Managerial Accounting Tools for Business Decision-Making, 2nd Canadian Edition by Jerry Weygandt Sol by Ace Test Banks

Managerial Accounting Tools for Business DecisionMaking, 2nd Canadian Edition By by Jerry Weygandt, Donald Kieso, Paul Kimmel, and Ibrahim Aly

CHAPTER 1 Managerial Accounting ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Study Objectives

Questions

Exercises

*1.

Explain the importance of managerial accounting information.

*2.

Explain the distinguishing features of managerial accounting.

2, 3

1, 4, 5, 6

*3.

Identify the three broad functions of management.

5, 6

*4.

Identify the role of management accountants in an organizational structure.

*5.

Explain the importance of business ethics.

4, 8, 15

*6.

Identify the accounting organizations and professional accounting careers in Canada.

*7.

Identify changes in managerial accounting.

10, 11, 12, 13, 14

A Problems

B Problems

Study Objective

Knowledge

For Instructor Use Only

* 1. Explain the importance of managerial accounting information.

Comprehension Q1

* 2. Explain the distinguishing features Q2, Q3, E1, of managerial accounting. E4, E5, E6 * 3. Identify the three broad functions of management.

Q5, E3

* 4. Identify the role of management accountants in an organizational structure.

Q6 Q7

* 5. Explain the importance of business Q4, Q8, Q15, ethics. E2 * 6. Identify the accounting organizations and professional accounting careers in Canada.

* 7. Identify trends in managerial accounting.

Q10, Q12, Q13

Q11, Q14

Application

Analysis

Synthesis Evaluation

BLOOM’ S TAXONOMY TABLE

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

1-2

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) Tina 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) Classified financial statements are the end product of financial accounting. The statements are prepared monthly, quarterly and annually. In managerial accounting, internal reports may be prepared daily, weekly, monthly, quarterly, annually, or 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 a particular user for a specific decision.

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. • May extend 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.

(a) The four categories of ethical standards for management accountants are: Objectivity, confidentiality, competence, and integrity. (b) No. Management accountants should not condone unethical acts by others within their organization.

Kent 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.

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Questions Chapter 1 (Continued) 6.

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 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.

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.

An enterprise resource planning (ERP) system is a software system that provides a comprehensive, centralized source of integrated 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.

10.

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.

*11. 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. 12.

The value chain refers to all activities associated with providing a product or service. For a manufacturer, this includes research and development, product design, acquisition of raw materials, production, sales and marketing, delivery, customer relations and subsequent service.

13.

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.

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Questions Chapter 1 (Continued) 14. Systems and controls sometimes unwittingly create incentives for managers to take unethical actions. For example, companies prepare budgets to provide 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. Or, if the budget is set at unattainable levels, managers sometimes take unethical actions to meet the targets in order to receive higher compensation or, in some cases, keep their jobs.

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SOLUTIONS TO EXERCISES EXERCISE 1-1 Financial Accounting

Managerial Accounting

Primary users

External users

Internal users

Types of reports

Financial statements

Internal reports

Frequency of reports Monthly, 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

Annual audit by certified public accountant

No independent audits

EXERCISE 1-2 The four specific standards are: (1) Competence (2) Confidentiality (3) Integrity (4) Objectivity EXERCISE 1-3 (a) (1) Planning. (b) (2) Directing. (c) (3) Controlling.

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EXERCISE 1-4 (a) (6) Chief executive officer (b) (5) Line position (c) (2) Chief financial officer (d) (1) Board of directors (e) (7) Staff position (f) (4) Controller (g) (3) Treasurer EXERCISE 1-5 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

F M F M F M F F M F

EXERCISE 1-6 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.

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SOLUTIONS TO CASES CASE 1-7 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) H. Wickenheiser

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

Mario Lemieux

Needs cost information for his department.

L. Richardson

Needs all accounting information.

Wayne Gretzky

Needs product cost information.

Patrick Roy

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

(b) H. Wickenheiser Mario Lemieux

None.

L. Richardson

All.

Wayne Gretzky

Income statement and cost of goods manufactured schedule.

Patrick Roy (c) H. Wickenheiser

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

Mario Lemieux

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

L. Richardson

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

Wayne Gretzky

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.

Patrick Roy

Cost of Product Design—Accumulated total costs of each new product, issued at end of each project. . 1-8

CASE 1-8

(1) It is ethical to use different performance measures to evaluate employees, if and only if, the things that are being measured are things that are under the direct control or responsibility of the individual being evaluated. This is not as much an ethics problem as it is a management problem—management is responsible for putting systems in place that are fair to all employees. (2) The first thing a company can do to ensure ethical treatment of employees is to establish a Code of Conduct that provides guidelines to employees who are unsure of what should be done in questionable situations. Another thing a company could do is practice transparent reporting—allow all employees to see the financial statements, and encourage them to question what they don’t understand, or what they think might not be right.

. 1-9

1-10

Legal Notice Copyright

Copyright © 2009 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved. The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence. The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

1-11

CHAPTER 2 ASSIGNMENT CLASSIFICATION TABLE Study Objectives 1. Define the three classes of manufacturing costs.

Questions 11, 12, 14,

Brief Exercises 1, 2, 9,

Exercises 14, 15, 16, 17, 18, 25

A Problems 36, 37, 41, 42, 43, 44

B Problems 45, 46, 48, 49, 51

2. Distinguish between product and period costs.

13,

3, 9,

15, 16, 17, 31

36, 37, 41, 42, 43, 44

45, 46, 48, 49

3. Distinguish between variable and fixed costs.

1, 2, 3,

19, 20, 21, 22, 23, 24

4. Explain the significance of the relevant range.

4, 5,

20,

5. Explain the concept of mixed costs.

6, 7, 8,

4, 6, 7, 8,

19, 21, 22, 23, 24, 27

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

9, 15,

30, 31, 32, 33, 35

38, 39, 40, 41, 42, 43

47, 48, 51, 52, 53

7. Indicate how the cost of goods manufactured is determined.

16, 17, 18, 19

10,

26, 28, 29, 30, 31, 32, 33, 34, 35

38, 39, 40, 41, 42, 43, 44

47, 48, 49, 50, 51, 52, 53, 54

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

10, 20

11, 12, 13

32, 33, 34, 35

38, 39

47, 48

ASSIGNMENT CHARACTERISTICS TABLE Problem Number 36 37 38

39 40 41 42 43 44 45 46 47

48 49 50 51 52 53 54

Difficulty Level

Description Classify manufacturing costs into different categories and compute the unit cost. Classify manufacturing costs into different categories and compute the unit cost. 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. Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet. Prepare a cost of goods manufactured schedule and a correct income statement Calculate raw materials purchased, cost of goods manufactured, and cost of goods sold. Calculate cost of goods manufactured, and cost of goods sold. Calculate cost of goods manufactured, and cost of goods sold. Determine missing amounts and calculate selected costs for schedules of cost of goods manufactured and sold. Classify manufacturing costs into different categories and compute the unit cost. Classify manufacturing costs into different categories and compute the unit cost. 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. Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet. Calculate prime cost, conversion cost and cost of goods manufactured. Prepare income statement schedules for cost of goods sold and cost of good manufactured. Calculate direct cost, indirect cost, prime cost, conversion cost, and total job cost. Prepare a cost of goods manufactured schedule and a correct income statement Calculate selected costs for the income statement, and schedules of cost of goods manufactured and sold. Determine missing amounts, prepare cost of goods manufactured and calculate inventory values.

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Simple

Time Allotted (min.) 20–30

Simple

20–30

Moderate

30–40

Moderate

30–40

Moderate

30–40

Moderate

20–30

Moderate

20–30

Moderate

30–40

Challenging

30–40

Simple

20–30

Simple

20–30

Moderate

30–40

Moderate

30–40

Moderate

20–30

Moderate

30–40

Challenging

20–30

Moderate

30–40

Moderate

20–30

Challenging

40–50

For Instructor Use Only

Study Objective

1. Define the three classes of manufacturing costs.

Knowledge Comprehension

Analysis

Synthesis

Q12, Q14 BE1, BE2, BE9 E14, E15

E16, E17, E18, E25 P36, P37 P45, P46, P48

P41, P42, P43 P49, P51

P44

2. Distinguish between product and period costs.

Q13 BE3, BE9 E15

E16, E17, E31 P36, P37 P45, P46, P48

P41, P42, P43 P49

P44

3. Distinguish between variable E22 and fixed costs.

Q1, Q2 BE4 E19, E20, E24

E23

Q3 E21

4. Explain the significance of the relevant range.

Q4, Q5 E20

5. Explain the concept of mixed E22 costs.

Q6 BE4 E19, E24

Q7, Q8 BE7, BE8 E23, E27

BE6 E21

Q9 E33

E30, E31, E32, E35 P39 P48

P38, P40 – P43 P47, P51 – P53

E33

Q16, Q17, Q18, Q19 P38, P40 – P43 BE11, BE12, BE13 P47, P49, P51 – P53 E26, E28 – E32, E34, E35 P39, P48, P50

Q10, E33

BE10 – BE13 E32, E34, E35 P39, P48

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

Q11

Application

Q15

7. Indicate how the cost of goods manufactured is determined. 8. Explain the difference between a merchandising balance sheet and a manufacturing balance sheet.

Q20

BE5

P38, P47

P44, P54

Evaluation

BLOOM’ S TAXONOMY TABLE

2-3

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

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 the apartment is used. Rent on a rental truck is a mixed cost because the cost usually includes a per day charge (a fixed total cost) plus an activity charge based on kilometers driven (a variable cost).

Variable cost per unit is determined by dividing “Change in costs” by “Change in activity”. In this case: ($185,000 - $100,000) ÷ ($90,000 - $40,000) = $1.70. At any level of activity fixed costs are total costs less variable costs, or in this case: $185,000 – ($1.70 x 90,000) which equals $32,000 per month.

The difference between income statements is 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.

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Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

Questions Chapter 2 (Continued) 9.

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 included in the inventory account shown: finished goods, work in process, and raw materials.

10.

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

11.

No, he 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 can not be easily associated with the finished product are considered indirect materials.

12.

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.

13.

The cost of raw materials that can be physically and directly associated with the finished product during the manufacturing process is called direct materials cost. The cost of factory employees whose work can be physically and directly associated with converting raw materials into finished goods is called the direct manufacturing labour cost. Direct manufacturing costs (also called prime costs) are the sum of all direct materials costs and direct labour costs. Indirect manufacturing costs consist of costs that are indirectly associated with the manufacture of the finished product. These costs may also be manufacturing costs that cannot be classified as direct materials or direct labour. Prime cost is the sum of all direct materials costs and direct labour costs. Conversion cost is the sum of all direct labour costs and manufacturing overhead costs, which together are the costs of converting raw materials into a final product.

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)

16.

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

$ 12,000 180,000 192,000 15,000 $177,000

17.

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

$240,000 200,000 150,000 $590,000

18.

(a) (b)

$616,000 $584,000

X = total cost of work in process.

(b)X = cost of goods manufactured.

Total cost of work in process ($26,000 + $590,000)...................................... Cost of goods manufactured ($616,000 – $32,000) ......................................

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Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

19.

Weygandt, Kimmel, Kieso, Aly

The order is finished goods inventory, work in process inventory and then raw materials inventory, and they are usually listed in the notes to the financial statements. The Balance Sheet will reflect the sum of the three.

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Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 2-1 (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. Amortization on factory equipment.

BRIEF EXERCISE 2-2 (a) (b) (c) (d) (e) (f) (g) (h)

Direct materials. Direct materials. Direct labour. Manufacturing overhead. Manufacturing overhead (Indirect materials). Direct materials. Direct materials. Manufacturing overhead (Indirect labour).

BRIEF EXERCISE 2-3 (a) (b) (c) (d) (e) (f)

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

BRIEF EXERCISE 2-4 Indirect labour is a variable cost because it increases in total directly and proportionately with the change in the activity level: $10,000 ÷ 3,000 units = $3.33 and $20,000 ÷ 6,000 units = $3.33. Supervisory salaries are a fixed cost because they remain the same in total regardless of changes in the activity level: $5,000 at both levels.

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Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

Maintenance is a mixed cost because it increases in total but not proportionately with changes in the activity level: $4,000 ÷ 3,000 units = $1.33 and $7,000 ÷ 6,000 units = $1.167.

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Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

BRIEF EXERCISE 2-5 VARIABLE COST Relevant Range

FIXED COST Relevant Range

$10,000

8,000

6,000

4,000

2,000

2,000 0

80 100

Activity Level

80 100

Activity Level

BRIEF EXERCISE 2-6

$80,000 Total Cost Line

COST

60,000

Variable Cost Element

40,000

20,000 Fixed Cost Element 0

500

1,000

1,500

2,000

Direct Labour Hours

. 1-9

2,500

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

BRIEF EXERCISE 2-7 High Low Difference $16,490 – $12,330 = $4,160 8,200 – 5,000 = 3,200 $4,160 ÷ 3,200 = $1.30—Variable cost per kilometer.

Total cost Less: Variable costs 8,200 x $1.30 5,000 x $1.30 Total fixed costs

High $16,490

Low $12,330

10,660 6,500 $5,830

$5,830

The mixed cost is $5,830 plus $1.30 per kilometer. BRIEF EXERCISE 2-8 High Low Difference $65,000 – $32,000 = $33,000 40,000 – 18,000 = 22,000 $33,000 ÷ 22,000

Total cost Less: Variable costs 40,000 x $1.50 18,000 x $1.50 Total fixed costs

= $1.50 per unit. Activity Level High Low $65,000 $32,000 60,000 000,000 $ 5,000

27,000 $ 5,000

The mixed cost is $5,000 plus $1.50 per unit produced.

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Weygandt, Kimmel, Kieso, Aly

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

BRIEF EXERCISE 2-9

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

Product Costs Direct Factory Labour Overhead X

X X X

BRIEF EXERCISE 2-10 (a) Direct materials used ........................................................... Direct labour ......................................................................... Total manufacturing overhead............................................. Total manufacturing costs ...........................................

$180,000 229,000 208,000 $617,000

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

$ 25,000 617,000 $642,000

BRIEF EXERCISE 2-11 DIEKER COMPANY Balance Sheet As at December 31, 2009 Current assets Cash................................................................... Accounts receivable ......................................... Inventories (Note 1) .......................................... Prepaid expenses ............................................. Total current assets .......................... Note 1: Finished goods ......................................................... Work in process ....................................................... Raw Materials ........................................................... . 1-11

$ 62,000 200,000 231,000 38,000 $531,000 $71,000 87,000 73,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

BRIEF EXERCISE 2-12 Direct Materials Used (1) (2) (3)

Direct Labour Used

Factory Overhead

Total Manufacturing Costs $136,000

$81,000 $144,000

BRIEF EXERCISE 2-13 Total Manufacturing Costs (1) $136,000 (2) (3)

Work in Process (January 1)

Work in Process (December 31)

$123,000 $58,000

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Cost of Goods Manufactured $174,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO EXERCISES EXERCISE 2-14 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

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

Direct labour.* Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct labour. Manufacturing overhead. Manufacturing overhead (Indirect materials). Manufacturing overhead (Indirect labour). Direct materials.

*or sometimes (c), depending on the circumstances EXERCISE 2-15 (a) Materials used in product ...... DM Amortization on plant .......... MOH Property taxes on store.....Period Labour 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 and are reflected in the cost of goods sold account. Period costs are recognized as an expense when incurred.

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Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 2-16 (a) Factory utilities ....................................................................... Amortization on factory equipment....................................... Indirect factory labour ............................................................ Indirect materials .................................................................... Factory manager’s salary ...................................................... Property taxes on factory building ........................................ Factory repairs ....................................................................... Manufacturing overhead ........................................................

$ 11,500 12,650 48,900 80,800 8,000 2,500 2,000 $166,350

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

$137,600 69,100 166,350 $373,050

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

$ 3,800 46,400 1,300 18,000 2,640 $72,140

EXERCISE 2-17 1. 2.

3. 4.

(a) (c)

5. 6.

(b)* (d)

7. 8.

(a) (b)

*or sometimes (c), depending on the circumstances.

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9. 10.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 2-18 1. (b) 2. (c) 3. (a) 4. (c) 5. (c) 6. (c) 7. (c) 8. (c) 9. (c) 10. (c) EXERCISE 2-19 (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 labour Utilities

Variable Variable Mixed

Rent Maintenance Supervisory salaries

Fixed Mixed Fixed

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 2-20 (a)

(b) The relevant range is 4,000 – 9,000 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: (4,000 – 9,000 units) Cost = Units $10,000* = = $2 per unit 5,000* *Any costs and units within the relevant range could have been used to calculate the same unit cost of $2.

(d) Fixed cost within the relevant range (4,000 to 9,000 units) = $7,000 .6

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 2-21 (a) Maintenance Costs:

$4,900 – $2,400 $2,500 = = $5 variable cost per machine hour 800 – 300 500

Total costs Less: Variable costs 800 x $5 300 x $5 Total fixed costs

800 Machine Hours $4,900

300 Machine Hours $2,400

4,000 1,500 $ 900

$ 900

Thus, maintenance costs are $900 per month plus $5 per machine hour.

(b)

$5,000 Total Cost Line

$4,900

$4,000

COSTS

Variable Cost Element $3,000

$2,000

$1,000 $ 900 Fixed Cost Element 0

200

400

600

. 1-17

800

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Machine Hours

EXERCISE 2-22 1. Wood used in the production of furniture. 2. Fuel used in delivery trucks. 3. Straight-line amortization 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.

Variable. Variable. Fixed. Variable. Fixed. Variable. Fixed. Fixed. Variable. Fixed. Mixed. Mixed.

EXERCISE 2-23 (a) Maintenance Costs: $5,000 8,000 -

$2,800 = 3,000

$2,200 5,000

= $0.44 variable cost per machine hour Activity Level Total cost Less: Variable costs 8,000 x $.44 3,000 x $.44 Total fixed costs

High $5,000

Low $2,800

3,520 00,000 $1,480

1,320 $1,480

Thus, maintenance costs are $1,480 per month plus $0.44 per machine hour. . 1-18

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 2-23 (Continued) (b)

$5,000 Total Cost Line $4,000

COSTS

Variable Cost Element $3,000

$2,000 $1,480 $1,000

Fixed Cost Element

2,000

4,000

6,000

8,000

Machine Hours

EXERCISE 2-24 (a)

Cost Direct materials Direct labour Utilities Property taxes Indirect labour Supervisory salaries Maintenance Amortization

Fixed

Variable X X

Mixed X

X X X X X

. 1-19

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EXERCISE 2-24 (Continued) (b)

Fixed costs

= $1,000 + $1,800 + $2,400 + $300 + $200 = $5,700

Variable costs to produce 3,000 units = $7,500 + $15,000 + $4,500 = $27,000 Variable cost per unit

= $27,000 ÷ 3,000 units = $9 per unit

Variable cost portion of mixed cost

= Total cost – Fixed portion

Utilities: Variable cost to produce 3,000 units = $1,800 – $300 = $1,500 Variable cost per unit

= $1,500 ÷ 3,000 units = $0.50 per unit

Maintenance: Variable cost to produce 3,000 units = $1,100 – $200 = $900 Variable cost per unit

= $900 ÷ 3,000 units = $0.30 per unit

Cost to produce 5,000 units = (Variable costs per + Fixed cost unit x 5,000 units) = (($9 + $0.50 + $0.30) x 5,000) + $5,700 = $49,000 + $5,700 = $54,700

. 1-20

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EXERCISE 2-25 (a)

(b)

Delivery service (product) costs: Indirect materials Amortization on delivery equipment Dispatcher’s salary Gas and oil for delivery trucks Drivers’ salaries Delivery equipment repairs Total Period costs: Property taxes on office building CEO’s salary Advertising Office supplies Office utilities Repairs on office equipment Total

$ 5,400 11,200 5,000 2,200 11,000 300 $35,100 $

870 12,000 1,600 650 990 180 $16,290

EXERCISE 2-26 (a) Work-in-process, 1/1 ............................... Direct materials used .............................. Direct labour ............................................ Manufacturing overhead Amortization 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 .................. (b) Finished goods, 1/1 ................................. Cost of goods manufactured ................. Cost of goods available for sale............. Finished goods, 12/31 ............................. Cost of goods sold .................................. . 1-21

$ 12,000 $100,000 110,000 $60,000 23,000 14,000 97,000 307,000 319,000 15,500 $303,500 $ 60,000 303,500 363,500 55,600 $307,900

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EXERCISE 2-27 CEPEDA MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2009 Work in process inventory, (1/1) .................... $210,000 Direct materials Raw materials inventory, (1/1) .............. $44,500 Raw materials purchases ..................... 158,000 Total raw materials available for use ...... 202,500 Less: Raw materials inventory, (12/31)..... 12,500 Direct materials used ............................ 190,000 Direct labour.................................................. 69,000 Manufacturing overhead Indirect labour ........................................ $18,000 Factory amortization .............................. 36,000 Factory utilities ....................................... 68,000 Total manufacturing overhead......... 122,000 Total manufacturing costs ............................ 381,000 Total cost of work in process ....................... 591,000 Less: Work in process inventory, (12/31)......... 81,000 Cost of goods manufactured ........................ $510,000 Calculations: Total raw materials available for use: Direct materials used ........................................................ Add: Raw materials inventory (12/31) ........................... Total raw materials available for use ...............................

$190,000 12,500 $202,500

Raw materials inventory (1/1): Direct materials used ........................................................ Add: Raw materials inventory (12/31) ............................. Less: Raw materials purchases ....................................... Raw materials inventory (1/1) ..........................................

$190,000 12,500 (158,000) $ 44,500

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

$510,000 81,000 $591,000

. 1-22

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EXERCISE 2-27 (Continued) Total manufacturing costs: Total cost of work in process .............................................. Less: Work in process (1/1) ................................................. Total manufacturing costs ...................................................

$591,000 (210,000) $381,000

Direct labour: Total manufacturing costs ................................................... Less: Total overhead ............................................................ Direct materials used ................................................. Direct labour .........................................................................

$381,000 (122,000) (190,000) $ 69,000

EXERCISE 2-28 A + $57,000 + $46,500 = $185,650 A = $82,150

$242,500 – $11,000 = F F = $231,500

$185,650 + B = $221,500 B = $35,850

$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

$58,400 + $86,000 + $81,600 = D D = $226,000

$337,000 – $70,000 = I I = $267,000

$226,000 + $16,500 = E E = $242,500 Additional explanation to EXERCISE 2-28 solution: Case A (a) Total manufacturing costs ................................................... Less: Manufacturing overhead ............................................ Direct labour ............................................................... Direct materials used ........................................................... . 1-23

$185,650 (46,500) (57,000) $ 82,150

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 2-28 (Continued) (b) Total cost of work in process .............................................. Less: Total manufacturing costs ......................................... Work in process (1/1) ............................................................

$221,500 (185,650) $ 35,850

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

$221,500 (185,275) $ 36,225

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

$ 58,400 86,000 81,600 $226,000

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

$226,000 16,500 $242,500

(f)

$242,500 (11,000) $231,500

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

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

$253,700 (102,000) (130,000) $ 21,700

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

$337,000 (253,700) $ 83,300

(i)

$337,000 (70,000) $267,000

. 1-24

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EXERCISE 2-29 (a) (a) $127,000 + $140,000 + $77,000 = $344,000 (b) $344,000 + $33,000 – $360,000 = $17,000 (c) $450,000 – ($200,000 + $132,000) = $118,000 (d) $40,000 + $470,000 – $450,000 = $60,000 (e) $245,000 – ($80,000 + $100,000) = $65,000 (f)

$245,000 + $60,000 – $80,000 = $225,000

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

IKERD COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2009 Work in process, January 1 ............................... Direct materials ................................................... Direct labour ....................................................... Manufacturing overhead .................................... Total manufacturing costs ......................... Total cost of work in process ............................ Less: Work in process inventory, December 31 ........................................ Cost of goods manufactured .............................

. 1-25

$ 33,000 $127,000 140,000 77,000 344,000 377,000 17,000 $360,000

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EXERCISE 2-30 (a)

AIKMAN CORPORATION Cost of Goods Manufactured Schedule For the Month Ended June 30, 2009 Work in process, June 1 ............................. Direct materials used .................................. Direct labour................................................ Manufacturing overhead Indirect labour ..................................... Factory manager’s salary ................... Indirect materials................................. Maintenance, factory equipment ........ Amortization, 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 30,000 $4,500 3,000 2,200 1,800 1,400 400 13,300 63,300 66,300 3,800 $62,500

AIKMAN CORPORATION Income Statement (Partial) For the Month Ended June 30, 2009 Net sales ................................................................ Cost of goods sold Finished goods inventory, June 1 ................ Cost of goods manufactured [from (a)] ......... Cost of goods available for sale................... Finished goods inventory, June 30 .............. Cost of goods sold ................................ Gross profit ...........................................................

. 1-26

$87,100 $ 5,000 62,500 67,500 7,500 60,000 $27,100

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EXERCISE 2-31 (a) DANNER, CHENEY, AND HOWE Schedule of Cost of Contract Services Provided For the Month Ended August 31, 2009 Supplies used (direct materials) ................................... $ 1,200 Salaries of professionals (direct labour)...................... 12,600 Service overhead: Utilities for contract operations ............................... $1,400 Contract equipment amortization ............................ 900 Insurance on contract operations ........................... 800 Janitorial services for professional offices ............ 400 Total overhead .................................................... 3,500 Cost of contract services provided ......................... $17,300 (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 2-32 (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 ............................. Direct labour ........................................... Manufacturing overhead ........................ Total manufacturing costs..................... Total cost of work-in-process ............... Less: Work-in-process, 12/31 ................ Cost of goods manufactured ................. (b) Sales....................................................... Cost of goods sold Finished goods, 1/1 ........................ Cost of goods manufactured ........ Cost of goods available for sale .... Finished goods, 12/31..................... Cost of goods sold ................... Gross profit............................................. . 1-27

$ 13,500

$141,000 200,000 180,000 521,000 534,500 17,200 $517,300 $900,000 $ 27,000 517,300 544,300 21,000 523,300 $376,700

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EXERCISE 2-32 (Continued) (c) Current assets Inventories (Note 1)……………………………… Note to Financial Statements – Note 1 Finished goods............................................... Work in process ............................................ Raw materials .................................................

$ 68,200 $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 2-33 1. 2. 3. 4. 5. 6. 7. 8.

(a) (a) (a), (c) (b) 1 (a) (a) (a) (b), (c) 1

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

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

Only ending inventory is reflected in the Balance Sheet

. 1-28

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EXERCISE 2-34 (a)

CHAMBERLIN MANUFACTURING Cost of Goods Manufactured Schedule For the Month Ended June 30, 2009 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 labour ................................................. 57,000 Manufacturing overhead Indirect labour ........................................ $5,500 Factory insurance .................................. 4,000 Machinery amortization ......................... 4,000 Factory utilities....................................... 3,100 Machinery repairs .................................. 1,800 Miscellaneous factory costs ................. 1,500 Total manufacturing overhead......... 19,900 Total manufacturing costs ............................ 126,800 Total cost of work in process ....................... 131,800 Less: Work in process inventory, June 30 ...... 7,000 Cost of goods manufactured ........................ $124,800

(b)

CHAMBERLIN MANUFACTURING (Partial) Balance Sheet As at June 30, 2009 Current assets Inventories (Note 1) ………………………………………

$ 26,100

Note to Financial Statements –Note 1 Finished goods .......................................... Work in process......................................... Raw materials ............................................

$26,100

. 1-29

$ 6,000 7,000 13,100

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EXERCISE 2-35 (a) Raw Materials account: (Beg 0 + purchases 5,000 – Raw materials used 4,650) X $9 = $3,150 Work in Process account Sept 30th: (4,600 X 10%) X $9 = $4,140 Finished Goods account: (4,600 X 90% X 25%) X $9 = $9,315 Cost of Goods Sold account: (4,600 X 90% X 75%) X $9 = $27,945 Selling Expenses account: 50 X $9 = $450 Proof of cost of head lamps allocated (5,000 X $9 = $45,000) Raw materials Work in process Finished goods Cost of goods sold Selling expenses Total (b) To:

$ 3,150 4,140 9,315 27,945 450 $45,000

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.

. 1-30

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SOLUTIONS TO PROBLEMS: SET A PROBLEM 2-36A (a)

Cost Item

Product Costs Direct Direct Manufact. Period Materials Labour Overhead Costs

Rent on factory equipment $ 7,000 Insurance on factory building 1,500 Raw materials $75,000 Utility costs for factory 900 Supplies for general office Wages for assembly line workers $43,000 Amortization on office equipment Miscellaneous materials 1,100 Factory manager’s salary 5,700 Property taxes on factory building 400 Advertising for helmets Sales commissions Depreciation on factory building 000,000 000,000 1,500 $75,000 $43,000 $18,100 (b) Total production costs Direct materials Direct labour Manufacturing overhead Total production cost

300 800

14,000 7,000 000,000 $22,100

$ 75,000 43,000 18,100 $136,100

Production cost per helmet = $136,100/10,0001 = $13.61 1 10,000 units is used even though this is 80% of full capacity since this is the firm’s

normal capacity level.

. 1-31

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PROBLEM 2-37A (a) Product Costs Direct Direct Manufact. Period Cost Item Materials Labour Overhead Costs Raw materials (1) $96,200 Wages for workers (2) $78,000 Rent on equipment $ 4,900 Indirect materials (3) 6,500 Factory supervisor’s salary 3,000 Janitorial costs 1,300 Advertising $8,500 Amortization - factory building (4) 600 Property taxes – factory building (5) 000,000 000,000 750 00,000 $96,200 $78,000 $17,050 $8,500 (1) (2) (3) (4) (5)

$74 X 1,300 = $96,200. $12 X 5 hrs X 1,300 = $78,000. $5 X 1,300 = $6,500. $7,200/12 = $600. $9,000/12 = $750.

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

$ 96,200 78,000 17,050 $191,250

Production cost per system = $191,250 ÷ 1,300 = $147.12 (rounded)

. 1-32

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PROBLEM 2-38A (a) Case 1 Total manufacturing costs = A A = $7,600 + $5,000 + $8,000 = $20,600 Ending work in process inventory = B $20,600 + $1,000 – B = $17,000 B = $20,600 + $1,000 – $17,000 = $4,600 Beginning finished goods inventory = C $17,000 + C = $18,000 C = $18,000 – $17,000 = $1,000 Cost of goods sold = D D = $18,000 – $3,400 = $14,600 Gross profit = E E = ($24,500 – $2,500) – $14,600 = $7,400 Net income = F F = $7,400 – $2,500 = $4,900 Case 2 Direct materials used = G G + $8,000 + $4,000 = $18,000 G = $18,000 – $8,000 – $4,000 = $6,000 Beginning work in process inventory = H $18,000 total manufacturing costs + H beginning work in process $3,000 ending work in process = $22,000 H = $22,000 + $3,000 – $18,000 = $7,000 Cost of goods sold = K K = $3,300 beginning inventory + $22,000 Cost of goods manufactured – $2,500 ending inventory = $22,800 (Note: Item I can only be solved after item K is solved.) . 1-33

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PROBLEM 2-38A (Continued) Sales = I (I – $1,400) – K = $7,000 (I – $1,400) – $22,800 = $7,000 I = $1,400 + $22,800 + $7,000 = $31,200 Goods available for sale = J J = $22,000 Cost of goods manufactured + $3,300 Beginning finished goods = $25,300 Operating expenses = L $7,000 – L = $5,000 L = $2,000 (b) CASE 1 Cost of Goods Manufactured Schedule Work in process, beginning ................................. Direct materials ..................................................... Direct labour.......................................................... Manufacturing overhead ...................................... Total manufacturing costs............................ Total cost of work in process .............................. Less: Work in process, ending ........................... Cost of goods manufactured ............................... (c)

$ 1,000 $7,600 5,000 8,000 20,600 21,600 4,600 $17,000

CASE 1 Income Statement Sales ...................................................................... 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 ................................

. 1-34

$24,500 2,500 $22,000 1,000 17,000 18,000 3,400 14,600

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Gross profit ........................................................... Operating expenses ............................................. Net income ............................................................ PROBLEM 2-38A (Continued)

7,400 2,500 $ 4,900

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

. 1-35

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

8,600 400 $28,000

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PROBLEM 2-39A (a)

STELLAR MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Year Ended June 30, 2009 Work in process, July 1, 2008 ............ Direct materials Raw materials inventory, July 1, 2008 .............................. Raw materials purchases ........... Total raw materials available for use ...................................... Less: Raw materials inventory, June 30, 2009 ................ Direct materials used .................. Direct labour........................................ Manufacturing overhead Plant manager’s salary ............... Factory utilities ............................ Indirect labour ............................. Factory machinery amortization ... 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 .............

. 1-36

$ 19,800 $ 48,000 96,400 144,400 39,600 $104,800 149,250 29,000 27,600 24,460 16,000 9,600 4,600 1,400 112,660 366,710 386,510 18,600 $367,910

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PROBLEM 2-39A (Continued) (b)

STELLAR MANUFACTURING COMPANY (Partial) Income Statement For the Year Ended June 30, 2009 Sales revenues Sales ........................................................... Less: Sales discounts............................... Net sales ..................................................... Cost of goods sold Finished goods inventory, July 1, 2008 ............................................. Cost of goods manufactured..................... Cost of goods available for sale ............... Less: Finished goods inventory, June 30, 2009............................... Cost of goods sold ............................. Gross profit ................................................

(c)

$554,000 4,200 $549,800 96,000 367,910 463,910 95,900 368,010 $181,790

STELLAR MANUFACTURING COMPANY (Partial) Balance Sheet As at June 30, 2009 Assets Current assets Cash ............................................................ Accounts receivable .................................. Inventories (Note 1) ....................................

$ 32,000 27,000 $ 154,100

Total current assets ....................

$213,100

Notes to Financial Statement- Note 1 Inventories: Finished goods ................................... Work in process.................................. Raw materials .....................................

. 1-37

$95,900 18,600 39,600

$154,100

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PROBLEM 2-40A (a)

TOMBERT COMPANY Cost of Goods Manufactured Schedule For the Month Ended October 31, 2009 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 ................... 34,000 Direct materials used ................. Direct labour....................................... Manufacturing overhead Factory facility rent .................... 60,000 Amortization on factory equipment ............................... 31,000 Indirect labour ............................ 28,000 Factory utilities* ......................... 8,400 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 70% = $8,400 **$8,000 X 60% = $4,800

. 1-38

$ 16,000

$248,000 190,000

132,200 570,200 586,200 14,000 $572,200

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PROBLEM 2-40A (Continued) (b)

TOMBERT COMPANY Income Statement For the Month Ended October 31, 2009 Sales (net) ......................................................... 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 .......... Amortization expense—sales equipment .............................................. Utilities expense* ...................................... Insurance expense** ................................. Total operating expenses ................. Net income ........................................................ **$12,000 X 30% **$8,000 X 40%

. 1-39

$780,000 $ 30,000 572,200 602,200 48,000 554,200 225,800 90,000 75,000 45,000 3,600 3,200 216,800 $ 9,000

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PROBLEM 2-41A

(a) Raw materials inventory, beginning ............... Raw material purchased1 ................................ Raw materials available for use ...................... Less: Raw materials inventory, ending ......... Raw materials used in production

$ 9,600 28,800 38,400 10,400 $28,000

28,000 + $10,400 = $38,400 $38,400 - $9,600 = $28,800

(b) Work in process inventory, beginning ........... Manufacturing costs added ............................ Total work in process during the month ........ Less: Work in process inventory, ending ..... Cost of goods manufactured2 2

$14,600 + $160,000 - $13,000 = $161,600

(c) Finished goods inventory, beginning............. Cost of goods manufactured .......................... Cost of goods available for sale ..................... Less: finished goods inventory, ending ........ Cost of goods sold3 3

$ 14,600 160,000 174,600 13,000 $161,600

$9,600 + $161,600 - $9,200 = $162,000

. 1-40

9,600 161,600 171,200 9,200 $162,000

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PROBLEM 2-42A

(a) Cost of goods sold = manufacturing cost per unit x number of units sold Cost of goods sold = ($3,000,000 ÷ 300,000) x 298,500 = $2,985,000 (b) Gross Profit = Sales – Cost of goods sold = ($18 x 298,500) - $2,985,000 = $2,388,000

(c) Cost of finished goods = number of units in inventory x per unit product cost Cost of finished goods = (300,000 – 298,500) x $10.001 = $15,000 1

$ 3,000,000 ÷ 300,000 = $ 10.00 per unit

. 1-41

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PROBLEM 2-43A

(a) Direct materials to be used

= = (b) Direct labour to be incurred

= = (c) Cost incurred for MOH

(d) Cost of goods sold

(Number of units produced + number of units in ending inventory – number of units in beginning inventory) x unit price for labour (80,000 + 10,000 – 8,000 ) x $2 $164,000 (Number of units produced + number of units in ending inventory – number of units in beginning inventory) x unit price for labour (80,000 + 10,000 – 8,000) x $1 $82,000

= =

(Number of units produced + number of units in ending inventory – number of units in beginning inventory) x unit price for overhead (80,000 + 10,000 – 8,000) x $0.40 $32,800

= = = =

Number of units sold x per unit cost 80,000 x ($2.00 + $1.00 + 0.40) 80,000 x $3.40 $272,000

. 1-42

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PROBLEM 2-44A (a) Raw materials used in production .........................$180,000 Plus: Raw materials inventory, ending ................. 55,000 Raw materials available for use .............................. 235,000 Less: Raw materials inventory, beginning ............ 25,000 Raw material purchased1 .........................................$210,000 (b) Cost incurred for the month (10,000 hrs x $15) ....$150,000 Plus: beginning of the month accrual ................... 10,000 160,000 Less: end of the month accrual ............................. 20,000 Cash disbursements for labour ..............................$140,000 (c)

Work in process inventory, beginning....................$ 15,000 Plus: Materials used in production ........................ 180,000 Labour costs (10,000 hrs x $15) ................... 150,000 Overhead (10,000 hrs x $10) ......................... 100,000 445,000 Less: work in process inventory, ending ............... 4,500 Cost of goods transferred to finished goods .........$440,500

(d) Cost of goods sold...................................................$400,000 Plus: finished goods inventory, ending ................ 50,000 Goods available for sale .......................................... 450,000 Less: Transferred from work in process (c).......... 440,500 Finished goods inventory, beginning .....................$ 9,500

. 1-43

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO PROBLEMS: SET B PROBLEM 2-45B

(a)

Product Costs Direct Direct Manufact. Period Materials Labour Overhead Costs

Cost Item

Maintenance costs on factory building $ 600 Factory manager’s salary 4,000 Advertising for helmets 8,000 Sales commissions 3,000 Amortization on factory building 700 Rent on factory equipment 6,000 Insurance on factory building 3,000 Raw materials $20,000 Utility costs for factory 800 Supplies for general office 200 Wages for assembly line workers $44,000 Amortization on office equipment 500 Miscellaneous materials 000,000 000,000 2,000 000,000 $20,000 $44,000 $17,100 $11,700

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

$20,000 44,000 17,100 $81,100

Production cost per motorcycle helmet = $81,100 ÷ 1,000 = $81.10

. 1-44

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 2-46B (a)

Product Costs Direct Direct Manufact. Period Cost Item Materials Labour Overhead Costs Raw materials (1) $46,000 Wages for workers (2) $52,000 Rent on equipment $ 1,300 Indirect materials (3) 6,000 Factory supervisor’s salary 3,500 Janitorial costs 1,400 Advertising $6,000 Amortization - factory building (4) 700 Property taxes - factory building (5) 000,000 000,000 450 00,000 $46,000 $52,000 $13,350 $6,000 (1) (2) (3) (4) (5)

$23 X 2,000 = $46,000. $13 X 2 hours X 2,000 = $52,000. $3 X 2,000 = $6,000. $8,400 ÷ 12 = $700. $5,400 ÷ 12 = $450.

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

$ 46,000 52,000 13,350 $111,350

Production cost per racket = $111,350 ÷ 2,000 = $55.68. (rounded)

. 1-45

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

PROBLEM 2-47B (a) Case 1 Total manufacturing costs = A A = $8,300 + $3,000 + $6,000 = $17,300 Ending work in process inventory = B $17,300 + $1,000 – B = $15,800 B = $17,300 + $1,000 – $15,800 = $2,500 Beginning finished goods inventory = C C + $ 15,800 = $17,300 C = $17,300 – $15,800 = $1,500 Cost of goods sold = D D = $17,300 – $1,200 = $16,100 Gross profit = E E = ($22,500 – $1,500) – $16,100 = $4,900 Net Income = F F = $4,900 – $2,700 = $2,200 Case 2 Direct materials used = G G + $4,000 + $5,000 = $18,000 G = $18,000 – $4,000 – $5,000 = $9,000 Beginning work in process inventory = H $18,000 + H – $2,000 = $20,000 H = $20,000 + $2,000 – $18,000 = $4,000 Goods available for sale = J J = $20,000 + $4,000 = $24,000 Cost of goods sold = K K = $24,000 – $2,500 = $21,500 . 1-46

Weygandt, Kimmel, Kieso, Aly

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 2-47B (Continued) (Note: Item I can only be solved after items J and K are solved.) Sales = I (I – $1,200) – K = $6,000 (I – $1,200) – $21,500 = $6,000 I = $1,200 + $21,500 + $6,000 = $28,700 Operating expenses = L $6,000 – L = $3,200 L = $2,800 (b)

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

(c)

$ 1,000 $8,300 3,000 6,000 17,300 18,300 2,500 $15,800

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

. 1-47

$22,500 1,500 $21,000 $ 1,500 15,800 17,300 1,200 16,100 4,900 2,700 $ 2,200

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 2-47B (Continued) CASE 1 (Partial) Balance Sheet Current assets Cash .............................................................. Receivables (net) .......................................... Inventories (Note 1)…………………………….. Prepaid expenses ......................................... Total current assets ..............................

$ 3,000 10,000 4,400 200 $17,600

Note 1 – Notes to Financial Statements Inventories Finished goods ............................................. Work in process ........................................... Raw materials ...............................................

. 1-48

$1,200 2,500 700

$4,400

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 2-48B (a)

RUIZ MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2009 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 labour ............................... Manufacturing overhead Plant manager’s salary ....... Indirect labour ..................... Factory utilities.................... Factory machinery amortization ..................... 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 .....

. 1-49

9,500

$ 47,000 67,500 114,500 44,200 $ 70,300 145,100 30,000 18,100 12,900 7,700 7,400 6,100 800 83,000 298,400 307,900 8,000 $299,900

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 2-48B (Continued) (b)

RUIZ MANUFACTURING COMPANY (Partial) Income Statement For the Year Ended December 31, 2009 Sales revenues Sales........................................................... 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............... Finished goods inventory, December 31 .......................................... Cost of goods sold ............................ Gross profit .......................................................

(c)

$475,000 2,500 $472,500 85,000 299,900 384,900 77,800 307,100 $165,400

RUIZ MANUFACTURING COMPANY (Partial) Balance Sheet As at December 31, 2009 Assets Current assets Cash ........................................................... Accounts receivable ................................. Inventories Finished goods .................................. Work in process ................................. Raw materials .................................... Total current assets ...................

. 1-50

$ 28,000 27,000 $77,800 8,000 44,200

130,000 $185,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 2-49B

(a) Prime costs = direct materials + direct labour Prime costs = $200,000 + $160,000 = $360,000 (b) Conversion costs = direct labour + manufacturing overhead Conversion costs = $160,000 + $128,000* = $288,000 *Manufacturing overhead = ($160,000/$10) x ($8) (c) Cost of goods manufactured = Beginning work in process inventory + total manufacturing costs1 - Ending work in process inventory 1

$200,000 + $160,000 + $128,000

. 1-51

$80,000 488,000 568,000 50,000 $518,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

PROBLEM 2-50B

(a) Let GP = Gross profit GP – non-manufacturing costs = net income GP = $50,000 + $170,000 = $220,000 (b) Let COGS = Cost of goods sold Sales – COGS = gross profit COGS = $560,000 - $220,000 = $340,000 (c) Let EFI = Ending finished goods inventory EFI = Beginning finished goods inventory + cost of goods manufactured – COGS EFI = $270,000 + $260,000 - $340,000 = $190,000 (d) Let TMC = total manufacturing costs Let BWI = Beginning work in process inventory Let EWI = Ending work in process inventory Let COGM = Cost of goods manufactured BWI + TMC – EWI = COGM $110,000 + TMC - $0 = $260,000 TMC = $370,000

. 1-52

Weygandt, Kimmel, Kieso, Aly

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 2-51B

(a) Direct costs = direct material + direct labour Dire ct costs = $500 + ($150 x 45) = $7,250 (b) Indirect costs = Overhead costs = $180 (c) Prime cost = direct costs = $7,250 (d) Conversion costs = direct labour + overhead Conversion costs = ($150 x 45) + $180 = $6,930 (e) Total job cost = direct material + direct labour + overhead Total job cost = $500 + $6,750 + $180 = $7,430

. 1-53

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 2-52B (a)

AGLER COMPANY Cost of Goods Manufactured Schedule For the Month Ended August 31, 2009 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 labour......................................... Manufacturing overhead Factory facility rent ...................... Amortization on factory equipment ................................. Indirect labour .............................. 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%

. 1-54

$ 25,000 $ 19,500 200,000 219,500 30,000 $189,500 160,000 $ 60,000 35,000 20,000 6,000 3,500 124,500 474,000 499,000 21,000 $478,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 2-52B (Continued) (b)

AGLER COMPANY Income Statement For the Month Ended August 31, 2009 Sales (net) ........................................................... 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 ............ Amortization—sales equipment ................................................ Utilities expense* ........................................ Insurance expense** ................................... Total operating expenses ................... Net income .......................................................... *$10,000 X 40% **$5,000 X 30%

. 1-55

$675,000 $ 40,000 478,000 518,000 64,000 454,000 221,000 75,000 70,000 50,000 4,000 1,500 200,500 $ 20,500

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 2-53B

(a) Cost of goods sold = $390 - $70 = $320 million (b) Total factory overhead cost = $320 - $80 - $180 = $60 million (c) Selling and administrative expenses = $70 - $22 = $48 million (d) Total product costs = $80 + $180 + $60 = $320 million (e) Total period costs = $48 million (f)

Prime cost = $80 + $180 = $260 million

(g) Conversion cost = $180 + $60 = $240 million (h) Cost of goods manufactured = $0 + $320 - $0 = $320 million

. 1-56

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 2-54B Abbreviations used: Let CON = Conversion cost Let FOH = Factory overhead costs Let PRI = Prime cost Let TMC = Total manufacturing costs BDMI is Beginning Direct Material Inventory EDMI is Ending Direct Materials Inventory (a) Calculations: Gross profit = $900,000 x 20% = $180,000 Cost of goods sold = $900,000 - $180,000 = $720,000 CON = $360,000 + (40% x CON) (0.6 x CON) = $360,000 CON = $600,000 FOH = $600,000 - $360,000 = $240,000 PRI = 70% x TMC DM + DL = 0.70(DM + DL + FOH) 1.0DM – 0.70DM = 0.70(DL + FOH) – DL 0.30DM = 0.70($360,000 + 240,000) - $360,000 DM = $200,000 Total manufacturing costs = $200,000 + $360,000 + $240,000 = $800,000 Ending WIP = 10% x TMC = 0.10 x $800,000 = $80,000 COGM = BWIP + TCM – EWIP = $68,000 + $800,000 - $80,000 = $788,000 BFI + COGM – EFI = COGS EFI = $30,000 + $788,000 - $720,000 = $98,000 EDMI = BDMI + DM Purchases – DM Used EDMI = $32,000 + $320,000 - $200,000 = $152,000

. 1-57

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 2-54B (Continued) MEDIUM-SIZED COMPANY Cost of Goods Manufactured Schedule For the month ended January 31, 2009 Work in process, beginning ................................ Direct materials Direct materials inventory, January 1 .................................. $ 32,000 Direct materials purchases .......... 320,000 Total direct materials available for use ....................... 352,000 Less: Direct materials inventory, January 31 ..................... 152,0002 Direct materials used ................................... $200,000 Direct labour......................................................... 360,000 Manufacturing overhead ..................................... 240,000 Total manufacturing costs........................... Total cost of work in process ............................. Less: Work in process, ending .......................... Cost of goods manufactured .............................. (b) Inventories destroyed: Finished goods

$98,0001

Work in process Direct materials Total

80,0003 152,0002 $330,000

. 1-58

$ 68,000

800,000 868,000 80,0003 $788,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO CASES CASE 2-55 Calculations to complete the data for operations in 2009: Raw materials1 inventory, beginning ...................... $13,000 Raw material purchased .......................................... 13,000 Raw materials available for use .............................. 26,000 Direct materials used .............................................. 20,000 Raw materials inventory, ending ............................ $ 6,000 1

Assume all raw materials are used as direct materials

Direct materials ........................................................ $20,000 Direct labour ............................................................ 25,000 Factory overhead ..................................................... 8,000 Manufacturing costs added during the year .......... $53,000 Work in process inventory, beginning ................... $ 8,000 Manufacturing costs ................................................ 53,000 Total work in process during the year .................... 61,000 Less: Work in process inventory, ending ............. 7,000 Cost of goods manufactured................................... $54,000 Finished goods inventory, beginning ..................... $ 6,000 Plus: Cost of goods manufactured ........................ 54,000 Cost of goods available for sale ............................. 60,000 Less: Cost of goods sold ....................................... 55,000 Finished goods inventory, ending .......................... $ 5,000 Sales ($9,000 + $55,000) .......................................... $64,000 Less: Cost of goods sold (given) ........................... 55,000 Gross profit (given) .................................................. 9,000 Less: Operating expenses ($9,000 – ($4,000)) ...... 13,000 Operating income (loss) .......................................... $ (4,000) . 1-59

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 2-55 (Continued) BYDO INC Cost of Goods Manufactured Schedule For the Year Ended December 31, 2009 Work in process, beginning Direct materials: Raw materials inventory, beginning Plus: Raw materials purchases Total raw materials available for use Less: Raw materials inventory, ending Direct materials used Direct labour Manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process, ending Cost of goods manufactured

$8,000 $13,000 13,000 26,000 6,000 20,000 25,000 8,000 53,000 61,000 7,000 $54,000

BYDO INC Schedule of Cost of Goods Sold For the Year Ended December 31, 2009 Finished goods inventory, beginning Plus: Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, ending Cost of goods sold

$ 6,000 54,000 60,000 5,000 $55,000

BYDO INC Income Statement For the Year Ended December 31, 2009 Sales Less: Cost of goods sold Gross profit Less: Operating expenses Operating income (loss)

$64,000 55,000 9,000 13,000 $(4,000)

. 1-60

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 2-56 (a) Direct materials inventory, beginning ............. Plus: Direct materials purchased .................... Direct materials available for use .................... Less: Direct materials inventory, ending ....... Direct materials used in production

$ 6,000 18,000 24,000 10,000 $14,000

(b) Finished goods inventory, beginning ............. Plus: Cost of goods manufactured ................. Cost of goods available for sale ...................... Less: Finished goods inventory, ending ....... Cost of goods sold ...........................................

$12,000 26,5003 38,5002 2,500 $36,0001

Sales of $60,000 x (100% - 40% Gross profit) = $36,000 $36,000 + $2,500 = $38,500 3 $38,500 - $12,000 = $26,500 2

(c) Finished goods inventory, beginning .............. Cost of goods manufactured ........................... Cost of goods available for sale ......................

$12,000 28,0004 $40,000

Work in process inventory, beginning ............ Plus: Direct materials used ............................. Plus: Conversion costs ................................... Total cost of work in process .......................... Less: Work in process inventory, ending ...... Cost of goods manufactured ...........................

