced Number of hours of more skilled labor/unit Total number of hours of more skilled labor Hourly rate for more skilled labor Total cost of more skilled labor Units to be produced Number of hours of less skilled labor/unit Total number of hours of less skilled labor Hourly rate for less skilled labor Total cost of less skilled labor Total cost for direct labor

Quarter 1

Quarter 2

Quarter 3

Quarter 4

1,100

1,350

750

820

Total 4,020 X

2,200 X $15 $33,000 1,100

2,700 X $15 $40,500 1,350

1,500 X $15 $22,500 750

1,640 X $15 $24,600 820

8,040 X $15 $120,600 4,020

3,300 X $12 39,600 $72,600

4,050 X $12 48,600 $89,100

2,250 X $12 27,000 $49,500

2,460 X $12 29,520 $54,120

12,060 X $12 144,720 $265,320

CREATIVE DESIGNS Manufacturing Overhead Budget For the Year Ending December 31, 2013 Quarter 1 Quarter 2 Quarter 3 Quarter 4

Total

Total costs for direct labor $72,600 $89,100 $49,500 $54,120 $265,320 Manufacturing overhead rate per direct labor dollar X 150% X 150% X 150% X 150% X 150% Manufacturing overhead costs $108,900 $133,650 $74,250 $81,180 $397,980

9-60

BYP 9-1 (Continued) CREATIVE DESIGNS Selling and Administrative Expense Budget For the Year Ending December 31, 2013 Expected unit sales Variable selling and administrative costs at $45 per unit sold Fixed selling and administrative costs Total selling and administrative costs

9-61

Quarter 1 Quarter 2 Quarter 3 Quarter 4 1,000 1,500 750 750

Total 4,000

$45,000

$67,500

$33,750

$180,000

7,500

30,000

$52,500

$75,000

$41,250

$210,000

BYP 9-2

DECISION-MAKING ACROSS THE ORGANIZATION

(a) The budget at Palmer Corporation is an imposed “top-down” budget which fails to consider both the need for realistic data and the human interaction essential to an effective budgeting/control process. The president has not given any basis for his goals, so one cannot know whether they are realistic for the company. True participation of company employees in preparation of the budget is minimal and limited to mechanical gathering and manipulation of data. This suggests there will be little enthusiasm for implementing the budget. The budget process is the merging of the requirements of all facets of the company on a basis of sound judgment and equity. Specific instances of poor procedures other than the approach and goals include the following: 1.

The sales by product line should be based upon an accurate sales forecast of potential market. Therefore, the sales by product line should have been developed first to derive the sales target rather than the reverse.

Production costs probably would be the easiest and most certain costs to estimate. Given variable and fixed production costs, one could estimate the sales volume needed to cover manufacturing costs plus the costs of other aspects of the operation. This would be helpful before budgets for marketing costs and corporate office expenses are set.

The initial meeting between the vice president of finance, executive vice president, marketing manager, and production manager should be held earlier. This meeting is held too late in the budgeting process.

(b) Palmer Corporation should consider the adoption of a “bottom to top” (participative) budget process. This means that the people responsible for performance under the budget would participate in the decisions by which the budget is established. In addition, this approach requires initial and continuing involvement of sales, financial, and production personnel to define sales and profit goals which are realistic within the constraints under which management operates. Although time-consuming, the approach should produce a more acceptable, honest, and workable goal-control mechanism. It also provides for goal congruence possibilities for both individuals and departments within the firm. 9-62

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

BYP 9-2 (Continued) The sales forecast should be developed considering internal sales forecasts as well as external factors. Costs within departments should be divided into fixed and variable, discretionary and nondiscretionary. (c) The functional areas should not necessarily be expected to cut costs when sales volume falls below budget. The time frame of the budget (one year) is short enough so that many costs are relatively fixed in amount. For those costs which are fixed, there is little hope for a reduction as a consequence of short-run changes in volume. However, the functional areas should be expected to cut costs should sales volume fall below target when:

Control is exercised over the costs within their function.

Budgeted costs were more than adequate for the originally targeted sales; i.e., slack was present.

Budgeted costs vary to some extent with changes in sales.

There are discretionary costs which can be delayed or omitted with no serious effect on the department. (CMA adapted)

9-63

BYP 9-3

MANAGERIAL ANALYSIS

(a) Direct materials

Either lower quality materials resulting in an inferior product and possible lost sales, or fewer units produced resulting in lost sales.

Direct labor

Reduced production resulting in lost sales, or reduction in quality of product resulting in lost sales.

Insurance

Less coverage; may increase risk beyond acceptable levels.

Depreciation

To reduce depreciation, fixed assets would have to be disposed of. Could result in less production and lost sales.

Machine repairs

Less efficient operations, or lost production and sales.

Sales salaries

Lost sales.

Office salaries

Less effective administrative functions.

Factory salaries

Lost production due to inefficiency, and therefore lost sales.

(b) Given the nature of their product, a decline in quality should be avoided, since this could result in lower future sales. Direct materials represent the largest single cost, and thus perhaps the greatest potential savings. Perhaps substitute materials of similar quality can be found, or less expensive materials can be used for aspects of the product where quality is not as critical. Additionally, it may be possible to renegotiate prices with the supplier. Elliot & Hesse should be very reluctant to reduce repair costs, since in the long run this can be very expensive. Perhaps salaried and hourly employees can be encouraged to take pay cuts if a profit-sharing mechanism is introduced.

9-64

BYP 9-4

REAL-WORLD FOCUS

(a) The factors that affect the budgeting process at Network Computing Devices, Inc. are general economic conditions affecting industry demand for computer products, the timing and market acceptance of new products of the Company and its competitors, the timing of significant orders from large customers, periodic changes in product pricing and discounting due to competitive factors, and the availability of key product components (raw materials). In addition, the budgeting process will be affected by the Company’s success with its products, its product and customer mix, and the level of competition it experiences. (b) Internationally, third quarter sales are adversely affected because European customers reduce their business activity in August. In addition, international sales are denominated in U.S. dollars and any change in the value of the dollar relative to foreign currencies could make the Company’s products more or less competitive in foreign markets.

9-65

BYP 9-5

REAL-WORLD FOCUS

(a) According to Mr. LaFaive, zero-based budgeting requires that the existence of a government program or programs be justified in each fiscal year, as opposed to simply basing budgeting decisions on a previous year’s funding level. Zero-based budgeting is often encouraged by fiscal watchdog groups as a way to ensure against unnecessary spending. (b) In addition to saving money and improving services, zero-based budgeting may: • • •

Increase restraint in developing budgets; Reduce the entitlement mentality with respect to cost increases; and Make budget discussions more meaningful during review sessions.

May increase the time and expense of preparing a budget; May be too radical a solution for the task at hand. You don’t need a sledgehammer to pound in a nail; Can make matters worse if not done in the right way. A substantial commitment must be made by all involved to ensure that this doesn’t happen.

(d) In Oklahoma, which has recently adopted zero-based budgeting, officials are applying the method to two departments and several agencies each year. Once those reviews are complete, the same departments and agencies will not see another zero-based review for eight years.

9-66

BYP 9-6

COMMUNICATION ACTIVITY

Date 2014 Mrs. Megan Parcells, CEO Life Protection Products Dear Mrs. Parcells: Allow me to congratulate you on the success of your new venture! The growth in sales you have experienced is phenomenal. You have managed the business side of the venture very well also. At the same time, I understand your concern about cash flow. You are selling these kits as fast as you can make them, and yet you are running out of cash. There is a solution to your problem. Before describing that, it may be helpful for you to understand why this situation occurred. The primary reason is that you are purchasing kit supplies at least two months in advance of sales. As your business expands, these materials costs continue to increase. Sales do not “catch up” until the Drs. Parcells have a seminar. You did not describe in detail how often these seminars are, but I would guess that they tend to run in cycles rather than being regularly spaced. Eventually, as sales stabilize, you will find that cash inflows exceed cash outflows, and your need for additional cash will subside. Presently, I think it would be a good idea to try to borrow additional funds. I have not seen all your financial data, but judging only from the cash budget you showed me, it appears that you have the basis of a very successful company. If so, your banker will be able to see the potential in your business and should be happy to provide the cash you need. You will need to prepare a full set of financial statements. I will be happy to assist you, if you desire. There is also a possibility that you have underpriced your product. You are providing a valuable service in assembling this information and these materials. The fact that every seminar results in a sellout of the materials may mean that you have priced your product too low. I know that your husband wishes to have these materials available to every family, but increasing the price a little may not make the price too high, and would better compensate you for your efforts.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

9-67

BYP 9-6 (Continued) However, even if you raised prices, you will find that you need additional cash as long as the business continues to expand. It certainly does not mean that you and Sue are doing anything wrong. It just means that you will be investing additional funds as long as you continue to grow. In my opinion, the best way to make sure these kits are available to as many families as possible is for you and Sue to have a consultant evaluate and determine the size of the market for you. Then you can decide whether to expand to meet the need, or whether to keep your own business small and allow competitors to imitate your product. Congratulations again on a very successful product. Call or email this office if we may be of further assistance preparing financial statements or providing additional advice. Sincerely, Ima Student Best and Superior, Certified Public Accountants

9-68

BYP 9-7

ETHICS CASE

(a) At best, if you disclose the errors in your calculations, you will be embarrassed. At worst, you will be dismissed without a recommendation for another job. (b) The president will continue making presentations using data that are grossly overstated. In time, your error may be detected when the events you projected do not materialize. (c) The most ethical scenario would be to admit your error, let the president know about the error, provide the president with corrected projections, and allow the president to decide how to alter his presentations during the second week of his speech-making.

9-69

BYP 9-8

ALL ABOUT YOU

Personal Budget Typical Month Income: Wages earned .................................................. Interest income ................................................ Income subtotal .......................................................... Income tax withheld ................................................... Spendable income........................................... Expenses: Rent ............................................................................. Utilities Electricity ......................................................... Telephone and Internet ................................... Food: Groceries ......................................................... Eating out......................................................... Insurance .................................................................... Transportation ............................................................ Student loan payments .............................................. Entertainment ............................................................. Savings ....................................................................... Miscellaneous ............................................................. Total investments and expenses .............. Surplus/Shortage........................................................

9-70

$2,500 50 2,550 300 $2,250 500 85 125 100 150 100 150 375 250 50 210 2,095 $ 155

BYP 9-9

CONSIDERING YOUR COSTS AND BENEFITS

We are concerned that the personal budgets presented on websites and in financial planning textbooks often list student loans among the sources of income. This type of thinking can lead to an overreliance on debt during college, and will result in accumulation of large amounts of debt that must be repaid. We would prefer a format that lists nondebt sources of income, then subtracts expenses, then shows debt borrowed. This format emphasizes an important point: Just like a business, in the short run you can borrow money when your cash inflows are not sufficient to meet your outflows, but in the long run you need to learn to live within your income, and your budget.

9-71

CHAPTER 10 Budgetary Control and Responsibility Accounting ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Learning Objectives

Questions

Do It!

Describe the concept of budgetary control.

1, 2

Evaluate the usefulness of static budget reports.

3, 4, 5

1, 2

Explain the development of flexible budgets and the usefulness of flexible budget reports.

6, 7, 8, 9, 10, 11, 12

3, 4, 5

Describe the concept of responsibility accounting.

13, 14, 15, 16, 17, 18, 24

Indicate the features of responsibility reports for cost centers.

Identify the content of responsibility reports for profit centers.

20, 21

Explain the basis and formula used in evaluating performance in investment centers.

22, 23, 24

8, 9, 10

*8.

Explain the difference between ROI and residual income.

25, 26

11, 12

A Problems

B Problems

1, 2, 8, 10

1, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12

1A, 2A, 3A

1B, 2B, 3B

15, 16

16, 17, 18, 19

20, 21

Exercises 1

1, 2

9, 11, 14

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter.

10-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare flexible budget and budget report for manufacturing overhead.

Simple

20–30

Prepare flexible budget, budget report, and graph for manufacturing overhead.

Moderate

30–40

State total budgeted cost formula, and prepare flexible budget reports for two time periods.

Simple

20–30

Prepare responsibility report for a profit center.

Moderate

20–30

Prepare responsibility report for an investment center, and compute ROI.

Moderate

40–50

Prepare reports for cost centers under responsibility accounting, and comment on performance of managers.

Moderate

40–50

*7A

Compare ROI and residual income.

Moderate

25–35

Prepare flexible budget and budget report for manufacturing overhead.

Simple

20–30

Prepare flexible budget, budget report, and graph for manufacturing overhead.

Moderate

30–40

State total budgeted cost formula, and prepare flexible budget reports for two time periods.

Simple

20–30

Prepare responsibility report for a profit center.

Moderate

20–30

Prepare responsibility report for an investment center, and compute ROI.

Moderate

40–50

Prepare reports for cost centers under responsibility accounting, and comment on performance of managers.

Moderate

40–50

*7B

Compare ROI and residual income.

Moderate

25–35

10-2

10-3

Learning Objective

Knowledge Comprehension

Application

Analysis

1. Describe the concept of budgetary control.

E10-1

Q10-1 Q10-2

2. Evaluate the usefulness of static budget reports.

E10-1

Q10-3 Q10-4

Q10-5 BE10-1 BE10-2

E10-2 P10-3A E10-10 P10-3B

3. Explain the development of flexible budgets and the usefulness of flexible budget reports.

Q10-9 Q10-12 E10-1

Q10-6 Q10-7 Q10-8 Q10-10

Q10-11 BE10-4 DI10-1 DI10-2 E10-3 E10-5

E10-7 BE10-5 E10-9 E10-4 E10-10 E10-6 E10-11 P10-1A E10-12 P10-3A P10-1B

Q10-13 Q10-14 Q10-15 Q10-16

Q10-17 E10-13 Q10-18 Q10-24

P10-6A P10-6B

BE10-6 E10-9 E10-11

E10-14

4. Describe the concept of responsibility accounting.

5. Indicate the features of responsibility reports for cost centers.

Q10-19

6. Identify the content of responsibility reports for profit centers.

Q10-20 Q10-21

BE10-7 DI10-3 E10-16

E10-15 P10-4A P10-4B

7. Explain the basis and formula used in evaluating performance in investment centers.

Q10-22 Q10-23 Q10-24

BE10-8 BE10-9 BE10-10 DI10-4

E10-16 E10-19 E10-17 E10-18

BE10-11 BE10-12

E10-20 E10-21 P10-7A

BYP10-5

BYP10-4 BYP10-6 BYP10-7

*8. Explain the difference between ROI and residual income. Broadening Your Perspective

Q10-25 Q10-26

Synthesis

Evaluation

E10-8 P10-3B

BE10-3 E10-8 P10-2A P10-2B

P10-5A P10-5B

P10-7B

BYP10-2 BYP10-3

BYP10-8 BYP10-9

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) Budgetary control is the use of budgets in controlling operations. (b) The steps in budgetary control are: (1) Develop the planned objectives (budget). (2) Analyze differences between actual and budgeted results. (3) Take corrective action. (4) Modify future plans, if necessary.

Purpose

Name of Report

Frequency

(a) (b) (c)

Scrap Departmental overhead costs Income statement

Daily Monthly Monthly and Quarterly

Primary Recipient(s) Production manager Department manager Top management

The budget report for the second quarter can include year-to-date information as well as data for the second quarter.

There is no justification for Ken’s concern. The sales budget is derived from the sales forecast and it represents management’s best estimate of sales. Thus, it is a useful basis for evaluating sales performance.

A static budget is an appropriate basis for evaluating a manager’s effectiveness in controlling costs when: (1) The actual level of activity closely approximates the master budget activity level and/or (2) The behavior of the costs in response to changes in activity is fixed.

Yes, this is true. A flexible budget is a series of static budgets at different levels of activity.

The performance is unfavorable. The budgeted indirect labor cost in the static budget is $1.35 per direct labor hour ($54,000 ÷ 40,000). At 45,000 direct labor hours, budgeted costs are $60,750 (45,000 X $1.35). Thus, indirect labor is $3,250 over budget ($64,000 – $60,750).

The performance is favorable. Factory insurance is a fixed cost. At 50,000 direct labor hours, the budgeted cost is still $6,500. Thus, factory insurance is $200 under budget ($6,500 – $6,300).

The steps in preparing a flexible budget are: (1) Identify the activity index and the relevant range of activity. (2) Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost. (3) Identify the fixed costs, and determine the budgeted amount for each cost. (4) Prepare the budget for selected increments of activity within the relevant range.

10.

Cali Company can say that total budgeted costs are $20,000 fixed plus $6.50 per direct labor hour [($85,000 – $20,000) ÷ 10,000].

11.

(a) At 9,000 hours, total budgeted costs are $86,000, or [$50,000 + ($4 X 9,000)]. (b) At 12,345 hours, total budgeted costs are $99,380, or [$50,000 + ($4 X 12,345)].

10-4

Questions Chapter 10 (Continued) 12.

Management by exception means that top management’s review of a budget report is focused either entirely or primarily on differences between actual results and planned objectives. The criteria for identifying exceptions are materiality and controllability of the item.

13.

Responsibility accounting is a method of controlling operations that involves accumulating and reporting costs (and revenues, where relevant) on the basis of the manager who has the authority to make the day-to-day decisions about the items. The purpose of responsibility accounting is to evaluate a manager’s performance on the basis of matters directly under that manager’s control.

14.

Eve should know that the following conditions contribute to the effective use of responsibility accounting: (1) Costs and revenues can be directly associated with the specific level of management responsibility. (2) The costs and revenues are controllable at the level of responsibility with which they are associated. (3) Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and revenues.

15.

A cost is controllable at a given level of managerial responsibility if the manager has the power to incur the cost within a given period of time. Most costs incurred directly are controllable, whereas costs incurred indirectly and allocated to a responsibility level are noncontrollable at that level.

16.

Responsibility reports differ from budget reports in two respects: (1) a distinction is made between controllable and noncontrollable items and (2) performance reports either emphasize, or only include, items controllable by the individual manager.

17.

Usually there is a relationship between a responsibility reporting system and a company’s organization chart. In a responsibility reporting system, reports are prepared for each level of responsibility in the organization chart.

18.

There are three types of responsibility centers: (a) A cost center incurs costs (and expenses) but does not generate revenues. (b) A profit center incurs costs (and expenses) and also generates revenues. (c) An investment center incurs costs (and expenses), generates revenues, and controls the investment funds available for use.

19.

(a) Only controllable costs are included in a performance report for a cost center. (b) Variable and fixed costs are not identified in the report.

20.

Direct fixed costs relate specifically to one center and are incurred for the sole benefit of that center. An indirect fixed cost relates to the company’s overall activities and is incurred for the benefit of more than one profit center. Both types of fixed costs are controllable. A direct fixed cost is controllable by a specific center manager and an indirect fixed cost is controllable by an officer higher up in the organization.

21.

Controllable margin is contribution margin less controllable fixed costs in a profit center. The purpose of controllable margin is to provide a basis for evaluating the manager’s effectiveness in controlling revenues and costs.

10-5

Questions Chapter 10 (Continued) 22. The primary basis for evaluating the performance of the manager of an investment center is return on investment (ROI). The formula is: Controllable Margin divided by Average Operating Assets. 23. ROI can be improved by: (1) increasing controllable margin and (2) reducing average operating assets. Controllable margin can be increased by increasing sales or by reducing variable and controllable fixed costs. 24. (a) The manager being evaluated should have direct input into the process of establishing budget goals and have the opportunity to respond to the evaluation. (b) Top management should make the evaluation entirely on matters controllable by the manager, and should fully support the evaluation process. *25. ROI fails to indicate the dollar amount of change in residual income. That is, a positive increase in residual income may result from a project that is rejected because of its negative effect on ROI. *26. Residual income is the income that remains after subtracting from the controllable margin the minimum rate of return on a company’s average operating assets. Residual income as a performance measure ignores the amount of difference in investments (average operating assets) by concentrating only on the amount of additional residual income.

10-6

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 MARIS COMPANY Sales Budget Report For the Quarter Ended March 31, 2014 Product Line Garden-Tools

Budget $310,000

Actual $305,000

Difference $5,000 U

BRIEF EXERCISE 10-2 MARIS COMPANY Sales Budget Report For the Quarter Ended June 30, 2014 Product Line

Second Quarter Budget Actual Difference

Garden-Tools $380,000 $384,000

$4,000 F

Year to Date Budget Actual Difference $690,000 $689,000

$1,000 U

BRIEF EXERCISE 10-3 (a)

PAIGE COMPANY Static Direct Labor Budget Report For the Month Ended January 31, 2014

Direct Labor (b)

(10,000 X $20)

Actual $204,000

Difference $4,000 U

PAIGE COMPANY Flexible Direct Labor Budget Report For the Month Ended January 31, 2014

Direct Labor .

Budget $200,000

10-7

Budget $208,000

(10,400 X $20)

Actual $204,000

Difference $4,000 F

BRIEF EXERCISE 10-3 (Continued) The static budget does not provide a proper basis for evaluating performance because the budget is not based on the hours actually worked. In contrast, the flexible budget provides the proper basis for evaluating performance because the budget is based on the hours actually worked.

BRIEF EXERCISE 10-4 GUNDY COMPANY Monthly Flexible Manufacturing Budget For the Year 2014 Activity level Finished units Variable costs Direct materials ($5) Direct labor ($6) Overhead ($8) Total variable costs ($19) Fixed costs Depreciation (1) Supervision (2) Total fixed costs Total costs (1) (2)

($2 X 1,200,000) ÷ 12 ($1 X 1,200,000) ÷ 12

10-8

80,000

100,000

120,000

$ 400,000 480,000 640,000 $1,520,000

$ 500,000 600,000 800,000 $1,900,000

$ 600,000 720,000 960,000 $2,280,000

200,000 100,000 300,000 $1,820,000

200,000 100,000 300,000 $2,200,000

200,000 100,000 300,000 $2,580,000

BRIEF EXERCISE 10-5 GUNDY COMPANY Manufacturing Flexible Budget Report For the Month Ended March 31, 2014

Units produced Variable costs Direct materials Direct labor Overhead Total variable costs Fixed costs Depreciation Supervision Total fixed costs Total costs

Budget

Actual

100,000

Difference Favorable F Unfavorable U

$ 500,000 600,000 800,000 $1,900,000

$ 525,000 596,000 805,000 $1,926,000

$25,000 U 4,000 F 5,000 U $26,000 U

200,000 100,000 300,000 $2,200,000

200,000 100,000 300,000 $2,226,000

–0– –0– –0– $26,000 U

Costs were not entirely controlled as evidenced by the difference between budgeted and actual for the variable costs.

BRIEF EXERCISE 10-6 HANNON COMPANY Assembly Department Manufacturing Overhead Cost Responsibility Report For the Month Ended April 30, 2014 Controllable Cost

Budget

Actual

Indirect materials Indirect labor Utilities Supervision

$16,000 20,000 10,000 5,000 $51,000

$14,300 20,600 10,850 5,000 $50,750

10-9

Difference Favorable F Unfavorable U $1,700 F 600 U 850 U 0U $ 250 F

BRIEF EXERCISE 10-7 ELBERT COMPANY Water Division Responsibility Report For the Year Ended December 31, 2014

Sales Variable costs Contribution margin Controllable fixed costs Controllable margin

Budget

Actual

$2,000,000 1,000,000 1,000,000 300,000 $ 700,000

$2,080,000 1,060,000 1,020,000 305,000 $ 715,000

Difference Favorable F Unfavorable U $80,000 F 60,000 U 20,000 F 5,000 U $15,000 F

BRIEF EXERCISE 10-8 COBB COMPANY Plastics Division Responsibility Report For the Year Ended December 31, 2014 Budget

Actual

Contribution margin Controllable fixed costs Controllable margin

$700,000 300,000 $400,000

$710,000 302,000 $408,000

Return on investment

20%

20.4%

.4% F

($400,000 ÷ $2,000,000)

($408,000 ÷ $2,000,000)

($8,000 ÷ $2,000,000)

BRIEF EXERCISE 10-9 III III III

26% ($1,300,000 ÷ $5,000,000) 25% ($2,000,000 ÷ $8,000,000) 30% ($3,600,000 ÷ $12,000,000)

10-10

Difference Favorable F Unfavorable U $10,000 F 2,000 U $ 8,000 F

BRIEF EXERCISE 10-10 III

A $300,000 ($2,000,000 X .15) increase in sales will increase contribution margin and controllable margin $210,000 ($300,000 X 70%). The new ROI is 30.2% ($1,510,000 ÷ $5,000,000).

III

A decrease in costs results in a corresponding increase in controllable margin. The new ROI is 30% ($2,400,000 ÷ $8,000,000).

III

A decrease in average operating assets reduces the denominator. The new ROI is 31.3% ($3,600,000 ÷ $11,500,000).

*BRIEF EXERCISE 10-11 Controllable Margin $660,000

÷ ÷

Average Operating Assets $3,000,000

= ROI = 22%

Controllable Margin $660,000 $660,000

– – –

(Minimum Rate of Return X Average Operating Assets) (10% X $3,000,000) $300,000

= = =

Residual Income Residual Income $360,000

= = =

Residual Income Residual Income $200,000

*BRIEF EXERCISE 10-12 Controllable Margin $800,000

÷ ÷

Average Operating Assets $4,000,000

Controllable Margin $800,000 $800,000

– – –

(Minimum Rate of Return X Average Operating Assets) (15% X $4,000,000) $600,000

10-11

= ROI = 20%

SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 10-1 Using the graph data, fixed costs are $90,000, and variable costs are $4.80 per direct labor hour [($330,000 – $90,000) ÷ 50,000]. Thus, at 65,000 direct labor hours, total budgeted costs are $402,000 [$90,000 + (65,000 X $4.80)]. DO IT! 10-2

Units produced

Budget 6,000 units

Actual 6,000 units

Difference Favorable F Unfavorable U

Variable costs Direct materials ($7) Direct labor ($13) Overhead ($18) Total variable costs

$ 42,000 78,000 108,000 228,000

$ 38,850 76,440 116,640 231,930

$3,150 F 1,560 F 8,640 U 3,930 U

Fixed costs Depreciation* Supervision** Total fixed costs Total costs

8,000 3,800 11,800 $239,800

8,000 4,000 12,000 $243,930

0 200 U 200 U $4,130 U

*$96,000/12 **$45,600/12 The flexible budget report indicates that actual overhead was 8.0% over budget. This cost was not well-controlled and should be examined further. The other variable costs came in under budget. The direct materials cost was 7.5% under budget; Mussatto should also investigate the cause of this difference, even though it is favorable. Finally, Mussatto also should investigate the unfavorable difference in supervision (5.3%) to determine if the budget amount is out-of-date.

10-12

DO IT! 10-3 WELLSTONE DIVISION Responsibility Report For the Year Ended December 31, 2014

Sales Variable costs Contribution margin Controllable fixed costs Controllable margin

Budget $2,000,000 800,000 1,200,000 550,000 $ 650,000

Actual $1,860,000 760,000 1,100,000 550,000 $ 550,000

Difference Favorable F Unfavorable U $140,000 U 40,000 F 100,000 U –0– $100,000 U

DO IT! 10-4 (a)

Controllable margin for 2013: Sales ..................................................... Variable costs ...................................... Contribution margin ............................ Controllable fixed costs ...................... Controllable margin ............................. Return on investment for 2013:

(b)

$500,000 300,000 200,000 75,000 $125,000 $125,000 $625,000

Expected return on investment for alternative 1: $125,000* = 25% $500,000 *Controllable margin remains unchanged from (a)

10-13

20%

DO IT! 10-4 (Continued) Controllable margin for alternative 2: Sales ($500,000 + 100,000) ............................ Variable costs ($300,000/$500,000 X $600,000) ................. Contribution margin ...................................... Controllable fixed costs ................................ Controllable margin ....................................... Expected return on investment for alternative 2:

10-14

$600,000 360,000 240,000 75,000 $165,000 $165,000 $625,000

26.4%

SOLUTIONS TO EXERCISES EXERCISE 10-1 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

True. False. Budget reports are prepared as frequently as needed. True. True. False. Budgetary control works best when a company has a formalized reporting system. False. The primary recipients of the sales report are the sales manager and top management. True. True. False. Top management’s reaction to unfavorable differences is often influenced by the materiality of the difference. True.

EXERCISE 10-2 (a)

CREDE COMPANY Selling Expense Report For the Quarter Ending March 31

Month

Budget

By Month Actual Difference

January February March

$30,000 $35,000 $40,000

$31,200 $34,525 $46,000

$1,200 U $ 475 F $6,000 U

Budget

Year-to-Date Actual Difference

$ 30,000 $ 65,000 $105,000

$ 31,200 $ 65,725 $111,725

$1,200 U $ 725 U $6,725 U

(b)

The purpose of the Selling Expense Report is to help management control selling expenses. The primary recipient is the sales manager.

(c)

Most likely, when management scrutinized the results for January and February, they would determine that the difference was insignificant (4% in January and 1.4% in February), and require no action. When the March results are examined, however, the fact that the difference is 15% of budget would probably cause management to investigate further. As a result of their investigation, management would either take corrective action or modify the amounts of budgeted selling expense for future months to reflect changing conditions.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

10-15

EXERCISE 10-3 THOME COMPANY Monthly Manufacturing Overhead Flexible Budget For the Year 2014 Activity level Direct labor hours Variable costs Indirect labor ($1) Indirect materials ($.60) Utilities ($.40) Total variable costs ($2.00) Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs

7,000

8,000

9,000

10,000

$ 7,000 4,200 2,800 14,000

$ 8,000 4,800 3,200 16,000

$ 9,000 5,400 3,600 18,000

$10,000 6,000 4,000 20,000

4,000 1,200 800 6,000 $20,000

4,000 1,200 800 6,000 $22,000

4,000 1,200 800 6,000 $24,000

4,000 1,200 800 6,000 $26,000

EXERCISE 10-4 (a)

THOME COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended July 31, 2014

Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Utilities Total variable costs Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs

10-16

Budget at 9,000 DLH

Actual Costs 9,000 DLH

Difference Favorable F Unfavorable U

$ 9,000 5,400 3,600 18,000

$ 8,800 5,300 3,200 17,300

$200 F 100 F 400 F 700 F

4,000 1,200 800 6,000 $24,000

4,000 1,200 800 6,000 $23,300

— — — — $700 F

EXERCISE 10-4 (Continued) (b)

THOME COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended July 31, 2014

Direct labor hours (DLH) Variable costs Indirect labor ($1.00) Indirect materials ($0.60) Utilities ($0.40) Total variable costs ($2.00) Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs

Budget at 8,500 DLH

Actual Costs 8,500 DLH

Difference Favorable F Unfavorable U

$ 8,500 5,100 3,400

$ 8,800 5,300 3,200

$300 U 200 U 200 F

17,000

17,300

300 U

4,000 1,200 800 6,000 $23,000

4,000 1,200 800 6,000 $23,300

— — — — $300 U

(c) In case (a) the performance for the month was satisfactory. In case (b) management may need to determine the causes of the unfavorable differences for indirect labor and indirect materials, or since the differences are small, 3.5% of budgeted cost for indirect labor and 3.9% for indirect materials, they might be considered immaterial.

10-17

EXERCISE 10-5 DEWITT COMPANY Monthly Selling Expense Flexible Budget For the Year 2014 Activity level Sales Variable expenses Sales commissions (6%) Advertising (4%) Traveling (3%) Delivery (2%) Total variable expenses (15%) Fixed expenses Sales salaries Depreciation Insurance Total fixed expenses Total expenses

$170,000

$180,000

$190,000

$200,000

$ 10,200 6,800 5,100 3,400

$ 10,800 7,200 5,400 3,600

$ 11,400 7,600 5,700 3,800

$ 12,000 8,000 6,000 4,000

25,500

27,000

28,500

30,000

35,000 7,000 1,000 43,000 $ 68,500

35,000 7,000 1,000 43,000 $ 70,000

35,000 7,000 1,000 43,000 $ 71,500

35,000 7,000 1,000 43,000 $ 73,000

EXERCISE 10-6 (a)

DEWITT COMPANY Selling Expense Flexible Budget Report For the Month Ended March 31, 2014

Sales Variable expenses Sales commissions Advertising Travel Delivery Total variable expenses Fixed expenses Sales salaries Depreciation Insurance Total fixed expenses Total expenses

10-18

Budget $170,000

Actual $170,000

Difference Favorable F Unfavorable U

$ 10,200 6,800 5,100 3,400 25,500

$ 11,000 6,900 5,100 3,450 26,450

$800 U 100 U 0U 50 U 950 U

35,000 7,000 1,000 43,000 $ 68,500

35,000 7,000 1,000 43,000 $ 69,450

0U 0U 0U 0U $950 U

EXERCISE 10-6 (Continued) (b)

DEWITT COMPANY Selling Expense Flexible Budget Report For the Month Ended March 31, 2014

Sales Variable expenses Sales commissions Advertising Travel Delivery Total variable expenses Fixed costs Sales salaries Depreciation Insurance Total fixed expenses Total expenses

Budget $180,000

Actual $180,000

Difference Favorable F Unfavorable U

$ 10,800 7,200 5,400 3,600

$ 11,000 6,900 5,100 3,450

$200 U 300 F 300 F 150 F

27,000

26,450

550 F

35,000 7,000 1,000 43,000 $ 70,000

35,000 7,000 1,000 43,000 $ 69,450

0U 0U 0U 0U $550 F

(c) Flexible budgets are essential in evaluating a manager’s performance in controlling variable expenses because the budget allowance varies directly with changes in the activity index. At $170,000 of sales, the manager was over budget (unfavorable) by $950 but at $180,000 of sales, the manager was under budget (favorable) by $550.

10-19

EXERCISE 10-7 (a)

KITCHEN HELP INC. Flexible Production Cost Budget Activity level Production levels Variable costs: Manufacturing ($6) Administrative ($4) Selling ($2) Total variable costs ($12) Fixed costs: Manufacturing Administrative Total fixed costs Total costs

90,000

100,000

110,000

$ 540,000 360,000 180,000 1,080,000

$ 600,000 400,000 200,000 1,200,000

$ 660,000 440,000 220,000 1,320,000

160,000 80,000 240,000 $1,320,000

160,000 80,000 240,000 $1,440,000

160,000 80,000 240,000 $1,560,000

(b) Let (X) represent number of units Sales price(X) = Variable costs(X) + Fixed costs + Profit Sales price(X) = Variable costs(X) + $240,000 + $200,000 (Sales price – Variable costs)(X) = $440,000 ($16 – $12)(X) = $440,000 $4(X) = $440,000 X = 110,000 units to be sold

10-20

EXERCISE 10-8 (a)

RENSING GROOMERS Flexible Budget Activity level Direct labor hours Variable costs: Grooming supplies ($5) Direct labor ($14) Overhead ($1) Total variable costs ($20) Fixed costs: Overhead Total fixed costs Total costs

550

600

700

$ 2,750 7,700 550 11,000

$ 3,000 8,400 600 12,000

$ 3,500 9,800 700 14,000

10,000 10,000 $21,000

10,000 10,000 $22,000

10,000 10,000 $24,000

(b) A flexible budget presents expected costs at various levels of production volume, not just one, so that comparisons can be made between actual costs and budgeted costs at the same volume. This allows the person to determine whether a difference between the actual results and budget is due to better or worse cost control than expected or due to achieving a different volume than that upon which the fixed budget was predicated. (c) $21,000 ÷ 550 = $38.18 $22,000 ÷ 600 = $36.67 $24,000 ÷ 700 = $34.29 (d) Cost formula is $10,000 + $20(X), where (X) = direct labor hours Total cost = $10,000 + ($20 X 650) = $23,000. Number of clients = 650 hrs ÷ 1.30 hrs/client = 500 Cost per client = $23,000 ÷ 500 = $46.00 Charge per client = $46.00 X 1.40 = $64.40

10-21

EXERCISE 10-9 (a)

LOWELL COMPANY Manufacturing Overhead Flexible Budget Report For the Quarter Ended March 31, 2014

Variable costs Indirect materials Indirect labor Utilities Maintenance Total variable costs Fixed costs Supervisory salaries Depreciation Property taxes and insurance Maintenance Total fixed costs Total costs

(b)

Budget

Actual

Difference Favorable F Unfavorable U

$12,000 10,000 8,000 6,000 36,000

$13,900 9,500 8,700 5,000 37,100

$1,900 U 500 F 700 U 1,000 F 1,100 U

36,000 7,000

0U 0U

8,000 5,000 56,000 $92,000

8,400 5,000 56,400 $93,500

400 U 0U 400 U $1,500 U

LOWELL COMPANY Manufacturing Overhead Responsibility Report For the Quarter Ended March 31, 2014

Controllable Costs Indirect materials Indirect labor Utilities Maintenance* Supervisory salaries

Budget $12,000 10,000 8,000 11,000 36,000 $77,000

*Includes variable and fixed costs

10-22

Actual $13,900 9,500 8,700 10,000 36,000 $78,100

Difference Favorable F Unfavorable U $1,900 U 500 F 700 U 1,000 F 0U $1,100 U

EXERCISE 10-10 (a)

SORIA COMPANY Selling Expense Flexible Budget Report Clothing Department For the Month Ended October 31, 2014

Sales in units Variable expenses Sales commissions ($.30) Advertising expense ($.09) Travel expense ($.45) Free samples ($.20) Total variable expenses ($1.04) Fixed expenses Rent Sales salaries Office salaries Depreciation—sale staff autos Total fixed expenses Total expenses

Budget 10,000

Actual 10,000

Difference Favorable F Unfavorable U

$ 3,000 900 4,500 2,000

$ 2,600 850 4,100 1,400

$ 400 F 50 F 400 F 600 F

10,400

8,950

1,450 F

1,500 1,200 800 500 4,000 $14,400

1,500 1,200 800 500 4,000 $12,950

0U 0U 0U 0 0U $1,450 F

(b) No, Joe should not have been reprimanded. As shown in the flexible budget report, variable costs were $1,450 below budget.

10-23

EXERCISE 10-11 (a) KIRKLAND PLUMBING COMPANY Home Plumbing Services Segment Responsibility Report For the Quarter Ended March 31, 2014

Service revenue Variable costs: Material and supplies Wages Gas and oil Total variable costs Contribution margin Controllable fixed costs: Supervisory salaries Insurance Equipment depreciation Total controllable fixed costs Controllable margin

Budget

Actual

Difference Favorable F Unfavorable U

$25,000

$26,000

$1,000 F

1,600 3,000 2,800 7,400 17,600

1,200 3,250 3,400 7,850 18,150

400 F 250 U 600 U 450 U 550 F

9,000 4,000 1,500 14,500 $ 3,100

9,500 3,600 1,300 14,400 $ 3,750

500 U 400 F 200 F 100 F $ 650 F

(b) MEMO TO:

Lenny Kirkland

FROM:

Student

SUBJECT:

The Reporting Principles of Performance Reports

When evaluating the performance of a company’s segments, the performance reports should: 1. Contain only data that are controllable by the segment’s manager. 2. Provide accurate and reliable budget data to measure performance. 3. Highlight significant differences between actual results and budget goals. 4. Be tailor-made for the intended evaluation. 5. Be prepared at reasonable intervals.

10-24

I hope these suggested guidelines will be helpful in establishing the performance reporting system to be used by Kirkland Plumbing Company.