$ 2,000 20,000 22,000 44,000 16,0006 $28,0005

$40,000 - $12,000 = $28,000 Cost of goods manufactured = $28,000 from point (4) 6 ($2,000 + $20,000 + $22,000) - $28,000 = $16,000 5

Note: What we are looking for here is the "cost of goods manufactured" (which is footnote 3). In order to calculate this, we need to calculate "cost of goods available for sale" (which is footnote 2). In order to calculate this, we need to know "cost of goods sold," which we can calculate from the information provided (footnote 1). . 1-61

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 2-57 (a) Sayers Manufacturing Cost of Goods Manufactured Schedule For the Month ended January 31, 2009 Work in process, beginning Direct materials: Direct materials inventory, beginning Plus: Direct materials purchases Total direct materials available for use Less: Direct materials inventory, ending Direct materials used Direct labour Manufacturing overhead1 Total manufacturing costs Total cost of work in process Less: Work in process, ending Cost of goods manufactured 1

$ 110,000 $ 80,000 900,000 980,000 90,000 890,000 710,000 386,600 1,986,600 2,096,600 74,600 $2,022,000

$75,000 + $50,000 + $125,000 + $92,500 + $2,800 + $10,000 + $31,300

(b) Sayers Manufacturing Schedule of Cost of Goods Sold For the Month Ended January 31, 2009 Finished goods inventory, beginning Plus: Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, ending Cost of goods sold

. 1-62

95,000 2,022,000 2,117,000 108,000 $2,009,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 2-58 (a) Direct costs of production Indirect costs of production Total costs of production

$220.00 180.00 $400.00

(b) Direct materials, beginning Plus: Direct material purchased Total material available for use Less: Direct materials, ending Direct materials used

$ 50.00 140.00 190.00 80.00 $110.00

$220.00 110.00 $110.00

(d) Total variable costs of production1 Less: direct costs of production Variable overhead costs

$280.00 220.00 $ 60.00

Includes DM, DL, VOH

(e) Total indirect costs of production2 Less: variable overhead costs Fixed manufacturing overhead 2

$180.00 60.00 $120.00

Indirect costs are overhead costs – both variable and fixed

(f) Work in process, beginning Plus: Manufacturing costs Direct material Direct labour Variable manufacturing overhead Fixed manufacturing overhead Total work in process cost Less: Work in process, ending Cost of goods manufactured . 1-63

$140.00 $110.00 110.00 60.00 120.00

400.00 540.00 180.00 $360.00

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 2-58 (Continued)

(g)

Finished goods inventory, beginning Plus: Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, ending Cost of goods sold

$240.00 360.00 600.00 250.00 $350.00

(h)

Direct Labour Variable manufacturing overhead Fixed manufacturing overhead Total conversion costs

$110.00 60.00 120.00 $290.00

(i)

Direct materials Direct labour Total prime costs

$110.00 110.00 $220.00

(j)

Period costs = Selling and administrative costs

$210.00

. 1-64

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 2-59

Raw materials inventory, beginning .......................$ 19,000 Plus: Raw material purchased ............................... 345,000 Raw materials available for use .............................. 364,000 Less: Raw materials used in production ............... 350,000 Raw materials inventory, ending ............................$ 14,000 Direct materials ........................................................$350,000 Direct labour ............................................................ 240,000 Factory overhead ($240,000 X 60%) ........................ 144,000 Manufacturing costs added during the year ..........$734,000 Cost of goods available for sale .............................$770,000 Less: finished goods inventory, beginning........... 38,000 Cost of goods manufactured...................................$732,000 Work in process inventory, beginning ...................$ 25,000 Manufacturing costs ................................................ 734,000 Total work in process during the year .................... 759,000 Less: Cost of goods manufactured ....................... 732,000 Work in process inventory, ending ......................... $ 27,000 Sales ($9,000 + $55,000) .......................................... $1,260,000 Less: Gross profit ($1,260,000 X 40%) ................... 504,000 Cost of goods manufactured................................... $ 756,000 Cost of goods available for sale ............................. $770,000 Less: cost of goods manufactured ........................ 756,000 Finished goods inventory, ending .......................... $ 14,000

. 1-65

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 2-60 (a) The stakeholders in this situation are: • • • •

The users of Robbin Industries’ financial statements. Wayne Terrago, controller. The vice-president of finance. The president of Robbin 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 shortterm personal or company need and thus create misleading financial statements would be unethical. Selecting one acceptable method of accounting and reporting among various acceptable methods is not necessarily unethical. (c) Ethically, the management of Robbin Industries should be trying to report the financial condition and results of operations as fairly as possible; that is, in accordance with GAAP. Wayne 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.

. 1-66

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-2

(1)

Waterways Corporation Schedule of Cost of Goods Manufactured For the Month of November, 2009

Work in process, beginning Direct materials Raw materials inventory, beginning

$52,900 $38,000

Raw material purchases Total raw materials available for use

185,400 223,400

Less: Raw materials inventory, ending Direct materials used Direct labour Manufacturing overhead Amortization--factory equipment Factory supplies used Factory utilities Indirect labour Rent--factory equipment

52,700

Repairs--factory equipment

$170,700 22,000 16,800 16,850 10,200 48,000 47,000 4,200

143,050

Total manufacturing costs Total cost of work in process

335,750 388,650

Less: Work in process, ending Cost of goods manufactured

42,000 $346,650

. 1-67

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

(2)

Weygandt, Kimmel, Kieso, Aly

Waterways Corporation Income Statement For the Month of November, 2009 Sales Cost of goods sold: Finished goods inventory, beginning Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, ending Gross profit Operating expenses: Advertising expenses Sales commissions Amortization--office equipment Office supplies expense Other administrative expenses Salaries Net income

. 1-68

$1,350,000 $72,550 346,650 419,200 68,300

54,000 40,500 2,500 1,400 72,000 325,000

350,900 999,100

495,400 $503,700

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

(3)

Weygandt, Kimmel, Kieso, Aly

Waterways Corporation Balance Sheet (partial) November 30, 2009 Current assets Cash Accounts receivable Inventories Raw materials inventory Work in process inventory Finished goods inventory Prepaid expenses Total current assets

$260,000 295,000 $52,700 42,000 68,300

. 1-69

163,000 41,250 $759,250

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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Legal Notice

. 1-70

CHAPTER 3 Job Order Costing ASSIGNMENT CLASSIFICATION TABLE Exercises

A Problems

B Problems

1, 2, 3, 4

9, 10, 11, 12, 14, 15, 16, 17, 19

22, 23, 24, 25, 27, 28, 30

31, 32, 33, 34, 37, 38, 39

7, 8, 9, 10, 11, 12

9, 10, 11, 14, 15, 16, 18, 20

22, 23, 24, 25, 27, 28, 30

31, 32, 33, 34, 37, 38, 39

Indicate how the predetermined overhead rate is determined and used.

13, 14, 15

10, 11, 13, 14, 15, 16, 19, 20, 21

22, 23, 24, 25, 26, 27, 28, 29, 30

31, 32, 33, 34, 35, 36, 37, 38, 39

Prepare entries for jobs completed and sold.

10, 11, 12, 14, 15, 16, 17, 18, 19

23, 24, 25, 26, 28, 30

31, 32, 34, 36, 37, 38, 39

Distinguish between underapplied and overapplied manufacturing overhead.

17, 18

13, 20, 21

23, 24, 26, 27, 29, 30

31, 32, 34, 35, 36, 37, 38, 39

Study Objectives

Questions

Explain the characteristics and purposes of cost accounting.

1, 2, 3, 4

Describe the flow of costs in a job order cost accounting system.

5, 6,

Explain the nature and importance of a job cost sheet.

Brief Exercises

. 3-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description

Difficulty Level

Time Allotted (min.)

Calculate the predetermined overhead rate and job costs for a service organization

Simple

20-30

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 a cost of goods manufactured schedule.

Simple

30−40

Calculate the predetermined overhead rate and proration of overhead.

Moderate

30−40

Analyze a job-order cost system and calculate work in process.

Challenging

30−40

Prepare T accounts in a comprehensive manufacturing job-order cost system and compare process costing.

Simple

20-30

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

Simple

20-30

Analyze manufacturing accounts and determine missing amounts.

Challenging

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 a partial income statement.

Moderate

30−40

Compute the predetermined overhead rate and a job cost.

Simple

20-30

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

Simple

30-40

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

Simple

20-30

Prepare entries and close out under- or overapplied overhead.

Moderate

20-30

Calculate various job costs in comprehensive manufacturing system.

Challenging

30-40

. 3-2

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number Description

Difficulty Level

Time Allotted (min.)

Analyze manufacturing accounts and determine missing amounts

Challenging

30-40

Calculate job costs and inventories, and prepare an income statement for a service organization

Moderate

30-40

. 3-3

Study Objective

Knowledge Comprehension

For Instructor Use Only

1. Explain the characteristics and purposes of cost accounting. 2. Describe the flow of costs in a job order cost accounting system.

Application

Analysis

Q1, Q2, Q3, Q4 Q5, Q6.

BE1

BE2, BE3, BE4

E12

E9, E10, E11, E14, E15, E16, E17, E19

P24, P27, P28, P30

P22, P23, P25

P32, P38, P39

P31, P33, P34, P37 3. Explain the nature and importance of a job cost sheet.

Q7, Q8, Q9, Q10 Q11, Q12

BE5

P24, P27, P28, P30

E9, E10, E11, E14, E15, E16, E18, E20

P32, P38, P39

P22, P23, P25 P31, P33, P34, P37 4. Indicate how the predetermined overhead rate is determined and used.

Q15

Q13, Q14

BE6

E13

E10, E11, E14, E15, E16, E19, P24, P27, P28, P30 E20, E21 P22, P23, P25, P26, P29

P32, P38, P39

P31, P33, P34, P35, P36, P37 5. Prepare entries for jobs completed and sold.

Q16

BE7

E12

E10, E11, E14, E15, E16, E17, P24, P28, P30 E18, E19 P23, P25, P26

P32, P38, P39

P31, P34, P36, P37 6. Distinguish between underapplied and overapplied manufacturing overhead.

Q17, Q18 BE8

E20, E21

E13

P23, P25, P26

P24, P28, P30

P31, P34, P35, P36, P37

P32, P38, P39

Synthesis

Evaluation

BLOOM’ S TAXONOMY TABLE

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

3-3

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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. Unit costs are determined by dividing the total cost of the job by the number of units produced. 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. Unit costs in a process costing system are determined by dividing the total processing costs for a certain period of time by the number of units produced during that time. (b) A company may 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 labour costs are time tickets and time cards.

Disagree. Entries to Manufacturing Overhead are also made periodically during an accounting period. For example, there will be adjusting entries for factory amortization, property taxes, and insurance. . 3-5

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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Questions Chapter 3 (Continued) 9.

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

Labour XX XX XX

Work in Process Inventory Manufacturing Overhead Factory Labour

XX XX XX

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 labour, 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 labour 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.

Tina is incorrect. There is a difference in computing total manufacturing costs. In job order costing, manufacturing overhead applied is used, whereas in Chapter 2, 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.

. 3-6

Factory Labour (2) Factory labour (5) Factory labour incurred used

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

Cost of Goods Sold (8) Cost of goods sold

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

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

SOLUTIONS TO BRIEF EXERCISES

For Instructor Use Only

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

BRIEF EXERCISE 3-1

3-7

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BRIEF EXERCISE 3-2 Jan. 31 31

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

4,000

Factory Labour ..................................................... Factory Wages Payable ................................ Employer Payroll Taxes Payable .................

5,000

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

2,000

4,000 4,200 800 2,000

BRIEF EXERCISE 3-3 Jan. 31

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

2,800 600 3,400

BRIEF EXERCISE 3-4 Jan. 31

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

4,200 800 5,000

BRIEF EXERCISE 3-5

Date 1/31 1/31

Job 1 Direct Materials 900

Direct Labour

Date 1/31 1/31

1,200

Date 1/31 1/31

Job 3 Direct Materials 700

Direct Labour 1,400

. 1-8

Job 2 Direct Materials 1,200

Direct Labour 1,600

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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BRIEF EXERCISE 3-6 Overhead rate per direct labour cost is 160%, or ($800,000 ÷ $500,000). Overhead rate per direct labour hour is $16, or ($800,000 ÷ 50,000). Overhead rate per machine hour is $8, or ($800,000 ÷ 100,000). BRIEF EXERCISE 3-7 Jan. 31

Feb. 28

Mar. 31

Work in Process Inventory ............................. Manufacturing Overhead ........................ ($40,000 X 90%)

36,000

Work in Process Inventory ............................. Manufacturing Overhead ........................ ($30,000 X 90%)

27,000

Work in Process Inventory ............................. Manufacturing Overhead ........................ ($50,000 X 90%)

45,000

36,000

27,000

45,000

BRIEF EXERCISE 3-8 Dec. 31

Dec. 31

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

1,500

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

900

. 1-9

1,500

900

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SOLUTIONS TO EXERCISES EXERCISE 3-9 (a) Factory Labour ........................................................ Factory Wages Payable .................................. Employer Payroll Taxes Payable.................... Employer Fringe Benefits Payable .................

72,000

(b) Work in Process Inventory ($72,000 X 85%) ......... Manufacturing Overhead ........................................ Factory Labour ................................................

61,200 10,800

60,000 8,000 4,000

72,000

EXERCISE 3-10 (a) May 31

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

10,400 800

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

12,500 1,200

Work in Process Inventory .................... ($12,500 X 80%) Manufacturing Overhead ...............

10,000

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

7,920

11,200

13,700

10,000 7,920

($2,000 + $2,500 + $1,900 + $1,520)*

*$1,900 X 80% (b) May 1 Balance 31 31 31 May 31 Balance

Work in Process Inventory 3,200 May 31 10,400 12,500 10,000 28,180

. 1-10

7,920

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EXERCISE 3-10 (Continued)

Job No. 430 431

Beginning Work In Process $1,200 0 $1,200

Job Cost Sheets Direct Direct Manufacturing* Material Labour Overhead $3,500 $ 3,000 $2,400 4,400 7,600 6,080 $7,900 $10,600 $8,480

Total $10,100 18,080 $28,180

*Direct labour X .80 EXERCISE 3-11 (a) 1.

$15,500, or ($5,000 + $6,000 + $4,500).

2. Last year 75%, or ($4,500 ÷ $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 Labour ..................................

12,000

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

9,600

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

45,100

EXERCISE 3-12 (a) + $50,000 + $42,500 = $155,650 (a) = $63,150 $155,650 + (b) = $201,500 (b) = $45,850 $201,500 – (c) = $192,300 (c) = $9,200 . 1-11

8,000 12,000 9,600 45,100

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EXERCISE 3-12 (Continued) [Note: The instructions indicate that manufacturing overhead is applied on the basis of direct labour 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 $120,000 (d) = $102,000 $83,000 + $120,000 + $102,000 = (e) (e) = $305,000 $305,000 + $15,500 = (f) (f) = $320,500 $320,500 – $11,800 = (g) (g) = $308,700 [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 3-13 (a) $2.44 per machine hour ($305,000 ÷ 125,000). (b) ($322,000) – ($2.44 x 130,000 Machine Hours) $322,000 – $317,200 = $4,800 underapplied (c) Cost of Goods Sold .................................................. Manufacturing Overhead ..................................... . 1-12

4,800 4,800

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EXERCISE 3-14 (a) (1) The source documents are: Direct materials—Materials requisition slips. Direct labour—Time tickets. Manufacturing overhead—Predetermined overhead rate. (2) The predetermined overhead rate is 125% of direct labour 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 labour ................................................................. Manufacturing overhead..............................................

$4,825 1,360 1,700 $7,885

The unit cost is $3.94 ($7,885 ÷ 2,000). (b) July 31

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

7,885 7,885

EXERCISE 3-15 1. 2.

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

46,300

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

29,200 6,800

Factory Labour .............................................................. Factory Wages Payable ......................................... Employer Payroll Taxes Payable ..........................

53,900

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

48,000 5,900

. 1-13

46,300

36,000 49,000 4,900

53,900

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EXERCISE 3-15 (Continued) 5. 6. 7. 8.

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

80,500

Work in Process Inventory ($48,000 X 150%) ...... Manufacturing Overhead ...............................

72,000

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

88,000

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

103,000

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

75,000

80,500 72,000 88,000 103,000 75,000

EXERCISE 3-16 1.

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

192,000

Factory Labour ....................................................... 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 Labour ...............................................

80,000 7,300

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

39,500

192,000 87,300

158,000

87,300 39,500

Manufacturing Overhead ....................................... 14,550 Accumulated Amortization—Machinery & Equipment ….. 14,550

. 1-14

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EXERCISE 3-16 (Continued) 5.

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

64,000

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

234,430

64,000

234,430

Computation of cost of jobs finished:

Job A20 A21 A23

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

Direct Labour $18,000 22,000 25,000

Manufacturing Overhead $14,400 17,600 20,000

Total $ 67,640 82,520 84,270 $234,430

EXERCISE 3-17 (a)

HANNIFAN MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2009 Work in process, May 1 ........................................ Direct materials used ........................................... Direct labour ......................................................... Manufacturing overhead applied ......................... Total manufacturing costs ........................... Total cost of work in process .............................. Less: Work in process, May 31 ........................... Cost of goods manufactured ...............................

. 1-15

$ 14,700 $62,400 32,000 40,000 134,400 149,100 17,900 $131,200

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EXERCISE 3-17 (Continued) (b)

HANNIFAN MANUFACTURING COMPANY (Partial) Income Statement For the Month Ended May 31, 2009 Sales ................................................................... 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 ........................................................

$200,000 $ 12,600 131,200 143,800 9,500 134,300 $ 65,700

(c) In the May 31 balance sheet, the manufacturing inventories will be reported in current assets as follows: Finished goods ................................................... $9,500 Work in process .................................................. 17,900 Raw materials...................................................... 7,100 EXERCISE 3-18 (a) Work in Process Inventory April 30 $9,300 (#10, $5,200 + #11, $4,100) May 31 $17,600 (#11, $8,000 + #13, $4,700 + #14, $4,900) June 30 $ 8,500 (#14, $4,900 + $3,600) (b) Finished Goods Inventory April 30 $1,200 (#12) May 31 $9,600 (#10) June 30 $20,200 (#11, $11,000 + #13, $9,200)

. 1-16

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EXERCISE 3-18 (Continued) (c) Gross Profit Job Number 12 10 11/13

Month May June July

Sales $ 1,500 12,000 25,250

Cost of Goods Sold $ 1,200 9,600 20,200

Gross Profit $ 300 2,400 5,050

EXERCISE 3-19 (a) 1

(b) 2. 3. 5.

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

1,500

Work in Process ............................... Operating Overhead ......................... Supplies ..............................

720 480

Work in Process ............................... Operating Overhead ......................... Salaries Payable .................

40,000 10,000

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

40,000

Work in Process ($40,000 X 90%).... Operating Overhead ...........

36,000

Cost of Completed Work.................. Work in Process .................

70,000

Work in Process 720 70,000 40,000 36,000 6,720

. 1-17

1,500

1,200

50,000

40,000

36,000

70,000

(6)

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EXERCISE 3-20 (a)

Gonzalez Direct materials $ 600 Auditor labour costs 5,400 Applied overhead 3,960 Total cost $9,960

Navarro $ 400 6,600 4,840 $11,840

Rojas $ 200 3,375 2,475 $6,050

(b) The Gonzalez job is the only incomplete job, therefore, $9,960. (c) Actual overhead Applied overhead Balance

$12,000 (DR) 11,275 (CR) $ 725 (DR)

EXERCISE 3-21 (a) Predetermined overhead rate = Estimated overhead ÷ Estimated decorator hours = $960,000 ÷ 40,000 decorator hours = $24 per decorator hour (b) Work in Process (40,500 hrs X $24) .................... 972,000 Operating Overhead ............................... (c)

Actual overhead Applied overhead Balance

$982,800 972,000 $ 10,800 Underapplied

. 1-18

972,000

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SOLUTIONS TO PROBLEMS: SET A PROBLEM 3-22A

(a) Total estimated indirect costs ÷ Estimated direct labour hours (30 employees x 1,500 hours per employee) Overhead rate per direct labour hour

$750,000

(b) Total estimated labour costs per employee ÷ Estimated direct labour hours per employee Direct labour rate per hour

$ 75,000 1,500 $ 50.00

$ 66.67 270 $18,000

45,000 $ 16.67

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PROBLEM 3-23A (a) $1,050,000 ÷ $700,000 direct labour costs = 150% of direct labour costs (b) See solution to part (e) for job cost sheets (c) Raw Materials Inventory ............................................ Accounts Payable ..............................................

90,000

Factory Labour ........................................................... Factory Wages Payable ..................................... Employer Payroll Taxes Payable.......................

65,000

Manufacturing Overhead ........................................... Accounts Payable .............................................. Accumulated Amortization ................................ Raw Materials Inventory .................................... Factory Labour ...................................................

71,000

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

79,000

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

50,000

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

75,000

(e) See next page for postings to job cost sheets.

. 1-20

90,000 49,000 16,000 20,000 19,000 17,000 15,000

79,000

50,000

75,000

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PROBLEM 3-23A (Continued) (b)&(e) Job Cost Sheets Job No. 50 Date Direct Materials Direct Manufacturing Overhead Labour Beg. $20,000 $12,000 *$16,000* Jan. 10,000 5,000 * 7,500* $30,000 $17,000 *$23,500* Cost of completed job Direct materials .............................................................. Direct labour................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................

$30,000 17,000 23,500 $70,500

*$5,000 X 150% Job No. 51 Date Direct Materials Jan.

$39,000 $39,000

Direct Labour $25,000 $25,000

Manufacturing Overhead **$37,500** **$37,500**

Cost of completed job Direct materials .............................................................. $ 39,000 Direct labour................................................................... 25,000 Manufacturing overhead ............................................... 37,500 Total cost ............................................................................... $101,500 **$25,000 X 150% Job No. 52 Date Direct Materials Jan. $30,000 ***$20,000 X 150%

Direct Labour $20,000

. 1-21

Manufacturing Overhead ***$30,000***

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PROBLEM 3-23A (Continued)

(f)

Finished Goods Inventory ...................................... Work in Process Inventory ............................. ($70,500 + $101,500)

172,000

Cost of Goods Sold ................................................ Finished Goods Inventory .............................. ($90,000 + $70,500)

160,500

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

280,000

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

Finished Goods Inventory 90,000 160,500 172,000 101,500

172,000

160,500

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 71,000 75,000 4,000 The balance indicates that manufacturing overhead was overapplied by $4,000.

. 1-22

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PROBLEM 3-24A

(a) 1/1

12/31

Work in Process Inventory Balance (1) 128,400 Completed work (5) (c) Direct materials (2) 121,000 Direct labour (3) 139,000 Manufacturing overhead (4) 166,800 Balance 169,000

386,200

(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 48,000 $121,000

(4)

Job 7640 Job 7641 Job 7642

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

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

(b) Job 7641 Beginning balance ................................................. Direct materials...................................................... Direct labour .......................................................... Manufacturing overhead ....................................... (c) Total cost of completed work Job 7640 ................................................................ Job 7641 ................................................................

. 1-23

$ 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

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PROBLEM 3-24A (Continued) Work in process balance ............................................. Unfinished job No. 7642 .............................................. (a) Current year’s cost Direct materials ................................ Direct labour .................................... Manufacturing overhead .................

$169,000 $169,000 (a)

$ 48,000 55,000 66,000 $169,000

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

Actual overhead ............................................................ Applied overhead .......................................................... Overapplied overhead .................................................. Manufacturing Overhead .............................................. 4,800 Cost of Goods Sold ............................................... (c) Sales (given)....................................................... Cost of goods sold Add: Job 7638 ................................................... Job 7639 ................................................... Job 7641 ................................................... Less: Overapplied overhead ........................... Gross profit .......................................................

. 1-24

$120,000 14,000 20,000 8,000 $162,000 $ 43,200 57,600 66,000 $166,800 $162,000 166,800 $ 4,800

4,800 $530,000

$ 87,000 92,000 199,200 378,200 4,800

373,400 $156,600

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PROBLEM 3-25A (a) (i) Raw Materials Inventory ............................................ Accounts Payable ..............................................

3,900 3,900

Factory Labour .......................................................... Cash ....................................................................

4,800

Manufacturing Overhead........................................... Accumulated Amortization—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 Labour ...................................................

3,600 1,200

Work in Process Inventory ($3,600 X 1.25) .............. Manufacturing Overhead ...................................

4,500

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

14,740

Job

Direct Materials

Direct Labour

Manufacturing Overhead*

Total Costs

Fowler Haines Krantz

$1,700 1,300 2,200

$1,160 900 2,180

$1,450 1,125 2,725

$ 4,310 3,325 7,105 $14,740

4,800 700 400

6,400

4,800 4,500 14,740

*125% X direct labour amount Cash............................................................................ Sales ...................................................................

18,900

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

14,740

. 1-25

18,900 14,740

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-25A (Continued) (b) 6/1

6/30

Work in Process Inventory Balance 5,540 June Completed work Direct materials 4,900 Direct labour 3,600 Overhead applied 4,500 Balance 3,800

14,740

$3,800

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

$3,800

(d)

ENOS INC. Cost of Goods Manufactured Schedule For the Month Ended June 30, 2009 Work in process, June 1 .......................................... Direct materials used ............................................... Direct labour............................................................. Manufacturing overhead applied ............................ Total manufacturing costs............................... Total cost of work in process ................................. Less: Work in process, June 30............................. Cost of goods manufactured ..................................

. 1-26

$ 5,540 $4,900 3,600 4,500 13,000 18,540 3,800 $14,740

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-26A

(a)

Overhead rate = $900,000 ÷ $1,800,000 = 50% of each labour $ Now calculate under- or over-applied overhead for the year. Actual Overhead-(given) Overhead applied--($1,583,600 x 50%) Under-applied overhead

$897,000 791,800 $105,200

(b) To prorate the over-applied overhead we need the ending balances in WIP and Finished Goods Inventories and the Cost of Goods Sold.

Cost of goods sold (given) Finished goods inventory (given) WIP inventory (see below) Total

$3,935,000 720,000 1,390,000 $6,045,000

% Allocation 65.10% $ 68,485 11.91% 12,530 22.99% 24,185 $105,200

Ending Work in process inventory: 1768B 1819C Total Direct materials $220,000 $ 420,000 $ 640,000 Direct labour 110,000 390,000 500,000 Manufacturing overhead* 55,000 195,000 250,000 $385,000 $1,005,000 $1,390,000 * Direct labour amount X 50% overhead rate (c) First adjust cost of goods sold for prorated under-applied overhead. (1) Cost of goods sold Plus: under-applied overhead Adjusted cost of goods sold . 1-27

$3,935,000 68,485 $4,003,485

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-26A (Continued) NICOLE LIMITED Income Statement for the year 2008 Sales Less: Adjusted cost of goods sold Gross profit Less: Operating expenses Net income before taxes Taxes at 40% Net income

. 1-28

$6,201,355 4,003,485 2,197,870 1,857,870 340,000 136,000 $ 204,000

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PROBLEM 3-27A Direct materials used: Beginning inventory Plus: purchases Total available for use Less: ending inventory Used in production Less: indirect materials Direct materials used (1)

$79,250 95,580 (1) 174,830 73,250 101,580 5,848 $95,732

Materials purchased: Account payable, ending Plus: cash payments Less: Accounts payable, beginning Materials purchased

$53,540 60,000 113,540 17,960 $95,580

Direct labour: Total Payroll Less: indirect labour Direct labour used

$83,500 15,375 $68,125

Manufacturing overhead applied: Overhead, Nov 30 Overhead, Nov 1 Overhead incurred during the month Plus: over-applied overhead Manufacturing overhead applied

$163,300 129,500 33,800 2,750 $ 36,550

. 1-29

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-27A (Continued) Cost of goods sold: Balance Nov 30 Balance Nov 1 Cost of goods sold for the month

$656,000 576,000 $ 80,000

Cost of completed goods: Finished goods Nov 30 Plus: cost of goods sold Goods available for sale Less: finished goods Nov 1 Cost of completed goods:

$63,000 80,000 143,000 60,000 $83,000

Ending work in process: Beginning work in process Plus: Direct materials used Direct labour Manufacturing overhead applied Total manufacturing cost for the month Less: completed goods transferred out Ending work in process

$ 58,875 95,732 68,125 36,550 259,282 83,000 $176,282

. 1-30

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-28A (a) Raw Materials Inventory Beg Bal 3,500 (1) 22,400 End Bal 7,100

Work in Process Inventory Beg Bal (2) (3) (i) End Bal

18,800 (2)

Finished Goods Inventory Beg Bal 2,890 (ii) 52,450 End Bal 4,025

1,500 410 1,300 --

52,450 (ii)

Cost of Goods Sold

51,315 (iii)

(iii)

Variable Factory Overhead (3) (5) (6) End Bal

2,040 18,800 5,000 30,420 3,810

51,315

Fixed Factory Overhead (4) (5) (7) (i) End Bal

3,210 (i) --

3,000 110 22,500 1,600 --

27,210 (i) --

(b)

1 2 3 4

Job Order Costing Custom furniture shop

Process Costing Paint producer

Unique differentiated products Large number of separate operations Labour intensive Products made to customer order

All output the same or very similar Continuous operations Highly automated Standard output made for inventory

. 1-31

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-29A

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

$1,050,000 ÷ $1,500,000 = 70% of direct labour cost. $1,500,000 ÷ 125,000 = $12.00 per direct labour hour. $840,000 ÷ 120,000 = $7.00 per machine hour.

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

D $140,000 120,000 84,000* $344,000

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

K $ 78,000 37,500 72,800*** $188,300

D $89,000 84,000 $ 5,000

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

K $74,000 72,800 $ 1,200

*$120,000 X 70% **11,000 X $12.00 ***10,400 X $7.00 (c) Manufacturing Overhead Incurred Applied Under (over) applied

. 1-32

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-30A

(a) $7,600

($18,850 + $7,975 – $19,225).

(b) $36,750

[$9,750 + $15,000 + (80% X $15,000)]. (Given in other data).

($18,850 – $1,900).

(d) $7,040

($8,800 X 80%).

(e) $12,440

[Given in other data—$3,800 + $4,800 + (80% + $4,800)].

(f)

($36,750 + $16,950 + $8,800 + $7,040 – $12,440).

$57,100

(g) $5,000

(Given in other data).

(h) $57,100

(See (f) above).

(i)

$58,100

($5,000 + $57,100 – $4,000).

(j)

$4,000

(Given in other data).

(k) $12,465

(Equal to factory labour incurred).

(l)

($12,465 – $8,800).

$3,665

(m) $7,040

($6,810* + $230) or (Same as (d)).

*$1,900 + $3,665 + $1,245

. 1-33

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO PROBLEMS: SET B PROBLEM 3-31B

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

45,000

Factory Labour .......................................................... Factory Wages Payable .................................... Employer Payroll Taxes Payable......................

31,500

Manufacturing Overhead .......................................... Accumulated Amortization ............................... Raw Materials Inventory ................................... Accounts Payable ............................................. Factory Labour ..................................................

37,500

(d) Work in Process Inventory ....................................... Raw Materials Inventory ................................... ($5,000 + $20,000 + $15,000)

40,000

Work in Process Inventory ....................................... Factory Labour .................................................. ($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 24,000 7,500 12,000 10,000 8,000 7,500

40,000

24,000

See solution to part (e) for postings to job cost sheets. . 1-34

35,200

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PROBLEM 3-31B (Continued) (b)&(e) Job Cost Sheets Job No. 25 Date Direct Materials Direct Manufacturing Overhead Labour Beg. $10,000 $6,000 *$ 9,000* Jan. 5,000 3,000 * 4,400* $15,000 $9,000 *$13,400* Cost of completed job Direct materials ............................................................. Direct labour .................................................................. Manufacturing overhead ............................................... Total cost ...............................................................................

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

*$22 X 200 direct labour hours Job No. 26 Date Direct Materials Jan.

$20,000 $20,000

Direct Labour $12,000 $12,000

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

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

$20,000 12,000 17,600 $49,600

**$22 X 800 direct labour hours Job No. 27 Date Direct Materials

Direct Labour Jan. $15,000 $9,000 ***$22 X 600 direct labour hours . 1-35

Manufacturing Overhead ***$13,200***

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-31B (Continued)

(f)

Finished Goods Inventory ..................................... Work in Process Inventory ............................ ($37,400 + $49,600)

87,000

Cost of Goods Sold ............................................... Finished Goods Inventory ............................. ($45,000 + $37,400)

82,400

Accounts Receivable ............................................. Sales................................................................ ($67,000 + $74,000)

141,000

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

Work in Process 25,000 87,000 40,000 24,000 35,200 37,200

87,000

82,400

141,000

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 Labour .................................................................... Manufacturing Overhead ................................................. Total costs assigned ................................................

$15,000 9,000 13,200 $37,200

(h) Manufacturing Overhead Actual Applied 37,500 35,200 2,300 The balance in the Manufacturing Overhead account is underapplied.

. 1-36

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-32B

(a) 1/1

12/31

Work in Process Inventory Balance (1) 115,500 Completed work (5) (iii) Direct materials (2) 100,000 Direct labour (3) 138,000 Manufacturing overhead (4)172,500 Balance (6) 193,000

333,000

(1)

Job 7650 Job 7651

$ 63,000 52,500 $115,500

(3)

Job 7650 Job 7651 Job 7652

$ 30,000 40,000 68,000 $138,000

(2)

Job 7650 Job 7651 Job 7652

$ 32,000 28,000 40,000 $100,000

(4)

Job 7650 Job 7651 Job 7652

$ 37,500 50,000 85,000 $172,500

(5) (i)

Job 7650 Beginning balance ................................................. Direct materials...................................................... Direct labour .......................................................... Manufacturing overhead .......................................

(ii) Job 7651 Beginning balance ................................................. Direct materials...................................................... Direct labour .......................................................... Manufacturing overhead ....................................... (iii) Total cost of completed work Job 7650 ................................................................. Job 7651 .................................................................

. 1-37

$ 63,000 32,000 30,000 37,500 $162,500 $ 52,500 28,000 40,000 50,000 $170,500 $162,500 170,500 $333,000

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PROBLEM 3-32B (Continued) (6) Work in process balance ................................................ Unfinished job No. 7652 ................................................. (iv) Current year’s cost Direct materials ........................... Direct labour ............................... Manufacturing overhead ............

$193,000 $193,000 (iv)

$ 40,000 68,000 85,000 $193,000

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

Actual overhead ............................................................. Applied overhead ........................................................... Underapplied overhead ................................................. Cost of Goods Sold ....................................................... 3,000 Manufacturing Overhead ....................................... (c) Sales (given)..................................................... Cost of goods sold Add: Job 7648 ................................................. Job 7649 ................................................. Job 7650 ................................................. Add: Underapplied overhead ......................... Gross profit ...................................................... . 1-38

$126,000 12,000 18,000 19,500 $175,500 $ 37,500 50,000 85,000 $172,500 $175,500 172,500 $ 3,000

3,000 $490,000

$ 98,000 62,000 162,500 322,500 3,000

325,500 $164,500

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-33B (a) First determine the total estimated manufacturing overhead costs for the year. Rent on factory building Amortization on factory equipment Indirect labour Production supervisor’s salary Total estimated MOH costs Predetermined overhead rate

$150,000 80,000 120,000 150,000 $500,000

Estimated annual overhead costs Expected annual operating activity

= $500,000 ÷ 40,000 machine hours = $12.50 per machine hour (b) Direct labour rate = $2,000,000 ÷ 20,000 labour hours = $100 per direct labour hour (c) Total cost of the job would be: Direct materials Direct labour Manufacturing overhead (200 hrs x $12.50) Total cost of the job

. 1-39

$15,000 5,000 2,500 $22,500

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PROBLEM 3-34B (a) (i) Raw Materials Inventory ........................................... Accounts Payable .............................................

5,000 5,000

Factory Labour .......................................................... Cash ...................................................................

7,600

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

1,400

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

5,800 1,500

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

5,600 2,000

Work in Process Inventory ....................................... ($5,600 X .75) Manufacturing Overhead ..................................

4,200

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

20,525

Job

Direct Materials

Direct Manufacturing Labour Overhead*

Total Costs

Looper Carpenter Ingle

$3,000 2,600 3,200

$2,400 2,200 2,100

$ 7,200 6,450 6,875 $20,525

$1,800 1,650 1,575

*75% of direct labour amount

. 1-40

7,600

1,400

7,300

7,600

4,200

20,525

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PROBLEM 3-34B (Continued) Cash ........................................................................... Sales (3 X $12,500) ............................................

37,500

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

20,525

(b) 5/1

5/31

37,500 20,525

Work in Process Inventory Balance 12,400 5/31 Completed work Direct materials 5,800 Direct labour 5,600 Overhead applied 4,200 Balance 7,475

20,525

$7,475

Job: Bennett (Direct materials $2,400 + Direct labour $2,900 + Manufacturing overhead $2,175) ................................. $7,475 (d)

CHRIS DUNCAN COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2009 Work in process, May 1 ........................................... Direct materials used .............................................. Direct labour ............................................................ Manufacturing overhead applied ............................ Total manufacturing costs .............................. Total cost of work in process ................................. Less: Work in process, May 31 .............................. Cost of goods manufactured ..................................

. 1-41

$12,400 $5,800 5,600 4,200 15,600 28,000 7,475 $20,525

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-35B

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

$900,000 ÷ $600,000 = 150% of direct labour cost. $800,000 ÷ 40,000 = $20.00 per direct labour hour. $750,000 ÷ 125,000 = $6.00 per machine hour.

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

A $ 92,000 48,000 72,000 * $212,000

Department B $ 86,000 35,000 70,000** $191,000

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

A $76,000 72,000 $ 4,000

Department B $75,000 70,000 $ 5,000

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

*$48,000 X 150% **3,500 X $20 ***12,600 X $6.00 (c) Manufacturing Overhead Incurred Applied Under (over) applied

. 1-42

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PROBLEM 3-36B (a) Work in process ......................................................... Raw materials inventory ....................................

13,000

Work in process ......................................................... Factory Labour ...................................................

20,000

Work in process ......................................................... Manufacturing Overhead ................................... (Overhead rate = $1,800 ÷ $1,200 = 150% of labour cost; $20,000 x 150% = $30,000)

30,000

Manufacturing Overhead........................................... Various accounts ...............................................

28,000

Finished goods .......................................................... Work in process .................................................

66,750

Calculation of finished goods: Beginning inventory, Work in process Plus: Raw materials Direct labour Manufacturing overhead Total manufacturing costs Ending inventory, Work in process Cost of goods manufactured (1) Order 12A Raw materials Direct labour Overhead ($1,000 x 150%)

Cost of goods sold .................................................... Finished goods...................................................

. 1-43

13,000 20,000 30,000

28,000 66,750

$ 7,400 13,000 20,000 30,000 70,400 3,650 (1) $ 66,750

$ 1,150 1,000 1,500 $ 3,650

63,450 63,450

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PROBLEM 3-36B (Continued) Calculation of cost of goods sold Beginning inventory, Finished goods Plus: Cost of goods manufactured Cost of goods available for sale Less: Ending inventory, Finished goods Cost of goods sold

$ 66,750 66,750 3,300 $ 63,450

Manufacturing Overhead ................................................. Cost of goods sold ............................................ Overhead incurred (given) Overhead applied: ($20,000 x 150%) Over-applied overhead

. 1-44

$28,000 $30,000 $ 2,000

2,000 2,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-37B (a) Check the relationship between direct labour and factory overhead applied for several of the jobs to see what the overhead rate is: Job 43: $288 ÷ $360 = 80% of direct labour cost. Job 44: $792 ÷ $990 = 80% of direct labour cost. Job 47: $680 ÷ $850 = 80% of direct labour cost. The predetermined overhead rate is 80% of direct labour costs. (b)

Total factory overhead applied Less: beginning overhead Overhead applied during the month Less: over-applied overhead Total factory overhead incurred

(1)

(c)

(d)

Work in process, beginning Less: direct labour Less: overhead applied ($150 x 80%) Direct material

$2,832 120 (1) 2,712 600 $2,112

$570 150 120 $300

Direct materials shown on the job sheets (Jobs 43 to 48) Less: Direct materials in beginning WIP Direct materials put into production in June

$4,190 300 (1) above $3,890

Direct labour shown on the job sheets (Jobs 43 to 48) Less: Direct labour in beginning WIP Direct labour costs incurred in June

$3,540 150 (given) $3,390

. 1-45

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-37 (Continued) (e)

(f)

Work in process inventory, June 1 Plus: manufacturing costs Direct material Direct labour Factory overhead applied Total manufacturing costs Less: Work in process inventory, June 30 Cost of goods manufactured for June Finished goods inventory, June 1 Plus: Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, June 30 Cost of goods sold

. 1-46

$ $3,890 3,390 2,712

$ 2,550 10,085 12,635 3,550 $9,085

570

9,992 10,562 477 $10,085

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-38B

(a) $78,900

($70,000 + $8,900).

(b) $30,500

[($19,000 + $90,400) – $78,900 (See (a))].

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

(d) $80,000

($104,000 manufacturing overhead applied ÷ 130%).

(e) $104,000

(Manufacturing overhead applied).

(f)

[$27,200 + $70,000 + $80,000 + $104,000 – $5,450 (See (g))].

$275,750

(g) $5,450

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

(h) $135,000

(Given in other data).

(i)

$275,750

(Same as (f)).

(j)

$267,750

[$135,000 + $275,750 – $143,000 (Given in other data)].

(k) $143,000

(Given in other data).

(l)

[$80,000 (See (d)) + $16,000].

$96,000

(m) $96,000

(Same as (l)).

(n) $82,100

[$104,000 + $3,000 (Given in other data) – $8,900 – $16,000].

. 1-47

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 3-39B (a)

Overhead rate = $267,000 ÷ 10,000 hours = $26.70 Project 80 Direct material ($80 + $120) Direct labour (40 hrs + 138 hrs) x $60/hour Overhead (40 hrs + 138 hrs) x $26.70/hour

(b)

200.00 10,680.00 4,752.60 $15,632.60

Work in Process, October 31

Materials Direct labour (at $60 per hour) Overhead (at $26.70 per DL hour)

(c)

Project 84 Project 85 $ 85.00 $ 100.00

Total $ 185.00

8,700.00

9,600.00

18,300.00

3,871.50 $12,656.50

4,272.00 $13,972.00

8,143.50 $26,628.50

PRICE-GORDON ARCHITECTURAL CONSULTANTS LTD. Income Statement for the month of October, 2009 $43,800.00 (1) 36,629.50 (2) 7,170.50 2,340.94 $ 4,829.56

Consulting revenue Less: Cost of services Gross Profit Less: Operating expenses Net Income

. 1-48

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PROBLEM 3-39B (Continued) (1)

(2)

Consulting revenue: Project 80 (178 hours at $120/hour) Project 86 (187 hours at $120/hour)

Cost of services: Project 80 (as in (a)) Project 86 Plus: under-applied overhead Adjusted cost of services

(3) Project 86 Direct material Direct labour (187 hrs x $60/hour) Overhead (187 hrs x $26.70/hour)

(4) Overhead incurred (given) Overhead applied: (138 + 145 + 160 + 187) x $26.70 Under-applied overhead

. 1-49

$21,360.00 22,440.00 $43,800.00

$15,632.60 16,362.90 (3) 31,995.50 4,634.00 (4) $36,629.50

$ 150.00 11,220.00 4,992.90 $16,362.90

$21,455.00 16,821.00 $ 4,634.00

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO CASES CASE 3-40 (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 labour 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 $15,000 per batch [($105,000 + $123,000 + $97,000 + $125,000) ÷ 30]. Another approach would be to use direct labour cost as the relevant basis to apply overhead on a predetermined basis. For example, a rate of 125% of direct labour cost ($450,000 ÷ $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 1 2 3 4 Direct materials $100,000 $220,000 $ 80,000 $200,000 Direct labour 60,000 132,000 48,000 120,000 Manufacturing overhead Applied ($15,000 X batches) 75,000 165,000 60,000 150,000 Total $235,000 $517,000 $188,000 $470,000 Production in batches Unit cost (per batch)

$47,000

. 1-50

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(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.)

. 1-51

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 3-41 (a) Using Job 22 as the basis for the calculation, Overhead rate = $5,100 ÷ $8,500 = 60% of the labour cost. (Note: Job 24 or Job 25 could have been used; the result would have been the same.)

(b)

Unit cost of Job 24: Direct Direct Materials Labour Beginning WIP $ 3,190 $ 7,210 Costs added in Oct. 410 3,500 Total $ 3,600 $ 10,710 Divide by the number of units Unit cost of Job 24

*Applied Overhead $ 4,326 2,100 $ 6,426

* $3,500 X 60% = $2,100 (c) (i) Raw Materials Inventory Beginning balance Plus Purchases Material available for use Less: Material used Ending balance

* Direct materials, Jobs 26, 27, 28 Direct materials, Jobs 22, 24, 25

$ $

. 1-52

7,800 8,500 16,300 11,540 * 4,760 8,980 2,560 11,540

TOTAL $14,726 6,010 20,736 50 $414.72

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CASE 3-42 (Continued) (ii) Work in Process Inventory Job 27 Direct materials (given) $ 3,600 Direct labour (given) 8,340 Overhead (60% of direct labour) 5,004 $16,944

Job 28 $1,200 2,910 1,746 $5,856

TOTAL $ 4,800 11,250 6,750 $22,800

(iii) Finished Goods Inventory Job 25 $13,200

From beginning WIP Plus: costs added in October Direct materials (given) Direct labour (given) Overhead (60% of direct labour)

(d)

Cost of Goods Manufactured Direct Direct Materials Labour Job 22 $ 5,150 $10,500 Job 24 3,600 10,710 Job 25 4,000 11,000 Job 26 4,180 9,200

. 1-53

1,200 4,500 2,700 $21,600

Applied Overhead $ 6,300 6,426 6,600 5,520

TOTAL $ 21,950 20,736 21,600 18,900 $ 83,186

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 3-42 (Continued) (e)

Under- or Over-applied Overhead Supervisory salaries Factory rent Amortization (machines) Indirect labour Factory supplies Property tax and insurance Benefits Total overhead incurred Less: Overhead applied ($30,450 X 60%) Under-applied overhead Cost of Goods Sold Manufacturing Overhead (1) Assumes factory site (2) 80% of total benefits costs

. 1-54

$ 4,000 2,000 3,000 5,000 1,100 1,250 2,560 18,910 18,270 $ 640 $

(1) (2)

640 $

640

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CASE 3-42 (a) (i) Overhead rate = $150,000 ÷ 12,500 = $12.00 per labour hour. (ii) Ending Work in process: Job 75 $6,150 900 1,500 1,200 (1) $9,750

From beginning WIP Plus: Direct materials Direct labour Overhead Total ending WIP (1)

100 direct labour hrs at $12/hour

(iii) Cost of Goods Manufactured Beginning Work in process (Jobs 70, 75, 80) Plus: Direct materials added Direct labour added Overhead applied Total manufacturing costs in WIP Less: Ending work in process (Job 75) Cost of goods manufactured (2)

900 hours at $12 per hour

. 1-55

$12,300 5,550 13,500 10,800 (2) 42,150 9,750 $32,400

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CASE 3-42 (Continued) (iv) Unadjusted Gross Margin: Sales Less: Cost of Goods Sold Beginning finished goods inventory Plus: Cost of goods manufactured Cost of goods available for sale Less: Ending finished goods inventory (3) Unadjusted gross margin (3)

(b)

$50,250 $ 32,400 32,400 12,300

20,100 $30,150

Job #90: $1,500 + $6,000 + (400 hrs x $12 per hour)

Raw materials inventory Cash/Accounts Payable

7,500

Work in Process Raw Material Inventory Wages Payable or Factory Labour Overhead (900 hrs x $12/hr)

29,850

Finished Goods Inventory Work in Process

32,400

Manufacturing overhead Cash/Accounts Payable

9,490

7,500

5,550 13,500 10,800

32,400

9,490

($1,500 +$2,200 + $2,490 + $1,500 + $1,800)

. 1-56

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CASE 3-42 (Continued) (c) Total overhead applied to Dec 1 (11,250 x $12) Plus: overhead applied in December (900 x $12) Total overhead applied during the year Less: Overhead incurred during the year ($160,010 + $9,490) Under-applied overhead Cost of goods sold will be increased by $23,700; therefore, net income will be decreased by $23,700.

. 1-57

$135,000 10,800 145,800 169,500 $ (23,700)

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CASE 3-43 (a) (b)

Overhead rate = $606,000 ÷ 120,000 = $5.05 per labour hour. Costs assigned to Jobs X-50, X-51, X-52: X-50 X-51 X-52 Total Beginning balance $ 54,000 $ $ $ 54,000 Material added 45,000 37,500 25,500 108,000 Labour added (1) 21,000 18,000 12,000 51,000 Overhead applied 17,675 15,150 10,100 42,925 $137,675 $70,650 $47,600 $255,925 (1) Direct labour cost Total direct labour hours Rate per hour

$51,000 8,500 $6.00

(c)

Cost of goods manufactured: Job X-50 $137,675 Job X-51 70,650 $208,325

(d)

Work in process, November 30 Job X-52 $47,600

(e)

Manufacturing overhead incurred: Supplies $12,000 Indirect labour 15,000 Supervisory salaries 6,000 Occupancy costs-factory 6,500 Factory equipment costs 8,000 Total overhead incurred 47,500 Less: overhead applied 42,925 Under-applied overhead $ 4,575

. 1-58

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CASE 3-44 (a) Costs assigned to Jobs 101 & 111: Job 101 Job 111 Prior to July: Direct materials $ 9,000 $ 600 Direct labour 2,000 100 Overhead applied 1 Added in July: Direct materials Direct labour

2,400

120

1,000

500 3,000

Overhead applied 1

1,200 $15,600

3,600 $7,920

(b)

(c)

Direct labour cost X 120% Direct Materials Inventory Beg Bal 3,000 4,900 Used Purchases 6,000 End Bal 4,100 Work in Process, ending Job 103 Job 115 Beginning balance $ 5,800 (1) $ Material added 3,600 (2) 800 Labour added 3,800 (3) 200 Overhead applied 4,560 (4) 240 $17,760 $1,240

(1) Direct Material Direct Labour Overhead applied-(120% of direct labour cost) Total . 1-59

$ 2,500 1,500 1,800 $ 5,800

Total $ 5,800 4,400 4,000 4,800 $19,000

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CASE 3-44 (Continued) (2) Total material used Less: Jobs 111 & 115 Material added to Job 103

$ 4,900 1,300 $ 3,600

(3) Total direct labour used Less: Jobs 101, 111, & 115 Labour added to Job 103

$ 8,000 4,200 $ 3,800

(4) Overhead applied = Direct labour cost X 120%

(d)

Finished Goods Inventory Beg Bal 18,000 18,000 Cost of Sales Completed* 23,520 End Bal 23,520 * Job 101, $15,600 + Job 111, $7,920

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CASE 3-45 (a) The stakeholders in this situation are:  Clara Biggio, controller for ESU Printing.  The president of ESU Printing.  The customers of ESU Printing.  The competitors of ESU Printing. (b) Padding cost-plus contracts is both unethical and illegal. Clara 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) Clara 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.

. 1-61

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-3 Answer (a)

JOB COST SHEET Quantity 244 units Job Number J57 Date Requested Dec 2 Date Completed Dec 15, 2009 Item special order parts Date 2-Dec 3-Dec 8-Dec 9-Dec 14-Dec 15-Dec

Direct Direct Materials Labour

Manufacturing Overhead Hours Rate Amount

$ 3,468 $

2 1/2

398 * $

995

398

1,194

398

1,194

800 2,400

Cost Summary Direct materials $ 6,668 Direct labour 240 Manufacturing overhead 3,383 Total Cost $ 10,291 Unit Cost ($10,249/244 units) $42.18 * 840,576  2,112

. 1-62

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JOB COST SHEET Quantity 142 units Job Number K52 Date Requested Dec 2 Date Completed Dec 15, 2007 Item special order parts Date 2-Dec 3-Dec 8-Dec 9-Dec 14-Dec 15-Dec

Direct Direct Materials Labour $ 1,734 $

398

796

398

796

398

796

400 1,200

Cost Summary Direct materials Direct labour Manufacturing overhead Total Cost Unit Cost ($5,821/142 units) •

Manufacturing Overhead Hours Rate Amount

840,576  2,112

. 1-63

$ 3,334 120 2,388 $ 5,842 $ 41.14

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(b)

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GENERAL JOURNAL DEBIT

Dec 1 Raw Materials Inventory Accounts Payable (Purchase of raw materials on account)

50,320

Dec 2 Work in Process Inventory Raw Materials Inventory (To assign materials to jobs J57 & K52)

5,202

Dec 2 Work in Process Inventory Manufactu ring Overhead Raw Materials Inventory (To assign materials to jobs and overhead)

40,000 3,000

50,320

5,202

43,000

Dec 3 Work in Process Inventory Factory Labour (To assign labour to jobs J57 & K52)

120

Work in Process Inventory Dec 3 Manufacturing Overhead (To assign overhead to jobs J57 & K52)

1,791

Dec 8 Work in Process Inventory Raw Materials Inventory (To assign materials to jobs J57 & K52)

1,200

Dec 9 Work In Process Inventory Factory Labour (To assign labour to jobs J57 & K52)

120

Dec 9 Work in Process Inventory Manufacturing Overhead (To assign overhead to jobs J57 & K52)

1,990

Dec 12 Factory Labour Cash (To record factory labour costs and payment)

64,000

. 1-64

CREDIT

120

1,791

1,200

120

1,990

64,000

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Dec 13 Manufacturing Overhead Cash (To record payment of factory water bill)

9,000

Dec 14 Work in Process Inventory Raw Materials Inventory (To assign materials to jobs J57 & K52)

3,600

Dec 15 Work In Process Factory Labour (To assign labour to jobs J57 & K52)

120

Dec 15 Work in Process Inventory Manufacturing Overhead (To assign overhead to jobs J57 & K52) Dec 15 Finished Goods Inventory Work in Process Inventory (To record completion of jobs J57 & K52)

9,000

3,600

120

1,990 1,990 16,070 16,070

Dec 18 Finished Goods Inventory Work in Process Inventory (To record completion of jobs)

49,000

Dec 21 Manufacturing Overhead Cash (To record payment of factory electric bill)

12,000

Dec 31 Manufacturing Overhead Property Taxes Payable Prepaid Insurance Accumulated Amortization (To record overhead costs)

36,800

. 1-65

49,000

12,000

12,000 8,000 16,800

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3,500

(d)Since production involved the use of machinery that required minimal labour, using machine hours as the cost driver for producing the screens would more accurately reflect the overhead costs than would direct labour. When the irrigation system is installed, this would require a great deal of labour and minimal machinery. Therefore, the cost driver for overhead costs would more likely be direct labour costs.