10-25

EXERCISE 10-12 (a) Fabricating Department = $50,000 fixed costs plus total variable costs of $2.00 per direct labor hour [($150,000 – $50,000) ÷ 50,000]. Assembling Department = $40,000 fixed costs plus total variable costs of $1.60 per direct labor hour [($120,000 – $40,000) ÷ 50,000]. (b) Fabricating Department = $50,000 + ($2.00 X 53,000) = $156,000. Assembling Department = $40,000 + ($1.60 X 47,000) = $115,200. (c)

$300

Total Budgeted Cost Line

250

Costs in (000)

200 Budgeted Variable Costs

150

100 Budgeted Fixed Costs

Direct Labor Hours in (000)

10-26

90 100

EXERCISE 10-13 (a) To Dallas Department Manager—Finishing Controllable Costs: Direct Materials Direct Labor Manufacturing Overhead Total

Budget $ 44,000 82,000 49,200 $175,200

Month: July Actual $ 41,500 83,400 51,000 $175,900

(b) To Assembly Plant Manager—Dallas Controllable Costs: Dallas Office Departments: Machining Finishing Total

Month: July

Budget $ 92,000

Actual $ 95,000

Fav/Unfav $3,000 U

219,000 175,200 $486,200

220,000 175,900 $490,900

1,000 U 700 U $4,700 U

10-27

Fav/Unfav $2,500 F 1,400 U 1,800 U $ 700 U

Month: July

Budget $ 130,000

Actual $ 132,000

Fav/Unfav $2,000 U

421,000 486,200 496,500 $1,533,700

424,000 490,900 494,200 $1,541,100

3,000 U 4,700 U 2,300 F $7,400 U

EXERCISE 10-14 (a)

MALONE COMPANY Mixing Department Responsibility Report For the Month Ended January 31, 2014 Controllable Cost Indirect labor Indirect materials Lubricants Maintenance Utilities

(b)

Budget $12,000 7,700 1,675 3,500 5,000 $29,875

Actual $12,250 10,200 1,650 3,500 6,400 $34,000

Difference $ 250 UU 2,500 U 25 F -01,400 U $4,125 U

Most likely, when management examined the responsibility report for January, they would determine that the differences were insignificant for indirect labor (2.1% of budget), lubricants (1.5%), and maintenance (0%) and require no action. However, the differences for indirect materials (32.5%) and utilities (28%) would cause management to investigate further. As a result of their investigation, management would either take corrective action or modify the budgeted amounts for future months to reflect changing conditions.

EXERCISE 10-15 (a) 1. 2. 3. 4. 5. 6.

10-28

Controllable margin ($250,000 – $100,000) Variable costs ($600,000 – $250,000) Contribution margin ($450,000 – $320,000) Controllable fixed costs ($130,000 – $90,000) Controllable fixed costs ($180,000 – $95,000) Sales ($250,000 + $180,000)

$150,000 350,000 130,000 40,000 85,000 430,000

EXERCISE 10-15 (Continued) (b)

DEITZ INC. Women’s Shoe Division Responsibility Report For the Month Ended June 30, 2014

Sales Variable costs Contribution margin Controllable fixed costs Controllable margin

Budget $600,000 340,000 260,000 100,000 $160,000

Actual $600,000 350,000 250,000 100,000 $150,000

Difference Favorable F Unfavorable U $ 0U 10,000 U 10,000 U 0U $10,000 U

EXERCISE 10-16 (a)

HARRINGTON COMPANY Sports Equipment Division Responsibility Report 2014

Sales Variable costs Cost of goods sold Selling and administrative Total Contribution margin Controllable fixed costs Cost of goods sold Selling and administrative Total Controllable margin

Budget

Actual

Difference

$900,000

$880,000

$20,000 U

440,000 60,000 500,000 400,000

408,000 61,000 469,000 411,000

32,000 F 1,000 U 31,000 F 11,000 F

100,000 90,000 190,000 $210,000

105,000 66,000 171,000 $240,000

5,000 U 24,000 F 19,000 F $30,000 F

(b) ($240,000 – $90,000)/$1,000,000 = 15%

10-29

EXERCISE 10-17 (a) Controllable margin = ($3,000,000 – $1,980,000 – $600,000) = $420,000 ROI = $420,000 ÷ $5,000,000 = 8.4% (b) 1.

Contribution margin percentage is 34%, or ($1,020,000 ÷ $3,000,000) Increase in controllable margin = $320,000 X 34% = $108,800 ROI = ($420,000 + $108,800) ÷ $5,000,000 = 10.6%

($420,000 + $150,000) ÷ $5,000,000 = 11.4%

$420,000 ÷ ($5,000,000 – $200,000) = 8.75%

EXERCISE 10-18 (a) DINKLE AND FRIZELL DENTAL CLINIC Preventive Services Responsibility Report For the Month Ended May 31, 2014

Service revenue Variable costs Filling materials Novocain Dental assistant wages Supplies Utilities Total variable costs Contribution margin Controllable fixed costs Dentist salary Equipment depreciation Total controllable fixed costs Controllable margin Return on investment*

Budget $39,000

Actual $40,000

Difference Favorable F Unfavorable U $1,000 F

4,900 3,800 2,500 2,250 390 13,840 25,160

5,000 3,900 2,500 1,900 500 13,800 26,200

100 U 100 U 0 350 F 110 U 40 F 1,040 F

9,400 6,000 15,400 $ 9,760

9,800 6,000 15,800 $10,400

400 U 0 400 U $ 640 F

12.2%

13.0%

0.8% F

*Average investment = ($82,400 + $77,600) ÷ 2 = $80,000 Budget ROI = $9,760 ÷ $80,000 Actual ROI = $10,400 ÷ $80,000 ROI Difference = $640 ÷ $80,000 10-30

EXERCISE 10-18 (Continued) (b) MEMO TO: Drs. Reese Dinkle and Anita Frizell FROM: Student SUBJECT: Deficiencies in the Current Responsibility Reporting System The current reporting system has the following deficiencies: 1. 2. 3. 4.

It does not clearly show both budgeted goals and actual performance. It does not indicate the contribution margin generated by the center, showing the amount available to go towards covering controllable fixed costs. It does not report only those costs controllable by the manager of the center. Instead, it includes both controllable and common fixed costs. This results in the center appearing to be unprofitable. It does not indicate the return on investment earned by the center.

All of these deficiencies have been addressed in the recommended responsibility report attached. As can be seen from that report, the Preventive Services center is profitable. The service revenues generated in this center are adequate to cover all of its costs, both variable and controllable fixed costs, and contribute toward the covering of the clinic’s common fixed costs. In addition, the report indicates the return on investment earned by the center and that it exceeds the budget goal.

10-31

EXERCISE 10-19 Planes: ROI = Controllable margin ÷ Average operating assets 13% = Controllable margin ÷ $25,000,000 Controllable margin = $25,000,000 X 13% = $3,250,000 Contribution margin = Controllable margin + Controllable fixed costs = $3,250,000 + $1,500,000 = $4,750,000 Service revenue = Contribution margin + Variable costs = $4,750,000 + $5,500,000 = $10,250,000 Taxis: ROI = Controllable margin ÷ Average operating assets 10% = $80,000 ÷ Average operating assets Average operating assets = $80,000 ÷ 10% = $800,000 Controllable margin = Contribution margin – Controllable fixed costs $80,000 = $250,000 – Controllable fixed costs Controllable fixed costs = $250,000 – $80,000 = $170,000 Contribution margin = Service revenue – Variable costs $250,000 = $500,000 – Variable costs Variable costs = $500,000 – $250,000 = $250,000

10-32

EXERCISE 10-19 (Continued) Limos: ROI = Controllable margin ÷ Average operating assets = $240,000 ÷ $1,500,000 = 16% Controllable margin = Contribution margin – Controllable fixed costs $240,000 = $480,000 – Controllable fixed costs Controllable fixed costs = $480,000 – $240,000 = $240,000 Contribution margin = Service revenue – Variable costs $480,000 = Service revenue – $300,000 Sales = $480,000 + $300,000 = $780,000

*EXERCISE 10-20 (a)

North Division: ROI = $140,000 ÷ $1,000,000 = 14% West Division: ROI = $360,000 ÷ $2,000,000 = 18% South Division: ROI = $210,000 ÷ $1,500,000 = 14%

(b)

North Division: Residual Income = $140,000 – (.13 X $1,000,000) = $10,000 West Division: Residual Income = $360,000 – (.16 X $2,000,000) = $40,000 South Division: Residual Income = $210,000 – (.10 X $1,500,000) = $60,000

10-33

*EXERCISE 10-20 (Continued) (c)

If ROI is used to measure performance, only the North Division (with a 14% ROI) and the South Division (with a 14% ROI) would make the additional investment that provides a 16% ROI. The West Division presently earns an 18% return ($360,000 ÷ $2,000,000), and therefore would decline the investment. If residual income is used to measure performance, all three divisions would probably make the additional investment because each would realize an increase in residual income.

*EXERCISE 10-21 (a)

ROI

(b)

Controllable margin – (Minimum rate of return X Average operating assets) = Residual income $200,000 – (Minimum rate of return X $1,000,000) = $100,000 $100,000 = Minimum rate of return X $1,000,000 Minimum rate of return = 10%

(c)

Controllable margin Controllable margin Controllable margin

(d)

ROI =

= Controllable margin 20% = $200,000 Average operating assets =

30% =

10-34

÷ ÷

Average operating assets Average operating assets $1,000,000

– (Minimum rate of return X Average operating assets) = Residual income – (13% X $1,200,000) = $204,000 = $360,000

Controllable margin $360,000

÷ ÷

Average operating assets $1,200,000

SOLUTIONS TO PROBLEMS PROBLEM 10-1A

(a)

COOK COMPANY Packaging Department Monthly Manufacturing Overhead Flexible Budget For the Year 2014

Activity level Direct labor hours 27,000 Variable costs Indirect labor ($.42)* $11,340 Indirect materials ($.30) 8,100 Repairs ($.18) 4,860 Utilities ($.24) 6,480 Lubricants ($.06) 1,620 Total variable costs ($1.20) 32,400

30,000

33,000

36,000

$12,600 9,000 5,400 7,200 1,800 36,000

$13,860 9,900 5,940 7,920 1,980 39,600

$15,120 10,800 6,480 8,640 2,160 43,200

Fixed costs Supervision** Depreciation Insurance Rent Property taxes Total fixed costs Total costs

8,000 6,000 2,500 2,000 1,500 20,000 $56,000

8,000 6,000 2,500 2,000 1,500 20,000 $59,600

8,000 6,000 2,500 2,000 1,500 20,000 $63,200

*$126,000/300,000 **$96,000/12

10-35

8,000 6,000 2,500 2,000 1,500 20,000 $52,400

PROBLEM 10-1A (Continued) (b)

COOK COMPANY Packaging Department Manufacturing Overhead Flexible Budget Report For the Month Ended October 31, 2014

Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Repairs Utilities Lubricants Total variable costs Fixed costs Supervision Depreciation Insurance Rent Property taxes Total fixed costs Total costs

Budget at 27,000 DLH

Actual Costs 27,000 DLH

Difference Favorable F Unfavorable U

$11,340 8,100 4,860 6,480 1,620 32,400

$12,432 7,680 4,800 6,840 1,920 33,672

$1,092 U 420 F 60 F 360 U 300 U 1,272 U

8,000 6,000 2,500 2,000 1,500 20,000 $52,400

8,000 6,000 2,460 2,000 1,500 19,960 $53,632

0U 0U 40 F 0U 0U 40 F $1,232 U

(c) The overall performance of management was slightly unfavorable. However, none of the unfavorable differences exceeded 10% of budget except for lubricants (19%).

10-36

PROBLEM 10-2A

(a)

ZELMER COMPANY Monthly Manufacturing Overhead Flexible Budget Ironing Department For the Year 2014

Activity level Direct labor hours 35,000 Variable costs Indirect labor ($.40) $14,000 Indirect materials ($.50) 17,500 Factory utilities ($.30) 10,500 Factory repairs ($.20) 7,000 Total variable costs ($1.40) 49,000 Fixed costs Supervision 4,000 Depreciation 1,500 Insurance 1,000 Rent 2,500 Total fixed costs 9,000 Total costs $58,000

10-37

40,000

45,000

50,000

$16,000 20,000 12,000 8,000 56,000

$18,000 22,500 13,500 9,000 63,000

$20,000 25,000 15,000 10,000 70,000

4,000 1,500 1,000 2,500 9,000 $65,000

4,000 1,500 1,000 2,500 9,000 $72,000

4,000 1,500 1,000 2,500 9,000 $79,000

PROBLEM 10-2A (Continued) (b)

ZELMER COMPANY Ironing Department Manufacturing Overhead Flexible Budget Report For the Month Ended June 30, 2014

Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Factory utilities Factory repairs Total variable costs Fixed costs Supervision* Depreciation Insurance Rent Total fixed costs Total costs (1) 41,000 X $0.40 (5) 41,000 X $0.44

Budget at 41,000 DLH

Actual Costs 41,000 DLH

Difference Favorable F Unfavorable U

$16,400 (1) 20,500 (2) 12,300 (3) 8,200 (4) 57,400

$18,040 (5) 19,680 (6) 13,120 (7) 10,250 (8) 61,090

$1,640 U 820 F 820 U 2,050 U 3,690 U

4,000 1,500 1,000 2,500 9,000 $66,400

4,000 1,500 1,000 2,500 9,000 $70,090

0U 0U 0U 0U 0U $3,690 U

(3) 41,000 X $0.30 (7) 41,000 X $0.32

(4) 41,000 X $0.20 (8) 41,000 X $0.25

(2) 41,000 X $0.50 (6) 41,000 X $0.48

*$48,000/12 (c) The manager was ineffective in controlling variable costs ($3,690 U). Fixed costs were effectively controlled. (d) The formula is fixed costs of $9,000 plus total variable costs of $1.40 per direct labor hour.

10-38

PROBLEM 10-2A (Continued) (e)

Total Budgeted Cost Line

$80 70

Costs in (000)

60 50 Budgeted Variable Costs

40 30 20 10

Budgeted Fixed Costs

Direct Labor Hours in (000)

10-39

PROBLEM 10-3A

(a) The formula is fixed costs $35,000 plus variable costs of $2.75 per unit ($165,000 ÷ 60,000 units). (b)

HILL COMPANY Assembling Department Flexible Budget Report For the Month Ended August 31, 2014 Difference

Units Variable costs* Direct materials ($.80 X 58,000) Direct labor ($.90 X 58,000) Indirect materials ($.40 X 58,000) Indirect labor ($.30 X 58,000) Utilities ($.25 X 58,000) Maintenance ($.10 X 58,000) Total variable ($2.75 X 58,000) Fixed costs Rent Supervision Depreciation Total fixed Total costs

Budget at 58,000 Units

Actual Costs 58,000 Units

Favorable F Unfavorable U

$ 46,400 52,200 23,200 17,400 14,500 5,800 159,500

$ 47,000 51,200 24,200 17,500 14,900 6,200 161,000

$ 600 U 1,000 F 1,000 U 100 U 400 U 400 U 1,500 U

12,000 17,000 6,000 35,000 $194,500

12,000 17,000 6,000 35,000 $196,000

0U 0U 0U 0U $1,500 U

*Note that the per unit variable costs are computed by taking the budget amount at 60,000 units and dividing it by 60,000. For example, direct materials per unit is therefore $0.80 or

This report provides a better basis for evaluating performance because the budget is based on the level of activity actually achieved. The manager should be criticized because every variable cost was over budget except for direct labor.

10-40

PROBLEM 10-3A (Continued) (c)

HILL COMPANY Assembling Department Flexible Budget Report For the Month Ended September 30, 2014 Difference Units Variable costs Direct materials (.80 X 64,000) Direct labor ($.90 X 64,000) Indirect materials ($.40 X 64,000) Indirect labor ($.30 X 64,000) Utilities ($.25 X 64,000) Maintenance ($.10 X 64,000) Total variable costs Fixed costs Rent Supervision Depreciation Total fixed costs Total costs

Budget at 64,000 Units

Actual Costs 64,000 Units

Favorable F Unfavorable U

$ 51,200 57,600 25,600 19,200 16,000 6,400 176,000

$ 51,700 56,320 26,620 19,250 16,390 6,820 177,100

$ 500 U 1,280 F 1,020 U 50 U 390 U 420 U 1,100 U

12,000 17,000 6,000 35,000 $211,000

12,000 17,000 6,000 35,000 $212,100

0U 0U 0U 0U $1,100 U

The manager’s performance was slightly better in September than it was in August. However, each variable cost was slightly over budget again except for direct labor. Note that actual variable costs in September were 10% higher than the actual variable costs in August. Therefore to find the actual variable costs in September, the actual variable costs in August must be increased 10% as follows:

Direct materials Direct labor Indirect materials Indirect labor Utilities Maintenance

10-41

August (actual) $ 47,000 X 110% 51,200 X 110% 24,200 X 110% 17,500 X 110% 14,900 X 110% 6,200 X 110% $161,000 X 80%

September (actual) = $ 51,700 56,320 26,620 19,250 16,390 6,820 $177,100

PROBLEM 10-4A

(a)

CLARKE INC. Patio Furniture Division Responsibility Report For the Year Ended December 31, 2014 Difference Budget

Actual

Favorable F Unfavorable U

Sales

$2,500,000

$2,550,000

$50,000 F

Variable costs Cost of goods sold Selling and administrative Total

1,300,000 220,000 1,520,000

1,259,000 226,000 1,485,000

41,000 F 6,000 U 35,000 F

Contribution margin

980,000

1,065,000

85,000 F

Controllable fixed costs Cost of goods sold Selling and administrative Total

200,000 50,000 250,000

203,000 52,000 255,000

3,000 U 2,000 U 5,000 U

$ 730,000

$ 810,000

$80,000 F

Controllable margin

(b) The manager effectively controlled revenues and costs. Contribution margin was $85,000 favorable and controllable margin was $80,000 favorable. Contribution margin was favorable primarily because sales were $50,000 over budget and variable cost of goods sold was $41,000 under budget. Apparently, the manager was able to control variable cost of goods sold when sales exceeded budget expectations. The manager was ineffective in controlling fixed costs. However, the unfavorable difference of $5,000 was only 6% of the favorable difference in controllable margin. (c) Two costs are excluded from the report: (1) noncontrollable fixed costs and (2) indirect fixed costs. The reason is that neither cost is controllable by the Patio Furniture Division Manager.

10-42

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

PROBLEM 10-5A

(a)

SUPPAN COMPANY Home Division Responsibility Report For the Year Ended December 31, 2014 (in thousands of dollars)

Sales Variable costs Cost of goods sold Selling and administrative Total Contribution margin Controllable direct fixed costs Cost of goods sold Selling and administrative Total Controllable margin ROI

(1)

(2)

Budget $1,300

Actual $1,400

Difference Favorable F Unfavorable U $100 F

620 100 720 580

675 125 800 600

55 U 25 U 80 U 20 F

170 80 250 $ 330

170 80 250 $ 350

0U 0U 0U $ 20 F

16.5% (1)

17.5% (2)

1% F (3)

(3)

(b) The performance of the manager of the Home Division was slightly above budget expectations for the year. The item that top management would likely investigate is the reason why variable cost of goods sold is $55,000 unfavorable. In making the inquiry, it should be recognized that the budget amount should be adjusted for the increased sales as follows: $1,400,000 X

= $667,692. Thus,

there should be an explanation of a $7,308 unfavorable difference.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

10-43

PROBLEM 10-5A (Continued) (c) 1.

= 19.2%.

10-44

= 19.4%.

= 21.8%.

PROBLEM 10-6A

(a) To Cutting Department Manager—Seattle Division Controllable Costs: Budget Actual Indirect labor $ 70,000 $ 73,000 Indirect materials 46,000 47,900 Maintenance 18,000 20,500 Utilities 17,000 20,100 Supervision 20,000 22,000 Total $171,000 $183,500

To Division Production Manager—Seattle Controllable Costs: Budget Seattle Division $ 51,000 Departments: Cutting 171,000 Shaping 148,000 Finishing 205,000 Total $575,000

To Vice President—Production Controllable Costs: Budget V-P Production $ 64,000 Divisions: Seattle 575,000 Denver 673,000 San Diego 715,000 Total $2,027,000

10-45

No. 1 Month: January Fav/Unfav $ 3,000 U 1,900 U 2,500 U 3,100 U 2,000 U $12,500 U

No. 2 Month: January Actual Fav/Unfav $ 52,500 $ 1,500 U 183,500 158,000 210,000 $604,000

12,500 U 10,000 U 5,000 U $29,000 U

No. 3 Month: January Actual Fav/Unfav $ 65,000 $ 1,000 U 604,000 678,000 722,000 $2,069,000

29,000 U 5,000 U 7,000 U $42,000 U

PROBLEM 10-6A (Continued)

To President Controllable Costs: President Vice-Presidents: Production Marketing Finance Total

Budget $ 74,200

No. 4 Month: January Actual Fav/Unfav $ 76,400 $ 2,200 U

2,027,000 130,000 104,000 $2,335,200

2,069,000 133,600 109,000 $2,388,000

42,000 U 3,600 U 5,000 U $52,800 U

(b) 1.

Within the Seattle division the rankings of the department managers were: (1) Finishing, (2) Shaping, and (3) Cutting. If the rankings were done on a percentage basis, they would rank as follows: (1) Finishing – 2.4% U (2) Shaping – 6.8% U and (3) Cutting – 7.3% U.

At the division manager level, the rankings were: (1) Denver, (2) San Diego, and (3) Seattle.

Rankings in terms of dollars may be somewhat misleading in this case because of the substantial difference between the production budget and the other budgets. On a percentage basis the differences and rankings are: (1) production, 2.1%; (2) marketing, 2.8%; and (3) finance, 4.8%.

10-46

*PROBLEM 10-7A

(a)

(b)

ROI = Controllable Margin ÷ Average Operating Assets ROI = $2,583,000 ÷ $12,300,000 ROI = 21%

Residual Income = Controllable Margin – (Minimum Rate of Return X Average Operating Assets) Residual Income = $2,583,000 – (.18 X $12,300,000) Residual Income = $2,583,000 – $2,214,000 = $369,000

The management of Jensen Division would clearly have accepted the investment opportunity it had in 2014 if residual income had been used as the performance measure because an increase in residual income results from a project whose ROI is greater than the minimum rate of return. If management of the Jensen Division had used ROI as the performance measure, the decision would be to reject the project because the ROI of 19% is less than Jensen’s ROI experience range of 20.1% to 23.5%. With bonuses based in part on ROI, the 19% project would have a negative effect on bonuses.

10-47

PROBLEM 10-1B

(a)

SPEIER COMPANY Flexible Monthly Manufacturing Overhead Budget Assembly Department For the Year 2014

Activity level Direct labor hours Variable costs Indirect labor ($.30) Indirect materials ($.20) Repairs ($.15) Utilities ($.10) Lubricants ($.05) Total variable costs ($.80) Fixed costs Supervision Depreciation Insurance Rent Property taxes Total fixed costs Total costs

10-48

18,000

20,000

22,000

24,000

$ 5,400 3,600 2,700 1,800 900

$ 6,000 4,000 3,000 2,000 1,000

$ 6,600 4,400 3,300 2,200 1,100

$ 7,200 4,800 3,600 2,400 1,200

14,400

16,000

17,600

19,200

6,300 2,500 1,000 800 500 11,100 $25,500

6,300 2,500 1,000 800 500 11,100 $27,100

6,300 2,500 1,000 800 500 11,100 $28,700

6,300 2,500 1,000 800 500 11,100 $30,300

PROBLEM 10-1B (Continued) (b)

SPEIER COMPANY Manufacturing Overhead Budget Report (Flexible) Assembly Department For the Month Ended January 31, 2014

Direct labor hours (DLH) Variable costs Indirect labor ($0.30) Indirect materials ($0.20) Repairs ($0.15) Utilities ($0.10) Lubricants ($0.05) Total variable costs ($0.80) Fixed costs Supervision* Depreciation Insurance Rent Property taxes Total fixed costs Total costs

Budget at 20,000 DLH

Actual Costs 20,000 DLH

Difference Favorable F Unfavorable U

$ 6,000 4,000 3,000 2,000 1,000

$ 6,200 3,600 2,300 1,700 1,050

$200 U 400 F 700 F 300 F 50 U

16,000

14,850

1,150 F

6,300 2,500 1,000 800 500 11,100 $27,100

6,300 2,500 1,000 850 500 11,150 $26,000

0U 0U 0U 50 U 0U 50 U $1,100 F

*$75,600/12

10-49

PROBLEM 10-2B

(a)

GONZALEZ COMPANY Flexible Monthly Manufacturing Overhead Budget Assembly Department For the Year 2014

Activity level Direct labor hours Variable costs Indirect labor ($1.00) Indirect materials ($.50) Utilities ($.30) Maintenance ($.20) Total variable costs ($2.00) Fixed costs Supervision Depreciation Insurance and taxes Total fixed costs Total costs

10-50

22,500

25,000

27,500

30,000

$22,500 11,250 6,750 4,500

$25,000 12,500 7,500 5,000

$27,500 13,750 8,250 5,500

$30,000 15,000 9,000 6,000

45,000

50,000

55,000

60,000

12,000 8,000 5,000 25,000 $70,000

12,000 8,000 5,000 25,000 $75,000

12,000 8,000 5,000 25,000 $80,000

12,000 8,000 5,000 25,000 $85,000

PROBLEM 10-2B (Continued) (b)

GONZALEZ COMPANY Assembly Department Manufacturing Overhead Budget Report (Flexible) For the Month Ended July 31, 2014

Direct labor hours (DLH) Variable costs Indirect labor ($1.00) Indirect materials ($0.50) Utilities ($0.30) Maintenance ($0.20) Total variable costs ($2.00) Fixed costs Supervision Depreciation Insurance and taxes Total fixed costs Total costs

Budget at 27,500 DLH

Actual Costs 27,500 DLH

Difference Favorable F Unfavorable U

$27,500 13,750 8,250 5,500

$26,000 11,350 8,050 5,400

$1,500 F 2,400 F 200 F 100 F

55,000

50,800

4,200 F

12,000 8,000 5,000 25,000 $80,000

12,000 8,000 5,000 25,000 $75,800

0F 0F 0F 0F $4,200 F

(c) Based on the above budget report, control over costs was effective. For variable costs, all differences were favorable. For fixed costs, there were no differences between budgeted and actual costs. (d) The formula is fixed costs of $25,000 plus total variable costs of $2.00 per direct labor hour.

10-51

PROBLEM 10-2B (Continued) (e)

Total Budgeted Cost Line

$100 90

Overhead Costs in (000)

80 70 Budgeted Variable Costs

60 50 40 30 20

Budgeted Fixed Costs

10 0

Direct Labor Hours in (000)

10-52

PROBLEM 10-3B

(a) The formula is fixed costs $21,000 plus total variable costs of $2.60 per unit ($130,000 ÷ 50,000 units). (b)

HARDESTY COMPANY Packaging Department Budget Report (Flexible) For the Month Ended May 31, 2014 Difference Units Variable costs* Direct materials ($.80 X 55,000) Direct labor ($.90 X 55,000) Indirect materials ($.30 X 55,000) Indirect labor ($.25 X 55,000) Utilities ($.20 X 55,000) Maintenance ($.15 X 55,000) Total variable costs ($2.60 X 55,000) Fixed costs Rent Supervision Depreciation Total fixed costs Total costs

Budget at 55,000 Units

Actual Costs 55,000 Units

Favorable F Unfavorable U

$ 44,000 49,500 16,500 13,750 11,000 8,250

$ 41,000 47,300 15,200 13,000 9,600 8,000

$3,000 F 2,200 F 1,300 F 750 F 1,400 F 250 F

143,000

134,100

8,900 F

10,000 7,000 4,000 21,000 $164,000

10,000 7,000 4,000 21,000 $155,100

0F 0F 0F 0F $8,900 F

*Note that the per unit variable costs are computed by taking the budget amount at 50,000 units and dividing it by 50,000. For example, direct materials per unit is $0.80 or

This report provides a better basis for evaluating performance because the budget is based on the level of activity actually achieved.

10-53

PROBLEM 10-3B (Continued) (c)

HARDESTY COMPANY Packaging Department Budget Report (Flexible) For the Month Ended June 30, 2014 Difference

Units Variable costs Direct materials ($.80 X 40,000) Direct labor ($.90 X 40,000) Indirect materials ($.30 X 40,000) Indirect labor ($.25 X 40,000) Utilities ($.20 X 40,000) Maintenance ($.15 X 40,000) Total variable costs ($2.60 X 40,000) Fixed costs Rent Supervision Depreciation Total fixed costs Total costs

Budget at 40,000 Units

Actual Costs 40,000 Units

Favorable F Unfavorable U

$ 32,000 36,000 12,000 10,000 8,000 6,000

$ 32,800* 37,840 12,160 10,400 7,680 6,400

$ 800 U 1,840 U 160 U 400 U 320 F 400 U

104,000

107,280

3,280 U

10,000 7,000 4,000 21,000 $125,000

10,000 7,000 4,000 21,000 $128,280

0U 0U 0U 0U $3,280 U

*Note that the actual variable costs in June was 20% less than the actual costs in May. Therefore to find the actual costs in June, the actual variable costs in May are multiplied by 80% as follows.

Direct materials Direct labor Indirect materials Indirect labor Utilities Maintenance

10-54

May (actual) $ 41,000 X 80% 47,300 X 80% 15,200 X 80% 13,000 X 80% 9,600 X 80% 8,000 X 80% $134,100 X 80%

June (actual) $ 32,800 37,840 12,160 10,400 7,680 6,400 $107,280

PROBLEM 10-4B

(a)

GUZMAN INC. Home Appliance Division Responsibility Report For the Year Ended December 31, 2014

Budget

Actual

Difference Favorable F Unfavorable U

Sales

$2,400,000

$2,310,000

$90,000 U

Variable costs Cost of goods sold Selling and administrative Total

1,200,000 240,000 1,440,000

1,258,000 232,000 1,490,000

58,000 U 8,000 F 50,000 U

Contribution margin

960,000

820,000

140,000 U

Controllable fixed costs Cost of goods sold Selling and administrative Total

200,000 60,000 260,000

192,000 63,000 255,000

8,000 F 3,000 U 5,000 F

$ 700,000

$ 565,000

$135,000 U

Controllable margin

(b) The manager did not effectively control revenues and costs. Contribution margin was $140,000 unfavorable and controllable margin was $135,000 unfavorable. Contribution margin was unfavorable primarily because sales were $90,000 under budget and variable cost of goods sold was $58,000 over budget. Apparently, the manager was unable to control variable cost of goods sold when sales failed to meet budget expectations. The manager was effective in controlling fixed costs. However, the favorable difference of $5,000 was only 3.7% of the unfavorable difference in controllable margin. (c) Two costs are excluded from the report: (1) noncontrollable fixed costs and (2) indirect fixed costs. The reason is that neither cost is controllable by the Home Appliance Division Manager. Copyright © 2012 John Wiley & Sons, Inc.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

10-55

PROBLEM 10-5B

(a)

STRAUSS COMPANY Lawnmower Division Responsibility Performance Report For the Year Ended December 31, 2014 (in thousands of dollars)

Sales Variable costs Cost of goods sold Selling and administrative Total Contribution margin Controllable fixed costs Cost of goods sold Selling and administrative Total Controllable margin ROI

(1)

10-56

(2)

Budget $3,050

Actual $2,900

Difference Favorable F Unfavorable U $150 U

1,300 340 1,640 1,410

1,400 300 1,700 1,200

100 U 40 F 60 U 210 U

270 140 410 $1,000

270 140 410 $ 790

0U 0U 0U $210 U

20% (1)

15.8% (2)

4.2% U (3)

(3)

PROBLEM 10-5B (Continued) (b) The performance of the manager of the Lawnmower Division was below budget expectations for the year. The item that top management would likely investigate first is the reason why sales were $150,000 below budget. Next, inquiry would be made as to the reason variable cost of goods sold is $100,000 unfavorable. Finally, the reasons for the favorable variable selling and administrative expenses would be discussed. It is conceivable that an inadequate selling effort contributed to the lower sales. (c) 1.

[$790,000 + ($1,400,000 X 20%)] ÷ $5,000,000 = 21.4%.

$790,000 ÷ [$5,000,000 – ($5,000,000 X 24%)] = 20.8%.

($790,000 + $260,000) ÷ $5,000,000 = 21.0%.

10-57

PROBLEM 10-6B

(a) To Cutting Department Manager—Phoenix Division Controllable Costs: Budget Actual Indirect labor $ 90,000 $ 95,000 Indirect materials 61,000 62,700 Maintenance 25,000 27,400 Utilities 20,000 25,200 Supervision 28,000 31,000 Total $224,000 $241,300

No. 1 Month: January Fav/Unfav $ 5,000 U 1,700 U 2,400 U 5,200 U 3,000 U $17,300 U

No. 2 To Division Production Manager—Phoenix Month: January Controllable Costs: Budget Actual Fav/Unfav Phoenix Division $ 70,000 $ 73,100 $ 3,100 U Departments: Cutting 224,000 241,300 17,300 U Shaping 177,000 190,000 13,000 U Finishing 245,000 250,000 5,000 U Total $716,000 $754,400 $38,400 U

To Vice-President—Production Controllable Costs: Budget V-P Production $ 70,000 Divisions: Phoenix 716,000 San Francisco 715,000 Tulsa 750,000 Total $2,251,000

10-58

No. 3 Month: January Actual Fav/Unfav $ 72,000 $ 2,000 U 754,400 724,000 760,000 $2,310,400

38,400 U 9,000 U 10,000 U $59,400 U

PROBLEM 10-6B (Continued)

To President Controllable Costs: President Vice-Presidents: Production Marketing Finance Total

Budget $ 91,300

No. 4 Month: January Actual Fav/Unfav $ 94,200 $ 2,900 U

2,251,000 160,000 120,000 $2,622,300

2,310,400 167,200 125,000 $2,696,800

59,400 U 7,200 U 5,000 U $74,500 U

(b) 1.

Within the Phoenix division the rankings of the department managers were: (1) Finishing, (2) Shaping, and (3) Cutting. If the rankings were done on a percentage basis, they would rank as follows: (1) Finishing – 2.0% U (2) Shaping – 7.3% U and (3) Cutting – 7.7% U.

At the division manager level, the rankings were: (1) San Francisco, (2) Tulsa, and (3) Phoenix.

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*PROBLEM 10-7B

(a)

(b)

ROI = Controllable Margin ÷ Average Operating Assets ROI = $1,500,000 ÷ $7,500,000 ROI = 20%

Residual Income = Controllable Margin – (Minimum Rate of Return X Average Operating Assets) Residual Income = $1,500,000 – (.15 X $7,500,000) Residual Income = $1,500,000 – $1,125,000 = $375,000

The management of Washington Enterprises would clearly have accepted the investment opportunity it had in 2014 if residual income had been used as the performance measure because an increase in residual income results from a project whose ROI is greater than the minimum rate of return. If management of the division had used ROI as the performance measure, the decision would be to reject the project because the ROI of 18% is less than Washington Enterprise’s ROI experience range of 19.9% to 23.3%. With bonuses based in part on ROI, the 18% project would have a negative effect on bonuses.

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BYP 10-1

DECISION-MAKING AT CURRENT DESIGNS

(a)

Current Designs Rotomolded Line Manufacturing Budget For the Year Ended December 31, 2013 Units to be produced Costs: Variable costs Polyethylene powder Finishing kits Labor—type I Labor—type II Indirect materials Manufacturing supplies Maintenance and utilities Total variable costs Fixed costs Supervision Insurance Depreciation Total fixed costs Total costs

10-61

Calculation

4,000 X 54 X $1.50 4,000 X $170 4,000 X 2 X $15 4,000 X 3 X $12

4,000 kayaks Amount budgeted

$ 324,000 680,000 120,000 144,000 40,000 53,800 88,000 1,449,800 90,000 14,400 109,800 214,200 $1,664,000

BYP 10-1 (Continued) (b)

Current Designs Rotomolded Line Manufacturing Flexible Budget Report For the Quarter Ended March 31, 2013 Units to be produced 900 kayaks 1,000 kayaks Costs: Variable costs Polyethylene powder (54 X 1.50 per unit) $ 72,900 $ 81,000 Finishing kits ($170 per unit) 153,000 170,000 Labor—type I (2 hours per unit X $15 per hour) 27,000 30,000 Labor—type II (3 hours per unit X $12 per hour) 32,400 36,000 Indirect materials ($10* per unit) 9,000 10,000 Manufacturing supplies ($13.45** per unit) 12,105 13,450 Maintenance and utilities ($22*** per unit) 19,800 22,000 Total variable costs ($362.45 per unit) 326,205 362,450 Fixed costs Supervision a 22,500 22,500 Insurance b 3,600 3,600 Depreciation c 27,450 27,450 Total fixed costs 53,550 53,550 Total costs $379,755 $416,000 *$40,000 ÷ 4,000 **$53,800 ÷ 4,000 ***$88,000 ÷ 4,000

10-62

a. $ 90,000 ÷ 4 b. $ 14,400 ÷ 4 c. $109,800 ÷ 4

1,050 kayaks

$ 85,050.00 178,500.00 31,500.00 37,800.00 10,500.00 14,122.50 23,100.00 380,572.50 22,500.00 3,600.00 27,450.00 53,550.00 $434,122.50

BYP 10-1 (Continued) (c)

Current Designs Rotomolded Line Manufacturing Flexible Budget Report For the Quarter Ended March 31, 2013

Difference Budget for Actual costs for F = favorable Units to be produced 1,050 kayaks 1,050 kayaks U = unfavorable Costs: Variable costs Polyethylene powder $ 85,050.00 $ 87,000.00 $1,950.00 Finishing kits 178,500.00 178,840.00 340.00 Labor—type I 31,500.00 31,500.00 0 Labor—type II 37,800.00 39,060.00 1,260.00 Indirect materials 10,500.00 10,500.00 0 Manufacturing supplies 14,122.50 14,150.00 27.50 Maintenance and utilities 23,100.00 26,000.00 2,900.00 Total variable costs 380,572.50 387,050.00 6,477.50 Fixed costs Supervision 22,500.00 20,000.00 2,500.00 Insurance 3,600.00 3,600.00 0 Depreciation 27,450.00 27,450.00 0 Total fixed costs 53,550.00 51,050.00 2,500.00 Total costs $434,122.50 $438,100.00 $3,977.50

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U U U U U U F F U

BYP 10-2

(a) 1.

DECISION-MAKING ACROSS THE ORGANIZATION

The primary causes of the loss in net income were the decrease in the number of boarding days and the decrease in the boarding fee. The number of boarding days decreased by 2,900 or approximately 13% (2,900 days ÷ 21,900 days), and the boarding fee decreased from $25(a) per day to $20(b) per day, a decrease of 20% ($5 ÷ $25). Together these resulted in a $167,500 decrease in sales revenue, a decrease of approximately 31% ($167,500 ÷ $547,500). (a)

$547,500 ÷ 21,900 days = $25 per day $380,000 ÷ 19,000 days = $20 per day

(b)

Management did a poor job in controlling variable expenses. Given that boarding days declined by about 13%, variable expenses should decline by about 13%, or more precisely, variable expenses should decline by $25,520

. However, variable

expenses only declined by $14,330 or about 7.4% ($14,330 ÷ $192,720). Thus, management did a poor job in controlling variable expenses. Management did a better job in controlling fixed expenses. Fixed expenses were under budget by $4,000 and this includes the additional expenses incurred in advertising and entertainment. 3.