. 1-66

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Legal Notice

. 1-67

CHAPTER 4 Process Costing ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

A Problems

B Problems

1, 2, 3

15, 17

36, 37

10, 11, 12, 13

5, 10

16, 18, 19, 20, 21, 22, 23, 25, 26, 27

33, 34, 35, 37, 38, 39, 40, 41

46, 47, 48, 50, 51, 53, 54, 55

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

8, 9, 14, 15, 18, 21, 22

4, 6, 7, 8, 9

16, 18, 19, 20, 21, 22, 23, 25, 26, 27, 28, 29, 30, 31

33, 34, 35, 37, 38, 39, 41, 42, 43, 44

45, 46, 47, 48, 50, 51, 53, 54

* 7.

Prepare a production cost report.

16, 17

20, 24, 25,

34, 35, 37, 38, 39, 40, 41, 43, 44

46, 48, 50, 51, 53, 54, 55

* 8.

Prepare a production cost report for a sequential department setting.

11, 12, 13

28, 29, 30, 31, 32

37, 42

45, 49, 56

* 9.

Calculate equivalent units using the FIFO method (Appendix).

21, 22

11, 12, 13

31, 32

42, 43, 44

45, 47, 48, 56

Study Objectives

Questions

Understand who uses process cost systems.

1, 2, 20

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

2, 3, 4, 5

Explain the flow of costs in a process cost system.

5, 6

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

6, 7

Calculate equivalent units using the weighted-average method.

. 4-1

Exercises

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

33A

Calculate equivalent units, unit costs, and costs assigned.

Simple

10-15

34A

Complete four steps necessary to prepare a production cost report.

Simple

30-40

35A

Complete four steps necessary to prepare a production cost report.

Simple

50-60

36A

Journalize transactions.

Simple

20-30

37A

Determine assignment of costs

Moderate

38A

Assign costs and prepare a production cost report

Simple

30-40

39A

Determine equivalent units and unit costs and assign costs.

Moderate

35-45

40A

Compute equivalent units and complete production cost report.

Moderate

20-30

41A

Determine assignment of costs

Moderate

20-30

42A

Determine assignment of costs using FIFO.

Simple

20-30

43A

Determine assignment of costs using FIFO.

Moderate

35-45

44A

Determine equivalent units and unit cost, and prepare a production cost report using FIFO.

Moderate

50-60

45B

Analyze a process costing system and calculate equivalent units and unit costs.

Moderate

50-60

46B

Calculate equivalent units, unit costs, and costs assigned.

Moderate

25-35

47B

Calculate equivalent units, unit costs, and costs assigned with FIFO.

Moderate

25-35

48B

Prepare a production cost report using FIFO.

Challenging

35-45

49B

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

Moderate

50-60

. 4-2

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

Difficulty Level

Time Allotted (min.)

50B

Complete four steps necessary to prepare a production cost report.

Simple

35-45

51B

Complete four steps necessary to prepare a production cost report.

Simple

50-60

52B

Journalize transactions.

Simple

20-30

53B

Assign costs and prepare a production cost report

Moderate

40-50

54B

Determine equivalent units and unit costs and assign costs.

Moderate

50-60

55B

Compute equivalent units and complete production cost report.

Challenging

30-40

56B

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

Moderate

50-60

. 4-3

Study Objective

Knowledge Comprehension

Application

Analysis

For Instructor Use Only

1. Understand who uses process cost systems.

Q1, Q2

Q20, E14

* 2. Explain the similarities and differ- Q2, Q3 ences between job order cost and process cost systems. * 3. Explain the flow of costs in a pro- Q6 cess cost system.

Q4, Q5, E14

E16, P36, 952

* 4. Make the journal entries to assign Q6 manufacturing costs in a process cost system.

Q7, BE1, BE2, BE3, E15, E17, P36, P37, P52

* 5. Calculate equivalent units using the weighted-average method.

Q10, Q11

Q12, Q13, BE5, BE10, E16, P33, P34, P35, E18, E19, E20, E21, E22, P46, P47, P50, E23, E25, E26, E27, P37, P51 P38, P39, P40, P41, P48, P53, P54, P55

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

Q14, Q15, Q18, Q21, Q22, P33, P34, P35, BE4, BE6, BE7, BE8, BE9, P42, P46, P47, E16, E18, E19, E20, E21, P50, P51 E22, E23, E25, E26, E27, E28, E29, E30, E31, P37, P38, P39, P41, P43, P44, P45, P48, P53, P54

7. Prepare a production cost report.

Q17

Q16

BE12, E20, E24, E25, P37, P34, P35, P46, P38, P39, P40, P41, P43, P47, P50, P51 P44, P48, P53, P54, P55

8. Prepare a production cost report for a sequential department setting.

Q19

9. Calculate equivalent units using the FIFO method. (Appendix)

BE11, BE12, BE13, E28, E29, E30, E31, E32, P37, P45, P49, P56

P42

Q21, Q22, BE11, BE12, P42, P47 BE13, E31, E32, P43, P44, P45, P48

Synthesis

Evaluation

BLOOM’ S TAXONOMY TABLE

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

4-3

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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.

Mel 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 production costs per unit, 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. This involves determining the amount of work completed on unfinished units in ending inventory.

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Questions Chapter 4 (Continued) 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). 13.

Units transferred out Work in process 800 X 100% 800 X 20% Total equivalent units 14. Units transferred out were 3,300. 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 (a) (b) 15. (a) (b)

Equivalent Units Materials Conversion Costs 12,000 12,000 800 12,800

160 12,160

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

The cost of the units transferred out is $126,000, or (14,000 X $9). The cost of the units in ending inventory is $9,000, or [(2,000 X $3) + (500 X $6)]. Eve 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.

16. 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. 17. The per unit conversion cost is $8.75. [Conversion costs = $6,000 – $3,200 = $2,800. Equivalent units for conversion costs are 320 (800 X 40%); $2,800 ÷ 320 = $8.75.] 18. 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. 19. 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 sum.

4-6

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mary, the cost of implementing the system must be balanced against the benefits provided from the additional information. *20. Units transferred out were 2,600 (2,000 + 600). *21 .(a)The cost of the units transferred out is $144,000 (12,000 X $12). (b) The cost of the units in ending inventory is $10,500 [(2,000 X $3) ÷ (500 X $9)].

4-7

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4-1 Mar. 31 31

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

45,000

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

50,000

45,000 50,000

BRIEF EXERCISE 4-2 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 ...........................................

30,000 20,000

45,000

50,000

BRIEF EXERCISE 4-3 Mar. 31

Work in Process—Assembly Department ..... ($30,000 X 200%) Work in Process—Finishing Department ...... ($20,000 X 200%) Manufacturing Overhead.........................

60,000 40,000 100,000

BRIEF EXERCISE 4-4

Beginning work in process Started into production Total units

January -40,000 40,000

March -48,000 48,000

July -56,000 56,000

Transferred out Ending work in process Total units

30,000 10,000 40,000

40,000 8,000 48,000

40,000 16,000 56,000

4-8

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BRIEF EXERCISE 4-5 January March July 1

Materials 40,000 (30,000 + 10,000) 48,000 (40,000 + 8,000) 56,000 (40,000 + 16,000)

Conversion Costs 34,000 (30,000 + 4,000)1 46,000 (40,000 + 6,000)2 44,000 (40,000 + 4,000)3

40% x 10,000 units, 2 75% x 8,000 units, 3 25% x 16,000 units

BRIEF EXERCISE 4-6 Total materials costs $32,000 Total conversion costs $54,000 Unit materials cost $3.20

Equivalent units of materials 10,000

Equivalent units of conversion costs 12,000

Unit conversion cost $4.50

Unit materials cost $3.20

Unit conversion cost $4.50

Total manufacturing cost per unit $7.70

BRIEF EXERCISE 4-7 Assignment of Costs

Equivalent Units

Unit Cost

Transferred out

40,000

$13.00

Work in process, 4/30 Materials Conversion costs Total costs

5,000 2,0001

$ 4.00 $ 9.00

40% x 5,000 units

4-9

$520,000

$20,000 18,000

38,000 $558,000

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BRIEF EXERCISE 4-8 Total materials Equivalent units costs ÷ of materials $15,000 20,000 BRIEF EXERCISE 4-8 (Continued) Total conversion *costs* $47,500

Unit materials cost $0.75

Unit conversion cost $2.50

Equivalent units of conversion costs 19,000

*$29,500 + $18,000 BRIEF EXERCISE 4-9 Costs accounted for Transferred out (18,000 X $3.25) Work in process Materials (2,000 X $0.75) $1,500 1 Conversion costs (1,200 X $2.50) 3,000 Total costs 1 2,000 X 60% = Equivalent units for conversion costs

$58,500 4,500 $63,000

BRIEF EXERCISE 4-10 Units transferred out Work in process, November 30 Materials (5,000 X 100%) Conversion costs (5,000 X 40%) Total equivalent units

4-10

Materials 8,000

Conversion Costs 8,000

5,000 13,000

2,000 10,000

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*BRIEF EXERCISE 4-11 Costs to Be Assigned Assignment of Costs

$664,000

4-11

Equivalent Units

Unit Cost

Total Costs Assigned

Transferred out Started and completed

30,000

$20.00

$600,000

Work in process, 3/31 Materials Conversion costs

5,000 2,000

$ 8.00 $12.00

$40,000 24,000

64,000 $664,000

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*BRIEF EXERCISE 4-12 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

MORA COMPANY (Partial) Production Cost Report For the Month Ended March 31 COSTS

Unit costs Costs in March (a) Equivalent units (b) Unit costs (a) ÷ (b)

Materials

Conversion Costs

$280,0001 35,000 $8.00

$384,0002 32,000 $12.00

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 $20.00) In process, March 31 Materials (5,000 X $8.00) Conversion costs (2,000 X $12.00) Total costs: 1 35,000 equivalent units X $8.00 per unit 2 32,000 equivalent units X $12.00 per unit .

4-12

Total $664,000 $20.00 $

0 664,000 $664,000

0 600,000

$ 40,000 24,000

64,000 $664,000

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*BRIEF EXERCISE 4-13 Total materials costs $70,0001 1

Unit materials cost $3.50

Unit conversion cost $2.00

$8,000 + $62,000 = $70,000

Total conversion costs $38,0002 2

Equivalent units of materials 20,000

$20,000 + $18,000

4-13

Equivalent units of conversion costs 19,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO EXERCISES EXERCISE 4-14 1. True. 2. True. 3. False. Companies that produce soft drinks and computer chips would all 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 by department are used. 9. False. In a process cost system, costs are summarized in a production cost report for each department. 10. False. In a process cost system, the unit cost of production is the sum of two unit costs: materials costs divided by the equivalent units of production for materials, and conversion costs divided by the equivalent units of production for conversion. EXERCISE 4-15 April 30

4-14

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

21,000 6,000

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

8,500 7,000

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

29,500 25,800

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

53,000

27,000

15,500

55,300 53,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 4-16 (a) Work in process, May 1 Started into production Total units to be accounted for Less: Transferred out Work in process, May 31 (b) Units transferred out Work in process, May 31 300 X 100% 300 X 40%

Work in process, May 1 Costs added Total materials cost

400 1,100 1,500 1,200 300 Equivalent Units Materials Conversion Costs 1,200 1,200 300 1,500

120 1,320

Direct Materials $2,040 5,160 $7,200

Conversion Costs $1,550 4,390 $5,940

$7,200 ÷ 1,500 = $4.80 (c) $5,940 ÷ 1,320 = $4.50 (d) Transferred out: 1,200 X ($4.80 + $4.50) = $11,160; Per unit cost = $4.80 + $4.50 is calculated in b and c (e) Work in process Materials (300 X $4.80) Conversion costs (120 X $4.50)

4-15

$1,440 540 $1,980

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 4-17 1. 2. 3.

7. 8. 9.

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

62,500

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

56,000

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

29,000 27,000

Work in Process—Cutting (1,680 X $15) ................ Work in Process—Assembly (1,720 X $15) ............ Manufacturing Overhead .................................

25,200 25,800

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

200,000

4-16

62,500 56,000 40,000 30,000

24,600

56,000

51,000 67,600 134,900 150,000 200,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 4-18 (a) Units to be accounted for Beginning work in process Started into production Total units Units accounted for Transferred out Ending work in process Total units (b)

(1)

January March May July

4-17

May

-9,000 9,000

-21,000 21,000

7,000 2,000 9,000

16,000 5,000 21,000

Equivalent Units of Production Materials 9,000 (7,000 + 2,000) 15,000 (12,000 + 3,000) 21,000 (16,000 + 5,000) 11,500 (10,000 + 1,500) 12000 x 60%

January

23000 x 30%

(2)

Equivalent Units of Production Conversion Costs 8,200 (7,000 + 1,2001) 12,900 (12,000 + 9002) 20,000 (16,000 + 4,0003) 10,600 (10,000 + 6004)

35000x 80%

41500x40%

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 4-19 (a)

Materials

Conversion Costs

9,000

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

3,000 12,000

1,800 10,800

(b) Materials: $45,000 ÷ 12,000 = $3.75 Conversion costs: ($16,200 + $18,900) ÷ 10,800 = $3.25 Costs accounted for Transferred out (9,000 X $7.00) Work in process, July 31 Materials (3,000 X $3.75) Conversion costs (1,800 X $3.25) Total costs

$63,000 $11,250 5,850

(Total costs: $45,000 + $16,200 + $18,900 = $80,100.)

4-18

17,100 $80,100

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 4-20 ORTIZ FURNITURE COMPANY Sanding Department Production Cost Report For the Month Ended March 31, 2009 Equivalent Units Quantities

Physical Units

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

-15,000 15,000

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

12,000 3,000 15,000

Costs Unit costs Costs in March Equivalent units Unit costs (a) ÷ (b) Costs to be accounted for Work in process, March 1 Started into production Total costs 1 (27 000+ 36 000)

4-19

Materials

Conversion Costs

12,000 3,000 15,000

12,000 600 12,600

Conversion Materials Costs Total $33,000 15,000 $2.20

$63,0001 $96,000 12,600 $7.20 $5.00 $

0 96,000 $96,000

(3,000 X 20%)

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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Cost Reconciliation Schedule Costs accounted for Transferred out (12,000 X $7.20) Work in process, March 31 Materials (3,000 X $2.20) Conversion costs (600 X $5.00) Total costs

4-20

$86,400 $6,600 3,000

9,600 $96,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 4-21 (a) Units transferred out Work in process, April 30 1,000 X 100% 1,000 X 40% Equivalent units of production

Materials 14,000 1,000

$100,000 + $800,000

Materials $900,0001 15,000 $60.00 2

4-21

Conversion Costs $432,0002 14,400 $30.00

Total $1,332,000 $90.00

$70,000 + $362,000

400 14,400

15,000

(b) Costs in April Equivalent units Unit costs

Conversion Costs 14,000

$1,260,000 $60,000 12,000

72,000 $1,332,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 4-22 (a) Materials: 68,0001 + (24,000 X 100%) = 92,000 equivalent units Conversion costs: 68,000 + (24,000 X 60%) = 82,400 equivalent units 1

20,000 + 72,000 – 24,000= 68 000 units transferred out

(b) Materials: $101,200 ÷ 92,000 = $1.10 Conversion costs: ($164,800 + $123,600) ÷ 82,400 = $3.50 (c) Units transferred out: 68,000 X $4.60 = $312,800 Units in ending work in process: 24,000 X $1.10 14,400 X $3.50

4-22

= =

$26,400 50,400 $76,800

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 4-23 (a) Work in process, September 1 Units started into production Units transferred out Work in process, September 30

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

Physical Units 1,600 18,400 20,000 15,000 5,000 20,000 Equivalent Units Materials Conversion Costs 15,000 15,000 5,000 20,000

(b)

500 15,500

Materials Conversion Costs

Work in process, September 1 Direct materials Conversion costs

$ 20,000

Costs added to production in polishing during September Material costs 177,200 Conversion costs ($102,680 + $257,140) Total cost $197,200

$43,180

359,820 $403,000

$197,200 ÷ 20,000 = $9.86 (Material costs per equivalent unit) $403,000 ÷ 15,500 = $26.00 (Conversion costs per equivalent unit) $9.86 + $26.00 = $35.86 cost per unit .

4-23

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 4-23 (Continued) (c) Costs accounted for Transferred out (15,000 X $35.86) Work in process, September 30 Materials (5,000 X $9.86) Conversion costs (500 X $26.00) Total costs Prove total costs: Beginning Inventory Added during the month: Materials Labour Manufacturing overhead Total [as in (c) above]

$537,900 $49,300 13,000

62,300 $600,200

$ 63,180 177,200 102,680 257,140 $600,200

EXERCISE 4-24 To: From: Re:

Stan Maley Student 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. .

4-24

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 4-25 BATISTA MANUFACTURING COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2009 Physical Units (Step 1)

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

15,000 60,000 75,000

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

49,000 26,000 75,000

Costs Unit costs (Step 3) Costs in February Equivalent units Unit costs (a) ÷ (b)

Equivalent Units Conversion Materials Costs (Step 2)

49,000 26,000 75,000

49,000 5,2001 54,200

Materials

Conversion Costs

(a) $198,0002 (b) 75,000 $2.64

$108,4003 54,200 $2.00

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

26,000 units X 1/5 complete = 5,200

$18,000 + $180,000 = $198,000

4-25

$306,400 $4.64

$ 32,175 274,2254 $306,400

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (49,000 X $4.64) Work in process, February 28 Materials (26,000 X $2.64) Conversion costs (5,2001 X 2.00) Total costs 1

Total

$227,360 $68,640 10,400

79,040 $306,400

$14,175 + $32,780 + $61,445 = $108,400 4

$180,000 (Materials) + $ 32,780 (Labour) + $61,445 ( Overhead) = $ 274,225

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 4-26 (a)

Containers in transit, April 1 Containers loaded Total containers

-800 800

Containers off-loaded1 Containers in transit, April 30 Total containers

450 350 800

Total containers less containers in transit

(b) Containers off-loaded Containers in transit, April 30 Total equivalent units 2 350 x 40% = 140 3 350 x 30% = 105

4-26

Equivalent Units Physical Direct Conversion Units Materials Costs 450 450 450 2 350 140 1053 590 555

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 4-27 (a) Completed Applications transferred out Work in process, September 30 Equivalent units

Materials 800 2001 1,000

Conversion Costs 800 1202 920

100 applications in process + 900 applications started in September – 800 completed applications = 200

200 X 60% completed in terms of conversion costs = 120

(b) Materials: $5,0003 ÷ 1,000 = $5.00 Conversion costs: $25,4004 ÷ 920 = $27.609 Costs accounted for: Transferred out (800 X $32.609) Work in process, September 30: Materials (200 X $5.00) Conversion costs (120 X $27.609) Total costs 3

$26,087 $1,000 3,313

4,313 $30,4005

4 ($1,000 + $4,000) ($4,000 + $12,000 + $9,400) 5 (Total costs = $1,000 Direct Materials + $4,000 Conversion costs + ($4,000 + $12,000 + $9,400 September costs) = $30,400)

4-27

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*EXERCISE 4-28

(a)

Physical Units

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

Equivalent Units Conversion Materials Costs

100 700 200 1,000

601 700 120 880

0 700 200 900

40% complete as to conversion costs, thus needs 60% more to complete the units, 60% X 100 units = 60 equivalent units

(b) Materials: $4,000 ÷ 900 = $4.444 Conversion costs: ($12,000 + $9,400) ÷ 880 = $24.318 Costs accounted for: Applications completed: Work in process, September 1 Conversion costs (60 x $24.318) Started and completed (700 x $28.762) Work in process, September 30: Materials (200 x $4.444) Conversion costs (120 x $24.318) Total costs 2 3

$5,000 1,459

$ 6,459 20,1342 889 2,918

$26,593 3,807 $30,4003

Adjusted for $1 rounding error Total costs to be accounted for: Direct material + conversion costs + September costs or $1,000 + $4,000 + $4,000 + $12,000 + $9,400 = $30,400

4-28

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*EXERCISE 4-29 (a) (1) Materials: Production Data Work in process, Aug1 Started and completed Work in process, Aug 31 Total

Physical Units -8,000 1,000 9,000

Materials Added This Period -100% 100%

Equivalent Units -8,000 1,000 9,000

(2) Conversion Costs: Production Data Work in process, Aug 1 Started and completed Work in process, Aug 31 Total (b) Unit costs are: Materials Conversion costs Total 1

Physical Units -8,000 1,000 9,000

% -100 40

Equivalent Units -8,000 400 8,400

$45,000 ÷ 9,000 = $5.00 $33,6001 ÷ 8,400 = 4.00 $9.00

$ 14,700 (Labour) + $ 18,900 (Manufacturing Overhead) = $ 33,600

EquivaCosts to Be lent Unit Assigned Assignment of Costs Units Cost Total mfg. Transferred out costs Started and completed 8,000 $9 Work in process, 8/31 Materials Conversion costs

1,000 400

$5 $4

$78,600 2

Reconciled: $45,000 (Materials) + $14,700 (Labour) + $18,900 (Manufacturing Overhead).

4-29

Total Costs Assigned $72,000 5,000 1,600

6,600 $78,6002

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

*EXERCISE 4-30 (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 1

Materials Added This Period Q 0% 100%

Equivalent Units

1,000 14,000

100%

1,000 12,000

Physical Units

Work Added This Period

Equivalent Units

2,000 11,000

80%1 100%

1,600 11,000

1,000 14,000

40%

400 13,000

2,000 11,000

$ 60,0002 ÷ 12,000 = $5.00 $143,000 ÷ 13,000 = 11.00 $16.00

Note: FIFO method considers the costs added in the current period only

4-30

-11,000

20% complete as to conversion costs, thus needs 80% more to complete the units, 80% X 2,000 units = 1,600 equivalent units.

(b) Materials Conversion costs 2

Physical Units

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Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

(c)

Costs to Be Assigned Total mfg. costs

*$218,200*

Assignment of Costs

Equivalent Units

Transferred out Work in process, 9/1 0 Conversion costs 1,600 Started and completed 11,000 Total costs transferred out Work in process, 9/30 Materials 1,000 Conversion costs 400 Total costs

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Unit Cost

Total Costs Assigned

$ 0 $11 $16

$15,200 17,600

$ 5 $11

$5,000 4,400

$ 32,800 176,000 208,800

9,400 $218,200

*Work in process, September 1, $15,200 + materials costs $60,000 + labour and overhead costs $143,000 = $218,200.

4-31

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*EXERCISE 4-31 (a) Work in process, March 1 Started into production Total units to be accounted for Less: Transferred out Work in process, March 31

800 1,000 1,800 1,300 500

(b) Materials: Physical Materials Added Equivalent Production Data Units This Period Units Work in process, March 1 800 --Started and completed 500 100% 500 Work in process, March 31 500 100% 500 Total 1,800 1,000 Unit cost = $6,600 ÷ 1,000 = $6.60. (c) Conversion costs: Physical Production Data Units Work in process, March 1 800 Started and completed 500 Work in process, March 31 500 Total 1,800

Work Added This Period 70%1 100% 40%

Equivalent Units 560 500 200 1,260

70% to complete the units, 70% X 800 units = 560 equivalent units

Unit cost = $2,500 (Labour) + $1,280 (Overhead) ÷ 1,260 = $3.00 (d) In process Painting, March 1 .......................................... Conversion costs in March (560 X $3.00) ....................... Total cost of units started in Feb & completed in Mar .

$3,680 1,680 $5,360

(e) 500 X ($6.60 + $3.00) = $4,800. (f)

Materials (5002 x $6.60) .................................................... Conversion costs (500 x 40%x $3.00) ............................. Total cost of work in process, March 31 ........................ 2

Work in process ending March 31st

4-32

$3,300 600 $3,900

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*EXERCISE 4-32 HIROHAMA MANUFACTURING COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2009 Equivalent Units

Quantities

Physical Units

Materials

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

15,000 60,000 75,000

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 35,0002 50,000 25,000 75,000

(Step 2)

0 35,000 35,000 25,000 60,000

13,5001 35,000 48,500 5,0003 53,500

Materials

Conversion Costs

$192,0004 60,000 $3.20

$107,0005 53,500 $2.00

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

4-33

Conversion Costs

(a) (b)

Total

$299,000 $5.20

$ 32,175 299,000 $331,175

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*EXERCISE 4-32 (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 $2.00) Total costs Units started and completed (35,000 X $5.20) Total costs transferred out Work in process, February 28 Materials (25,000 X $3.20) Conversion costs (5,000 X $2.00) Total costs

$32,175

27,000 $ 59,175 182,000 $241,175 80,000 10,000

10% complete as to conversion costs; needs 90% more to complete the units, 90% X 15,000 = 13,500 equivalent units 2 60,000 – 25,000 = 35,000 3 25,000 X 20% = 5,000 4 Cost of materials added $57,000 plus costs transferred in $135,000. 5 Labour $35,100 plus overhead $71,900.

4-34

90,000 $331,175

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO PROBLEMS—SET A PROBLEM 4-33A

(a)

Unit cost for beginning work in process inventory: Direct material cost per unit: Total material cost $200,000 ÷ Equivalent units (800 x 100%) 800 $250.00 Conversion cost per unit: Total conversion cost ÷ Equivalent units (800 x 50%)

Total unit cost for beginning inventory

(b)

Beginning work in process Started during the month Total units in production Less: ending work in process Units completed and transferred out

4-35

$200,000 400 $500.00 $750.00

800 1,200 2,000 400 1,600

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 4-34A

(a) Physical units 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

18,000 2,000 20,000

(b) Equivalent units Materials Units transferred out Work in process, June 30 2,000 X 100% 2,000 X 60% Total equivalent units

18,000 2,000 20,000

4-36

1,200 19,200

Unit Costs $9.90 ($198,000 ÷ 20,000) $8.50 (($50,400 + $112,800) ÷ 19,200) $18.40 ($9.90 + $8.50)

(d) Costs accounted for Transferred out (18,000 X $18.40) Work in process, June 30 Materials (2,000 X $9.90) Conversion costs (1,200 X $8.50) Total costs .

Conversion Costs 18,000

$331,200 $19,800 10,200

30,000 $361,200

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PROBLEM 4-34A (Continued) (e)

KASTEN COMPANY Molding Department Production Cost Report For the Month Ended June 30, 2009

Quantities

Physical Units (Step 1)

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

18,000 2,000 20,000

Costs Unit costs (Step 3) Costs in June Equivalent units Unit costs (a) ÷ (b)

Equivalent Units Conversion Materials Costs (Step 2)

18,000 2,000 20,000

18,000 1,200 (2,000 X 60%) 19,200

Materials

Conversion Costs

(a) $198,000 (b) 20,000 $9.90

$163,200 19,200 $8.50

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

Total $361,200 $18.40

$ 0 361,200 $361,200

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (18,000 X $18.40) Work in process, June 30 Materials (2,000 X $9.90) Conversion costs (1,200 X $8.50) Total costs .

4-37

$331,200 $19,800 10,200

30,000 $361,200

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PROBLEM 4-35A

(a) (1) Physical units T12 Tables

C10 Chairs

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

0 20,000 20,000

0 16,000 16,000

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

17,000 3,000 20,000

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

4-38

T12 Tables Conversion Materials Costs 17,000 17,000 3,000 20,000

1,800 18,800

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

400 15,900

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PROBLEM 4-35A (Continued) (3) Unit costs

Materials ($380,000 ÷ 20,000) ($288,000 ÷ 16,000) Conversion costs ($338,4001 ÷ 18,800) ($222,6002 ÷ 15,900) Total

T12 Tables $19

C10 Chairs $18

$37

$32

1 $234,400 Labour + Overhead $104,000 = $338,400 2 $125,900 Labour + Overhead $96,700 = $222,600

(4)

T12 Tables Costs accounted for Transferred out (17,000 X $37) Work in process Materials (3,000 X $19) Conversion costs (1,800 X $18) Total costs

$629,000 $57,000 32,400

89,400 $718,400

C10 Chairs Costs accounted for Transferred out (15,500 X $32) Work in process Materials (500 X $18) Conversion costs (400 X $14) Total costs

4-39

$496,000 $9,000 5,600

14,600 $510,600

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PROBLEM 4-35A (Continued) (b)

ORTEGA INDUSTRIES INC. Cutting Department—Plant 1 Production Cost Report For the Month Ended July 31, 2009

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 20,000 20,000

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

17,000 3,000 20,000

Costs Unit costs (Step 3) Costs in July Equivalent units Unit costs (a) ÷ (b)

17,000 3,000 20,000

17,000 1,800 (3,000 X 60%) 18,800

Materials

Conversion Costs

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

$338,400 18,800 $18

Costs to be accounted for Work in process, July 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (17,000 X $37) Work in process, July 31 Materials (3,000 X $19) Conversion costs (1,800 X $18) Total costs .

4-40

Total $718,400 $37

$ 0 718,400 $718,400

$629,000 $57,000 32,400

89,400 $718,400

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PROBLEM 4-36A

1. 2.

3. 4.

5. 6.

7. 8. 9.

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

300,000

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

210,000 45,000

Factory Labour ................................................ Wages Payable .........................................

248,900

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

182,500 66,400

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

790,000

Work in Process—Mixing (28,000 X $22) ....... Work in Process—Packaging ......................... (6,000 X $22) Manufacturing Overhead .........................

616,000 132,000

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

979,000

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

1,315,000

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

2,500,000

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

1,604,000

4-41

300,000

255,000 248,900

248,900 790,000

748,000 979,000 1,315,000 2,500,000 1,604,000

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PROBLEM 4-37A (a) Calculation of cost per equivalent unit

Beginning WIP in Dept B Transferred in from Dept A

Department B Completed and transferred out Ending work in process Transferred in (100%) Materials (0%)1 Conversion (37.5%)

Physical Units 15,000 46,000 61,000

45,000 16,000

45,000 45,000

--61,000

6,000 45,000 51,000

Additional Material is added at the end in Department B.

Per Unit Costs: Beginning WIP Costs added in March Equivalent units Cost per equiv. unit

Total

$2.616

146,000 transferred in x $0.95/unit = $43,700

45,000 16,000

61,000 1

Equivalent Units Trans ConIn Material version

4-42

Trans In $ 9,500 $43,700 1 $53,200 61,000 $0.872

ConMaterial version $11,200 $ 13,000 $63,000 $ 13,000 $74,200 45,000 51,000 $0.289 $1.455

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PROBLEM 4-37A (Continued)

Total Cost of units transferred out: Units transferred out2 Cost per unit

Trans In

Material

Conversion

Material

Conversion

45,000 $2.616 $117,720

Transferred to Finished Goods Total

(b)

Cost of ending WIP Transferred in (100%) Material (0%) Conversion (37.5%) Cost per unit

16,000 ---

$22,682

4-43

Trans In

$0.872 $13,952

$0.289 $ ---

6,000 $1.455 $8,730

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PROBLEM 4-38A

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

35,000 700,000 735,000

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

710,000 25,000 735,000

Equivalent Units Conversion Materials Costs

710,000 25,000 735,000

710,000 10,000 720,000

Materials

Conversion Costs

$ 69,000 1,548,000 $1,617,000

$ 48,150 563,8501 612,000

Equivalent units

735,000

720,000

Per unit cost

$2.20

$0.85

Cost per unit

Beginning work in process Added during month

$225,920 + $337,930 = $563,850

(b) Costs accounted for Transferred out (710,000 X $3.05) Work in process, November 30 Materials (25,000 X $2.20) Conversion costs (10,000 X $.85) Total costs .

4-44

$2,165,500 $55,000 8,500

63,500 $2,229,000

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PROBLEM 4-38A (Continued) (c)

CAVALIER COMPANY Assembly Department Production Cost Report For the Month Ended November 30, 2009

Quantities

Physical Units (Step 1)

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

35,000 700,000 735,000

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

710,000 25,000 735,000

Costs Unit costs (Step 3) Costs in November Equivalent units Unit costs (a) ÷ (b)

Equivalent Units Conversion Materials Costs (Step 2)

710,000 25,000 735,000

710,000 10,000 (25,000 X 40%) 720,000

Materials

Conversion Costs

(a) $1,617,000 (b) 735,000 $2.20

$612,000 720,000 $.85

Costs to be accounted for Work in process, November 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (710,000 X $3.05) Work in process, November 30 Materials (25,000 X $2.20) Conversion costs (10,000 X $.85) Total costs .

4-45

Total $2,229,000 $3.05

$ 117,150 2,111,850 $2,229,000

$2,165,500 $55,000 8,500

63,500 $2,229,000

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PROBLEM 4-39A (a) (1) Physical Units Units to be accounted for Work in process, July 1 Started into production Total units

500 1,000 1,500

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

900 600 1,500

Equivalent Units Conversion Materials Costs

900 600 1,500

900 180 1,080

(2) Materials

Conversion Costs

$ 750 2,400

$ 600 2,6401

$3,150

$3,240

Equivalent units

1,500

1,080

Per unit cost

$2.10

$3.00

Cost per unit

Beginning work in process Added during month

1$1,580 (Direct Labour) + $1,060 (Manufacturing Overhead)

(3) Costs accounted for Transferred out (900 X $5.10) Work in process, July 31 Materials (600 X $2.10) Conversion costs (180 X $3.00) Total costs

4-46

$4,590 $1,260 540

1,800 $6,390

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PROBLEM 4-39A (Continued) (b)

CHEN COMPANY Basketball Department Production Cost Report For the Month Ended July 31, 2009 Equivalent Units

Quantities

Physical Units (Step 1)

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

500 1,000 1,500

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

900 600 1,500

Costs Unit costs (Step 3) Costs in July Equivalent units Unit costs (a) ÷ (b)

Conversion Materials Costs (Step 2)

(a) (b)

900 600 1,500

900 180 1,080

Materials

Conversion Costs

$3,150 1,500 $2.10

$3,240 1,080 $3.00

Costs to be accounted for Work in process, July 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (900 X $5.10) Work in process, July 31 Materials (600 X $2.10) Conversion costs (180 X $3.00) Total costs .

4-47

Total $6,390

$1,350 5,040 $6,390

$4,590 $1,260 540

1,800 $6,390

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PROBLEM 4-40A

(a) Computation of equivalent units: Physical Units Units accounted for Transferred out Work in process, October 31 Materials (50,000 x 60%) Conversion costs (50,000 x 40%) Total units

130,000 50,000

Equivalent Units Conversion Materials Costs 130,000

130,000

30,000

180,000

160,000

20,000 150,000

Computation of October unit costs Materials: $240,000 ÷ 160,000 equivalent units = $1.50 Conversion cost: $105,000 ÷ 150,000 equivalent units = .70 Total unit cost, October $2.20

(b) Cost Reconciliation Schedule Costs accounted for Transferred out (130,000 X $2.20) Work in process, October 31 Materials (30,000 X $1.50) Conversion costs (20,000 X $0.70) Total costs

4-48

$286,000 $45,000 14,000

59,000 $345,000

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PROBLEM 4-41A

(a) Cost of units transferred to finished goods: Units transferred out Total cost per unit

11,900 $12.00 $142,800

(b) Physical Units Units to be accounted for Work in process, May 1 Started into production Total units Units accounted for Transferred out Work in process, May 31 Material (100%) Conversion (40%) Total units

Cost of WIP May 31 Transferred in (100%) Material (100%) Conversion (40%) Cost per unit

Total 4,000

4-49

1,900 14,000 15,900 11,900 4,000

11,900

4,000 15,900

Trans In

15,900

1,600 13,500

ConMaterial version

4,000 4,000

$38,400 .

Equivalent Units ConverMaterials sion Costs

$6.00 $24,000

$2.00 $8,000

1,600 $4.00 $6,400

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*PROBLEM 4-42A (a)

Units in beginning work in process Plus: transferred in Total units in production Less: completed and transferred out Units in ending work in process

25,000 175,000 200,000 170,000 30,000

(b) and (c) Quantities Units to be accounted for Work in process, beginning Transferred into production Total units Units accounted for Work in process, beginning Transferred in and completed Work In process, ending Total units

4-50

Physical Units

Equivalent Units ConverTrans Materision In als Costs

25,000 175,000 200,000

25,000 25,000 25,000 5,000 145,000 145,000 145,000 145,000 30,000 30,000 --12,000 200,000 175,000 170,000 162,000 (b) (c)

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*PROBLEM 4-43A Equivalent Units Quantities

Units to be accounted for Work in process, beginning Started this period Total units

Physical Material Labour Units

Over head

35,000 295,000 330,000

Units accounted for Work in process, beginning Materials (0%) Labour (40%1) Overhead (64%2) Started and completed Work In process, ending Materials (100%) Labour (50%) Overhead (40%)

22,400 265,000 265,000 265,000 265,000 30,000 30,000 15,000 12,000

Total equivalent units (m)

330,000 295,000m 294,000m 299,400m

Current period costs(n)

$45,380 $12,200n $15,000n $18,180n

Per equivalent unit cost [(n) ÷ (m)]

$0.1531 $0.0414 $0.0510 $0.0607

35,000 --14,000 3

Labour 60% complete, 40% to be completed Overhead 36% complete, 64% to be completed 3 330, 000 – 35,000 (beginning WIP) – 30,000 (ending WIP) 2

4-51

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PROBLEM 4-43A(Continued) Costs for completed goods and ending work in process Material Labour Total Beginning Inventory

$2,617

Complete beginning WIP Materials (0 x $0.0414) Labour (14,000 x $0.0510) Overhead (22,400 x $0.0607)

2,073

Started and completed Materials (265,000 x $0.0414) Labour (265,000 x $0.0510) Overhead (265,000 x $0.0607) Cost for units transferred out

40,572

$1,330

$435

Conversion $852

--714 1,359

10,971 13,515 45,262

12,301

14,664

16,086 18,297

Ending work in process 2,735 Materials (30,000 x $0.0414) 1,242 Labour (15,000 x $0.0510) 765 Overhead (12,000 x $0.0607) 728 Total costs $47,997 $13,543 $15,429 $19,025

4-52

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*PROBLEM 4-44A (a) A. BASKETBALLS Physical Units

Quantities Units to be accounted for Work in process, beginning Started into production Total units

500 1,600 2,100

Units accounted for Work in process, beginning Started and completed Work In process, ending Total units

500 1,000 600 2,100

(1)

Equivalent units— Materials

Work in process, Aug 1 Started and completed Work in process, Aug 31 Total Equivalent units— Conversion

Work in process, Aug 1 Started and completed Work in process, Aug 31 Total 1100% Materials added, 0% to be added

4-53

Physical Units 500 1,000 600 2,100

Materials Added This Period

Equivalent Units

0%1 100% 100%

Conversion Added This Period

0 1,000 600 1,600

Equivalent Units

30%2 100% 30%

2 30% completed, 70% to be added

150 1,000 180 1,330

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*PROBLEM 4-44A (Continued) (2) Unit costs

Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

Materials

Conversion

$1,600 1,600 $1.00

$2,1603 1,330 $1.624

3Direct Labour, $1,160 + Manufacturing Overhead, $1,000

(3) Costs for completed goods and ending work in process

Beginning WIP

Total

Beg WIP

$1,125

Complete beginning WIP Materials (0 x $1.00) Conversion (150 x $1.624)

244

Started and completed Materials (1,000 x $1.00) Conversion (1,000 x $1.624)

2,624

4-54

Conversion

$244

Ending WIP Materials (600 x $1.00) 892 Conversion (180 x $1.624) Total costs $4,885

Materials

$1,000 1,624 600 $1,125

$1,600

292 $2,160

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*PROBLEM 4-44A (Continued) B. SOCCER BALLS Physical Units

Quantities Units to be accounted for Work in process, beginning Started into production Total units

200 2,000 2,200

Units accounted for Work in process, beginning Started and completed Work In process, ending Total units

200 1,850 150 2,200

(1) Equivalent units— Materials

Work in process, Aug 1 Started and completed Work in process, Aug 31 Total Equivalent units— Conversion

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

Physical Units 200 1,850 150 2,200

Physical Units 200 1,850 150 2,100

4100% completed as to materials, 0% to be added

4-55

Materials Added This Period 0%4 100% 100%

Conversion Added This Period 10%5 100% 60%

Equivalent Units 0 1,850 150 2,000

Equivalent Units 20 1,850 90 1,960

590% completed, 10% to be added

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*PROBLEM 4-44A (Continued) (2) Unit costs

Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

Materials

Conversion

$2,500 2,000 $1.250

$1,9956 1,960 $1.018

6Direct Labour $1,000 + Manufacturing Overhead $995

(3) Costs for completed goods and ending work in process Total Beginning work in process Complete beginning WIP Materials (0 x $1.250) Conversion (20 x $1.018) Started and completed Materials (1,850 x $1.250) Conversion (1,850 x $1.018) Cost for units transferred out

$450 20

4-56

Materials

Conversion

$450 $20

4,195 $2,312 $4,665

Ending work in process 280 Materials (150 x $1.250) Conversion (90 x $1.018) Total costs $4,945

Beg WIP

$450

$2,312

1,883 $1,903

188 $450

$2,500

92 $1,995

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*PROBLEM 4-44A (Continued) (b)

JESSICA COMPANY Production Cost Report—Basketballs For the Month Ended August 31

Quantities Units to be accounted for Work in process, August 1 Started into production Total units Units accounted for Completed and transferred out Work in process, August 1 Started and completed Work in process, August 31 Total units Costs Unit costs Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)] Costs to be accounted for Work in process, August 1 Added into production Total costs Cost Reconciliation Schedule Costs accounted for Transferred out Work in process, August 1 Conversion costs to complete beginning inventory (150 X $1.624) Started and completed (1,000 X $2.624) Work in process, August 31 Materials (600 X $1) Conversion costs (180 X $1.624) Total costs *($1,600 + $1,160 + $1,000) .

4-57

Physical Units

Equivalent Units Conversion Materials Costs

500 1,600 2,100

500 1,000 600 2,100

0 1,000 600 1,600 Materials

150 1,000 180 1,330 Conversion Costs

$1,600 1,600 $1.00

$2,160 1,330 $1.624 $1,125 3,760* $4,885

$1,125 244 2,624 $ 600 292

$3,993

892 $4,885

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SOLUTIONS TO PROBLEMS—SET B *PROBLEM 4-45B

(a) Quantities

Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Work in process, beginning Materials-1 (0%) Materials-2 (100%) Conversion (40%1) Started and completed Work In process, ending Materials-1 (100%) Materials-2 (100%) Conversion (70%) Total equivalent units

Equivalent Units Materi- Materi- ConverPhysical als als sion Units (1) (2) Costs

10,000 40,000 50,000

10,000 10,000 30,000 10,000

10,000 10,000 7,000 50,000

Current period costs (b) Per equivalent unit cost 1

($2.00 + $1.00 + $2.15)

4-58

30,000 30,000

4,000 30,000

40,000 50,000

41,000

$80,000 $50,000 $88,000 $5.151

$2.00

$1.00

$2.15

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PROBLEM 4-46B (a) Quantities

Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Completed Work In process, ending Strips (100%) Buckles (100%) Conversion (50%)

Physical Units

Equivalent Units ConverStrips Buckles sion Costs

12,200 22,800 35,000

21,000 14,000

21,000

14,000 14,000 7,000 35,000

35,000m 35,000m 28,000m

TOTAL

Strips

ConverBuckles sion Costs

Costs to be accounted for: Work in process, beginning

$4,650

$3,000

$750

$900

Added during the month

$137,550

61,800

13,650

62,100

Total equivalent units (m)

Costs

Total costs (n)

$142,200 $64,800n $14,400n $63,000n

Per equivalent unit cost [(n) ÷ (m)]

$4.51281 $1.8514 $0.4114

($1.8514 + $0.4114 + $2.25) 4-59

$2.25

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PROBLEM 4-46B (Continued) (b) Cost accounted for as follows:

TOTAL

Completed and transferred out (21,000 x $4.5128)

$94,769

Ending work in process Strips (14,000 x $1.8514) Buckles (14,000 x $0.4114) Conversion (7,000 x $2.25) Total costs

ConverStrips Buckles sion Costs

$47,430 $25,920 $5,760 $15,750 $142,199

(c) The weighted average cost of a completed belt is $4.5128 each. This is less than the planning and control cost for a belt, which might indicate that no modifications in the production process are required. However, companies should practice continuous improvement, and still look for ways that could reduce their manufacturing costs, and increase their gross margin. Management should also investigate the accuracy of their control cost of $4.85, as it may be out of date, and does not reflect actual experience.

4-60

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*PROBLEM 4-47B (a) (1) Per unit conversion cost for last period: Number of units transferred 25,000 X Percentage completed 70% = Equivalent units 17,500 Cost assigned $22,000 Per unit conversion cost last period $1.257 (2) Per unit conversion cost for this period: Equivalent units this period: Complete beginning inventory (30%1 x 25,000) Started and completed (100,000-25,000) Started ending inventory (60% x 60,000*) Total equivalent units for the current period 170% completed, 30% to be added

Equivalent units Cost assigned Per unit conversion cost this period

4-61

118,500 $143,000 $1.2067

7,500 75,000 36,000 118,500

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(b) Equivalent units, ending inventory (60,000* x 60%) Conversion per unit cost Total conversion cost in ending inventory

36,000 $1.2067 $43,441

*Calculation of units in ending inventory Beginning work in process Plus: Started Total units in production Less: units completed and transferred out Units in ending inventory

25,000 135,000 160,000 100,000 60,000

(c) Per unit cost of units in beginning inventory: 70% completed last month at a rate of $1.257 30% completed this month at a rate of $1.2067 Weighted average unit cost

$0.88 $0.36 $1.24

4-62

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*PROBLEM 4-48B

PETRO-PURE CORPORATION Production Cost Report For the current period

Quantities Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Work in process, beginning Materials (25%) Conversion (30%) Started and completed Work In process, ending Materials (60%) Conversion (50%) Total equivalent units (m)

Physical Units 18,000 27,000 45,000

18,000 4,500 15,000 12,000

4-63

15,000

5,400 15,000

7,200 6,000 45,000

Costs added this period Cost per equivalent unit [(s) ÷ (t)]

Equivalent Units Conversion Materials Costs

$26.105

26,700

26,400

$252,000

$440,000

$9.438

$16.667

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*PROBLEM 4-48B (Continued) Costs

TOTAL

Materials

Conversion Costs

Costs to be accounted for: Work in process, beginning Added this period Total costs

$96,000 692,000 $788,000

$32,000 252,000 $284,000

$64,000 440,000 $504,000

$96,000 132,471

$32,000

$64,000

Cost accounted for as follows: Work in process, beginning Complete beginning WIP Material (4,500 x $9.438) Conversion (5,400 x $16.667) Started and Completed (15,000 x $26.105) Work in process, ending Material (7,200 x $$9.438) Conversion (6,000 x $16.667) Total costs

4-64

42,471 90,000 391,575 167,954

141,575

250,000

67,954 100,000 $788,000

$284,000

$504,000

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*PROBLEM 4-49B (a) A. BICYCLES Physical Units

Quantities Units to be accounted for Work in process, beginning Started into production Total units

200 1,000 1,200

Units accounted for Work in process, beginning Started and completed Work In process, ending Total units

200 800 200 1,200

(1) Equivalent units—Materials Physical Units Work in process, Mar 1 Started and completed Work in process, Mar 31 Total

200 800 200 1,200

Materials Added This Period 0% 100% 100%

Equivalent Units 0 800 200 1,000

Equivalent units—Conversion Physical Units Work in process, Mar 1 Started and completed Work in process, Mar 31 Total .

4-65

200 800 200 1,200

Conversion Added This Period 20% 100% 40%

Equivalent Units 40 800 80 920

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*PROBLEM 4-49B (Continued) (2) Unit costs

Costs in March (a) Equivalent units (b) Unit costs [(a) ÷ (b)] 1

Materials

Conversion

$50,000 1,000 $50.00

$55,2001 920 $60.00

Direct Labour $25,200 + Manufacturing Overhead $30,000

Costs

TOTAL

Materials

Conversion Costs

Costs to be accounted for: Work in process, beginning Added this period Total costs

$19,280 105,200 $124,480

$50,000 $50,000

$55,200 $55,200

Cost accounted for as follows: Work in process, beginning Complete beginning WIP Material (0 x $50.00) Conversion (40 x $60.00) Started and Completed (800 x $110.00) Total cost of units completed Work in process, ending Material (200 x $50.00) Conversion (180 x $60.00) Total costs

4-66

$19,280 2,400 $2,400 88,000 109,680

$40,000

48,000

14,800 10,000 4,800 $124,480

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*PROBLEM 4-49B (Continued) A. TRICYCLES Physical Units

Quantities Units to be accounted for Work in process, beginning Started into production Total units

100 800 900

Units accounted for Work in process, beginning Started and completed Work In process, ending Total units

100 740 60 900

(1) Equivalent units—Materials Physical Units Work in process, Mar 1 Started and completed Work in process, Mar 31 Total

100 740 60 900

Materials Added This Period 0% 100% 100%

Equivalent Units 0 740 60 800

Equivalent units—Conversion Physical Units Work in process, Mar 1 Started and completed Work in process, Mar 31 Total

4-67

100 740 60 900

Conversion Added This Period 25% 100% 25%

Equivalent Units 25 740 15 780

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*PROBLEM 4-49B (Continued) (2) Unit costs

Costs in March (a) Equivalent units (b) Unit costs [(a) ÷ (b)] 1

Materials

Conversion

$38,400 800 $48.00

$35,1001 780 $45.00

Direct Labour $15,100 + Manufacturing Overhead $20,000

Costs

TOTAL

Materials

Conversion Costs

Costs to be accounted for: Work in process, beginning Added this period Total costs

$6,125 73,500 $79,625

$38,400

$35,100

Cost accounted for as follows: Work in process, beginning Complete beginning WIP Material (0 x $48.00) Conversion (25 x $45.00) Started and Completed (740 x $93.00) Total cost of units completed Work in process, ending Material (60 x $48.00) Conversion (15 x $45.00) Total costs .

4-68

$6,125 1,125 $1,125 68,800 76,070

$35,520

33,300

3,555 2,880 1,675 $79,625

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*PROBLEM 4-49B (Continued) (b)

NATIONAL 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 1,000 1,200

Units accounted for Completed and transferred out Work in process, March 1 Started and completed Work In process, March 31 Total units

200 800 200 1,200

4-69

0 800 200 1,000

40 800 80 920

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*PROBLEM 4-49B (Continued) Costs

Materials

Conversion Costs

Unit costs (Step 3) Costs in March (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

$50,000 1,000 $50.00

$55,200 920 $60.00

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 $60.00) Started and completed (800 X $110.00) Work in process, March 31 Materials (200 X $50) Conversion costs (80 X $60.00) Total costs *($50,000 + $25,200 + $30,000)

4-70

$ 19,280 105,200* $124,480

$19,280 2,400 88,000 $10,000 4,800

$109,680

14,800 $124,480

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PROBLEM 4-50B (a) Quantities Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Started and completed Work In process, ending Materials (100%) Conversion (40%) Total equivalent units (m) Costs added this period Cost per equivalent unit [(s) ÷ (t)]

(d) Costs Costs to be accounted for: Work in process, beginning Added this period Total costs Cost accounted for as follows: Started and Completed (30,000 x $27.00) Work in process, ending Material (5,000 x $17.00) Conversion (2,000 x $10.00) Total costs

4-71

Physical Units

Equivalent Units Conversion Materials Costs

0 35,000 35,000

30,000 5,000

30,000

5,000 (b)

2,000 32,000

35,000

$27.00

$595,000 $320,000 $17.00 (c) $10.00

TOTAL

Materials

Conversion Costs

$915,000 $915,000

$595,000 $595,000

$320,000 $320,000

$810,000 105,000

$510,000

$300,000

85,000 $915,000

$595,000

20,000 $320,000

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PROBLEM 4-50B (Continued) (e)

BICNELL CORPORATION Molding Department Production Cost Report For the Month Ended January 31, 2009 Equivalent Units

Quantities

Physical Units (Step 1)

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

0 35,000 35,000

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

30,000 5,000 35,000

Costs Unit costs (Step 3) Costs in January Equivalent units Unit costs (a) ÷ (b)

Conversion Materials Costs (Step 2)

30,000 5,000 35,000

30,000 2,000 (5,000 X 40%) 32,000

Materials

Conversion Costs

(a) $595,000 (b) 35,000 $17

$320,000 32,000 $10

Costs to be accounted for Work in process, January 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (30,000 X $27) Work in process, January 31 Materials (5,000 X $17) Conversion costs (2,000 X $10) Total costs .

4-72

Total $915,000 $27

0 915,000 $915,000

$810,000 $85,000 20,000

105,000 $915,000

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PROBLEM 4-51B Plant A: F12 Refrigerators Quantities (1) Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Started and completed Work In process, ending Materials (100%) Conversion (75%) (2) Total equivalent units

Physical Units --20,000 20,000

16,000 4,000

Costs Costs to be accounted for: Work in process, beginning Added this period Total costs

4-73

16,000

20,000

3,000 19,000

$840,000

$665,000

$42

$35

TOTAL

Materials

Conversion Costs

--$1,505,000 $1,505,000

--$840,000 $840,000

--$665,000 $665,000

$672,000

$560,000

20,000

$77

(4) Cost accounted for as follows: Started and Completed (16,000 x $77.00) $1,232,000 Work in process, ending 273,000 Material (4,000 x $42.00) Conversion (3,000 x $35.00) Total costs $1,505,000 .

16,000 4,000

Costs added this period (3) Cost per equivalent unit

Equivalent Units Conversion Materials Costs

168,000 $840,000

105,000 $665,000

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PROBLEM 4-51B (Continued) Plant B: F24 Freezers Quantities (1) Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Started and completed Work In process, ending Materials (100%) Conversion (60%) (2) Total equivalent units

Physical Units --18,000 18,000

15,500 2,500

Costs Costs to be accounted for: Work in process, beginning Added this period Total costs

4-74

15,500

18,000

1,500 17,000

$684,000

$442,000

$38

$26

TOTAL

Materials

Conversion Costs

--$1,126,000 $1,126,000

--$684,000 $684,000

--$442,000 $442,000

$589,000

$403,000

18,000

$64

(4) Cost accounted for as follows: Started and Completed (15,500 x $64.00) $992,000 Work in process, ending 134,000 Material (2,500 x $38.00) Conversion (1,500 x $26.00) Total costs $1,126,000 .

15,500 2,500

Costs added this period (3) Cost per equivalent unit

Equivalent Units Conversion Materials Costs

95,000 $684,000

39,000 $442,000

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PROBLEM 4-51B (Continued) ATKINS CORPORATION Stamping Department--Plant A Production Cost Report For the Month Ended June 30, 2009

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

4-75

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

(4,000 X 75%)

Total $1,505,000 $77

$ 0 1,505,000 $1,505,000

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PROBLEM 4-51B (Continued) 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

4-76

$1,232,000 $168,000 105,000

273,000 $1,505,000

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PROBLEM 4-52B 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 7,140

Factory Labour ........................................................... Wages Payable ....................................................

20,770

Work in Process—Blending ....................................... Work in Process—Packaging .................................... Factory Labour ....................................................

13,320 7,450

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

41,500

Work in Process—Blending (900 X $20) ................... Work in Process—Packaging (300 X $20) ................. Manufacturing Overhead ....................................

18,000 6,000

Work in Process—Packaging .................................... Work in Process—Blending ...............................

44,940

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

67,490

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

90,000

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

62,000

4-77

25,000

26,070 20,770

20,770 41,500

24,000 44,940 67,490 90,000 62,000

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PROBLEM 4-53B

Quantities Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Started and completed Work In process, ending Materials (100%) Conversion (60%) (a) Total equivalent units

Physical Units 25,000 415,000 440,000

400,000 40,000

Costs Costs to be accounted for: Work in process, beginning Added this period Total costs for this period

4-78

400,000

40,000 440,000

24,000 424,000

$1,100,000

$254,400

$2.50

$0.60

TOTAL

Materials

Conversion Costs

$55,200 1,299,200 $1,354,400

$29,000 1,071,000 $1,100,000

$26,200 228,200 $254,400

440,000

Costs for this period (see below) (3) Cost per equivalent unit

Equivalent Units Conversion Materials Costs

$3.10

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PROBLEM 4-53B (Continued) (b) Cost accounted for as follows: Started and Completed (400,000 x $3.10) $1,240,000 Work in process, ending 114,400 Material (40,000 x $2.50) Conversion (24,000 x $0.60) Total costs $1,354,400

(c)

$1,000,000

$240,000

100,000 $1,000,000

14,400 $254,400

CROSBY COMPANY Assembly Department Production Cost Report For the Month Ended October 31, 2009 Equivalent Units

Quantities

Physical Units (Step 1)

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

25,000 415,000 440,000

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

400,000 40,000 440,000

4-79

Conversion Materials Costs (Step 2)

400,000 40,000 440,000

400,000 24,000 (40,000 X 60%) 424,000

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PROBLEM 4-53B (Continued) Costs

Unit costs (Step 3) Costs in October Equivalent units Unit costs (a) ÷ (b)

Materials

Conversion Costs

(a) $1,100,000 (b) 440,000 $2.50

$254,400 424,000 $.60

Costs to be accounted for Work in process, October 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (400,000 X $3.10) Work in process, October 31 Materials (40,000 X $2.50) Conversion costs (24,000 X $.60) Total costs

4-80

Total

$1,354,400 $3.10

$ 55,200 1,299,200 $1,354,400

$1,240,000 $100,000 14,400

114,400 $1,354,400

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PROBLEM 4-54B (a) Quantities Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Started and completed Work In process, ending Materials (100%) Conversion (10%) (1) Total equivalent units

Physical Units 500 1,000 1,500

900 600

Costs Costs to be accounted for: Work in process, beginning Added this period Total costs

4-81

900

600 1,500

60 960

$60,000

$57,600

$40

$60

TOTAL

Materials

Conversion Costs

$19,280 98,320 $117,600

$10,000 50,000 $60,000

$9,280 48,320 $57,600

1,500

Costs for this period (see below) (2) Cost per equivalent unit

Equivalent Units Conversion Materials Costs

$100

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PROBLEM 4-54B (Continued) (3) Cost accounted for as follows: Started and Completed (900 x $100.00) Work in process, ending Material (600 x $40.00) Conversion (60 x $60.00) Total costs

(b)

$90,000 27,600

$54,000

24,000 $117,600

3,600 $57,600

$60,000

KILEY COMPANY Bicycle Department Production Cost Report For the Month Ended May 31, 2009

Quantities

500 1,000 1,500

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

900 600 1.500

Costs Unit costs (Step 3) Costs in May Equivalent units Unit costs (a) ÷ (b)

4-82

Equivalent Units Conversion Materials Costs (Step 2)

Physical Units (Step 1)

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

$36,000

900 600 1,500

(a) (b)

900 60 960

Materials

Conversion Costs

$60,000 1,500 $40

$57,600 960 $60

Total $117,600 $100

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PROBLEM 4-54B (Continued) $ 19,280 98,320 $117,600

Costs to be accounted for Work in process, May 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (900 X $100) Work in process, May 31 Materials (600 X $40) Conversion costs (60 X $60) Total costs

4-83

$ 90,000 $24,000 3,600

27,600 $117,600

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PROBLEM 4-55B (a) Quantities Units to be accounted for Work in process, beginning Started this period Total units Units accounted for Started and completed Work In process, ending Materials (2/3) Conversion (1/3) Total equivalent units

Physical Units 10,000 100,000 110,000

95,000 15,000

(b) Costs Costs to be accounted for: Total costs Cost accounted for as follows: Started and Completed (95,000 x $2.90) Work in process, ending Material (10,000 x $2.00) Conversion (5,000 x $0.90) Total costs .

4-84

95,000

10,000 105,000

5,000 100,000

$210,000

$90,000

$2.00

$0.90

TOTAL

Materials

Conversion Costs

$300,000

$210,000

$90,000

$275,500 24,500

$190,000

$85,500

110,000

Costs for this period (see below) Cost per equivalent unit

Equivalent Units Conversion Materials Costs

$2.90

20,000 $300,000

$210,000

4,500 $90,000

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*PROBLEM 4-56B (a) A. BASKETBALLS Physical Units

Quantities Units to be accounted for Work in process, beginning Started into production Total units

500 1,600 2,100

Units accounted for Work in process, beginning Started and completed Work In process, ending Total units

500 1,000 600 2,100

(1) Equivalent units—Materials Physical Units Work in process, Aug 1 Started and completed Work in process, Aug 31 Total

500 1,000 600 2,100

Materials Added This Period 0% 100% 100%

Equivalent Units 0 1,000 600 1,600

Equivalent units—Conversion Physical Units Work in process, Aug 1 Started and completed Work in process, Aug 31 Total .

4-85

500 1,000 600 2,100

Conversion Added This Period 40% 100% 50%

Equivalent Units 200 1,000 300 1,500

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*PROBLEM 4-56B (Continued) (2) Unit costs

Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

Materials

Conversion

$1,600 1,600 $1.00

$2,175 1,500 $1.45

(3) Costs

TOTAL

Materials

Conversion Costs

Costs to be accounted for: Work in process, beginning Added this period Total costs

$1,125 3,775 $4,900

$1,600

$2,175

Cost accounted for as follows: Work in process, beginning Complete beginning WIP Material (0 x $1.00) Conversion (200 x $1.45) Started and Completed (1,000 x $2.45) Total cost of units completed Work in process, ending Material (600 x $1.00) Conversion (300 x $1.45) Total costs

4-86

$1,125 290 --290 2,450 3,865

1,000

1,450

1,035 600 435 $4,900

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*PROBLEM 4-56B (Continued) B. SOCCER BALLS Physical Units

Quantities Units to be accounted for Work in process, beginning Started into production Total units

200 2,000 2,200

Units accounted for Work in process, beginning Started and completed Work In process, ending Total units

200 1,850 150 2,200

(1) Equivalent units—Materials Physical Units Work in process, Aug 1 Started and completed Work in process, Aug 31 Total

200 1,850 150 2,200

Materials Added This Period 0% 100% 100%

Equivalent Units 0 1,850 150 2,000

Equivalent units—Conversion Physical Units Work in process, Aug 1 Started and completed Work in process, Aug 31 Total

4-87

200 1,850 150 2,200

Conversion Added This Period 20% 100% 70%

Equivalent Units 40 1,850 105 1,995

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*PROBLEM 4-56B (Continued) (2) Unit costs

Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

Materials

Conversion

$2,600 2,000 $1.30

$1,995 1,995 $1.00

(3) Costs

TOTAL

Materials

Conversion Costs

Costs to be accounted for: Work in process, beginning Added this period Total costs

$450 4,595 $5,045

$2,600

$1,995

Cost accounted for as follows: Work in process, beginning Complete beginning WIP Material (0 x $1.30) Conversion (40 x $1.00) Started and Completed (1,850 x $2.30) Total cost of units completed Work in process, ending Material (150 x $1.30) Conversion (105 x $1.00) Total costs

4-88

$450 40 --40 4,255 4,745

2,405

1,850

300 195 105 $5,045

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*PROBLEM 4-56B (Continued) (b) MALONEY COMPANY Production Cost Report—Basketballs For the Month Ended August 31

Quantities Units to be accounted for Work in process, August 1 Started into production Total units Units accounted for Completed and transferred out Work in process, August 1 Started and completed Work in process, August 31 Total units Costs Unit costs (Step 3) Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)] 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 $1.45) Started and completed (1,000 X $2.45) Work in process, August 31 Materials (600 X $1) Conversion costs (300 X $1.45) Total costs *($1,600 + $1,175 + $1,000) .

4-89

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

500 1,600 2,100 500 1,000 600 2,100

0 1,000 600 1,600

200 1,000 300 1,500

Materials

Conversion Costs

$1,600 1,600 $1

$2,175 1,500 $1.45 $1,125 3,775* $4,900

$1,125 290 2,450 $ 600 435

$3,865

1,035 $4,900

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SOLUTIONS TO CASES CASE 4-57

(a) The unit cost suggests that Sid took the total costs and divided these costs by the units started into production. Total costs charged to the Mixing Department ($88,000 + $573,000 + $769,000) divided by the units started during July (91,000 litres), results in a per unit cost of $15.71 (1,430,000 ÷ 91,000). (b) The principal errors made by Sid 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. (c)

SUNSHINE BEACH COMPANY Mixing Department Production Cost Report For the Month Ended July 31, 2009 Equivalent Units

Quantities Units to be accounted for Work in process, July 1 Started into production Total units Units accounted for Transferred out Work in process, July 31 Total units

4-90

Physical Units

Materials

Conversion Costs

94,000 5,000 99,000

94,000 1,000 95,000

8,000 91,000 99,000 94,000 5,000 99,000

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CASE 4-57 (Continued) Costs Unit costs Costs in July Equivalent units Unit costs [(a) ÷ (b)]

Materials

Conversion Costs

(a) $594,000 (b) 99,000 $6.00

$836,000 95,000 $8.80

Costs to be accounted for Work in process, July 1 Started into production Total costs a) $21,000 + 573,000

Total $1,430,000 $14.80

$ 88,000 1,342,0001 $1,430,000 (b) $67,000 + $769,000

Cost Reconciliation Schedule Costs accounted for Transferred out (94,000 X $14.80) Work in process, July 31 Materials (5000 X $6.00) Conversion costs (1,000 X $8.80) Total costs 1

$573,000 + $769,000

4-91

$1,391,200 $30,000 8,800

38,800 $1,430,000

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CASE 4-58 (a) If 3,000 sofas were started into production, and material is added at the beginning of the process, then all the sofas would have a material cost assigned to them. $420,000 was spent on material in the framing department during the month, which means the per unit material cost was $140 ($420,000 ÷ 3,000). (b) Total costs transferred out were $600,000. Of that cost $140 x 2,500 would be the material cost. Conversion costs would be $600,000 less the material cost of $350,000, or $250,000. This was the cost for 2,500 sofas, so the conversion cost for one sofa is $100 ($250,000 ÷ 2,500). (c) If 3,000 sofas were started into production, and 2,500 were transferred out, then the ending work in process inventory would consist of 500 units. The total cost assigned to these units is $100,000—which includes 100% of the material cost. After we take into consideration the total material cost of $70,000 (500 x $140), we have $30,000 that would have been assigned to the sofas for conversion costs. That would give each sofa $60 each ($30,000 ÷ 500 sofas). The total amount should be $100 each; therefore the ending work in process is at 60% completion ($60 ÷ $100), Or, considering that each sofa should have $100 in conversion costs, we have recorded a cost corresponding to just 300 sofas ($30,000 ÷ $100), which is 60% of the 500 units in inventory (300 ÷ 500).

4-92

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CASE 4-59 (a) Use the equation to determine the overhead rate for the year: Y = 60,000 + 2x Where: 60,000 is the fixed component and 2 is the variable rate. Predetermined overhead rate for 2009: Fixed component ($60,000 ÷ 120,000 DL hours) Variable component (as above)

(b) Quantities Units to be accounted for Work in process, beginning Transferred in Total units Units accounted for Completed (b) Work In process, ending Transferred in (100%) Materials (100%)1 Conversion (60%) Total equivalent units 1

$0.50 2.00 $2.50

Equivalent Units Physical Transfer Conversion Units Materials Costs In 4,000 13,000 17,000

13,000 4,000

13,000

4,000 4,000 17,000

17,000

2,400 15,400

Materials are added at the 50% mark, and the units are 60% complete.

4-93

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CASE 4-59 (Continued) Equivalent Units TOTAL Transfer Conversion Materials Costs In Costs to be accounted for Beginning work in process Added into production Total costs

$29,925 $12,000 141,375 52,000 $171,310 $64,000

$5,100 15,300 $20,400

$12,825 84,0751 $96,900

17,000

15,400

$11.2569 $3.7647

$1.2000

$6.2922

Equivalent units (c)

Per unit cost

(d) Work In process, ending Transferred in (100%) Materials (100%)1 Conversion (60%)

$34,960 15,059 4,800 15,101

Conversion costs = (8,850 x $7,00) for labour + (8,850 x 2.50) for overhead

4-94

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CASE 4-60 (a)

Opening Balances (1) Raw Materials Raw materials used Plus: ending inventory Raw materials required Less: purchases Raw materials, beginning inventory

136,000 8,000 144,000 125,000 19,000

19,000 units x $6.00 per unit =

$114,000

(2) Work in Process Transferred to finished goods Plus: ending inventory Units in Production Less: units processed Work in Process, beginning inventory Material cost (26,000 x $6.00) Conversion (26,000 x 70% x $17.00)

(3) Finished Goods Units sold ($4,080,000 ÷ $40 per unit) Plus: ending inventory Finished units required Less: units transferred in Finished goods, beginning inventory 7,000 units x $23 per unit = .

4-95

140,000 22,000 162,000 136,000 26,000 $156,000 $309,400 $465,400

102,000 45,000 147,000 140,000 7,000 $161,000

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CASE 4-60 (Continued) (b)

Equivalent units for 2009

ConverMaterial sion 140,000 140,000

Completed and transferred out Ending work in process Material (22,000 @100%) Conversion (22,000 @ 45%)

(c)

(d)

(e)

22,000 9,900 162,000 149,900

Total cost for 2009 Material (162,000 x $6.00) Conversion (149,900 x $17.00)

$ 972,000 2,548,300 $3,520,300

Cost assigned to ending work in process Material (22,000 x $6.00) Conversion (9,900 x $17.00)

Cost of units completed and transferred to finished goods: 140,000 units x $23 per unit

4-96

$3,220,000

$132,000 168,300 $300,300

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*CASE 4-61 (a) (1) Weighted Average Quantities Units to be accounted for

Equivalent Units Physical Material Material Conversion Units 1 2 Costs

Work in process, beginning 16,000 Started in May 84,000 Total units 100,000 Units accounted for Completed Work In process, ending Material 1 (100%) Material 2 (100%)1 Conversion (95%) Total equivalent units 1

80,000 20,000

80,000

20,000 20,000 100,000 100,000

100,000

19,000 99,000

Material 2 is added to the process at 90% completion; goods are 95% completed

(b) Cost per equivalent unit Material 1 Material Conversion TOTAL 2 Costs Production costs for May Work in process, beginning $53,725 $45,600 Costs incurred for May 280,800 228,400 Total costs $334,525 $274,000

$0 7,000 $7,000

$8,125 45,400 $53,225

Equivalent units (from (a))

100,000

99,000

$2.7400

$0.7000

$0.5407

Cost per equivalent unit

4-97

$3.98

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*CASE 4-61 (Continued)

(2) First-in, first-out Quantities Units to be accounted for

Equivalent Units Physical Material Material Conversion Units 1 2 Costs

Work in process, beginning 16,000 Started in May 84,000 Total units 100,000 Units accounted for Work in process, beginning Material 1 (0%1) Material 2 (100%2) Conversion (85%3) Completed Work In process, ending Material 1 (100%) Material 2 (100%4) Conversion (95%) Total equivalent units

16,000 --16,000 64,000 20,000

64,000

13,600 64,000

20,000 20,000 19,000 96,600

100,000

84,000

100,000

TOTAL

Material 1

Material Conversion 2 Costs

(b) Cost per equivalent unit

Production costs for May Costs incurred for May

$280,800 $228,400

$7,000

$45,400

Equivalent units (from (a))

84,000

100,000

96,600

$2.7190

$0.0700

$0.4699

Cost per equivalent unit

$3.2589

1Material is 100% complete, 0% to be added 2Material is 0% complete, needs 100% to be added

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*CASE 4-61 (Continued) 3 Conversion is 15% complete, 85% to be added 4Material 2 is added to the process at 90% completion

(c) The weighted average method is generally easier to use as the calculations are simpler. This method tends to obscure current period costs as the cost per equivalent unit includes both current costs and prior costs that were in the beginning inventory. This method is most appropriate when conversion costs, inventory levels, and raw material prices are stable. The FIFO method is based on the work done in the current period only. This method is most appropriate when conversion costs, inventory levels or raw materials prices fluctuate. This method should also be used when accuracy in current equivalent costs is important or when a standard cost system is used.

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*CASE 4-62

(a)

From the current period labour and overhead costs: Overhead rate = total overhead cost ÷ level of activity = $60,600 ÷ $50,500 = 120%

(b)

Components of beginning work in process: Direct labour (given) $7,000 Overhead ($7,000 x 120%) 8,400 Total conversion costs 15,400 Material ($37,000 - $15,400) 21,600 $37,000

(c) Weighted Average Quantities Units to be accounted for Work in process, beginning Started in July Total units Units accounted for Completed Work In process, ending Material 1 (100%) Conversion (60%) Total equivalent units

4-100

Equivalent Units Physical Material ConverUnits 1 sion 6,000 24,000 30,000

20,000 10,000

20,000

10,000 30,000

30,000

6,000 26,000

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*CASE 4-62 (Continued) (d) First-in, first-out Quantities Units to be accounted for Work in process, beginning Started in May Total units Units accounted for Work in process, beginning Material (0%) Conversion (30%1) Started and completed Work In process, ending Material (100%) Conversion (60%) Total equivalent units

Equivalent Units Physical ConverUnits Material sion 6,000 24,000 30,000

6,000 --14,000 10,000

14,000

1,800 14,000

10,000 24,000

6,000 21,800

Material

Conversion

Beginning inventory Costs incurred for July

$37,000 $21,600 180,500 69,400 $217,500 $91,000

$15,400 111,100 $126,500

Equivalent units (from (a))

30,000

26,000

$7.98987 $3.0333

$4.8654

30,000

(e) Weighted average Cost per equivalent unit Production costs for July

Cost per equivalent unit

Total

Cost of goods completed and transferred out 20,000 units x $7.98987 per unit = $159,797.40 .

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*CASE 4-62 (Continued) (f) First-in, first-out Material

Conversion

Costs incurred for July

$180,500 $69,400

$111,100

Equivalent units (from (a))

24,000

21,800

$7.988

$2.8917

$5.0963

Cost assigned to ending WIP Work In process, ending Material (10,000@2.8917) $28,917 Conversion (6,000@5.0963)) 30,578 Total cost $59,495

$28,917

Cost per equivalent unit Production costs for July

Cost per equivalent unit

TOTAL

$28,917

$30,5781 $30,578

Consists of: Labour $50,500 ÷ 21,800 = $2.3165 x 6,000 = $13,899 Overhead $60,600 ÷ 21,800 = $2.7798 x 6,000 = $16,679

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CASE 4-63

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

Sue Wooten, molding department head. Fred Barando, quality control inspector. Customers of R.B. Patrick Company. The department manager of the assembly department.

(b) Fred is placed in an ethical dilemma. He can offend his department head by disregarding her instructions and lose the support of his supervisor, maybe his job. He can follow Sue’s instructions and be in violation of company policy. He can also report Sue’s instructions to supervisors (plant superintendent or vicepresident of production). The company should make the position of quality control inspector responsible to someone other than the department head. Fred should not report to Sue.

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SOLUTION TO WATERWAYS CONTINUING PROBLEM

WCP-3

(a) Production Report: Weighted Average Method Waterways Corporation Molding Department Production Report For the month of January, 2009 Equivalent Units Physical ConMateri- verUnits als sion Quantities Units to be accounted for: Work in process, Jan 1 (80% materials, 30% conversion) 24,000 Started into production 60,000 Total units 84,000 Units accounted for: Transferred out Work in process, Jan 31 (50% materials, 10% conversion) Total units

4-104

58,000

58,000 58,000

26,000 84,000

13,000 2,600 71,000 60,600

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Costs

Unit costs Costs in January* Equivalent units Unit costs [(a) / )b)] Costs to be accounted for Work in process, January 1 Started into production Total costs *Additional computations to support production costs report data: Materials cost: $168,360 + $265,450 Conversion costs: $67,564 + $16,892 + $289,468 + $60,578 Cost Reconciliation Schedule Costs accounted for Transferred out (58,000 X $13.28) Work in process, Jan 31 Materials (13,000 x $6.11) Conversion (2,600 x $7.17) Total costs

4-105

Conversion Materials Costs Total (a) $433,810 $434,502 $868,312 (b) 71,000 60,600 $6.11 $7.17 $13.28 $252,816 615,496 $868,312

$770,240 79,430 18,642

98,072 $868,312

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*(b) Equivalent Units -- FIFO Method Equivalent Units

Physical Units

Materials

Conversion

Units accounted for Completed and transferred out

Work in process, January 1 (20% materials, 70% conversion)

24,000

4,800

16,800

Started and completed in January

34,000

Work in process, Jan 31 (50% materials, 10% conversion)

26,000

13,000

2,600

Total units

84,000

51,800

53,400

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Legal Notice

4-107

CHAPTER 5 Activity-Based Costing ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises 1, 2

Exercises

A Problems

B Problems

13, 14, 15, 16, 17, 18, 24, 25

31, 32, 34, 35, 36, 37, 38

39, 41, 42, 43, 44, 45, 46

31, 32, 33, 34, 35, 36, 37, 38

39, 40, 41, 42, 43, 44, 45, 46, 47

*1.

Recognize the difference 1, 2, 3, between traditional costing 4, 5 and activity-based costing.

*2.

Identify the steps in the 7 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 the activity 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

24, 25, 26, 27, 28

*7.

Understand the value of using activity levels in activity-based costing.

10, 11, 12

29, 30

*8.

Apply activity-based costing to service industries.

9, 10

19, 20

3, 4, 5, 6, 7, 12

13, 15, 16, 17, 18, 20, 21, 22, 23, 24, 25 23

. 5-1

31, 37

39, 46

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

31A

Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value-added or non-value-added.

Moderate

35–45

32A

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

35–45

33A

Assign overhead to products using ABC and evaluate a decision..

Moderate

25–35

34A

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

40–50

35A

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

35–45

36A

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

35–45

37A

Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.

Moderate

35–45

38A

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

35–45

39B

Assign overhead costs to services using traditional costing and ABC; compute unit costs; classify activities as value-added or non–value-added

Moderate

40–50

40B

Assign overhead to products using ABC and evaluate a decision..

Moderate

35–45

41B

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

35–45

42B

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

40–50

43B

Assign overhead costs using traditional costing and ABC; compare results

Moderate

30-40

44B

Assign overhead costs using traditional costing and ABC; compare results

Moderate

40–50

. 5-2

ASSIGNMENT CHARACTERISTICS TABLE (Continued)

45B

Assign overhead costs using traditional costing and ABC; compare results

Moderate

40–50

46B

Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.

Moderate

35–45

47B

Assign overhead costs using ABC

Moderate

25–35

. 5-3

Study Objective

Knowledge Comprehension

For Instructor Use Only

*1. Recognize the difference between traditional costing and activity-based costing.

Q1 Q2 Q3 Q4 Q5

*2. Identify the steps in the development of an activitybased costing system.

Application BE1 BE2 E13 E14 E15 E16 E17 E18

*3. Know how companies identify Q9 the activity cost pools used in activity-based costing.

E19 E20

*4. Know how companies identify Q6 and use cost drivers in Q10 Q11 activity-based costing. Q12

BE3 BE4 BE5 BE6 BE7 BE12 E13 E15

*5. Understand the benefits and limitations of activity-based costing.

Q13 Q14 Q15

*6. Differentiate between valueadded and non-value-added activities.

Q8 Q16 Q17

BE8 BE9 E24 E25

*7. Understand the value of using activity levels in activity-based costing.

Q19

BE10 BE11 BE12

*8. Apply activity-based costing to service industries.

Q18

BE9 BE10

E24 E25 P31 P32 P34 P35 P36 P37

Analysis

P38 P39 P41 P42 P43 P44 P45 P46

E13 E14 E15 E16 E17 E18 E24 E25

P32 P34 P35 P36 P37 P38 P40 P41

P42 P42 P44 P45 P46 P47

E24 E25 P32 P34 P35 P36 P37 P38 P40

P41 P42 P43 P44 P45 P46 P47

Synthesis

Evaluation P32 P34 P35 P36 P37 P38

P41 P42 P43 P44 P45 P46

P32 P33 P34 P35 P36 P37 P38

P40 P41 P42 P43 P44 P45 P46

E20

E16 E17 E18 E20 E21 E22 E23 E24

E25 P31 P32 P33 P34 P35 P36 P37 P38

P39 P40 P41 P42 P43 P44 P45 P46 P47

E13 E15 E16 E17 E18 E20 E21 E22 E23 E23

E26 E27 E28 P31

P37 P39 P46

BE8 BE9 E24 E25 E26

P31 P32 P33 P34 P35 P36 P37 P38 P39

P40 P41 P42 P43

E23 P47 E27 E28 P37 P46

P31 P37 P39 P47

P37 P46

P46

P37 P46

BE10 E29 E30 E28 P37

P46

E28 P37

BLOOM’ S TAXONOMY TABLE

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

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ANSWERS TO QUESTIONS 1.

Direct labour is a valid basis for allocating overhead when: (a) direct labour constitutes a significant part of total product cost, and (b) there is a high correlation between direct labour and changes in the amount of overhead costs.

The amount of direct labour in many industries has greatly decreased, due to advances in computerized systems, technological innovation, global competition and automation. Total overhead costs resulting from amortization 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.

(a) The principal differences are: (1) Primary focus (2) Bases of allocation (3) Total product costs

Activity-Based Costing Activities performed in making products Multiple cost drivers Sum of costs of activities consumed in making product

Traditional Costing Units of production Single unit-level base Direct materials plus direct labour plus manufacturing overhead

(b) There are two assumptions that must be met in using ABC: (1) All overhead costs related to the activity must be driven by the cost driver used to assign costs to products. (2) All overhead costs related to the activity should respond proportionally to changes in the activity level of the cost driver. 6.

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.

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Questions Chapter 5 (Continued)

(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.

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 activity

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 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

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Questions Chapter 5 (Continued)

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.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1 (a)

Estimated annual overhead costs = Predetermined overhead rate Expected annual operating activity $1,000,000 100,000 = $10 per direct labour hour

(b)

90,000 direct labour hours X $10 = $900,000 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 a new overhead cost allocation method that uses multiple bases. That method is activitybased costing.

BRIEF EXERCISE 5-2 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. Assigning overhead using ABC will usually increase the cost per unit for low-volume products. Therefore, a traditional overhead allocation such as direct labour hours is usually a poor cost driver for assigning overhead costs to low-volume products.

As a result, for Sassafras, 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.

. 5-8

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BRIEF EXERCISE 5-3 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 Direct labour hours Number of inspections

BRIEF EXERCISE 5-4 (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 5-5 Machine setups Machining Inspections

$180,000 ÷ 2,500 = $72 per setup $325,000 ÷ 25,000 = $13 per machine hour $ 87,500 ÷ 1,750 = $50 per inspection

BRIEF EXERCISE 5-6 Estimated Overhead ÷ Expected use of Cost = Activity-based Drivers per Activity Overhead Rates Designing: $450,000 ÷ 12,000 = $37.50 per designer hr. Sizing & cutting: $4,000,000 ÷ 160,000 = $25.00 per machine hr. Stitching & trimming: $1,440,000 ÷ 80,000 labour hrs. = $18.00 per labour hr Wrapping & packing: $336,000 ÷ 32,000 finished units = $10.50 per unit . 5-9

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BRIEF EXERCISE 5-7 First determine the overhead rates. Estimated Overhead ÷ Expected use of Cost = Activity-based Drivers per Activity Overhead Rates Ordering & receiving: $90,000 ÷ 15,000 = $6.00 per order Etching: $480,000 ÷ 60,000 = $8.00 per machine hour Soldering: $1,760,000 ÷ 440,000 = $4.00 per labour hour Then use the rates to determine total overhead applied. Cost Drivers 11,000 orders 50,000 machine hours 500,000 labour hours

Overhead Total Overhead Rates = Applied $6 $ 66,000 $8 400,000 $4 2,000,000 $2,466,000

BRIEF EXERCISE 5-8 (a) (b) (c) (d) (e) (f) (g) (h)

Non-value-added Non-value-added Value-added Non-value-added Non-value-added Non-value-added Non –value added Value-added

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BRIEF EXERCISE 5-9 Value-added Activities (1) Designing and drafting (3) On-site supervision (5) Consultation with client

Non-value-added Activities (2) Staff meetings (4) Lunch (6) Entertaining prospective client

BRIEF EXERCISE 5-10 (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 5-11 (a) (b) (c) (d) (e) (f) (g) (h)

Facility-level Unit-level Product-level Unit-level Batch-level Batch-level Product-level Facility-level

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BRIEF EXERCISE 5-12 (a) Product design

(b)

$50,000 = $5,000 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

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SOLUTIONS TO EXERCISES EXERCISE 5-13 (a)

Estimated overhead = Predetermined overhead rate Direct labour costs $300,000 = 200% of direct labour cost $50,000 + $100,000

(b) Activity cost pools Machining Machine setup

Cost drivers Machine hours Set up hours

Activity-based overhead rates Machining: $200,000 = $100 per machine hr. 1,000 + 1,000 (c) Traditional costing $50,000 X 200% $100,000 X 200%

Estimated overhead $200,000 100,000

Machine setup: $100,000 = $200 per setup hr. 500

Standard $100,000 $100,000

Activity-based costing Machining: 1,000 X $100 1,000 X $100

Custom $200,000 $200,000

$100,000 $100,000

Machine setup: 100 X $200 400 X $200

20,000 $120,000

. 5-13

80,000 $180,000

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EXERCISE 5-14 (a)

Traditional costing system

Sales Costs Operating income (b)

Product 540X

Product 137Y

Product 249S

$200,000 55,000 $145,000

$160,000 50,000 $110,000

$80,000 15,000 $65,000

Product 540X

Product 137Y

Product 249S

$200,000 50,000 $150,000

$160,000 35,000 $125,000

$80,000 35,000 $45,000

Activity-based costing system

Sales Costs Operating income (c) Product 540X:

($150,000 – $145,000) ÷ $145,000 = 3.45%

Product 137Y

($125,000 – $110,000) ÷ $110,000 = 13.64%

Product 249S

($45,000 – $65,000) ÷ $65,000 = (30.77%)

(d) These costs of 540X under both methods could be similar because the cost drivers under both methods might be the same; for example, they both may be based on units of production, or volume.

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EXERCISE 5-15 (a)

Activity cost pools

Cost drivers

Estimated overhead

Cutting

Machine hours

$300,000

Design

Number of setups

600,000

Activity-based overhead rates Cutting: $300,000 = $1.50 per machine hr 200,000

Design: $600,000 = $400 per setup 1,500 Wool

Activity-based costing Allocations Cutting 100,000 X $1.50 100,000 X $1.50

$150,000 $150,000

Design 1,000 X $400 500 X $400 Total cost allocated

(b)

Estimated overhead = Direct labour hours

400,000 200,000 $350,000

$550,000

$900,000 450,000

= $2 per direct labour hour

Wool Traditional costing 225,000 X $2 225,000 X $2

Cotton

$450,000 $450,000

) The wool product line is allocated $100,000 ($550,000 – $450,000) more overhead cost when an activity-based costing system is used. As a result, the cotton product line is allocated $100,000 ($450,000 – $350,000) less. . 5-15

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EXERCISE 5-16 (a) Direct labour hours for car wheels (40,000 X 1) = 40,000 Direct labour hours for truck wheels (10,000 X 3) = 30,000 Total direct labour hours 70,000 $700,000 ( total estimated overhead) 70,000 (total direct labour hours)

= $10 per direct labour hr.

Overhead assigned Car wheels Truck wheels Total overhead

(40,000 X $10) (30,000 X $10)

= $400,000 = 300,000 $700,000

(b) Estimated Overhead ÷ Expected use of Cost = Activity-based Drivers per Activity Overhead Rates Setting up machines: $180,000 ÷ 1,000 = $180 per set-up Assembling: $280,000 ÷ 70,000 = $4 per labour hour Inspection: $240,000 ÷ 1,200 = $200 per inspection

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EXERCISE 5-16 (Continued) (c)

Car Wheels

Activity-based overhead applied: Setting up machines— # of set-ups ($180 x 200) ($180 x 800) Assembly—Direct labour hours ($4 x 40,000) ($4 x 30,000) Inspection—Number of inspections ($200 x 100)

Truck Wheels

$36,000 $144,000

160,000 120,000 20,000 220,000

($200 x 1,100) Total overhead costs applied

(d)

$216,000

$484,000

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.

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EXERCISE 5-17 (a) Estimated Overhead ÷ Expected use of Cost = Activity-based Drivers per Activity Overhead Rates Scheduling & travel: $90, 000 ÷ 1,500 = $60 per travel hour Set-up time: $70,000 ÷ 700 = $100 per set-up Supervision: $40,000 ÷ $400,000 = $0.10 per direct labour dollar Commercial Activity-based overhead applied: Scheduling & travel—travel hours ($60 x 1,000) ($60 x 500) Set-up time—number of set-ups ($100 x 450) ($100 x 250) Supervision—direct labour dollars ($0.10 x $100,000) ($0.10 x $300,000) Total overhead costs applied

(b) Revenues Direct material costs Direct labour costs Overhead costs applied Net income (loss)

Residential

$60,000 $30,000

45,000 25,000 10,000 $115,000

Commercial

30,000 $85,000

Residential

$300,000 $30,000 100,000 115,000

. 5-18

245,000 $55,000

$480,000 $50,000 300,000 85,000

435,000 $45,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-17 (Continued) (c)

. 5-19

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-18 (a) Traditional costing: $235,000 ÷ 2,500 (800 + 1,700) hours = $94 per direct labour hour (1) One mobile safe: 800 hours X $94 = $75,200 $75,200 ÷ 200 units = $376 each (2) One walk-in safe: 1,700 hours X $94 = $159,800 $159,800 ÷ 50 units = $3,196 each (b) Activity-based costing: (1) Material handling costs $150,000 ÷ 500 (300 + 200) moves = $300 per move (a) One mobile safe: 300 moves X $300 = $90,000 $90,000 ÷ 200 = $450 each (b) One walk-in safe: 200 moves X $300 = $60,000 $60,000 ÷ 50 = $1,200 each (2) Purchasing activity costs $85,000 ÷ 800 (450 + 350) orders = $106.25 per order (a) One mobile safe: 450 orders X $106.25 = $47,812.50 $47,812.50 ÷ 200 = $239.0625 each (b) One walk-in safe: 350 orders X $106.25 = $37,187.50 $37,187.50 ÷ 50 = $743.75 each

. 5-20

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-18 (Continued) (c) The total amount of overhead allocated to each unit of the two products under the two allocation approaches is: Traditional Costing $ 376 $3,196

Mobile safe Walk-in safe

Activity-Based Costing **$689.0625** $ 1,943.75**

**$450 + $239.0625 **$1,200 + $743.75 EXERCISE 5-19 The following activities might be identified at Quik Prints Company from your analysis of its operations and a discussion with the owner-manager, Damon Hastings. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Hiring and training personnel Purchasing supplies and materials Selling, promoting, and marketing Billing and collecting Designing Offset printing Copying Faxing Collating Cutting and folding

. 5-21

11. 12. 13.

Maintenance and repairs Delivery Accounting

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-20 Budgeted Costs

Activity Cost Pool

Cost Driver

Engineering design Engineering prototypes

Engineering

Engineering hours

Amortization, machinery Electricity, machinery

Machinery

Machine hours

Machine setup, indirect labour Machine setup Machine setup, indirect materials

Number of setups

Inspections Tests

Quality control

Number of tests or inspections

Amortization, plant Insurance, plant Property taxes Oil, heating Electricity, plant lighting

Factory utilities

Square feet or Machine hours

Custodial wages

Maintenance

. 5-22

Number of machines or Machine hours

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-21 The following cost drivers might be used to assign overhead: 1. 2. 3. 4. 5. 6. 7. 8.

Labour hours Labour hours Labour hours Litres of chemicals Number of cartfuls or labour hours Number of cartfuls Litres of juice Litres of juice

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

Litres of wine or months of aging Number of bottles Number of bottles Number of boxes Number of shipments Number of litres processed Number of litres processed

EXERCISE 5-22 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

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 labour hours Number of employees; number of parts; direct labour hours Number of employees Book or market value of assets Cost of goods manufactured, direct labour hours; number of employees Machine hours; number of machines Litres of paint; number of appliances

. 5-23

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EXERCISE 5-23 (a) Estimated Overhead ÷ Expected use of Cost = Activity-based Drivers per Activity Overhead Rates Materials handling: $35,000 ÷ 1,000 = $35 per requisition Machine set-ups: $27,500 ÷ 500 = $55 per set-up Quality inspections: $27,000 ÷ 600 = $45 per inspection (b)

Activity-based overhead applied

Instruments

Materials handling—# of requisitions ($35 x 400) ($35 x 600)

$14,000

Machine set-ups—# of set-ups ($55 x 200) ($55 x 300)

11,000

Quality inspections—# of inspections ($45 x 200) ($45 x 400) Total overhead costs applied

Gauges

$21,000

16,500 9,000 $34,000

18,000 $55,500

Number of units produced

300

Overhead per unit

$680

$185

. 5-24

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EXERCISE 5-23 (Continued) (c)

MEMO To:

President, Fontillas 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.

. 5-25

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-24 (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 pool: Sales commissions Advertising—TV/Radio Advertising—Newspaper Catalogues Cost of catalogue sales Credits and collection

Number of Cost Driver Used

Overhead Rate

High Intensity Attire

$930,000 250 min. 2,000 in. 60,000 $9,000 $930,000

$0.05 $300 $10 $2.50 $1.00 $0.03

$46,500 75,000 20,000 150,000 9,000 27,900 $328,400

(b) As compared to ABC, traditional costing grossly undercosts the selling costs assigned to the “high intensity” product line. The difference of $48,400 ($328,400 – $280,000) in the month of March is a 14.7% understatement. (c) All six activities, as selling activities, are non-value-added activities.

. 5-26

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EXERCISE 5-25 (a) (1) Traditional product costing system: Quality-control overhead costs assigned in June to the low-calorie dessert line are $9,350 ($55,000 X .17). (2) Activity-based costing system:

Activity cost pool:

Number of Cost Driver Used

Over head Rate

Over head applied

Inspections of: Materials received In Process

6,000 kg. 10,000 servings

$0.60 $0.33

$3,600 3,300

420 orders

$12.00

5,040

CFIA Certification

$11,940

(b) As compared to ABC, the traditional costing system undercosts the quality-control overhead cost assigned to the low-calorie dessert product line by $2,590 ($11,940 – $9,350) in the month of June. That is a 27.7% understatement. (c) All three activities, as quality-control related activities, are non-valueadded activities.

. 5-27

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-26 It is assumed that any activity which directly enhances or improves the quality or quantity of the vines, grapes, or wine is a value-added activity. 1. 2. 3. 4. 5. 6. 7. 8.

Value-added Non-value-added Value-added Value-added Non-value-added Value-added Value-added Value-added

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

. 5-28

Value-added Value-added Non-value-added Non-value-added Non-value-added Non-value-added Non-value-added

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-27 1. 2. 3. 4. 5. 6.

Value-added Non-value-added Non-value-added Non-value-added Non-value-added Value-added

7. 8. 9. 10. 11. 12.

Value-added Value-added Non-value-added Non-value-added Non-value-added Value-added

EXERCISE 5-28 Value-Added Activities

Non-Value-Added Hours Activities Writing contracts and letters 1.0 Staff meetings 1.0 Doing research Taking depositions Contemplating legal strategy 1.0 Traveling 2.5 Eating lunch Litigating a case in court Entertaining Total hours 5.5

Hours 0.5 1.0 1.0 1.0 2.0 5.5

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.

. 5-29

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 5-29 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 5-30 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Facility-level activity Product-level activity Batch-level activity Product-level activity Product-level activity Batch-level or unit-level activity Facility-level activity Batch-level or unit-level activity Unit-level activity Unit-level activity

. 5-30

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SOLUTIONS TO PROBLEMS—SET A PROBLEM 5-31A (a) Computation of unit costs—traditional costing. Products Home Commercial Model Model $18.50 $26.50 19.00 19.00 * 23.40* * 23.40* $60.90 $68.90

Manufacturing Costs Direct materials Direct labour Overhead Total unit cost *$15.60 X 1.5 = $23.40

(b) Determine activity-based overhead rates: Receiving: $70,350 ÷ 335,000 = $0.21 per kilogram Forming: $150,500 ÷ 35,000 = $4.30 per machine hour Assembly: $390,600 ÷ 217,000 = $1.80 per part Testing: $51,000 ÷ 25,500 = $2 per test Painting: $52,580 ÷ 5,258 = $10 per litre Packing & shipping: $787,250 ÷ 335,000 = $2.35 per kilogram (c)

Activity-based overhead applied Receiving—kilograms $0.21 x 215,000; $0.21 x 120,000 Forming—machine hours $4.30 x 27,000; $4.30 x 8,000 Assembly—# of parts $1.80 x 165,000; $1.80 x 52,000 Testing—# of tests $2 x 15,500; $2 x 10,000 Painting—# litres $10 x 3,680; $10 x 1,578

. 5-31

Home

Commercial

$45,150

$25,200

116,100

34,400

297,000

93,600

31,000

20,000

36,800

15,780

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 5-31A (Continued) Packing and shipping--kilograms $2.35 x 215,000; $2.35 x 120,000

505,250

282,000

Total overhead applied

$1,031,300

$470,980

Home

Commercial

Total overhead applied

$1,031,300

$470,980

Total units produced

54,000

10,200

Per unit overhead cost

$19.10

$46.17

(d) Computation of unit costs—activity-based costing.

(e)

Manufacturing costs

Home

Commercial

Direct Material Direct labour Overhead cost

$18.50 19.00 19.10

$26.50 19.00 46.17

Per unit cost

$56.60

$91.67

Value Added Forming Assembling Painting Packing & shipping

Non-Value-Added Receiving Testing

. 5-32

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PROBLEM 5-31A (Continued) (f)

(1) Activity-based costing shows the commercial model absorbs nearly 21/2 ($46.17 ÷ $19.10) 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 as under the traditional costing. Under traditional costing, the margin of error on the commercial model was almost 100%, an understatement of $22.77 on an assignment of $23.40. These distorted overhead assignments have likely led to overpricing the home model and underpricing the commercial model.

. 5-33

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PROBLEM 5-32A

(a) Computation of indirect manufacturing costs—using the plant-wide allocation rate of $800 per labour hour: 50 labour hours x $800 overhead rate = $40,000 for 1,000 pairs The rate would be $40 per pair ($40,000 ÷ 1,000).

(b)

Activity-based overhead applied Material handling—# of parts $8.00 x 4,000 parts

$32,000

Assembly—labour hours $80.00 x 50 hours

4,000

Inspection—minutes $12.00 x 60 minutes

720

Total overhead applied Number of pairs per batch

$36,720 1,000

Overhead applied per pair

$36.72

(c) The traditional product-costing system overcosts the shoes by $3.28 ($40.00 – $36.72). This may have caused the shoes to be overpriced.

. 5-34

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 5-33A (a) The total manufacturing cost per unit using activity-based costing is as follows: Activity-based overhead applied

(b)

Royale

Majestic

Purchasing—purchase orders $30 x 15,000 $30 x 25,000 Machine set-ups—# of set-ups $50 x 5,000 $50 x 13,000 Machining—machine hours $40 x 75,000 $40 x 45,000 Inspections—# of inspections $25 x 9,000 $25 x 19,000 Total overhead applied Number of units manufactured

$3,925,000 25,000

475,000 $3,675,000 10,000

Per unit overhead cost

$157.00

$367.50

Computation of unit costs

Royale

Majestic

Direct Material Direct labour Overhead cost Per unit cost

$700.00 120.00 157.00 $977.00

$420.00 100.00 367.50 $887.50

Gross Profit: Selling Price Less: per unit cost Gross profit

Royale $1,600.00 977.00 $623.00

Majestic $1,300.00 887.50 $412.50

. 5-35

$450,000 $750,000 250,000 650,000 3,000,000 1,800,000 225,000

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(c) Management’s future plans for the two television models are not sound. Under ABC costing, the Royale model is $210.50 ($623.00 – $412.50) per unit more profitable than the Majestic model. If any product should be phased out, it is the Majestic.

. 5-36

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 5-34A (a) The normal selling price per mountain bike using the single-rate method for assigning overhead on a plant-wide basis is as follows: Overhead rate = $300,000 ÷ 10,000 labour hours = $30 per labour hour Single rate method: Direct material Direct labour Applied overhead ($30 x 7.5 hours per unit) Full cost per unit Plus: mark-up at 20%

$160.00 180.00 225.00 565.00 113.00

Normal price per mountain bike

$678.00

The unit price offered of $575 is lower than the normal price. Therefore the company should refuse the offer even if sales would increase 30%.

(b) Determine activity-based overhead rates: Machining: $75,000 ÷ 25,000 = $3.00 per machine hour Reworking: $45,000 ÷ 600 = $75 per unit Inspection: $25,000 ÷ 500 = $50 per hour Scrap: $35,000 ÷ 140 = $250 per unit General: $120,000 ÷ 12,000 = $10 per direct labour hour

. 5-37

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PROBLEM 5-34A (Continued) Activity-based costing method: Direct Material Direct labour Machining ($3 x 6 hrs) Rework labour ($75 x 0.25 hrs) Inspection ($50 x 0.1 hour) Scrap costs ($250 x 0.05 units) General overhead ($10 x 7.5 DLH) Full cost per unit Plus: mark-up at 20%

$160.00 180.00 18.00 18.75 5.00 12.50 75.00 469.25 93.85

Normal price per mountain bike

$563.10

Using an activity-based costing approach, Kiddy should accept the offered price of $575, which has a slightly higher mark-up than the target mark-up of 20%.

. 5-38

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PROBLEM 5-35A (a) Predetermined overhead rate using machine hours: $830,000 ÷ 100,000 hrs. = $8.30 per machine hour (b) Manufacturing cost per stair under traditional costing: Direct materials ............................................................... Direct labour ................................................................... Overhead (14,500 X $8.30).............................................. Total cost of 280 stairs ...........................................

$103,600 112,000 120,350 $335,950

Cost per stair ($335,950 ÷ 280).......................................

$1,199.82

(c) Manufacturing cost per stair under activity-based costing: Determine activity-based overhead rates: Purchasing: $57,000 ÷ 600 = $95 per order Handling materials: $82,000 ÷ 8,000 = $10.25 per move Production: $210,000 ÷ 100,000 = $2.10 per direct labour hour Setting-up: $85,000 ÷ 1,250 = $68 per set-up Inspecting: $90,000 ÷ 6,000 = $15 per inspection Inventory control: $126,000 ÷ 168,000 = $0.75 per component Utilities: $180,000 ÷ 90,000 = $2.00 per square foot Assign overhead to the order Purchasing ($95 x 60 orders) Handling materials ($10.25 x 800 moves) Production ($2.10 x 5,000 direct labour hrs) Setting-up ($68 x 100 set-ups) Inspecting ($15 x 450 inspections) Inventory control: ($0.75 x 16,000 components) Utilities ($2.00 x 8,000 square feet) Total overhead applied to this order

. 5-39

$5,700 8,200 10,500 6,800 6,750 12,000 16,000 $65,950

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 5-35A (Continued) Total manufacturing cost per stair under ABC: Direct materials ...................................................................... Direct labour........................................................................... Overhead ................................................................................ Total cost of 280 stairs...................................................

$ 103,600 112,000 65,950 $ 281,550

Total cost per stair ($281,550 ÷ 280) .....................................

$1,005.54

(d) 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.

. 5-40

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PROBLEM 5-36A (a) Predetermined overhead rate—traditional method Total estimated overhead Divide by: Number of direct labour hours (150,000 + 27,000) Overhead rate per direct labour hour

$1,241,660 177,000 $7.015

Computation of unit costs

CoolDay

LiteMist

Direct Material Direct labour Overhead cost : $7.015 x 0.05; 0.09 Total unit cost

$0.400 0.250 0.351 $1.001

$1.200 0.500 0.631 $2.331

(b) Determine activity-based overhead rates: Processing: $145,860 ÷ 6,600 = $22.10 per cart Aging: $396,000 ÷ 6,600,000 = $0.06 per month Bottling & corking: $270,000 ÷ 900,000 = $0.30 per bottle Labeling & boxing: $189,000 ÷ 900,000 = $0.21 per bottle Inspecting equipment: $240,800 ÷ 800 = $301 per inspection

. 5-41

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PROBLEM 5-36A (Continued) (c)

Assign overhead to the product

CoolDay

Processing ($22.10 x 6,000 carts) ($22.10 x 600 carts) Aging ($0.06 x 3,000,000 months) ($0.06 x 3,600,000 months) Bottling & corking ($0.30 x 600,000) ($0.30 x 300,000) Labeling & boxing ($0.21 x 600,000) ($0.21 x 300,000) Inspecting ($301 x 350 inspections) ($301 x 450 inspections)

$132,600

Total overhead assigned

$723,950

LiteMist

$13,260 180,000 216,000 180,000 90,000 126,000 63,000 105,350 135,450 $517,710

CoolDay

LiteMist

Total overhead applied

$723,950

$517,710

Total units produced

3,000,000

300,000

Per unit overhead cost

$0.2413

$1.7257

(d) Computation of ABC unit costs

CoolDay

LiteMist

Direct Material Direct labour Overhead cost : see above Total unit cost

$0.400 0.250 0.241 $0.891

$1.200 0.500 1.726 $3.426

. 5-42

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PROBLEM 5-36A (Continued) (e) To:

Mr. Tyler Silva

From:

Student

Subject:

Product costs using traditional approach versus ABC

The memorandum covers the following points: a.