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Management’s decisions to stay competitive probably were sound. Given the decline in boarding days, the decision not to replace the worker was sound. The decision to reduce rates was probably forced by the competition. Without the additional advertising and entertainment expenses, the loss in net income might have been even greater.

BYP 10-2 (Continued) (b)

GREEN PASTURES Income Statement Flexible Budget Report For the Year Ended December 31, 2014 Difference Boarding days (BD) Sales ($25) Less variable expenses Feed ($5) Veterinary fees ($3) Blacksmith fees ($.25) Supplies ($.55) Total variable expenses ($8.80) Contribution margin Less fixed expenses Depreciation Insurance Utilities Repairs and maintenance Labor Advertising Entertainment Total fixed expenses Net income

Budget at 19,000 BD $475,000

Actual at 19,000 BD $380,000

Favorable F Unfavorable U $ 95,000 U

95,000 57,000 4,750 10,450

104,390 58,838 4,984 10,178

9,390 U 1,838 U 234 U 272 F

167,200 307,800

178,390 201,610

11,190 U 106,190 U

40,000 11,000 14,000 11,000 95,000 8,000 5,000 184,000 $123,800

40,000 11,000 12,000 10,000 88,000 12,000 7,000 180,000 $ 21,610

0U 0U 2,000 F 1,000 F 7,000 F 4,000 U 2,000 U 4,000 F $102,190 U

The primary causes of the decrease in net income are the decreases in boarding rates and volume. The average daily rate charged was $20 = ($380,000 ÷ 19,000). This rate resulted in a decrease in sales revenue of $95,000 or 20% = ($95,000 ÷ $475,000). Given that it is “an extremely competitive business,” if Green Pastures had not reduced rates, boarding days almost certainly would have declined even more.

10-65

BYP 10-2 (Continued) 2.

Management did a poor job of controlling variable expenses. These expenses in total were $11,190 over budget or 6.7%, or ($11,190 ÷ $167,200). Moreover, each individual variable expense was over budget, except for supplies. Management did a good job of controlling fixed expenses as noted in part (a).

As noted in part (a), management’s decisions to stay competitive probably were sound.

(d) Given that the industry is “extremely competitive,” management should consider two options. One, become the lowest cost operator. If Green Pastures is the company with the lowest operating costs, it can underprice its competitors and take customers away from them (increasing its sales). Eventually, some of its competitors (those with the highest operating costs) will go out of business, and Green Pastures will get their customers, or at least some of them. (Wal-Mart is an example of this strategy.) Option two is to offer its customers a superior product or service. If customers perceive that Green Pastures is the “best” boarding stable in Kentucky, the company will take customers away from its competitors. Also, if Green Pastures is perceived as the “best,” many customers will be willing to pay a premium for its boarding service, and Green Pastures will be able to raise its rates. (Gillette is an example of this strategy.)

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BYP 10-3

MANAGERIAL ANALYSIS

(a) Mary Gammel—Profit Center: Responsible for sales, inventory cost, advertising, sales personnel, printing, and travel. She is not responsible for the assets invested in her division and probably does not control the rent or depreciation costs either. As a profit center manager she might have control of the insurance, but she probably does not. Stephen Flott—Cost Center: Responsible for inventory cost, advertising, sales personnel, printing, and travel. As a cost center manager, he might or might not have control of rent and insurance costs, but he probably does not. He does not have control of the assets invested in his department; thus, he does not have control of the depreciation. Jose Gomez—Investment Center: Responsible for all items shown. (b) Mary Gammel Budget differences: The cost of goods sold is 28% ($42,000 ÷ $150,000) above budget and so should definitely be brought to her attention. Travel is 30% ($6,000 ÷ $20,000) below budget. Students may differ as to whether they believe that this should be brought to her attention. The differences in rent and depreciation should not be brought to her attention because she does not control those costs. Stephen Flott Budget differences: The cost of goods sold, which is 22% ($22,000 ÷ $100,000) above budget, should definitely be brought to his attention. Travel costs are 30% ($9,000 ÷ $30,000) below budget. This should probably be brought to his attention, so that he can verify that the goal of travel is being adequately accomplished by other means. The 67% ($20,000 ÷ $30,000) increase in rent and 10% ($10,000 ÷ $100,000) decrease in depreciation are not under his control and so should not be brought to his attention. It should probably be pointed out to students that all budget differences are monitored by someone within the company. These differences that are not the responsibility of the various managers are still within the scope of top management’s responsibility.

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BYP 10-3 (Continued) Jose Gomez Budget differences: As manager of an investment center, Mr. Gomez is responsible for all categories of the budget. The selection in this case would be which differences merit his attention. Any decrease in a company’s gross profit rate (gross profit ÷ sales) is a cause for concern. (Remember the gross profit is sales minus cost of goods sold.) Thus, the 6% [($26,500 – $25,000) ÷ $25,000] increase in cost of goods sold should be brought to his attention. Travel is below budget 25% ($500 ÷ $2,000), which is $500. This is not a large percentage of total costs, nor is it a large dollar amount, so there could be an argument that this should be left out. The 23% ($2,300 ÷ $10,000) increase in rent is only a $2,300 increase, so it could be included, though it might be left out as immaterial. The 40% ($16,000 ÷ $40,000) increase in depreciation should definitely be included.

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BYP 10-4

REAL-WORLD FOCUS

(a) The company’s costs do not increase proportionately with the revenues increase in the third and fourth quarter because the behavior of the costs is primarily fixed. (b) Static budgeting seems to be most appropriate for Computer Associates because costs do not respond proportionately with changes in the activity level (revenues).

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BYP 10-5

REAL-WORLD FOCUS

(a) The two most common pain points are (1) dealing with other managers and (2) technology issues, mainly frustration of budgeting in Excel spreadsheets. (b) Of those companies that participated in the survey, 97 percent said that they prepare annual budgets. Of those that prepare annual budgets, 60 percent say that they begin the process by determining sales forecasts. (c) The most common amount of time for the budgeting process is 4 to 8 weeks. (d) The most commonly defined range of acceptable tolerance levels was that variances were tolerated up to 5 to 10 percent. Beyond that level there were consequences. (e) Severe consequences were defined as: Compensation is affected or other sanctions applied, the manager receives a formal reprimand, or job losses result (the manager responsible for the variance, or the variance drives company layoffs due to missed numbers).

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BYP 10-6

COMMUNICATION ACTIVITY

(a) Fred Bedner should be able to control all the variable costs and the fixed costs of supervision (but not his portion) and inspection. Insurance and depreciation ordinarily are not the responsibility of the department manager. (b) The total variable cost per unit is $25 ($50,000 ÷ 2,000). The total cost during the month to manufacture 1,500 units is variable costs $37,500 (1,500 X $25) plus fixed costs ($35,000) or $72,500 ($37,500 + $35,000). (c)

FLEMING COMPANY Production Department Manufacturing Overhead Flexible Budget Report For the Month Ended Difference Budget at 1,500 units

Actual at 1,500 units

Favorable F Unfavorable U

$16,500 9,000 7,500

$22,500 13,500 8,200

$ 6,000 U 4,500 U 700 U

4,500 37,500

5,000 49,200

500 U 11,700 U

Fixed costs Supervision Inspection costs Insurance expense Depreciation Total fixed

17,000 1,000 2,000 15,000 35,000

18,400 1,200 2,200 14,700 36,500

1,400 U 200 U 200 U 300 F 1,500 U

Total costs

$72,500

$85,700

$13,200 U

Variable costs Indirect materials ($11) Indirect labor ($6) Maintenance expense ($5) Manufacturing supplies ($3) Total variable ($25)

(d) A production department is a cost center. Thus, the report should include only the costs that are controllable by the production manager. This report is shown in Illustration 10–21. In this type of report, no distinction is made between variable and fixed costs. Copyright © 2012 John Wiley & Sons, Inc.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

10-71

BYP 10-6 (Continued) FLEMING COMPANY Production Department Manufacturing Overhead Responsibility Report For the Month Ended

Controllable Cost Indirect materials Indirect labor Maintenance expense Manufacturing supplies Supervision* Inspection costs Total

Budget $16,500 9,000 7,500 4,500 7,000 1,000

Actual $22,500 13,500 8,200 5,000 8,400 1,200

Difference Favorable F Unfavorable U $ 6,000 U 4,500 U 700 U 500 U 1,400 U 200 U

$45,500

$58,800

$13,300 U

*$10,000 is deducted from both budget and actual for Mr. Bedner’s cost.

To: From: Subject:

Mr. Fred Bedner, Production Manager , Vice President of Production Performance Evaluation for the Month of XXXXX

Your performance in controlling costs that are your responsibility was very disappointing in the month of XXXXX. As indicated in the accompanying responsibility report, total costs were $13,300 over budget. On a percentage basis, costs were 29% over budget. As you can see, actual costs were over budget for every cost item. In two instances, costs were more significantly over budget (Indirect materials 36% and Indirect labor 50%).

10-72

BYP 10-6 (Continued) Fred, it is imperative that you get costs under control in your department as soon as possible. I think we need to talk about ways to implement more effective cost control measures. I would like to meet with you in my office at 9 a.m. on Wednesday to discuss possible alternatives.

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BYP 10-7

ETHICS CASE

(a) The stakeholders in this ethical situation are:  The employees and managers of each investment center.  The central management and chief executive officer.  The customers who buy the product.  The owners or stockholders. (b) Pressure to perform is a frequently identified cause for unethical conduct. Employees are more prone to engage in unethical conduct when unreasonable demands are made upon them. Rather than lose their jobs or be demoted, if given no alternatives, employees may seek to cut corners, reduce quality control, use questionable sales tactics, and bend the rules. (c) The company might maintain open lines of communication with its employees to better know the pressures of its managers. By “keeping in touch,” the company may avoid making unreasonable demands on its managers and employees. The company might also develop a company code of ethical conduct and enforce it. However, if dismissal or demotion continues to be the probable consequence of failure to meet objectives, some managers are likely to engage in unethical behavior in an attempt to meet the objectives.

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BYP 10-8

ALL ABOUT YOU

(a)

The basic idea is to set up individual envelopes for different expense categories. Once you have used up the money in a particular envelope, you can’t use more. Begin by preparing a monthly budget. Identify those items that you will pay in cash. These would include things like groceries, eating out at restaurants, clothing, gasoline, car repairs, gifts, and entertainment. These are the categories for which you will have envelopes. Next, decide how often to fill the envelopes and determine the amount to put in each envelope. If you continually run out of money in a particular envelope you many need to re-evaluate your allocation. If you don’t use up all the money in an envelope in one month, you can carry it over to the next month.

(b)

Answers will vary by student.

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BYP 10-9

CONSIDERING YOUR COSTS AND BENEFITS

In general, in past years it has usually been considered prudent to purchase a home rather than to rent. As noted, over time, home prices have usually appreciated in most parts of the country. Mortgage interest provides some tax relief, and by purchasing a home you get some control over your housing costs. However, recent turbulence in the housing market has made the decision more complicated. In some parts of the country home prices have fallen considerably, and there is no indication how soon they will recover. In some areas renting appears to be an attractive alternative to purchasing. In the scenario described, there is considerable uncertainty surrounding this individual’s life. Purchasing a home is a huge decision, with very high transactions costs. It is often suggested that, because of the high transactions costs, you should not purchase a home unless you intend on living in it for a number of years. The person in the case is starting a new job in a new community. Until they are more certain that they will like their job, that the job is stable, and that they like the community, they should delay the purchase of a home.

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CHAPTER 11 Standard Costs and Balanced Scorecard ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises 1

Do It!

Exercises

A Problems

B Problems

Distinguish between a standard and a budget.

1, 2

Identify the advantages of standard costs.

Describe how companies set standards.

4, 5, 6, 7, 8, 9

2, 3

1, 2, 3, 4, 17

State the formulas for determining direct materials and direct labor variances.

10, 11

4, 5

2, 3

4, 5, 6, 7, 8, 9, 10, 13, 14, 19

1A, 2A, 3A, 4A, 5A, 6A

1B, 2B, 3B, 4B, 5B, 6B

State the formula for determining the total manufacturing overhead variance.

11, 12, 19

1A, 2A, 3A, 4A, 5A, 6A

1B, 2B, 3B, 4B, 5B, 6B

Discuss the reporting of variances.

13, 14

10, 14, 15

Prepare an income statement for management under a standard costing system.

2A, 5A, 6A

2B, 5B, 6B

Describe the balanced scorecard approach to performance evaluation.

15, 16, 17

*9.

Identify the features of a standard cost accounting system.

8, 9

18, 19, 20

*10.

Compute overhead controllable and volume variances.

20, 21, 22, 23

10, 11

21, 22, 23

7A, 8A, 9A, 10A

7B, 8B, 9B, 10B

11-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Compute variances.

Simple

20–30

Compute variances, and prepare income statement.

Simple

30–40

Compute and identify significant variances.

Moderate

20–30

Answer questions about variances.

Complex

30– 0

Compute variances, prepare an income statement, and explain unfavorable variances.

Moderate

30–40

*6A

Journalize and post standard cost entries, and prepare income statement.

Moderate

40–50

*7A

Compute overhead controllable and volume variances.

Simple

10–15

*8A

Compute overhead controllable and volume variances.

Simple

10–15

*9A

Compute overhead controllable and volume variances.

Moderate

10–15

*10A

Compute overhead controllable and volume variances.

Moderate

10–15

Compute variances.

Simple

20–30

Compute variances, and prepare income statement.

Simple

30–40

Compute and identify significant variances.

Moderate

30–40

Answer questions about variances.

Complex

30–40

Compute variances, prepare an income statement, and explain unfavorable variances.

Moderate

30–40

*6B

Journalize and post standard cost entries, and prepare income statement.

Moderate

40–50

*7B

Compute overhead controllable and volume variances.

Simple

10–15

*8B

Compute overhead controllable and volume variances.

Simple

10–15

*9B

Compute overhead controllable and volume variances.

Moderate

10–15

*10B

Compute overhead controllable and volume variances.

Moderate

10–15

11-2

11-3

Learning Objective Distinguish between a standard and a budget. Identify the advantages of standard costs. Describe how companies set standards.

Knowledge Comprehension Application Q11-1 BE11-1 Q11-2 E11-1 Q11-3 E11-1

State the formulas for determining direct materials and direct labor variances.

Q11-10 Q11-11

State the formula for determining the total manufacturing overhead variance.

Q11-12

Discuss the reporting of variances. Prepare an income statement for management under a standard costing system. Describe the balanced scorecard approach to performance evaluation. Identify the features of a standard cost accounting system. Compute overhead controllable and volume variances.

Q11-13 Q11-14 Q11-18

1. 2. 3.

*9.

*10.

Broadening Your Perspective

Q11-8

Q11-4 Q11-5 Q11-6

Q11-7 Q11-9

Q11-15 DI11-4 Q11-16 Q11-17 Q11-19

Q11-20 Q11-21 Q11-22 Q11-23 BYP11-5 BYP11-7

BE11-2 E11-1 BE11-3 E11-2 DI11-1 E11-3 BE11-4 E11-7 BE11-5 E11-9 DI11-2 E11-10 DI11-3 E11-13 E11-4 E11-14 E11-5 P11-1A E11-6 P11-2A BE11-6 P11-1A DI11-3 P11-2A E11-11 P11-5A E11-12 P11-6A E11-19 P11-1B E11-10 E11-14 E11-16 P11-6A P11-2A P11-2B P11-5A P11-5B BE11-7 E11-17

Analysis

Synthesis

Evaluation

E11-4 E11-17 P11-5A E11-8 P11-6A E11-19 P11-1B P11-3A P11-2B P11-4A P11-5B P11-3B P11-6B P11-4B P11-2B E11-11 P11-3B P11-5B E11-12 P11-4B P11-6B E11-19 P11-3A P11-4A E11-15 P11-3A P11-3B P11-6B

BE11-8 E11-20 E11-19 BE11-9 P11-6A E11-18 P11-6B BE11-10 P11-7A P11-8B E11-20 BE11-11 P11-8A P11-9B E11-21 E11-21 P11-9A P11-10BE11-22 E11-22 P11-10A E11-23 P11-7B BYP11-3 BYP11-1

BYP11-2 BYP11-4 BYP11-6 BYP11-8 BYP11-9 BYP11-10

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) This is incorrect. Standard costs are predetermined unit costs. (b) Agree. Examples of governmental regulations that establish standards for a business are the Fair Labor Standards Act, the Equal Employment Opportunity Act, and a multitude of environmental laws.

(a) Standards and budgets are similar in that both are predetermined costs and both contribute significantly to management planning and control. The two terms differ in that a standard is a unit amount and a budget is a total amount. (b) There are important accounting differences between budgets and standards. Except in the application of manufacturing overhead to jobs and processes, budget data are not journalized in cost accounting systems. In contrast, standard costs may be incorporated into cost accounting systems. It is possible for a company to report inventories at standard costs in its financial statements, but it is not possible to report inventories at budgeted costs.

In addition to facilitating management planning, standard costs offer the following advantages to an organization: (1) They promote greater economy by making employees more “cost-conscious.” (2) They may be useful in setting selling prices. (3) They contribute to management control by providing a basis for evaluating cost control. (4) They are useful in highlighting variances in “management by exception.” (5) They simplify the costing of inventories and reduce clerical costs.

The management accountant provides input to the setting of standards through the accumulation of historical cost data and knowledge of the behavior of costs in response to changes in activity levels. Management has the responsibility for setting the standards.

Ideal standards represent optimum levels of performance under perfect operating conditions. Normal standards represent efficient levels of performance that are attainable under expected operating conditions.

(a) The direct materials price standard should be based on the purchasing department’s best estimate of the cost of raw materials and an amount for related costs such as receiving, storing, and handling. (b) The direct materials quantity standard should be based on both quality and quantity requirements plus allowances for unavoidable waste and normal spoilage.

Agree. The direct labor quantity standard should include allowances for rest periods, cleanup, machine setup, and machine downtime.

With standard costs, the predetermined overhead rate is determined by dividing budgeted overhead costs by an expected standard activity index.

A favorable cost variance has a positive connotation. It suggests efficiencies in incurring manufacturing costs and in using direct materials, direct labor, and manufacturing overhead. An unfavorable cost variance has a negative connotation. It suggests that too much was paid for one or more of the manufacturing cost elements or that the elements were used inefficiently.

11-4

Questions Chapter 11 (Continued) 10.

(a) (1) actual price. (b) (3) actual quantity. (c) (5) standard price.

11.

(1) – (3) = total labor variance; (1) – (2) = labor price variance; and (2) – (3) = labor quantity variance.

12.

Overhead applied = $9 X 27,000 = $243,000.

13.

Variances should be reported to appropriate levels of management as soon as possible. The principle of “management by exception” may be used with variance reports.

14.

The purchasing department would be responsible for an unfavorable materials price variance when it paid more than the standard price for the materials. The purchasing department would also be responsible for an unfavorable materials quantity variance if it purchased materials of inferior quality which caused an excess use of materials.

15.

The four perspectives of the balanced scorecard are: financial, customer, internal process, and learning and growth. The financial perspective employs financial measures of performance used by most firms. The customer perspective evaluates the company from the viewpoint of those people who buy its product in terms of price, quality, product innovation, customer service, and other dimensions. The internal process perspective evaluates the value chain—product development, production, delivery and after-sale service—to ensure that the company is operating effectively and efficiently. The learning and growth perspective evaluates how well the company develops and retains its employees. The four perspectives are linked in that the results in one perspective influence the results in the next.

16.

Kerry James is not correct. The balanced scorecard does not replace financial measures, it instead integrates both financial and nonfinancial measures. In fact, financial measures are very critical to the balanced scorecard, since they represent the final “destination” of all the company’s efforts.

17.

The possibilities for nonfinancial measures are limitless. Some that were mentioned in the chapter were: capacity utilization of plants, average age of key assets, impact of strikes, brand-loyalty statistics, market profile of customer-end products, number of new products, employee stock ownership percentages, number of scientists and technicians used in R&D, customer satisfaction data, factors affecting customer product selection, number of patents and trademarks held, customer brand awareness, number of ATMs by state, number of products used by average customer, percentage of customer service calls handled by interactive voice response units, personnel cost per employee, credit card retention rates.

18.

(a) Variances are reported in income statements for management below gross profit which is reported at standard costs. Each variance is identified and the total variance is shown. (b) Standard costs may be used in costing inventories when there is no significant difference between actual costs and standard costs. When there are significant differences, actual costs must be reported.

11-5

(2) standard price. (4) standard price. (6) standard quantity.

Questions Chapter 11 (Continued) *19. (a) A standard cost accounting system is a double-entry system of accounting in which standard costs are used in making entries and standard cost variances are formally recognized in the accounts. (b) The variance account will have: (1) a debit balance when the materials price variance is unfavorable and (2) a credit balance when the labor quantity variance is favorable. *20. Overhead controllable variance = actual overhead costs ($248,000) – overhead budgeted. Overhead budgeted is based on standard hours allowed as follows: variable costs (27,000 X $5 = $135,000) + fixed costs (28,000 X $4 = $112,000) = total overhead budgeted ($247,000). Thus, the controllable variance is $1,000 unfavorable. *21. The purpose of computing the overhead volume variance is to determine whether plant facilities were efficiently used during the period. The basic formula is fixed overhead rate X (normal capacity – standard hours allowed). *22. Fixed costs remain the same at every level of activity within the relevant range. Since the predetermined overhead rate is based on normal capacity, it follows that if standard hours allowed are less than standard hours at normal capacity, fixed overhead costs will be underapplied. The reverse is true when production exceeds normal capacity. *23. John should include the following points about overhead variances: (1) Standard hours allowed are used in each of the variances. (2) Budgeted costs for the controllable variance are derived from the flexible budget. (3) The controllable variance generally pertains to variable costs. (4) The volume variance pertains solely to fixed costs.

11-6

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11-1 (a) Standards are stated as a per unit amount. Thus, the standards are materials $2.60 ($1,300,000 ÷ 500,000) and labor $3.40 ($1,700,000 ÷ 500,000). (b) Budgets are stated as a total amount. Thus, the budgeted costs for the year are materials $1,300,000 and labor $1,700,000.

BRIEF EXERCISE 11-2 (a) Standard direct materials price per gallon = $2.60 ($2.30 + $.20 + $.10). (b) Standard direct materials quantity per gallon = 4 pounds (3.6 + .4). (c) Standard materials cost per gallon = $10.40 ($2.60 X 4).

BRIEF EXERCISE 11-3 (a) Standard direct labor rate per hour = $15.00 ($13.00 + $.80 + $1.20). (b) Standard direct labor hours per gallon = 1.5 hours (1.1 + .25 + .15). (c) Standard labor cost per gallon = $22.50 ($15.00 X 1.5). BRIEF EXERCISE 11-4 Total materials variance = $1,192 U (3,200 X $5.06*) – (3,000** X $5.00). Materials price variance = $192 U (3,200 X $5.06) – (3,200 X $5.00). Materials quantity variance = $1,000 U (3,200 X $5.00) – (3,000 X $5.00). *$16,192 ÷ 3,200

**1,500 X 2

BRIEF EXERCISE 11-5 Total labor variance = $680 U (2,100 X $10.80) – (2,000 X $11.00). Labor price variance = $420 F (2,100 X $10.80) – (2,100 X $11.00). Labor quantity variance = $1,100 U (2,100 X $11.00) – (2,000 X $11.00).

11-7

BRIEF EXERCISE 11-6 The formula is:

Actual Overhead Overhead – Applied = Total Overhead Variance $118,000 – *$122,400* $4,400 F

*20,400 X $6 = $122,400

BRIEF EXERCISE 11-7 1. 2. 3. 4.

financial ...................................... (c) return on assets customer ..................................... (d) brand recognition internal process ......................... (a) plant capacity utilization learning and growth ................... (b) employee work days missed due to injury

*BRIEF EXERCISE 11-8 (a) Raw Materials Inventory ............................................. Materials Price Variance ..................................... Accounts Payable ...............................................

12,000

(b) Work in Process Inventory (5,800 X $2*) ................... Materials Quantity Variance ............................... Raw Materials Inventory (5,600 X $2) .................

11,600

500 11,500 400 11,200

*$12,000 ÷ 6,000

*BRIEF EXERCISE 11-9 (a) Factory Labor .............................................................. Labor Price Variance ........................................... Factory Wages Payable ......................................

25,500

(b) Work in Process Inventory (3,150 X $8.50*) .............. Labor Quantity Variance ..................................... Factory Labor ......................................................

26,775

*$25,500 ÷ 3,000

11-8

1,500 24,000 1,275 25,500

*BRIEF EXERCISE 11-10 The formula is:

Overhead Overhead Actual Overhead – Budgeted = Controllable Variance $118,000 – *$131,600* $13,600 F

*(20,400 X $4) + $50,000 = $131,600 *BRIEF EXERCISE 11-11 The formula is: Fixed Overhead Overhead X (Normal Capacity Hours – Standard Hours Allowed) = Volume Rate Variance (25,000 – 20,400)

$2.00*/hr. X

= $9,200 U

*($50,000 ÷ 25,000 hrs.) SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 11-1 Manufacturing Cost Standard Quantity Standard X Element Direct materials 2 pounds Direct labor 0.2 hours Manufacturing overhead 0.2 hours Total

Price

Standard

$ 5.00 15.00 18.75*

*125% of direct labor cost DO IT! 11-2 The variances are: Total materials variance = (29,000 X $6.30) – (32,000* X $6.00) = $9,300 favorable Materials price variance = (29,000 X $6.30) – (29,000 X $6.00) = $8,700 unfavorable Materials quantity variance = (29,000 X $6.00) – (32,000* X $6.00) = $18,000 favorable

*(16,000 X 2)

11-9

DO IT! 11-3 The variances are: Total labor variance = (4,100 X $14.30) – (3,800* X $14.00) = $5,430 unfavorable Labor price variance = (4,100 X $14.30) – (4,100 X $14.00) = $1,230 unfavorable Labor quantity variance = (4,100 X $14.00) – (3,800* X $14.00) = $4,200 unfavorable Total overhead variance = $81,300 – $83,600** = $2,300 favorable *2,000 X 1.9 **3,800 hours X $22.00

DO IT! 11-4 1. 2. 3. 4. 5. 6.

Learning and growth perspective. Financial perspective. Customer perspective. Internal process perspective. Learning and growth perspective. Customer perspective.

11-10

SOLUTIONS TO EXERCISES EXERCISE 11-1 (a) Direct materials: (2,000 X 3) X $5 = $30,000 Direct labor: (2,000 X 1/2) X $15 = $15,000 Overhead: $15,000 X 70% = $10,500 (b) Direct materials: 3 X $5 = $15.00 Direct labor: 1/2 X $15 = 7.50 Overhead: $7.50 X 70% = 5.25 Standard cost: $27.75 (c) The advantages of standard costs which are carefully established and prudently used are: 1. Management planning is facilitated. 2. Greater economy is promoted by making employees more costconscious. 3. Setting selling prices is facilitated. 4. Management control is enhanced by having a basis for evaluation of cost control. 5. Variances are highlighted in management by exception. 6. Costing of inventories is simplified and clerical costs are reduced. EXERCISE 11-2

Ingredient

Amount Per Gallon

Standard Waste

Grape concentrate Sugar (54 ÷ 50) Lemons (60 ÷ 50) Yeast Nutrient Water (2,600 ÷ 50)

60* oz. 1.08 lb. 1.2 1 tablet 1 tablet 52 oz.

4% 10% 25% 0% 0% 0%

Standard Usage (a) 62.5 oz. (b) 1.20 lb. (c) 1.6 1 tablet 1 tablet 52 oz.

*3,000 ÷ 50 (a) (b) (c)

.96X = 60 ounces; or X = (60 ounces)/.96. .90X = 1.08 pounds; or X = (1.08 pounds)/.90. .75X = 1.2 lemons; or X = (1.2 lemons)/.75.

11-11

Standard Price $.06 .30 .60 .25 .20 .005

Standard Cost Per Gallon $3.75 .36 .96 .25 .20 .26 $5.78

EXERCISE 11-3 Direct materials Cost per pound [$5 – (2% X $5) + $0.25] Pounds per unit (4.5 + 0.5)

$5.15 X 5

$25.75

Direct labor Cost per hour ($12 + $3) Hours per unit (2 + .3)

$ 15 X 2.3

34.50

Manufacturing overhead 2.3 hours X $7 Total standard cost per unit

16.10 $76.35

EXERCISE 11-4 (a) Actual service time Setup and downtime Cleanup and rest periods Standard direct labor hours per oil change

1.0 hours 0.2 hours 0.3 hours 1.5 hours

(b) Hourly wage rate Payroll taxes ($12 X 10%) Fringe benefits ($12 X 25%) Standard direct labor hourly rate

$12.00 1.20 3.00 $16.20

(c) Standard direct labor cost per oil change = 1.50 hours X $16.20 per hour = $24.30 (d) Direct labor quantity variance = (1.60 hours X $16.20) – (1.50 hours X $16.20) = $25.92 – $24.30 = $1.62 U

11-12

EXERCISE 11-5 (a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (29,000 X $4.70) (28,500* X $5.00) $136,300 – $142,500 = $6,200 F *9,500 X 3 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (29,000 X $4.70) (29,000 X $5.00) $136,300 – $145,000 = $8,700 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (29,000 X $5.00) (28,500 X $5.00) $145,000 – $142,500 = $2,500 U (b) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (28,000 X $5.15) (28,500 X $5.00) $144,200 – $142,500 = $1,700 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (28,000 X $5.15) (28,000 X $5.00) $144,200 – $140,000 = $4,200 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (28,000 X $5.00) (28,500 X $5.00) $140,000 – $142,500 = $2,500 F

11-13

EXERCISE 11-6 (a) Total labor variance: ( AH X AR ) – ( SH X SR ) (40,600 X $12.15) (40,000* X $12.00) $493,290 – $480,000 = $13,290 U *10,000 X 4 (b) Labor price variance: ( AH X AR ) – ( AH X SR ) (40,600 X $12.15) (40,600 X $12.00) $493,290 – $487,200 = $6,090 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (40,600 X $12.00) (40,000 X $12.00) $487,200 – $480,000 = $7,200 U (c) Labor price variance: ( AH X AR ) – ( AH X SR ) (40,600 X $12.15) (40,600 X $12.25) $493,290 – $497,350 = $4,060 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (40,600 X $12.25) (41,000* X $12.25) $497,350 – $502,250 = $4,900 F *4.1 X 10,000 EXERCISE 11-7 Total materials variance: ( AQ X AP ) – ( SQ X SP ) (1,900 X $2.65*) (1,880** X $2.50) $5,035 – $4,700 = $335 U Materials price variance: ( AQ X AP ) – (1,900 X $2.65) $5,035 – *$5,035 ÷ 1,900 11-14

( AQ X SP ) (1,900 X $2.50) $4,750 = $285 U **235 X 8

EXERCISE 11-7 (Continued) Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (1,900 X $2.50) (1,880 X $2.50) $4,750 – $4,700 = $50 U Total labor variance: ( AH X AR ) – ( SH X SR ) (700 X $11.80*) (705** X $12.00) $8,260 – $8,460 = $200 F *$8,260 ÷ 700

**235 X 3

Labor price variance: ( AH X AR ) – ( AH X SR ) (700 X $11.80) (700 X $12.00) $8,260 – $8,400 = $140 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (700 X $12.00) (705 X $12.00) $8,400 – $8,460 = $60 F

11-15

EXERCISE 11-7 (Continued) (Not Required) Materials Variance Matrix (1)

(2)

(3)

Actual Quantity X Actual Price 1,900 X $2.65 = $5,035

Actual Quantity X Standard Price 1,900 X $2.50 = $4,750

Standard Quantity X Standard Price 1,880 X $2.50 = $4,700

Price Variance (1) – (2) $5,035 – $4,750 = $285 U

Quantity Variance (2) – (3) $4,750 – $4,700 = $50 U

Total Variance (1) – (3) $5,035 – $4,700 = $335 U

Labor Variance Matrix (1)

(2)

(3)

Actual Hours X Actual Rate 700 X $11.80 = $8,260

Actual Hours X Standard Rate 700 X $12.00 = $8,400

Standard Hours X Standard Rate 705 X $12.00 = $8,460

Price Variance (1) – (2) $8,260 – $8,400 = $140 F

Quantity Variance (2) – (3) $8,400 – $8,460 = $60 F

Total Variance (1) – (3) $8,260 – $8,460 = $200 F

11-16

EXERCISE 11-8 (a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (1,220 X $128) (1,200 X $130) $156,160 – $156,000 = $160 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (1,220 X $128) (1,220 X $130) $156,160 – $158,600 = $2,440 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (1,220 X $130) (1,200 X $130) $158,600 – $156,000 = $2,600 U Total labor variance: ( AH X AR ) – ( SH X SR ) (4,150 X $13) (4,300 X $12.50) $53,950 – $53,750 = $200 U Labor price variance: ( AH X AR ) – ( AH X SR ) (4,150 X $13) (4,150 X $12.50) $53,950 – $51,875 = $2,075 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (4,150 X $12.50) (4,300 X $12.50) $51,875 – $53,750 = $1,875 F (b) The unfavorable materials quantity variance may be caused by the carelessness or inefficiency of production workers. Alternatively, the excess quantities may be caused by inferior quality materials acquired by the purchasing department. The unfavorable labor price variance may be caused by misallocation of the work force by the production department. In this case, more experienced workers may have been assigned to tasks normally done by inexperienced workers. An unfavorable labor variance may also occur when workers are paid higher wages than expected. The manager who authorized the wage increase is responsible for this variance.

11-17

EXERCISE 11-9 (a)

Number of units = Total standard cost ÷ Standard cost per unit Number of units = $405,000 ÷ $20.00 (5 lb X $4 per lb) = 20,250

(b) AQ = [(SQ X SP) Quantity variance] ÷ SP AQ = ($405,000 + $9,000) ÷ $4.00 per lb = 103,500 pounds (c)

AP = [(AQ X SP) Price variance] ÷ AQ AP = [(103,500 X $4) – $5,175] = $408,825 ÷ 103,500 lb = $3.95/lb

(d) AH = [(SH X SR) Quantity variance] ÷ SR AH = ($180,000 + $6,000) ÷ $10.00/hr = 18,600 hours (e)

AR = [(AH X SR) Price variance] ÷ AH AP = [(18,600 X $10) + $3,840] = $189,840 ÷ 18,600 hr = $10.21/hr

EXERCISE 11-10 TOBY TOOL & DIE COMPANY Direct Labor Variance Report For the Month Ended March 31, 2014 Job No.

Actual Hours

Standard Hours

Quantity Variance (a)

Actual Standard Rate (1) Rate (2)

Price Variance (b) Explanation

A257 A258 A259

221 450 300

225 430 300

$ 80.00 F 400.00 U ( 0

$20.00 $21.00 $20.60

$20.00 $20.00 $20.00

A260

116 110 Totals

120.00 U $ 440.00 U

$18.00

$20.00

$ 0 Repeat job 450.00 U Rush job 180.00 U Replacement worker 232.00 F New trainee $398.00 U

LQV = SR X (AH – SH) (b) LPV = AH X (AR – SR) (a)

11-18

(1)

Actual costs ÷ actual hours Standard costs ÷ standard hours

(2)

EXERCISE 11-11 Total overhead variance: Actual Overhead – Overhead Applied $263,000 – $255,000 (51,000 X $5)

= $8,000 U

EXERCISE 11-12 (a)

Overhead Budget ÷ (at normal capacity) Variable $250,000 Fixed 600,000 (b)

Standard Hours Allowed 95,000

Direct Labor Hours (at normal capacity) 100,000 100,000 Predetermined Overhead Rate $8.50

Overhead Applied $807,500 (95,000 X $8.50)

Predetermined Overhead Rate $2.50 $6.00

Overhead Applied $807,500

Total Overhead = Variance = $48,500 U

EXERCISE 11-13 (AQ X AP) – ( SQ X SP) = Total Materials Variance ( $10,800) – (2,140* X $5) = $100 U

(a)

(AQ X AP) – ( AQ X SP) = Materials Price Variance ( $10,800) – (2,400 X $5) = $1,200 F ( AQ X SP) – ( SQ X SP) = Materials Quantity Variance (2,400 X $5) – (2,140* X $5) = $1,300 U *1,070 X 2 (b) One possible cause of an unfavorable materials quantity variance is the purchase of substandard materials. Such materials would normally be purchased at a lower price than normal, which means there would also be favorable materials price variance. Substandard materials could also cause work slowdowns and delays, causing an unfavorable labor quantity variance. Therefore, the purchase of substandard materials could cause all three variances mentioned.

11-19

EXERCISE 11-14 (a) PICARD LANDSCAPING Variance Report – Purchasing Department For the Current Month

Project Remington Chang Wyco

Actual (1) Pounds Actual Purchased Price 500 400 550

$2.40 2.30 2.60

(2) Standard Price Price Variance (a) $2.50 2.50 2.50

Total price variance

$50 F 80 F 55 U

Explanation Purchased poor-quality seeds Seeds on sale Price increased

$75 F

(a)

MPV = AQ X (AP – SP) (1)Actual costs ÷ actual quantity (2)Standard costs ÷ standard quantity.

(b) PICARD LANDSCAPING Variance Report – Production Department For the Current Month Project Remington Chang Wyco

Actual Pounds 500 400 550

Standard Standard Pounds Price 460 410 480

Total quantity variance

MQV = SP X (AQ – SQ)

(b)

11-20

$2.50 2.50 2.50

Quantity Variance (b)

Explanation

$100 U 25 F 175 U

Purchased poor-quality seeds Purchased higher-quality seeds New employee

$250 U

EXERCISE 11-15 BURTE CORPORATION Variance Report – Purchasing Department For Week Ended January 9, 2014 Type of Materials

Quantity Purchased

Actual Price

Standard Price

Price Variance

Explanation

Rogue 11 Storm 17 Beast 29

25,000 lbs.

$5.20

7,000 oz. 22,000 units.

$3.45

$5.00 $3.30

$0.40

$0.42

$5,000 U $1,050 U $ 440 F

Price increase Rush order Bought larger quantity

25,000 = $5,000/($5.20 – $5.00). $5,000 U because the actual price ($5.20) exceeds the standard price ($5.00). $1,050/7,000 = $0.15; $3.30 + $0.15 = $3.45 $440/22,000 = $0.02; $0.40 + $0.02 = $0.42 EXERCISE 11-16 FISK COMPANY Income Statement For the Month Ended January 31, 2014 Sales revenue (8,000 X $8)............................................. Cost of goods sold (8,000 X $5) .................................... Gross profit (at standard) .............................................. Variances Materials price ........................................................ $1,200 U Materials quantity ................................................... 800 F Labor price .............................................................. 550 U Labor quantity ......................................................... 750 U Overhead ................................................................. 800 U Total variance—unfavorable .......................... Gross profit (actual) ....................................................... Selling and administrative expenses ............................ Net income ......................................................................

11-21

$64,000 40,000 24,000

2,500 21,500 8,000 $13,500

EXERCISE 11-17 1.

Balanced scorecard—(c) An approach that incorporates financial and nonfinancial measures in an integrated system that links performance measurement and a company’s strategic goals.

Variance—(a) The difference between total actual costs and total standard costs.

Learning and growth perspective—(d) A viewpoint employed in the balanced scorecard to evaluate how well a company develops and retains its employees.

Nonfinancial measures —(e) An evaluation tool that is not based on dollars.

Customer perspective—(f) A viewpoint employed in the balanced scorecard to evaluate the company from the perspective of those people who buy its products or services.

Internal process perspective—(h) A viewpoint employed in the balanced scorecard to evaluate the efficiency and effectiveness of the company’s value chain.

Ideal standards—(g) An optimum level of performance under perfect operating conditions.

Normal standards—(b) An efficient level of performance that is attainable under expected operating conditions.

*EXERCISE 11-18 1.

11-22

Raw Materials Inventory (18,000 X $4.40) ................ Materials Price Variance (18,000 X $.10) ................. Accounts Payable (18,000 X $4.50) ..................

79,200 1,800

Work in Process Inventory (17,500 X $4.40) ........... Materials Quantity Variance (500 X $4.40) ............... Raw Materials Inventory (18,000 X $4.40) ........

77,000 2,200

Factory Labor (15,300 X $5.50)................................. Labor Price Variance (15,300 X $.50) ............... Factory Wages Payable (15,300 X $5.00) .........

84,150

81,000

79,200 7,650 76,500

*EXERCISE 11-18 (Continued) 4.

Work in Process Inventory (15,400 X $5.50) ............ Labor Quantity Variance (100 X $5.50) ............. Factory Labor (15,300 X $5.50) ..........................

84,700

Work in Process Inventory ($84,700 X 100%) .......... Manufacturing Overhead ...................................

84,700

550 84,150 84,700

*EXERCISE 11-19 (a) $126,000 ($128,000 – $2,000). (b) $129,000 ($126,000 + $3,000). (c) $138,500 ($140,000 – $1,500). (d) $140,900 ($140,000 + $900). (e) $163,800 ($165,000 – $1,200). *EXERCISE 11-20 Raw Materials Inventory (1,900 X $2.50) ............................ Materials Price Variance (1,900 X $0.15) ............................ Accounts Payable (1,900 X $2.65) ..............................

4,750 285

Work in Process Inventory (1,880* X $2.50) ...................... Materials Quantity Variance (20 X $2.50) ........................... Raw Materials Inventory (1,900 X $2.50) ....................

4,700 50

5,035

4,750

*235 X 8 Factory Labor (700 X $12) ................................................... Labor Price Variance (700 X $0.20) ............................. Factory Wages Payable (700 X $11.80) ......................

8,400

Work in Process Inventory (705* X $12) ............................ Labor Quantity Variance (5 X $12) .............................. Factory Labor (700 X $12) ...........................................

8,460

*235 X 3

11-23

140 8,260 60 8,400

*EXERCISE 11-21 (a) Item Variable overhead ................................... Fixed overhead ....................................... Total overhead ........................................ (b) Total overhead variance: Actual Overhead – Overhead Applied $55,000 – $52,800 (16,000* X $3.30)

Amount $34,650 19,800 $54,450

Hours 16,500 16,500 16,500

Rate $2.10 1.20 $3.30

= $2,200 U

*4,000 X 4 hrs. = 16,000 hrs. Overhead controllable variance: Actual Overhead – Overhead Budgeted $55,000 – $53,400 = $1,600 U [(16,000 X $2.10) + $19,800] Overhead volume variance: Fixed Overhead Normal Capacity Standard Hours Rate X Hours – Allowed $1.20 X [(16,500 – (4,000 X 4)] = $600 U (c) The overhead controllable variance is generally associated with variable overhead costs. Thus, this variance indicates the production manager’s inefficiency in controlling variable overhead costs. The overhead volume variance relates to fixed overhead costs. This variance indicates whether plant facilities were efficiently used. In this case 500 (16,500 – 16,000) hours of plant capacity were not utilized.

11-24

*EXERCISE 11-22 (a) 1. Total actual overhead cost

Overhead Budgeted

= ($18,000 + $12,600) +

Overhead Controllable Variance $1,200

= $31,800 2.

Actual variable overhead cost = Actual Overhead – Fixed Overhead –

= $31,800

$12,600

= $19,200 3.

Variable overhead cost applied = 2,000 hours X $9 = $18,000

Fixed overhead cost applied

= 2,000 hours X $6 = $12,000

Overhead volume variance

(2,100* –

2,000)

= $600 U *$12,600 ÷ $6 per hour = 2,100 hours (b)

Number of loans processed

= Standard hours allowed ÷ Standard hours per application = 2,000 ÷ 2 = 1,000 loans processed

11-25

EXERCISE 11-23 (a) (Actual) – (Applied) = Total Overhead Variance ($19,000) – (1,800 X $10*) = $1,000 U (Actual) – ($19,000) – Fixed OH Rate $3**

(Budgeted) ($17,600)

*$200,000/20,000

Normal Capacity (1,667***

= Overhead Controllable Variance = $1,400 U

– –

Standard Hours Overhead Volume Allowed = Variance 1,800) = $400 F

**($5,000 X 12)/20,000

***20,000/12

(b) The cause of an unfavorable controllable variance could be higher than expected use of indirect materials, indirect labor, and factory supplies, or increases in indirect manufacturing costs, such as fuel and maintenance costs. A favorable volume variance would be caused by production of more units than what is considered normal capacity.

11-26

SOLUTIONS TO PROBLEMS PROBLEM 11-1A

(a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (5,100 X $7.20) (4,900 X $7.00) $36,720 – $34,300 = $2,420 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (5,100 X $7.20) (5,100 X $7.00) $36,720 – $35,700 = $1,020 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (5,100 X $7.00) (4,900 X $7.00) $35,700 – $34,300 = $1,400 U Total labor variance: ( AH X AR ) – ( SH X SR ) (7,500 X $12.50) (7,840* X $12.00) $93,750 – $94,080 = $330 F *4,900 X 1.6 Labor price variance: ( AH X AR ) – ( AH X SR ) (7,500 X $12.50) (7,500 X $12.00) $93,750 – $90,000 = $3,750 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (7,500 X $12.00) (7,840 X $12.00) $90,000 – $94,080 = $4,080 F (b) Total overhead variance: Actual Overhead Overhead – Applied ($59,700 + $21,000) – (7,840 X $10.00) $80,700 $78,400 = $2,300 U

11-27

PROBLEM 11-2A

(a) 1. Total materials variance: ( AQ X AP ) – ( SQ X SP ) (10,600 X $2.25) (10,000 X $2.10) $23,850 – $21,000 = $2,850 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (10,600 X $2.25) (10,600 X $2.10) $23,850 – $22,260 = $1,590 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (10,600 X $2.10) (10,000 X $2.10) $22,260 – $21,000 = $1,260 U 2. Total labor variance: ( AH X AR ) – ( SH X SR ) (14,400 X $8.40*) (15,000 X $8.00**) $120,960 – $120,000 = $960 U *$120,960 ÷ 14,400

**$120,000 ÷ 15,000

Labor price variance: ( AH X AR ) – ( AH X SR ) (14,400 X $8.40) (14,400 X $8.00) $120,960 – $115,200 = $5,760 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (14,400 X $8.00) (15,000 X $8.00) $115,200 – $120,000 = $4,800 F (b)

Total overhead variance: Actual Overhead Overhead – Applied $189,500 – $193,500 = $4,000 F (45,000* X $4.30) *15,000 X 3

11-28

PROBLEM 11-2A (Continued) (c)

AYALA CORPORATION Income Statement For the Month Ended June 30, 2014 Sales revenue .................................................... Cost of goods sold (at standard) ...................... Gross profit (at standard).................................. Variances Materials price ............................................ Materials quantity....................................... Labor price ................................................. Labor quantity ............................................ Overhead .................................................... Total variance—favorable .................. Gross profit (actual) .......................................... Selling and administrative expenses ............... Net income .........................................................

$400,000 334,500* 65,500 $ 1,590 U 1,260 U 5,760 U 4,800 F 4,000 F 190 65,690 40,000 $ 25,690

*Materials $21,000 + labor $120,000 + overhead applied $193,500.

11-29

PROBLEM 11-3A

(a) 1.

Total materials variance: ( AQ X AP ) – ( SQ X SP ) (90,500 X $4.15) (89,600* X $4.40) $375,575 – $394,240 = $18,665 F *11,200 X 8 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (90,500 X $4.15) (90,500 X $4.40) $375,575 – $398,200 = $22,625 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (90,500 X $4.40) (89,600 X $4.40) $398,200 – $394,240 = $3,960 U

Total labor variance: ( AH X AR ) – ( SH X SR ) (14,200 X $14.10) (13,440* X $13.40) $200,220 – $180,096 = $20,124 U *11,200 X 1.2 Labor price variance: ( AH X AR ) – ( AH X SR ) (14,200 X $14.10) (14,200 X $13.40) $200,220 – $190,280 = $9,940 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (14,200 X $13.40) (13,440 X $13.40) $190,280 – $180,096 = $10,184 U

(b)

Total overhead variance: Actual Overhead Overhead – Applied $86,000 – $81,984 ($49,000 + $37,000) (13,440* X $6.10**) = $4,016 U *11,200 X 1.2

11-30

**$3.50 + $2.60

PROBLEM 11-3A (Continued) (c) The materials price variance is more than 4% from standard. The actual price for materials of $4.15 is $.25 below the standard price of $4.40 or 5.7% ($.25 ÷ $4.40). The same result can be obtained by dividing the total price variance by the total standard price for the quantities purchased ($22,625 ÷ $398,200). The labor price variance is 5.2% from standard ($.70 ÷ $13.40). The same result can be obtained by dividing the total price variance by the total standard price for the direct labor hours used ($9,940 ÷ $190,280). The labor quantity variance is 5.7% (760 ÷ 13,440) from standard. The same result can be obtained by dividing the total quantity variance by the total standard price for the standard hours allowed ($10,184 ÷ $180,096).

11-31

PROBLEM 11-4A

(a) $3,510 ÷ 117,000 = $.03; $.92 + $.03 = $.95 standard materials price per pound. OR 117,000 X $.92 = $107,640; $107,640 + $3,510 = $111,150; $111,150 ÷ 117,000 = $.95 per pound. (b) $4,750 ÷ $.95 = 5,000 pounds; 117,000 – 5,000 = 112,000 standard quantity for 28,000 units or 4.0 pounds (112,000 ÷ 28,000) per unit. OR $111,150 – $4,750 = $106,400; $106,400 ÷ $.95 = 112,000; 112,000 ÷ 28,000 = 4.0 pounds per unit. (c) Standard hours allowed are 44,800 (28,000 X 1.6). (d) $7,200 ÷ $12.00 = 600 hours over standard; 44,800 standard hours + 600 hours = 45,400 actual hours worked. OR 44,800 X $12 = $537,600; $537,600 + $7,200 = $544,800; $544,800 ÷ $12 = 45,400 actual hours worked. (e) $9,080 ÷ 45,400 = $.20; $12.00 – $.20 = $11.80 actual rate per hour. OR $544,800 – $9,080 = $535,720; $535,720 ÷ 45,400 = $11.80 actual rate per hour. (f)

$360,000 ÷ 50,000 = $7.20 predetermined overhead rate per direct labor hour.

(g) Direct materials 4.0 pounds X $.95 = $3.80; direct labor 1.6 X $12.00 = $19.20; manufacturing overhead 1.6 X $7.20 = $11.52. $3.80 + $19.20 + $11.52 = $34.52 standard cost per unit. (h) 44,800 X $7.20 = $322,560 overhead applied. (i)

11-32

$34.52 [see (g) above] X 28,000 = $966,560 or direct materials $106,400 + direct labor $537,600 + overhead applied $322,560 = $966,560.

PROBLEM 11-5A

(a) Materials price variance: ( AQ X AP ) – ( AQ X SP ) (3,050 X $1.38*) (3,050 X $1.46) $4,209 – $4,453

= $244 F

*$4,209 ÷ 3,050 Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (3,050 X $1.46) (3,000* X $1.46) $4,453 – $4,380 *1,500 X 2 Labor price variance: ( AH X AR) – ( AH X SR) (1,600 X $23*) (1,600 X $24) $36,800 – $38,400 *$36,800 ÷ 1,600 Labor quantity variance: ( AH X SR) – (SH X SR ) (1,600 X $24) (1,500* X $24) $38,400 – $36,000

= $73 U

= $1,600 F

= $2,400 U

*1,500 X 1 hr. (b) Total Overhead variance: Actual Overhead Overhead – Applied $22,400 – $24,000 ($7,400 + $15,000) (1,500 X $16*) *$10 + $6

11-33

= $1,600 F

PROBLEM 11-5A (Continued) (c) PACE LABS, INC. Income Statement For the Month Ended November 30, 2014 Service revenue ..................................................... Cost of service provided (at standard) (1,500 X $42.92) .................................................. Gross profit (at standard) ...................................... Variances Materials price ................................................ Materials quantity ........................................... Labor price...................................................... Labor quantity ................................................ Overhead......................................................... Total variance—favorable ...................... Gross profit (actual)............................................... Selling and administrative expenses ................... Net income .............................................................

$75,000 64,380 10,620 $ 244 F 73 U 1,600 F 2,400 U 1,600 F 971 11,591 5,000 $ 6,591

(d) The unfavorable materials quantity variance could be caused by poor quality materials or inexperienced workers or faulty test procedures. The unfavorable labor quantity variance could be caused by inexperienced workers, poor quality materials, or faulty test procedures.

11-34

*PROBLEM 11-6A

(a) 1.

Raw Materials Inventory (6,200 X $1.00)............ Materials Price Variance [6,200 X ($1.05 – $1.00)] .................................. Accounts Payable (6,200 X $1.05) ..............

6,200

Work in Process Inventory (5,700* X $1) ........... Materials Quantity Variance [(6,200 – 5,700) X $1.00] .................................. Raw Materials Inventory .............................

5,700

310 6,510

500 6,200

*1,900 X 3 3.

5. 6.

Factory Labor (2,000 X $8) ................................. Labor Price Variance [2,000 X ($8.00 – $7.80)] .......................... Factory Wages Payable (2,000 X $7.80) ..... Work in Process Inventory (1,900 X $8.00) ................................................. Labor Quantity Variance [(2,000 – 1,900) X $8.00] .................................. Factory Labor .............................................. Manufacturing Overhead .................................... Accounts Payable ....................................... Work in Process Inventory (3,800* X $6.25**) ............................................. Manufacturing Overhead ............................ *1,900 X 2

11-35

16,000 400 15,600 15,200 800 16,000 25,000 25,000 23,750 23,750

**$4.00 + $2.25

Finished Goods Inventory (1,900 X $23.50) ............................................... Work in Process Inventory .........................

44,650 44,650

Accounts Receivable .......................................... Sales Revenue .............................................

65,000

Cost of Goods Sold ............................................ Finished Goods Inventory ..........................

44,650

65,000 44,650

*PROBLEM 11-6A (Continued) (b)

Raw Materials Inventory (1) 6,200 (2) 6,200

Materials Price Variance (1) 310

Work in Process Inventory (2) 5,700 (7) 44,650 (4) 15,200 (6) 23,750

Factory Labor 16,000 (4) 16,000

Materials Quantity Variance (2) 500

Finished Goods Inventory (7) 44,650 (8) 44,650

Manufacturing Overhead (5) 25,000 (6) 23,750

Labor Price Variance (3) 400

(3)

(8)

Cost of Goods Sold 44,650

Labor Quantity Variance (4) 800

1,250

JORGENSEN CORPORATION Income Statement For the Month Ended January 31, 2014 Sales revenue......................................................... Cost of goods sold (at standard) (1,900 X $23.50) .................................................. Gross profit (at standard) ...................................... Variances Materials price ................................................ Materials quantity ........................................... Labor price...................................................... Labor quantity ................................................ Overhead......................................................... Total variance—unfavorable .................. Gross profit (actual)............................................... Selling and administrative expenses ................... Net income .............................................................

11-36

1,250

$65,000 44,650 20,350 $ 310 U 500 U 400 F 800 U 1,250 U 2,460 17,890 2,000 $15,890

*PROBLEM 11-7A

Overhead controllable variance: Actual Overhead Overhead – Budgeted $80,700 – $78,800 = $1,900 U [(7,840* X $7.50) + $20,000] *(4,900 X 1.6 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $2.50/hr. X (8,000 – 7,840)

11-37

= $400 U

*PROBLEM 11-8A

Overhead controllable variance: Actual Overhead Overhead – Budgeted $189,500 – $190,250 [(45,000* X $3.00) + (42,500 X $1.30)]

= $750 F

*(15,000 X 3 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $1.30/hr. X (42,500 – 45,000) = $3,250 F

11-38

*PROBLEM 11-9A

Overhead controllable variance: Actual Overhead Overhead – Budgeted $86,000 – $83,944 = $2,056 U ($49,000 + $37,000) [(13,440* X $2.60) + $49,000] *(11,200 X 1.2 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $3.50/hr. X (14,000 – 13,440)

11-39

= $1,960 U

*PROBLEM 11-10A

Overhead controllable variance: Actual Overhead Overhead – Budgeted $22,400 – $23,000 = $600 F ($7,400 + $15,000) [(1,500 X $6) + $14,000] Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $10 X (1,400* – 1,500) = $1,000 F *$14,000 ÷ $10

11-40

PROBLEM 11-1B

(a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (20,000 X $5.95) (19,400* X $6.00) $119,000 – $116,400 = $2,600 U *9,700 X 2 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (20,000 X $5.95) (20,000 X $6.00) $119,000 – $120,000 = $1,000 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (20,000 X $6.00) (19,400 X $6.00) $120,000 – $116,400 = $3,600 U Total labor variance: ( AH X AR ) – ( SH X SR ) (19,600 X $13.10) (19,400* X $13.00) $256,760 – $252,200 = $4,560 U *9,700 X 2 Labor price variance: ( AH X AR ) – ( AH X SR ) (19,600 X $13.10) (19,600 X $13.00) $256,760 – $254,800 = $1,960 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (19,600 X $13.00) (19,400 X $13.00) $254,800 – $252,200 = $2,600 U (b) Total overhead variance: Actual Overhead Overhead – Applied ($68,800 + $50,000) – (19,400 X $6.00*) $118,800 $116,400 = $2,400 U *Standard per labor hour overhead cost ($3.50 variable + $2.50 fixed).

11-41

PROBLEM 11-2B

(a) 1.

Total materials variance: ( AQ X AP ) – ( SQ X SP ) (21,000 X $3.70) (22,000 X $3.50) $77,700 – $77,000 = $700 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (21,000 X $3.70) (21,000 X $3.50) $77,700 – $73,500 = $4,200 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (21,000 X $3.50) (22,000 X $3.50) $73,500 – $77,000 = $3,500 F

Total labor variance: ( AH X AR ) – ( SH X SR ) (3,450 X $11.50) (3,600 X $12.00) $39,675 – $43,200 = $3,525 F Labor price variance: ( AH X AR ) – ( AH X SR ) (3,450 X $11.50) (3,450 X $12.00) $39,675 – $41,400 = $1,725 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (3,450 X $12.00) (3,600 X $12.00) $41,400 – $43,200 = $1,800 F

(b) Total overhead variance: Actual Overhead Overhead – Applied $94,800 – $100,800 = $6,000 F (3,600 X $28*) *($16 + $12)

11-42

PROBLEM 11-2B (Continued) (c)

HUANG COMPANY Income Statement For the Month Ended July 31, 2014 Sales revenue .................................................... Cost of goods sold (at standard) ...................... Gross profit (at standard).................................. Variances Materials price ............................................ Materials quantity....................................... Labor price ................................................. Labor quantity ............................................ Total overhead ........................................... Total variance—favorable .................. Gross profit (actual) .......................................... Selling and administrative expenses ............... Net income ......................................................... 1

$270,000 221,0001 49,000 $ 4,200 U 3,500 F 1,725 F 1,800 F 6,000 F 8,825 57,825 20,000 $ 37,825

Materials $77,000 (22,000 X $3.50) + Direct labor $43,200 (3,600 X $12.00) + Overhead applied $100,800.

11-43

PROBLEM 11-3B (a) 1.

Total materials variance: ( AQ X AP ) – ( SQ X SP ) (76,000 X $7.20) (78,500* X $6.75) $547,200 – $529,875 = $17,325 U *15,700 X 5 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (76,000 X $7.20) (76,000 X $6.75) $547,200 – $513,000 = $34,200 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (76,000 X $6.75) (78,500 X $6.75) $513,000 – $529,875 = $16,875 F

Total labor variance ( AH X AR ) – ( SH X SR ) (14,800 X $11.20) (15,700 X $11.45) $165,760 – $179,765 = $14,005 F Labor price variance: ( AH X AR ) – ( AH X SR ) (14,800 X $11.20) (14,800 X $11.45) $165,760 – $169,460 = $3,700 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (14,800 X $11.45) (15,700 X $11.45) $169,460 – $179,765 = $10,305 F

(b) Total overhead variance: Actual Overhead – $169,000 – ($120,000 + $49,000)

*$6.25 + $3.15 11-44

Overhead Applied $147,580 = $21,420 U (15,700 X $9.40*)

PROBLEM 11-3B (Continued) (c) The following variances are more than 5% from standard: Materials price variance. The actual price of $7.20 is 6.7% higher than the standard price of $6.75. The same result can be obtained by dividing the total variance by the total standard. For the materials price variance, the computation would be $34,200 ÷ $513,000 = 6.7%. Labor quantity variance. The actual hours of 14,800 is 5.7% under the standard hours of 15,700. The same result can be obtained by dividing the total variance by the total standard. For example, for the labor quantity variance, the computation would be $10,305 ÷ $179,765 = 5.7%. The unfavorable materials price variance was caused by paying more than the standard cost for the materials purchased. This unfavorable variance may have been caused by price increases or the purchase of better quality materials. Since the labor quantity variance is favorable, the latter explanation is reasonable. Better quality materials may have required fewer hours of labor to construct the suits.

11-45

PROBLEM 11-4B

(a) $10,000 ÷ 200,000 = $.05; $1.00 – $.05 = $.95 standard materials price per pound. OR 200,000 X $1.00 = $200,000; $200,000 – $10,000 = $190,000; $190,000 ÷ 200,000 = $.95. (b) $23,750 ÷ $.95 = 25,000 pounds; 200,000 + 25,000 = 225,000 standard quantity for 45,000 units or 5.0 pounds (225,000 ÷ 45,000) per unit. OR $190,000 + $23,750 = $213,750; $213,750 ÷ $.95 = 225,000; 225,000 ÷ 45,000 = 5.0 pounds per unit. (c) Standard hours allowed are 90,000 (45,000 X 2). (d) $10,080 ÷ $12 = 840 hours over standard; 90,000 standard hours + 840 hours = 90,840 actual hours worked. OR 90,000 X $12 = $1,080,000; $1,080,000 + $10,080 = $1,090,080; $1,090,080 ÷ $12 = 90,840 actual hours worked. (e) $18,168 ÷ 90,840 = $.20; $12.00 – $.20 = $11.80 actual rate per hour. (f)

$713,800 ÷ 86,000 = $8.30 predetermined overhead rate per direct labor hour.

(g) Direct materials 5.0 pounds X $.95 = $4.75; direct labor 2 X $12.00 = $24.00; manufacturing overhead 2 X $8.30 = $16.60. $4.75 + $24.00 + $16.60 = $45.35 standard cost per unit. (h) 90,000 X $8.30 = $747,000 overhead applied. (i)

11-46

$45.35 [see (g) above] X 45,000 = $2,040,750 or direct materials $213,750 + direct labor $1,080,000 + overhead applied $747,000 = $2,040,750.

PROBLEM 11-5B

(a) Materials price variance: ( AQ X AP ) – ( AQ X SP ) (2,530 X $2.00*) (2,530 X $1.80) $5,060 – $4,554

= $506 U

*$5,060 ÷ 2,530 Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (2,530 X $1.80) (2,500 X $1.80) $4,554 – $4,500

= $54 U

Labor price variance: (AH X AR) – (AH X SR) (1,240 X $21*) (1,240 X $20.50) $26,040 – $25,420

= $620 U

*$26,040 ÷ 1,240 Labor quantity variance: (AH X SR) – ( SH X SR ) (1,240 X $20.50) (1,250* X $20.50) $25,420 – $25,625 *2,500 X .5 (b) Total overhead variance: Actual Overhead – Overhead Applied $15,800 – $16,250 [($10,100 + $5,700) – (1,250 X $13*) *($8 + $5)

11-47

= $205 F

= $450 F

PROBLEM 11-5B (Continued) (c) BONITA LABS Income Statement For the Month Ended May 31, 2014 Service revenue ..................................................... Cost of service provided (at standard) ($18.55 X 2,500) .................................................. Gross profit (at standard) ...................................... Variances Materials price ................................................ Materials quantity ........................................... Labor price...................................................... Labor quantity ................................................ Overhead......................................................... Total variance—unfavorable.................. Gross profit (at actual) .......................................... Selling and administrative expenses ................... Net income .............................................................

$55,000 46,375 8,625 $ 506 U 54 U 620 U 205 F 450 F 525 8,100 2,000 $ 6,100

(d) The unfavorable materials price variance could be caused by using the wrong shipping method or rising prices. The unfavorable materials quantity variance could be caused by inexperienced workers, carelessness, poor quality material, or faulty test procedures. The unfavorable labor price variance could be caused by rising labor costs, or assigning the wrong workers to perform the tests.

11-48

*PROBLEM 11-6B (a) 1.

5. 6.

11-49

Raw Materials Inventory (8,100 X $4.00)......... Materials Price Variance [8,100 X ($3.70 – $4.00)] ....................... Accounts Payable (8,100 X $3.70) ........... Work in Process Inventory (8,250* X $4.00) ............................................. Materials Quantity Variance [(8,100 – 8,250) X $4.00] ....................... Raw Materials Inventory .......................... *5,500 X 1.5 Factory Labor (5,200 X $9.00) ......................... Labor Price Variance [5,200 X ($9.20 – $9.00)] ............................... Factory Wages Payable (5,200 X $9.20) ....................................... Work in Process Inventory (5,500 X $9.00) .............................................. Labor Quantity Variance [(5,500 – 5,200) X $9.00] ....................... Factory Labor ........................................... Manufacturing Overhead ................................. Accounts Payable ....................................

32,400 2,430 29,970 33,000 600 32,400 46,800 1,040 47,840 49,500 2,700 46,800 87,500 87,500

Work in Process Inventory (5,500 X $15.40) ............................................ Manufacturing Overhead .........................

84,700

Finished Goods Inventory (5,500 X $30.40) ............................................ Work in Process Inventory ......................

167,200

84,700

167,200

Accounts Receivable ....................................... Sales Revenue ..........................................

270,000

Cost of Goods Sold ......................................... Finished Goods Inventory .......................

167,200

270,000 167,200

*PROBLEM 11-6B (Continued) (b)

Raw Materials Inventory (1) 32,400 (2) 32,400

Materials Price Variance (1) 2,430

Work in Process Inventory (2) 33,000 (7) 167,200 (4) 49,500 (6) 84,700

Factory Labor 46,800 (4) 46,800

Materials Quantity Variance (2) 600

Finished Goods Inventory (7) 167,200 (8) 167,200

(3)

Manufacturing Overhead (5) 87,500 (6) 84,700

(3)

Labor Price Variance 1,040

(8)

Cost of Goods Sold 167,200

Labor Quantity Variance (4) 2,700

(c) Overhead Variance (1) ................................................... Manufacturing Overhead .......................................

2,800 2,800

(1) [$87,500 – (5,500 X $15.40)]

(d)

FRIO MANUFACTURING COMPANY Income Statement For the Month Ended January 31, 2014 Sales revenue......................................................... Cost of goods sold (at standard) (5,500 X $30.40) .................................................. Gross profit (at standard) ...................................... Variances Materials price ................................................ Materials quantity ........................................... Labor price...................................................... Labor quantity ................................................ Overhead......................................................... Total variance—favorable ...................... Gross profit (actual)............................................... Selling and administrative expenses ................... Net income .............................................................

11-50

$270,000 167,200 102,800 $2,430 F (600 F (1,040 U 2,700 F 2,800 U 1,890 104,690 60,000 $ 44,690

*PROBLEM 11-7B

Overhead controllable variance: Actual Overhead Overhead – Budgeted ($68,800 + $50,000) – [($50,000 + (19,400* X $3.50)] $118,800 $117,900 = $900 U Overhead volume variance: Normal Standard Fixed Overhead X Capacity – Hours Rate Hours Allowed 2.50/hr. X (20,000 – 19,400*) *9,700 X 2

11-51

= $1,500 U

*PROBLEM 11-8B

Overhead controllable variance: Actual Overhead Overhead – Budgeted $94,800 – $98,400 = $3,600 F [(3,600 X $16) + $40,800*] *3,400 X $12 Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $12/hr. X (3,400 – 3,600)

11-52

= $2,400 F

*PROBLEM 11-9B

Overhead controllable variance: Actual Overhead Overhead – Budgeted $169,000 – $174,455 = $5,455 F ($120,000 + $49,000) [(15,700 X $3.15) + $125,000] Overhead volume variance: Normal Standard Fixed Overhead X Capacity – Hours Rate Hours Allowed $6.25/hr. X (20,000 – 15,700) = $26,875 U

11-53

*PROBLEM 11-10B

Overhead controllable variance: Actual Overhead – Overhead Budgeted $15,800 – $16,000 [($10,100 + $5,700) – [(1,250* X $8) + $6,000] = $200 F Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $5.00 X (1,200** – 1,250*) = $250 F *2,500 X .5

11-54

**$6,000 ÷ $5.00/hour

BYP 11-1

DECISION-MAKING AT CURRENT DESIGNS

(a) Quantity variance for polyethylene powder Price variance for polyethylene powder Quantity variance for finishing kits Price variance for finishing kits Quantity variance for type I workers Price variance for type I workers Quantity variance for type II workers Price variance for type II workers

Unfavorable Unfavorable NEI = Not enough information Favorable Favorable NEI = Not enough information Unfavorable NEI = Not enough information

(b) Quantity variance for polyethylene powder ( AQ X SP ) – ( SQ X SP ) (1,200 X $1.50) (1,080* X $1.50) $1,800 – $1,620 = $180 U *54 X 20 Price variance for polyethylene powder ( AQ X AP ) – ( AQ X SP ) (1,200 X $1.70*) (1,200 X $1.50) $2,040 – $1,800

= $240 U

*$2,040 ÷ 1,200 Quantity variance for finishing kits ( AQ X SP ) – ( SQ X SP ) (20 X $170) (20 X $170) $3,400 – $3,400

=$ 0

Price variance for finishing kits ( AQ X AP ) – ( AQ X SP ) (20 X $162*) (20 X $170) $3,240 – $3,400

= $160 F

*$3,240 ÷ 20

11-55

BYP 11-1 (Continued) Quantity variance for type I workers ( AH X SR ) – ( SH X SR ) (38 X $15) (40* X $15) $570 – $600

= $30 F

*20 X 2 Price variance for type I workers ( AH X AR ) – ( AH X SR ) (38 X $15*) (38 X $15) $570 – $570

=$ 0

*$570 ÷ 38 Quantity variance for type II workers ( AH X SR ) – ( SH X SR ) (65 X $12) (60* X $12) $780 – $720

= $60 U

*20 X 3 Price variance for type II workers ( AH X AR ) – ( AH X SR ) (65 X $12.25*) (65 X $12.00) $796.25 – $780 *$796.25 ÷ 65

11-56

= $16.25 U

BYP 11-2

DECISION-MAKING ACROSS THE ORGANIZATION

(a) When setting a standard for computer/labor hours usage, Tryon Professionals should consider the following factors: 1.

A standard set conservatively high may discourage clients from purchasing the model.

A standard set too low may encourage sales of the model, but if customers use more hours than the standard suggests, they may be upset at having been misled.

Clients are likely to use the standard as an evaluation tool for their own employees operating the model. Standards set inappropriately may adversely affect productivity and/or morale of client employees.

(b) Logical alternatives for the standard include: 1.

34 hours:

The average number of hours used for one application by all five financial institutions.

45 hours:

The conservatively high number experienced by one financial institution.

25 hours:

The optimistic low number experienced by one financial institution.

30 hours:

The number of hours required most frequently in the sample of five institutions.

(c) In light of earlier factors listed, the second and third choices for the standard should be eliminated (i.e., 45 and 25 hours). The average 34 hours is probably the most representative. However, Milton Professionals may select 30 hours, given that the company has a high incentive to sell the new model. Consequently, it may make the most sense to pick the lower of the two remaining choices (30 hours).

11-57

BYP 11-2 (Continued) (d) Standard material cost for one model application:

11-58

User Manuals:

$320 ÷ 20 manuals = $16/application.

Computer Forms:

$60 ÷ 250 forms = $.24/form $.24/form X 50 forms = $12/application.

BYP 11-3

MANAGERIAL ANALYSIS

(a) The overhead application rate is $144,000 divided by 5,000 hours, or $28.80 per direct labor hour. (b) The standard direct labor hours are used to apply overhead to production, so the calculation is $28.80 X 4,500, or $129,600. (c)

Actual Overhead – Overhead Applied = Total Overhead Variance $150,000 $129,600 = $20,400 U The overhead budgeted for 4,500 direct labor hours is computed below. Fixed:

$22,500 + $13,000 + $27,000 + $8,000 + $3,000 + $1,500 + $500 + $300 = $75,800

Variable: ($12,000 + $43,000 + $10,000 + $2,500 + $700) ÷ 5,000 = $13.64 Fixed Variable (4,500 X $13.64)

$ 75,800 61,380 $137,180

The variances are: Controllable: Actual ($150,000) – Budgeted ($137,180) = $12,820 U Volume: $15.16*/hr. X (5,000 – 4,500) = $7,580 U *$75,800 ÷ 5,000 hrs. (d) Both variances appear significant. The controllable variance is 9.3% of budgeted overhead ($12,820 ÷ $137,180), and the volume variance is 5.8% of applied overhead ($7,580 ÷ $129,600). (e) The controllable variance is caused by either spending more than expected on overhead items, or using more than expected of overhead items (for example, more indirect labor hours). The volume variance is caused by underutilizing factory time. To improve performance, management must spend less on overhead items, use them more efficiently, and increase production to 1,000 units.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

11-59

BYP 11-4

REAL-WORLD FOCUS

(a) Glassmaster is using standard costs because management states that a factor that contributed to improved margins (profit) was a favorable materials price variance. (b) The materials price variance experienced should not lead to changes in the standard for the next fiscal year. Management indicates that the favorable variance is temporary and will begin to reverse itself as stronger worldwide demand for commodity products improves in tandem with the economy.

11-60

BYP 11-5

REAL-WORLD FOCUS

(a) The objectives for each perspective are: Financial: Increase profitability, lower costs, increase revenue Customer: Flight is on-time, lowest prices, more customers Internal: Improve turnaround time. Learning: Ground crew alignment. (b) To measure achievement of the customer perspective objectives of ontime flights, lowest prices and more customers, the company will use FAA on time arrival ratings, customer ranking, and number of customers. (c) To achieve the learning perspective objective of ground crew alignment, the company plans to implement an employee stock ownership plan and ground crew training.

11-61

BYP 11-6

REAL-WORLD FOCUS

(a) The normal industry standard for plants to be considered operating at 100% capacity is two shifts working about 250 days a year. (b) A government task force urged the company to try to operate at 120% capacity by traditional standards. (c) It is argued that assembly lines need too much scheduled maintenance and restocking. This is normally done during the period that the company is proposing to run a third shift. For example, the paint shop typically requires 4 hours of cleaning per day. To address these issues, the company is considering “overspeeding” some parts of the line so it can be slowed down later. (d) Potential drawbacks of the midnight shift are that midnight-shift workers are prone to above-average rates of on-the-job errors, absenteeism and illness. All of these issues could cause the night shift to deviate materially from standards for materials, labor and overhead. (e) Another potential problem with this approach is that each plant can only make a limited number of car models. Adding a third shift at the Kansas City plant assumes that the market demand for these cars will be sufficient to absorb the additional cars produced. If not, the company will have to discount the selling price and lay off employees.

11-62

BYP 11-7

COMMUNICATION ACTIVITY

To:

Professor Standard

From:

I. M. Smart

Subject:

Setting Standard Costs

This memorandum covers two points as follows: (a) The comparative advantages and disadvantages of ideal versus normal standards. Ideal standards represent optimum levels of performance under perfect operating conditions. In contrast, normal standards represent efficient levels of performance that are attainable under expected operating conditions. An advantage of ideal standards is that they stimulate the conscientious worker to ever-increasing improvement. The disadvantage of ideal standards is that because they are so difficult to meet, they lower the morale of the entire work force. Normal standards are rigorous but attainable. Such standards should stimulate the worker to self-improvement without discouraging him or her or lowering the morale of the work force. (b) Factors to be considered in setting standards for direct materials, direct labor, and manufacturing overhead. 1.

11-63

Direct materials. The direct materials price standard is the cost per unit of direct materials that should be incurred. This standard should be based on the purchasing department’s best estimate of the cost of raw materials. The price standard should include allowances for related costs such as receiving, storing and handling.

BYP 11-7 (Continued) The direct materials quantity standard is the quantity of direct materials that should be used per unit of finished goods. This standard is a physical measure and it should include allowances for unavoidable waste and normal spoilage. 2.

Direct labor. The direct labor price standard is the rate per hour that should be incurred for direct labor. This standard should be based on current wage rates adjusted for expected cost of living adjustments and employer payroll taxes and fringe benefits. The direct labor quantity standard is the time that should be required to make one unit of product. In setting this standard, allowances should be made for rest periods, cleanup, and machine setup and downtime.

11-64

Manufacturing overhead. For this standard, a standard predetermined overhead rate is used. This rate is determined by dividing budgeted overhead costs by an expected standard activity index. The budgeted overhead costs should be based on a realistic estimate of overhead costs at normal capacity.

BYP 11-8

ETHICS CASE

(a) Bill and his fellow painters in the painting department will benefit from Bill’s slow action. The company and its customers are harmed. The company will incur higher costs on the product and therefore will have to set a higher selling price or suffer a smaller gross profit. Customers will have to pay a greater price for the product or stockholders will obtain less benefit from their investment. (b) Deliberately falsifying and distorting the time study was unethical. If every employee in every phase of producing this new product distorted the time study, the company would not be competitive. If the company is not competitive and profitable, it will eventually go out of business and Bill will be out of a job. It is in Bill’s best interest to support the development of reasonable standards and improved efficiency. (c) The company might conduct several time study tests using different employees. Or the company might conduct unannounced time studies. And the standard might be changed more often than every six months by conducting monthly time studies to effect continuous improvements in efficiency. Incentives might be offered to employees who produce the most efficient effort in the time studies, thereby discouraging distorted, inefficient performance.

11-65

BYP 11-9

ALL ABOUT YOU

(a) The panel made recommendations regarding a number of areas of concern in higher education. For example, it suggested that new approaches should be used to control costs, and it stated that the cost of tuition should grow no faster than median family income. It made recommendations to strengthen the Pell Grant program, which is the core of the federal financial aid program. It also recommended that public universities should use standardized tests to measure student learning. (b) As discussed in the chapter, standards provide a mechanism for evaluating performance and, if used properly, can be used as a motivational tool. The results of standardized tests might help to evaluate the effectiveness of various approaches to education. They might also be used to “weed out” schools that are not meeting minimum expectations. (c) Potential disadvantages of standards are that they might reduce the willingness of instructors or institutions to experiment with new teaching approaches. In addition, in order to obtain high scores, instructors might feel compelled to “teach to the exam,” thus narrowing the breadth of exposure obtained by the student. Also, by their very nature, standardized tests have a difficult time addressing differences across various instructional settings that can cause differences in results. (d) Answers will vary depending on student response.