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 labour costs. In the case of the Mendocino 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 labour rates, too much overhead was allocated to the high volume CoolDay product. This reduced the apparent profitability of this product. The total cost of the two products under the two approaches was as follows: CoolDay LiteMist Traditional approach $1.001 $2.331 ABC

$0.891

$3.426

Therefore, the relative profitability of the two products should be determined using ABC costing.

. 5-43

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PROBLEM 5-37A

(a) Computation of assigned overhead under traditional costing (“direct labour dollars” appears in the first line of the schedule of overhead data): Predetermined overhead rate X direct labour dollars Overhead assigned to audit: Overhead assigned to tax:

(b)

.40 X $1,000,000 = $400,000 .40 X $800,000 = $320,000

(1) Determine activity-based overhead rates: Employee training: $216,000 ÷ $1,800,000 = $0.12 per DL dollar Secretarial: $76,200 ÷ 2,500 = $30.48 per report/form Computing: $204,000 ÷ 60,000 = $3.40 per minute Facility rental: $142,500 ÷ 40 = $3,562.50 per employee Travel: No rate; expenses are traced directly (2) Assign overhead:

Audit

Tax

Training ($0.12 x $1,000,000 DL$) ($0.12 x $800,000 DL$) Secretarial ($30.48 x 600 reports ($30.48 x 1,900 reports) Computing ($3.40 x 25,000 min.) ($3.40 x 35,000 min.) Rent ($3, 562.50 x 22 employees) ($3, 562.50 x 18 employees) Travel (Direct)

$120,000

56,000

64,125 25,300

Total overhead assigned

$357,663

$362,337

. 5-44

$96,000 18,288 57,912 85,000 119,000 78,375

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PROBLEM 5-37A (Continued) (c)

Value-Added Typing and secretarial Computing

Non-Value-Added Employee training Facility rental Travel

(d) Overhead is assigned to the two service lines as follows: Audit $400,000 357,663

Traditional costing ABC

Tax $320,000 362,337

Traditional costing using direct labour dollars as the overhead base assigned $80,000 more to Audit than to Tax. But under ABC, using six different overhead categories, it shows the two departments are more closely matched in total costs, differing by only $4,674. It would appear that under the traditional method Audit would be subsidizing some of Tax’s overhead cost.

. 5-45

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PROBLEM 5-38A (a) Determine activity-based overhead rates: Machine set-up: $25,000 ÷ 50 = $500 per set-up Order processing: $60,000 ÷ 800 = $75 per order Warehouse costs: $90,000 ÷ 400 = $225 per inventory unit Shipping: $35,000 ÷ 7,500 = $4.667 per unit GOGO ltd. Income Statement for the year ended December 31, 2009 Standard $475,000

Sales Direct costs: Direct material 200,000 Direct labour 54,000 Variable Overhead: Machine set-up1 11,000 1 Order processing 22,500 1 Warehouse costs 45,000 1 Shipping 23,333 Contribution margin $119,167 Fixed overhead: Plant administration Other fixed Net operating profit 1

Deluxe $380,000

Super Total $560,000 $1,415,000

150,000 14,000

240,000 24,000

590,000 92,000

5,500 15,000 22,500 2,333 $170,667

8,500 22,500 22,500 9,334 $233,166

25,000 60,000 90,000 35,000 523,000 88,000 182,000 $253,000

Amount = Overhead rate x Expected use of cost driver

(b) Activity-based costing (ABC) provides a more detailed breakdown of costs and better matches each cost with the activity that incurred the cost. This additional information should enable GoGo to make better decisions. For example, if GoGo wants to reduce costs, with ABC it can identify the most costly activities and/or which costs are most

. 5-46

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amenable to reduction. Also the company will have more accurate cost information for product costing.

. 5-47

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SOLUTIONS TO PROBLEMS—SET B PROBLEM 5-39B (a) Computation of unit costs—traditional costing. Products Curler Dryer

Manufacturing Costs

Direct materials $5.25 Direct labour 8.00 Overhead ($438,000 ÷ 120,000 hours) 3.65 Total unit cost $16.90 (b) Determine activity-based overhead rates: Purchasing: $57,500 ÷ 500 = $115 per order Receiving: $42,000 ÷ 140,000 = $0.30 per kilogram Assembly: $166,000 ÷ 830,000 = $0.20 per part Testing: $52,000 ÷ 130,000 = $0.40 per test Finishing: $60,000 ÷ 120,000 = $0.50 per unit Shipping: $60,500 ÷ 12,100 = $5.00 per carton (c)

Assign overhead:

Curler

Purchasing ($115 x 170 orders) ($115 x 330 orders) Receiving ($0.30 x 58,000 kgs.) ($0.30 x 82,000 kgs.) Assembly ($0.20 x 415,000 parts) ($0.20 x 415,000 parts) Testing ($0.40 x 82,000 tests) ($0.40 x 48,000 tests) Finishing ($0.50 x 80,000 units) ($0.50 x 40,000 units) Shipping ($5.00 x 8,040 cartons) ($5.00 x 4,060 cartons) Total overhead costs Units produced Per unit overhead cost

$19,550

. 5-48

$9.75 8.00 3.65 $21.40

Dryer $37,950

17,400 24,600 83,000 83,000 32,800 19,200 40,000 20,000 40,200 20,300 $232,950 $205,050 80,000 40,000 $2.91 $5.13

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PROBLEM 5-39B (Continued)

Manufacturing Costs

Products Curler Dryer

Direct materials Direct labour Overhead (as above) Total unit cost

$5.25 8.00 2.91 $16.16

(e)

Value Added Assembling Finishing Packing and shipping

Non-Value-Added Purchasing Receiving Testing

(f)

(1) Activity-based costing shows the blow dryer will absorb 76 percent more overhead per unit, $5.13 versus $2.91, than the hair curler.

$9.75 8.00 5.13 $22.88

(2) A comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal as under traditional costing at $3.65 per unit; rather it is $2.91 per curler unit and $5.13 per dryer unit. Under traditional costing, the margin of error on the curlers is 74 cents per unit, an overstatement of 25%, and on the dryers it is $1.48 per unit, an understatement of 29%. These distorted overhead assignments have likely led to overpricing the curlers and underpricing the dryers.

. 5-49

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PROBLEM 5-40B (a) The allocation of total manufacturing overhead using activity-based costing is as follows: Ice Cool House Chest Purchasing ($40 x 2,500 orders) $100,000 ($40 x 1,975 orders) $79,000 Set-ups ($250 x 480 set-ups) 120,000 ($250 x 300 set-ups) 75,000 Machine hrs. ($4.00 x 60,000 hrs.) 240,000 ($4.00 x 20,000 hrs.) 80,000 Testing ($20 x 5,000 tests) 100,000 ($20 x 3,000 tests) 60,000 Total overhead costs $560,000 $294,000 Units produced 50,000 20,000 Per unit overhead cost

(b)

Per unit gross profit: Selling price Less: unit cost Direct material Direct labour Overhead Gross profit per unit

$11.20

Ice House

$14.70

Cool Chest

$35.00 $9.50 8.00 11.20

28.70 $6.30

$24.00 $6.00 5.00 14.70

25.70 $(1.70)

(c) Activity-based costing reveals a very different situation than traditional costing. Management must be stunned to learn that the “Cool Chest” is unprofitable, losing $1.70 per unit while its other product, “Ice House,” earns gross profit of $6.30 per unit. Obviously, management must revise its marketing and selling efforts as well as its pricing, and maybe its production, of the “Cool Chest.”

. 5-50

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PROBLEM 5-41B (a)

Determine plant-wide overhead rate: $1,500,000 = $5.00 per machine hour 300,000 Determine applied overhead per unit: 3,000 machine hrs x $5 per hour = $2.50 per unit 6,000 units produced Bid price per unit of Job #287 (using single overhead rate) Direct materials Direct labour Applied overhead Full manufacturing cost per unit Mark-up (25% x $5.70) Bid price per unit

(b)

$1.350 1.850 2.500 $5.700 1.425 $7.125

Determine activity-based overhead rates: Purchasing & receiving: $300,000 ÷ 3,000 = $100 per receipt Machining: $900,000 ÷ 300,000 = $3.00 per machine hour Materials handling: $160,000 ÷ 400,000 = $0.40 per move Shipping: $140,000 ÷ 280,000 = $0.50 per kilometer

. 5-51

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PROBLEM 5-41B (Continued) Per unit applied overhead: Purchasing & Receiving ($100 x 3 receipts) Machine operating costs ($3.00 x 3,000 machine hrs) Materials handling ($0.40 x 300 moves) Shipping ($0.50 x 2,300 kilometers) Total overhead costs Units produced

1,150 $10,570 6,000

Per unit overhead cost

$1.762

$300 9,000 120

Bid price per unit of Job #287 (using activity-based overhead rate) Direct materials Direct labour Applied overhead Full manufacturing cost per unit Mark-up (25% x $5.70) Bid price per unit

$1.350 1.850 1.762 $4.962 1.240 $6.202

Using an activity-based approach, Mars Company’s bid price of $6.202 per unit is lower than Arrow Company’s bid price of $6.75 per unit. Thus, Mars is more likely to receive the contract.

. 5-52

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PROBLEM 5-42B (a) Predetermined overhead rate using machine hours: $1,750,000 ÷ 100,000 hrs. = $17.50 per machine hour (b) Manufacturing cost per kitchen under traditional costing: Direct materials Direct labour Applied overhead ($17.50 x 15,000 hrs.) Full manufacturing cost Number of kitchens produced Manufacturing cost per kitchen

$180,000 200,000 262,500 $642,500 50 $12,850

(c) Manufacturing cost per kitchen under activity-based costing: Determine activity-based overhead rates: Purchasing: $114,400 ÷ 650 = $176 per order Material handling: $164,320 ÷ 8,000 = $20.54 per move Production: $500,000 ÷ 100,000 = $5.00 per direct labour hour Setting up machines: $174,480 ÷ 1,200 = $145.40 per set-up Inspecting: $184,800 ÷ 6,000 = $30.80 per inspection Inventory control: $252,000 ÷ 36,000 = $7.00 per component Utilities: $360,000 ÷ 90,000 = $4.00 per square foot Assign overhead for 50 kitchens: Purchasing ($176 x 50 orders) Handling materials ($20.54 x 800 moves) Production ($5 x 12,000 direct labour hrs) Setting-up ($145.40 x 100 set-ups) Inspecting ($30.80 x 450 inspections) Inventory control: ($7 x 3,000 components) Utilities ($4.00 x 8,000 square feet) . 5-53

$8,800 16,432 60,000 14,540 13,860 21,000 32,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Total overhead applied to this order

Weygandt, Kimmel, Kieso, Aly

$166,632

Per unit manufacturing cost: Direct materials Direct labour Overhead Total cost Spread over 50 kitchens

$180,000 200,000 166,632 546,632 ÷ 50

Manufacturing cost per kitchen

$10,932.64

(d) The difference between the traditional cost and the activity-based cost per unit of $1,917.36 ($12,850 vs. $10,932.64) is significant—17.5% ($1,917.36 ÷ $10,932.64). The traditional costing did not take into account the mass production of 50 identical kitchen arrangements rather than building custom-made, one-of-a-kind, kitchen arrangements. ABC allowed for the savings in fewer orders, fewer material moves, fewer setups, fewer labour hours, and fewer inspections when producing 50 identical units. The greater accuracy of ABC over traditional costing, which used only one cost driver (machine hours), results from the identification of multiple activities and their relevant cost drivers. Management can make much better pricing decisions using the ABC costing method.

. 5-54

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PROBLEM 5-43B (a) Quality control costs assigned to the Varnish line under the traditional system: 30% x $100,000 direct labour cost = $30,000 quality control costs (b) Quality control costs assigned to the Varnish line under activitybased costing: Incoming material inspection: $25 x 50 types of material In-process inspection: $0.30 x 30,000 units Product certification: $150 x 80 orders Total quality control cost applied to this line

$1,250 9,000 12,000 $22,250

(c) With respect to the quality control costs, the traditional productcosting system over-costs the Varnish paint product line by $7,750 ($30,000 - $22,250). If the traditional method is used, it could lead to over-pricing the Varnish line, and losing sales to competitors who are using the more accurate way to allocate overhead costs. It could also lead to other bad pricing decisions, based on under-costing the products the Varnish paint is subsidizing.

. 5-55

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PROBLEM 5-44B (a) Computation of unit costs—traditional costing Overhead cost: $1,485,000 ÷ (60,000 + 30,000) = $16.50 per DL hour Per Unit cost:

StarDew

VineRose

Direct materials Direct labour Overhead: $16.50 x 0.075 direct labour hours $16.50 x 0.15 direct labour hours

$1.100 0.500

$2.400 1.000

Unit cost—traditional costing

$2.838

1.238 2.475 $5.875

(b) Determine activity-based overhead rates: Grape processing: $189,000 ÷ 10,000 = $18.90 per cart of grapes Aging: $416,000 ÷ 60 months = $6,933.33 per month Bottling & corking: $360,000 ÷ 1,600,000 = $0.225 per bottle Labeling & boxing: $240,000 ÷ 1,600,000 = $0.15 per bottle Inspecting equipment: $280,000 ÷ 560 = $500 per inspection

. 5-56

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PROBLEM 5-44B (Continued)

(c)

Assign overhead to the product

StarDew

Processing ($18.90 x 8,000 carts) ($18.90 x 2,000 carts) Aging ($0.13 x 800,000 ltr/month) ($0.13 x 2,400,000 ltr/month) Bottling & corking* ($0.90 x 200,000) ($0. 90 x 200,000) Labeling & boxing* ($0.60 x 200,000) ($0.60 x 200,000) Inspecting ($500 x 160 inspections) ($500 x 400 inspections)

$151,200

Total overhead assigned

$635,200

VineRose $37,800

104,000 312,000 180,000 180,000 120,000 120,000 80,000 200,000 $849,800

*Bottles are the cost drivers for both bottling and corking and labeling and boxing.

StarDew

VineRose

Total overhead applied Total litres produced

$635,200 800,000

$849,800 200,000

Per litre overhead cost

$0.794

$4.249

(d) Computation of unit costs

StarDew

VineRose

Direct Material Direct labour Overhead cost : see above Total unit cost

$1.100 0.500 0.794 $2.394

$2.400 1.000 4.249 $7.649

. 5-57

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PROBLEM 5-44B (Continued) (e) To:

Mr. Jorge Rojo

From:

Student

Subject:

Product costs using traditional approach versus ABC

The student’s memorandum should cover the following points: (1) 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. (2) 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 labour costs. (3)

In the case of the Vino Verite Corporation, the VineRose product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When overhead costs were allocated using labour rates, too much overhead was allocated to the high volume StarDew product. This reduced the apparent profitability of this product.

(4) The total cost of the two products under the two approaches was as follows: StarDew VineRose Traditional approach Activity-based costing

$2.838 $2.368

$5.875 $7.753

Therefore, the relative profitability of the two products should be determined using ABC costing.

. 5-58

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PROBLEM 5-45B (a) Determine activity-based overhead rates: Engineering: $80,000 ÷ 4,000 = $20 per engineering hour Set-ups: $45,000 ÷ 250 = $180 per set-up Machining: $120,000 ÷ 20,000 = $6 per machine hour Inspection: $60,000 ÷ 1,500 = $40 per inspection Processing: $35,000 ÷ 7,000 = $5 per direct labour hour Net Profit per unit

Disk

Gear

Sales Less: Per unit manufacturing cost Direct materials Direct labour Overhead: Engineering ($20 x .05 hrs.) ($20 x .15 hrs.) Set-ups ($180 x 25 set-ups)/5,000 ($180 x 9 set-ups)/3,000 Machining ($6 x 2.5 hrs) ($6 x 1.0 hrs) Inspection ($40 x 250 inspections)/5,000 ($40 x 125 inspections)/3,000 Processing ($5 x 0.10 DL hrs.) ($5 x 0.50 DL hrs) Total manufacturing cost

$35.00

$43.00

10.00 1.20

7.50 6.00

30.60

2.50 27.21

Net profit per unit

$4.40

$15.79

12.57%

36.72%

Profit margin percentage

1.00 3.00 0.90 0.54 15.00 6.00 2.00 1.67 0.50

(b) The gear requires more direct labour hours than the disk (0.5 vs. 0.1). By using the direct labour hours to assign overhead, the gear absorbs more overhead costs than the brake disk. However, by using the activity-based costing method, the costs assigned to the gear more accurately reflect the actual consumption of resources used by the activities to produce the gear. . 5-59

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 5-46B (a) Computation of assigned overhead under traditional costing: Overhead rate = $265,000 ÷ 5,000 DL hours = $53 per DL hour Overhead assigned to farm animals:$53 x 2,000 = $106,000 Overhead assigned to pets: $53 x 3,000 = $159,000 (b)

Determine activity-based overhead rates: Drug treatment: $64,000 ÷ 4,000 = $16 per treatment Surgery: $70,000 ÷ 800 = $87.50 per operation Travel: $28,000 ÷ 28,000 = $1.00 per mile Consultation: $33,000 ÷ 3,000 = $11 per call Accounting/Office: $30,000 ÷ 5,000 = $6 per direct labour hour Boarding & grooming: No rate; expenses are traced directly Assign overhead:

Farm

Drug treatment ($16 x 1,700 treatments) ($16 x 2,300 treatments) Surgery ($87.50 x 200 operations) ($87.50 x 600 operations) Travel ($1.00 x 26,000 miles) ($1.00 x 2,000 miles) Consultation ($11 x 600 calls) ($11 x 2,400 calls) Accounting/Office ($6 x 2,000 DLH) ($6 x 3,000 DLH) Boarding & grooming (Direct)

$27,200

Total overhead assigned

$89,300

. 5-60

Pets $36,800

17,500 52,500 26,000 2,000 6,600 26,400 12,000 18,000 40,000 $175,700

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PROBLEM 5-46B (Continued) (c)

Value-Added Drug treatment Surgery Consultation Boarding/Grooming

Non-Value-Added Travel Accounting/Office

(d) Comparison of overhead assigned: Traditional costing: Farm animals Pets Total

$106,000 159,000 $265,000

40% 60%

$ 89,300 175,700 $265,000

34% 66%

Activity-based costing: Farm animals Pets Total

(e) The difference in the overhead assigned is significant. Under the traditional method, Farm Animals is subsidizing some of the overhead cost that actually belongs to Pets. This makes the pet service look more profitable than it really is, and could lead to some poor decisions by management.

. 5-61

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PROBLEM 5-47B (a)

Determine activity-based overhead rates: Material requisitions: $54,000 ÷ 108 = $500 per requisition Product inspections: $8,200 ÷ 54 = $151.85 per inspection Orders shipped: $103,000 ÷ 296 = $347.97 per order Thunderbolt

Assign overhead: Material requisitions: $500 x 46 requisitions $500 x 62 requisitions Product inspections $151.85 x 23 inspections $151.85 x 31 inspections Orders shipped $347.97 x 167 orders $347.97 x 129 orders

Earthquake

$23,000 $31,000 3,493 4,708 58,111 44,888

Total overhead assigned

$84,604

$80,596

(b) Three conditions that should be present in PDI are: • The consumption ratios of unit-based and non-unit-based activities must differ. • Non-unit-based costs should be a significant portion of total overhead costs. • Measurement costs of the identified cost pools must be relatively low.

. 5-62

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SOLUTIONS TO CASES CASE 5-48 (a) Computation of the average hourly charge-out rate: Total overhead Total billable hours

$1,172,000 = 60,000

$19.53 per billable hour

Direct labour cost Total billable hours

$1,350,000 = 60,000

$22.50 per billable hour

Average charge out rate:

(b)

2 x ($19.53 + $22.50) = $84.06

Determine activity-based overhead rates: Planning and review: $300,000 ÷ 60,000 = $5 per billable hour Research: $50,000 ÷ 200 = $250 per journal General administration: $600,000 ÷ 300 = $2,000 per client Building & Equipment: $120,000 ÷ 1,200 = $100 per sq. metre Clerical: $102,000 ÷ 17 = $6,000 per staff member Assign overhead: Planning & review ($5 x 45,000 hours) ($5 x 15,000 hours) Research ($250 x 140 journals) ($250 x 60 journals) General admin ($2,000 x 120 clients) ($2,000 x 180 clients) Build & Equip ($100 x 800 sq. metres) ($100 x 400 sq. metres) Clerical ($6,000 x 10 staff) ($6,000 x 7 staff) Total overhead assigned

MGMT Consult $225,000

$75,000 35,000 15,000 240,000 360,000 80,000 40,000 60,000 42,000 $640,000

. 5-63

EXEC Train

$532,000

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CASE 5-48 (Continued) Assignment of activity cost pools to services: Management Consulting: Total overhead Total billable hours Executive Training: Total overhead Total billable hours

$640,000 = 45,000

$14.22 per billable hour

$532,000 = 15,000

$35.47 per billable hour

Charge-out rate: Management Consulting: Direct Labour Cost $20.00 ($900,000 ÷ 45,000 hrs) Overhead 14.22 (as above) $34.22 x 2 = $66.88 per hour Executive Training: Direct Labour Cost Overhead

$30.00 ($450,000 ÷ 15,000 hrs) 35.47 (as above) $65.47 x 2 = $130.94 per hour

ii)

ABC increases the number of cost pools used to accumulate overhead costs. Rather than accumulating all overhead costs in a single company-wide pool, or accumulating them in departmental pools, costs are accumulated by activity. As a result, many pools are created according to the number of cost-driving activities that can be identified. ABC changes the base used to assign overhead costs to products. Rather than assigning costs on a basis of direct labour or some other measure of volume, costs are assigned on a basis of cost-driving activities that can be traced to the product or job involved. . 5-64

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iii)

CASE 5-48 (Continued)

iv)

ABC changes a manager’s perception that many of the overhead costs are indirect. It becomes obvious with ABC that many overhead costs can be identified with specific activities, and thereby are recognized as being traceable to individual products.

(d) ABC Costing can be expensive to use because of the increased cost of identifying multiple activities and applying numerous cost drivers. Certain overhead costs still need to be allocated using some arbitrary volume-based cost driver, such as labour or machine hours. (e) The cost driver used would have a bearing on the overhead calculation. Thus underestimating or overestimating these would impact on the billing charges that would be passed on to the client.

. 5-65

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CASE 5-49 (a)

Computation of activity-based overhead rate: Market analysis: $1,050,000 ÷ 15,000 = $70 per hour of analysis Product design: $2,280,000 ÷ 2,500 = $912 per design Product development: $3,600,000 ÷ 90 = $40,000 per product Prototype testing: $1,400,000 ÷ 700 = $2,000 per test

(b) Charges to in-house manufacturing department: Market analysis ($70 x 1,800 hours) Product design ($912 x 280 designs) Product development ($40,000 x 10 products) Prototype testing ($2,000 x 92 tests)

$126,000 255,360 400,000 184,000

Total overhead assigned

$965,360

(c) Charges to outside R & D contractor: Market analysis ($70 x 800 hours) Product design ($912 x 178 designs) Product development ($40,000 x 3 products) Prototype testing ($2,000 x 70 tests)

$56,000 162,336 120,000 140,000

Total overhead assigned

$478,336

(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 incurring costs; 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 R & R to compile realistic costs for bidding and charging outside users of its R & D department’s services.

. 5-66

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CASE 5-50 B & B Electronics should not continue with its plans to emphasize the Flat model and phase out the Deluxe model. As shown in the following activitybased costing analysis, the Flat model has a gross margin of less than 3 percent, while the Deluxe model generates a gross margin of over 31 percent. Computation of activity-based overhead rate: Soldering: $900,000 ÷ 1,500,000 = $0.60 per joint Shipments: $800,000 ÷ 20,000 = $40 per shipment Quality control: $1,200,000 ÷ 80,000 = $15 per inspection Purchase orders: $800,000 ÷ 160,000 = $5 per order Machine power: $37,500 ÷ 150,000 = $0.25 per machine hour Machine set-ups: $1,000,000 ÷ 10,000 = $100 per set-up Assign overhead:

Flat

Soldering $0.60 x 300,000; 1,200,000 joints $180,000 Shipments $40 x 4,800; 15,200 shipments 192,000 Quality control $15 x 21,000; 59,000 inspections 315,000 Purchase orders $5 x 110,000; 50,000 orders 550,000 Machine power $0.25 x 15,000; 135,000 machine hours 3,750 Machine set-ups $100 x 4,000; 6,000 set-ups 400,000 Total overhead assigned

$1,640,750

. 5-67

Deluxe $720,000 608,000 885,000 250,000 33,750 600,000 $3,096,750

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CASE 5-50 (Continued) Cost per model: Flat 4,000

Deluxe 22,000

$2,600,000 280,000 400,000 1,640,750 $4,920,750

$5,500,000 660,000 4,400,000 3,096,750 $13,656,750

Units produced Direct material ($650; $250) Direct labour ($70; $30) Machining ($100; $200) Manufacturing overhead

Profitability analysis: Flat 4,000

Deluxe 22,000

Total

Sales Less: Cost of goods sold Gross margin

$5,040,000 4,920,750 $ 119,250

$19,800,000 13,656,750 $ 6,143,250

$24,840,000 18,577,500 $ 6,262,500

Per Unit calculations: Selling Price Less: Cost of goods sold Gross margin Gross margin percentage

$1,260.00 1,230.19 $ 29.81 2.37%

$900.00 620.76 $279.24 31.03%

Units Sold

. 5-68

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CASE 5-51 (a) Computation of the overhead rate: Total overhead $1,200,000 = = Total direct labour hours 30,000

$40 per DL hour

Calculation of production costs using traditional costing:

Material Labour Overhead/DLH ($40 x 500 DLH) ($40 x 1,000 DLH) ($40 x 2,000 DLH)

Beginner Intermediate Advanced $20,800 $13,000 $8,000 7,000 14,000 28,000 20,000 40,000 $47,800

(b)

$67,000

80,000 $116,000

Computation of activity-based overhead rate: Order processing: $60,000 ÷ 100 = $600 per order Materials handling: $600,000 ÷ 120,000 = $5 per kilogram Amortization: $420,000 ÷ 20,000 = $21 per machine hour Quality control: $120,000 ÷ 40 = $3,000 per inspection Assign Overhead: Order processing-$600 x 6; 4; 3 orders Materials handling-$5 x 8,000; 3,200; 1,500 kg Machine amortization-$21 x 1,200; 300; 200 hours Quality control--

Beginner

Intermediate Advanced

$3,600

$2,400

$1,800

40,000

16,000

7,500

25,200

6,300

4,200

. 5-69

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CASE 5-51 (Continued) $3,000 x 3; 3; 3 inspections

9,000 $77,800

9,000 $33,700

9,000 $22,500

Calculation of production costs using activity-based costing:

Material Labour ABC overhead applied

Beginner Intermediate Advanced $20,800 $13,000 $8,000 7,000 14,000 28,000 77,800 33,700 22,500 $105,600 $60,700 $58,500

(c) The amount charged to each product for overhead is different under the two methods. A predetermined overhead rate based on direct labour-hours is a broad average that treats all products as if they accumulate overhead costs on the same basis. The use of only one allocation base to allocate the costs of many different types of costs obscures the relationship between the cost and the activity that gives rise to the cost (that is, the cost driver). Activity-based costing provides a truer picture of the costs associated with the different models by computing activity rates based on the different activity costs and their respective cost drivers. Product costs are then determined by costing the resources consumed on the activities used to produce each product.

. 5-70

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CASE 5-52 (a) Walker Ltd. is currently using a plant-wide overhead rate that is applied on the basis of direct-labour dollars. In general, a plant-wide manufacturing-overhead rate is acceptable only if a similar relationship between overhead and direct labour dollars exists in all departments or the company manufactures products that receive the same proportional services from each department. In most cases, departmental overhead rates are preferable to plant-wide overhead rates because plant-wide overhead rates do not provide the following: • A framework for reviewing overhead costs on a departmental basis, identifying departmental cost overruns, or taking corrective action to improve departmental cost control. • Sufficient information about product profitability, thus increasing the difficulties associated with management decision-making. (b) Because the company uses a plant-wide overhead rate applied on the basis of direct-labour dollars, the elimination of direct labour in the Assembly Department through the introduction of robots may appear to reduce the overhead cost of the Department to zero. However, this change will not reduce fixed manufacturing costs such as depreciation and plant supervision. In reality, the use of robots is likely to increase fixed costs because of increased depreciation. Under the current method of allocating overhead costs, the remaining departments will have to absorb these costs. (c) In order to improve the allocation of overhead costs in the three departments, management should move toward an activity-based costing system. The firm should: 1. Establish activity-cost pools for each significant activity. 2. Select a cost driver for each activity that best reflects the relationship of the activity to the overhead costs incurred. In order to accommodate the automation of the Assembly Department in its overhead accounting system, the company should: • Establish a separate overhead pool and rate for the Department.

. 5-71

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• Identify fixed and variable overhead costs and establish fixed and variable overhead rates. • Apply overhead costs to the Department on the basis of robot or machine hours.

. 5-72

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CASE 5-53 (a) Computation of the overhead rate per unit: Total Overhead # of Overhead Usage Cost units per unit Faster 50% X 4,000,000 = $ 2,000,000 ÷ 400 = $5,000 Slower 50% X 4,000,000 = $ 2,000,000 ÷ 500 = $4,000 Profitability analysis using current pricing:

Direct materials per unit Direct labour per unit Applied overhead per unit Full cost Selling price Materials at Labour at Selling price

140% 140%

Faster $8,000 1,750 5,000

Slower $6,500 1,850 4,000

$14,750

$12,350

$11,200 2,450 $13,650

$9,100 2,590 $11,690

CMC should change its pricing policy. With the current approach, both models are sold at a price that is lower than full cost. (b) Computation of the overhead rate per unit using ABC: Purchasing: $1,000,0001 ÷ 9 = $111,111 per purchase Receiving: $500,0001 ÷ 6 = $83,333 per shipment received Machining: $1,500,0001 ÷ 200,000 = $7.50 per machine hour Handling: $400,0001 ÷ 175 = $2,286 per move Shipping: $600,0001 ÷ 8,250 = $73 per kilometer 1

Use $4,000,000 overhead costs x respective percentages

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CASE 5-53 (Continued) Assignment of overhead—

Faster

Purchasing $111,111 x 5 purchases Receiving $83,333 x 3 shipments Machining: $7.50 x 100,000 hours Handling $2,286 x 75 moves Shipping $73 x 4,000 kilometres

$555,555 250,000 750,000 171,450 292,000

Total overhead assigned

$2,019,005

Number of units produced

400

Overhead assigned per unit

$5,048

Profitability Analysis

Faster

Direct material per unit Direct labour per unit Overhead cost per unit Total per unit cost Selling Price Profit per unit

$8,000 1,750 5,048 14,798 15,000 $202

According to activity-based costing, CMC should accept the selling price of $15,000 because it provides a profit of $202.

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CASE 5-54 (a) Computation of the overhead rate: Total overhead $3,500,000 Total budgeted direct = $700,000 = labour cost Profitability analysis using current pricing: Direct materials per unit Direct labour per unit Applied overhead per unit (500% x $0.25) Full product cost Markup at 25% Selling price

500% of DL cost

Mocha $3.20 0.25 1.25 $4.70 1.18 $5.88

Vanilla $2.80 0.25 1.25 $4.30 1.08 $5.38

(b) 1. Computation of the overhead rates using the controller’s approach: Purchasing: $575,000 ÷ 1,150 = $500 per purchase order Materials handling: $612,500 ÷ 1,750 = $350 per set-up Quality control: $150,000 ÷ 500 = $300 per batch Roasting: $950,000 ÷ 100,000 = $9.50 per hour Blending: $462,500 ÷ 23,125 = $20 per hour Packaging: $750,000 ÷ 30,000 = $25 per hour

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CASE 5-54 (Continued) Assign overhead:. (See below for calculations) Purchasing: $500 per order Materials handling: $350 per set-up Quality control: $300 per batch Roasting: $9.50 per hour Blending: $20 per hour Packaging: $25 per hour Total overhead assigned

Mocha $2,000 1,050 300 9,500 10,000 2,500 $25,350

Vanilla $2,000 4,200 1,200 190 200 50 $7,840

Calculations for determining overhead assignment: For 50,000 kg of Mocha Purchase orders: 50,000 ÷ 12,500 kilograms = 4 purchase orders Number of batches: 50,000 ÷ 50,000 kilograms = 1 batch Set-ups: 3 x 1 batch = 3 set-ups Roasting: (50,000 ÷ 50 kg) x 1.00 hour = 1,000 hours Blending: (50,000 ÷ 50 kg) x 0.50 hour = 500 hours Packaging: (50,000 ÷ 50 kg) x 0.10 hour = 100 hours For 1,000 kg of Vanilla Purchase orders: 1,000 ÷ 250 kilograms = 4 purchase orders Number of batches: 1,000 ÷ 250 kilograms = 4 batches Set-ups: 3 per batch x 4 batches = 12 set-ups Roasting: (1,000 ÷ 50 kg) x 1.00 hour = 20 hours Blending: (1,000 ÷ 50 kg) x 0.50 hour = 10 hours Packaging: (1,000 ÷ 50 kg) x 0.10 hour = 2 hours

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CASE 5-54 (Continued) Computation of per unit overhead costs: Mocha: $25,350 ÷ 50,000 kg = $0.507 per kg Vanilla: $7,840 ÷ 1,000 kg = $7.84 per kg Mocha Direct materials per kg Direct labour per kg Applied overhead per kg Full product cost per kg

$6.400 0.500 0.507 $7.407

Vanilla $5.600 0.500 7.840 $13.94

The new product cost using an activity-based costing approach is $7.407 per kilogram of Mocha coffee and $13.94 per kilogram of Vanilla coffee.

(c) The ABC analysis indicates that several activities other than direct labour are responsible for overhead. The cost computations show that the current system significantly under-costs Vanilla coffee ($8.60 vs. $13.94 per kg), the low volume product, and over-costs the high-volume product, Mocha coffee ($9.40 vs. $7.41 per kg). The implication of the ABC analysis is that the low-volume products are using resources but are not covering their share of the cost of those resources. The Vanilla blend is currently priced at $10.76 (5.38 per 500g bag x2), which is significantly below its activity-based cost of $13.94. The company should set long-run prices above cost. If there is excess capacity and many of the costs are fixed, it may be acceptable to price some products below full activity-based cost temporarily in order to build demand for the product. Otherwise, the high-volume, high-margin products are subsidizing the low-volume, low-margin products.

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CASE 5-55 (a) The stakeholders (parties affected by Marcus’s and Ray’s actions) in this case are: • Marcus as cost accountant. • Ray and all personnel employed in the production of the Supercut Model of lawn tractor. • Hi-Power Mower management. • Hi-Power Mower owners (shareholders). • 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. Ray is coercing Marcus to massage the data to save the product line and, thus, Ray’s job. Ray is advocating knowingly providing false data, deceiving management, and jeopardizing Marcus’s job. (c) Marcus 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 (see Appendix D, “Standards of Ethical Conduct for Management Accountants—Objectivity”). Marcus’s obligation is to provide management with timely, truthful information.

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-5

(a)

These answers are examples of possible cost drivers. Not all possible answers have been given.

Assembling—number of parts Billing—number of billings sent Digging trenches—machine hours or labour costs Janitorial— cost per square feet maintained Machine maintenance—number of maintenance hours Machine set ups—number of set ups needed Molding— machine hours Packaging— cost per package or number of labour hours Payroll— number of employees Plant supervision— number of employees Product design— cost per design or development costs or number of designs Purchasing materials— number of purchase orders Selling— number of sales calls or number of items sold Testing— number of tests Welding— labour cost or labour hours

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(b)

Waterways Corporation

Activity Cost Pools

Cost Drivers

Estimated Overhead

Expected Use of Cost Drivers per Activity

ActivityBased Overhead Rates

Actual Use of Drivers

Actual Cost Assigned

Installation Labour $1,999,728 12,960 $154.30 12,841 $1,981,366 cost Machining Machine 1,670,400 41,760,000 0.04 41,522,000 (all machine hours 1,660,880 use)

Customer orders Shipping Design Selling

Number of orders none (direct) Cost per design Number of sales calls

28,237

2,567 N/A

11.00

2,611

28,721

usage

traced directly

816

102.00

714

328,500

21,900

15.00

22,100

331,500

(c)

Testing of products—batch or unit if all items are tested Designing new products--product Packaging--unit Molding--unit Assembling--unit Amortization--facility Machine maintenance--facility

Advertising--product Equipment set up--batch Electricity required to run equipment— batch Requisitioning materials--batch

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(1) If Waterways is better able to control its overhead costs, it may be worth the time and initial costs required to set up and use ABC. Waterways does have a large variety of items that are manufactured. However, the items manufactured do not differ greatly in terms of the complexity of production. If, however, the cost savings are not sufficient to cover the added costs of using an ABC system, it would not be a wise decision for Waterways to use ABC. This may well be the case as the complexity of production is not very diverse. Also, because Waterways does handle special orders, dealing with differing cost drivers for special orders may prove difficult and expensive. (2) The use of ABC may allow managers to see what is actually driving the highest costs and better manage these costs, particularly those that are not value-added costs. It might also allow Waterways to focus on the constraints (or bottlenecks) in production and eliminate them. This translates into making continuous improvement in performance.

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Legal Notice

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CHAPTER 6 Decision-Making: Cost-Volume-Profit ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

A Problems

B Problems

* 1. List the five components of cost-volume-profit analysis.

1, 2, 6

15, 19, 21, 23

35, 38

49, 50

* 2. Explain what the contribution margin is and how it can be expressed.

3, 4, 7, 8, 9

1, 8, 11

15, 20, 23

36, 37, 40, 41, 42, 43, 45, 46, 47

48, 51, 53, 54, 55, 56, 57, 58, 60, 61

* 3. Identify the three ways to determine the break-even point.

5, 10, 11, 12

3, 4

18, 20, 23, 24

34, 35, 36, 37, 38, 39, 40, 41, 43, 44, 45, 46, 47

48, 49, 50, 51, 52, 53, 54, 55, 56, 57, 58, 60, 61

* 4. State the formulas for determining sales required to earn the target net income.

5, 7

16, 22

34, 35, 37, 38, 39, 40, 41, 42, 44, 45

49, 50, 51, 53, 54, 55, 56, 57, 58, 61

34, 43

48, 55

36, 37, 40, 41, 42

51, 54, 56, 60

Exercises

* 5. State the formulas for determining sales required to earn the target net income after tax. * 6. Define margin of safety, and state the formulas for calculating it.

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* 7. Explain the term “sales mix” and its effect on break-even sales.

20, 21, 22

11, 12, 13, 14

17, 27, 28, 29, 30, 31

* 8. Understand how cost structure and operating leverage affects profitability. (Appendix 6A)

15, 16, 17, 18, 19

8, 9, 10

26, 32, 33

44, 46

59, 60

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ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

34A

Calculate the break-even point in units and target income after tax.

Moderate

20–30

35A

Determine variable and fixed costs, calculate the breakeven point, prepare a CVP graph, and determine net income.

Moderate

25–35

36A

Determine the contribution margin ratio, break-even point in dollars, and margin of safety

Moderate

20–30

37A

Prepare a CVP income statement; calculate the breakeven point, contribution margin ratio, margin of safety ratio, and sales for target net income

Simple

20–30

38A

Compute the break-even point under alternative courses of action

Simple

25–35

39A

Determine the break-even point in dollars and units, and target income

Moderate

25–35

40A

Compute the break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in the business environment.

Moderate

20–30

41A

Compute the break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in the business environment.

Moderate

35-40

42A

Determine the contribution margin ratio, break-even point, and margin of safety.

Moderate

10-15

43A

Determine the contribution margin, break-even point, and target sales after taxes

Simple

25-35

44A

Determine the contribution margin, break-even point, target sales, and degree of operating leverage

Moderate

25-35

45A

Determine the contribution margin, break-even point in dollars, and target income.

Simple

15-20

46A

Calculate the degree of operating leverage and evaluate its impact on financial results

Moderate

25-35

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Problem Number

47A 48B

Description

Determine the break-even sales under alternative sales strategies and evaluate them. Determine the contribution margin, break-even point, and target sales after taxes

Weygandt, Kimmel, Kieso, Aly

Difficulty Level

Time Allotted (min.)

Simple

15-20

Moderate

20–30

49B

Determine variable and fixed costs, calculate the breakeven point, prepare a CVP graph, and determine net income

Moderate

25–35

50B

Determine variable and fixed costs and net income.

Simple

10–15

51B

Prepare a CVP income statement, and calculate the break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income.

Moderate

20–30

52B

Calculate the break-even point under alternative courses of action

Moderate

20–30

53B

Determine the break-even point in dollars and target income

Moderate

20–30

54B

Calculate the break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in the business environment.

Moderate

20–30

55B

Determine the break-even point and target income

Moderate

20–30

56B

Calculate the break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

Moderate

25–35

57B

Determine the contribution margin ratio, break-even point in dollars, and target sales.

Moderate

25–35

58B

Determine the contribution margin, break-even point in dollars, and sales

Simple

10–15

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59B

Calculate the degree of operating leverage and evaluate its impact on financial results

Moderate

25–35

60B

Calculate the contribution margin ratio, break-even point, margin of safety ratio and the degree of operating leverage and evaluate their impact on financial results.

Moderate

25–35

61B

Determine break-even sales under alternative sales strategies and evaluate.

Simple

20–30

. 6-5

Study Objective

Knowledge Comprehension

Application

For Instructor Use Only

*1.

List the five components of cost-volume-profit analysis.

Q1 Q6

BE2 E15

E19 E21

*2.

Explain what the contribution margin is and how it can be expressed.

Q8 Q9 BE1

BE8 E20 BE11 E23 E15

*3.

Identify the three ways to determine the break-even point.

Q5 Q10 Q12

BE3 BE4

E20 E23

*4.

State the formulas for determining sales required to earn the target net income.

Q14 BE5 BE7

E16

*5.

State the formulas for determining sales required to earn the target net income after tax.

* 6.

Define margin of safety, and state the formulas for calculating it.

Explain the term “sales mix” and its effect on break-even sales.

Q22

Q20 Q21

**8.

Understand how cost structure Q16 and operating leverage affects Q18 profitability. (Appendix 6A)

Q15 Q17 Q19

Q13 BE6 E15

E23

E25

Analysis

Synthesis

Evaluation

P35A P50B P49B

P38A

Q3 P36A P37A P42A P45A E18 E24 P34A P35A P36A P37A

P46A P56B P51B P57B P53B P58B P55B P61B

P40A P43A P47A

P48B P54B P60B

P39A P51B P44A P53B P45A P55B P46A P56B P49B P57B P50B P58B P61B P44A P55B P45A P56B P49B P57B P50B P58B P51B P61B P53B

P38A P40A P41A P43A P47A

P48B P52B P54B P60B

E22 P34A P35A P37A P39A P42A P34A P55B

P38A P40A P41A P54B

P43A P48B

E18 P37A P56B E24 P42A P36A P51B

P40A P41A P54B

BE11 BE14 E31 BE12 E17 BE13 E27

E28 E29 E30

P61B

P47A

BE8 BE9 BE10

E26 E32 E33

P44A P46A P59B

P60B

BLOOM’ S TAXONOMY TABLE

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

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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.

*2.

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.

If the selling price is reduced but variable and fixed costs remain unchanged, the break-even point will increase.

No. Only two of the basic components of cost-volume-profit (CVP) analysis, unit selling price 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.

There is no truth in Andrea’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.

8. RICE COMPANY CVP (Partial ) Income Statement Sales Less: Variable costs ($500,000 X .70) + ($200,000 X .70) Contribution margin 9.

$900,000 490,000 $410,000

Contribution margin per unit is $15 ($40 – $25). The contribution margin ratio is 37.5% ($15 ÷ $40).

*10. 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.

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Questions Chapter 6 (Continued) *11.

Break-even sales in dollars is determined by dividing total fixed costs by the contribution margin ratio, so the break-even point is $22,000 ÷ 25% = $88,000.

*12.

(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.

13.

(a)

Margin of safety is the difference between actual or expected sales and sales at the breakeven point.

(b) 1,600 X $12 = $19,200; $19,200 – $13,440 = $5,760; $5,760 ÷ $19,200 = 30%. 14.

At break-even sales, the contribution margin is equal to fixed costs, or $240,000. To determine target net income in sales, first calculate the contribution margin ratio: $240,000 ÷ $600,000 = 40%. The sales volume to achieve net income of $60,000 is: (Fixed costs + target net income) ÷ contribution margin ratio. Or

$240,000 + $60,000

= $750,000

0.4 *15. Cost structure refers to the proportion of fixed costs versus variable costs that a company incurs. Cost structure can have a considerable effect on a company’s break-even point. If two companies have the same level of sales dollars and exactly the same amount of expenses, but opposite cost structures, their break-even points will be very different. The company with a larger proportion of fixed costs will have a much higher break-even point than the one with a larger proportion of variable costs. *16. Operating leverage measures how sensitive net income is to a specific percentage change in the sales volume. In highly leveraged firms—those with high fixed costs and low variable costs— small changes in sales volume result in large changes in net profit. Firms with low leverage—low fixed costs and high variable costs—are not affected as much by changes in sales volume. Firms can increase their operating leverage by altering their cost structure, or converting variable expenses to fixed expenses. *17. The replacement of manual labour with automated equipment will increase a firm’s fixed costs and decrease its variable costs. This will increase operating leverage, but at the same time, will also raise the break-even point. *18. Operating leverage is measured in degrees, and can be calculated by dividing the total contribution margin by net income. *19. Acorn Company’s net income would increase by twice the amount as Oak Company’s with the same percentage increase in sales volume. For example, if both companies experienced an

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Questions Chapter 6 (Continued

)increase of 10% in sales volume, Acorn Company would have an 80% increase in net income, while Oak Company would only achieve a 40% increase. 20.

Sales mix means the proportions in which a company’s products are sold, relative to each other. The break-even point in a multi-product company is determined by calculating a weightedaverage contribution margin ratio. The proportions of high margin versus low margin products sold will raise or lower the break-even point accordingly.

21.

If the sales mix shifts so the company is selling more of the lower- priced tires, the weighted average contribution margin ratio will be lowered, which will, in turn, raise the break-even point.

22.

To calculate the break-even point for a company that has many products, contribution margin will frequently be determined based on sales information for divisions or product lines, rather than individual products.

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 1.

(a) (b)

$256 ($640 – $384) 40% ($256 ÷ $640)

$210 ($300 – $90) 30% ($90 ÷ $300)

(e) (f)

$1,280 ($320 ÷ 25%) $960 ($1,280 – $320)

BRIEF EXERCISE 6-2 FONTILLAS MANUFACTURING INC. CVP Income Statement For the Quarter Ended March 31, 2009

Sales ...................................................................... Variable costs ($920,000 + $70,000 + $86,000) ... Contribution margin ............................................. Fixed costs ($440,000 + $45,000 + $98,000) ........ Net income ............................................................ BRIEF EXERCISE 6-3 (a) $520Q = $286Q + $187,200 + $0 $234Q = $187,200 Q = 800 units (b) Contribution margin per unit is $234 ($520 – $286) Q = $187,200 ÷ $234 Q = 800 units

. 6-8

$2,200,000 1,076,000 1,124,000 583,000 $ 541,000

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BRIEF EXERCISE 6-4 Contribution margin ratio = [($300,000 – $180,000) ÷ $300,000] = 40% Required sales in dollars = $160,000 ÷ 40% = $400,000

BRIEF EXERCISE 6-5 If variable costs are 60% of sales, the contribution margin ratio is ($1 – $0.60) ÷ $1 = 40%. X = ($195,000 + $75,000) ÷ 40% X = $675,000

BRIEF EXERCISE 6-6 (a) Margin of safety in dollars—$1,200,000 – $840,000 = $360,000 (b) Margin of safety ratio—$360,000 ÷ $1,200,000 = 30%

BRIEF EXERCISE 6-7 Contribution margin per unit is $1.50 ($6.00 – $4.50) Required sales in units = ($480,000 + $1,500,000) ÷ $1.50 = 1,320,000 units.

*BRIEF EXERCISE 6-8 The degree of operating leverage is calculated by dividing the total contribution margin by net income. To determine the contribution margin multiply the degree of operating leverage by the net income. Delta Corp: Epsilon Co.:

$50,000 x 1.4 = $70,000 $50,000 x 5.6 = $280,000

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*BRIEF EXERCISE 6-9 Operating leverage-Before the purchase: $160,000 ÷ $40,000 = 4.0 After the purchase: $240,000 ÷ $40,000 = 6.0 By replacing variable expenses with fixed expenses (amortization), Sanjay’s Shingle Corporation is increasing its operating leverage. That is, before the purchase, the percentage increase in net income will be 4 times the percentage increase in sales volume. After the purchase, it will be 6 times. By changing its cost structure, Sanjay’s will have greater benefits (increased income) if revenues increase, but also greater risks (decreased income) if revenues decrease. An increase in operating leverage will also result in a higher break-even point, which might be riskier for Sanjay’s if the market is uncertain. *BRIEF EXERCISE 6-10 Break-even for Finch Co: $50,000 ÷ ($90,000 ÷ $150,000) = $83,3341 Break-even for Sparrow: $95,000 ÷ ($135,000 ÷ $150,000) = $105,5561 Sparrow Co. is more highly leveraged, so their break-even point will be higher. This is risky in an unstable market, but could result in higher returns once they reach break-even. Finch Co. has taken a more conservative approach. They will reach break-even faster, but their income on sales above that point will be less. 1

rounded to the nearest dollar

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BRIEF EXERCISE 6-11 Sales mix %: Bedroom--$500,000 ÷ ($500,000 + $750,000) = 40% Dining Room--$750,000 ÷ ($500,000 + $750,000) = 60% Contribution margin ratio: Bedroom--$250,000 ÷ $500,000 = 50% Dining Room--$300,000 ÷ $750,000 = 40% Weighted-average contribution margin ratio: (40% x 50%) + (60% x 40%) = 44% BRIEF EXERCISE 6-12 Per unit: Sales Less: variable costs Contribution margin Sales mix Weighted-average unit contribution margin =

A12 $50.00 $40.00 $10.00

Models B22 $100.00 70.00 $30.00

C124 $400.00 $300.00 $100.00

60%

25%

15%

($10 x 60%) + ($30 x 25%) + ($100 x 15%) = $28.50

BRIEF EXERCISE 6-13 Break-even in units = Fixed costs ÷ per unit contribution margin Break-even in units = $199,500 ÷ $28.50 = 7,000 units 4,200 units of A12 (7,000 x 60%) 1,750 units of B22 (7,000 x 25%) 1,050 units of C124 (7,000 x 15%)

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BRIEF EXERCISE 6-14 Weighted-average contribution margin ratio = (30% x 10%) + (50% x 20%) + (20% x 45%) = 22% Break-even in sales dollars = $440,000 ÷ 22% = $2,000,000 Birthday: Standard tapered: Large scented:

$2,000,000 x 30% = $600,000 $2,000,000 x 50% = $1,000,000 $2,000,000 x 20% = $400,000

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SOLUTIONS TO EXERCISES EXERCISE 6-15 (a)

If contribution margin ratio is 30%, then variable cost will be 70%. $15.00 x 0.70 = $10.50

(b)

Contribution margin per unit: $15.00 x 0.30 = $4.50 $6,750 ÷ $4.50 = 1,500 CDs to break even.

(c)

[($6,750 + $16,200) ÷ $4.50] = 5,100 CDs to make $16,200 net income

EXERCISE 6-16 (a)

If variable cost ratio is 30%, then contribution margin ratio is 70%. [($56,000 + $140,000) ÷ 0.70] = $280,000

(b)

Sales revenue Variable costs Contribution margin Fixed costs Net income

$280,000 (from (a) 84,000 $280,000 x 0.30 196,000 56,000 $140,000

EXERCISE 6-17 Weighted-average contribution margin = (0.15 x $120) + (0.60 x $60) + (0.25 x $40) = $64 Break-even in units = $5,440,000 ÷ $64 = 85,000 Destroyer: Voyager: Rebel:

85,000 x 15% = 12,750 units 85,000 x 60% = 51,000 units 85,000 x 25% = 21,250 units

. 6-13

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EXERCISE 6-18 (a)

(1) Contribution margin per room = Contribution margin per room = Contribution margin ratio =

$50 – ($8 + $28) $14 $14 ÷ $50 = 28%

Fixed costs = $7,200 + $1,500 + $1,200 + $300 = $10,200 Break-even point in rooms = $10,200 ÷ $14 = 729 (rounded up) (2) Break-even point in dollars

= =

729 rooms X $50 per room $36,450 per month

OR Fixed costs ÷ Contribution margin ratio = $10,200 ÷ 0.28 = $36,450 per month (b)

(1) 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 $50 = $75,000 Margin of safety in dollars = $75,000 – $36,450 = $38,550 (2) Margin of safety ratio: $38,571 = 51.43% $75,000

EXERCISE 6-19 (a)

At break even, fixed costs = contribution margin = $105,000 $350,000 - $105,000 = $245,000 variable costs $105,000 ÷ $350,000 = 30% contribution margin ratio

(b)

The increase in sales is $70,000 ($420,000 - $350,000) Increase in contribution margin = $70,000 x 0.30 = $21,000 Increase in fixed costs would be $21,000, the same as the increase in contribution margin at break even.