11-66

BYP 11-10

CONSIDERING YOUR COSTS AND BENEFITS

Discussion Guide: The practice of medicine holds an unusual place in society. On the one hand, it provides a critical, life-sustaining service. We expect and demand the highest-quality service. We measure its success in terms of health improvement and lives saved. On the other hand, it is a business, and like other businesses, it must operate profitably. Some healthcare providers characterize this delicate balance as “The Business of Caring.” How should we balance providing quality health-care and reducing costs? In recent years, managerial accounting has played an important, although not always successful, role in this issue. In the 1990s, health-care providers made extensive use of managerial accounting techniques to reduce costs. By the end of that decade, a number of important studies suggested that the quality of health care had suffered as a result of concentrating too much on cost-controlling efforts and not enough on maintaining quality. Today, many health-care organizations are implementing balanced scorecards in an effort to balance the dual (and in some ways competing) goals of quality health-care and reduced costs. For example, by providing incentives for preventive medicine, health-care providers can reduce costs and at the same time improve patient health. It is likely that, in order to provide health-care to more Americans, we will have to reduce costs. It is hoped that successful implementation of balanced scorecard programs will result in reduced costs through increased efficiency, while increasing the quality of health-care.

11-67

CHAPTER 12 Planning for Capital Investments ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Do It!

Exercises

2, 3

Explain the net present value method.

4, 5, 6, 7

2, 3, 4, 5

Identify the challenges presented by intangible benefits in capital budgeting.

8, 9

Describe the profitability index.

Indicate the benefits of performing a post-audit.

Explain the internal rate of return method.

12, 13, 16

7, 8

Describe the annual rate of return method.

3, 14, 15

Learning Objectives

Questions

Discuss capital budgeting evaluation, and explain inputs used in capital budgeting.

Describe the cash payback technique.

12-1

A Problems

B Problems

1, 2, 6, 9, 10, 11

1A, 2A

1B, 2B

1, 2, 3, 4 10, 11

1A, 2A, 3A, 4A, 5A

1B, 2B, 3B, 4B, 5B

5, 6, 7

3A, 5A

3B, 5B

8, 9, 10, 11

1A, 2A

1B, 2B

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Compute annual rate of return, cash payback, and net present value.

Moderate

30–40

Compute annual rate of return, cash payback, and net present value.

Complex

30–40

Compute net present value, profitability index, and internal rate of return.

Moderate

20–30

Compute net present value considering intangible benefits.

Moderate

20–30

Compute net present value and internal rate of return with sensitivity analysis.

Moderate

30–40

Compute annual rate of return, cash payback, and net present value.

Moderate

30–40

Compute annual rate of return, cash payback, and net present value.

Complex

30–40

Compute net present value, profitability index, and internal rate of return.

Moderate

20–30

Compute net present value considering intangible benefits.

Moderate

30–40

Compute net present value and internal rate of return with sensitivity analysis.

Moderate

30–40

12-2

12-3

Learning Objective

Knowledge Comprehension

Application

Discuss capital budgeting evaluation, and explain inputs used in capital budgeting.

Q12-1

Describe the cash payback technique.

Q12-2 Q12-3

BE12-1 DI12-1 E12-9 E12-10

Explain the net present value method. Q12-5 Q12-6

Q12-4 Q12-7

BE12-3 E12-8 E12-10 E12-11

Identify the challenges presented by intangible benefits in capital budgeting.

Q12-8

Describe the profitability index.

Indicate the benefits of performing a post-audit.

Q12-11

Explain the internal rate of return method.

Q12-12 Q12-13

Q12-16

BE12-7 E12-7

Describe the annual rate of return method.

Q12-14 Q12-15

Q12-3

BE12-9 E12-8 E12-9

BYP12-4

BYP12-5 BYP12-2

Broadening Your Perspective

Q12-9

Analysis Synthesis

E12-11

Evaluation

E12-1 E12-2 E12-6 P12-1A

P12-2A P12-1B P12-2B

BE12-4 P12-5A P12-5B

BE12-2 BE12-5 DI12-2 E12-1 E12-2 E12-3 E12-4 P12-1A

P12-2A P12-3A P12-4A P12-1B P12-2B P12-3B P12-4B

BE12-4

P12-4A P12-4B

Q12-10

BE12-5 E12-4

P12-3A P12-3B

BE12-6 P12-5A P12-5B E12-10 E12-11 BYP12-1 BYP12-8 BYP12-9

BE12-8 DI12-3 E12-6

E12-5 P12-3A P12-3B

DI12-4 P12-1A P12-2A

P12-1B P12-2B

BYP12-3 BYP12-6 BYP12-7

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

The screening of proposed capital expenditures may be done by a capital budgeting committee which submits its findings to the officers of the company. The officers, in turn, select the projects they believe to be the most worthy of funding and submit them to the board of directors. The directors ultimately approve the capital expenditure budget for the year.

The cash payback technique is relatively easy to compute and understand. However, it should not ordinarily be the only basis for the capital budgeting decision because it ignores the expected profitability of the investment and the time value of money.

Tom is not correct. The formula for the cash payback technique is: Cost of the capital investment ÷ Net annual cash flow. The formula for the annual rate of return is: Expected annual net income ÷ average investment.

The two tables are: (1) The present value of a single future amount (Table 3 in Appendix A). This table is used when a project has uneven cash payments over its useful life and to compute the present value of the salvage value of the project. (2) The present value of an annuity (Table 4 in Appendix A). This table is used when a project has equal cash payments occurring at equal intervals of time over its useful life.

The decision rule is: Accept the project when net present value is zero or positive; reject the project when net present value is negative.

The discount rate has two elements, a cost of capital element and a risk element. Many times companies set the risk element equal to zero; thus, they are setting the discount rate equal to the cost of capital. However, if a project is considered to be riskier than the firm’s other projects, the discount rate should include a risk element.

The following simplifying assumptions were made: • All cash flows come at the end of the year. • All cash flows are immediately reinvested in another project that has a similar return. • All cash flows can be predicted with certainty.

Examples of intangible benefits of investment projects would be increased product quality, improved safety, and enhanced employee loyalty. Intangible benefits often complicate the capital budgeting process because their value can be difficult to quantify. Ignoring intangible benefits may result in rejecting projects that would be financially beneficial to the company.

Two approaches can be taken. Under the first approach, management should ask whether the value of the intangible benefits exceeds the amount by which the net present value of the project is negative. If so, the project should be accepted. Under the second approach, management should make conservative dollar estimates of the value of the intangible benefits and the net present value should be recalculated.

12-4

Questions Chapter 12 (Continued) 10.

When trying to choose between competing proposals, simply comparing the net present value of the competing proposals ignores the fact that one proposal may require a considerably larger investment. The profitability index is useful because it incorporates the required initial investment into the evaluation.

11.

A post-audit is a thorough evaluation of how well a project’s actual performance matches the original projections. Performing post-audits can be valuable because: (1) managers are more likely to submit reasonable and accurate data if they know that their estimates will be evaluated subsequently, (2) they provide a process for determining whether projects should be continued, and (3) they improve the development of future investment proposals because, by evaluating their past successes and failures, managers improve their estimation techniques.

12.

When the net annual cash flows are equal each year, the steps are: (1) Compute the internal rate of return factor by dividing Capital Investment by Net Annual Cash Flows. (2) Use the factor and the present value of an annuity of 1 table to find the internal rate of return.

13.

Under the internal rate of return method, the objective is to find the rate that will make the present value of the expected net annual cash flows equal the present value of the proposed capital expenditure. The decision rule under the internal rate of return method is: Accept the project when the internal rate of return is equal to or greater than the required rate of return, and reject the project when the internal rate of return is less than the required rate.

14.

The advantages of this method are the simplicity of its calculation and management’s familiarity with the accounting terms used in the computation. A limitation is that it does not consider the time value of money. Also, by employing accrual accounting numbers rather than cash flows, it ignores the fact that the value of an investment proposal is based on the cash flows that it generates.

15.

The formula for the annual rate of return technique is: Expected annual net income ÷ Average investment.

16.

Cost of capital is the average rate of return that the company must pay to obtain borrowed and equity funds. The decision rule is: Accept the project when the internal rate of return is equal to or greater than the required rate of return (which often is its cost of capital). Reject the project when the internal rate of return is less than the required rate of return.

12-5

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 12-1 $450,000 ÷ $50,000 = 9 years BRIEF EXERCISE 12-2 Net annual cash flows – $40,000 X 5.65 Capital investment Net present value

Present Value $226,000 215,000 $ 11,000

The investment should be made because the net present value is positive. BRIEF EXERCISE 12-3

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 10% Discount Present Flows X Factor = Value $25,000 X 3.79079 = $ 94,770 65,000 X .62092 = 40,360 135,130 136,000 $ (870)

Since the net present value is negative, the project is unacceptable. BRIEF EXERCISE 12-4

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $34,000 X 5.53482 = ($188,184) 0X .50187 =( 0) ( 188,184) ( 200,000) ($ (11,816)

The reduction in downtime would have to have a present value of at least $11,816 in order for the project to be acceptable.

12-6

BRIEF EXERCISE 12-5 Project A

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $70,000 X 6.41766 = $449,236 0 X .42241 = 0 449,236 400,000 $ 49,236

Profitability index = $449,236/$400,000 = 1.12 Project B

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $50,000 X 6.41766 = $320,883 0 X .42241 = 0 320,883 280,000 $ 40,883

Profitability index = $320,883/$280,000 = 1.15 Project B has a lower net present value than Project A, but because of its lower capital investment, it has a higher profitability index. Based on its profitability index, Project B should be accepted. BRIEF EXERCISE 12-6 Original estimate

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

12-7

Cash 10% Discount Present Flows X Factor = Value $46,000 X 5.75902 = $264,915 0 X .42410 = 0 264,915 250,000 $ 14,915

BRIEF EXERCISE 12-6 (Continued) Revised estimate

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 10% Discount Present Flows X Factor = Value $39,000 X 6.49506 = ($253,307) 0X .35049 =( 0) ( 253,307) ( 260,000) ($ (6,693)

The original net present value was projected to be a positive $14,915; however, the revised estimate is a negative $6,693. The project is not a success.

BRIEF EXERCISE 12-7 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. $176,000/$33,740 = 5.21636 By tracing across on the 7-year row we see that the discount factor for 8% is 5.20637. Thus, the internal rate of return on this project is approximately 8%. BRIEF EXERCISE 12-8 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. Since this exercise has a salvage value, not all cash flows are equal. In this case, the internal rate of return can be approximated by identifying the discount rate that will result in a net present value of zero. By experimenting with various rates, we determined that the net present value is approximately zero when a discount rate of approximately 9% is used.

12-8

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

BRIEF EXERCISE 12-8 (Continued) Net annual cash flows = $400,000 – $150,000 = $250,000 Cash 9% Discount Present Flows X Factor = Value Present value of net annual cash flows $250,000 X 7.16073 = $1,790,183 Present value of salvage value 716,000 X .35554 = 254,567 2,044,750 Capital investment 2,045,000 Net present value $ (250) The 9% internal rate of return exceeds the company’s 7% required rate of return; thus, the project should be accepted.

BRIEF EXERCISE 12-9 The annual rate of return is calculated by dividing expected annual income by the average investment. The company’s expected annual income is: $130,000 – $70,000 = $60,000 Its average investment is: $470,000 + $10,000 = $240,000 2 Therefore, its annual rate of return is: $60,000/$240,000 = 25%

12-9

SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 12-1 Estimated annual cash inflows................................. Estimated annual cash outflows .............................. Net annual cash flow .................................................

$80,000 40,000 $40,000

Cash payback period = $120,000/$40,000 = 3 years. DO IT! 12-2 Estimated annual cash inflows................................. Estimated annual cash outflows .............................. Net annual cash flow .................................................

Present value of net annual cash flows Capital investment Net present value a Table 4, Appendix A.

$80,000 40,000 $40,000

Cash Flow

12% Discount Factor

Present Value

$40,000

3.03735 a

$121,494 120,000 $ 1,494

Since the net present value is positive, the project should be accepted DO IT! 12-3 Estimated annual cash inflows................................. Estimated annual cash outflows .............................. Net annual cash flow .................................................

$80,000 40,000 $40,000

$120,000/$40,000 = 3.00. Using Table 4 of Appendix A and the factors that correspond with the four-period row, 3.00 is between the factors for 12% and 15%. Since the project has an internal rate that is more than 12%, the company’s required rate of return, the project should be accepted.

12-10

DO IT! 12-4 Revenues .................................................................... Less: Expenses (excluding depreciation) .................... Depreciation ($120,000/4 years) .......................... Annual net income .....................................................

$80,000 $40,000 30,000

70,000 $ 10,000

Average investment = ($120,000 + 0)/2 = $60,000. Annual rate of return = $10,000/$60,000 = 16.7%. Since the annual rate of return, 16.7%, is greater than Wallowa’s required rate of return, 12%, the proposed project is acceptable.

12-11

SOLUTIONS TO EXERCISES EXERCISE 12-1 (a) The cash payback period is: $56,000 ÷ $7,500 = 7.5 years The net present value is:

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

8% Cash Discount Present Flows X Factor = Value $ 7,500 X 5.74664 = $43,100 27,000 X .54027 = 14,587 57,687 56,000 $ 1,687

(b) In order to meet the cash payback criteria, the project would have to have a cash payback period of less than 4 years (8 ÷ 2). It does not meet this criteria. The net present value is positive, however, suggesting the project should be accepted. The reason for the difference is that the project’s high estimated salvage value increases the present value of the project. The net present value is a better indicator of the project’s worth. EXERCISE 12-2 (a) Year 1 2 3

AA Net Annual Cash Flow $ 7,000 9,000 12,000

Cash payback period 2.50 years $22,000 – $16,000 = $6,000 $6,000 ÷ $12,000 = .50

12-12

Cumulative Net Cash Flow $ 7,000 16,000 28,000

EXERCISE 12-2 (Continued) BB 22,000 ÷ 10,000 = 2.2 years

Year 1 2 3

CC Net Annual Cash Flow $13,000 12,000 11,000

Cumulative Net Cash Flow $13,000 25,000 36,000

Cash payback period 1.75 years $22,000 – 13,000 = $9,000 $9,000 ÷ $12,000 = .75 The most desirable project is CC because it has the shortest payback period. The least desirable project is AA because it has the longest payback period. As indicated, only CC is acceptable because its cash payback is 1.75 years. (b)

AA Year

Discount Factor

Cash Flow

1 .89286 $ 7,000 2 .79719 9,000 3 .71178 12,000 Total present value Investment Net present value

Present Value

BB Cash Present Flow Value

$ 6,250 $10,000 7,175 10,000 8,541 10,000 21,966 (22,000) $ (34)

CC Cash Flow

Present Value

$ 8,929 $13,000 7,972 12,000 7,118 11,000 24,019(1) (22,000) $ 2,019

$11,607 9,566 7,830 29,003 (22,000) $ 7,003

(1) This total may also be obtained from Table 4: $10,000 X 2.40183 = $24,018. (The difference of $1 is due to rounding)

Project CC is still the most desirable project. Also, on the basis of net present values, project BB is also acceptable. Project AA is not desirable.

12-13

EXERCISE 12-3 Investment in new equipment ............. Disposal of old equipment ................... Additional training required ................. Net initial investment required ............

$2,450,000 (260,000) 85,000 $2,275,000

Calculation of net present value:

Cash flows

Maintenance Net cash flows from operations: Terminal salvage Present value of cash inflows Initial investment Net present value

Year 1 2 3 4 5 6 7

Discount Factor, 9% 0.91743 0.84168 0.77218 0.70843 0.64993 0.59627 0.54703

Amount $ 390,000 400,000 411,000 426,000 434,000 435,000 436,000

Present Value $ 357,798 336,672 317,366 301,791 282,070 259,377 238,505

0.64993

(100,000)

(64,993)

350,000

2,028,586 191,461

0.54703

2,220,047 (2,275,000) $ (54,953)

Based on the net present calculation alone, the sewing machine should not be purchased. However, the internal rate of return would be only slightly lower than the 9% minimum required, so the company may want to look at some of the non-quantitative factors involved.

12-14

EXERCISE 12-4 Machine A

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $15,000 X 5.53482 = $83,022 0 X .50187 = 0 83,022 75,500 $ 7,522

Profitability index = $83,022/$75,500 = 1.10 Machine B Cash 9% Discount Present Flows X Factor = Value Present value of net annual cash flows $30,000 X 5.53482 = ($166,045) Present value of salvage value 0X .50187 = ( 0) ( 166,045) Capital investment ( 180,000) Net present value ($ (13,955) Profitability index = $166,045/$180,000 = .92 Machine B has a negative net present value, and also a lower profitability index. Machine B should be rejected and Machine A should be purchased. EXERCISE 12-5 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. $430,000/$101,000 = 4.25743 By tracing across on the 6-year row, we see that the discount factor for 11% is 4.23054. Thus, the internal rate of return on this project is approximately 11%. Since this is above the company’s required rate of return, the project should be accepted. Copyright © 2012 John Wiley & Sons, Inc.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

12-15

EXERCISE 12-6 (a)

Total net investment = $29,300 + $1,500 – $2,000 = $28,800 Annual net cash flow = $7,000 Payback period = $28,800 ÷ $7,000 = 4.1 years

(b)

Net present value approximates zero when discount rate is 12%. Item Net annual cash flows Capital investment Net present value

(c)

Amount $7,000

Years 1–6

PV Factor 4.11141

Present Value $28,780 (28,800) $ (20)

Because the approximate internal rate of return of 12% exceeds the required rate of return of 10%, the investment should be accepted.

EXERCISE 12-7 (a)

Project

Capital Investment ÷

Net Annual Cash Flows*

Internal Rate of Return = Factor

22A 23A 24A

$240,000 $270,000 $280,000

($16,700 + $40,000) ($20,600 + $30,000) ($17,500 + $40,000)

= = =

÷ ÷ ÷

4.233 5.336 4.870

Closest Discount Factor

Internal Rate of Return

4.23054 5.32825 4.86842

11% 12% 10%

*(Annual income + Depreciation expense) (b) The acceptable projects are 22A and 23A because their rates of return are equal to or greater than the 11% required rate of return.

12-16

EXERCISE 12-8 The annual rate of return is calculated by dividing expected annual income by the average investment. The company’s expected annual income is: $70,000 – $41,500 = $28,500 Its average investment is: $300,000 + $80,000 = $190,000 2 Therefore, its annual rate of return is: $28,500 ÷ $190,000 = 15% EXERCISE 12-9 (a) Cost of hoist: $35,000 + $3,300 + $700 = $39,000. Net annual cash flows: Number of extra mufflers 5 X 52 weeks Contribution margin per muffler ($72 – $36 – $12) Total net annual cash flows (a) X (b) Cash payback period = $39,000 ÷ $6,240 = 6.25 years. (b) Average investment: ($39,000 + $3,000) ÷ 2 = $21,000. Annual depreciation: ($39,000 – $3,000) ÷ 8 = $4,500. Annual net income: $6,240 – $4,500 = $1,740. Annual rate of return = $1,740 ÷ $21,000 = 8.3% (rounded).

12-17

(a) 260 (b) X $24 $6,240

EXERCISE 12-10 (a) 1. 2.

Cash payback period: $190,000 ÷ $50,000 = 3.8 years. Annual rate of return: $12,000 ÷ [($190,000 + $0) ÷ 2] = 12.63%.

(b)

Item

Amount

Years

PV Factor

Present Value

Net annual cash flows Capital investment Net present value

$ 50,000

1–5

3.60478

$180,239)) (190,000) $ (9,761)))

EXERCISE 12-11 (a) Year 1 2 3

Net Annual Cash Flow $45,000 40,000 35,000

Cumulative Net Cash Flow $ 45,000 85,000 120,000

Cash payback period 2.57 years (2 + [($105,000 – $85,000) ÷ $35,000]) (b) Average annual net income = ($10,000 + $12,000 + $14,000 + $16,000 + $18,000) ÷ 5 = $14,000 Average investment = ($105,000 + $0) ÷ 2 = $52,500 Annual rate of return = $14,000 ÷ $52,500 = 26.67% (c) Net cash flows

12-18

Year 1 2 3 4 5

Discount Factor, 12% 0.89286 0.79719 0.71178 0.63552 0.56743

Amount $45,000 40,000 35,000 30,000 25,000

Present Value $ 40,179 31,888 24,912 19,066 14,186

Present value of cash in flows Initial investment

130,231 (105,000)

Net present value

$ 25,231

SOLUTIONS TO PROBLEMS PROBLEM 12-1A

(a) Project Kilo $150,000 ÷ ($14,000 + $30,000) = 3.41 years

Year 1 2 3 4 5

Project Lima Cash Flow $51,000 ($18,000 + $33,000) $50,000 ($17,000 + $33,000) $49,000 ($16,000 + $33,000) $45,000 ($12,000 + $33,000) $42,000 ($ 9,000 + $33,000)

Cumulative Cash Flow $ 51,000 $101,000 $150,000 $195,000 $237,000

Cash payback period 3.33 years $165,000 – $150,000 = $15,000 $15,000 ÷ $45,000 = .33

Year 1 2 3 4 5

Project Oscar Cash Flow $67,000 ($27,000 + $40,000) $63,000 ($23,000 + $40,000) $61,000 ($21,000 + $40,000) $53,000 ($13,000 + $40,000) $52,000 ($12,000 + $40,000)

Cash payback period 3.17 years $200,000 – $191,000 = $9,000 $9,000 ÷ $53,000 = .17

12-19

Cumulative Cash Flow $ 67,000 $130,000 $191,000 $244,000 $296,000

PROBLEM 12-1A (Continued) (b)

Project Kilo Item Net annual cash flows Capital investment Negative net present value Discount Factor .86957 .75614 .65752 .57175 .49718

Year 1 2 3 4 5 Total Capital investment Positive (negative) net present value

Amount $44,000

Years 1–5

PV Factor 3.35216

Present Value $147,495 (150,000) $ (2,505)

Project Lima Cash Flow PV $ 51,000 $ 44,348 50,000 37,807 49,000 32,218 45,000 25,729 42,000 20,882 $237,000 160,984 (165,000)

Project Oscar Cash Flow PV $ 67,000 $ 58,261 63,000 47,637 40,109 61,000 30,303 53,000 25,853 52,000 202,163 $296,000 (200,000)

$ (4,016)

2,163

(c) Project Kilo = $14,000 ÷ [($150,000 + $0) ÷ 2] = 18.67%. Project Lima = $14,400 ÷ [($165,000 + $0) ÷ 2] = 17.5%. Project Oscar = $19,200 ÷ [($200,000 + $0) ÷ 2] = 19.2%. (d) Project Kilo Lima Oscar

Cash Payback 3 2 1

The best project is Oscar.

12-20

Net Present Value 2 3 1

Annual Rate of Return 2 3 1

PROBLEM 12-2A

(a)

Sales Expenses Drivers’ salaries Out-of-pocket expenses Depreciation Total expenses Net income Cash inflow

(1) Annual Net Income *$108,000*

(2) Annual Cash Inflow $108,000

* 48,000* * 30,000* * 25,000* * 103,000* *$ 5,000*

48,000 30,000 0 78,000 $ 30,000

*5 vans X 10 trips X 6 students X 30 weeks X $12.00 = $108,000. (b) 1.

Cash payback period = $75,000 ÷ $30,000* = 2.50 years. *$5,000 + $25,000

Annual rate of return = $5,000 ÷

($75,000 + 0) = 13.33%. 2

(c) Present value of annual cash inflows ($30,000 X 2.28323*) = $68,497 Capital investment = (75,000) Net present value = $ (6,503) *3 years at 15%, PV of annuity of 1. (d) The computations show that the commuter service is not a wise investment for these reasons: (1) annual net income will only be $5,000, (2) the annual rate of return (13.33%) is less than the cost of capital (15%), (3) the cash payback period is 83% (2.5 ÷ 3) of the useful life of the vans, and (4) net present value is negative.

12-21

PROBLEM 12-3A (a) (1) Option A Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value Capital investment Net present value

Cash 8% Discount Present Flows X Factor = Value a$40,000a X 5.20637 = ($208,255) ( (50,000) X .73503 = ( (36,752) ( 0) X .58349 =( 0) ($171,503) ( (160,000) ($ 11,503)

aNet annual cash flows = $70,000 – $30,000 = $40,000

(2) Profitability index = $171,503/$160,000 = 1.07 (3) The internal rate of return can be approximated by finding the discount rate that results in a net present value of approximately zero. This is accomplished with a 10% discount rate.

Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value Capital investment Net present value

Cash 10% Discount Present Flows X Factor = Value a$40,000a X 4.86842 = ($194,737) ( (50,000) X .68301 = ( (34,151) ( 0) X .51316 = ( 0) ($160,586) (160,000) ($ 586

aNet annual cash flows = $70,000 – $30,000 = $40,000

(1) Option B Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value

Cash 8% Discount Flows X Factor b$54,000b X 5.20637 0 X .73503 8,000 X .58349

Capital investment Net present value bNet annual cash flows = $80,000 – $26,000 = $54,000

(2) Profitability index = $285,812/$227,000 = 1.26

12-22

Present = Value = $281,144 = 0 = 4,668 $285,812 (227,000) $ 58,812

PROBLEM 12-3A (Continued) (3) Internal rate of return on Option B is 15%, as calculated below:

Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value Capital investment Net present value

Cash 15% Discount Present Flows X Factor = Value b$54,000b X 4.16042 = $224,663 0 X .57175 = 0 8,000 X .37594 = 3,008 $227,671 (227,000) $ 671

bNet annual cash flows = $80,000 – $26,000 = $54,000

(b) Option A has a lower net present value than Option B, and also a lower profitability index and internal rate of return. Therefore, Option B is the preferred project.

12-23

PROBLEM 12-4A

(a) The net present value based on the original estimates is as follows:

Present value of net annual cash flows Present value of cost of overhaul Present value of salvage value Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $ 8,000 X 5.53482 = ($ 44,279 ( (6,000) X .70843 = ( (4,251) ( 12,000) X .50187 = ( 6,022 ($ 46,050 (60,000) ($(13,950)

Based on its negative net present value, the tow truck should not be purchased. (b) The net present value based on the revised estimates is as follows:

Present value of net annual cash flows Present value of cost of overhaul Present value of salvage value Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $13,500* X 5.53482 = ($74,720) ( (6,000)* X .70843 = ( (4,251) ( 12,000 * X .50187 = ( 6,022) ($76,491) (60,000) ($16,491)

*$8,000 + ($3,000 + $750 + $1,000 + $750) Based on the revised figures, the tow truck has a positive net present value and therefore should be purchased. (c) The present value of the intangible benefits was $30,441 (the increase in the net present value from a negative $13,950 to a positive $16,491). Rick’s estimates of the value of these intangible benefits may be overly optimistic. In order for the project to be acceptable, the present value of the intangible benefits would only have to be $13,950. That is the amount by which the original estimate fell short of having a positive net present value.

12-24

PROBLEM 12-5A

(a) Using the original estimates, the net present value is calculated as follows: Cash 8% Discount Present Flows X Factor = Value a a Present value of net annual cash flows $ 100,000 X 9.81815 = $ 981,815 Present value of salvage value 1,500,000 X .21455 = 321,825 1,303,640 Capital investment ($300,000 + $600,000) (900,000) Net present value $ 403,640 aNet annual cash flows = $940,000 – $840,000

The positive net present value of the project suggests that it should be accepted. (b) Using the revised estimates, the net present value is calculated as follows:

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 8% Discount Present Flows X Factor = Value b$ b 50,000 X 9.81815 = $(490,908) 1,500,000 X .21455 = (321,825) $(812,733) (900,000) $ (87,267)

bNet annual cash flows = $800,000 – $750,000

Under these revised estimates, the project should be rejected. It appears that many of the camp’s costs are fixed; thus, when the number of players declines, cash inflows decline, but cash outflows don’t decline proportionately.

12-25

PROBLEM 12-5A (Continued) (c) Using the original estimates, but an 11% discount rate, the net present value is calculated as follows:

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 11% Discount Present Flows X Factor = Value c$ X 7.96333 = $ 796,333 c 100,000 X .12403 = 186,045 1,500,000 $ 982,378 (900,000) $ 82,378

cNet annual cash flows = $940,000 – $840,000

The positive net present value of the project suggests that it should be accepted; however, it is not nearly as profitable using an 11% discount rate. (d) The internal rate of return can be determined by calculating the discount rate that results in a net present value of approximately zero. In this case the internal rate of return was approximately 12%.

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 12% Discount Present Flows X Factor = Value $ 40,000 X 3.60478 = $144,191 1,332,000 X .56743 = 755,817 $900,008 (900,000) $ 8

The project had a high internal rate of return, even though the business itself was not generating much cash flows, because the property increased significantly in value during the 5-year period.

12-26

PROBLEM 12-1B

(a) Project Mary $140,000 ÷ [($10,000 + $28,000)] = 3.68 years Project Winnie Cash Flow Cumulative Cash Flow $47,500 ($12,500 + $35,000) $ 47,500 $47,000 ($12,000 + $35,000) $ 94,500 $46,000 ($11,000 + $35,000) $140,500 $43,000 ($ 8,000 + $35,000) $183,500 $41,000 ($ 6,000 + $35,000) $224,500

Cash payback period 3.80 years $175,000 – $140,500 = $34,500 $34,500 ÷ $43,000 = .80

Year 1 2 3 4 5

Project Sarah Cash Flow $57,000 ($19,000 + $38,000) $54,000 ($16,000 + $38,000) $52,000 ($14,000 + $38,000) $47,000 ($ 9,000 + $38,000) $46,000 ($ 8,000 + $38,000)

Cash payback period 3.57 years $190,000 – $163,000 = $27,000 $27,000 ÷ $47,000 = .57

12-27

Cumulative Cash Flow $ 57,000 $111,000 $163,000 $210,000 $256,000

PROBLEM 12-1B (Continued) (b)

Project Mary Item Net annual cash flows Capital investment Negative net present value Discount Factor .89286 .79719 .71178 .63552 .56743

Year 1 2 3 4 5 Total Capital investment Positive (negative) net present value (c) Project Mary Project Winnie Project Sarah

Amount $38,000

PV Factor 3.60478

$ (3,018) Project Winnie Cash Flow PV $ 47,500 $ 42,411 47,000 37,468 46,000 32,742 43,000 27,327 41,000 23,265 $224,500 163,213 (175,000)

Project Sarah Cash Flow PV $ 57,000 $ 50,893 54,000 43,048 52,000 37,013 47,000 29,869 46,000 26,102 $256,000 186,925 (190,000)

$ (11,787)

$ (3,075)

= $10,000 ÷ [($140,000 + $0) ÷ 2] = 14.29%. = $ 9,900 ÷ [($175,000 + $0) ÷ 2] = 11.31%. = $13,200 ÷ [($190,000 + $0) ÷ 2] = 13.89%.

(d) Project Mary Winnie Sarah

Years 1–5

Present Value $136,982 (140,000)

Cash Payback 2 3 1

Net Present Value 1 3 2

Annual Rate of Return 1 3 2

The best project is Mary, but even Mary should not be recommended, because the net present value is negative.

12-28

PROBLEM 12-2B

(a)

Sales Expenses Drivers’ salaries Out-of-pocket expenses Depreciation Total expenses Net income Cash inflow

(1) Annual Net Income *$144,000*

(2) Annual Cash Inflow $144,000

43,000 * 42,000*** * 30,000 * 115,000 $ 29,000

43,000 42,000 0 85,000 $ 59,000

*5 vans X 10 trips X 6 students X 32 weeks X $15.00 = $144,000. **$26,000 + $4,000 + $5,300 + $4,500 + $2,200 = $42,000 (b) 1. 2.

Cash payback period = $90,000 ÷ $59,000 = 1.53 years. Annual rate of return = $29,000 ÷

($90,000 + 0) 2

= 64.44%.

(c) Present value of annual cash inflows ($59,000 X 2.28323*) = $134,711 Capital investment = (90,000) Net present value = $ 44,711 *3 years at 15%, PV of ordinary annuity. (d) The computations show that the commuter service is a good investment for these reasons: (1) annual net income will be $29,000, (2) the annual rate of return is 64.44%, (3) the cash payback period is 51% (1.53 ÷ 3) of the useful life of the vans, and (4) net present value is positive.

12-29

PROBLEM 12-3B

(a) (1) Option A Present value of net annual cash inflows Present value of cost to rebuild Present value of salvage value

Cash Flows a $32,000a ( (53,000) ( 0)

X X X X

Capital investment Net present value

11% Discount Present Factor = Value 4.23054 = ($135,377) .73119 = ( (38,753) .53464 = ( 0) ( 96,624) (100,000) ($ (3,376)

aNet annual cash inflows = $56,000 – $24,000 = $32,000

(2) Profitability index = $96,624/$100,000 = .97 (3) The internal rate of return can be approximated by finding the discount rate that results in a net present value of approximately zero. This is accomplished with a 10% discount rate.

Present value of net annual cash inflows Present value of cost to rebuild Present value of salvage value

Cash Flows a $32,000a ( (53,000) ( 0)

X X X X

Capital investment Net present value

10% Discount Present Factor = Value 4.35526 = ($139,368) .75132 = ( (39,820) .56447 = ( 0) ( 99,548) (100,000) $ (452)

aNet annual cash inflows = $56,000 – $24,000 = $32,000

(1) Option B Present value of net annual cash inflows Present value of cost to rebuild Present value of salvage value

Cash Flows b $36,000b 0 24,000

X X X X

Capital investment Net present value bNet annual cash inflows = $60,000 – $24,000 = $36,000

(2) Profitability index = $165,130/$160,000 = 1.03

12-30

11% Discount Factor 4.23054 .73119 .53464

= = = =

Present Value $152,299 0 12,831 165,130 (160,000) $ 5,130

PROBLEM 12-3B (Continued) (3) Internal rate of return on Option B is 12%, as calculated below:

Present value of net annual cash inflows Present value of cost to rebuild Present value of salvage value Capital investment Net present value

Cash 12% Discount Present Flows X Factor = Value b b $36,000 X 4.11141 = $148,011 0 X .71178 = 0 24,000 X .50663 = 12,159 160,170 (160,000) $ 170

bNet annual cash inflows = $60,000 – $24,000 = $36,000

(b) Option A has a lower net present value than Option B, and also a lower profitability index and internal rate of return. Therefore, Option B is the preferred project. Option A is unacceptable due to its negative NPV.

12-31

PROBLEM 12-4B

(a) The net present value based on the original estimates is as follows:

Present value of net annual cash inflows Present value of cost of overhaul Present value of salvage value

Cash 10% Discount Flows X Factor $ 9,600 X 5.33493 ( (7,000) X .68301 16,000 X .46651

Capital investment Net present value

Present = Value = ($ 51,215 = ( (4,781) = ( 7,464 (53,898 (65,000) ($(11,102)

Based on its negative net present value, the tow truck should not be purchased. (b) The net present value based on the revised estimates is as follows:

Present value of net annual cash inflows Present value of cost of overhaul Present value of salvage value Capital investment Net present value

Cash 10% Discount Present Flows X Factor = Value $14,500* X 5.33493 = ($77,356) (7,000)* X .68301 = ( (4,781) 16,000 * X .46651 = ( 7,464) (80,039) (65,000) ($15,039)

*$9,600 + ($2,600 + $600 + $1,200 + $500) Based on the revised figures, the tow truck has a positive net present value and therefore should be purchased. (c) The present value of the intangible benefits was $26,141 (the increase in the net present value from a negative $11,102 to a positive $15,039). Brad’s estimates of the value of these intangible benefits may be overly optimistic. In order for the project to be acceptable, the present value of the intangible benefits would only have to be $11,102. That is the amount by which the original estimate fell short of having a positive net present value.

12-32

PROBLEM 12-5B

(a) Using the original estimates, the net present value is calculated as follows:

Present value of net annual cash inflows Present value of salvage value Capital investment ($200,000 + $350,000) Net present value

Cash 12% Discount Present Flows X Factor = Value a a $130,000 X 7.46944 = $ 971,027 700,000 X .10367 = 72,569 1,043,596 (550,000) $ 493,596

aNet annual cash inflows = $700,000 – $570,000

The positive net present value of the project suggests that it should be accepted. (b) Using the revised estimates, the net present value is calculated as follows:

Present value of net annual cash inflows Present value of salvage value Capital investment Net present value

Cash 12% Discount Present Flows X Factor = Value b b $ 62,000 X 7.46944 = $463,105 700,000 X .10367 = 72,569 535,674 (550,000) $ (14,326)

bNet annual cash inflows = $570,000 – $508,000

Under these revised estimates, the project should be rejected. It appears that many of the camp’s costs are fixed; thus, when the number of campers declines, cash inflows decline, but cash outflows don’t decline proportionately.

12-33

PROBLEM 12-5B (Continued) (c) Using the original estimates, but a 15% discount rate, the net present value is calculated as follows:

Present value of net annual cash inflows Present value of salvage value

Cash 15% Discount Flows X Factor = c c $130,000 X 6.25933 = 700,000 X .06110 =

Capital investment Net present value

Present Value $813,713 42,770 856,483 (550,000) $306,483

cNet annual cash inflows = $700,000 – $570,000

The positive net present value of the project suggests that it should be accepted; however, it is not nearly as profitable using a 15% discount rate. (d) The internal rate of return can be determined by calculating the discount rate that results in a net present value of approximately zero. In this case the internal rate of return was approximately 15%.

Present value of net annual cash inflows Present value of salvage value Capital investment Net present value

Cash Flows $ 65,000 668,000

X X X

15% Discount Present Factor = Value 3.35216 = $217,890 .49718 = 332,116 550,006 (550,000) $ 6

The project had a high internal rate of return, even though the business itself was not generating much cash flows, because the property increased significantly in value during the 5-year period.

12-34

BYP 12-1

DECISION-MAKING AT CURRENT DESIGNS

(a) Average investment = ($256,000 + 0) ÷ 2 = $128,000 Annual rate of return = $15,200 ÷ $128,000 = 11.88% (b) Net annual cash flow = $15,200 + $32,000 = $47,200 Payback period = $256,000 ÷ $47,200 = 5.42 years (c) Event Net annual cash flow Oven purchase Net present value

Time Period 1-8 0

Cash 9% Discount Present Flows Factor Value $ 47,200 5.53482 $ 261,244 (256,000) 1.00000 (256,000) $ 5,244

Time Period 1-8 0

Cash 15% Discount Present Flows Factor Value $ 47,200 4.48732 $ 211,802 (256,000) 1.00000 (256,000) $ (44,198)

Accept the proposal (d) Event Net annual cash flow Oven purchase Net present value

Do not accept the proposal

12-35

BYP 12-2

DECISION-MAKING ACROSS THE ORGANIZATION

Sales Costs and expenses Cost of goods sold Selling expenses Administrative expenses Depreciation Loss on disposal of machine Total costs and expenses Net income (1) (2) (3) (4) (5) (6)

Purchase New Machine $5,000,000 (1) $3,500,000 704,000 448,000 130,000 40,000

(2) (3) (4) (5) (6) 4,822,000 $ 178,000

10,000 X $100 X 4 years = $4,000,000 X 125% = $5,000,000 $5,000,000 X (100% – 30%) = $3,500,000 $160,000 X 110% X 4 years = $704,000 $112,000 X 4 years = $448,000 $122,000 + $3,000 + $5,000 = $130,000 Assuming old machine has zero scrap value

(a) Annual rate of return = 68.5%; ($178,000 ÷ 4) ÷ [($130,000 + $0) ÷ 2] (b) Cash payback period = 1.49 yrs.; $130,000 ÷ [($178,000 + $130,000 + $40,000) ÷ 4] (c) Net present value = Net annual cash flows Capital investment Net present value

Amount $ 87,000 * $130,000

Factor 2.85498 1.00000

Present Value $248,383 (130,000) $118,383

*($178,000 + $130,000 + $40,000) ÷ 4 (d) The new machine should be purchased. The analysis shows that net income will be $178,000 over the four years with the new machine, which results in a 68.5% annual rate of return. The cash payback period of 1.49 years meets management’s minimum requirement of three years. In addition, net present value is $118,383 positive, which indicates that the investment meets the required minimum rate of return of 15%.

12-36

BYP 12-3

MANAGERIAL ANALYSIS

(a) Using the original estimates, the present value is calculated as follows:

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 11% Discount Present Flows X Factor = Value a $ 460,000 X 7.19087 = ($3,307,800) 2,000,000 X .20900 = ( 418,000) (3,725,800 (4,000,000) ($ (274,200)

aNet annual cash flows = $4,000,000 – $3,540,000

The negative net present value of the project suggests that it should be rejected. (b) Using the revised estimates, the net present value is calculated as follows: Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 11% Discount Present Flows X Factor = Value b$ 720,000b X 7.19087 = $5,177,426 2,000,000 X .20900 = 418,000 5,595,426 (4,000,000) $1,595,426

bNet annual cash flows = $4,200,000 – $3,480,000

Under these revised estimates, the project should be accepted.

12-37

BYP 12-3 (Continued) (c) Using the original estimates, but a 9% discount rate, the net present value is calculated as follows:

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value c c $ 460,000 X 8.06069 = $3,707,917 2,000,000 X .27454 = 549,080 $4,256,997 (4,000,000) $ 256,997

Net annual cash flows = $4,000,000 – $3,540,000

Using the original estimates, but the lower discount rate, the net present value is positive, suggesting the project should be accepted. (d) If Bob is correct in either his belief that the estimated net annual cash flows are too conservative, or that the discount rate being used is too high, then the project is acceptable. At a minimum, this analysis suggests that further investigation is warranted.

12-38

BYP 12-4

REAL-WORLD FOCUS

This disclosure, provided by the company’s management in its annual report, suggests that the scroll compressor project has not achieved the goals originally hoped for. In deciding whether to continue with this project, management should undertake a post-audit. This would involve collecting data on results obtained thus far and comparing those results with original projections. Those people responsible for the original projections should then be asked to provide explanations for differences between the results and projections. Careful consideration of the nature of these differences and their implications for future performance should provide valuable information regarding the decision to continue or terminate the project.

12-39

BYP 12-5

REAL-WORLD FOCUS

Answers to this problem will vary depending on the year chosen by the student. The following solution is provided for the year ended August 1, 2010. (a) The statement of cash flows indicates that capital expenditures (purchase of plant assets) were $315 million in 2010, a decrease of $36 million from the prior year. (b) The statement of cash flows indicates $400 million of long-term borrowings were made in 2010. Note 13 indicates that interest rates on existing long-term borrowing ranged from 3.05% to 8.88% during the year. (c) The internal rate of return on these capital expenditures is approximately 7%, computed as follows: $315 million ÷ $42 million = 7.5 Note that the factor for n = 10, i = 6% is 7.36009. (Table A-4, n = 10, i = 6%) and the factor for 5% is 7.72173. 7.5 is approximately halfway between 7.36009 and 7.72173, so the IRR is estimated to be 5.5%.

12-40

BYP 12-6

To: From: Subject:

COMMUNICATION ACTIVITY

Maria Fierro, Supervisor , Assistant Chief Accountant Recommendation for New Hoist

The quantitative analysis pertaining to this management decision is as follows: Cost of hoist: $35,000 + $3,300 + $700 = $39,000. Net annual cash flows: Number of extra mufflers 5 X 52 weeks Contribution margin per muffler ($72 – $36 – $12) Total net annual cash flows (a) X (b) Cash payback period = $39,000 ÷ $6,240 = 6.25 years.

(a) 260 (b) X $24 $6,240

Average investment: ($39,000 + $3,000) ÷ 2 = $21,000. Annual depreciation: ($39,000 – $3,000) ÷ 8 = $4,500. Annual net income: $6,240 – $4,500 = $1,740. Annual rate of return = $1,740 ÷ $21,000 = 8.3% (rounded). These data indicate that the cash payback period is 78% of the new asset’s useful life. This would generally be considered fairly high, indicating a less desirable project. The data also show a 8.3% annual rate of return. This is a low return and it is below what management would consider an acceptable return. The quantitative data do not include any technique that considers the time value of money. However, I believe there is a strong probability that the discounted cash flow technique would show a negative net present value for the new hoist. I believe that the information I have presented would indicate that, based on the current data, the investment should not be made.

12-41

BYP 12-7

ETHICS CASE

(a) The stakeholders are: • • • • •

Yourself. Your spouse and children. Employees of NuComp Company. Citizens of the town where the company is presently located. The stockholders of NuComp Company.

(b) The ethical issue is: • An employee’s personal interests and those of his co-workers and the town versus the best interests of the company and its stockholders. (c) The student should recognize a conflict of interest. The company should hire an outside consultant to study and evaluate such a move rather than place one of its employees in this dilemma. You should rise above the conflict of interest and perform an objective economic evaluation, but also be prepared to remind management, should they be so oblivious, of the consequences to the employees and the town. Knowingly preparing a biased or false report is unethical.

12-42

BYP 12-8

ALL ABOUT YOU

Results will vary depending on article selected by the student. Some common signals identified in articles are: bills more than two months in arrears; must make decisions about who to pay; you have a debt judgment filed against you; spending exceeds income; all credit cards are at their maximum.

12-43

BYP 12-9

YOUR COSTS AND BENEFITS

(a) The total cost of the installed solar panels was $80,000. The “out-ofpocket” cost to the couple was $27,000. (b) Using the total annual electricity bill of $5,000 mentioned in the story, the cash payback of the project using the total costs of $80,000 is 16 years ($80,000 ÷ $5,000). The cash payback based on the “out-of-pocket” cost of $27,000 is 5.4 years ($27,000 ÷ $5,000). (c) The net present value of the project using the total cost is: Cash X 6% Discount = Flows Factor Present value of net annual cash flows Capital investment Net present value

$5,000 X

11.46992

Present Value

= $ 57,350 (80,000) $(22,650)

The net present value of the project using the out-of-pocket cost is:

Present value of net annual cash flows Capital investment Net present value

Cash X 6% Discount = Flows Factor

Present Value

$5,000 X

$57,350 (27,000) $30,350

11.46992

(d) The wholesale price of panels per watt at the time the article was written was $1.70 per watt. The price per watt the article says that subsidies no longer would be needed is $1.00. One solar panel provider said that it would be providing panels that cost $1.00 per watt within three years of the time the article was written.

12-44

CHAPTER 13 Statement of Cash Flows ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Do It!

Exercises

A Problems

B Problems

Learning Objectives

Questions

*1.

Indicate the usefulness of the statement of cash flows.

1, 2, 6, 15

*2.

Distinguish among operating, investing, and financing activities.

3, 4, 5, 6, 7, 8, 9, 16, 22

1, 2, 3

*3.

Prepare a statement of cash flows using the indirect method.

10, 11, 12, 13, 14

4, 5, 6, 7

4, 5, 6, 7, 8, 9

2A, 3A, 5A, 7A, 9A, 11A

2B, 3B, 5B, 7B, 9B, 11B

*4.

Analyze the statement of cash flows.

8, 9, 10, 11

7, 9

7A, 8A

7B, 8B

*5.

Explain how to use a worksheet to prepare the statement of cash flows using the indirect method.

12A

*6.

Prepare a statement of cash flows using the direct method.

8, 18, 19, 20, 21

13, 14, 15

11, 12, 13, 14

4A, 6A, 8A, 10A

4B, 6B, 8B, 10B

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix*to the chapter.

13-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Distinguish among operating, investing, and financing activities.

Simple

10–15

Determine cash flow effects of changes in equity accounts.

Simple

10–15

Prepare the operating activities section—indirect method.

Simple

20–30

*4A

Prepare the operating activities section—direct method.

Simple

20–30

Prepare the operating activities section—indirect method.

Simple

20–30

*6A

Prepare the operating activities section—direct method.

Simple

20–30

Prepare a statement of cash flows—indirect method, and compute free cash flow.

Moderate

40–50

*8A

Prepare a statement of cash flows—direct method, and compute free cash flow.

Moderate

40–50

Prepare a statement of cash flows—indirect method.

Moderate

40–50

*10A

Prepare a statement of cash flows—direct method.

Moderate

40–50

11A

Prepare a statement of cash flows—indirect method.

Moderate

40–50

*12A

Prepare a worksheet—indirect method.

Moderate

40–50

Distinguish among operating, investing, and financing activities.

Simple

10–15

Determine cash flow effects of changes in plant asset accounts.

Simple

10–15

Prepare the operating activities section—indirect method.

Simple

20–30

*4B

Prepare the operating activities section—direct method.

Simple

20–30

Prepare the operating activities section—indirect method.

Simple

20–30

*6B

Prepare the operating activities section—direct method.

Simple

20–30

Prepare a statement of cash flows—indirect method, and compute free cash flow.

Moderate

40–50

13-2

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

*8B

Prepare a statement of cash flows—direct method, and compute free cash flow.

Moderate

40–50

Prepare a statement of cash flows—indirect method.

Moderate

40–50

*10B

Prepare a statement of cash flows—direct method.

Moderate

40–50

11B

Prepare a statement of cash flows—indirect method.

Moderate

40–50

13-3

Learning Objective

Knowledge Comprehension

Application

Analysis

Indicate the usefulness of the statement of cash flows.

Q13-6

Q13-1 Q13-2

Q13-15

Distinguish among operating, investing, and financing activities.

Q13-4 Q13-6 Q13-22 BE13-1

Q13-3 Q13-5 Q13-7 Q13-8 Q13-9 Q13-16

BE13-2 BE13-3 DI13-1 E13-2 E13-1 E13-3 E13-2 P13-1A P13-1B

Prepare a statement of cash flows using the indirect method.

Q13-13

Q13-10 Q13-11 Q13-12 Q13-14

BE13-4 BE13-5 BE13-6 DI13-2 E13-4 E13-5 E13-7

E13-8 P13-3B BE13-7 E13-9 P13-5B E13-6 P13-3A P13-7B P13-2A P13-5A P13-9B P13-2B P13-7A P13-11B P13-7A P13-7B P13-9A P13-11A

Analyze the statement of cash flows.

E13-7 E13-9 P13-7A P13-8A P13-7B

P13-8B BE13-8 BE13-9 BE13-10 BE13-11 DI13-3

Explain how to use a worksheet to prepare the statement of cash flows using the indirect method.

*6.

Prepare a statement of cash flows using the direct method.

Broadening Your Perspective

Q13-18

Q13-17

BE13-12 E13-10 P13-12A

Q13-8 Q13-20 Q13-21

Q13-19 E13-13 P13-4B P13-8A BE13-13 E13-14 P13-6B P13-8B BE13-14 P13-4A P13-8B BE13-15 P13-6A P13-10B E13-11 P13-8A E13-12 P13-10A

BYP13-3 BYP13-4

BYP13-5 BYP13-6 BYP13-9

BYP13-1

Synthesis

Evaluation

P13-7A P13-8A P13-7B P13-8B

BYP13-2 BYP13-7 BYP13-8

BLOOM’ S TAXONOMY TABLE

13-4 Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activities of a company during a period. (b) Disagree. The statement of cash flows is required. It is the fourth basic financial statement.

The statement of cash flows answers the following questions about cash: (a) Where did the cash come from during the period? (b) What was the cash used for during the period? and (c) What was the change in the cash balance during the period?

The three types of activities are: Operating activities include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. Investing activities include: (a) acquiring and disposing of investments and property, plant and equipment and (b) lending money and collecting loans. Financing activities include: (a) obtaining cash from issuing debt and repaying amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.

(a) Major inflows of cash in a statement of cash flows include cash from operations; issuance of debt; collection of loans; issuance of capital stock; sale of investments; and the sale of property, plant, and equipment. (b) Major outflows of cash include purchase of inventory, payment of wages and other operating expenses, payment of cash dividends; redemption of debt; purchase of investments; making loans; redemption of capital stock; and the purchase of property, plant, and equipment.

The statement of cash flows presents investing and financing activities so that even noncash transactions of an investing and financing nature are disclosed in the financial statements. If they affect financial conditions significantly, the FASB requires that they be disclosed in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements.

Examples of significant noncash activities are: (1) issuance of stock for assets, (2) conversion of bonds into common stock, (3) issuance of bonds or notes for assets, and (4) noncash exchanges of property, plant, and equipment.

Comparative balance sheets, a current income statement, and certain transaction data all provide information necessary for preparation of the statement of cash flows. Comparative balance sheets indicate how assets, liabilities, and equities have changed during the period. A current income statement provides information about the amount of cash provided or used by operations. Certain transactions provide additional detailed information needed to determine how cash was provided or used during the period.

The advantage of the direct method is that it presents the major categories of cash receipts and cash payments in a format that is similar to the income statement and familiar to statement users. Its principal disadvantage is that the necessary data can be expensive and time-consuming to accumulate. The advantage of the indirect method is it is often considered easier to prepare, and it focuses on the differences between net income and net cash provided by operating activities. It also tends to reveal less company information to competitors. Its primary disadvantage is the difficulty in understanding the adjustments that comprise the reconciliation. Both methods are acceptable but the FASB expressed a preference for the direct method. Yet, the indirect method is the overwhelming favorite of companies.

13-5

Questions Chapter 13 (Continued) 9. When total cash inflows exceed total cash outflows, the excess is identified as a “net increase in cash” near the bottom of the statement of cash flows. 10. The indirect method involves converting accrual net income to net cash provided by operating activities. This is done by starting with accrual net income and adding or subtracting noncash items included in net income. Examples of adjustments include depreciation and other noncash expenses, gains and losses on the sale of noncurrent assets, and changes in the balances of current asset and current liability accounts from one period to the next. 11. It is necessary to convert accrual-based net income to cash-basis income because the unadjusted net income includes items that do not provide or use cash. An example would be an increase in accounts receivable. If accounts receivable increased during the period, revenues reported on the accrual basis would be higher than the actual cash revenues received. Thus, accrual-basis net income must be adjusted to reflect the net cash provided by operating activities. 12. A number of factors could have caused an increase in cash despite the net loss. These are (1) high cash revenues relative to low cash expenses; (2) sales of property, plant, and equipment; (3) sales of investments; (4) issuance of debt or capital stock, and (5) differences between cash and accrual accounting, e.g. depreciation. 13. Depreciation expense. Gain or loss on sale of a noncurrent asset. Increase/decrease in accounts receivable. Increase/decrease in inventory. Increase/decrease in accounts payable. 14. Under the indirect method, depreciation is added back to net income to reconcile net income to net cash provided by operating activities because depreciation is an expense but not a cash payment. 15. The statement of cash flows is useful because it provides information to the investors, creditors, and other users about: (1) the company’s ability to generate future cash flows, (2) the company’s ability to pay dividends and meet obligations, (3) the reasons for the difference between net income and net cash provided by operating activities, and (4) the cash investing and financing transactions during the period. 16. This transaction is reported in the note or schedule entitled “Noncash investing and financing activities” as follows: “Issuance of common stock for land, $1,700,000.” *17. A worksheet is desirable because it allows the accumulation and classification of data that will appear on the statement of cash flows. It is an optional but efficient device that aids in the preparation of the statement of cash flows. *18. Net cash provided by operating activities under the direct approach is the difference between cash revenues and cash expenses. The direct approach adjusts the revenues and expenses directly to reflect the cash basis. This results in cash net income, which is equal to “net cash provided by operating activities.”

13-6

Questions Chapter 13 (Continued) *19. (a) Cash receipts from customers = Revenues from sales

(b) Purchases = Cost of goods sold

+ Decrease in accounts receivable – Increase in accounts receivable

+ Increase in inventory – Decrease in inventory

Cash payments to suppliers = Purchases

+ Decrease in accounts payable – Increase in accounts payable

*20. Sales ..................................................................................................................... Add: Decrease in accounts receivable .................................................................. Cash receipts from customers ...............................................................................

$2,000,000 200,000 $2,200,000

*21. Depreciation expense is not listed in the direct method operating activities section because it is not a cash flow item—it does not affect cash. 22. In its 2010 statement of cash flows, PepsiCo reported (a) $8,448 million net cash provided by operating activities, (b) $7,668 million used for investing activities, and (c) $1,386 million provided by financing activities.

13-7

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 (a) (b) (c) (d)

Cash inflow from financing activity, $150,000. Cash outflow from investing activity, $200,000. Cash inflow from investing activity, $50,000. Cash outflow from financing activity, $20,000.

BRIEF EXERCISE 13-2 (a) Investing activity. (b) Investing activity. (c) Financing activity.

(d) Operating activity. (e) Financing activity. (f) Financing activity.

BRIEF EXERCISE 13-3 Cash flows from financing activities Proceeds from issuance of bonds payable ....................... Payment of dividends .......................................................... Net cash provided by financing activities ..................

$ 500,000) (60,000) $ 440,000)

BRIEF EXERCISE 13-4 Net income .......................................................... $2,000,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ................................ $160,000 Accounts payable increase ....................... 280,000 Accounts receivable increase ................... (350,000) 90,000 Net cash provided by operating activities ........................................... $2,090,000

13-8

BRIEF EXERCISE 13-5 Cash flows from operating activities Net income ............................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ................................... Gain on disposal of plant assets ................. Net cash provided by operating activities ..............................................

$250,000 $ 70,000 (12,000)

58,000 $308,000

BRIEF EXERCISE 13-6 Net income .................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Decrease in prepaid expenses............................. Decrease in inventory .......................................... Increase in accounts receivable .......................... Net cash provided by operating activities .....

$250,000 $ 28,000 30,000 (80,000)

(22,000) $228,000

BRIEF EXERCISE 13-7 Original cost of equipment sold .................................. Less: Accumulated depreciation ............................... Book value of equipment sold .................................... Less: Loss on disposal of plant assets ..................... Cash received from sale of equipment .......................

$ 22,000 8,500 13,500 6,500 $ 7,000

BRIEF EXERCISE 13-8 Free cash flow = $155,397,000 – $130,820,000 – $0 = $24,577,000 BRIEF EXERCISE 13-9 Free cash flow = $450,000 – $250,000 – $0 = $200,000 BRIEF EXERCISE 13-10 Free cash flow = $45,000,000 – $1,400,000 = $43,600,000

13-9

BRIEF EXERCISE 13-11 Free cash flow is cash provided by operations less capital expenditures and cash dividends paid. For Russel Inc. this would be $283,000 ($643,000 – $280,000 – $80,000). Since it has positive free cash flow that far exceeds its dividend, an increase in the dividend might be possible. However, other factors should be considered. For example, it must have adequate retained earnings, and it should be convinced that a larger dividend can be sustained over future years. It could also use the free cash flow to expand its operations or pay down its debt. *BRIEF EXERCISE 13-12 Reconciling Items

Balance Sheet Accounts

Balance 1/1/14

Credit

Balance 12/31/14

Prepaid expenses Accrued expenses payable

18,600 8,200

(a) 6,500 (b) 2,000

12,100 10,200

Debit

Statement of Cash Flow Effects Operating activities Decrease in prepaid expenses Increase in accrued expenses payable

(a) 6,500 (b) 2,000 8,500

8,500

*BRIEF EXERCISE 13-13 Receipts from Sales = customers revenues

+ Decrease in accounts receivable – Increase in accounts receivable

$1,022,679,000 = $1,085,307,000 – $62,628,000 (Increase in accounts receivable)

13-10

*BRIEF EXERCISE 13-14 + Decrease in income taxes payable

Cash payment Income tax = for income taxes expense

– Increase in income taxes payable

$112,000,000 = $360,000,000 – $248,000,000* *$525,000,000 – $277,000,000 = $248,000,000 (Increase in income taxes payable) *BRIEF EXERCISE 13-15

Cash Operating payments for expenses, = operating excluding expenses depreciation

+ Increase in prepaid expenses – Decrease in prepaid expenses and + Decrease in accrued expenses payable – Increase in accrued expenses payable

$58,700 = $70,000 – $6,800 – $4,500 SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 13-1 1. 2. 3. 4. 5.

Financing activity Operating activity Financing activity Investing activity Investing activity

13-11

DO IT! 13-2 Cash flows from operating activities Net income ............................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................... Amortization expense .................................... Gain on disposal of plant assets................... Decrease in accounts receivable .................. Increase in accounts payable ........................ Net cash provided by operating activities .................................................

$100,000 $4,000 3,000 (3,900) 6,000 3,200

12,300 $112,300

DO IT! 13-3 (a) Free cash flow = $72,400 – $26,000 – $18,000 = $28,400 (b) Cash provided by operating activities fails to take into account that a company must invest in new plant assets just to maintain the current level of operations. Companies must also maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company’s cash-generating ability.

13-12

SOLUTIONS TO EXERCISES EXERCISE 13-1 (a) (b) (c) (d) (e) (f) (g)

Financing activities. Noncash investing and financing activities. Noncash investing and financing activities. Financing activities. Investing activities. Operating activities. Operating activities.

EXERCISE 13-2 (a) Operating activity. (b) Noncash investing and financing activity. (c) Investing activity. (d) Financing activity. (e) Operating activity. (f) Operating activity. (g) Operating activity. (h) Financing activity.

(i) Operating activity. (j) Noncash investing and financing activity. (k) Investing activity. (l) Noncash investing and financing activity. (m) Operating activity (loss); investing activity (cash proceeds from sale). (n) Financing activity.

EXERCISE 13-3 1. (a) Cash ........................................................... Loss on Disposal of Plant Assets ........... Land ...................................................

10,000 2,000 12,000

(b) The cash receipt ($10,000) is reported in the investing section. The loss ($2,000) is added to net income in the operating section. 2. (a) Cash ........................................................... Common Stock ..................................

22,000 22,000

(b) The cash receipt ($22,000) is reported in the financing section. 3. (a) Depreciation Expense .............................. Accumulated Depreciation— Buildings .........................................

14,000 14,000

(b) Depreciation expense ($14,000) is added to net income in the operating section. .

13-13

EXERCISE 13-3 (Continued) 4. (a) Salaries and Wages Expense ............................... Cash ................................................................

7,000 7,000

(b) Salaries and wages expense is not reported separately on the statement of cash flows. It is part of the computation of net income in the income statement, and is included in the net income amount on the statement of cash flows. 5. (a) Equipment .............................................................. Common Stock .............................................. Paid-in Capital in Excess of Par— Common Stock ..........................................

9,000 1,000 8,000

(b) The issuance of common stock for equipment ($9,000) is reported as a noncash financing and investing activity at the bottom of the statement of cash flows. 6. (a) Cash ....................................................................... Accumulated Depreciation—Equipment .............. Equipment ...................................................... Gain on Disposal of Plant Assets .................

3,200 8,000 10,000 1,200

(b) The cash receipt ($3,200) is reported in the investing section. The gain ($1,200) is deducted from net income in the operating section. EXERCISE 13-4 BRACEWELL COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ................................................................. $195,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ........................................ $40,000 Gain on disposal of plant assets....................... (5,000) Increase in accounts payable ............................ 17,000 Increase in accounts receivable........................ (15,000) Decrease in prepaid expenses .......................... 4,000 41,000 Net cash provided by operating activities ... $236,000 13-14

EXERCISE 13-5 NASREEN INC. Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income .......................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ................................. Decrease in inventory ................................. Increase in accrued expenses payable ..... Increase in prepaid expenses .................... Decrease in accounts payable ................... Increase in accounts receivable ................ Net cash provided by operating activities .............................................

13-15

$153,000 $ 24,000) 14,000) 6,000) (2,000) (10,000) (31,000)

1,000 $154,000

EXERCISE 13-6 CHAUDRY CORP Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .............................. Loss on disposal of plant assets ............ Net cash provided by operating activities ......................................... Cash flows from investing activities Sale of plant assets ......................................... Construction of equipment ............................. Purchase of equipment ................................... Net cash used by investing activities .....

$ 67,000)

$ 23,000) 5,000)

95,000) 16,000* (53,000) (70,000) (107,000)

Cash flows from financing activities Payment of cash dividends ............................. *Cost of equipment sold .................................. *Accumulated depreciation ............................. *Book value ...................................................... *Loss on disposal of plant assets .................. *Cash proceeds ................................................

13-16

28,000)

(17,000) $ 49,000) (28,000) 21,000) (5,000) $ 16,000)

EXERCISE 13-7 (a)

MEERA CORPORATION Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income .......................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ................................. Loss on sale of land .................................... Decrease in accounts receivable ............... Decrease in accounts payable ................... Net cash provided by operating activities ............................................

$ 22,630) $ 5,000 ) 1,000 2,600 (15,730 )

15,500

Cash flows from investing activities Sale of land ......................................................... Cash flows from financing activities Issuance of common stock................................ Payment of dividends ........................................ Net cash used by financing activities ......... Net increase in cash ................................................. Cash at beginning of period ..................................... Cash at end of period ............................................... (b) $15,500 – $0 – $19,500 = ($4,000)

13-17

(7,130)

5,000 $ 3,000 (19,500 ) (16,500) 4,000 10,700 $ 14,700

EXERCISE 13-8 SYAL COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income .................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ......................... Decrease in inventory......................... Decrease in accounts payable ........... Increase in accounts receivable ........ Net cash provided by operating activities .................................... Cash flows from investing activities Sale of land ................................................. Purchase of equipment .............................. Net cash used by investing activities .......................................... Cash flows from financing activities Issuance of common stock ....................... Payment of cash dividends ....................... Redemption of bonds ................................ Net cash used by financing activities .......................................... Net increase in cash .......................................... Cash at beginning of period .............................. Cash at end of period ........................................

13-18

$103,000)

$32,000) 17,000) (12,000) (14,000)

) 23,000 126,000)

27,000) (60,000) (33,000) 42,000) (45,000) (50,000) (53,000) 40,000) 33,000) $ 73,000)

EXERCISE 13-9 (a)

CASSANDRA CORPORATION Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income.................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense........................... $ 5,800* Loss on disposal of plant assets ........ 4,700** Increase in accounts payable .............. 3,500) Increase in accounts receivable .......... (2,900) Net cash provided by operating activities ........................................ Cash flows from investing activities Sale of plant assets ...................................... Purchase of investments ............................. Net cash used by investing activities .....

) 11,100) 29,400)

3,500) (4,000) (500)

Cash flows from financing activities Issuance of common stock ......................... $ 5,000 Payment of dividends .................................. (14,600) Retirement of bonds .................................... (20,000) Net cash used by financing activities .....

(29,600)

Net decrease in cash ........................................... Cash at beginning of period ............................... Cash at end of period ..........................................

(700)) 17,700 $ 17,000

*[$14,000 – ($10,000 – $1,800)] (b) $29,400 – $0 – $14,600 = $14,800

$ 18,300)

13-19

**[$3,500 – ($10,000 – $1,800)]

*EXERCISE 13-10 ERISA MAGAMBO COMPANY Worksheet Statement of Cash Flows For the Year Ended December 31, 2014 Balance Sheet Accounts

Reconciling Items

Balance 12/31/13

Debit

Credit

Balance 12/31/14

Debits Cash Accounts receivable Inventory Land Equipment Total

22,000 76,000 187,000 100,000 200,000 585,000

(k) (a)

36,000 9,000

(f)

50,000

11,000 50,000

(b) (e)

7,000 25,000

(d)

24,000

(i) (j)

50,000 120,000

(a)

9,000

(c)

11,000

(f)

50,000

(g) (h)

70,000 50,000

(k)

416,000 36,000 452,000

58,000 85,000 180,000 75,000 250,000 648,000

Credits Accumulated depreciation—equipment Accounts payable Bonds payable Common stock Retained earnings Total

42,000 45,000 200,000 164,000 134,000 585,000

(g)

70,000

(j)

120,000

(b)

7,000

Statement of Cash Flow Effects Operating activities Net income Increase in accounts receivable Decrease in inventory Decrease in accounts payable Depreciation expense Investing activities Sale of land Purchase of equipment Financing activities Payment of dividends Redemption of bonds Issuance of common stock Totals Increase in cash Totals

13-20

(d)

24,000

(e)

25,000

(i)

50,000 452,000 452,000

66,000 34,000 150,000 214,000 184,000 648,000

*EXERCISE 13-11 Revenues .................................................................. Deduct: Increase in accounts receivable .............. Cash receipts from customers* ....................... Operating expenses ................................................. Deduct: Increase in accounts payable................... Cash payments for operating expenses** ...... Net cash provided by operating activities .............. **

$195,000) 60,000 $135,000 78,000) 25,000 (53,000) $ 82,000

Accounts Receivable Balance, Beginning of year 0 Revenues for the year 195,000 Cash receipts for year Balance, End of year 60,000

** Payments for the year

Accounts Payable Balance, Beginning of year 53,000 Operating expenses for year Balance, End of year

135,000

0 78,000 25,000

*EXERCISE 13-12 (a) Cash payments to suppliers Cost of goods sold .................................. Add: Increase in inventory .................... Cost of purchases ................................... Deduct: Increase in accounts payable .... Cash payments to suppliers ..................

$4,527.8 million 17.1 $4,544.9 million 139.6 $4,405.3 million

(b) Cash payments for operating expenses Operating expenses exclusive of depreciation .................................... $9,397.6 million ($10,517.6 – $1,120) Add: Increase in prepaid expenses ...... $ 65.3) Deduct: Increase in accrued expenses payable .................... 190.6 (125.3) Cash payments for operating expenses .... $9,272.3 million

13-21

*EXERCISE 13-13 Cash flows from operating activities Cash receipts from Customers .................................................. Dividend revenue .......................................

$240,000* 18,000* $258,000*

Less cash payments: To suppliers for merchandise ................... For salaries and wages .............................. For operating expenses ............................. For income taxes ........................................ For interest ................................................. Net cash provided by operating activities ............................................

115,000 57,000 28,000 16,000 10,000

226,000 $ 32,000*

*$50,000 + $190,000

*EXERCISE 13-14 Cash payments for rent Rent expense ..................................................... Add: Increase in prepaid rent .......................... Cash payments for rent .....................................

$ 40,000* 3,400* $ 43,400*

Cash payments for salaries Salaries expense ................................................ Add: Decrease in salaries payable .................. Cash payments for salaries ..............................

$ 65,000* 2,000* $ 67,000*

Cash receipts from customers Revenue from sales ........................................... Add: Decrease in accounts receivable ............ Cash receipts from customers..........................

$170,000* 12,000* $182,000*

13-22

SOLUTIONS TO PROBLEMS PROBLEM 13-1A

Transaction (a) Recorded depreciation expense on the plant assets. (b) Recorded and paid interest expense. (c) Recorded cash proceeds from a sale of plant assets. (d) Acquired land by issuing common stock. (e) Paid a cash dividend to preferred stockholders. (f) Paid a cash dividend to common stockholders. (g) Recorded cash sales. (h) Recorded sales on account. (i) Purchased inventory for cash. (j) Purchased inventory on account.

13-23

SCF Activity Affected

Cash Inflow, Outflow, or No Effect?

No cash flow effect

Cash outflow

Cash inflow

No cash flow effect

Cash outflow

O O O O

Cash inflow No cash flow effect Cash outflow No cash flow effect

PROBLEM 13-2A

(a) Net income can be determined by analyzing the retained earnings account. Retained earnings beginning of year .......................... Add: Net income (plug) ................................................ Less: Cash dividends .................................................. Stock dividends ................................................. Retained earnings, end of year ....................................

$250,000 77,200* 327,200 16,000 11,200 $300,000

*($300,000 + $11,200 + $16,000 – $250,000) (b) Cash inflow from the issue of stock was $13,800 ($155,000 – $130,000 – $11,200). Common Stock 130,000 11,200 13,800 155,000

Stock Dividend Shares Issued for Cash

Cash outflow for dividends was $16,000. The stock dividend does not use cash. (c) Both of the above activities (issue of common stock and payment of dividends) would be classified as financing activities on the statement of cash flows.

13-24

PROBLEM 13-3A

TOBY ZED COMPANY Partial Statement of Cash Flows For the Year Ended November 30, 2014 Cash flows from operating activities Net income .......................................................... Adjustments to reconcile net income to net cash provided by operating activities activities: Depreciation expense ............................. Decrease in inventory ............................. Decrease in accrued expenses payable ... Increase in prepaid expenses ................ Increase in accounts receivable ........... Decrease in accounts payable ............... Net cash provided by operating activities........................................

13-25

$1,450,000

$ 85,000 500,000 (105,000) (175,000) (200,000) (340,000)

(235,000) $1,215,000

*PROBLEM 13-4A

TOBY ZED COMPANY Partial Statement of Cash Flows For the Year Ended November 30, 2014 Cash flows from operating activities Cash receipts from customers......... Less cash payments: To suppliers ............................... For operating expenses ............ Net cash provided by operating activities ..........

$7,300,000 (1) $4,740,000 (2) 1,345,000 (3)

6,085,000 $1,215,000

Computations: (1) Cash receipts from customers Sales.................................................................. Deduct: Increase in accounts receivable ...... Cash receipts from customers ........................

$7,500,000 200,000 $7,300,000

(2) Cash payments to suppliers Cost of goods sold ........................................... Deduct: Decrease in inventory ....................... Cost of purchases ............................................ Add: Decrease in accounts payable .............. Cash payments to suppliers ............................

$4,900,000 500,000 4,400,000 340,000 $4,740,000

(3) Cash payments for operating expenses Operating expenses, exclusive of depreciation............................... Add: Increase in prepaid expenses .................................. Decrease in accrued expenses payable .................... Cash payments for operating expenses ........................................ *($1,150,000 – $85,000)

13-26

$1,065,000* $175,000 105,000

280,000 $1,345,000

PROBLEM 13-5A

RATTIGAN COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................. $ 55,000 Loss on disposal of plant assets ................ 25,000 Increase in accounts payable...................... 14,000 Increase in income taxes payable............... 6,000 Increase in accounts receivable ................. (15,000) Net cash provided by operating activities ..............................................

13-27

$226,000

85,000 $311,000

*PROBLEM 13-6A

RATTIGAN COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers.......... Less cash payments: For operating expenses ............. $610,000 (2) For income taxes ........................ 34,000 (3) Net cash provided by operating activities ............................ (1) Computation of cash receipts from customers Revenues .................................................................. Deduct: Increase in accounts receivable ($75,000 – $60,000) ................................... Cash receipts from customers................................ (2) Computation of cash payments for operating expenses Operating expenses per income statement ........... Deduct: Increase in accounts payable ($41,000 – $27,000) ................................... Cash payments for operating expenses ................ (3) Computation of cash payments for income taxes Income tax expense per income statement ........... Deduct: Increase in income taxes payable ($13,000 – $7,000) ..................................... Cash payments for income taxes ...........................

13-28

$955,000 (1) 644,000 $311,000 $970,000 15,000 $955,000 $624,000 14,000 $610,000 $ 40,000 6,000 $ 34,000

PROBLEM 13-7A

(a)

RAJESH COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ......................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ................................. Increase in accounts payable .................... Decrease in income taxes payable ............ Increase in inventory .................................. Increase in accounts receivable ................ Net cash provided by operating activities ..............................................

$32,000 $13,300 14,000 (1,000) (10,000) (19,000)

29,300

Cash flows from investing activities Sale of plant assets ............................................ Cash flows from financing activities Issuance of common stock ................................ Redemption of bonds ......................................... Payment of dividends ......................................... Net cash used by financing activities ........... Net increase in cash ................................................ Cash at beginning of period ................................... Cash at end of period .............................................. (b) $29,300 – $0 – $20,000 = $9,300

13-29

(2,700)

9,700 4,000 (6,000) (20,000) (22,000) 17,000 20,000 $37,000

*PROBLEM 13-8A

(a)

RAJESH COMPANY Statement of Cash Flows For the Year Ended December 31, 2012 Cash flows from operating activities Cash receipts from customers ...... Less cash payments: To suppliers ............................ For operating expenses ......... For income taxes .................... For interest .............................. Net cash provided by operating activities .......

$223,000 (1) $171,000 (2) 10,700 (3) 9,000 (4) 3,000

29,300

Cash flows from investing activities Sale of plant assets ........................ Cash flows from financing activities Issuance of common stock ........... Redemption of bonds .................... Payment of dividends .................... Net cash used by financing activities ..............................

193,700

9,700 4,000 (6,000) (20,000)

Net increase in cash .............................. Cash at beginning of period .................. Cash at end of period ............................

(22,000) 17,000 20,000 $ 37,000

Computations: (1)

13-30

Cash receipts from customers Sales ................................................................ Deduct: Increase in accounts receivable ..... Cash receipts from customers ..............................

$242,000 19,000 $223,000

*PROBLEM 13-8A (Continued) (2)

(3)

(4)

Cash payments to suppliers Cost of goods sold ............................................... Add: Increase in inventory .................................. Cost of purchases ................................................ Deduct: Increase in accounts payable ............... Cash payments to suppliers ................................

$175,000 10,000 185,000 14,000 $171,000

Cash payments for operating expenses Operating expenses ............................................. Deduct: Depreciation........................................... Cash payments for operating expenses .............

$ 24,000 13,300 $ 10,700

Cash payments for income taxes Income tax expense ............................................. Add: Decrease in income taxes payable ............. Cash payments for income taxes ........................

(b) $29,300 – $0 – $20,000 = $9,300

13-31

$ $

8,000 1,000 9,000

PROBLEM 13-9A

SINJH INC. Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ......................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ................................ Gain on disposal of plant assets............... Increase in accounts payable .................... Decrease in accrued expenses payable ..... Increase in prepaid expenses ................... Increase in inventory ................................. Increase in accounts receivable................ Net cash provided by operating activities ............................................

$172,900 $45,000 (5,000) 44,700 (500) (3,300) (9,650) (59,800)

184,350

Cash flows from investing activities Sale of plant assets ........................................... Purchase of long-term investments ................. Purchase of plant assets ................................... Net cash used by investing activities ..........

12,500 (26,000) (80,000)

Cash flows from financing activities Sale of common stock ....................................... Redemption of bonds ........................................ Payment of cash dividends ............................... Net cash used by financing activities ........

45,000 (40,000) (43,900)

Net increase in cash .................................................. Cash at beginning of period ..................................... Cash at end of period ................................................

13-32

11,450

(93,500)

(38,900) 51,950 48,400 $100,350

*PROBLEM 13-10A

SINJH INC. Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ............. Less cash payments: To suppliers.................................... For income taxes............................ For operating expenses ................. For interest ..................................... Net cash provided by operating activities............... Cash flows from investing activities Sale of plant assets ............................... Purchase of investments ...................... Purchase of plant assets....................... Net cash used by investing activities...................................... Cash flows from financing activities Sale of common stock ........................... Redemption of bonds ............................ Payment of cash dividends................... Net cash used by financing activities...................................... Net increase in cash...................................... Cash at beginning of period ......................... Cash at end of period ....................................