. 6-14

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EXERCISE 6-20 Total Per unit $68,400 $120 44,460 78 $23,940 $42

(a) Sales ($120 x 570) Variable costs (65% of sales) Contribution Margin (b)

Break-even point in dollars =

$21,000 = $60,000 0.35

Break-even point in units =

$21,000 = 500 units $42

% 100% 65% 35%

EXERCISE 6-21 (a) $150Q = $90Q + $570,000 + $150,000 $60Q = $720,000 Q = 12,000 units OR $570,000 + $150,000 $150 - $90 $570,000 + $210,000* $150 - $90 = 13,000 units *$150,000 + $60,000 = $210,000 desired profit

(b)

Units needed in 2010 =

(c)

Use the equation: Sales = variable costs + fixed costs + net income 12,000X = (12,000 x $90) + $570,000 + $210,000 Selling price (X) would have to be $155

. 6-15

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EXERCISE 6-22 Current selling price = $350,000 ÷ 5,000 units = $70 1.

Increase selling price to $77 ($70 x 110%). Net income = ($77 x 5,000) – $210,000 – $90,000 = $85,000.

Reduce variable costs to 55% of sales. Net income = $350,000 – ($350,000 x 0.55) – $90,000 = $67,500.

Alternative 1, increasing selling price, will produce the highest net income.

EXERCISE 6-23 (a)

(1) Contribution margin ratio is:

$27,360 = 76% $36,000

Break-even point in dollars =

$15,428 = $20,300 0.76

(2) Round-trip fare =

$36,000 = $25 1,440

Break-even point in fares =

$20,300 = 812 $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 $15,428.

. 6-16

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EXERCISE 6-24 (a)

$3,200

Sales Line

2,800

DOLLARS (000)

2,400

Total Cost Line Break-even Point

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: $4Q = $2.40Q + $800,000 + $0 $1.60Q = $800,000 Q = 500,000 units (2) Break-even sales in dollars: 500,000 units X $4 per unit = $2,000,000 (c) (1) Margin of safety in dollars: $2,500,000 – $2,000,000 = $500,000 (2) Margin of safety ratio: $500,000 ÷ $2,500,000 = 20%

. 6-17

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EXERCISE 6-25 (a)

Income statement without changes:

VOLMAR COMPANY CVP Income Statement (Unchanged) For the Year Ended December 31, 2009

Sales (60,000 x $25) ...................................... Variable costs ................................................ Contribution margin ...................................... Fixed costs..................................................... Net income ..................................................... (b)

Total

Per Unit

$1,500,000 720,000 780,000 400,000 $ 380,000

$25.00 12.00 $13.00

Income statement with changes: Proposed selling price per unit = $25.00 – ($3.00 X 0.50) = $23.50 Expected variable cost per unit = $12.00 – ($12.00 X 0.25) = $9.00 Expected level of sales = 60,000 x 105% = 63,000 New fixed costs = $400,000 + $150,000 = $550,000 VOLMAR COMPANY CVP Income Statement (with changes) For the Year Ended December 31, 2009

Sales (63,000 x $23.50) ................................. Variable costs (63,000 x $9.00) ..................... Contribution margin ...................................... Fixed costs ($400,000 + $150,000) ................ Net income .....................................................

. 6-18

Total

Per Unit

$1,480,500 567,000 913,500 550,000 $363,500

$23.50 9.00 $14.50

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*EXERCISE 6-26 (a) CM ratio = contribution margin ÷ sales Old-Fashioned: $80,000 ÷ $400,000 = 20% Mech-Apple: $240,000 ÷ $400,000 = 60% Mech-Apple will be more sensitive to changes in sales volume, because after reaching their break-even point, 60 cents from every sales dollar goes to profit. Old-Fashioned will only receive 20 cents from every sales dollar towards profit. (b) Operating leverage = contribution margin ÷ net income Old-Fashioned: $80,000 ÷ $60,000 = 1.33 Mech-Apple: $240,000 ÷ $60,000 = 4.00 (c)

1. Old-Fashioned: 10% x 1.33 = 13.30% decrease, or $7,980 Mech-Apple: 10% x 4.00 = 40% decrease, or $24,000 2. Old-Fashioned: 5% x 1.33 = 6.65% increase, or $3,990 Mech-Apple: 5% x 4.00 = 20% increase, or $12,000

(d) The investment banker should not make her decision solely on the information provided. Other factors, such as the market situation, should be considered, because this will impact the profitability of the companies. For example, Mech-Apple will benefit from its high degree of operating leverage, but only if it is above break-even. With its current cost structure, it has a much higher break-even point than OldFashioned has, and carries a much higher risk in an unstable market. Profitability will not be as great for Old-Fashioned, with an operating leverage of only 1.33, but with a lower break-even point it will achieve profitability much faster.

. 6-19

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EXERCISE 6-27 Weighted-average contribution margin per unit = (30% x $30) + (50% x $20) + (20% x $40) = $27 Break-even in units = $4,600,000 ÷ $27 = 170,370 units Lawn mowers: 170,370 x 30% = 51,111 units Weed-trimmers: 170,370 x 50% = 85,185 units Chain saws: 170,370 x 20% = 34,074 units EXERCISE 6-28 (a) Weighted average contribution margin ratio: (65% x 20%) + (35% x 60%) = 34% Break-even = $16,000,000 ÷ 0.34 = $47,058,824 Oil changes: 65% x $47,058,824 = $30,588,236 Brake repairs: 35% x $47,058,824 = $16,470,588 (b)

Desired net income per outlet = $63,750 Required sales = (fixed costs + desired net income) ÷ CM ratio = ($80,000 + $63,750) ÷ 34% = $422,794 of which 65% or $274,816 should be oil changes, and 35%, or $147,978 should be brake repairs.

. 6-20

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EXERCISE 6-29 (a) Weighted average contribution margin ratio: (0.80 x 10%) + (0.20 x 60%) = 20% Break-even sales = $12,000,000 ÷ 0.20 = $60,000,000 Distributed as follows-Pouches: 0.80 x $60,000,000 = $48,000,000 Non-standard: 0.20 x $60,000,000 = $12,000,000 (b) New weighted average contribution margin ratio: (0.40 x 10%) + (0.60 x 60%) = 40% Break-even sales = $12,000,000 ÷ 0.40 = $30,000,000 Distributed as follows-Pouches: 40% x $30,000,000 = $12,000,000 Non-standard: 60% x $30,000,000 = $18,000,000 EXERCISE 6-30 (a) Weighted average contribution margin per unit: (40% x $40) + (50% x $20) + (10% x $50) = $31 Break-even in units = $620,000 ÷ $31 = 20,000 units (b) Shoes: 20,000 x 40% = 8,000 units Gloves: 20,000 x 50% = 10,000 units Range finder: 20,000 x 10% = 2,000 units (c) Net income = total contribution margin – fixed costs (8,000 x $40) + (10,000 x $20) + (2,000 x $50) - $620,000 = $0

. 6-21

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EXERCISE 6-31 (a)

Percentage of sales: TV Division DVD Division

$600,000 ÷ $1,000,000 = 60% $400,000 ÷ $1,000,000 = 40%

Contribution margin: TV Division $150,000 ÷ $600,000 = 25% DVD Division $160,000 ÷ $400,000 = 40% (b) Weighted average contribution margin ratio: (0.60 x 25%) + (0.40 x 40%) = 31% (c) Break-even = $124,000 ÷ 0.31 = $400,000 (d) TV Division: DVD Division:

60% x $400,000 = $240,000 40% x $400,000 = $160,000

*EXERCISE 6-32 (a)

Operating Leverage: Billings Co:

$320,000 ÷ $150,000 = 2.133

Bozeman Co:

$520,000 ÷ $150,000 = 3.467

Billings Co. has an operating leverage of 2.133, which means that for every percentage increase in sales (above break even) the company’s net income will increase by 2.133 times the percent. It also means the company has a lower break even point. It would be the opposite for Bozeman. They have a much higher break even point, but past that, their net income will increase by a percentage that is 3.467 times the percentage increase in sales.

. 6-22

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*EXERCISE 6-32 (continued) (b) Billings and Bozeman Companies CVP Income Statement

Billings $660,000 308,000 352,000 170,000 $182,000

Sales revenue Variable costs Contribution margin Fixed costs Net income

Bozeman $660,000 88,000 572,000 370,000 $202,000

(c) Operating leverage is a measure of the sensitivity of net income to changes in the level of sales. The degree of operating leverage is determined by the cost structure of an organization. Billings Co. has a lower measure, meaning it has more variable costs than fixed costs. This is preferable during a time of economic stability—they are able to reach break even quickly, but the return on sales will be lower than a company with higher leverage. With a 10% increase in sales, they achieved a $32,000 increase in net income. (10% x 2.133 O.L. = 21.33% increase in sales; or $150,000 x 121.33 = $182,000 (rounded).) The low variable costs and high fixed costs for Bozeman Co. results in a higher operating leverage, and will lead to a much higher contribution margin from sales; however, their break even point is much higher as well. Compared to Billings, a 10% increase in sales for Bozeman lead to a $52,000 increase in net income--$20,000 more net income on the same $60,000 increase in sales. This is a good cost structure to have if you are certain you will reach break even.

. 6-23

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*EXERCISE 6-33 (a) Operating leverage Manual System: $300,000 ÷ $240,000 = 1.25 Computerized System: $900,000 ÷ $240,000 = 3.75

(b) For any increase in sales, Computerized System would produce a higher net income, because it has a higher operating leverage. (c) To determine margin of safety, first calculate the sales at break even: Manual System: $60,000 ÷ ($300,000 ÷ $1,500,000) = $300,000 Computerized System: $660,000 ÷ ($900,000 ÷ $1,500,000) = $1,100,000 Margin of Safety Manual System: $1,500,000 – $300,000 = $1,200,000 Computerized System: $1,500,000 – $1,100,000 = $400,000 Manual System has three times the safety margin that Computerized System has, so would be in a far better position to withstand a greater decline in sales before operating at a loss.

. 6-24

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SOLUTIONS TO PROBLEMS-SET A PROBLEM 6-34A (a)

Variable cost per unit = ($75,000 + $90,000 + $45,000 + $60,000) ÷ 15,000 = $18 Total fixed costs = $30,000 + $40,000 = $70,000 Contribution margin per unit = $38 - $18 = $20 Units at break even = $70,000 ÷ $20 = 3,500

(b)

New Contribution margin per unit = $43 - $18 = $25 Target net income = ($70,000 + $25,000) ÷ $25 = 3,800

(c)

Net income before taxes = $30,000 ÷ (1.00 - 0.40) = $50,000 Let X = selling price per unit Sales = variable costs + fixed costs + desired net income before tax 7,500X = ($18 x 7,500) + $70,000 + $50,000 7,500X = $255,000 X = $34 per unit

(d)

Let X = selling price per unit 9,000X = ($18 x 9,000) + $70,000 + 0.30(9,000X) 9,000X = $232,000 + 2,700X 6,300X = $232,000 X = $36.825 Proof: (small rounding error) Sales revenue (9,000 x $36.825) $331,428 Less: variable costs (9,000 x $18.00) 162,000 Contribution margin 169,428 Less: fixed costs 70,000 Net income before tax ($331,428 x 0.30) $99,428

. 6-25

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PROBLEM 6-35A (a)

Variable cost per haircut = ($4.00 + $0.60 + $0.40) = $5.00 Total fixed costs = [$1,800 + (3 x $1,300) + $800 +$500 +$300 + $200] = $7,500

(b)

Contribution margin per unit = $11 - $5 = $6 Units at break even = $7,500 ÷ $6 = 1,250 Sales at break even = $11 x 1,250 = $13,750

(c)

CVP graph:

(d) Total contribution margin – fixed costs = net income [($6 x 1,500) – $7,500] = $1,500

. 6-26

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PROBLEM 6-36A

(a)

Contribution ratio = Contribution margin ÷ Sales ($50 - $30) ÷ $50 = 40%

(b)

Break-even in dollars: $30,000 ÷ 40% = $75,000

(c)

Margin of safety = (2,800 x $50) - $75,000 = $65,000 $65,000 ÷ $50 = 1,300 margin of safety in units

(d)

Current unit contribution margin $50 - $30 = $20 Total contribution margin is $20 x 2,800 = $56,000 New contribution margin is [$56,000 + (56,000 x 0.60)] = $89,600 Total sales required: $89,600 ÷ 40% = $224,000 Proof: Sales revenue Less: variable costs Contribution margin

Before $140,000 84,000 $56,000

. 6-27

After $149,333 134,400 $89,600

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PROBLEM 6-37A (a) BOISCLAIR COMPANY CVP Income Statement For the Year Ended December 31, 2009

Net Sales Less: variable costs COGS ($430,000 + $352,000 + $316,000) Selling and Admin ($70,000 + $20,000) Contribution Margin Less: fixed costs COGS Selling and Admin ($65,000 + $60,000) Net income before tax

(b)

$1,800,000 100% $1,098,000 90,000

283,000 125,000

1,188,000 612,000

66% 34%

408,000 $204,000

Contribution margin ratio = ($612,000 ÷ $1,800,000) = 34% (1) Sales at break even = $408,000 ÷ 0.34 = $1,200,000 (2) Units at break even = $1,200,000 ÷ $1.00 = 1,200,000

(d)

= [($1,800,000 – $1,200,000) ÷ $1,800,000] = 33.33%

Sales = (fixed costs + net income) ÷ CM ratio Sales = [($408,000 + 238,000) ÷ 0.34] = $1,900,000 or Sales = $1,900,000 ÷ $1.00 per unit = 1,900,000 units.

. 6-28

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PROBLEM 6-38A (a)

Contribution margin = $2,400,000 - $1,560,000 = $840,000 CM ratio = $840,000 ÷ $2,400,000 = 35% Break-even in dollars = $980,000 ÷ 0.35 = $2,800,000

(b) (1) New sales total = ($2,400,000 x 1.20) = $2,880,000 Contribution margin = $2,880,000 - $1,560,000 = $1,320,000 CM ratio = $1,320,000 ÷ $2,880,000 = 46% Break-even in dollars = $980,000 ÷ 0.46 = $2,130,435 (2) New variable costs = $1,560,000 + (0.05 x $2,400,000) = $1,680,000 New fixed costs = $980,000 - $210,000 + $60,000 = $830,000 CM = $2,400,000 - $1,680,000 = $720,000 CM ratio = $720,000 ÷ $2,400,000 = 30% Break-even in dollars = $830,000 ÷ 0.30 = $2,766,667

Proof: Sales Less: variable costs Contribution margin Less: fixed costs Net income before tax

$2, 766,667 1,680,000 830,000 830,000 --

(c) Alternative 1 is the recommended course of action using breakeven analysis because it has the lower break-even point.

. 6-29

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PROBLEM 6-39A (a)

(b)

Sales (40,000 x $90) Less: Variable costs (40,000 x $60)

$3,600,000 2,400,000

Contribution Margin Less: Fixed costs Net Income

1,200,000 810,000 $390,000

Contribution margin ratio = $1,200,000 ÷ $3,600,000 = 33.33% Break-even point in dollars = $810,000 ÷ 33.33% = $2,430,000 (rounded) Contribution margin per unit = $90 - $60 = $30 Break-even point in units = $810,000 ÷ $30 = 27,000 units

(c)

Because fixed costs do not change, we can find the maximum by using contribution margin. Current level: 40,000 X $30 = $1,200,000 Next levels: 55,000 x $25 = $1,375,000 70,000 x $20 = $1,400,000 85,000 x $15 = $1,275,000 100,000 x $10 = $1,000,000 Maximum contribution margin is $1,400,000; less fixed costs of $810,000 means maximum profit is $590,000. This can be achieved by selling 70,000 units at $85 each ($25 CM plus $60 variable costs).

(d)

At a selling price of $80: Breakeven = $810,000 ÷ $20 = 40,500 units or $3,240,000

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PROBLEM 6-40A (a) (1) Contribution margin per unit = $40 - $22 = $18 Break-even in units = $270,000 ÷ $18 = 15,000 units (2) New selling price per unit = $38 New fixed costs = $270,000 + $34,000 = $304,000 New contribution margin per unit = $38 - $22 = $16 Break-even in units = $304,000 ÷ $16 = 19,000 (b) (1) Margin of safety = ($40 x 20,000) – ($40 x 15,000) = $200,000 Margin of safety ratio = $200,000 ÷ $800,000 = 25% (2) Margin of safety = ($38 x 24,000) – ($38 x 19,000) = $190,000 Margin of safety ratio = $190,000 ÷ $912,000 = 20.83%

(c)

VALUE SHOE STORE CVP Income Statement For the Year Ended December 31, 2009

Sales Less: Variable costs Contribution margin Less: Fixed costs Net income before tax

Current

New

$800,000 440,000 360,000 270,000 $90,000

$912,000 528,000 384,000 304,000 $80,000

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 and the margin of safety percentage would decrease. . 6-31

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PROBLEM 6-41A (a)

(1) Contribution margin

Current Year $1,600,00 100% 0

Sales ($16 per unit) Less: variable costs Direct materials ($5.11 per unit) Direct labour ($2.85 per unit) Manufacturing overhead Selling expenses ($0.96) Administrative expenses ($0.56) Contribution margin Contribution margin Sales (100,000 x 110% x 16)

$511,000 285,000 252,000 96,000 56,000

1,200,000 $400,000

75% 25%

Projected Year

Less: variable costs Direct materials($5.11) Direct labour (2.85) Manufacturing overhead ($2.52) Selling expenses ($0.96) Administrative expenses ($0.56) Contribution margin

$562,100 313,500 277,200 105,600 61,600

$1,760,000

100%

1,320,000 $440,000

75% 25%

(2) Fixed costs—Current Year Manufacturing overhead Selling expenses Administrative expenses

$108,000 144,000 224,000 $476,000

(b) Contribution margin per unit = $400,000 ÷ 100,000 = $4 Break-even in units = $476,000 ÷ $4 = 119,000 units Contribution margin ratio = $400,000 ÷ $1,600,000 = 25%

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PROBLEM 6-41A (Continued) (c) Target net income = ($476,000 + $310,000) ÷ 0.25 = $3,144,000 (d) Safety of margin ratio = ($3,144,000 - $1,904,000) ÷ $3,144,000 Safety of margin ratio = 39.44% (e)

(1) Contribution margin Sales Less: variable costs Direct materials Direct labour Manufacturing overhead Selling expenses Administrative expenses Contribution margin

With changes $1,600,000 $511,000 181,000 108,000 216,000 56,000

1,072,000 $528,000

(2) Contribution margin ratio = $528,000 ÷ $1,600,000 = 33% (3) Fixed costs—with changes Manufacturing overhead Selling expenses Administrative expenses

$252,000 24,000 224,000 $500,000

Break-even in sales = $500,000 ÷ 0.33 = $1,515,151

. 6-33

100%

67% 33%

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PROBLEM 6-41A (Continued) By incorporating the changes, the break-even sales declined—which means the company’s overall risk is decreased. It will not take them as long to reach break-even as before, so they will show profits sooner. However, the changes actually had opposing effects. Reducing variable costs increases the contribution margin ratio, but also leads to a higher break-even point because of higher fixed costs (purchase of equipment). On the other hand, moving to commissioned sales increases variable costs and lowers fixed costs resulting in a lower contribution margin ratio and a lower break even point.

. 6-34

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PROBLEM 6-42A (a)

(1) Sales Less: Contribution margin Direct material Direct labour Variable MOH Variable selling and admin costs

(2) Sales Less: Gross Profit Direct material Direct labour Variable MOH Fixed manufacturing overhead

$1,400,000 $300,000 420,000 300,000 200,000

1,220,000 $180,000

$1,400,000 $300,000 420,000 300,000 200,000

1,220,000 $180,000

(3) Contribution margin ratio = $300,000 ÷ $1,400,000 = 21.4% CM at breakeven = $1,000,000 x 0.214 = Less: fixed manufacturing overhead Fixed selling and admin expense

$214,000 180,000 $ 34,000

(b) Incremental sales = $1,400,000 x 20% = $280,000 Incremental contribution margin = $280,000 x 21.4% = $60,000 rounded. The maximum increased advertising expenditure would be equal to the incremental contribution margin earned on the increased sales, which is $60,000. The company is operating above break even, so the contribution margin will all go to profits, or additional fixed costs as in this situation. The other fixed costs are irrelevant to this decision, because they would be incurred whether or not the advertising expenditure is increased.

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PROBLEM 6-43A (a) Contribution margin per unit = $750 - $450 = $300 Break-even = $180,000 ÷ $300 = 600 units. Before tax target income = $360,000 ÷ (1 - .25) = $480,000 Target income = ($180,000 + $480,000) ÷ 300 = 2,200 units.

(b)

(1) -Reduce selling price by $60; sell 3,400 units Sales (400 x $750) + (3,000 x $690) Variable costs (3,400 x $450) Contribution margin Less: Fixed costs Income before tax Tax at 25% Income after tax

$2,370,000 1,530,000 840,000 180,000 660,000 165,000 $495,000

(2) Reduce variable costs by $20, selling price by $40, sell 2,800 more units Sales (400 x $750) + (2,800 x $710) Variable costs: (400 x $450) + (2,800 x $430) Contribution margin Less: Fixed costs Income before tax Tax at 25% Income after tax

. 6-36

$2,288,000 1,384,000 904,000 180,000 724,000 181,000 $543,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 6-43A (Continued) (3) Reduce fixed costs by $20,000, lower selling price by 5% ($750 x 5% = $37.50), sell 2,900 units Sales (400 x $750) + (2,500 x $712.50) $2,081,250 Variable costs (2,900 x $450) Contribution margin Less: Fixed costs Income before tax Tax at 25% Income after tax

1,305,000 776,250 160,000 616,250 154,063 $462,187

To achieve its desired net income, the company should select the second alternative where the sales price is reduced by $40, and 2,500 units are sold during the remainder of the year. This alternative results in the highest net income and exceeds the company’s desired net income after taxes.

. 6-37

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-44A (a) Reformat the income statement to CVP format. All amount are in $000s. Sales $80,000 Variable costs ($35,600 + $14,400) 50,000 Contribution margin 30,000 Less: Fixed costs ($7,000 + $11,000) 18,000 Operating income $12,000 Contribution margin ratio = $30,000 ÷ $80,000 = 37.5% Break-even point = $18,000 ÷ 0.375 = $48,000 (b) If a hired workforce replaces sales agents, commissions will be reduced to 8% of sales, or $6,400; but fixed costs will increase by $7,800. All amount are in $000s. Sales $80,000 Variable costs ($35,600 + $6,400) 42,000 Contribution margin 38,000 Less: Fixed costs ($18,000 + $7,800) 25,800 Operating income $12,200 Contribution margin ratio = $38,000 ÷ $80,000 = 47.5% Break-even point = $25,800 ÷ 0.475 = $54,316 (rounded) (c) Operating leverage = contribution margin ÷ operating income Current situation: from part (a) $30,000,000 ÷ $12,000,000 = 2.50 Proposed situation: from part (b) $38,000,000 ÷ $12,200,000 = 3.11

. 6-38

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-44A (Continued) The calculations indicate that at a sales level of $80 million, a percentage change in sales and contribution margin will result in 2.50 times that percentage change in operating income if Olin continues to use sales agents. If they choose to employ their own, the change in operating income will be 3.11 times the percentage change in sales. The higher contribution margin per dollar of sales and higher fixed costs from Olin 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 $7.8 million. None of the other costs are relevant, because they will not change between alternatives. Let the sales volume = S 18% x S = (8% x S) + 7,800,000 0.18S = 0.08S + $7,800,000 0.10S = $7,800,000 S = $78,000,000

. 6-39

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-45A (a)

Sales (50,000 x $180) Variable costs (50,000 x $80) Contribution margin Less: Fixed costs Income before tax

$9,000,000 4,000,000 5,000,000 4,000,000 $1,000,000

(b) Break-even = $4,000,000 ÷ $100 = 40,000 units (c) Incremental contribution margin = 5,000 x $100 = $500,000 Incremental cost = $400,000 New operating income = $1,000,000 + ($500,000 - $400,000) = $1,100,000

. 6-40

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*PROBLEM 6-46A Contribution margin ratio: Old Company--$220,000 ÷ $400,000 = 55% New Company--$320,000 ÷ $400,000 = 80%

(a) Break-even point in dollars: Old Company--$170,000 ÷ 0.55 = $309,090 New Company--$270,000 ÷ 0.80 = $337,500 Margin of safety ratio: Old Company—($400,000 - $309,090) ÷ $400,000 = 22.73% New Company—($400,000 - $337,500) ÷ $400,000 = 15.63% (b) Degree of operating leverage: Old Company—$220,000 ÷ $50,000 = 4.4 New Company—$320,000 ÷ $50,000 = 6.4 Operating leverage measures the impact any increase or decrease in sales will have on a company’s net income. In this situation, any percentage increase in sales for Old Company will result in an increase in operating income equal to 4.4 times that percentage. For New Company, it would be equal to 6.4 times that percentage. In the current situation, New Company stands to gain much more from sales increases than Old Company. The opposite effect will occur with any declines in sales. In this case, Old Company is in a better position because its income will decrease by a smaller amount in relation to any decreases in sales.

. 6-41

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-46A (Continued) (c) New income statements with a 20% increase in sales:

Sales Variable costs Contribution margin Less: Fixed costs Net income

Old Company $480,000 216,000 264,000 170,000 $94,000

New Company $480,000 96,000 384,000 270,000 $114,000

(d) New income statements with a 20% decrease in sales:

Sales Variable costs Contribution margin Less: Fixed costs Net income (loss)

Old Company $320,000 144,000 176,000 170,000 $6,000

New Company $320,000 64,000 256,000 270,000 $(14,000)

(e) New Company, with its high ratio of fixed costs to variable costs is highly leveraged, and stands to add 6.4 times any percentage sales increases to its net income, compared to Old Company, which has less leverage. But the same cost structure that gives New Company the greater benefits from increased sales has also given it a higher breakeven point. Another risk is that any decreases in sales will have the same, but opposite impact—causing a faster decline in profits. Simply stated, it will take New Company longer to reach break-even, but after that the return on sales will be much greater. Old Company will start to earn a profit sooner (lower break-even point), but the impact on operating income from any increases in sales will be less. Alternatively, any benefit becomes a risk if the company is losing sales.

. 6-42

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-47A (a) Weighted average contribution margin ratio: (10% x 60%) + (60% x 30%) + (10% x 50%) + (20% x 80%) = 45% Target income = ($1,200,000 + $150,000) ÷ 45% = $3,000,000 Appetizers: 10% x $3,000,000 = $300,000 Entrees: 60% x $3,000,000 = $1,800,000 Desserts: 10% x $3,000,000 = $300,000 Beverages: 20% x $3,000,000 = $600,000 (b) New weighted average contribution margin ratio: (20% x 60%) + (30% x 10%) + (10% x 50%) + (40% x 80%) = 52% New fixed costs = $1,200,000 x 150% = $1,800,000 Target income = ($1,800,000 + $150,000) ÷ 52% = $3,750,000 Appetizers: 20% x $3,750,000 = $750,000 Entrees: 30% x $3,750,000 = $1,125,000 Desserts: 10% x $3,750,000 = $375,000 Beverages: 40% x $3,750,000 = $1,500,000 (c) Revised weighted average contribution margin ratio: (10% x 60%) + (60% x 10%) + (10% x 50%) + (20% x 80%) = 33% Target income = ($1,800,000 + $150,000) ÷ 33% = $5,909,090 Appetizers: 10% x $5,909,090 = $590,909 Entrees: 60% x $5,909,090 = $3,545,454 Desserts: 10% x $5,909,090 = $590,909 Beverages: 20% x $5,909,090 = $1,181,818 By changing the mix and the contributions from some of the products, Terry has increased her break-even point, and will have to accomplish $750,000 more in sales to make the same income. If her predictions do not work out, and the mix stays the same, she will need to almost double her sales to make the same income. She will only benefit if her new scheme works so well that sales increase more than $750,000. At which point, she would be earning 52% contribution margin—the greatest amount of all three scenarios. . 6-43

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO PROBLEMS-SET B PROBLEM 6-48B (a)

Contribution margin per unit = $600 - $300 = $300 Units at break even = $150,000 ÷ $300 = 500 units Net income before taxes = $360,000 ÷ (1.00 - 0.25) = $480,000 Target net income = ($150,000 + $480,000) ÷ $300 = 2,100 units

(b) (1) Reduce selling price by $60; additional 2,700 units sold Sales (400 x $600) + (2,700 x $540) Variable costs (3,100 x $300) Contribution margin Less: Fixed costs Income before tax Tax at 25% Income after tax

$1,698,000 930,000 768,000 150,000 618,000 154,500 $463,500

(2) New variable cost is $280; reduce selling price by $40; additional 2,500 units sold Sales (400 x $600) + (2,500 x $560) $1,640,000 Variable costs: (400 x $300) + (2,500 x 280) 820,000 Contribution margin 820,000 Less: Fixed costs 150,000 Income before tax 670,000 Tax at 25% 167,500 Income after tax $502,500

. 6-44

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-48B (Continued) (3) Reduce fixed costs by $20,000, lower selling price by 5% ($600 x 5% = $30), sell 2,200 more units

Sales (400 x $600) + (2,200 x $570) Variable costs (2,600 x $300) Contribution margin Less: Fixed costs Income before tax Tax at 25% Income after tax

$1,494,000 780,000 714,000 130,000 584,000 146,000 $438,000

. 6-45

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-49B (a)

Variable cost per haircut = ($3.50 + $0.30 + $0.20) = $4.00 Total fixed costs = [($1,200 + $600) + (4 x $1,200) + $200 + $1,000 +$175 + $25] = $8,000

(b)

Contribution margin per unit = $12 - $4 = $8 Units at break even = $8,000 ÷ $8 = 1,000 Sales at break even = $12 x 1,000 = $12,000

(c)

CVP graph: $32,000 28,000 Sales line

DOLLARS

24,000 20,000

Break-even Point Total Cost Line

16,000 12,000 8,000

Fixed Cost Line

4,000 250

500

750

1000 1250 1500 1750 2000

Number of Units

(d)

Total contribution margin – fixed costs = net income [(($12 - $4) x 1,500) – $8,000] = $4,000

. 6-46

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-50B

(a)

Break-even sales = Sales – Margin of Safety Break-even sales = $600,000 – $300,000 = $300,000

(b)

If contribution margin ratio is 40%, then variable cost ratio is 60% Variable costs = 60% x $600,000 = $360,000

(c)

At break-even, contribution margin = fixed costs Contribution margin at break-even = $300,000 x 40% = $120,000 Therefore, Fixed costs = $120,000

(d)

Sales Variable costs Contribution margin Less: Fixed costs Operating income

$500,000 100% 300,000 60% 200,000 40% 120,000 $80,000

. 6-47

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-51B (a) CORBIN COMPANY CVP Income Statement (Estimated) For the Year Ending December 31, 2009

Net Sales (2,500,000 units at $0.80 ea.) Less: variable costs COGS ($360,000 + $590,000 + $270,000) Selling & Admin ($100,000 + $150,000) Contribution Margin Less: fixed costs Manufacturing overhead Selling and Admin ($78,000 + $40,000) Net income before tax

(b)

$2,000,000 $1,220,000 250,000

1,470,000 73.5% 530,000 26.5%

220,000 118,000

338,000 $192,000

Contribution margin ratio = ($530,000 ÷ $2,000,000) = 26.5% Selling price per bottle = $0.80 (given) (1) Units at break even = $1,275,472 ÷ $0.80 = 1,594,340 (2) Sales at break even = $338,000 ÷ 0.265 = $1,275,472

(c)

Contribution margin ratio = 26.5% (from (b)) Margin of safety = $2,000,000 - $1,275,472 = $724,528 Margin of safety ratio = $724,528 ÷ $2,000,000 = 36.2%

(d)

Target income sales = (fixed costs + net income) ÷ CM ratio = (338,000 + 272,000) ÷ 0.265 = $2,301,887

. 6-48

100%

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-52B (a) Prepare a CVP income statement: DELGADO MANUFACTURING CVP Income Statement For the Year Ending December 31, 2009

Net Sales (60,000 units at $25 ea.) Less: variable costs Cost of goods sold Selling & Admin ($65,000 + $55,000) Contribution Margin Less: fixed costs Cost of goods sold Selling &Admin ($275,000 + $65,000) Net income before tax

$780,000 120,000

420,000 340,000

$1,500,000

100%

900,000 600,000

60% 40%

760,000 $(160,000)

Contribution margin ratio = ($600,000 ÷ $1,500,000) = 40% Sales at break even = $760,000 ÷ 0.40 = $1,900,000 (b) (1) Increase selling price by 20% or $5 Sales increase by $5 x 60,000 = $300,000 to $1,800,000 CM increases by $300,000 to $900,000 New CM ratio = $900,000 ÷ $1,800,000 = 50% Sales at break even = $760,000 ÷ 0.50 = $1,520,000 (2) Variable costs increase by 6% x $1,500,000 = $90,000 to $990,000 Contribution margin decreases by $90,000 to $510,000 Fixed costs decrease by $170,000 ($200,000 - $30,000) to $590,000 New CM ratio = $510,000 ÷ $1,500,000 = 34% Sales at break even = $590,000 ÷ 0.34 = $1,735,294

. 6-49

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-52B (Continued)

Proof: Sales Less: variable costs Contribution margin Less: fixed costs Net income before tax

Option 1 $1,520,000 760,000 760,000 760,000 --

Option 2 $1,735,294 1,145,294 590,000 590,000 --

It appears obvious that they should go with Alternative (1), which reduces the break–even point significantly lower than Alternative (2). However, Alternative (1) is still very risky, and may not be the right choice either. For Alternative (1) the break-even point is still higher than the sales achieved in 2009, so Delgado would be in a position where they would have to increase their total sales by $20,000 just to break-even at the same time as they are raising their prices by 20%. Unless they have a very good sense of how the market will react to a price increase, they would be wise to start looking for even more alternatives.

. 6-50

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-53B

(a)

Variable cost per haircut = ($6.00 + $1.50 + $0.50 + $0.25) = $8.25 Total fixed costs = [($1,500 + $500) + (4 x $1,500) + $500 + $1,000 +$300 + $50] = $9,850

(1) CM per haircut = $15.00 - $8.25 = $6.75 Sales in units at break even = $9,850 ÷ $6.75 = 1,460 (rounded) (2) Selling price per haircut = $15.00 Sales in dollars at break even = 1,460 x $15.00 = $21,900 (3) Monthly capacity = 5 barbers x 20 haircuts per day x 24 days Monthly capacity = 2,400 haircuts Ratio of BE to capacity = 1,460 ÷ 2,400 = 60.83% (b)

Sales Variable costs Contribution margin Less: Fixed costs Operating income

$22,500 12,375 10,125 9,850 $275

(1,500 x $15) (1,500 x $8.25)

Profit in March = (1,600 x $6.75) - $9,850 = $950 Profit in April has to be $4,000 + ($4,000 - $950) = $7,050 Target net income = (9,850 + $7,050) ÷ $6.75 = 2,504 units It is not possible, since capacity is 2,400 haircuts per month, and John would have to give 2,504 haircuts to bring his target net income to $4,000 for each month.

. 6-51

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-54B (a)

Current break-even point: where Q = the number of pairs of shoes $30Q = $13Q + $204,000 $17Q = $204,000 Q = 12,000 pairs of shoes After proposed changes-New selling price per pair = $28 New fixed costs = $204,000 + $51,000 = $255,000 New break-even point: where Q = the number of pairs of shoes $28Q = $13Q + $255,000 $15Q = $255,000 Q = 17,000 pairs of shoes

(b)

Current situation-Margin of safety in units = 16,000 – 12,000 = 4,000 Margin of safety ratio = 4,000 ÷ 16,000 = 25% After proposed changes-Margin of safety in units = 21,000 – 17,000 = 4,000 Margin of safety ratio = 4,000 ÷ 21,000 = 19% (rounded)

(c)

THRIFTY SHOE STORE CVP Income Statement Current $480,000 208,000 272,000 204,000 $68,000

Sales Less: Variable costs Contribution margin Less: Fixed costs Net income before tax

. 6-52

After $588,000 273,000 315,000 255,000 $60,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-54B (Continued) The proposed changes will raise the break-even point by 5,000 units, reduce income by $8,000 and narrow the margin of safety by 6%. The recommendation is not to accept the proposed changes.

. 6-53

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-55B (a) Variable costs Direct materials Direct labour Overhead Selling and Admin

Fixed costs Overhead Selling and Admin

Total $32,000 40,000 20,000 24,000 $116,000

Per unit $ 4.00 5.00 2.50 3.00 $14.50

$30,000 33,000 $63,000

Current break-even point: where Q = the number of units $35Q = $14.50Q + $63,000 $20.50Q = $63,000 Q = 3,073 units (b)

Target net income in units: where Q = the number of units $37.50Q = $14.50Q + $63,000 + $22,000 $23Q = $85,000 Q = 3,696 units

(c)

Before tax net income = $28,000 + (1.00 – 0.30) = $40,000 Target selling price: where P = unit selling price 7,500P = (7,500 x $14.50) + $63,000 + $40,000 7,500P = $211,750 P = $28.23

. 6-54

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-55B (Continued)

(d)

Let the unit price be P Before tax profit = 30% x (9,000 x P) 9,000P = (9,000 x $14.50) + $63,000 + [30% x (9,000 x P)] 9,000P = $130,500 + $63,000 + 2,700P P = $30.71

. 6-55

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-56B (a)

Current Year $2,400,000

Projected Year 2,880,0007

626,500 507,500 270,0001 108,0002 168,0003

751,8007 609,0007 324,0007 129,6007 201,6007

Total variable costs (1) Contribution margin Less: Fixed costs Manufacturing overhead4 Selling expenses5 Administrative expenses6

1,680,000 720,000

2,016,000 864,000

270,000 252,000 252,000

(2)

774,000

$(54,000)

$90,000

Sales (200,000 units) Less: Variable costs Direct materials Direct labour Manufacturing overhead Selling expenses Administrative expenses

Total fixed costs

Net income (loss) 1

$540,000 x 50% 2 $360,000 x 30% 3 $420,000 x 40% 4 $540,000 x 50% (b)

$360,000 x 70% $420,000 x 60% 7 Current year x 1.2 6

Contribution margin ratio = $720,000 ÷ $2,400,000 = 30% Break-even in sales = $774,000 ÷ 0.30 = $2,580,000 Per unit contribution margin = $720,000 ÷ 200,000 units = $3.60 Break-even in units = $774,000 ÷ $3.60 = 215,000 units

(c)

Break-even sales from (b) = $2,580,000

. 6-56

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 6-56B (Continued) Sales required to generate income = $620,000 ÷ 0.30 = $2,066,067 Sales to meet target net income = $2,580,000 + $2,066,067 = $4,646,667 (d)

Margin of safety = $4,646,667 - $2,580,000 = $2,066,067 Margin of safety ratio = $2,066,067 ÷ $4,646,667 = 44.5%

(e)

New costs: Direct materials (no change) Direct labour ($507,500 - $240,000) MOH $540,000—30%; 70% Selling expenses $360,000—80%; 20% Admin expenses (no change) Total

Variable $626,500 267,500 162,000 288,000 168,000 $1,512,00

Fixed

$378,000 72,000 252,000 $702,000

(1) Contribution margin = $2,400,000 - $1,512,000 = $888,000 (2) Contribution margin ratio = $888,000 ÷ $2,400,000 = 37% (3) Break-even in sales dollars = $702,000 ÷ 0.37 = $1,897,297

The break-even point in dollars declined from $2,580,000 to $1,897,297. 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 for compensating 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 amortization) and reduced its variable direct labour cost, both of which would increase the break-even point.

. 6-57

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 6-57B (a)

Redo the pro forma income statement in CVP format Sales $1,000,000 100% Variable costs ($600,000 + $150,000) 750,000 75% Contribution margin 250,000 25% Less: Fixed costs 10,000 Income before taxes 240,000 Income tax expense (25%) 60,000 Net income $ 180,000 Break-even in sales, where S = sales in dollars 1.00S = 0.75S + $10,000 + $0 0.25S = $10,000 S = $40,000

(b)

Switch from outside sales agents to their own salespeople: Variable costs would decrease by: $1,000,000 x 10% = $100,000 Fixed costs would increase by: $60,000 + (3 x $30,000) = $150,000

Sales Variable costs ($750,000 - $100,000) Contribution margin Less: Fixed costs ($10,000 + $150,000) Income before taxes Income tax expense (25%) Net income

$1,000,000 100% 650,000 65% 350,000 35% 160,000 190,000 47,500 $142,500

Break-even in sales, where S = sales in dollars 1.00S = 0.65S + $160,000 + $0 0.35S = $160,000 S = $457,143 . 6-58

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 6-57B (Continued) (c)

Increase outside sales commissions to 20% Variable costs would increase by: $1,000,000 x 5% = $50,000 CM will decrease by $50,000 to $200,000 New contribution margin will be $200,000 ÷ $1,000,000 = 20% Break-even in sales, where S = sales in dollars 1.00S = 0.80S + $10,000 + $240,000 0.20S = $250,000 S = $1,250,000

(d) Identical net income would arise when sales are equal. Let sales be S. Sales for option (1)—employ own salespeople S = $600,000 + (5% x S) + $160,000 + $240,000 Sales for option (2)—go with outside agents and 20% S = $600,000 + (20% x S) + $10,000 + $240,000 Or to simplify 0.05S + $160,000 = 0.20S + $10,000 $150,000 = 0.15S $1,000,000 = S

Proof: Sales Less: variable costs Contribution margin Less: fixed costs Net income before tax

Option 1 $1,520,000 760,000 760,000 760,000 --

. 6-59

Option 2 $1,735,294 1,145,294 590,000 590,000 --

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 6-58B (a)

Sales Variable costs Contribution margin Less: Fixed costs Operating income

$3,150,000 1,350,000 1,800,000 800,000 $1,000,000

$35.00 $15.00 $20.00

100% 43% 57%

Break-even = $800,000 ÷ $20.00 = 40,000 units (b)

10% increase in sales = 10% increase in CM New CM = $1,800,000 x 110% = $1,980,000 New income = $1,980,000 - $800,000 = $1,180,000

(c)

New unit purchase price = $14.00 x 1.3 = $18.20 New variable cost = $18.20 + $1.00 = $19.20 New unit CM = $35.00 - $19.20 = $15.80 Sales for target net income = [($800, 000 + $1,000,000) ÷ $15.80] x $35 = $3,987,3401 1 rounded Proof: Sales (113,924 x $35) Less: variable costs (113,924 x $19.20) Contribution margin Less: fixed costs Net income before tax

. 6-60

$3,987,340 2,187,340 1,800,000 800,000 $1,000,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*PROBLEM 6-59B Contribution margin ratio: Retro Company--$200,000 ÷ $500,000 = 40% Modern Company--$400,000 ÷ $500,000 = 80% (a) Break-even point in dollars: Retro Company--$140,000 ÷ 0.40 = $350,000 Modern Company--$340,000 ÷ 0.80 = $425,000 Margin of safety ratio: Retro Company—($500,000 - $350,000) ÷ $500,000 = 30% Modern Company—($500,000 - $425,000) ÷ $500,000 = 15% (b) Degree of operating leverage: Retro Company—$200,000 ÷ $60,000 = 3.33 Modern Company—$400,000 ÷ $60,000 = 6.67 Operating leverage measures the impact any increase or decrease in sales will have on a company’s net income. In this situation, any percentage increase in sales for Retro Company will result in 3.33 times that percentage increase in operating income. In the current situation, Modern Company, with an operating leverage of 6.67, stands to increase its net income by twice the factor of Retro. The opposite effect will occur with any declines in sales. In this case, Retro Company is in a better position because its income will decrease by a smaller amount in relation to any decreases in sales.

. 6-61

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PROBLEM 6-59B (Continued) (c) New income statements with a 25% increase in sales:

Sales Variable costs Contribution margin Less: Fixed costs Net income

Retro $625,000 375,000 250,000 140,000 $110,000

Modern $625,000 125,000 500,000 340,000 $160,000

(d) New income statements with a 25% decrease in sales:

Sales Variable costs Contribution margin Less: Fixed costs Net income (loss)

Retro $375,000 225,000 150,000 140,000 $10,000

Modern $375,000 75,000 300,000 340,000 $(40,000)

(e) Modern Company, with its high ratio of fixed costs to variable costs is highly leveraged, and stands to add 6.67 times any percentage sales increases to its net income, compared to Retro Company, which has less leverage. But the same cost structure that gives Modern Company the greater benefits from increased sales has also given it a higher break-even point. Another risk is that any decreases in sales will have the same, but opposite impact—causing a faster decline in profits. Simply stated, it will take Modern Company longer to reach breakeven, but after that the return on sales will be much greater. Retro Company will start to earn a profit sooner (lower break-even point), but the impact on operating income from any increases in sales will be less. Alternatively, any benefit becomes a risk if the company is losing sales.

. 6-62

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*PROBLEM 6-60B (a)

Sales (10,000 x $480) $4,800,000 $480.00 100.0% Variable costs (10,000 x $180) 1,800,000 $180.00 37.5% Contribution margin 3,000,000 $300.00 62.5% Less: Fixed costs 2,200,000 Operating income $800,000

(b)

Contribution margin ratio = $300 ÷ $480 = 62.5% Break-even in sales dollars = $2,200,000 ÷ 0.625 = $3,520,000 Margin of safety ratio = ($4,800,000 - $3,520,000) ÷ $4,800,000 = 26.67% Operating leverage = $3,000,000 ÷ $800,000 = 3.75

(c)

Sales (10,000 x $480) Variable costs (10,000 x $80) Contribution margin Less: Fixed costs Operating income

(d)

Contribution margin ratio = $400 ÷ $480 = 83.3% Break-even in sales dollars = $3,200,000 ÷ 0.833 = $3,841,5371 Margin of safety ratio = ($4,800,000 - $3,841,537) ÷ $4,800,000 = 19.97% Operating leverage = $4,000,000 ÷ $800,000 = 5.00 1 rounded

$4,800,000 $480.00 100.0% 800,000 $80.00 16.7% 4,000,000 $400.00 83.3% 3,200,000 $800,000

(e) By automating the system, ComfortCraft increases their contribution margin ratio, so that the return on every dollar of sales will be greater than before the automation ($0.833 compared to $0.625). This is also reflected in an increased degree of operating leverage. However, they also raise their break-even point—so, it will take them longer to start earning profits, but after that, their profits will raise significantly faster than under the manual system. A cost structure that has a higher level of fixed costs could be adopted when a company is operating within a stable marketplace, and is not adverse to a higher level of risk. . 6-63

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 6-61B (a) Weighted average contribution margin ratio: (10% x 50%) + (55% x 30%) + (10% x 60%) + (25% x 75%) = 46.25% Target sales = ($400,000 + $155,000) ÷ 46.25% = $1,200,000 Appetizers: 10% x $1,200,000 = $120,000 Entrees: 55% x $1,200,000 = $660,000 Desserts: 10% x $1,200,000 = $120,000 Beverages: 25% x $1,200,000 = $300,000 (b) New weighted average contribution margin ratio: (15% x 50%) + (30% x 15%) + (15% x 60%) + (40% x 75%) = 51% New fixed costs = $400,000 x 150% = $600,000 Target sales = ($600,000 + $155,000) ÷ 51% = $1,480,392 Appetizers: 15% x $1,480,392 = $222,059 Entrees: 30% x $1,480,392 = $444,117 Desserts: 15% x $1,480,392 = $222,059 Beverages: 40% x $1,480,392 = $592,157 (c) Revised weighted average contribution margin ratio: (10% x 50%) + (55% x 15%) + (10% x 60%) + (25% x 75%) = 38% Target sales = ($600,000 + $155,000) ÷ 38% = $1,986,842 Appetizers: 10% x $1,986,842 = $198,684 Entrees: 55% x $1,986,842 = $1,092,763 Desserts: 10% x $1,986,842 = $198,684 Beverages: 25% x $1,986,842 = $496,711 By changing the mix and the contributions from some of the products, Debbie has increased her break-even point, and will have to accomplish almost $300,000 more in sales to make the same income. If her predictions are incorrect, and the mix stays the same, she will need to increase sales almost $800,000 to make the same income. She would only benefit if her new scheme worked so well that sales increased more than $300,000. At that point, she would be earning 51% contribution margin—the greatest amount of all three scenarios.

. 6-64

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SOLUTIONS TO CASES CASE 6-62 (a) (1) Capital –Intensive Variable cost per unit = $5.00 + $6.00 + $3.00 + $2.00 = $16.00 Contribution margin = $30.00 - $16.00 = $14.00 Fixed costs = $2,508,000 + $502,000 = $3,010,000 Break-even in units = $3,010,000 ÷ $14.00 = 215,000 units (2) Labour–Intensive Variable cost per unit = $5.50 + $8.00 + $4.50 + $2.00 = $20.00 Contribution margin = $30.00 - $20.00 = $10.00 Fixed costs = $1,538,000 + $502,000 = $2,040,000 Break-even in units = $2,040,000 ÷ $10.00 = 204,000 units (b) Clay Company would be indifferent between the two manufacturing methods at the volume (Q) where total costs are equal. $16Q + $3,010,000 = $20Q + $2,040,000 $4Q = $970,000 Q = 242,500 units (c) Clay should employ the capital-intensive manufacturing method if they are working in fairly stable market conditions and are certain they will pass 215,000 units in sales. The labour-intensive method is more suitable in a more risky market because with the lower fixed costs the break-even point is lower, and it takes less time to start earning a profit. If Clay is certain they will exceed 215,000 units in sales, then the capital-intensive method would be preferred, as the return on each $1.00 sold will be greater than with the labour-intensive method.

. 6-65

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CASE 6-63 (a) Unit contribution margin = $23 – ($12 + $5) = $6.00 Income last year: Sales (185,000 units) $4,255,000 $ 23.00 100% Variable costs 3,145,000 $ 17.00 74% Contribution margin 1,110,000 $ 6.00 26% Less: Fixed costs 900,000 Operating income $ 210,000 Income required this year: Fixed costs ($900,000 - $59,000) Plus: target net income Contribution margin needed Less: CM earned (30,000 x $6) Total CM left to be earned

841,000 210,000 1,051,000 180,000 $ 871,000

Contribution required on remaining sales: Let CM = contribution margin per unit Let Q = 160,000 – 30,000) = 130,000 units 130,000CM = $871,000 CM = $6.70 per unit

. 6-66

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CASE 6-63 (Continued) (b) Sales (185,000 x $23) Variable costs (185,000 x $17) (185,000 x $8.35*) Contribution margin Total fixed costs Net income

Current $4,255,000

New $4,255,000

3,145,000 1,110,000 900,000 $210,000

1,544,750 2,710,250 2,500,000 $210,250

* $3.35 + $5.00 Operating leverage (CM ÷ Net income)

Current 5.29

New 12.89

With a 20% increase in sales, income will increase by…………… Increase in income Previous income New income

106% $222,000 210,000 $432,000

258% $ 542,050 210,250 $ 752,300

With a 20% decrease in sales, income will decrease by …………..

106%

258%

$(222,000) 210,000 $(12,000)

$(542,050) 210,250 $(331,800)

Decrease in income Previous income New income

. 6-67

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 6-63 (Continued)

MEMO To: President From: Cost analyst Subject: Proposed Cost Structure As you can see from the above analysis, a move to the new cost structure has potential benefits, but it is also considerably more risky. Should sales volume increase by 20% over this year, the new cost structure will generate an increase in net income of over 3 times the present net income, compared to approximately 2 times the present net income under the current cost structure. However, should sales volume decrease by 20% from this year's, under the old structure we will be in essentially a break-even position, while under the proposed structure we will incur a significant loss.

In general, a move to a structure with high fixed costs and low variable costs is much more sensitive to upswings and downswings in sales volume. If there is a high probability of sales volume increases in the future, the changes are probably a good idea; if there is some uncertainty about future sales volumes, the changes may not be such a good idea.