$332,980 (1) $100,410 (2) 27,280 16,210 (3) 4,730

148,630 184,350

12,500 (26,000) (80,000) (93,500) 45,000 (40,000) (43,900) (38,900) 51,950 48,400 $100,350

Computations: (1) Cash receipts from customers Sales ............................................... Deduct: Increase in accounts receivable................................. Cash receipts from customers ...... .

13-33

$392,780 59,800 $332,980

*PROBLEM 13-10A (Continued) (2) Cash payments to suppliers Cost of goods sold ................................................ Add: Increase in inventory ................................... Cost of purchases ................................................. Deduct: Increase in accounts payable ................ Cash payments to suppliers ................................. (3) Cash payments for operating expenses Operating expenses exclusive of depreciation ............................................ Add: Increase in prepaid expenses ......... $3,300 Decrease in accrued expenses payable .......................................... 500 Cash payment for operating expenses ....

13-34

$135,460 9,650 145,110 44,700 $100,410

$ 12,410 3,800 $ 16,210

PROBLEM 13-11A

STRACKMAN LUX COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................. Loss on disposal of plant assets ................ Decrease in accounts receivable ................ Increase in accounts payable...................... Decrease in prepaid expenses .................... Increase in inventory ................................... Net cash provided by operating activities ...............................................

$ 45,000 $40,000 6,000* 18,000 6,350 5,720 (12,550)

63,520 108,520

Cash flows from investing activities Sale of land .......................................................... Sale of plant assets ............................................. Purchase of equipment ....................................... Net cash used by investing activities .........

20,000 6,000 (95,000)

Cash flows from financing activities Payment of cash dividends................................. Net cash used by financing activities .........

(25,000)

(69,000)

(25,000)

Net increase in cash.................................................... Cash at beginning of period ....................................... Cash at end of period ..................................................

14,520 45,000 $ 59,520

Noncash investing and financing activities Exchange of common stock for land .................

$ 35,000

*($6,000 – $12,000)

13-35

*PROBLEM 13-12A

JHUTTI COMPANY Worksheet—Statement of Cash Flows For the Year Ended December 31, 2014 Balance Sheet Accounts

Reconciling Items Debit Credit

Balance 12/31/13

Balance 12/31/14

Debits Cash Accounts receivable Inventory Investments Plant assets Totals Credits Accumulated depreciation—plant assets Accounts payable Accrued expenses payable Bonds payable Common stock Retained earnings Totals

47,250 57,000 102,650 87,000 205,000 498,900

(m) (a) (b)

43,050 23,900 19,250

(f)

92,000

40,000 48,280 18,830 70,000 200,000 121,790 498,900

(h)

41,300

(d)

6,730

(l)

80,600

(e) (h)

3,000 47,000

(g) (c)

47,900 5,120

(i) 30,000 (j) 40,000 (k) 133,810

Statement of Cash Flow Effects Operating activities Net income Increase in accounts receivable Increase in inventory Increase in accounts payable Decrease in accrued expenses payable Depreciation expense Gain on disposal of plant assets Investing activities Sale of investments Sale of plant assets Purchase of plant assets Financing activities Sale of common stock Issuance of bonds Payment of dividends Totals Increase in cash Totals

13-36

(k) 133,810 (c)

5,120

(g)

47,900

(e) (h) (j) (i)

(a) (b)

23,900 19,250

(d)

6,730

(h)

8,550

(f)

92,000

3,000 14,250 40,000 30,000 (l) 580,910 580,910

80,600 537,860 (m) 43,050 580,910

90,300 80,900 121,900 84,000 250,000 627,100 46,600 53,400 12,100 100,000 240,000 175,000 627,100

PROBLEM 13-1B

Transaction (a) Recorded depreciation expense on the plant assets. (b) Incurred a loss on disposal of plant assets. (c) Acquired a building by paying cash. (d) Made principal repayments on a mortgage. (e) Issued common stock (f) Purchased shares of another company to be held as a long-term equity investment. (g) Paid cash dividends to common stockholders. (h) Sold inventory on credit. The company uses a perpetual inventory system. (i) Purchased inventory on credit. (j) Paid wages to employees.

13-37

SCF Activity Affected O

Cash inflow, outflow, or no cash flow effect? No cash flow effect

No cash flow effect

I F

Cash outflow Cash outflow

F I

Cash inflow Cash outflow

Cash outflow

No cash flow effect

O O

No cash flow effect Cash outflow

PROBLEM 13-2B

(a) Cash inflows (outflows) related to plant assets 2014: Equipment purchase Land purchase Proceeds from plant assets sold

($90,000) (30,000) 21,000*

*Cost of equipment sold $250,000 + $90,000 – $300,000 = $40,000 Accumulated depreciation removed from accounts for sale of plant assets Accumulated Depreciation— Equipment 93,000 Plug 12,000 64,000 Depreciation Expense 145,000 Cash proceeds = Cost $40,000 – accumulated depreciation $12,000 – loss $7,000 = $21,000 Note to instructor—some students may find journal entries helpful in understanding this exercise. Equipment .............................................................. Cash ................................................................

90,000

Land........................................................................ Cash ................................................................

30,000

Cash (plug) ............................................................ Accumulated Depreciation—Equipment.............. Loss on Disposal of Plant Assets ........................ Equipment .....................................................

21,000 12,000 7,000

(b) Equipment purchase Land purchase Proceeds from plant assets sold

13-38

90,000 30,000

40,000

Investing activities (outflow) Investing activities (outflow) Investing activities (inflow)

PROBLEM 13-3B

ASQUITH COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ......................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ................................ $ 95,000 Amortization expense ................................ 20,000 Decrease in accounts receivable .............. 230,000 Increase in accrued expenses payable ....... 155,000 Increase in accounts payable.................... 50,000 Increase in inventory ................................. (120,000) Increase in prepaid expenses ................... (125,000) Net cash provided by operating activities ............................................

13-39

$ 880,000

305,000 $1,185,000

*PROBLEM 13-4B

ASQUITH COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers......... Less cash payments: To suppliers ............................... For operating expenses ............ Net cash provided by operating activities ..........

$5,480,000 (1) $3,380,000 (2) 915,000 (3)

4,295,000 $1,185,000

Computations: (1) Cash receipts from customers Sales.................................................................. Add: Decrease in accounts receivable .......... Cash receipts from customers ........................

$5,250,000 230,000 $5,480,000

(2) Cash payments to suppliers Cost of goods sold ........................................... Add: Increase in inventory .............................. Cost of purchases ............................................ Deduct: Increase in accounts payable........... Cash payments to suppliers ............................

$3,310,000 120,000 3,430,000 50,000 $3,380,000

(3) Cash payments for operating expenses Operating expenses .................. Add: Increase in prepaid expenses .......................... $ 125,000 Deduct: Increase in accrued expenses payable ...... (155,000) Cash payments for operating expenses ................................

13-40

$ 945,000

(30,000) $ 915,000

PROBLEM 13-5B

ANNE DROID INC. Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income .......................................................... Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable ............... Increase in income taxes payable.............. Decrease in accounts payable ................... Net cash provided by operating activities ............................................

13-41

$115,000 $ 15,000 8,000 (11,000)

12,000 $127,000

*PROBLEM 13-6B

ANNE DROID INC. Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers............. Less cash payments: For operating expenses ................ For income taxes ........................... Net cash provided by operating activities ..............

$566,000 (1) $411,000 (2) 28,000 (3)

(1) Computation of cash receipts from customers Revenues ......................................................................... Add: Decrease in accounts receivable ($70,000 – $55,000) ............................................... Cash receipts from customers....................................... (2) Computation of cash payments for operating expenses Operating expenses........................................................ Add: Decrease in accounts payable ($51,000 – $40,000) ............................................... Cash payments for operating expenses ....................... (3) Income tax expense ........................................................ Deduct: Increase in income taxes payable ($12,000 – $4,000) ............................................ Cash payments for income taxes ..................................

13-42

439,000 $127,000

$551,000 15,000 $566,000

$400,000 11,000 $411,000 $ 36,000 8,000 $ 28,000

PROBLEM 13-7B

(a)

ROCASTLE COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income.................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense........................... Increase in income taxes payable ....... Increase in accounts receivable .......... Decrease in accounts payable............. Increase in inventory ............................ Net cash used by operating activities ....................................... Cash flows from investing activities Sale of plant assets ...................................... Purchase of equipment................................ Net cash provided by investing activities ............................................ Cash flows from financing activities Issuance of bonds ........................................ Payment of cash dividends ......................... Net cash used by financing activities ............................................ Net decrease in cash ........................................... Cash at beginning of period ............................... Cash at end of period ..........................................

(b) ($5,000) – $7,000 – $25,000 = ($37,000)

13-43

$28,000

$ 6,000 4,000 (11,000) (12,000) (20,000)

(33,000) (5,000)

12,000 (7,000) 5,000 10,000 (25,000) (15,000) (15,000) 33,000 $18,000

*PROBLEM 13-8B

(a)

ROCASTLE COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ........ Less cash payments: To suppliers .............................. For operating expenses ($37,000 – $6,000) ................. For interest ................................ For income taxes ...................... Net cash used by operating activities .......................... Cash flows from investing activities Sale of plant assets .......................... Purchase of equipment .................... Net cash provided by investing activities ................ Cash flows from financing activities Issuance of bonds ............................ Payment of cash dividends ............. Net cash used by financing activities ................................

$275,000 (1) $236,000 (2) 31,000 7,000 6,000 (3)

280,000 (5,000)

12,000 (7,000) 5,000 10,000 (25,000)

Net decrease in cash ............................... Cash at beginning of period .................... Cash at end of period ..............................

(15,000) (15,000) 33,000 $ 18,000

Computations: (1) Cash receipts from customers Sales ................................................................ Deduct: Increase in accounts receivable ..... Cash receipts from customers ......................

13-44

$286,000 (11,000) $275,000

*PROBLEM 13-8B (Continued) (2) Cash payments to suppliers Cost of goods sold ............................................... Add: Increase in inventory .................................. Cost of purchases ................................................ Add: Decrease in accounts payable................... Cash payments to suppliers ................................

$204,000 20,000 224,000 12,000 $236,000

(3) Cash payments for income taxes Income tax expense ............................................. Deduct: Increase in income taxes payable ........ Cash payments for income taxes ........................

$ 10,000 4,000 $ 6,000

(b) ($5,000) – $7,000 – $25,000 = ($37,000)

13-45

PROBLEM 13-9B

MINNIE HOOPER COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .............................. Loss on disposal of plant assets ............ Increase in accounts payable .................. Decrease in accrued expenses payable .................................................. Increase in accounts receivable.............. Increase in inventory ............................... Net cash provided by operating activities .......................................... Cash flows from investing activities Sale of investments ......................................... Sale of plant assets ......................................... Purchase of plant assets ................................. Net cash used by investing activities ................................................ Cash flows from financing activities Issuance of bonds ........................................... Sale of common stock ..................................... Payment of cash dividends ............................. Net cash provided by financing activities ................................................ Net increase in cash ................................................ Cash at beginning of period ................................... Cash at end of period ..............................................

13-46

$ 108,160

$ 25,000 5,000 8,320 (3,730) (26,200) (21,850)

(13,460) 94,700

27,500 10,000 (149,000) (111,500) 70,000 50,000 (43,000) 77,000 60,200 33,400 $ 93,600

*PROBLEM 13-10B

MINNIE HOOPER COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ............. Less cash payments: To suppliers.................................... For income taxes............................ For operating expenses ................. For interest ..................................... Net cash provided by operating activities ............... Cash flows from investing activities Sale of plant assets ............................... Sale of investments ............................... Purchase of plant assets....................... Net cash used by investing activities...................................... Cash flows from financing activities Sale of common stock ........................... Issuance of bonds ................................. Payment of cash dividends................... Net cash provided by financing activities ..................... Net increase in cash...................................... Cash at beginning of period ......................... Cash at end of period ....................................

13-47

$271,300 (1) $ 112,990 (2) 37,270 23,400 (3) 2,940

176,600 94,700

10,000 27,500 (149,000) (111,500) 50,000 70,000 (43,000) 77,000 60,200 33,400 $ 93,600

*PROBLEM 13-10B (Continued) Computations: (1) Cash receipts from customers Sales............................................................................... Deduct: Increase in accounts receivable ................... Cash receipts from customers .....................................

$297,500 26,200 $271,300

(2) Cash payments to suppliers Cost of goods sold ........................................................ Add: Increase in inventory .......................................... Cost of purchases ......................................................... Deduct: Increase in accounts payable........................ Cash payments to suppliers .........................................

$ 99,460 21,850 121,310 8,320 $112,990

(3) Cash payments for operating expenses Operating expenses ...................................................... Add: Decrease in accrued expenses payable ............ Cash payments for operating expenses ......................

$ 19,670 3,730 $ 23,400

13-48

PROBLEM 13-11B

VERNET COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................. Gain on disposal of plant assets ................ Increase in accounts payable...................... Decrease in prepaid expenses .................... Increase in accounts receivable ................. Increase in inventory ................................... Net cash provided by operating activities .............................................. Cash flows from investing activities Sale of land .......................................................... Sale of plant assets ............................................. Purchase of equipment ....................................... Net cash used by investing activities .........

$50,000 $ 57,000 (6,000)* 13,000 4,400 (13,000) (30,000)

25,400 75,400

35,000 37,000 (80,000) (8,000)

Cash flows from financing activities Payment of cash dividends.................................

(82,940)

Net decrease in cash................................................... Cash at beginning of period ....................................... Cash at end of period ..................................................

(15,540) 57,000 $41,460

Noncash investing and financing activities Exchange of common stock for land .................

$25,000

*($37,000 – $31,000)

13-49

BYP 13-1

FINANCIAL REPORTING PROBLEM

(a) Net cash provided by operating activities: 2010 2009

$8,448 million $6,796 million

(b) The increase in cash and cash equivalents for the year ended December 26, 2009 was $1,879 million, and the increase was $2,000 million for the year ended December 25, 2010. (c) PepsiCo uses the indirect method of computing and presenting the net cash provided by operating activities. (d) The change in accounts and notes receivable used cash of $268 million in 2010. The change in inventories provided cash of $276 million in 2010. The change in accounts payable (and other current liabilities) provided cash of $488 million in 2010. (e) The net cash used by investing activities in 2010 was $7,668 million. (f)

13-50

In note 14, under the “Other Supplemental Information” section cash flow information disclosed interest paid of $1,043 million and income taxes paid of $1,495 million in 2010.

BYP 13-2

(a)

COMPARATIVE ANALYSIS PROBLEM

$8,448 – $3,253 – $2,978 = $9,532 – $2,215 – $4,068 =

PepsiCo $2,217

Coca-Cola

$3,249

All amounts in millions (b) The companies are similar in their ability to generate cash. Both had a significant amount of “free cash” available after covering capital expenditures and cash dividends.

13-51

BYP 13-3

(a)

DECISION-MAKING ACROSS THE ORGANIZATION

DEL CARPIO COMPANY Statement of Cash Flows For the Year Ended January 31, 2014 Cash flows from operating activities Net loss .................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................... Gain from sale of investment ........ Net cash provided by operating activities .............. Cash flows from investing activities Sale of investment................................. Purchase of investment ........................ Purchase of fixtures and equipment .... Net cash used by investing activities ..................................... Cash flows from financing activities Sale of capital stock .............................. Purchase of treasury stock .................. Net cash provided by financing activities ..................................... Net increase in cash ..................................... Cash at beginning of period ......................... Cash at end of period ................................... Noncash investing and financing activities Issuance of note for truck.....................

13-52

$ (44,000)*

$ 75,000 (10,000)

65,000 21,000

85,000 (75,000) (320,000) (310,000)* 405,000 (15,000) 390,000 101,000 140,000 $241,000 $ 25,000

BYP 13-3 (Continued) *Computation of net income (loss) Sales of merchandise .............................. Interest revenue ....................................... Gain on sale of investment ($85,000 – $75,000) ............................... Total revenues and gains................. Merchandise purchased .......................... Operating expenses ($160,000 – $75,000) ............................. Depreciation ............................................. Interest expense ....................................... Total expenses.................................. Net loss .....................................................

$350,000 6,000 10,000 366,000 $245,000 85,000 75,000 5,000 410,000 $ (44,000)

(b) From the information given, it appears that from an operating standpoint, Del Carpio Company did not have a superb first year, having suffered a $44,000 net loss. Sara is correct; the statement of cash flows is not prepared in correct form. The correct format classifies cash flows from three activities—operating, investing, and financing; and it also presents significant noncash investing and financing activities in a separate schedule. Sara is wrong, however, about the actual increase in cash not being $101,000; $101,000 is the correct increase in cash.

13-53

BYP 13-4

REAL-WORLD FOCUS

(a) Crucial to the SEC’s effectiveness is its enforcement authority. Each year the SEC brings hundreds of civil enforcement actions against individuals and companies that break the securities laws. Typical infractions include insider trading, accounting fraud, and providing false or misleading information about securities and the companies that issue them. (b) The main purposes of these laws can be reduced to two common-sense notions:  Companies publicly offering securities for investment dollars must

tell the public the truth about their businesses, the securities they are selling, and the risks involved in investing.  People who sell and trade securities—brokers, dealers, and exchan-

ges—must treat investors fairly and honestly, putting investors’ interests first. (c) President Franklin Delano Roosevelt appointed Joseph P. Kennedy, President John F. Kennedy’s father, to serve as the first Chairman of the SEC.

13-54

BYP 13-5

REAL-WORLD FOCUS

Answers will vary depending on the company chosen by the student.

13-55

BYP 13-6

COMMUNICATION ACTIVITY

MEMO To:

Bart Sampson

From:

Student

Re:

Statement of cash flows

The statement of cash flows provides information about the cash receipts and cash payments of a firm, classified as operating, investing, and financing activities. The operating activities section of the company’s statement of cash flows shows that cash increased by $172,000 as a result of transactions which affected net income. This amount is computed by adjusting net income for those items which affect net income, but do not affect cash, such as sales on account which remain uncollected at year-end. The investing activities section of the statement reports cash flows resulting from changes in investments and other long-term assets. The company had a cash outflow from investing activities due to purchases of buildings and equipment. The financing activities section of the statement reports cash flows resulting from changes in long-term liabilities and stockholders’ equity. The company had a cash inflow from financing activities due to the issuance of common stock and an outflow due to the payment of cash dividends. If you have any further questions, please do not hesitate to contact me.

13-56

BYP 13-7

ETHICS CASE

(a) The stakeholders in this situation are: Milton Williams, president of Babbit Corporation. Jerry Roberts, controller. The Board of Directors. The stockholders of Babbit Corporation. (b) The president’s statement, “We must get that amount above $1 million,” puts undue pressure on the controller. This statement along with his statement, “I know you won’t let me down, Jerry,” encourages Jerry to do something unethical. Controller Jerry Roberts’ reclassification (intentional misclassification) of a cash inflow from a long-term note (financing activity) issuance to an “increase in payables” (operating activity) is inappropriate and unethical. (c) It is unlikely that any board members (other than board members who are also officers of the company) would discover the misclassification. Board members generally do not have detailed enough knowledge of their company’s transactions to detect this misstatement. It is possible that an officer of the bank that made the loan would detect the misclassification upon close reading of Babbit Corporation’s statement of cash flows. It is also possible that close scrutiny of the balance sheet showing an increase in notes payable (long-term debt) would reveal that there is no comparable financing activity item (proceeds from note payable) in the statement of cash flows.

13-57

BYP 13-8

ALL ABOUT YOU

(a) The article describes three factors that determine how much money you should set aside. (1) Your willingness to take risk. You need to evaluate how willing you are to experience wide swings in your financial position. (2) Your needs. Your need to carefully evaluate your situation and evaluate the possibility of various events and what the financial implications would be. This is also impacted by the number of dependents you have. (3) Your upcoming expenses. Here you need to look further out into the horizon and consider the implications of larger events such as a big trip, a wedding, or education costs. (b) They recommend having at least three months of living expenses set aside, and up to six months. (c) Responses to this question will vary. What is most important is that students begin the process of considering their cash needs and developing a plan to set aside enough money to provide a cushion in the event of a financial “hiccup.”

13-58

CHAPTER 14 Financial Statement Analysis ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Discuss the need for comparative analysis.

1, 2, 3, 5

Identify the tools of financial statement analysis.

2, 3, 5, 6

Explain and apply horizontal analysis.

3, 4, 25

Describe and apply vertical analysis.

Do It!

Exercises

2, 3, 5, 6, 7

1, 4

1, 3, 4

3, 4, 25

2, 4, 8

2, 3, 4

Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

5, 6, 7, 8, 9, 10, 11,12, 13, 14, 15, 16, 17, 18, 19

2, 9, 10, 11, 12, 13

2, 4

5, 6, 7, 8, 9, 10, 11

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

Understand the concept of earning power, and how irregular items are presented.

20, 21, 22, 23

14, 15

3, 4

12, 13

8, 9

Understand the concept of quality of earnings.

Problems

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

14-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

14-2

Description

Difficulty Level

Time Allotted (min.)

Prepare vertical analysis and comment on profitability.

Simple

20–30

Compute ratios from balance sheet and income statement.

Simple

20–30

Perform ratio analysis, and evaluate financial position and operating results.

Simple

20–30

Compute ratios, and comment on overall liquidity and profitability.

Moderate

30–40

Compute selected ratios, and compare liquidity, profitability, and solvency for two companies.

Moderate

50–60

Compute numerous ratios.

Simple

30–40

Compute missing information given a set of ratios.

Complex

30–40

Prepare income statement with discontinued operations and extraordinary loss.

Moderate

30–40

Prepare income statement with nontypical items.

Moderate

30–40

14-3

Learning Objective

Knowledge

1. Discuss the need for comparative analysis.

Comprehension Q14-1 Q14-2 Q14-3

Q14-5 BE14-1 Q14-5

Application

Analysis

2. Identify the tools of financial statement analysis.

Q14-6 BE14-2

Q14-2 Q14-3

3. Explain and apply horizontal analysis.

BE14-2 Q14-25

Q14-3 DI14-4

Q14-4 BE14-2 BE14-3 BE14-5 BE14-6

BE14-7 DI14-1 E14-1 E14-3 E14-4

4. Describe and apply vertical analysis.

BE14-2 Q14-25

Q14-3 DI14-4

Q14-4 BE14-2 BE14-4 BE14-8

E14-2 P14-1 E14-3 E14-4

5. Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

Q14-6 Q14-8 BE14-2

Q14-5 Q14-7 Q14-9 Q14-10 Q14-11 Q14-12 Q14-13

Q14-14 Q14-19 Q14-15 BE14-2 Q14-16 BE14-9 Q14-17 BE14-10 Q14-18 DI14-2 DI14-4 E14-6 E14-7

E14-8 BE14-11 E14-9 BE14-12 E14-10 BE14-13 P14-2 E14-5 P14-3 E14-11 P14-5 P14-1 P14-6

6. Understand the concept of earning power, and how irregular items are presented.

Q14-20 Q14-21 Q14-22 Q14-23

DI14-4 BE14-14 BE14-15 DI14-3 E14-12

E14-13 P14-8 P14-9

7. Understand the concept of quality of earnings.

Q14-24 DI14-4

Broadening Your Perspective

BYP14-4 BYP14-5

Synthesis

Evaluation

BE14-2

BYP14-8

BYP14-1 BYP14-3

P14-2 P14-3 P14-4 P14-7

BYP14-2 BYP14-6 BYP14-7

BLOOM’ S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems

ANSWERS TO QUESTIONS 1.

(a) Kurt is not correct. There are three characteristics: liquidity, profitability, and solvency. (b) The three parties are not primarily interested in the same characteristics of a company. Short-term creditors are primarily interested in the liquidity of the enterprise. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.

(a) Comparison of financial information can be made on an intracompany basis, an intercompany basis, and an industry average basis (or norms). (1) An intracompany basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years. (2) The industry averages basis compares an item or financial relationship of a company with industry averages (or norms) published by financial rating services. (3) An intercompany basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies. (b) The intracompany basis of comparison is useful in detecting changes in financial relationships and significant trends within a company. The industry averages basis provides information as to a company’s relative performance within the industry. The intercompany basis of comparison provides insight into a company’s competitive position.

Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or decrease of an item over a period of time. In this approach, the amount of the item on one statement is compared with the amount of that same item on one or more earlier statements. Vertical analysis (also called common-size analysis) expresses each item within a financial statement in terms of a percent of a base amount.

(a) $350,000 X 1.224 = $428,400, 2014 net income. (b) $350,000 ÷ .05 = $7,000,000, 2013 revenue.

A ratio expresses the mathematical relationship between one quantity and another. The relationship is expressed in terms of either a percentage (200%), a rate (2 times), or a simple proportion (2:1). Ratios can provide clues to underlying conditions that may not be apparent from individual financial statement components. The ratio is more meaningful when compared to the same ratio in earlier periods or to competitors’ ratios or to industry ratios.

(a) Liquidity ratios: Current ratio, acid-test ratio, receivables turnover, and inventory turnover. (b) Solvency ratios: Debt to total assets and times interest earned.

Gordon is correct. A single ratio by itself may not be very meaningful and is best interpreted by comparison with: (1) past ratios of the same company, (2) ratios of other companies, or (3) industry norms or predetermined standards. In addition, other ratios of the enterprise are necessary to determine overall financial well-being.

(a) Liquidity ratios measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. (b) Profitability ratios measure the income or operating success of a company for a given period of time. (c) Solvency ratios measure the ability of the company to survive over a long period of time.

14-4

Questions Chapter 14 (Continued) 9.

The current ratio relates current assets to current liabilities. The acid-test ratio relates cash, short-term investments, and net receivables to current liabilities. The current ratio includes inventory and prepaid expenses while the acid-test ratio excludes these. The acid-test ratio provides additional information about short-term liquidity and is an important complement to the current ratio.

10.

Monte Company does not necessarily have a problem. The receivables turnover ratio can be misleading in that some companies encourage credit and revolving charge sales and slow collections in order to earn a healthy return on the outstanding receivables in the form of high rates of interest.

11.

(a) (b) (c) (d)

12.

The price earnings (P/E) ratio is a reflection of investors’ assessments of a company’s future earnings. In this question, investors favor Microsoft because it has the higher P/E ratio. The investors feel that Microsoft will be able to generate even higher future earnings and so the investors are willing to pay more for the stock.

13.

The payout ratio is cash dividends divided by net income. In a growth company, the payout ratio is often low because the company is reinvesting earnings in the business.

14.

(a) The increase in profit margin is good news because it means that a greater percentage of net sales is going towards income. (b) The decrease in inventory turnover signals bad news because it is taking the company longer to sell the inventory and consequently there is a greater chance of inventory obsolescence. (c) An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations. (d) The earnings per share ratio is a deceptive ratio. The decrease might be bad news to the company because it could mean a decrease in net income. If there is an increase in stockholders’ investment (as a result of issuing additional shares) and a decrease in EPS, then this means that the additional investment is earning a lower return (as compared to the return on common equity before the additional investment). Generally, this is undesirable. (e) The increase in the price-earnings ratio is generally good news because it means that the market price per share of stock has increased and investors are willing to pay that higher price for the stock. An increase in the P/E ratio is good news for investors who own the stock and don’t want to buy any more. It is bad news for investors who want to buy (or buy more of) the stock. (f) The increase in the debt to total assets ratio is bad news because it means that the company has increased its obligations to creditors and has lowered its equity “buffer.” (g) The decrease in the times interest earned ratio is bad news because it means that the company’s ability to meet interest payments as they come due has weakened.

14-5

Asset turnover. Inventory turnover. Return on common stockholders’ equity. Times interest earned.

Questions Chapter 14 (Continued)

Net Income Return on assets = Average Assets (7.6%)

15.

Net Income – Preferred Dividends Return on common stockholders’ equity = Average Common Stockholders' Equity (12.8%)

The difference between the two rates can be explained by looking at the denominator value and by remembering the basic accounting equation, A = L + SE. The asset value will clearly be the larger of the two denominator values; therefore, it will also give the smaller return. 16.

(a) The times interest earned ratio, which is an indication of the company’s ability to meet interest payments, and the debt to total assets ratio, which indicates the company’s ability to withstand losses without impairing the interests of creditors. (b) The current ratio and the acid-test ratio, which indicate a company’s liquidity and short-term debt-paying ability. (c) The earnings per share and the return on stockholders’ equity, both of which indicate the earning power of the investment.

17.

Earnings per share means earnings per share of common stock. Preferred stock dividends are subtracted from net income in computing EPS in order to obtain income available to common stockholders.

18.

(a) Trading on the equity means that the company has borrowed money at a lower rate of interest than it is able to earn by using the borrowed money. Simply stated, it is using money supplied by nonowners to increase the return to the owners. (b) A comparison of the return on total assets with the rate of interest paid for borrowed money indicates the profitability of trading on the equity.

19.

Net income – Preferred dividends = Earnings per share Weighted average common shares outstanding

= $2.60 EPS of $2.60 is high relative to what? Is it high relative to last year’s EPS? The president may be comparing the EPS of $2.60 to the market price of the company’s stock. 20.

Discontinued operations refers to the disposal of a significant component of the business such as the stopping of an entire activity or eliminating a major class of customers. It is important to report discontinued operations separately from continuing operations because the discontinued component will not affect future income statements.

21.

EPS on income before extraordinary items usually is more relevant to an investment decision than EPS on net income. Income before extraordinary items represents the results of continuing and ordinary business activity. It is therefore a better basis for predicting future operating results than an EPS figure which includes the effect of extraordinary items that are not expected to recur again in the foreseeable future.

14-6

Questions Chapter 14 (Continued) 22.

Extraordinary items are events and transactions that are unusual in nature and infrequent in occurrence. Therefore, an extraordinary item is a one-time item which is not typical of the company’s operations. When comparing EPS trends, extraordinary items should be omitted since they are not reflective of normal operations. In this example, the trend is unfavorable because EPS, exclusive of extraordinary items, has decreased from $3.20 to $2.99.

23.

Items (a), (d), and (g) are extraordinary items.

24.

(1) Use of alternative accounting methods. Variations among companies in the application of generally accepted accounting principles may hamper comparability. (2) Use of pro forma income measures that do not follow GAAP. Pro forma income is calculated by excluding items that the company believes are unusual or nonrecurring. It is often difficult to determine what was included and excluded. (3) Improper revenue and expense recognition. Many high-profile cases of inappropriate accounting involve recording items in the wrong period.

25.

The following provide examples of horizontal and vertical analysis: Horizontal Analysis: Financial Highlights; Results of operations-consolidated reviews; Result of Operations–Division Review; and Reconciliation of GAAP and Non-GAAP information. Vertical Analysis: Pie charts; Asset category allocation; and Reconciliation of GAAP and NonGAAP information.

14-7

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 Dear Uncle Liam, It was so good to hear from you! I hope you and Aunt Doreen are still enjoying your new house. You asked some interesting questions. They relate very well to the material that we are studying now in my financial accounting class. You said you heard that different users of financial statements are interested in different characteristics of companies. This is true. A short-term creditor, such as a bank, is interested in the company’s liquidity, or ability to pay obligations as they become due. The liquidity of a borrower is extremely important in evaluating the safety of a loan. A long-term creditor, such as a bondholder, would be interested in solvency, the company’s ability to survive over a long period of time. A long-term creditor would also be interested in profitability. They are interested in the likelihood that the company will survive over the life of the debt and be able to meet interest payments. Stockholders are also interested in profitability, and in the solvency of the company. They want to assess the likelihood of dividends and the growth potential of the stock. It is important to compare different financial statement elements to other items. The amount of a financial statement element such as cash does not have much meaning unless it is compared to something else. Comparisons can be done on an intracompany basis. This basis compares an item or financial relationship within a company for the current year to one or more previous years. Intracompany comparisons are useful in detecting changes in financial relationships and significant trends. Comparisons can also be done with industry averages. This basis compares an item or financial relationship with industry averages or norms. Comparisons with industry averages provide information as to a company’s relative performance within the industry. Finally, comparisons can be done on an intercompany basis. This basis compares an item or financial relationship with the same item or relationship in one or more competing companies. Intercompany comparisons are useful in determining a company’s competitive position. I hope this answers your questions. If it does not, or you have more questions, please write me again or call. We could even meet for lunch sometime; it would be great to see you! Love, Your niece (or nephew) 14-8

BRIEF EXERCISE 14-2 (a) The three tools of financial statement analysis are horizontal analysis, vertical analysis, and ratio analysis. Horizontal analysis evaluates a series of financial statement data over a period of time. Vertical analysis evaluates financial statement data by expressing each item in a financial statement as a percent of a base amount. Ratio analysis expresses the relationship among selected items of financial statement data. (b) Horizontal Analysis Current assets

2012 100%

2013 105%

2014 109%

(105% = $230,000/$220,000; 109% = $240,000/$220,000) Vertical Analysis Current assets*

2012 44%

2013 38%

2014 38%

*as a percentage of total assets (44% = $220,000/$500,000; 38% = $230,000/$600,000; 38% = $240,000/$630,000) Ratio Analysis Current ratio

2012 1.38

2013 1.35

2014 1.30

(1.38 = $220,000/$160,000; 1.35 = $230,000/$170,000; 1.30 = $240,000/$184,000) BRIEF EXERCISE 14-3 Horizontal analysis: Increase or (Decrease) Dec. 31, 2014 Dec. 31, 2013 Amount Percentage Accounts receivable $ 520,000 $ 350,000 $170,000 49% Inventory $ 840,000 $ 500,000 $340,000 68% Total assets $2,500,000 $3,000,000 ($500,000) (17)% = .49

14-9

= .68

= (.17)

BRIEF EXERCISE 14-4 Vertical analysis:

Accounts receivable Inventory Total assets

Dec. 31, 2014 Dec. 31, 2013 Amount Percentage* Amount Percentage** $ 520,000 20.8% $ 350,000 11.7% $ 840,000 33.6% $ 500,000 16.7% $2,500,000 100% $3,000,000 100%

= .208

= .117

= .336

= .167

BRIEF EXERCISE 14-5

Net income

(a) 2012–2013 (b) 2013–2014

2014 $525,000

2013 $475,000

2012 $550,000

Increase or (Decrease) Amount Percentage (75,000) (14%) (50,000) (11%)

= .14

= .11

BRIEF EXERCISE 14-6

Net income

2014 $560,000

X .40 = .40X = 560,000 – X 14-10

2013 X

Increase 40%

BRIEF EXERCISE 14-6 (Continued) 1.40X = 560,000 X = 400,000 2013 Net income = $400,000

BRIEF EXERCISE 14-7 Comparing the percentages presented results in the following conclusions: The net income for Kemplar increased in 2013 because of the combination of an increase in sales and a decrease in both cost of goods sold and expenses. However, the reverse was true in 2014 as sales decreased while both cost of goods sold and expenses increased. This resulted in a decrease in net income.

BRIEF EXERCISE 14-8

Sales Cost of goods sold Expenses Net income

2014 100.0 59.2 25.0 15.8

2013 100.0 62.4 25.6 12.0

2012 100.0 64.5 27.5 8.0

Net income as a percent of sales for Dagman increased over the three-year period because cost of goods sold and expenses both decreased as a percent of sales every year.

BRIEF EXERCISE 14-9 (a) Working capital = Current assets – Current liabilities Current assets Current liabilities Working capital

14-11

$46,690,000 40,600,000 $ 6,090,000

BRIEF EXERCISE 14-9 (Continued) (b) Current ratio: = = 1.15:1 (c) Acid-test ratio:

= = .63:1 BRIEF EXERCISE 14-10 (a) Asset turnover =

= 5.5 times

(b) Profit margin

= = 14.5% 14-12

BRIEF EXERCISE 14-11 (a) Receivables turnover =

(1)

2014

2013

= 7.0 times

= 6.0 times

*($520,000 + $550,000) ÷ 2 (2)

**($480,000 + $520,000) ÷ 2

Average collection period = 52.1 days

= 60.8 days

(b) Gladow Company should be pleased with the effectiveness of its credit and collection policies. The company has decreased the average collection period by 8.7 days and the collection period of approximately 52 days is well within the 60 days allowed in the credit terms. BRIEF EXERCISE 14-12 (a) Inventory turnover = (1)

Cost of goods sold Average inventory

2014

Beginning inventory Purchases Goods available for sale Ending inventory Cost of goods sold

2013 = 4.4 times

= 5.0 times

$ 980,000 4,440,000 5,420,000 1,020,000 $4,400,000

$ 860,000 4,720,000 5,580,000 980,000 $4,600,000

(2) Days in inventory = 83.0 days

14-13

= 73.0 days

BRIEF EXERCISE 14-12 (Continued) (b) Management should be concerned with the fact that inventory is moving slower in 2014 than it did in 2013. The decrease in the turnover could be because of poor pricing decisions or because the company is stuck with obsolete inventory.

BRIEF EXERCISE 14-13 Payout ratio =

Cash dividends Net income

.20 = X = $68,000 (.20) = $13,600 Cash dividends = $13,600 Return on assets =

.16 = .16X = $68,000 X= X = $425,000 Average assets = $425,000

14-14

BRIEF EXERCISE 14-14 REEVES CORPORATION Partial Income Statement Income before income taxes ......................................................... Income tax expense ($500,000 X 30%) .......................................... Income before extraordinary item ................................................. Extraordinary loss from flood, net of $24,000 tax savings ($80,000 X 30%) .................................................. Net income ......................................................................................

$500,000 150,000 350,000 56,000 $294,000

BRIEF EXERCISE 14-15 BLEVINS CORPORATION Partial Income Statement Loss from operations of European facilities, net of $105,000 income tax saving ($350,000 X 30%) ... $245,000 Loss on disposal of European facilities, net of $45,000 income tax saving ($150,000 X 30%) ......... 105,000 $350,000 SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 14-1

Current assets Plant assets Total assets

14-15

Amount $(26,000) 71,000 $ 45,000

Increase (Decrease) in 2014 Percent (11.6)% [($199,000 – $225,000) ÷ $225,000] 9.5% [($821,000 – $750,000) ÷ $750,000] 4.6% [($1,020,000 – $975,000) ÷ $975,000]

DO IT! 14-2 2014 (a) Current ratio: $1,350 ÷ $900 = $1,343 ÷ $810 =

1.50:1

(b) Inventory turnover: $984/[($430 + $390) ÷ 2)] = $895/[($390 + $326) ÷ 2)]=

2.40 times

9.1%

(d) Return on assets: $364/[($2,310 + $2,243) ÷ 2)] = $213/[($2,243 + $2,100) ÷ 2)] =

16.0%

(e) Return on common stockholders’ equity: $364/[($1,020 + $1,040) ÷ 2)] = $213/[$1,040 + $960) ÷ 2)] =

35.3%

(f)

Debt to total assets ratio: $1,290 ÷ $2,310 = $1,203 ÷ $2,243 =

(g) Times interest earned: ($364 + $242 + $10) ÷ $10 = ($213 + $142 + $20) ÷ $20 =

14-16

2013 1.66:1

2.50 times

5.9%

9.8%

21.3% 55.8% 53.6% 62 times 19 times

DO IT! 14-3 GRINDERS CORPORATION Income Statement (Partial) Income before income taxes ........................................ Income tax expense ...................................................... Income from continuing operations ............................ Discontinued operations Loss from operations of music division, net of $21,000 income tax saving ........ Gain from disposal of music division, net of $14,000, taxes............................. Income before extraordinary item ................................ Extraordinary earthquake loss, net of $56,000 income tax saving .............................. Net income .....................................................................

$500,000 175,000 325,000 $39,000 26,000

(13,000) 312,000 (104,000) $208,000

DO IT! 14-4 1. 2. 3. 4. 5. 6.

A measure used to evaluate a company’s liquidity. Pro forma income: Usually excludes items that a company thinks are unusual or nonrecurring. Quality of earnings: Indicates the level of full and transparent information provided to users of the financial statements. Discontinued operations: The disposal of a significant segment of a business. Horizontal analysis: Determines increases or decreases in a series of financial statement data. Comprehensive income: Includes all changes in stockholders’ equity during a period except those resulting from investments by stockholders and distributions to stockholders. Current ratio:

14-17

SOLUTIONS TO EXERCISES EXERCISE 14-1 GALLUP INC. Condensed Balance Sheets December 31 Increase or (Decrease) Amount Percentage

2014

2013

Assets Current assets Plant assets (net) Total assets

$128,000 396,000 $524,000

$100,000 330,000 $430,000

($28,000 ( 66,000 94,000

(28.0%) (20.0%) (21.9%)

Liabilities Current liabilities Long-term liabilities Total liabilities

$ 91,000 138,700 229,700

$ 70,000 95,000 165,000

($21,000) ( 43,700) ( 64,700)

(30.0%) (46.0%) (39.2%)

159,000 135,300

115,000 150,000

( 44,000 (14,700)

(38.3%) (9.8%)

294,300

265,000

( 29,300)

( 11.1%)

$524,000

$430,000

($94,000)

21.9%

Stockholders’ Equity Common stock, $1 par Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

14-18

EXERCISE 14-2 CONARD CORPORATION Condensed Income Statements For the Years Ended December 31

Net sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Income before income taxes Income tax expense Net income

2014 Amount Percent

2013 Amount Percent

$750,000 480,000 270,000 105,000 75,000 180,000 90,000 36,000 $ 54,000

$600,000 408,000 192,000 84,000 54,000 138,000 54,000 18,000 $ 36,000

100.0% 64.0% 36.0% 14.0% 10.0% 24.0% 12.0% 4.8% 7.2%

100.0% 68.0% 32.0% 14.0% 9.0% 23.0% 9.0% 3.0% 6.0%

EXERCISE 14-3 (a)

GARCIA CORPORATION Condensed Balance Sheets December 31

2014 Assets Current assets Property, plant & equipment (net) Intangibles Total assets

14-19

2013

Percentage Increase Change (Decrease) from 2013

$ 76,000 $ 80,000

$ (4,000)

(5.0%)

100,000 90,000 24,000 40,000 $200,000 $210,000

(10,000) (16,000) $(10,000)

(11.1%) (40.0%) (4.8%)

EXERCISE 14-3 (Continued) GARCIA CORPORATION Condensed Balance Sheets (Continued) December 31

2014

2013

Liabilities and stockholders’ equity Current liabilities $ 40,000 $ 48,000 Long-term liabilities 140,000 150,000 Stockholders’ equity 20,000 12,000 Total liabilities and stockholders’ equity $200,000 $210,000

(b)

14-20

Percentage Increase Change (Decrease) from 2013

$ (8,000)

(16.7%)

(10,000)

(6.7%)

8,000)

(66.7%)

$(10,000)

(4.8%)

GARCIA CORPORATION Condensed Balance Sheet December 31, 2014 Amount

Percent

Assets Current assets Property, plant, and equipment (net) Intangibles Total assets

$ 76,000 100,000 24,000 $200,000

38% 50% 12% 100%

Liabilities and stockholders’ equity Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity

$ 40,000 140,000 20,000 $200,000

20% 70% 10% 100%

EXERCISE 14-4 (a)

HENDI CORPORATION Condensed Income Statements For the Years Ended December 31

Net sales Cost of goods sold Gross profit Operating expenses Net income

(b)

2014

2013

$600,000 468,000 132,000 60,000 $ 72,000

$500,000 400,000 100,000 54,000 $ 46,000

Increase or (Decrease) During 2013 Amount Percentage $100,000 68,000 32,000 6,000 $ 26,000

HENDI CORPORATION Condensed Income Statements For the Years Ended December 31

Net sales Cost of goods sold Gross profit Operating expenses Net income

2014 Amount Percent

2013 Amount Percent

$600,000 468,000 132,000 60,000 $ 72,000

$500,000 400,000 100,000 54,000 $ 46,000

100.0% 78.0% 22.0% 10.0% 12.0%

EXERCISE 14-5 (a) Current ratio = 2.0:1 ($4,054 ÷ $2,014) Acid-test ratio = 1.4:1 ($2,830 ÷ $2,014) Receivables turnover = 4.2 times ($8,258 ÷ $1,988.5)* Inventory turnover = 5.9 times ($5,328 ÷ $899)** *($2,035 + $1,942) ÷ 2 **(898 + 900) ÷ 2

20.0% 17.0% 32.0% 11.1% 56.5%

14-21

100.0% 80.0% 20.0% 10.8% 9.2%

EXERCISE 14-5 (Continued) (b)

Ratio Current Acid-test Receivables turnover Inventory turnover

Nordstrom 2.0:1 1.4:1 4.2 5.9

J.C. Penney 2.05:1 1.05:1 37.2 3.1

Industry 1.70:1 .70:1 46.4 4.3

Nordstrom is similar to J.C. Penney for the current and acid-test ratios, but significantly below for the receivables turnover. Nordstrom is much better than J.C. Penney for the inventory turnover. Nordstrom is better than the industry average for the current and acidtest ratios but below the industry average for the receivables turnover. Its inventory turnover ratio however is higher than the industry average.

EXERCISE 14-6 (a) Current ratio as of February 1, 2013 = 2.8:1 ($140,000 ÷ $50,000). Feb. 3 7 11 14 18

2.8:1 2.2:1 2.2:1 2.6:1 2.3:1

No change in total current assets or liabilities. ($112,000 ÷ $50,000). No change in total current assets or liabilities. ($100,000 ÷ $38,000). ($100,000 ÷ $43,000).

(b) Acid-test ratio as of February 1, 2013 = 2.5:1 ($125,000* ÷ $50,000). *$140,000 – $10,000 – $5,000 Feb. 3 7 11 14 18

14-22

2.5:1 1.9:1 1.9:1 2.2:1 1.9:1

No change in total quick assets or current liabilities. ($97,000 ÷ $50,000). ($94,000 ÷ $50,000). ($82,000 ÷ $38,000). ($82,000 ÷ $43,000).

EXERCISE 14-7 (a)

= 2.8:1.

(b)

= 1.6:1.

(c)

= 6.5 times.

(d)

= 3.4 times.

(1) (2)

EXERCISE 14-8 (a) Profit margin

= 6.0%.

(b) Asset turnover

(d) Return on common stockholders’ equity

14-23

= 1.25 times.

= 7.5%.

= 11.2%.

EXERCISE 14-9 (a)

= $1.80.

(b)

= 6.0 times.

(c)

= 35%.

(d)

= 6.5 times.

EXERCISE 14-10 (a) Inventory turnover = 3.4 =

3.4 X $190,000 = Cost of goods sold Cost of goods sold = $646,000. (b) Receivables turnover = 8.8 =

8.8 X $99,500 = Net sales (credit) = $875,600. (c) Return on common stockholders’ equity = 25% =

.25 X $528,000 = Net income = $132,000. 14-24

EXERCISE 14-10 (Continued)

(d) Return on assets = 20% =

Average assets =

= $660,000

= $660,000 Total assets (Dec. 31, 2014) = ($660,000 X 2) – $650,000 = $670,000. EXERCISE 14-11 (a)

($4,300 + $22,000+ $10,000)/$12,000 = 3.03:1

(b) ($4,300 + $22,000)/$12,000 = 2.19:1 (c)

$100,000/[($22,000 + $24,000)/2] = 4.35 times

(d) $60,350/[($10,000 + $7,000)/2] = 7.10 times (e)

$14,000/$100,000 = 14%

(f)

$100,000/[($111,300 + $120,700)/2] = .86 times

(g) $14,000/[($111,300 + $120,700)/2] = 12.1% (h) $14,000/[($99,300 + $89,600)/2] = 14.8% (i)

$12,000/$111,300 = 10.8%

EXERCISE 14-12 (a)

DOUGLAS CORPORATION Partial Income Statement For the Year Ended October 31, 2014 Income before income taxes .................................................. Income tax expense ($550,000 X 30%) .................................. Income before extraordinary item ......................................... Extraordinary loss from flood, net of $42,000 income tax saving ($140,000 X 30%) ............................. Net income ..............................................................................

14-25

$550,000 165,000 385,000 (98,000) $287,000

EXERCISE 14-12 (Continued) (b) To:

Chief Accountant

From: Your name, Independent Auditor After reviewing your income statement for the year ended 10/31/14, we believe it is misleading for the following reasons: The amount reported for income before extraordinary items is overstated by $42,000. The income tax expense should be 30% of $550,000, or $165,000, not $123,000. Also, the effect of the extraordinary loss on net income is only $98,000, not $140,000. An income tax savings of $42,000 should be netted against the extraordinary loss.

EXERCISE 14-13 (a)

MAULDER CORPORATION Partial Income Statement For the Year Ended December 31, 2014 Income from continuing operations ...................................... Discontinued operations Gain on discontinued division, net of $10,500 income taxes .............................................................. Income before extraordinary item ......................................... Extraordinary item Extraordinary loss, net of $21,000 income tax saving ...... Net income ..............................................................................

$290,000 24,500 314,500 (49,000) $265,500

(b) The correction of an error in last year’s financial statements is a prior period adjustment. The correction is reported in the 2014 retained earnings statement as an adjustment that increases the reported beginning balance of retained earnings by $17,500, or [$25,000 – ($25,000 X 30%)].

14-26

SOLUTIONS TO PROBLEMS PROBLEM 14-1

(a)

Condensed Income Statement For the Year Ended December 31, 2014 Lionel Company Dollars Percent Net sales $1,549,035 100.0% Cost of goods sold 1,053,345 68.0% Gross profit 495,690 32.0% Operating expenses 278,825 18.0% Income from operations 216,865 14.0% Other expenses and losses Interest expense 7,745 .5% Income before income taxes 209,120 13.5% Income tax expense 61,960 4.0% Net income $ 147,160 9.5%

Barrymore Company Dollars Percent $339,038 237,325 101,713 77,979 23,734

100.0% 70.0% 30.0% 23.0% 7.0%

2,034 21,700 8,476 $ 13,224

.6% 6.4% 2.5% 3.9%

(b) Lionel Company appears to be more profitable. It has higher relative gross profit, income from operations, income before taxes, and net income. a

Lionel’s return on assets of 15.0% return on assets of 6.0%

. Also, Lionel’s return on common

stockholders’ equity of 18.0% return on stockholders’ equity of 7.0%

14-27

is higher than Barrymore’s

is higher than Barrymore’s d

PROBLEM 14-1 (Continued) $147,160 is Lionel’s 2014 net income. $981,067 is Lionel’s 2014 average assets: a

Current assets Plant assets Total assets

2014 2013 $401,584 $388,020 596,920 575,610 $998,504 + $963,630 =

$13,224 is Barrymore’s 2014 net income. $220,400 is Barrymore’s 2014 average assets: b

Current assets Plant assets Total assets

2014 2013 $ 86,450 $ 82,581 142,842 128,927 $229,292 + $211,508 =

$147,160 is Lionel’s 2014 net income. $817,556 is Lionel’s 2014 average stockholders’ equity: c

2014 2013 Common stock $578,765 $578,765 Retained earnings 252,224 225,358 Stockholders’ equity $830,989 + $804,123 =

$13,224 is Barrymore’s 2014 net income. $188,914 is Barrymore’s 2014 average stockholders’ equity: d

2014 2013 Common stock $137,435 $137,435 Retained earnings 55,528 47,430 Stockholders’ equity $192,963 + $184,865 =

14-28

PROBLEM 14-2

(a) Earnings per share =

= $3.20.

(b) Return on common stockholders’ equity =

= = 38.1%.

(d) Current ratio =

= 1.70:1

(e) Acid-test ratio =

= 1.15:1

(f)

Receivables turnover =

= = 17.4 times.

14-29

= 21.3%.

PROBLEM 14-2 (Continued) (g) Inventory turnover =

(h) Times interest earned =

(i)

Asset turnover =

= 19.4 times.

= 2.0 times.

*($852,800 + $946,100) ÷ 2

(j)

14-30

Debt to total assets =

= 42.6%.

= 8.9 times.

PROBLEM 14-3

(a)

2013

2014

(1) Profit margin. = 5.0%

= 6.0%

(2) Asset turnover. = 1.1 times

= 1.1 times

(3) Earnings per share. = $1.03

= $1.31

(4) Price-earnings ratio. = 4.9 times

= 6.1 times

(5) Payout ratio. = 62.5% *($113,000 + $32,000 – $125,000)

= 52.4% **($125,000 + $42,000 – $145,000)

(6) Debt to total assets. = 26.7%

14-31

= 23.4%

PROBLEM 14-3 (Continued) (b) The underlying profitability of the corporation appears to have improved. For example, profit margin and earnings per share have both increased. In addition, the corporation’s price-earnings ratio has increased, which suggests that investors may be looking more favorably at the corporation. Also, the corporation appears to be involved in attempting to reduce its debt burden as its debt to total assets ratio has decreased. Similarly, its payout ratio has decreased, which should help its overall solvency.

14-32

PROBLEM 14-4

(a) LIQUIDITY 2012

2013

Change

Current

= 1.9:1

=1.9:1

No change

Acid-test

= 1.0:1

= 1.1:1

Increase

Receivables turnover

= 9.5 times

= 9.6 times

Increase

*($88,000 + $80,000) ÷ 2 Inventory turnover

**($80,000 + $98,000) ÷ 2 = 4.7 times Increase

= 4.5 times

*($118,000 + $135,000) ÷ 2

**($135,000 + $125,000) ÷ 2

An overall increase in short-term liquidity has occurred. PROFITABILITY Profit margin

= 5.3%

= 5.0%

Decrease

Asset turnover

= 1.2 times

= 1.3 times

Increase

Return on assets

= 6.6%

= 6.4%

Decrease

Earnings per share

= $2.10

= $2.13

Increase

Profitability has remained relatively the same.

14-33

PROBLEM 14-4 (Continued) (b)

2013 1.

Return on common stockholders’ equity

Debt to total assets

(a) (b) (c) (d)

14-34

Price-earnings ratio

= 13.2%

= 50.9%

= 4.2 times

($200,000 + $130,000 + $200,000 + $116,000) ÷ 2. ($380,000 + $180,000 + $200,000 + $130,000) ÷ 2. $100,000 + $48,000 + $44,000 + $150,000. $50,000 ÷ 20,000.

2014 = 11.2%

Change Decrease

= 34.6%

Decrease

= 5.0 times

Increase

PROBLEM 14-5

(a)

Ratio

Target

Wal-Mart

(All Dollars Are in Millions) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)

Current 1.7:1 ($17,213 ÷ $10,070) Receivables turnover 10.3 ($67,390 ÷ $6,560) Average collection period 35.4 (365 ÷ 10.3) Inventory turnover 6.2 ($45,725 ÷ $7,388) Days in inventory 58.9 (365 ÷ 6.2) Profit margin 4.3% ($2,920 ÷ $67,390) Asset turnover 1.5 ($67,390 ÷ $44,119a) Return on assets 6.6% ($2,920 ÷ $44,119a) Return on common stockholders’ equity 18.9% ($2,920 ÷ $15,417b) Debt to total assets 64.6% ($28,218 ÷ $43,705) Times interest earned 6.9 ($5,252 ÷ $757)

($43,705 + $44,533) ÷ 2 ($15,487 + $15,347) ÷ 2

.9:1 100.6

($48,331 ÷ $55,561) ($405,046 ÷ $4,025)

3.6 (365 ÷ 100.6) 9.0 ($304,657 ÷ $33,836) 40.6 (365 ÷ 9.0) 3.5% ($14,335 ÷ $405,046) 2.4 ($405,046 ÷ $167,067.5c) 8.6% ($14,335 ÷ $167,067.5c) 21.1% ($14,335 ÷ $68,017d) 58.6% ($99,957 ÷ $170,706) 12.4 ($23,358 ÷ $1,884)

($170,706 + $163,429) ÷ 2 ($70,749 + $65,285) ÷ 2

(b) The comparison of the two companies shows the following: Liquidity—Target’s current ratio of 1.7:1 is significantly better than Wal-Mart’s .9:1. However, Wal-Mart has a better inventory turnover ratio than Target and its receivables turnover is substantially better than Target’s. Profitability—With the exception of profit margin, Wal-Mart betters Target in all of the profitability ratios. Thus, it is more profitable than Target. Solvency—Wal-Mart betters Target in both of the solvency ratios. Thus, it is more solvent than Target.

14-35

PROBLEM 14-6

(a) Current ratio =

= 1.5:1.

(b) Acid-test ratio =

= 0.93:1.

= 6.3 times. (d) Inventory turnover =

(e) Profit margin ratio =

(f)

= 4.5 times.

= 7.3%.

Asset turnover =

= 0.8 times.

(g) Return on assets =

= 6.2%.

(h) Return on common stockholders’ equity =

= 10.2%.

14-36

PROBLEM 14-6 (Continued) (i)

Earnings per share =

= $1.22.

(1) $150,000 ÷ $5.00

(j)

Price-earnings ratio =

(k) Payout ratio =

= 16.0 times.

= 37.3%.

(2) $200,000 + $36,700 – $223,000

(l)

Debt to total assets =

(m) Times interest earned = (3) $36,700 + $20,000 + $7,500

14-37

= 40.5%.

= 8.6 times.

PROBLEM 14-7

Receivables turnover = 10 =

Average receivables =

= $1,050,000

= $1,050,000 Net receivables 12/31/14 + $950,000 = $2,100,000 Net receivables 12/31/14 = $1,150,000 Profit margin = 14.5% = .145 = Net income = $10,500,000 X .145 = $1,522,500 Income before income taxes = $1,522,500 + $550,000 = $2,072,500 Return on assets = 20% = .20 = Average assets = $1,522,500 ÷ .20 = $7,612,500 = $7,612,500 Assets (12/31/14) = $7,725,000 Total current assets = $7,725,000 – $4,620,000 = $3,105,000 Inventory = $3,105,000 – $1,150,000 – $480,000 = $1,475,000 Total liabilities and stockholders’ equity = $7,725,000 Total liabilities = $7,725,000 – $3,400,000 = $4,325,000

14-38

PROBLEM 14-7 (Continued) Current ratio = 3.0 = Current liabilities = $3,105,000 ÷ 3.0 = $1,035,000 Long-term notes payable = $4,325,000 – $1,035,000 = $3,290,000

Inventory turnover = 4.2 =

Cost of goods sold = $1,597,500 X 4.2 = $6,709,500 Gross profit = $10,500,000 – $6,709,500 = $3,790,500 Income from operations = $3,790,500 – $1,500,000 = $2,290,500 Interest expense = $2,290,500 – $2,072,500 = $218,000

14-39

PROBLEM 14-8

VIOLET BICK CORPORATION Condensed Income Statement For the Year Ended December 31, 2014 Operating revenues ($12,900,000 – $2,000,000) ........................ Operating expenses ($8,700,000 – $2,500,000) .......................... Income from operations ............................... Other expenses and losses.......................... Income before income taxes ........................ Income tax expense ($4,500,000 X 30%) ..... Income from continuing operations ............ Discontinued operations Loss from operations of hotel chain*, net of $150,000 income tax saving........................................... Gain on sale of hotels, net of $90,000 income taxes ........................ Income before extraordinary item ............... Extraordinary item Extraordinary loss, net of $210,000 income tax saving ............................. Net income .................................................... *$2,000,000 – $2,500,000 = ($500,000)

14-40

$10,900,000 6,200,000 4,700,000 200,000 4,500,000 1,350,000 3,150,000

($350,000) 210,000

(140,000) 3,010,000 (490,000) $ 2,520,000

PROBLEM 14-9

GOWER CORPORATION Income Statement For the Year Ended December 31, 2014 Net sales ............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Selling and administrative expenses ............... Income from operations .................................... Other revenues and gains ................................. Other expenses and losses .............................. Income before income taxes ............................. Income tax expense ($334,000 X 30%) ............. Income from continuing operations ................. Discontinued operations Income from operations of discontinued division, net of $4,500 income taxes ....... Loss on sale of discontinued division, net of $24,000 income tax saving .......... Income before extraordinary item ................... Extraordinary item Gain from expropriation, net of $30,000 income taxes .......................................... Net income .........................................................

14-41

$1,600,000 1,100,000 500,000 160,000 340,000 $22,000 28,000

(6,000) 334,000 100,200 233,800

10,500 (56,000)

(45,500) 188,300 70,000 $ 258,300

BYP 14-1

FINANCIAL REPORTING PROBLEM

(a)

PEPSICO, INC. Trend Analysis of Net Sales and Net Income For the Five Years Ended 2010 Base Period 2006—(in millions) 2010

2009

2008

2007

2006

(1) Net sales Trend

$57,838 165%

$43,232 123%

$43,251 123%

$39,474 112%

$35,137 100%

(2) Net income Trend

6,320 112%

5,946 105%

5,142 91%

5,658 100%

5,642 100%

Between 2006 and 2007 PepsiCo’s net sales increased by 12%. Its net sales did not change from 2008 to 2009. In 2010 it increased 34% over 2009. PepsiCo’s net income did not increase between 2006 and 2007 and decreased by 9% in 2008. Between 2008 and 2010 net income increased by 23%. (b) (dollar amounts in millions) (1) Profit Margin 2010: 2009:

$6,320 ÷ $57,838 = 10.9% $5,946 ÷ $43,232 = 13.8%

(2) Asset Turnover 2010: 2009:

$57,838 ÷ [($68,153 + $39,848) ÷ 2] = 1.07 times $43,232 ÷ [($39,848 + $35,994) ÷ 2] = 1.14 times

(3) Return on Assets 2010: 2009:

14-42

$6,320 ÷ [($68,153 + $39,848) ÷ 2] = 11.7% $5,946 ÷ [($39,848 + $35,994) ÷ 2] = 15.7%

BYP 14-1 (Continued) (4) Return on Common Stockholders’ Equity 2010: 2009:

$6,320 ÷ [($21,273 + $16,908) ÷ 2] = 33.1% $5,946 ÷ [($16,908 + $12,203) ÷ 2] = 40.9%

In general, PepsiCo’s profitability has decreased from 2009 to 2010. (c) (dollar amounts in millions) (1) Debt to Total Assets 2010: 2009:

$46,677 ÷ $68,153 = 68.5% $22,406 ÷ $39,848 = 56.2%

(2) Times Interest Earned 2010: 2009:

($8,232 + $903) ÷ $903 = 10.1 times ($8,079 + $397) ÷ $397 = 21.4 times

Although creditors are providing more than 50% of PepsiCo’s total assets, its long-term solvency is not in jeopardy. PepsiCo has the ability to pay the interest on its debt even through the times interest earned ratio decreased from 21 to 10 times. (d) Substantial amounts of important information about a company are not in its financial statements. Events involving such things as industry changes, management changes, competitors’ actions, technological developments, governmental actions, and union activities are often critical to the successful operation of a company. Financial reports in the media and publications of financial service firms (Standard & Poors, Dun & Bradstreet) will provide relevant information not usually found in the annual report.

14-43

BYP 14-2

COMPARATIVE ANALYSIS PROBLEM

(a)

PepsiCo (1) (i) Percentage increase in net sales (ii) Percentage increase (decrease) in net income (2) (i) Percentage increase (decrease) in total assets (ii) Percentage increase (decrease) in total common stockholders’ equity (3) Basic earnings per share Price-earnings ratio

Coca-Cola Company

$57,838 − $43,232 = 33.8% $43,232

$35,119 − $30,990 = 13.3% $30,990

$6,320 − $5,946 $5,946

$11,809 − $6,824 $6,824

= 6.3%

= 73.1%

$68,153 − $39,848 = 71% $39,848

$72,921 − $48,671 = 49.8% $48,671

$21,273 − $16,908 = 25.8% $16,908

$31,003 − $24,799 = 25% $24,799

$3.97*

$5.12*

$65.69 = 16.5 times $3.97

$65.77 = 12.8 times $5.12

*Given on income statement

(b) PepsiCo’s net sales increased by 33.8 while Coca-Cola’s increased by 13.3%. PepsiCo’s net income increased 6.3% while Coca-Cola’s net income increased 73.1% from 2009 to 2010. PepsiCo’s total assets increased 71.0% while Coca-Cola increased its assets 49.8%. PepsiCo increased stockholders’ equity by 25.8% while Coca-Cola’s stockholders’ equity increased 25.0%. The absolute amounts of earnings per share, $3.97 for PepsiCo and $5.12 for Coca-Cola, are not comparable in a qualitative way since these amounts are dependent on the number of shares outstanding.

14-44

BYP 14-3

DECISION-MAKING ACROSS THE ORGANIZATION

The current ratio increase is a favorable indication as to liquidity, but alone tells little about the going-concern prospects of the client. From this ratio change alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The acid-test ratio decrease is an unfavorable indication as to liquidity, especially when the current-ratio increase is also considered. This decline is also unfavorable as to the going-concern prospects of the client because it reflects a declining cash position and raises questions as to reasons for the increases in other current assets, such as inventories. The change in asset turnover cannot alone tell anything about either solvency or going-concern prospects. There is no way to know the amount and direction of the changes in sales and assets. An increase in sales would be favorable for going-concern prospects, while a decrease in assets could represent a number of possible scenarios and would need to be investigated further. The increase in net income is a favorable indicator for both solvency and going-concern prospects, although much depends on the quality of receivables generated from sales and how quickly they can be converted into cash. If there has been a decline in sales, a significant factor is that management has been able to reduce costs to produce an increase in earnings. Indirectly, the improved income picture may have a favorable impact on solvency and going-concern potential by enabling the client to borrow currently (if it needs to do so) to meet cash requirements. The 32-percent increase in earnings per share, which is identical to the percentage increase in net income, is an indication that there has probably been no change in the number of shares of common stock outstanding. This, in turn, indicates that financing was not obtained through the issuance of common stock. It is not possible to reach conclusions about solvency and going-concern prospects without additional information about the nature and extent of financing.

14-45

BYP 14-3 (Continued) The collective implications of these data alone are that the client entity is about as solvent and as viable a going concern at the end of the current year as it was at the beginning although there may be a need for short-term operating cash.

14-46

BYP 14-4

REAL-WORLD FOCUS

(a) Optional elements include:  Financial highlights  Letter to stockholders  Corporate message  Report of management  Board of directors and management  Stockholder information

(b) SEC-required elements include:  Auditors’ report  Management discussion  Financial statements and notes  Selected financial data

(c) Management discussion. This series of short, detailed reports discusses and analyzes the company’s performance. It covers results of operations, and the adequacy of liquid and capital resources to fund operations. (d) Auditors’ report. This summary of the findings of an independent firm of certified public accountants shows whether the financial statements are complete, reasonable, and prepared consistent with generally accepted accounting principles (GAAP) at a set time. (e) Selected financial data. This information summarizes a company’s financial condition and performance over five years or longer. Data for making comparisons over time may include revenue (sales), gross profit, net earnings (net income), earnings per share, dividends per share, financial ratios such as return on equity, number of shares outstanding, and the market price per share.

14-47

BYP 14-5

COMMUNICATION ACTIVITY

To:

Kyle Benson

From:

Accounting Major

Subject:

Financial Statement Analysis

There are two fundamental considerations in financial statement analysis: (1) the bases of comparison and (2) the factors affecting quality of earnings. Each of these considerations is explained below. 1.

14-48

Bases of comparison. The bases of comparison are: a.

Intracompany—This basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years.

Industry averages—This basis compares an item or financial relationship of a company with industry averages (or norms).

Intercompany—This basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies.

Factors affecting quality of earnings are: a.

Alternative accounting methods—Variations among companies in the application of generally accepted accounting principles may hamper comparability and reduce quality of earnings.

Pro forma income—This income figure usually excludes items that the company thinks are unusual or nonrecurring.

Improper recognition—Because some managers have felt pressure from investors to continually increase earnings, they have manipulated the earnings numbers to meet these expectations.

BYP 14-6

ETHICS CASE

(a) The stakeholders in this case are:      

Robert Turnbull, president of Turnbull Industries. Perry Jarvis, public relations director. You, as controller of Turnbull Industries. Stockholders of Turnbull Industries. Potential investors in Turnbull Industries. Any readers of the press release.

(b) The president’s press release is deceptive and incomplete and to that extent his actions are unethical. (c) As controller you should at least inform Perry, the public relations director, about the biased content of the release. He should be aware that the information he is about to release, while factually accurate, is deceptive and incomplete. Both the controller and the public relations director (if he agrees) have the responsibility to inform the president of the bias of the about to be released information.

14-49

BYP 14-7

ALL ABOUT YOU

Student responses will vary. We suggest that in class you ask for a few students to share their responses in order to increase students understanding of the various reasons why different people will choose different investment vehicles.

14-50

APPENDIX A Time Value of Money SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE A-1 (a) Interest = p X i X n I = $9,000 X .05 X 12 years I = $5,400 Accumulated amount = $9,000 + $5,400 = $14,400 (b) Future value factor for 12 periods at 5% is 1.79586 (from Table 1) Accumulated amount = $9,000 X 1.79586 = $16,162.74

BRIEF EXERCISE A-2 (1) Case A Case B

5% 6%

3 periods 8 periods

(2) Case A Case B

BRIEF EXERCISE A-3 FV = p X FV of 1 factor = $8,400 X 1.60103 = $13,448.65

BRIEF EXERCISE A-4 FV of an annuity of 1 = p X FV of an annuity factor = $78,000 X 16.86994 = $1,315,855.32

A-1

3% 4%

8 periods 12 periods

BRIEF EXERCISE A-5 FV = p X FV of 1 factor + (p X FV of an annuity factor) = ($5,000 X 2.40662) + ($1,000 X 28.13238) = $12,033.10 + $28,132.38 = $40,165.48

BRIEF EXERCISE A-6 FV = p X FV of 1 factor = $35,000 X 1.46933 = $51,426.55

BRIEF EXERCISE A-7 (a) (1) 12% 8% 3%

(b) 7 periods 11 periods 16 periods

(2) 10% 10% 4%

20 periods 7 periods 10 periods

BRIEF EXERCISE A-8 (a)

i = 10% ?

$25,000

Discount rate from Table 3 is .42410 (9 periods at 10%). Present value of $25,000 to be received in 9 years discounted at 10% is therefore $10,602.50 ($25,000 X .42410).

A-2

BRIEF EXERCISE A-8 (Continued) (b)

i = 9% ?

$25,000 $25,000 $25,000 $25,000 $25,000 $25,000

Discount rate from Table 4 is 4.48592 (6 periods at 9%). Present value of 6 payments of $25,000 each discounted at 9% is therefore $112,148.00 ($25,000 X 4.48592).

BRIEF EXERCISE A-9 i = 8% ?

$750,000

Discount rate from Table 3 is .63017 (6 periods at 8%). Present value of $750,000 to be received in 6 years discounted at 8% is therefore $472,627.50 ($750,000 X .63017). Chaffee Company should therefore invest $472,627.50 to have $750,000 in six years.

BRIEF EXERCISE A-10 i = 6% ?

$450,000

Discount rate from Table 3 is .62741 (8 periods at 6%). Present value of $450,000 to be received in 8 years discounted at 6% is therefore $282,334.50 ($450,000 X .62741). Lloyd Company should invest $282,334.50 to have $450,000 in eight years. .

A-3

BRIEF EXERCISE A-11 i = 8% ?

$46,000 $46,000 $46,000 $46,000

$46,000 $46,000

Discount rate from Table 4 is 8.55948. Present value of 15 payments of $46,000 each discounted at 8% is therefore $393,736.08 ($46,000 X 8.55948). Arthur Company should pay $393,736.08 for this annuity contract.

BRIEF EXERCISE A-12 i = 5% ?

$80,000

Discount rate from Table 4 is 5.07569. Present value of 6 payments of $80,000 each discounted at 5% is therefore $406,055.20 ($80,000 X 5.07569). Kaehler Enterprises invested $406,055.20 to earn $80,000 per year for six years.

A-4

BRIEF EXERCISE A-13 i = 5% ?

$300,000

Diagram for Principal

i = 5% ?

$16,500 $16,500 $16,500 $16,500

$16,500 $16,500

Diagram for Interest

Present value of principal to be received at maturity: $300,000 X 0.37689 (PV of $1 due in 20 periods at 5% from Table 3) .............................................................. Present value of interest to be received periodically over the term of the bonds: $16,500* X 12.46221 (PV of $1 due each period for 20 periods at 5% from Table 4) ........................................................................ Present value of bonds ...............................................................

$113,067*

205,626** $318,693**

*$300,000 X .055 **Rounded. BRIEF EXERCISE A-14 The bonds will sell at a discount (for less than $300,000). This may be proven as follows: Present value of principal to be received at maturity: $300,000 X .31180 (PV of $1 due in 20 periods at 6% from Table 3) .............................................................. Present value of interest to be received periodically over the term of the bonds: $16,500 X 11.46992 (PV of $1 due each period for 20 periods at 6% from Table 4) ........................................................................ Present value of bonds ............................................................... *Rounded.

A-5

$ 93,540*

189,254* $282,794*

BRIEF EXERCISE A-15 i = 6% ?

$65,000

Diagram for Principal

i = 6% ?

$2,600

Diagram for Interest

Present value of principal to be received at maturity: $65,000 X .70496 (PV of $1 due in 6 periods at 6% from Table 3) ............................................................. Present value of interest to be received annually over the term of the note: $2,600* X 4.91732 (PV of $1 due each period for 6 periods at 6% from Table 4) ................................................................. Present value of note received .................................................. *$65,000 X .04

A-6

$45,822.40

12,785.03 $58,607.43

BRIEF EXERCISE A-16 i = 4% ?

$2,500,000

Diagram for Principal

i = 4% ?

$75,000 $75,000 $75,000 $75,000

$75,000 $75,000 $75,000

Diagram for Interest

Present value of principal to be received at maturity: $2,500,000 X 0.53391 (PV of $1 due in 16 periods at 4% from Table 3) ............................................................. Present value of interest to be received periodically over the term of the bonds: $75,000* X 11.65230 (PV of $1 due each period for 16 periods at 4% from Table 4) ....................................................................... Present value of bonds and cash proceeds ............................. *($2,500,000 X .06 X 1/2)

$1,334,775

873,923** $2,208,698**

**Rounded

BRIEF EXERCISE A-17 i = 9% ?

$3,200 $3,200 $3,200 $3,200 $3,200 $3,200 $3,200 $3,200

Discount rate from Table 4 is 5.53482. Present value of 8 payments of $3,200 each discounted at 9% is therefore $17,711.42 ($3,200 X 5.53482). Mark Barton should not purchase the tire retreading machine because the present value of the future cash inflows is less than the $18,000 purchase price of the retreading machine. Copyright © 2012 John Wiley & Sons, Inc.

Weygandt, Managerial Accounting, 6/e, Solutions Manual

(For Instructor Use Only)

A-7

BRIEF EXERCISE A-18 i = 5% ?

$48,850

Discount rate from Table 4 is 7.72173. Present value of 10 payments of $48,850 each discounted at 5% is therefore $377,206.51 ($48,850 X 7.72173). Frazier Company should receive $377,206.51 from the issuance of the note.

BRIEF EXERCISE A-19 i = 8% ?

$40,000

$45,000

$50,000

To determine the present value of the future cash inflows, discount the future cash flows at 8%, using Table 3. Year 1 ($40,000 X .92593) = Year 2 ($45,000 X .85734) = Year 3 ($50,000 X .79383) = Present value of future cash inflows

$ 37,037.20 38,580.30 39,691.50 $115,309.00

To achieve a minimum rate of return of 8%, Leffler Company should pay no more than $115,309.00. If Leffler pays less than $115,309.00, its rate of return will be greater than 8%.

A-8

BRIEF EXERCISE A-20 i=? $4,765.50

$12,000

Present value = Future value X Present value of 1 factor $4,765.50 = $12,000 X Present value of 1 factor Present value of 1 factor = $4,765.50 ÷ $12,000 = .39713 The .39713 for 12 periods approximates the value found in the 8% column (.39711). Colleen Mooney will receive a 8% return.

BRIEF EXERCISE A-21 i = 11% $29,319

$75,000

n=? Present value = Future value X Present value of 1 factor $29,319 = $75,000 X Present value of 1 factor Present value of 1 factor = $29,319 ÷ $75,000 = .39092 The .39092 at 11% is found in the 9 years row. Wayne Kurt therefore must wait 9 years to receive $75,000.

A-9

BRIEF EXERCISE A-22 i=? ?

$1,200 $1,200 $1,200 $1,200 $1,200 $1,200

$1,200 $1,200

$10,271.38

Present value = Future amount X Present value of an annuity factor $10,271.38 = $1,200 X Present value of an annuity factor Present value of an annuity factor = $10,271.38 ÷ $1,200 = 8.55948

The 8.55948 for 15 periods is found in the 8% column. Joanne Quick will therefore earn a rate of return of 8%.

BRIEF EXERCISE A-23 i = 9% $1,300 $1,300 $1,300 $1,300 $1,300 $1,300

$6,542.83 n=? Present value = Future amount X Present value of an annuity factor $6,542.83 = $1,300 X Present value of an annuity factor Present value of an annuity factor = $6,542.83 ÷ $1,300 = 5.03295

The 5.03295 at an interest rate of 9% is shown in the 7-year row. Therefore, Patty will receive 7 payments.

A-10

BRIEF EXERCISE A-24 i = 9% ?

$2,700 $2,700 $2,700 $2,700 $2,700 $2,700 $2,700

Discount rate from Table 4 is 5.03295. Present value of 7 payments of $2,700 each discounted at 9% is therefore $13,588.97 ($2,700 X 5.03295). Barney Googal should purchase the tire retreading machine because the present value of the future cash flows is greater than the purchase price of the retreading machine ($12,820).

BRIEF EXERCISE A-25 i = 11% ?

$20,000

$30,000

$40,000

To determine the present value of the future cash flows, discount the future cash flows at 11%, using Table 3. Year 1 ($20,000 X .90090) = Year 2 ($30,000 X .81162) = Year 3 ($40,000 X .73119) = Present value of future cash flows

$18,018.00 24,348.60 29,247.60 $71,614.20

To achieve a minimum rate of return of 11%, Ramos Company should pay no more than $71,614.20. If Ramos pays less than $71,614.20, its rate of return will be greater than 11%.

A-11

BRIEF EXERCISE A-26 10*

–18,000

50,000

I/YR.

PMT

10.76% *2024 – 2014 BRIEF EXERCISE A-27 10

60,000

–8,860

I/YR.

PMT

7.80%

BRIEF EXERCISE A-28 40

178,000*

–8,400

I/YR.

PMT

3.55% (semiannual) *$198,000 – $20,000

A-12

BRIEF EXERCISE A-29 (a) Inputs:

6.9

–16,000

PMT

Answer:

86,530.07

(b) Inputs:

Answer:

*200 X $1,000

A-13

8.65

14,000**

200,000*

PMT

–178,491.52

**$200,000 X .07

BRIEF EXERCISE A-30 (a) Note—set payments at 12 per year. Inputs: 96 7.8

42,000

PMT

–589.48

Answer: (b) Note—set payments to 1 per year. Inputs: 5 7.25

8,000

PMT

Answer:

A-14

–1,964.20