. 6-68

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CASE 6-64 (a) Selling price per unit ($1,200,000 ÷ 200,000) = $6.00 Costs: Cost of goods sold (75%; 25%) Selling (50%; 50%) Administrative (25%; 75%) Total

Variable $600,000 140,000 40,000 $780,000

Variable costs per unit are: Cost of goods sold ($600,000 ÷ 200,000) Selling ($140,000 ÷ 200,000) Administrative ($40,000 ÷ 200,000) Total

Fixed $200,000 140,000 120,000 $460,000

Total $800,000 280,000 160,000 $1,240,000

$3.00 0.70 0.20 $3.90

Contribution margin per unit ($6.00 – $3.90) = $2.10 Contribution margin ratio ($2.10 ÷ $6.00) = 35% Break-even point in sales dollars = $460,000 ÷ 35% = $1,314,288 Break-even point in units = $460,000 ÷ $2.10 = 219,048 (b) Variable unit cost = $3.90 + $0.25 = $4.15 Sales volume = 260,000 units (200,000 X 130%) Sales: (260,000 X $6.25) Less: variable costs (260,000 x $4.15) Contribution margin Less: fixed costs Net income before tax

$1,625,000 1,079,000 546,000 460,000 $86,000

Contribution margin ratio = $546,000 ÷ $1,625,000 = 33.6% Break-even point in sales = $460,000 ÷ 0.336 = $1,369,048 Contribution margin per unit = $6.25 – $4.15 = $2.10 Break-even point in units = $460,000 ÷ $2.10 = 219,048

. 6-69

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CASE 6-64 (Continued) This plan would have no affect on the break-even point in units, but increases break-even point in sales dollars because of the higher price.

(c)

New variable cost per unit: $3.90 + $0.09 = $3.99 New selling price per unit: $6.00 - $0.30 = $5.70 New fixed costs: $460,000 + $35,000 = $495,000 New sales volume: 200,000 x 160% = 320,000 Sales: (320,000 X $5.70) Less: variable costs (320,000 x $3.99) Contribution margin Less: fixed costs Net income before tax

$1,824,000 1,276,800 547,200 495,000 $52,200

Contribution margin ratio = $547,200 ÷ $1,824,000 = 30% Break-even point in sales = $495,000 ÷ 0.30 = $1,650,000 Contribution margin per unit = $5.70 – $3.99 = $1.71 Break-even point in units = $495,000 ÷ $1.71 = 289,474 (d) Phan’s plan should be accepted. It produces a higher net income with a lower break-even point than Nguyen’s plan.

. 6-70

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*CASE 6-65 (a) Current approach: Contribution margin ratio = $800,000 ÷ $2,000,000 = 40% Automated approach: Contribution margin ratio = $1,600,000 ÷ $2,000,000 = 80% The contribution margin ratio under the current approach is equal to one-half the ratio under the automated approach because of the difference in total variable costs. For the current approach, variable expenses are high, which means the contribution from each dollar of sales is less. With the automated approach, the variable costs are less—leaving considerably more contribution to cover fixed costs. (b) Current approach: Break-even point = $200,000 ÷ 0.40 = $500,000 Automated approach: Break-even point = $600,000 ÷ 0.80 = $750,000 Even though the CM ratio under the automated approach is twice as much as under the current approach, the fixed costs are three times as much. The result is the break-even point for the automated approach is much higher than for the current approach. So, while under the automated approach the return on sales is greater after the break-even point, it takes a longer time for the company to reach profitable operations. (c) Current approach: Margin of safety ratio: ($2,000,000 - $500,000) ÷ $2,000,000 = 75% Automated approach: Margin of safety ratio: ($2,000,000 - $750,000) ÷ $2,000,000 = 62.5%

. 6-71

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CASE 6-65 (Continued) The current approach is less risky. Their sales can decline by 75% before they would no longer be profitable. Under the automated approach, their margin of safety is only 62.5%. (d) Current approach: Degree of operating leverage: $800,000 ÷ $600,000 = 1.33 Automated approach: Degree of operating leverage: $1,600,000 ÷ $1,000,000 = 1.6 In times of falling sales, the current approach would be preferred. If there was a 10% decrease in sales, profit under the current approach would decrease by 13.3% compared to 16% under the automated approach. (e) Current approach: Let S be Sales Total expenses = 0.60S + $200,000 Automated approach: Let S be Sales Total expenses = 0.20S + $600,000 Point of indifference is the level of sales where total expenses under both approaches will be the same: 0.60S + $200,000 = 0.20S + $600,000 0.40S = $400,000 S = $1,000,000 Proof: Sales Less: variable costs Contribution margin Less: fixed costs Net income before tax

Current $1,000,000 600,000 400,000 200,000 $200,000

. 6-72

Automated $1,000,000 200,000 800,000 600,000 $200,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 6-65 (Continued) (f) Issues that need to be considered in automation include: (1) the organization’s tolerance for risk, (2) knowledge of the marketplace and consumer trends, (3) the margin of safety required for regular operations, and (4) the short and long term profit goals for the organization.

. 6-73

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CASE 6-66 (a) Selling price per unit Variable costs Contribution margin per unit

$8.00 4.80 $3.20

100% 60% 40%

Break-even = $880,000 ÷ $3.20 = 275,000 units (b)

For contribution margin ratio to remain at 40%, variable costs must be 60% of sales. New variable cost: Cost of candy ($4.00 x 115%) $4.60 Selling expenses 0.80 $5.40 If $5.40 is 60% of sales, then the new selling price per box must be $9.00 ($5.40 ÷ 60%)

(c)

Now $6,240,000 3,744,000 2,496,000 880,000 1,616,000 646,400 $969,600

Sales (780,000 x $8) Variable costs Contribution margin Total fixed costs Income before tax Income tax at 40% Net income

Required income before tax is $1,616,000 Unit selling price = $8.00 Unit variable cost = $5.40 Contribution margin ratio = $2.60 ÷ $8.00 = 32.5% Required sales to maintain income before tax of $1,616,000 = ($880,000 + $1,616,000) ÷ 32.5% = $7,680,000

. 6-74

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CASE 6-67 (a) Sales (75,000 units) Variable costs Contribution margin Total fixed costs Income before tax Income tax at 45% Net income

Total $1,875,000 750,000 1,125,000 300,000 825,000 371,250 $453,750

Per Unit $25.00 10.00 $15.00

Break-even point = $300,000 ÷ $15.00 = 20,000 units (b)

Before tax income = after tax income ÷ (1 - tax rate) Before tax income = $247,500 ÷ (1 - .45) = $450,000 Sales = ($300,000 + $450,000) ÷ $15 = 50,000 units

(c)

New variable cost per unit = $10 - $5 + $10 = $15 New contribution margin per unit = $25 - $15 = $10 Fixed costs increase by $15,000 ($90,000 ÷ 6 years) Break-even = ($300,000 + $15,000) ÷ $10 = 31,500 units

(d)

Sales = ($315,000 + $825,000) ÷ $10 = 114,000 units

(e)

New variable cost = $15, which must be 40% of sales Selling price per unit = $15 ÷ 40% = $37.50

. 6-75

% 100% 40% 60%

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 6-68

(a) The stakeholders in this situation are: • Ronnie Drake, accountant of Benson Company. • The dislocated personnel of Benson. • The senior management who made the decision. (b) As an accountant, Ronnie has a responsibility to • Communicate information fairly and objectively and • Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. Ronnie will violate the standards of ethical conduct for accountants if he fails to inform senior management of his error. He risks losing a promotion and receiving a less favourable performance review if he reveals his error. (c) Ronnie’s alternatives are: • Keep quiet. • Inform management of his error. Even though it appears there is nothing at stake in this situation, the actions recommended must be idealistic and ethical. Any individual who is willing to act ethically when there is nothing at stake is more likely to act ethically when there is something to lose.

. 6-76

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-6

(Note: All figures are rounded) Part 1: (a) (1) The contribution margin ratio is 30% ($883,920  $2,937,120): Waterways Corporation Contribution Margin Income Statement for Water Control and Timer For the Year 2009 Unit Cost Sales (696,000 $2,937,120 $4.22 100% units) Variable 2,053,200 2.95 70% expenses Contribution 883,920 1.27 30% margin Fixed Expenses 683,338 Net income from $ 200,582 product (2) Break-even point in units = 538,061 units Fixed expenses$683,338 Unit CM $1.27 = 538,061 units (rounded) Break-even point in dollars = $2,277,793 Fixed expenses$683,338 CM ratio 0.30 = $2,277,793 (rounded)

. 6-77

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(3) Margin of safety in dollars = $659,327 Sales $2,937,120 Less: Break-even in dollars $ 659,327

2,277,793

Margin of safety ratio = 22.45% Margin of safety in dollars $659,327 Sales$2,937,120 = 22.45%

(4) Waterways would have to sell an additional 15,794 units. 10% increase in net income = 0.10 x $200,582.00 = $20,058.20 Because Waterways is operating above break-even, any increase in net income will also be an equal increase in contribution margin. Required increase in contribution margin = $20,058.20 Required increase in unit sales = $20,058.20  $1.27 = 15,794 (rounded) (5) Waterways is operating above the break even point, so every dollar increase in contribution margin means a dollar increase in income. Since additional sales of 71,090 units will contribute 71,090 x $1.27 = $90,284.30 margin, net income will also increase by $90,284.30.

. 6-78

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

(b) Current situation: Sales (491,740 x $26.50) Variable expenses: Manufacturing

Weygandt, Kimmel, Kieso, Aly

$13,031,110 $26.50 100% $6,863,512

Variable expenses: Selling and administrative 2,661,352 9,524,864 19.37 73% Contribution margin 3,506,246 $ 7.13 27% Fixed expenses: Manufacturing $2,050,140 Fixed expenses: Selling and administrative 794,950 2,845,090 Net income from screen units $ 661,156 (1) The changes would create a $101,651 increase in net income, but would also decrease the contribution margin ratio from 27% to 25%. New number of units = 491,740 x 110% = 540,914 New contribution margin per unit = $7.13 + $0.25 -$0.71 = $6.67 CM per unit

. 6-79

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

New net income (see below) Previous net income Increase in net income

Weygandt, Kimmel, Kieso, Aly

762,807 661,156 $101, 651

Sales (540,914 x $26.75) $14,469,450 $26.75 100% Variable expenses: 540,914 x ($19.37 - $0.71) 10,861,553 20.08 75% Contribution margin 3,607,897 $ 6.67 25% Fixed expenses: Manufacturing $2,050,140 Fixed expenses: Selling and administrative 794,950 2,845,090 Net income from screen units $ 762,807 (2) If the average sales price did not increase, the contribution margin ratio would drop 3% (from 27% to 24%). Profit would decrease by $33,578 ($661,156 − $627,578). This definitely would not be in the best interest of the company. Sales (540,914 x $26.50) $14,334,221 $26.50 100% Variable expenses: 540,914 x ($19.37 - $0.71) 10,861,553 20.08 76% Contribution margin 3,472,668 $ 6.42 24% Fixed expenses: Manufacturing $2,050,140 Fixed expenses: Selling and administrative 794,950 2,845,090 Net income from screen units $ 627,578

. 6-80

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Part 2: (a)Total units = 450,000 + 1,500,000 + 50,000 = 2,000,000

450,000 = 22.5% 2,000,000 1,500,000 Valves = = 75% 2,000,000 50,000 Controllers = = 2.5% 2,000,000 Sales mix Sprinklers =

(b) Sales price Variable costs Manufacturing Selling & admin.

Sprinklers Valves $ 26.50 $ 11.20

13.96 1.30 15.26 Contribution margin $ 11.24

7.95 0.50 8.45 $ 2.75

Controllers $ 42.50 29.75 3.41 33.16 $ 9.34

Weighted-Average Unit Contribution Margin Weighted-Avg Unit CM  Sales Mix % = Unit CM Sprinklers $ 11.24 22.5% $ 2.53 Valves 2.75 75.0% 2.06 Controllers 9.34 2.5% 0.23 $ 4.82

. 6-81

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units

Part 3: Sales (4,000 x $42.50) $170,000 $42.50 100% Variable expenses: (4,000 x ($9.75 + $3.41) 52,640 13.16 31% Contribution margin 117,360 $ 29.34 69% Fixed expenses: Manufacturing $81,000 Fixed expenses: Selling and administrative 13,122 94,122 Net income $23,238 (a) Contribution margin ratio (as above) = 69% Degree of operating leverage = $117,360 ÷ $23,238 = 5 (rounded) Break-even point in dollars = $94,122 ÷ 0.69 = $136,409 (rounded) Margin of safety ratio = ($170,000 – $136,409) ÷ $170,000 = 19.76% (b) If these figures represent the cost structure for the company as a whole, it suggests that Waterways is well positioned to operate in a stable market. Although the high proportion of fixed costs means it will take longer to reach break-even, it also means that for every dollar of sales above break-even, the company will be receiving a greater return on the dollar.

. 6-82

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The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence. The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

. 6-83

CHAPTER 7 Incremental Analysis ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Questions

Brief Exercises

Exercises

A Problems

B Problems

Identify the steps in management’s decisionmaking process.

1, 2

Describe the concept of incremental analysis.

3, 4

Identify the relevant costs in accepting an order at a special price.

3, 4

12, 13, 25, 27

41, 43

Identify the relevant costs in a make-or-buy decision.

6, 7

14, 15, 27

29, 30, 31, 37

43, 46, 47

Identify the relevant costs in determining whether to sell or process materials further.

8, 9, 10

6, 7

16, 17, 18, 27

32, 35

44, 51

Identify the relevant costs in determining whether to keep or replace equipment.

19, 20, 27

33, 39

42, 45, 47, 52

Identify the relevant costs in deciding whether to eliminate an unprofitable segment.

21, 26, 27

34, 36, 40

48, 53, 54

Determine the sales mix when a company has limited resources.

13, 14

22, 23, 24

38, 40

49, 50, 54

. 7-1 7-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

28A

Prepare incremental analysis for a special-order decision and identify non-financial factors in the decision..

Moderate

20–30

29A

Prepare incremental analysis related to a make-or-buy decision, consider opportunity cost, and identify nonfinancial factors.

Moderate

30–40

30A

Calculate the contribution margin and prepare a differential analysis for the make-or-buy decision.

Moderate

20–30

31A

Calculate the contribution margin and prepare an incremental analysis concerning a make-or-buy decision.

Moderate

20–30

32A

Determine whether a product should be sold or processed further.

Moderate

30–40

33A

Calculate gain or loss, and determine if equipment should be replaced.

Moderate

30–40

34A

Calculate the contribution margin and prepare an incremental analysis for the decision whether to eliminate divisions.

Moderate

30–40

35A

Prepare incremental analysis for the decision whether to sell or process materials further.

Simple

20–30

36A

Calculate the contribution margin and prepare incremental analysis concerning the decision to keep or drop a product to maximize operating income.

Simple

20–30

37A

Calculate the contribution margin and prepare incremental analysis for a make-or-buy decision.

Challenging

40–50

38A

Determine the sales mix with limited resources.

Simple

20–30

39A

Calculate contribution margin and prepare incremental analysis for maximizing operating income and replacing equipment.

Moderate

20–30

. 7-2 7-2

Problem Number

Description

Difficulty Level

Time Allotted (min.)

40A

Calculate contribution margin and prepare incremental analysis for elimination of product and special order.

Moderate

30–40

41B

Prepare incremental analysis for a special-order decision and identify non-financial factors in the decision.

Moderate

20–30

42B

Calculate the contribution margin and prepare an Challenging incremental analysis for maximizing operating income and replacing equipment.

30–40

43B

Prepare incremental analysis related to a make-or-buy decision, consider opportunity cost, and identify nonfinancial factors.

Moderate

30–40

44B

Determine whether a product should be sold or processed further.

Moderate

30–40

45B

Calculate the gain or loss, and determine if equipment should be replaced.

Moderate

30–40

46B

Calculate contribution margin and prepare differential analysis for make-or-buy decision.

Moderate

30–40

47B

Calculate the contribution margin and prepare incremental analysis for a make-or-buy decision.

Moderate

30–40

48B

Calculate the contribution margin and prepare incremental analysis for the decision whether to eliminate divisions.

Moderate

20–30

49B

Calculate the contribution margin and prepare incremental analysis for maximizing operating income.

Moderate

20–30

50B

Determine sales mix with limited resources.

Simple

20–30

51B

Prepare incremental analysis for the decision whether to sell or process materials further.

Moderate

20–30

52B

Calculate the contribution margin and prepare incremental analysis for maximizing operating income and replacing equipment.

Moderate

30–40

. 7-3 7-3

Problem Number

Description

Difficulty Level

Time Allotted (min.)

53B

Calculate contribution margin and prepare incremental analysis concerning keeping or dropping a product to maximize operating income.

Moderate

20–30

54B

Calculate the contribution margin and prepare incremental analysis for the elimination of a product and special order.

Moderate

30–40

. 7-4 7-4

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

For Instructor Use Only

Study Objective

Knowledge Comprehension

Application

Analysis

Synthesis

Evaluation

*1.

Identify the steps in management’s BE1 decision-making process.

Q1 Q2

*2.

Describe the concept of incremental analysis.

Q3 Q4

BE2

E11

P36A P53b

*3.

Identify the relevant costs in accepting an order at a special price.

BE3 BE4

E12 E13 E25

E27 P28A

P41B P43B

*4.

Identify the relevant costs in a make-or-buy decision.

Q6 Q7

BE5

E14 E15 E27

P29A P30A P31A P37A

P43B P46B P47B

*5.

Identify the relevant costs in determining whether to sell or process materials further.

BE6 BE7

E16 E17 E18

E27 P32A P35A

P44B P51B

*6.

Identify the relevant costs in determining whether to keep or replace equipment.

Q11

BE8

E19 E20 E27

P33A P45B P39A P47B P42B P52B

*7.

Identify the relevant costs in deciding whether to eliminate an unprofitable segment.

Q12

BE9

E21 E26 E27

P34A P36A P40A

P48B P53B P54B

Determine the sales mix when a company has limited resources.

E22 E23 E24

P38A P40A

P49B P50B P54B

E11

Q8 Q9 Q10

Q14

Q13

BE10

BLOOM’ S TAXONOMY TABLE

7-4

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

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. At times this goes against what would be expected because it may happen that variable costs do not change under the alternative courses of action while 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 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.

. 7-5

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

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.

13.

Contribution margin per unit of a limited resource is obtained by dividing the contribution margin per unit of each product by the number of units of the limited resource required for each product.

14.

The theory of constraints is a specific approach that a company uses to identify and manage constraints in order to achieve its goals. A manufacturing constraint might be due to a bottleneck in production or to poorly trained machine operators. It could be machinery that breaks down frequently, or a company policy that does not allow overtime. Other constraints: limited warehouse space, scarce raw materials, highly specialized workers—anything that would cause production to be less than 100% of capacity.

. 7-6

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

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 Determine incremental difference between choosing B over A: Incremental revenue ($185,000 - $150,000) Incremental cost ($125,000 - $100,000) Incremental income (loss)

$35,000 25,000 $10,000

Alternative B is better than Alternative A.

BRIEF EXERCISE 7-3 Determine incremental difference between accepting and rejecting the order: Incremental revenue (3,000 units x $24 per unit) Incremental cost: Variable cost (3,000 units x $20 per unit) Shipping cost (3,000 units x $2 per unit) Incremental income (loss)

$72,000 $60,000 6,000

66,000 $6,000

The special order should be accepted, as it will generate a $6,000 net profit for the company.

. 7-7

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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BRIEF EXERCISE 7-4 Incremental revenue (3,000 units x $24 per unit) Incremental cost: Variable cost (3,000 units x $20 per unit) Shipping cost (3,000 units x $2 per unit) Opportunity cost [3,000 x ($45 – $20)] Incremental income (loss)

$72,000 $60,000 6,000 75,000

141,000 $(69,000)

If the special order was accepted without any extra capacity, the company would lose $69,000. BRIEF EXERCISE 7-5 Per Unit Number of units

10,000

Variable manufacturing costs Fixed manufacturing costs Purchase price Total annual cost

$4.50 $3.00 $5.00

Make $45,000 30,000 --$75,000

Buy

Net Income Increase (Decrease)

$30,000 50,000 $80,000

$45,000 --(50,000) $(5,000)

It would cost the company $5,000 less to make the part. BRIEF EXERCISE 7-6 Sell $60.00

Sales per unit

Process Further $70.00

Net Income Increase (Decrease) $10.00

Cost per unit: Variable 35.00 43.00 (8.00) Cost per unit: Fixed 10.00 10.00 --Total per unit cost 45.00 53.00 (8.00) Net Income per unit $15.00 $17.00 $2.00 The bookcases should be processed further because the incremental revenues exceed incremental costs by $2.00 per unit.

. 7-8

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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BRIEF EXERCISE 7-7 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 $60,000 ($150,000 – $90,000) and only incur incremental costs of $50,000. Therefore, the company should process AB1 further. If XY1 is processed further, the company will earn incremental revenue of $40,000 ($130,000 – $90,000) but will incur incremental costs of $50,000. Therefore, the company should sell XY1 rather than process it further. BRIEF EXERCISE 7-8 Keep Equipment

Replace Equipment

Net Income Increase (Decrease)

$2,400,000 --$2,400,000

$2,000,000 250,000 $2,250,000

$400,000 (250,000) $150,000

Period of 4 years Variable costs New machine cost

The old factory machine should be replaced as it will save the company $150,000 over four years. BRIEF EXERCISE 7-9 Sales Variable costs Contribution margin Fixed costs Net Income per unit

Continue

Eliminate

Increase (Decrease)

$200,000 175,000 $25,000 30,000 $(5,000)

$ ------15,000 $(15,000)

$(200,000) 175,000 $(25,000) 15,000 $(10,000)

The Big Bart product line should be continued because $25,000 of contribution margin will not be realized if the line is eliminated. This amount is greater than the $15,000 savings of fixed costs.

. 7-9

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

BRIEF EXERCISE 7-10 Contribution per unit Hours of limited resource per unit

Product A $10 2

Product B $12 3

CM per unit of limited resource

. 7-10

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO EXERCISES EXERCISE 7-11 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 non-financial information. True. True. False. Costs that are the same under all alternative courses of action do not affect the decision. False. With 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 7-12 (a) They are currently working at 75% capacity, which is the equivalent of 350,000 units. An additional 15,000 units would be within their current plant capacity. Total variable costs: 70% x ($2,500,000 + $875,000) Number of units Variable cost per unit

$2,362,500 350,000 $6.75

Incremental revenue (15,000 units x $7.50 per unit) $112,500 Incremental cost: Variable cost (15,000 units x $6.75 per unit) $101,250 Shipping cost 3,000 Fixed cost --104,250 Incremental income (loss) $8,250 (b) They should accept the special order, as it will increase their net income by $8,250.

. 7-11

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 7-13 (a) They are currently working at 70% capacity, which is the equivalent of 1,000,000 ($5,250,000 ÷ $5.25) units. An additional 200,000 units would be within their current plant capacity. Variable cost per unit: Direct materials and direct labour Variable manufacturing overhead Variable selling expenses

Selling price per unit: ($3.50 + $1.00) Incremental revenue (200,000 units x $4.50) Incremental cost: Variable cost (200,000 units x $3.50 per unit) Incremental income (loss)

$2.50 1.00 --$3.50 $4.50 $900,000 700,000 $200,000

Hardy Fiber should accept the Army’s offer since it would increase net income by $200,000. (b) If they could sell one million units at $8.00, they should not accept the Army’s offer, because for every unit they produce for the Army at $1.00 contribution margin, they would have to give up $4.25 ($8.00 - $3.75) contribution margin on a sale on the open market.

. 7-12

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 7-14 (a) Number of units: 30,000

Make

Direct material ($5.00) Direct labour ($6.00) Variable MOH ($3.60) Fixed MOH Purchase price ($15.50) Total annual cost

$150,000 180,000 108,000 45,000 --$483,000

Buy

Income Increase (Decrease)

$45,000 465,000 $510,000

$150,000 180,000 108,000 --(465,000) $(27,000)

(b) They should not purchase the shades as it would cost them $27,000 more than if they made them. (c) Yes, by purchasing the lamp shades, a total cost saving of $8,000 will result as shown below.

Number of units: 30,000

Make

Direct material ($5.00) Direct labour ($6.00) Variable MOH ($3.60) Fixed MOH Purchase price ($15.50) Opportunity cost Total annual cost

$150,000 180,000 108,000 45,000 --35,000 $518,000

. 7-13

Buy

$45,000 465,000 $510,000

Income Increase (Decrease) $150,000 180,000 108,000 --(465,000) 35,000 $8,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 7-15 (a) (1)

Direct materials Direct labour Variable overhead Fixed overhead Purchase price Total annual cost

Make $800,000 600,000 120,000 500,000 --$2,020,000

Buy ------$200,000 1,800,000 $2,000,000

Net Income Increase (Decrease) $800,000 600,000 120,000 300,000 (1,800,000) $20,000

Yes. The offer should be accepted as net income will increase by $20,000. (2)

Direct materials Direct labour Variable overhead Fixed overhead Opportunity cost Purchase price Total annual cost

Make $800,000 600,000 120,000 500,000 300,000 --$2,320,000

Buy ------500,000 --1,800,000 $2,300,000

Net Income Increase (Decrease) $800,000 600,000 120,000 --300,000 (1,800,000) $20,000

Yes. The offer should be accepted as net income will increase by $20,000. (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.

. 7-14

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 7-16 Sell Basic Kit

Process Further Stage 2 Kit

Net Income Increase (Decrease)

$28.00

$35.00

$7.00

(14.00) -0(14.00) $14.00

(7.00) (10.00) (17.00) $18.00

(3.00) $4.00

Per unit selling price Costs: Material Labour Incremental revenue

Wanda should carry the Stage 2 Kits. The incremental revenue, $7, exceeds the incremental processing costs, $3. Thus, net income will increase by processing the kits further. EXERCISE 7-17 (a)

Sales ($50,000 + $10,000 + $60,000) Less: Joint costs Net income

$120,000 100,000 $20,000

(b) Sales ($190,000 + $35,000 + $220,000) Joint costs Additional costs ($100,000 + $30,000 + 150,000) Net income (c) Revenue of final product Revenue at split-off Incremental revenue Less: Incremental costs Incremental profit (loss)

$445,000 (100,000) (280,000) $65,000

Product 12

Product 14

Product 16

$190,000 50,000 140,000 100,000 $40,000

$35,000 10,0001 25,000 30,000 $(5,000)

$220,000 60,000 160,000 150,000 $10,000

. 7-15

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 7-17 (continued) Products 12 and 16 should be processed further and product 14 should be sold at the split-off point. (d) Sales ($190,000 + $10,0001 + $220,000) Joint costs Additional costs ($100,000 + $150,000) Net income

$420,000 (100,000) (250,000) $70,000

Net income is $5,000 ($70,000 – $65,000) higher in (d) than in (b) because product 14 is not processed further, thereby increasing overall profit $5,000. EXERCISE 7-18 Revenue of final product Revenue at split-off Incremental revenue Less: Incremental costs Incremental profit (loss)

Sarco

Barco

Larco

$300,000 200,000 100,000 120,000 $(20,000)

$400,000 300,000 100,000 89,000 $11,000

$800,000 400,000 400,000 250,000 $150,000

From this analysis we see that Barco and Larco should be processed further because the incremental revenue exceeds the incremental costs, but Sarco should be sold as is.

. 7-16

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 7-19 (a)

Cost Accumulated depreciation ($100,000 ÷ 5 years) x 1 Book value Sales proceeds Loss on sale

$100,000 20,000 80,000 30,000 $50,000

(b) Retain Scanner Annual operating cost (over 4 years) New scanner cost Old scanner salvage Total

$420,000

Replace Scanner * $312,000 120,000 (30,000) $402,000

Net Income Increase (Decrease) $108,000 (120,000) 30,000 $18,000

Yes. Lucas Hospital should replace the old scanner because it will result in a savings of $18,000 over the next four years. (c) As shown in (a) above, replacing the old scanner will result in reporting a loss of $50,000. 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 ($80,000) 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 Alliant is willing to pay ($30,000).

. 7-17

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 7-20

Annual operating costs New computer cost Salvage for old computer Total

Retain Computer

Replace Computer

Net Income Increase (Decrease)

$120,000

$90,000 25,000 (5,000) $110,000

$30,000 (25,000) 5,000 $ 10,000

$120,000

The current computer should be replaced. The incremental analysis shows that net income for the five-year period will be $10,000 higher by replacing the current computer. EXERCISE 7-21

Sales Variable costs ($60,000 + $25,000) Contribution margin Fixed costs ($16,500 + $23,000) Net Income (loss)

Continue

Eliminate

Net Income Increase (Decrease)

$100,000 85,000 15,000 39,500 $(24,500)

$ -0-0-039,500 $(39,500)

$(100,000) 85,000 (15,000) -0$(15,000)

Maggie is incorrect. The incremental analysis above shows that net income will be $15,000 less if the Erie 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.)

. 7-18

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 7-22 (a)

Product A

Product B

Product C

$9.00 3.00 $6.00 2 hrs $3.00

$12.00 9.50 $2.50 1 hr $2.50

$14.00 12.00 $2.00 2 hrs $1.00

Selling price Less: variable costs & expenses Contribution margin per unit Limited resources used CM per unit of limited resources

(b) All additional machine hours should be used to produce Product A, because they can earn the highest amount ($3.00) per hour making that product. (c) (1) If the machine hours were allocated equally, each product would have 500 machine hours for production. This would result in a total contribution as follows: Product A ($3.00 x 500 hours) Product B ($2.50 x 500 hours) Product C ($1.00 x 500 hours) Total contribution margin

$1,500 1,250 500 $3,250

(2) If all the machine hours were allocated to the product with the highest contribution margin per unit of limited resource (Product A), the total contribution margin would be $4,500 ($3.00 x 1,500 hours). EXERCISE 7-23 (a)

Basic

Deluxe

Selling price Less: variable costs & expenses Contribution margin per unit Limited resources used CM per unit of limited resources

$40.00 18.00 $22.00 0.5 hrs $44.00

$52.00 24.00 $28.00 0.7 hrs $40.00

. 7-19

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 7-23 (Continued) (b) All additional machine hours should be used to produce the Basic product, because they can earn the highest amount ($44.00) per hour making that product. (c) (1) If the machine hours were allocated equally between both products, each product would have 500 machine hours for production. This would result in a total contribution as follows: Basic ($44.00 x 500 hours) Deluxe ($40.00 x 500 hours) Total contribution margin

$22,000 20,000 $42,000

(2) If all the machine hours were allocated to the product with the highest contribution margin per unit of limited resource (Basic), the total contribution margin would be $44,000 ($44.00 x 1,000 hours). EXERCISE 7-24 (a)

Product D

Product E

Product F

$25.00 $10.00 2.5 hrs

$75.00 $10.00 7.5 hrs

$30.00 $10.00 3.0 hrs

(b)

Product D

Product E

Product F

Selling price Less: variable costs Contribution margin per unit Limited resources used CM per unit of limited resources

$200.00 30.00 $170.00 2.5 hrs $68.00

$300.00 165.00 $135.00 7.5 hrs $18.00

$250.00 178.00 $72.00 3.0 hrs $24.00

Direct labour cost for the unit Labour rate per hour Number of hours used per unit

(c) Production should emphasize Product D because it has the higher contribution margin per hour of direct labour. The total contribution margin they could earn would be $136,000 ($68 x 2,000 hours). . 7-20

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 7-25 (a) Calculate the incremental income (loss) from the special order: Incremental revenue (5,000 units x $4.75 per unit) Incremental cost: Materials [5,000 x ($10,000 ÷ 20,000 units)] Labour [5,000 x ($30,000 ÷ 20,000 units)] Variable overhead [5,000 x ($20,000 ÷ 20,000 units)] Fixed cost Incremental income (loss)

$23,750 $2,500 7,500 5,000 5,000

20,000 $3,750

(b) Innova Company should accept the order as it will provide an additional $3,750 income. (c) Two assumptions would be made with respect to the decision from (b). First, it is assumed that sales of the product in other markets would not be affected by this special order. Any lost sales would have to be considered in the decision. Second, if Mudd was operating at full capacity and would have to forego regular sales, they would likely reject the special offer. EXERCISE 7-26 (a)

Current net income is $30,000 + $75,000 – $30,000 = $75,000

(b)

Allocate common fixed costs based on sales: Stunner: ($300,000 ÷ $800,000) X $300,000 = $112,500 Double-Set: ($500,000 ÷ $800,000) X $300,000 = $187,500 Stunner Double-Set

Sales Variable costs Contribution margin Fixed costs Net Income (loss) 1$112,500 + 30,000

$300,000 150,000 150,000 142,5001 $7,500

2$187,500 + 75,000

. 7-21

$500,000 200,000 300,000 262,5002 $37,500

Total $800,000 350,000 450,000 405,000 $45,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 7-26 (Continued) (c) As shown in the analysis above, Kirk should not eliminate the MegaPower product line. Elimination of the line would cause net income to drop from $75,000 to $45,000. The reason for this decrease in net income is that elimination of the product line would result in the loss of $60,000 of contribution margin while saving only $30,000 of fixed expenses. EXERCISE 7-27 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.

. 7-22

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SOLUTIONS TO PROBLEMS—SET A PROBLEM 7-28A

(a) Calculate per unit cost for the relevant costs: Variable COGS: ($3,600,000 – $1,080,000) ÷ 112,500 units = $22.40 Variable S & A: ($450,000 – $225,000) ÷ 112,500 units = $2.00 Calculate the incremental income (loss) from the special order: Incremental revenue (10,000 units x $28 per unit) Incremental cost: Variable COGS (10,000 x $22.40 per unit) Variable S & A (10,000 x $2.00 per unit) Additional S & A (10,000 x $0.50 per unit) Incremental income (loss)

$280,000 $224,000 20,000 5,000

249,000 $31,000

(b) Yes, the special order should be accepted because net income will increase by $31,000. (c) Unit selling price = $22.40 (variable manufacturing costs) + $2.50 variable selling and administrative expenses + $4.10 net income = $29. (d) Non-financial 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

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PROBLEM 7-29A (a) Number of units: 7,000

Make

Direct material ($4.80) Direct labour ($4.30) Indirect labour ($0.43) Utilities ($0.40) Fixed costs Freight costs ($0.40) Receiving costs Purchase price ($10.00) Total annual cost

$33,600 30,100 3,010 2,800 5,200 ------$74,710

Buy

Income Increase (Decrease)

$1,700 2,800 1,250 70,000 $75,750

$33,600 30,100 3,010 2,800 3,500 (2,800) (1,250) (70,000) $(1,040)

(b) The company should continue to make WISCO because net income would be $1,040 less if WISCO was purchased from the supplier. (c) The decision would be different. Because of the opportunity cost of $5,000, net income will be $3,960 higher if WISCO is purchased as shown below: Net Income Increase Make Buy (Decrease) Total annual cost (from a) $74,710 $75,750 $(1,040) Opportunity cost 5,000 --5,000 Total annual cost $79,710 $75,750 $3,960

(d) Non-financial factors include: (1) the adverse effect on employees if WISCO is purchased, (2) how long the supplier will be able to satisfy the Borealis 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 Borealis. . 7-24

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-30A (a) Number of units: 1,200

Make

Direct material ($100) Direct labour ($80) Variable OH ($40) Purchase price ($260) Total cost

$120,000 96,000 48,000 --$264,000

Buy

Income Increase (Decrease)

312,000 $312,000

$120,000 96,000 48,000 (312,000) $(48,000)

As long as the company has the excess capacity, they would be better off making the sails. (b) The best decision would be to rent out the space as shown below. The differential savings would be $80,000 - $48,000 = $32,000. Net Income Per Make Increase (Based on 1,200 units) Unit Sails Buy Sails (Decrease) Manufacturing cost $220 $264,000 $ 0 $264,000) Purchase price $260 0 312,000 ( (312,000)) Opportunity cost 80,000 0 80,000 Total annual cost $344,000 $312,000 $ (32,000) (c)

Some qualitative factors that Harmon should consider are: 1. whether the workers have the right skills to make the sails, 2. whether the supplier of the sails would be willing to provide sails in case they had to discontinue their own production, and 3. what the consequences would be if demand for sailboats increased, and they did not have enough capacity to meet the demand. 4. whether Harmon will be able to exercise control over the future price of the product 5. whether Harmon will be able to exercise control over the quality of the product and the potential for interruptions in the supply of the product. . 7-25

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PROBLEM 7-31A

(a) Number of units: 1,000 Direct material ($65) Material handlings ($6.50) Direct labour ($48) Variable OH ($60.00) Fixed OH ($60)1 Purchase price ($200) Total cost 1

Make $65,000 6,500 48,000 60,000 60,000 --$239,500

Buy

Income Increase (Decrease)

$60,000 200,000 $260,000

$65,000 6,500 48,000 60,000 (200,000) $(20,500)

$126.50 - $6,50 = $120.00 x 50% each for variable and fixed

As long as the company has the idle capacity, they would be better off making IMC2. (b) In order for Interdesign 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 $20,500 more (1,000 x $20.50). Interdesign would have to increase their contribution margin by more than $20,500 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.

. 7-26

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 7-32A (a) (1)

Table Cleaner Not Processed Further Sales: FloorShine (18,000 X $20) Table Cleaner (9,000 X $25) Costs: CDG costs Additional costs of FloorShine Gross profit

(2)

$360,000 225,000 $585,000 210,000 250,000

460,000 $125,000

Table Cleaner Processed Further Sales: FloorShine (18,000 X $20) Table Stain Remover (9,000 X $20) Table Polish (9,000 X $20) Costs: CDG costs Additional costs of FloorShine TCP Gross profit

$360,000 180,000 180,000 $720,000 210,000 250,000 120,000

580,000 $140,000

(3) Management did not make the correct decision because if they had processed the table cleaner further, gross profit would have increased by $15,000. (b) Net Don’t Income Process Process Increase Further Further (Decrease) Incremental revenue $225,000 $360,000 $135,000 Incremental costs --120,000 (120,000) Totals $225,000 $240,000 $15,000 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.

. 7-27

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 7-33A (a)

Cost Accumulated amortization ($120,000 ÷ 6 yrs) x 1 yr Book value Sales proceeds Loss on sale

(b) (1)

$120,000 20,000 100,000 (25,000) $75,000

Retain Old Elevator Sales ($240,000 X 5 yrs.) Less costs: Variable costs Fixed costs Selling & administrative Amortization Net income

$1,200,000 $175,000 115,000 145,000 100,000

(2)

535,000 $ 665,000

Replace Old Elevator Sales Less costs: Variable costs Fixed costs Selling and administrative Amortization Operating income Less: Loss on old elevator Net income

$1,200,000 $60,000 42,000 145,000 180,000

. 7-28

427,000 773,000 75,000 $698,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-33A (Continued) (c)

Variable operating costs Fixed operating costs

Retain Old Elevator $175,000 115,000

Replace Old Elevator $60,000 42,000

Net Income Increase (Decrease) $115,000 73,000

New elevator cost Salvage on old elevator Totals

----$290,000

180,000 (25,000) $257,000

(180,000) 25,000 $33,000

(d) MEMO TO: Cab Calway 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 $100,000 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 $100,000 would be deducted as amortization expense over the next five 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 $100,000 book value will be expensed under either alternative, making it irrelevant.

. 7-29

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-34A (a)

First determine variable costs: Division I—COGS 70% x $200,000 = $140,000 S&A 40% x $65,000 = $26,000 Division II—COGS 90% x $189,000 = $170,100 S&A 70% x $60,000 = $42,000

Sales Variable costs Contribution margin (b)

Div. I $250,000 166,000 $84,000

Div. II $200,000 212,100 $(12,100)

First determine fixed costs: Division I—COGS 30% x $200,000 = $60,000 S&A 60% x $65,000 = $39,000 Division II—COGS 10% x $189,000 = $18,900 S&A 30% x $60,000 = $18,000

Division I: Contribution margin Fixed costs Totals

Division II: Contribution margin Fixed costs Totals

Keep Div I $84,000 99,000 $(15,000)

Keep Div II $(12,100) 36,900 $(49,000)

Shut Div I --$49,500 $(49,500)

Income Increase (Decrease) $(84,000) 49,500 $(34,500)

Shut Div II --$18,450 $(18,450)

Income Increase (Decrease) $12,100 18,450 $30,550

Division I should be continued because it is producing positive contribution margin of $84,000. Income from operations will decrease

. 7-30

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-34A (Continued) $34,500 by discontinuing this division. Division II should be eliminated as its negative contribution margin is $12,100. Income from operations would increase $30,550 if Division II is eliminated. (c)

First determine variable and fixed costs for Div III & Div IV Division III— Variable COGS 80% x $300,000 = $240,000 Variable S&A 50% x $60,000 = $30,000 Fixed COGS 20% x $300,000 = $60,000 Fixed S&A 50% x $60,000 = $30,000 Division IV— Variable COGS 75% x $250,000 = $187,500 Variable S&A 60% x $50,000 = $30,000 Fixed COGS 25% x $250,000 = $62,500 Fixed S&A 40% x $50,000 = $20,000

Each division will have an additional fixed cost charge of $6,150 which is an equal share of the unavoidable fixed costs from Division II.

RIBEIRO MANUFACTURING COMPANY CVP Income Statement For the Quarter Ended March 31, 2009

Sales Variable costs Cont. Margin Fixed costs Net Income d)

Div I $250,000 166,000 84,000 105,150 $(21,150)

Div III $500,000 270,000 230,000 96,150 $133,850

Div IV $400,000 217,500 182,500 88,650 $93,850

Total $1,150,000 653,500 496,500 289,950 $206,550

Income from operations with Division II of $176,000 (given) plus incremental income of $30,550 from eliminating Division II = $206,550 income from operations without Division II.

. 7-31

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-35A (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 A--$45,000 (3,000 units x $15.00 per unit) Product B--$97,200 (6,000 units x $16.20 per unit) Product C--$43,200 (2,000 units x $21.60 per unit) Revenue at split-off: Product A--$30,000 (3,000 units x $10.00 per unit) Product B--$69,600 (6,000 units x $11.60 per unit) Product C--$38,800 (2,000 units x $19.40 per unit) A $15,000 14,000 $ 1,000

Incremental revenue Incremental cost Increase (decrease) in profit

B $27,600 16,000 $11,600

C $4,400 9,000 $(4,600)

Products A and B 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.

. 7-32

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-36A Calculation of contribution margin per unit: Selling price per unit Less: variable costs/unit Contribution margin/unit

A $95 50 $45

B $78 45 $33

C $120 42 $ 78

Fixed costs = $22 x (8,000 + 20,000) = $616,000 Company profit with Products A and B: A B Units sold 8,000 20,000 $760,000 $1,560,000 Sales Revenue 400,000 900,000 Less: variable costs $360,000 $660,000 Contribution margin Less: fixed costs Net Profit Company profit with Products A and C: A C Units sold 8,800* 11,000 $836,000* $1,320,000 Sales Revenue 440,000* 462,000 Less: variable costs $396,000 $858,000 Contribution margin Less: fixed costs Net Profit *Product A sales increase by 10%

. 7-33

Total $2,320,000 $1,300,000 1,020,000 616,000 $404,000

Total $2,156,000 902,000 1,254,000 616,000 $638,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-37A (Continued)

Assuming fixed costs do not change, Straus Company should replace Product B with Product C. The contribution given up by dropping Product B is more than covered by the increased contribution margin from Product A, and the total from Product C: ($396,000 + $858,000) – ($360,000 + $660,000) = $234,000.

. 7-34

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 7-37A

(a) Based on one box of 24

Make

Buy

Income Increase (Decrease)

Direct material Direct labour Variable OH* Purchase price Total cost

$6.00 4.00 1.50 --$11.50

$4.80 3.60 1.35 1.90 $11.65

$1.20 0.40 0.15 (1.90) $(0.15)

*Variable overhead per unit = [(100,000 x $3.00) - $150,000] ÷ 100,000 Kamloops should make the tube because it would cost them $15,000 (100,000 x $0.15) more to purchase them. (b) The maximum purchase price would be $1.75, the amount that would make the cost of the two alternatives equal: ($11.50 – $11.65 + $1.90)

$ 237,500

(2) Produce the tubes (125,000 x $1.75) Plus: rent on new machine Total annual cost

218,750 10,000 $ 228,750

Advantage of producing their own tubes is $8,750.

. 7-35

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-37A (Continued)

(d) (1) Purchase all the tubes (125,000 x $1.90)

$237,500

(2) Produce the tubes (125,000 x $1.75) Plus: rent on new machine Total annual cost

$218,750 10,000 $228,750

(3) Produce 100,000 tubes (100,000 x $1.75) No rental equipment required Purchase 25,000 tubes (25,000 x $1.90)

$175,000 --47,500 $222,500

Of the three alternatives, the least expensive would be to produce the first 100,000 units, and then purchase the additional 25,000 from the outside vendor.

(e) Qualitative factors to consider: • Control over the quality of the tube • Convenient delivery schedules • Control over future price increases

. 7-36

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-38A

(a)

Calculation of contribution margin per unit: Selling price per unit Less: variable costs/unit Contribution margin/unit

E. $30 12 $18

S. $50 18 $32

D. $100 42 $58

Ignoring the machine constraint, Manning would focus on producing the Deluxe model, which has the largest contribution margin per unit.

(b)

Calculation of contribution margin per unit of constrained resource: E. S. D. Contribution margin/unit $18 $32 $58 Machine hours per unit 5.0 0.8 1.6 CM per machine hour $3.60 $40 $36.25

(c)

If additional machine time was available, it should be used to produce the Standard model, which has the highest contribution margin per machine hour, which is the constraining resource.

. 7-37

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-39A First calculate the per unit contribution for both scenarios: Retain Old Machine Per unit selling price ($280 x 1.05) $294 Less costs: Direct materials $25 Direct Labour ($45 x 1.20 x 4 hr) 216 Variable overhead 16 257 Contribution margin per unit $37 Replace Old Machine Per unit selling price ($280 x 1.05) $294 Less costs: Direct materials $25 Direct Labour ($45 x 1.20 x 3 hr) 162 Variable overhead ($4 x 3 hr) 12 199 Contribution margin per unit $95 Then determine total contribution margin over 5 years: Retain Old Equipment $37 x 50,000 x 5 years = $9,250,000 Replace Old Equipment $95 x 52,000 x 5 years = $24,700,000 Finally, complete the incremental analysis: Retain Old All figures are in millions Machine CM for 5 years New machine cost Salvage for old machine Salvage for new machine New operator Total

$9.250

Replace Old Machine

Net Income Increase (Decrease)

$24.700 ($3.500) 0.085 0.075 (0.600) $20.760

$15.450 ($3.500) 0.085 0.075 (0.600) $11.510

The company will increase its profits by $11,510,000 over 5 years if it opts to purchase the new machine.

. 7-38

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7- 40A

(a)

Calculation of contribution margin per unit: Product Based on 1,000 units each A B C Selling price per unit $75 $95 $105 Less: variable costs/unit 40 60 90 Contribution margin/unit $35 $35 $15 Product C should not be eliminated because it is contributing $15,000 (1,000 x $15) towards fixed costs and profit.

(b)

Calculation of CM per limited resource: Product Contribution margin/unit Machine hours per product CM per machine hour

A $35 7 $5

B $35 5 $7

C $15 5 $3

The company should produce product B because it has the largest contribution margin per constrained resource (machine hours).

. 7-39

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-40A (Continued) (c)

If the company could sell unlimited quantities of any of the three products, they would only sell Product B, as this product has the highest CM per MH. To produce C they would have to cut down on production of B. Opportunity cost of producing C: 500 units x 5 hours per unit = 2,500 machine hours required 2,500 hours taken away from B: 2,500 x $7 = $17,500 $17,500 ÷ 500 units = $35 per unit The minimum selling price would be the variable costs per unit plus opportunity cost = $90 + $35 = $125.

(d) Determine sequence of production: Product A B CM per machine hour $5 $7 Sequence of production (2) (1)

Total hours available First produce 500 units of each 500 x (7 + 5 + 5) Hours remaining Produce 1,000 units of B Hours left for A Produce 500 units of A Hours remaining

C $3 (3)

17,000 (8,500) 8,500 (5,000) 3,500 (3,500) ---

They should produce 1000 units of A (500 + 500); 1,500 units of B (500 + 1,000); and 500 units of C.

. 7-40

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SOLUTIONS TO PROBLEMS—SET B PROBLEM 7-41B (a) Production capacity = 22,500 units (18,000 ÷ 80%). Units for special order = 4,500 (22,500 – 18,000). Current selling price = $24 ($432,000 ÷ 18,000). Special order price = $19.20 ($24 X 80%). (b) Manufacturing cost for one unit: Variable costs Fixed costs ($72,000 ÷ 18,000)

$13.20 4.00 $17.20

$86,400

Incremental cost: Variable COGS Packaging

(4,500 x $13.20 per unit)

(4,500 x $2.00 per unit)

$59,400 9,000

Sales commission

4,000

Rental on logo machine

5,000

Incremental income (loss)

77,400 $9,000

Yes, the special order should be accepted because net income will increase by $9,000. (d) Lowest selling price = incremental cost per unit, $77,400 ÷ 4,500 units = $17.20 + net income per unit, $1.20 = $18.40.

. 7-41

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-41B (Continued) (e) Non-financial 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.

. 7-42

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-42B (a) Total CM # of units CM per unit MH per unit CM per MH

A10 $265,000 1,000 $265.00 2.0 $132.50

A20 $450,000 250 $1,800.00 4.0 $450.00

A30 $263,000 750 $350.67 1.5 $233.78

A40 $525,000 600 $875.00 3.0 $291.67

Sharp Aerospace should produce only A20, because it has the highest contribution margin per constrained resource (machine hours). (b)

Number of machine hours required: Rank North Plane--A10 (1,000 x 2.0 hrs) (4) North Plane--A20 (250 x 4.0 hrs) (1) North Plane--A30 (750 x 1.5 hrs) (3) North Plane--A40 (600 x 3.0 hrs) (2) Polaris--A10 (200 x 2.0 hrs) Total hours required for maximum production Total capacity of machine hours available Start by producing 90% for North Plane Produce 90% of A20 (225 units) Produce 90% of A40 (540 units) Produce 90% of A30 (675 units) Produce 90% of A10 (900 units) Machine hours remaining Produce A10 for Polaris (200 units) Balance remaining for North Plane Produce 10% of A20 (25 units) Use the balance for A40 (55 units) Balance remaining

. 7-43

Total 2,000 1,000 1,125 1,800 400 6,325

90% 1,800 900 1,013 1,620

6,000 900 1,620 1,013 1,800

100 167

5,333 667 400 267 267 ---

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-42B (Continued) Incremental gain from sales to Polaris 200 units x ($1,500 x 1.10) $330,000 Less: variable costs (200 x $1,235) 247,000 Opportunity cost of selling to Polaris A10 (100 x $265 CM per unit ) 26,500 A30 (75 x $350.67 CM per unit ) 26,300 A40 [600 – 540 – 55) x $875 CM per unit ) 4,375 Gain from sale to Polaris

$83,000

57,175 $25,825

If Sharp Aerospace takes the new order they will earn an additional $25,825 in contribution margin.

(c)

New capacity: 6,000 x 125% Required for contract (1,000 x 2) + (250 x 4) + (750 x 1.5) + (600 x 3) Hours left to produce A20 (highest CM per unit) MH required to produce one unit of A20 Number of A20 units that could be produced at $1,800 per unit Additional contribution earned over 4 years life of the equipment Total contribution margin from additional sales Cost of the equipment

7,500 5,925 1,575 4 393 $1,800 $707,400 4 $2,829,600 2,500,000 $ 329,600

Sharp Aerospace should buy the new technology because its purchase cost is $329,600 less than the additional contribution margin they would earn.

. 7-44

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PROBLEM 7-43B (a) Number of units: 35,000 Direct material ($2.20) Direct labour (2,000 x 3 x $12) Manufacturing costs Purchase price ($4.00) Freight costs ($0.50) Receiving clerk Opportunity cost (5,000 x $0.80) Total annual cost

Make

Buy

Income Increase (Decrease)

$77,000 72,000 10,300 ------4,000 $163,300

------$140,000 $17,500 8,500 --$166,000

$77,000 72,000 10,300 (140,000) (17,500) (8,500) 4,000 $(2,700)

Dunham should continue to make the part because net income would be $2,700 less if it was purchased from the supplier. (b) The decision would be different. Because of the opportunity cost of $12,000, net income will be $9,300 higher if the part is purchased as shown below: Net Income Increase Make Buy (Decrease) Total annual cost (from a) $163,300 $166,000 $(2,700) Opportunity cost 12,000 --12,000 Total annual cost $175,300 $166,000 $9,300 (c) Non-financial factors include: (1) the adverse effect on employees if the part is purchased, (2) how long the supplier will be able to satisfy the Dunham 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.

. 7-45

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PROBLEM 7-44B (a) (1)

Glass Cleaner Not Processed Further Sales Revenue MetalShine (20,000 ÷ 0.75) X $15 Glass Cleaner (10,000 ÷ 0.75) X $24 Costs TLC Additional costs for MetalShine Gross profit

(2)

$400,000 320,000 $720,000 200,000 270,000

470,000 $250,000

Glass Cleaner is Processed Further Sales MetalShine (20,000 ÷ 0.75) X $15 Plastic Cleaner (10,000 ÷ 0.75) X $20 Plastic Polish (10,000 ÷ 0.75) X $20 Costs TLC Additional costs for MetalShine MST Gross profit

$400,000 266,667 266,666 $933,333 200,000 270,000 140,000

610,000 $323,333

(3) If the glass cleaner is processed further overall company profits will be $73,333 higher. Therefore, management made the wrong decision by choosing to not process the glass cleaner further. (b)

Incremental revenue Incremental costs Totals

Don’t Process Further $320,000 --$320,000

. 7-46

Process Further $533,333 140,000 $393,333

Net Income Increase (Decrease) $213,333 (140,000) $(73,333)

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-44B (Continued) When trying to decide if the glass cleaner should be processed further into PC and PP, only the relevant data need be considered. All of the costs that occurred prior to the creation of the glass cleaner are sunk costs and can be ignored.

. 7-47

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-45B

(a)

Cost Accumulated amortization (120,000 ÷ 6 years) x 1 year Book value Less: Sales proceeds Loss on sale

(b) (1)

$120,000 20,000 100,000 10,000 $90,000

Retain Old Press Sales ($200,000 X 5) Less costs: Variable costs ($30,000 X 5) Fixed costs ($20,000 X 5) Sell & Admin ($24,000 X 5) Amortization ($20,000 x 5 yr) Net income

(2)

$1,000,000 $150,000 100,000 120,000 100,000

470,000 $530,000

Replace Old Press

Sales Less costs: Variable costs ($10,000 X 5) Fixed costs ($7,000 X 5) Sell & Admin Amortization Operating income Less: Loss on old press Net income

$1,000,000 $ 50,000 35,000 120,000 150,000

. 7-48

355,000 645,000 90,000 $555,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-45B (Continued) (c)

Variable costs Fixed costs Salvage of the old press Cost of the new press Totals

(d)

Retain Old Press $150,000 100,000

$250,000

Replace Old Press $50,000 35,000 (10,000) 150,000 $225,000

Net Income Increase (Decrease) $100,000 65,000 10,000 (150,000) $25,000

MEMO

TO: Jill Jabowski FROM: Student SUBJECT: Relevant Data for Decision to Replace Old Press When deciding whether or not to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $90,000 loss that would be experienced if we replace the old press with the newer model is related to a sunk cost, namely the cost of the old press. Sunk costs are irrelevant in decision making. The loss occurs when comparing the book value of the old press to the cash proceeds that would be received. The book value of $100,000 would be deducted as amortization expense over the next five years if the press were retained. If the press 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 $100,000 book value will be expensed under either alternative, making it irrelevant.

. 7-49

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PROBLEM 7-46B

(a) Per unit costs 1,500 units

Make

Buy

Income Increase (Decrease)

Direct material Direct labour Variable OH Purchase price Total cost

$150.00 120.00 80.00 --$350.00

------$380.00 $380.00

$150.00 120.00 80.00 (380.00) $(30.00)

Y&U should be making the reading lamps, because they could save $30 per unit or $45,000. The president was including the fixed overhead cost in the calculation. Variable overhead = Total overhead ($160) – Fixed overhead ($120,000 ÷ 1,500) = $80. But this amount has been allocated, so Y&U will incur the cost whether or not they make the reading lamps. This is an example of an irrelevant cost, because it does not differ between the two alternatives. (b) The best decision would be to rent out the space as shown below. The differential savings would be $120,000 - $45,000 = $75,000.

Based on 1,500 units Manufacturing cost ($350) Purchase price ($380) Opportunity cost Total annual cost

Make

Buy

Income Increase (Decrease)

$525,000 --120,000 $645,000

--$570,000 --$570,000

$525,000 (570,000) 120,000 $75,000

. 7-50

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(c) Qualitative factors to consider would be (1) whether Y&U will be able to exercise control over the future price of the product, (2) whether Y&U will be able to exercise control over the quality of the product and (3) the potential for interruptions in the supply of the product.

. 7-51

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PROBLEM 7-47B (a) Cost of purchasing the ice cream Less: savings on variable costs Direct materials ($3.00 x 20%) Direct labour ($2.00 x 10%) Variable overhead ($1.50 - [$100,000 ÷ 100,000]) x 10%

$0.90 $0.60 $0.20 $0.05

Differential cost

$0.85 $0.05

Quincy should produce the ice cream because it costs them $0.05 per box less than if they purchased it. (b) Quincy should pay no more than the cost to produce it themselves, which is $0.85 per box as determined in (a).

(c)

Purchase the ice cream (125,000 x $0.90)

$112,500

Cost of producing the ice cream (125,000 x $0.85)

106,250

Plus: lease on new machine Total annual cost

10,000 $116,250

Advantage of purchasing all the ice cream

. 7-52

$3,750

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PROBLEM 7-47B (Continued) (d)

(1) Purchase all the ice cream (125,000 x $0.90)

$112,500

(2) Produce all the ice cream (125,000 x $0.85) Plus: lease on new machine Total annual cost

106,250 10,000 $116,250

(3) Produce 100,000 boxes (100,000 x $0.85) Purchase 25,000 boxes (25,000 x $0.90)

$85,000 22,500 $107,500

The least expensive alternative is (3): buy 25,000 units and produce 100,000 units. (e) Some of the qualitative factors might include • Quality • Reliability of the vendor • On-time delivery • Technology • Dairy company ability • Strike possibilities

. 7-53

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-48B (a)

Determine the variable costs: Kelowna: COGS 90% x $400,000 = $360,000 Kelowna: S&A 60% x $100,000 = $60,000 Moncton: COGS 95% x $390,000 = $370,500 Moncton: S&A 80% x $120,000 = $96,000 Kelowna 405,000

Sales Less: Variable costs COGS $360,000 Selling & Admin 60,000 Contribution margin (b)

420,000 $(15,000)

Moncton $500,000 $370,500 96,000

466,500 $33,500

Determine the fixed costs: Kelowna: COGS $400,000 - $360,000 = $40,000 Kelowna: S&A $100,000 - $60,000 = $40,000 Moncton: COGS $390,000 - $370,500 = $19,500 Moncton: S&A $120,000 - $96,000 = $24,000 (1) Kelowna Contribution margin Fixed costs Totals 1

Keep $(15,000) (80,000) $(95,000)

Would incur savings of 70%

. 7-54

Close --$(24,000)1 $(24,000)

Income Increase (Decrease) $15,000 56,000 $71,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-48B (Continued) (2)

Income Increase Moncton Keep Close (Decrease) Contribution margin $33,500 --$(33,500) Fixed costs (43,500) $(13,050) 30,450 Totals $(10,000) $(13,050) $(3,050) The Kelowna Division should be eliminated because it is producing negative contribution margin ($15,000). Income from operations will increase $71,000 if the division is discontinued. The Moncton Division should be continued as its contribution margin, $33,500, is greater than the $30,450 savings in fixed costs ($43,500 – $13,050) that would result from elimination. Therefore, income from operations would decrease $3,050 if the Moncton Division were eliminated.

(c)

Calculate costs for Brandon and Sherbrooke Brandon— Variable COGS 80% x $480,000 = $384,000 Variable S&A 60% x $207,000 = $124,200 Fixed COGS 20% x $480,000 = $96,000 Fixed S&A 40% x $207,000 = $82,800 Sherbrooke — Variable COGS 90% x $576,000 = $518,400 Variable S&A 70% x $246,000 = $172,200 Fixed COGS 10% x $576,000 = $57,600 Fixed S&A 30% x $246,000 = $73,800 Allocation of unavoidable fixed costs: Brandon—30% x $24,000 = $7,200 Sherbrooke—50% x $24,000 = $12,000 Moncton—20% x $24,000 = $4,800

. 7-55

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-48B (Continued) LAOS MANUFACTURING COMPANY CVP Income Statement For the Quarter Ended March 31, 2009

Sales Variable costs Cont. Margin Fixed costs Net Income

Brandon $730,000 508,200 221,800 186,000 $35,800

Sbrook $920,000 690,600 229,400 143,400 $86,000

Moncton $500,000 466,500 33,500 48,300 $(14,800)

Total $2,150,000 1,665,300 484,700 377,700 $107,000

(d) Income from operations with Kelowna of $36,000 (given) plus incremental income of $71,000 from eliminating Kelowna = $107,000, income from operations without Kelowna.

. 7-56

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 7-49B Note: some of these numbers have been rounded Contribution margin per unit: Selling price Direct materials Direct labour Variable overhead Total variable costs Contribution margin (a)

$50.00 $5.00 5.00 2.50 $12.50 $37.50

$60.00 $10.00 9.00 4.50 $23.50 $36.50

$150.00 $25.00 30.00 15.00 $70.00 $80.00

$100.00 $15.00 20.00 10.00 $45.00 $55.00

Determine direct labour hours required for each unit: Labour cost per unit Labour cost per hour Labour hours (b)

$5.00 $15.00 0.3333

$ 9.00 $15.00 0.6000

$30.00 $15.00 2.0000

$20.00 $15.00 1.3333

Contribution margin per unit of constrained resource (DLH): (a) ÷ (b) Production sequence

$112.51 (1)

$60.83 (2)

$40.00 (4)

$41.25 (3)

Total number of DLH required to produce estimated demand of each unit: A B C D Total estimated demand (units) DLH per unit Total hours needed > 80,000

8,000 0.3333 2,667

. 7-57

24,000 20,000 0.6000 2.0000 14,400 40,000

30,000 1.3333 40,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 7-49B (Continued) Now determine products and quantities to maximize operating income based on highest to lowest CM per DLH: Produce A (8,000 units) 2,667 Produce B (24,000 units) 14,400 Produce D (30,000 units) 40,000 Produce C (11,467 units) 22,933 Total hours available 80,000

. 7-58

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-50B

(a) Calculation of contribution margin per unit: Econ Stand Selling price per unit Less: variable costs/unit Contribution margin/unit

$180 99 $81

$250 150 $100

Deluxe $430 280 $150

Ignoring the machine constraint, Simon would focus on producing the Deluxe model, which has the largest contribution margin per unit.

(b) Calculation of contribution margin per unit of constrained resource. Econ Stand Deluxe Contribution margin/unit Machine hours per unit CM per machine hour

(c)

$81 0.6 $135

$100 0.9 $111

$150 1.2 $125

If additional machine time was available, it should be used to produce the Economy model, which has the highest contribution margin per machine hour, which is the constraining resource.

. 7-59

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-51B

(a) Total selling price: Number of units

1 3,000

2 4,000

3 2,500

4 500

Price per unit $15.00 After further processing (a) $45,000

$12.25 $49,000

$15.70 $39,250

$10.25 $5,125

Price per unit At split-off point

$ 9.50 $38,000

$ 11.00 $27,500

$ 7.75 $3,875

$10.00 (b) $30,000

Incremental revenue (a – b)

$15,000

$11,000

$11,750

$1,250

Less: incremental costs Incremental profit (loss)

14,800 $200

8,500 $2,500

12,000 $(250)

1,250 -

If only one product could be processed further, it should be Microprocessor 2 because it has the highest incremental profit. (b) The relevant information would be the additional costs and the incremental sales value after further processing. (c) The decision should not be different if the method of allocating common costs was changed because joint processing costs are sunk costs and irrelevant to this decision.

. 7-60

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PROBLEM 7-52B (a)

Determine new costs-With old machine: New unit selling price: $180.00 x 1.1 = $198.00 New labour cost: $30.00 x 1.15 = $34.50 x 4 hrs = $138.00 With new machine: New unit selling price: $180.00 x 1.1 = $198.00 New labour cost: $30.00 x 1.15 = $34.50 x 3.5 hrs = $120.75 New variable overhead: $2.40 x 3.5 = $8.40 Determine annual CM for both machines Next Year Per unit-Selling price Less variable costs: Direct materials Direct labour Variable overhead Total variable overhead

Old $198.00

New $198.00

15.00 138.00 9.60 162.60

$15.00 120.75 8.40 144.15

Contribution margin per unit

$35.40

$53.85

Units produced

50,000

52,000

$1,770,000

$2,800,200

Annual contribution margin

. 7-61

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-52B (Continued) Keep Old Machine $8,850,000

Total CM earned (5 yrs) New machine Salvage of old machine Salvage of new machine New operator Net gain

$8,850,000

Buy New Machine $14,001,000 (2,500,000) 70,000 60,000 (450,000) $11,181,000

The company should purchase the new machine. (b) Fixed Overhead ($3.20 x 100,000) Cost of the operator Amortization ($2,500,000 - $60,000) ÷ 5 years Total new fixed costs Sales = ($898,000 + $460,000) ÷ $53.85 = 25,218 units

. 7-62

$320,000 90,000 488,000 $898,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-53B

Calculation of contribution margin per unit: Product A B C Selling price per unit $75 $58 $80 Less: variable costs/unit 35 30 45 Contribution margin/unit $40 $28 $35 Operating income before Product C is introduced: Product A B Number of units 12,000 28,000 Contribution margin

$480,000

$784,000

Total

$1,264,000

Operating income after Product C is introduced: Product Number of units Contribution margin

A 13,200

C 15,000

Total

$528,000

$525,000

$1,053,000

Assuming fixed costs do not change (which means they are not relevant for this decision), Yars Company should not replace Product B with Product C as it will lead to a decrease in contribution margin of $211,000 ($1,264,000 - $1,053,000).

. 7-63

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-54B (a) Calculation of contribution margin per unit: Product (based on 1,000 units each) A B C Selling price per unit $50 $60 $65 Less: variable costs/unit 25 40 60 Contribution margin/unit $25 $20 $5 Product C should not be eliminated because it is contributing $5 per unit towards fixed costs and profit. (b) Calculation of contribution margin per unit of limited resources: Product A B C Contribution margin/unit $25 $20 $5 Labour hours per unit 4 3 2 Contribution margin per hr $6.25 $6.67 $2.50 The company should produce product B because it has the largest contribution margin per constrained resource (direct labour hours). (c)

If the company could sell unlimited quantities of any of the three products, they would only sell Product B, as this product has the highest CM per DLH. To produce C they would have to cut down on production of B.

. 7-64

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 7-54B (Continued)

Opportunity cost of producing C: 500 units x 2 hours per unit = 1,000 DLH required 1,000 hours taken away from B: 1,000 x $6.67 = $6,670 $6,670 ÷ 500 units = $13.34 per unit The minimum selling price would be the variable costs per unit plus opportunity cost = ($60,000 ÷ 1,000) + $13.34 = $73.34

(d) CM per DLH Production sequence DLH per unit

A $6.25 (2)

B $6.67 (1)

C $2.50 (3)

Hours available First produce 500 units of each 500 x (4 + 3 + 2) Hours remaining Produce 1,000 units of B Hours left for A Produce 375 units of A Hours remaining

9,000 (4,500) 4,500 (3,000) 1,500 (1,500) -

They should produce 875 units of A (500 + 375); 1,500 units of B (500 + 1,000); and 500 units of C.

. 7-65

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO CASES CASE 7-55 Calculation of costs—keeping the old machine Sales: 12,000 units x $100 per unit x 4 years = $4,800,000 COGS: $4,800,000 x (100% – 25%) = $3,600,000 Administrative: $100,000 x 4 years = $400,000 Selling: $180,000 x 4 years = $720,000 Calculation of costs—keeping the old machine Sales: 12,000 units x 1.20 x $100 per unit x 4 years = $5,760,000 COGS: $5,760,000 x (100% – 30%) = $4,032,000 Administrative: $113,000 x 4 years = $452,000 Selling: $180,000 x 1.10 x 4 years = $792,000 Cost of the new machine: $125,000 + $6,000 + $4,000 = $135,000

Keep Old Machine Sales Less costs: Cost of goods sold Selling Administrative Operating income

$4,800,000 $3,600,000 720,000 400,000

. 7-66

4,720,000 $80,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 7-55 (Continued) Buy New Machine Sales Less costs: Cost of goods sold Selling Administrative Operating income

Operating income Cost of the new machine Totals

$5,760,000 $4,032,000 792,000 452,000

Retain Old Machine $80,000 $80,000

Replace Old Machine $484,000 (135,000) $349,000

5,276,000 $484,000

Net Income Increase (Decrease) $404,000 (135,000) $269,000

The new machine should be purchased. The incremental analysis shows that total net income will increase from $80,000 to $349,000 over the four years with the new machine.

. 7-67

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

CASE 7-56

(a)

Contribution margin from the special order: Revenue (250 units x $240) Less: variable costs Direct material Other direct costs Indirect costs (200 x $40) Contribution margin

$60,000 $7,000 2,000 8,000

17,000 $43,000

Axia should accept the order because it will contribute $43,000 towards profits.

(b) If Axia is at full capacity it will need to reduce the volume of either gadgets or widgets in order to produce the special units. As shown below, Axia should produce the special unit to earn $215 CM per hour, and sacrifice the gadgets, with the lowest CM per hour. New Per unit: Widget Gadget Order Machine hours 0.75 (1) 1.10 (1) 0.80 (2) Selling price Less: variable costs Direct materials Direct costs Indirect costs CM per unit CM per machine hour

. 7-68

$200

$280

$240

25 6 30 $61 $139 $185

30 10 44 $84 $196 $178

28 8 32 $68 $172 $215

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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(1) Indirect costs per unit ÷ $40 per machine hour (2) 200 machine hours ÷ 250 units

(c) Available capacity = 1,000 x (100% - 95%) = 50 hrs. To process the special order 200 hours are required, but 50 were already available, so only 150 machine hours of gadget production will be sacrificed. At $178 per machine hour, this would be $26,700. (d) Contribution margin from the special order (a) Less: equipment rental to produce special order Net profit from doing the special order

. 7-69

$43,000 33,000 $10,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 7-57

(a) Per unit:

Make

Buy Silver

Selling price Less: Avoidable costs Unavoidable cost Purchase price

$14.50

5.65 1.00 --6.65 $7.85

Profit per unit Profit for 5,000 units

$39,250

(1)

--1.00 11.00 12.00 $2.50 $12,500

(1)

Buy Alpha $14.50 --1.00 4.00 5.00 $9.50

(1)

$47,500

(1) $5,000(2) ÷ 5,000 units = $1.00 (2)

The $5,000 cost that will continue to be incurred, even if the product is not manufactured.

The company will make the most profit if the clocks are purchased from Alpha Company. The company will make $8,250 less if the clocks are manufactured by Technology Plus. The company will make $35,000 less if the clocks are purchased from Silver Star. (b) There are several important non-financial 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 Alpha; however, there may be a problem with product quality given the significant employee turnover and there is a serious question about Alpha’s ability to remain in

. 7-70

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 7-57 (Continued) business. However, the company could purchase just this one order from Alpha, and then continue to search for another manufacturer, or stop manufacturing the clocks. Silver Star’s stringent requirements for preferred customer status, in the form of large sales requirements, appear to limit the possibilities for Technology Plus to use it as a supplier. However, if Technology Plus does desire to continue to offer the clocks because of their popularity, then perhaps Silver Star could be used in the future. (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 Alpha to manufacture the retailer’s order. After that, the company should determine any opportunity costs involved in dropping that line of clocks. Even if they do not make money on the clocks, loss in sales of other products from cancelled orders may be greater than any loss experienced in producing them.

. 7-71

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 7-58 (a) First calculate the net income if only the dress is cut and sold. Selling price of the dress Less costs: Material Recovery from remnants Cutting costs Other costs Contribution margin per unit

$200.00 $ 50.00 (5.00) 20.00 80.00 $145.00 $ 55.00

Sales from dresses alone ($55 x 1,250) = $68,750 Next calculate net income if the dress and accessories are produced and sold. Dress sales in units = 1,250 x 120% = 1,500 Cape sales in units = (70% + 6%) x 1,500 = 1,140 Handbag sales in units = (70% + 15%) x 1,500 = 1,275 Sales: Dresses (1,500 x $200) $300,000 Capes (1,140 x $27.50) 31,350 Handbags (1,275 x $9.50) 12,113 Total sales 343,463 Less: Material costs (1,500 x $50) $75,000 Cutting costs (1,500 x $29) 43,500 Other costs: Dresses (1,500 x $80) 120,000 Capes (1,140 x $19.50) 22,230 Handbags (1,275 x $6.50) 8,288 269,018 Net income 74,445 Less: net income from dresses alone 68,750 Advantage of selling dresses and accessories $5,695

. 7-72

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CASE 7-58 (Continued) (b) Based on the incremental analysis, management should produce and sell the dress with the cape and handbag. The incremental profit would be $5,695. (c) A complete wardrobe set will enhance the firm’s image as a high fashion designer.

. 7-73

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CASE 7-59 (a) Incremental cost of the order: Materials (5,000 x $2.00) Labour (5,000 x $3.60) Special device

(b) Incremental cost [as in (a)] Plus: allocation of costs* Rent (50% x $1,000) Heat and light (50% x $100) Total

$10,000 18,000 2,000 $30,000 $30,000 500 50 $30,550

* Amortization on the equipment used for standard sales is not included on the assumption that the equipment is used only to produce the standard sales product. There is insufficient information to estimate the amount of power and "other" costs, which would be required by the new units. (c) Contribution margin on standard units: Sales $25,000 Material $8,000 Labour 9,000 Power 400 Other 900 18,300 Contribution margin $ 6,700 One-half lost to produce order $ 3,350 The opportunity cost is the lost contribution margin from the forgone sales of standard units ($3,350).

. 7-74

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CASE 7-60 Continued (d)

Amortization on the equipment for the standard sales is a sunk cost. Rent and Heat and light are allocated costs which make them irrelevant to this decision as well.

(e) Differential revenue (5,000 x $7.00) Differential costs [from (a)] Opportunity cost [from (b)] Differential income

$35,000 $30,000 3,350

33,350 $ 1,650

The firm will be $1,650 better off by accepting the order. (This is somewhat overstated because variable power or "other" costs have not been included in the cost to produce the special order.)

. 7-75

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 7-60

(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 Phelps. (b) It is not unusual to re-evaluate fixed cost allocations periodically. However, the allocation should be based on the underlying economics of the situation rather than the motives of individuals. (c) Robert 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.

. 7-76

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-7

Part 1: The small set is the best use of a limited resource as it produces a higher contribution margin per machine hour.

Contribution margin per unit Machine hours required Contribution margin per unit of limited resource *$77 − $50 **$150 − $100

Small Large Set Set $27* $50** 9 20 $ 3 $ 2.50

Part 2: (a) Even though contribution margin per unit would be cut to $0.15 ($2.60 − 2.30) on the additional units, Waterways would increase its profits by $2,250 to $60,000 (compared to $57,750). It can handle the BC special order, but only by adding a shift. Profit with no special order Unit profit $1.65 35,000 × $1.65 $57,750 a year Added profit with Canadian co. Unit profit $0.15 15,000 × $0.15 $2,250 Reject Order

Accept Order

Net Income Increase/(Decrease) Revenues $0 $39,000* $39,000 Costs 0 36,750** (36,750) Net income $0 $2,250 $2,250 * 15,000 X $2.60 ** 15,000 X ($2.30 +.30 – .15)

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM WCP-7 (Continued) Incremental analysis indicates that Waterways should accept the special order because net income increases by $2,250. (b)

Alberta irrigation company: Contribution margin per unit would be $0.90 and would increase profits by $1,800. This special order would not bring on a need for an added shift and should, therefore, be accepted. Added profit with Unit profit $0.90 irrigation company 2,000 x .90 $1,800

Reject Order Revenues Costs Net income

Accept Order

$0 0 $0

Net Income Increase/(Decrease) $6,400 * $6,400 4,600** (4,600) $1,800 $1,800

* 2,000 X $3.20 ** 2,000 X $2.30

Incremental analysis indicates that Waterways should accept the special order because net income increases by $1,800 (c)

Accepting both special orders would increase net income by $4,050. Currently, Waterways is earning a contribution margin of $57,750 (35,000 units X $1.65) on the connectors. If it accepts both special orders, contribution margin would increase by $4,050 ($2,250 + $1 800) or 7%. Acceptance would depend on management's opinion regarding the added shift.

. 7-78

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PROBLEM WCP-7 (Continued) Part 3: (a)The cost to make the units is $469,200 ($1.02 x 460,000 units). The cost to purchase the units is $372,600 ($0.81 x 460,000).

However, the fixed cost that cannot be eliminated by buying the units amounts to $101,200 ($0.22 x 460,000). The total cost increases by $4,600. The company should continue to make the fitting.

Variable and fixed costs Fixed cost not eliminated Total annual cost

Make $469,200

Income Change $96,600

$101,200

-101,200 ($4,600)

Make Part Variable costs ($1.02 – 0.22) Fixed costs ($0.22) Purchase price ($0.81) Total cost

Buy $372,600

Buy Part

$368,000*

Net Income Increase/ (Decrease) $368,000

101,200** 0 $469,200

101,200 372,600*** $473,800

0 (372,600) $ (4,600)

* 460,000 X $0.80 ** 460,000 X $0.22 *** 460,000 X $0.81

. 7-79

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PROBLEM WCP-7 (Continued) (b) The opportunity cost is $4,600. If Waterways decides to buy the small fitting, it is going to cost them $4,600 more, or to put it another way, they are giving up the opportunity of saving $4,600 by making the part. (c) If Waterways adds that amount to the cost of making the small fitting, it still does not bring the cost up to the total cost of buying the unit. Therefore, the company would still be better off to make the small fittings and buy the timing units.

Variable costs ($1.02 - 0.22) Fixed costs ($0.22) Purchase price ($0.81) Total annual cost Savings from making the timing unit Purchase of new equipment Total cost

Make Part

Buy Part

$368,000 101,200 0 $469,200 1,656 *

$ 0 101,200 372,600 $473,800 0 2,345 $476,145

$470,856

Net Income Increase (Decrease) $368,000 0 (372,600) $ (4,600) 1,656 2,345 $ (5,289)

*Cost of buying the timing unit, $12.66, less cost of making the unit. $9.90, means they are saving $2.76 variable cost per unit if they make them, or a total of $1,656 for the 600 units required.

. 7-80

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PROBLEM WCP-7 (Continued) Part 4: Replacing the machine will result in a net loss. Waterways should keep the old machine for the 2 years remaining.

Retain Machine Replace Machine Revenues Production costs New machine cost Total

$222,300* 169,000** 0 $ 53,300

$444,600*** 338,000**** 57,000 $49,600

Net Income Increase/(Decrease) $ 222,300 (169,000) ( 57,000) $ (3,700)

* $8.55 × 50 units per day × 260 days × 2 years ** $6.50 × 50 units per day × 260 days × 2 years *** $8.55 × 100 units per day × 260 days × 2 years **** $6.50 ×100 units per day × 260 days × 2 years

Profits from machine for 2 years Cost of new machine

Retain Machine $ 53,300*

Replace Machine $ 106,600

Income Change $ 53,300

57,000

(57,000) $ (3,700)

*($8.55 − $6.50) × 50 units per day × 260 days × 2 years

. 7-81

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Legal Notice

. 7-82

CHAPTER 8 Alternative Inventory Costing Methods: A Decision-Making Perspective ASSIGNMENT CLASSIFICATION TABLE Study Objectives

Brief Questions Exercises

Exercises

A Problems

B Problems

Explain the difference between absorption costing and variable costing.

1, 2, 3, 4, 7

1, 2, 4, 5, 7, 8, 9, 10

11, 12, 13, 14, 15, 16, 17, 18

19, 20, 21, 22, 23, 24, 25, 26

27, 28, 29, 30, 31, 32, 33, 34

Discuss the effect that changes in the production level and sales level have on net income measured under absorption costing versus under variable costing.

6, 8, 9, 10, 11, 12, 15

9, 10

15, 16, 17, 18

19, 20, 21, 22, 23, 24, 25, 26

27, 28, 29, 30, 31, 32, 34

Discuss the advantages of variable costing versus absorption costing for management decision-making.

13, 14, 16

20, 21, 22, 23, 24, 25, 26

28, 30, 31, 32, 34

*4.

Discuss the effect of a normal costing method on income reported under absorption costing and variable costing (Appendix 8A).

11, 18

19, 22, 24

27, 30, 32

. *5.

Discuss the throughput costing method (Appendix 8A).

4, 5

3, 6, 7

. 8-1

1-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

19A

Calculate the product cost; prepare income statements under variable costing and absorption costing and reconcile the difference.

Easy

30-40

20A

Prepare income statements under absorption costing and variable costing for a company with beginning inventory.

Easy

50-60

Moderate

30-40

Moderate

40-50

Moderate

20-30

Easy

40-50

Moderate

20-30

Challenging

40-50

Easy

30-40

Moderate

40-50

Moderate

30-40

Moderate

30-40

Challenging

40-50

21A

22A

23A

24A

25A

26A

27B

28B 29B

30B

31B

Prepare absorption- and variable costing income statements; reconcile the differences between absorption- and variable-costing income statements when sales and production levels change; discuss the usefulness of absorption costing versus variable costing. Prepare an income statement under variable costing, absorption costing, and throughput costing and reconcile the differences; discuss the usefulness of absorption costing versus variable costing. Calculate the product cost; prepare income statements under variable costing and absorption costing and reconcile the difference when sales and production levels change. Calculate the product cost; prepare income statements under variable costing, absorption costing, and throughput costing, and reconcile the differences. Explain variable costing and absorption costing and reconcile the differences when sales and production levels change. Prepare and reconcile the differences between absorption- and variable costing income statements when sales and production levels change; discuss the usefulness of absorption costing versus variable costing. Calculate the product cost; prepare income statements under variable costing, absorption costing, and throughput costing, and reconcile the differences. Prepare income statements under absorption costing and variable costing for a company with beginning inventory. Prepare absorption- and variable costing income statements; reconcile the differences between absorption- and variable-costing income statements when sales and production levels change; discuss the usefulness of absorption costing versus variable costing. Calculate the product cost; prepare income statements under variable costing, absorption costing, and throughput costing, and reconcile the differences when sales and production levels change. Calculate the product cost; prepare income statements under variable costing and absorption costing and reconcile the differences when sales and production levels change.

. 8-2

1-2

32B

Calculate the product cost contribution margin under variable costing and throughput costing and the gross margin under absorption costing.

33B

Prepare an income statement under variable costing.

34B

Calculate the product cost; prepare income statements under variable costing and absorption costing, and reconcile the differences when sales and production levels change; discuss the usefulness of absorption costing versus variable costing.

Moderate

30-40

Easy

15-20

Challenging

30-40

. 8-3

1-3

Study Objective

Knowledge Comprehension

Application

Analysis

For Instructor Use Only

*1.

Explain the difference between Q1, Q2, Q3, Q4, Q7 absorption costing and variable BE1, BE2, costing. BE3

BE4 BE5 BE7 BE8, BE10

E11 P19A P27B E12 P20A P30B E13 P21A P32B E14 P22A P33B E16 P24A P26A

E16 E18 P23A P25A

P28B P29B P31B P34B

*2.

Discuss the effect that changes Q6, Q11, Q15 in the production level and sales level have on net income measured under absorption costing versus under variable costing.

Q9, Q10

Q8 Q12 BE10 E16

P19A P20A P21A P22A P24A P26A

BE9 E15 E17 E18 P23A P25A

P28B P29B P31B P34B

*3.

Discuss the advantages of variable costing versus absorption costing for management decision-making.

Q13, Q14

Q16

P20A P31B P21A P34B P22A P24A P26A

*4.

Discuss the effect of a normal costing method on income reported under absorption costing and variable costing (Appendix 8A).

*5.

Discuss the throughput costing Q5, BE3 method (Appendix 8A).

BE6 BE7 E11

P19A P22A P24A

P27B P30B P32B

E15 P28B P23A P31B P25A P34B

P27B P30B P32B

E18

Synthesis

Evaluation

BLOOM’ S TAXONOMY TABLE

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

8-3

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ANSWERS TO QUESTIONS 1. Variable costing is a system for determining product costs that is used primarily for making managerial decisions. Under variable costing, direct materials, direct labour, and variable manufacturing overhead are considered product costs. In contrast, absorption costing is required for external reporting purposes and is used by some managers for internal decisions. Under absorption costing, product costs include direct material, direct labour, and manufacturing overhead (both fixed and variable) costs. Throughput costing treats all costs as period expenses except for direct materials. It is suitable only for companies engaged in a manufacturing process in which conversion costs such as direct labour and manufacturing overhead are fixed costs and do not vary proportionately with the units of production. Assembly-line and continuous processes that are highly automated are most likely to meet this criterion. 2. The costs that are included as product costs under a variable costing system are direct materials, direct labour, and variable manufacturing overhead. 3. Fixed manufacturing overhead costs are treated as a period cost, similar to selling and administrative costs. These costs are expensed each period, as they are incurred. 4. Under variable costing, direct materials, direct labour and variable manufacturing overhead are included as product costs. Under throughput costing, only direct material costs are considered product costs. 5. In throughput costing, the conversion costs—direct labour and variable manufacturing overhead—are considered to be fixed, and are expensed in the month they are incurred

. 1-5

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Questions Chapter 8 (Continued) 6. Some of the fixed manufacturing overhead costs are deferred to a future period in the inventory account under absorption costing when inventory increases. 7. The main difference is the timing of some expenses. Variable costing treats fixed manufacturing overhead costs as a period cost and therefore expenses these costs each period. Absorption costing treats fixed manufacturing overhead costs as a product cost and therefore will defer some of these costs to future periods when production exceeds sales. Conversely, when sales exceeds production, more fixed costs will be charged to cost of goods sold than under variable costing. 8. The difference is going to be in the value of the ending inventory. Under absorption costing the fixed manufacturing overhead will be included, so ending inventory will be $210,000 (10,500 units x $20). Variable costing does not include fixed manufacturing overhead as a period cost, so the per unit cost of inventory will be $15, and the value of the ending inventory will be $157,500. The difference is $52,500, that is, Absorption costing will report a $52,500 higher net income than variable costing because a portion of the fixed manufacturing overhead costs are deferred in inventory. 9. 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. 10. 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.

. 1-6

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Questions Chapter 8 (Continued) 11. 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 should 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. 12. Production changes do not affect the amount of fixed manufacturing overhead costs in a given period. However, production changes affect the expensing of fixed manufacturing overhead costs. When production exceeds sales, a portion of fixed manufacturing overhead is deferred to a future period when using absorption costing. If variable costing is used, all fixed manufacturing overhead incurred in the period is expensed in the current period. 13. No, variable costing is generally just a managerial technique. Under generally accepted accounting principles (GAAP), variable costing is not allowed for external financial statements. 14. Some of the benefits include: (1) Net income computed under variable costing is unaffected by changes in production levels. As a result, it is much easier to understand the impact of fixed and variable costs on the computation of net income when variable costing is used. (2) The use of variable costing is consistent with cost-volume-profit analysis and incremental analysis. (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.

. 1-7

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Questions Chapter 8 (Continued) (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. 15. The differences between absorption costing and variable costing techniques occur when inventory levels change between two periods of time. Since just-in-time inventory management reduces finished goods inventory, the differences between absorption and variable costing are greatly reduced, if not totally offset. 16. Both systems can be useful to management but variable costing has several advantages for internal decision making. Variable costing is consistent with cost-volume-profit analysis and incremental analysis. It also makes it easier to understand the impact of fixed and variable costs on net income. Since net income computed under variable costing is closely tied to changes in sales levels (not production levels as is the case with absorption costing), it provides a more realistic assessment of success or failure during a period. Companies that use variable costing for internal decision making must also maintain absorption costing systems for external reporting as required under GAAP.

. 1-8

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 Variable costing--

Product Cost

Commission fees for salespersons Glue for wooden chairs—variable Fabric for T-shirts Labour costs for producing TVs Factory rent expense—fixed Factory utility costs—variable Car mileage costs for salespersons Administrative expenses—fixed Administrative Internet connection fees Wages—assembly line BRIEF EXERCISE 8-2 Absorption costing--

X X X X X X X X X

Product Cost

. 1-9

Period Cost X

X X X X X X X X X

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BRIEF EXERCISE 8-3 Throughput costing--

Product Cost

Period Cost X X

X X X X X X X X

BRIEF EXERCISE 8-4 Variable Costing Direct materials Direct labour Variable manufacturing overhead Total product costs

$14,490 25,530 32,420 $72,440

BRIEF EXERCISE 8-5 Absorption Costing Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead Total product costs

$14,490 25,530 32,420 10,000 $82,440

. 1-10

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BRIEF EXERCISE 8-6 Throughput Costing Direct materials Total product costs

$14,490 $14,490

BRIEF EXERCISE 8-7 (a) Absorption Costing Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead ($120,000 ÷ 12,000) Total product cost per unit

Per Unit $20.00 12.00 15.00 10.00 $57.00

(b) Variable Costing Direct materials Direct labour Variable manufacturing overhead Total product cost per unit

Per Unit $20.00 12.00 15.00 $47.00

Per Unit $20.00 $20.00

. 1-11

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BRIEF EXERCISE 8-8 Rafael Corp. Income Statement For the Year Ended December 31, 2009 Variable Costing _______________________________________________________________ Sales (30,000 units x $12) Less: variable costs Variable COGS (30,000 units x $4) Variable S&A expenses (30,000 units x $1) Contribution margin Less: fixed costs Fixed manufacturing overhead Fixed selling and administration expenses Net Income before tax

$360,000 $120,000 30,000

80,000 10,000

150,000 210,000

90,000 $120,000

BRIEF EXERCISE 8-9 (a)

Rafael Corp. Income Statement For the Year Ended December 31, 2009 Absorption Costing _______________________________________________________________ Sales (30,000 units x $12) Less: Cost of goods sold (30,000 units x ($4 + $2)) Gross Margin Less: Selling and administration expenses Variable (30,000 x $1) Fixed Net Income before tax

. 1-12

$360,000 180,000 180,000 30,000 10,000

40,000 $140,000

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BRIEF EXERCISE 8-9 (Continued) (b) Rafael Corp.’s production exceeded its sales by 10,000 units (40,000 30,000). It had fixed manufacturing costs per unit of $2. Under variable costing, fixed manufacturing overhead is expensed in the year incurred, while under absorption costing it is included in inventory. Therefore, $20,000 (10,000 X $2) of fixed manufacturing overhead is included in Rafael’s inventory under absorption costing. As a result, absorption costing income exceeds variable costing income by $20,000.

BRIEF EXERCISE 8-10 When production is greater than sales, absorption costing net income is greater than variable costing net income by an amount equal to the number of units in ending inventory times the fixed overhead rate per unit. Fixed overhead rate per unit = $190,000 ÷ 20,000 units = $9.50 per unit Absorption costing net income Less: Fixed overhead in ending inventory (2,000 x $9.50) Variable costing net income

$25,000 19,000 $6,000

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SOLUTIONS TO EXERCISES EXERCISE 8-11 (a)

Manufacturing Cost Per Unit—Variable costing Direct materials Direct labour Variable manufacturing overhead Total product cost per unit

$800 1,500 300 $2,600

(b)

WU EQUIPMENT COMPANY Income Statement For the Year-Ended December 31, 2009 Variable Costing _______________________________________________________________ Sales (1,200 units x $4,500) Less: variable costs Variable COGS (1,200 units x $2,600) Variable S&A expense (1,200 units x $70) Contribution margin Less: fixed costs Fixed manufacturing overhead Fixed S&A expense Net Income

(c)

$5,400,000 $3,120,000 84,000

1,200,000 100,000

Manufacturing Cost Per Unit—Throughput costing Direct materials Total product cost per unit

$800 $800

. 1-14

3,204,000 2,196,000

1,300,000 $896,000

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EXERCISE 8-11 (Continued) (d)

WU EQUIPMENT COMPANY Income Statement For the Year-Ended December 31, 2009 Throughput Costing _______________________________________________________________ Sales (1,200 units x $4,500) Less: COGS (1,200 units x $800) Throughput contribution margin Less: Operating expenses Direct labour (1,500 x $1,500) Variable MOH (1,500 x $300) Variable S&A (1,200 x $70) Fixed MOH Fixed selling and administration expenses Net Income

$5,400,000 960,000 4,440,000 $2,250,000 450,000 84,000 1,200,000 100,000

4,084,000 $356,000

(e) When production is greater than sales, variable costing net income is greater than throughput costing net income by an amount equal to the number of units in ending inventory times the per unit variable conversion costs (direct labour and variable overhead). Per unit cost = $1,500 + $300 = $1,800 Ending inventory = 1,500 produced – 1,200 sold = 300 units Costs deferred in ending inventory = 300 x $1,800 = $540,000 Variable costing net income Less: conversion costs deferred in ending inventory Throughput costing net income

. 1-15

$896,000 540,000 $356,000

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EXERCISE 8-12 (a)

Absorption costing: First determine per unit absorption costing COGS-Variable manufacturing costs Fixed manufacturing costs ($100,000 ÷ 10,000) Per unit absorption costing COGS:

$40.00 10.00 $50.00

ASIAN WINDOWS Income Statement For the Year Ended December 31, 2009 Absorption Costing _______________________________________________________________ Sales (8,500 shades x $90) Less: COGS (8,500 shades x $50) Gross profit Less: selling and administration expenses Variable (8,500 x $9) Fixed Net Income

. 1-16

$765,000 425,000 340,000 $76,500 250,000

326,500 $13,500

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EXERCISE 8-12 (Continued) (b) Variable costing: ASIAN WINDOWS Income Statement For the Year Ended December 31, 2009 Variable Costing _______________________________________________________________ Sales (8,500 shades x $90) Less: variable costs Variable COGS (8,500 shades x $40) Variable S&A (8,500 units x $9) Contribution margin Less: fixed costs Fixed manufacturing overhead Fixed S&A expense Net Income before tax

. 1-17

$765,000 $340,000 76,500

100,000 250,000

416,500 348,500

350,000 $(1,500)

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EXERCISE 8-13 (a) Variable costing per unit manufacturing cost: Direct materials Direct labour Variable manufacturing overhead Manufacturing cost per unit

$ 7.50 2.45 5.75 $15.70

(b) BOB'S COMPANY Income Statement For the Year Ended December 31, 2009 Variable Costing _______________________________________________________________ Sales (80,000 lures x $25) Less: variable costs Variable COGS (80,000 lures x $15.70) Variable S&A (80,000 lures x $3.90) Contribution margin Less: fixed costs Fixed manufacturing overhead Fixed S&A expense Net Income before tax

$2,000,000 $1,256,000 312,000

234,650 240,100

1,568,000 432,000

474,750 $(42,750)

EXERCISE 8-14 (a)

Absorption costing per unit manufacturing cost: Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead ($235,000 ÷ 95,000) Absorption manufacturing cost per unit

. 1-18

$ 7.50 2.45 5.75 2.47 $18.17

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EXERCISE 8-14 (Continued) (b) BOB'S COMPANY Income Statement For the Year Ended December 31, 2009 Absorption Costing _______________________________________________________________ Sales (80,000 lures x $25) $2,000,000 Less: COGS (80,000 lures x $18.17) 1,453,600 Gross profit 546,400 Less: selling and administration expenses Variable (80,000 lures x $3.90) $312,000 Fixed 240,100 552,100 Net Income $(5,700)

EXERCISE 8-15 (a)

(b)

Manufacturing Cost Per Unit—Variable Costing Direct material Direct labour Variable manufacturing overhead Manufacturing cost per unit

$0.26 0.34 0.38 $0.98

Manufacturing Cost Per Unit—Absorption Costing Direct material Direct labour Variable manufacturing overhead Fixed Manufacturing overhead ($96,459 ÷ 260,700) Manufacturing cost per unit

$0.26 0.34 0.38 0.37 $1.35

. 1-19

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EXERCISE 8-15 (Continued) (c) EMPEY MANUFACTURING Income Statement For the Year Ended December 31, 2009 Absorption Costing _____________________________________________________________ Sales (260,700 units x $2) $521,400 Less: COGS (260,700 units x $1.35) 351,945 Gross profit 169,455 Less: selling and administration expenses Variable (260,700 units x $0.26) $67,782 Fixed 81,125 148,907 Net Income $20,548 (d) Net income is the same under both costing methods, $20,548. The net incomes are the same because production equals sales for the year. When this condition occurs, both methods deduct all of the fixed manufacturing overhead costs in the current year. There is no ending inventory in which fixed manufacturing overhead costs can be deferred. (e) It would be beneficial for Empey Manufacturing to prepare both a variable costing income statement and an absorption costing income statement for a variety of reasons. First, to satisfy the requirements of generally accepted accounting principles, the company is required to prepare an absorption costing income statement. However, management frequently requests a variable costing income statement because it provides useful information for decision making purposes. The variable costing income statement provides information that is necessary for cost-volume-profit analysis as well as incremental analysis. In addition, net income calculated in a variable costing income statement more closely follows changes in sales, thus it is a better indicator of performance. Also, net income calculated in a variable costing income statement is not affected by changes in production the way absorption costing net income is. . 1-20

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EXERCISE 8-16 (a)

Manufacturing Cost Per Unit—Variable Costing Direct material ($90,000 ÷ 10,000 units produced) $9.00 Direct labour ($30,000 ÷ 10,000 units) 3.00 Variable manufacturing overhead ($24,000 ÷ 10,000 units) 2.40 Manufacturing cost per unit $14.40 Finished goods inventory cost = (10,000 – 9,000 units) x $14.40 = $14,400

(b) Absorption costing would show a higher net income because a portion of the fixed costs are deferred to future periods in the ending inventory. The following computation indicates that finished goods inventory will be $5,000 higher under absorption costing which will cause its net income to be $5,000 higher.

Manufacturing Cost Per Unit—Absorption Costing Direct material Direct labour Variable manufacturing overhead Fixed Manufacturing overhead ($50,000 ÷ 10,000) Manufacturing cost per unit

$9.00 3.00 2.40 5.00 $19.40

Finished goods inventory cost = (10,000 – 9,000 units) x $19.40 = $19,400 Inventory (absorption costing) Inventory (variable costing) Fixed overhead deferred in ending inventory

$19,400 14,400 $5,000

Or, fixed manufacturing overhead per unit x ending inventory $50,000 ÷ 10,000 = $5.00 x 1,000 = $5,000

. 1-21

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EXERCISE 8-17 (a)

Variable utility expense: $2,700 (12 months x 500 hours per month x $0.45 per hour) Fixed utility expense: $24,000 (12 months x $2,000 per month) Manufacturing cost using variable approach: Direct material $54,000 Direct labour 37,000 Indirect material (nails) 340 Utilities 2,700 $94,040

(b)

Manufacturing cost using absorption approach: Direct material $54,000 Direct labour 37,000 Indirect material (nails) 340 Utilities ($24,000 + $2,700) 26,700 Rent 21,400 $139,440

(c) The entire difference in costs between the two methods results from having fixed overhead included as part of manufacturing costs only under the absorption costing method. This difference amounts to $45,400 (Fixed utilities cost, $24,000 + Fixed rent, $21,400).

. 1-22

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EXERCISE 8-18 First determine unit manufacturing costs:

Direct materials Direct labour Variable MOH Fixed MOH ($18,000 ÷ 3,000) Unit manufacturing cost

TPC

$8.00

$8.00 9.00 12.00

$8.00

$29.00

$8.00 9.00 12.00 6.00 $35.00

TPC

$800 24,000 24,800 22,400 $2,400

$2,900 87,000 89,900 81,200 $8,700

$3,500 105,000 108,500 98,000 $10,500

Then determine the value of ending inventory:

Beginning inventory (100 units) Finished goods added (3,000 units) Goods available for sale (3,100 units) Cost of goods sold (2,800 units) Value of ending inventory (300 units)

(a) Therefore, absorption costing net income will be $1,800 more than net income using variable costing: FMOH deferred in ending inventory equals 300 units x $6.00 FMOH per unit, or ($10,500 - $8,700). (b) And, variable costing net income will be $6,300 more than net income using throughput costing: conversion costs deferred in ending inventory equals 300 units x $21.00 per unit, or ($8,700 - $2,400).

. 1-23

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SOLUTIONS TO PROBLEMS—Set A PROBLEM 8-19A (a) (1) Manufacturing Cost Per Unit—Absorption Costing Direct material Direct labour Variable manufacturing overhead Fixed Manufacturing overhead ($200,000 ÷ 10,000) Manufacturing cost per unit

$40.00 16.00 4.00 20.00 $80.00

(2) BLUE MOUNTAIN PRODUCTS Income Statement For the Month Ended June 30, 2009 Absorption Costing _______________________________________________________________ Sales (9,000 units x $150) $1,350,000 Less: COGS (9,000 units x $80) 720,000 Gross profit 630,000 Less: selling and administration expenses Variable (9,000 units x $6) $54,000 Fixed 400,000 454,000 Net Income $176,000

(b) (1) Variable costing per unit manufacturing cost: Direct materials Direct labour Variable manufacturing overhead Manufacturing cost per unit

. 1-24

$40.00 16.00 4.00 $60.00

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PROBLEM 8-19A (Continued) (2) BLUE MOUNTAIN PRODUCTS Variable Costing Income Statement For the Month Ended June 30, 2009 ______________________________________________________________ Sales (9,000 units x $150) $1,350,000 Less: variable costs Variable COGS (9,000 units x $60) $540,000 Variable S&A (9,000 units x $6) 54,000 594,000 Contribution margin 756,000 Less: fixed costs ($200,000 + $400,000) 600,000 Net Income before tax $156,000 (c) When production exceeds sales, absorption costing net income will exceed variable costing net income by an amount equal to the fixed overhead rate times the number of units in ending inventory. The difference in net income is $20,000 ($176,000 – $156,000) which equals the 1,000 tents in ending inventory times the $20 fixed overhead rate. (d) (1) The throughput manufacturing cost consists of direct material only, so the per unit rate would be $40. (2)

BLUE MOUNTAIN PRODUCTS Throughput Costing Income Statement For the Month Ended June 30, 2009 ____________________________________________________________ Sales (9,000 units x $150) $1,350,000 Less: COGS (9,000 units x $40) 360,000 Throughput contribution margin 990,000 Less: Operating expenses Variable COGS (10,000 units x ($16 + $4)) $200,000 Variable S&A (9,000 units x $6) 54,000 Fixed ($200,000 + $400,000) 600,000 $854,000 Net Income before tax $136,000 . 1-25

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PROBLEM 8-19A (Continued) (e) The difference is $20,000 which is the per unit deferred variable conversion costs times the number of tents in ending inventory, or 1,000 tents x (direct labour, $16 + variable MOH, $4). PROBLEM 8-20A (a)

Required calculations: Sales ($2,000 x 3,000 units) Per unit variable manufacturing costs: ($2,000 x 0.15) Variable manufacturing costs (4,000 x $300) Ending inventory (4,000 manufactured – 3,000 sold) Variable selling expenses (3,000 x ($2,000 x 0.10))

$6,000,000 $300 $1,200,000 1,000 units $600,000

AFN COMPANY Income Statement For the Year Ended December 31, 2009 Variable Costing _______________________________________________________________ Sales $6,000,000 Less: Variable COGS Inventory, beginning $ --Plus Cost of goods manufactured 1,200,000 Cost of goods available for sale 1,200,000 Less: Inventory, ending 300,000 Variable cost of goods sold 900,000 Variable selling and administrative 600,000 1,500,000 Contribution Margin 4,500,000 Less: fixed costs Fixed manufacturing costs 2,400,000 Fixed administrative costs 600,000 3,000,000 Net Income $1,500,000

. 1-26

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PROBLEM 8-20A (Continued) Required calculations: Sales ($2,000 x 4,000 units) Per unit variable manufacturing costs: ($2,000 x 0.15) Variable manufacturing costs (3,000 x $300) Beginning inventory (1,000 units x $300 per unit) Ending inventory (1,000 + 3,000 – 4,000) Variable selling expenses (4,000 x ($2,000 x 0.10))

$8,000,000 $300 $900,000 $300,000 --$800,000

AFN COMPANY Income Statement For the Year Ended December 31, 2010 Variable Costing _______________________________________________________________ Sales $8,000,000 Less: Variable COGS Inventory, beginning $300,000 Plus Cost of goods manufactured 900,000 Cost of goods available for sale 1,200,000 Less: Inventory, ending --Variable cost of goods sold 1,200,000 Variable selling and administrative 800,000 2,000,000 Contribution Margin 6,000,000 Less: fixed costs Fixed manufacturing costs 2,400,000 Fixed administrative costs 600,000 3,000,000 Net Income $3,000,000

. 1-27

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PROBLEM 8-20A (Continued) (b)

Required calculations: Sales ($2,000 x 3,000 units) Per unit variable manufacturing costs: ($2,000 x 0.15) Per unit fixed manufacturing costs: ($2,400,000 ÷ 4,000) Absorption manufacturing costs (4,000 x $900) Ending inventory (4,000 – 3,000) x $900 Selling expenses (3,000 x ($2,000 x 0.10))

$6,000,000 $300 $600 $3,600,000 $900,000 $600,000

AFN COMPANY Income Statement For the Year Ended December 31, 2009 Absorption Costing _______________________________________________________________ Sales $6,000,000 Less: COGS Inventory, beginning $ --Plus Cost of goods manufactured 3,600,000 Cost of goods available for sale 3,600,000 Less: Inventory, ending 900,000 Cost of goods sold 2,700,000 Gross profit 3,300,000 Less: Selling and Administration Selling costs 600,000 Administrative costs 600,000 1,200,000 Net Income $2,100,000

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PROBLEM 8-20A (Continued) Required calculations: Sales ($2,000 x 4,000 units) Per unit variable manufacturing costs: ($2,000 x 0.15) Per unit fixed manufacturing costs: ($2,400,000 ÷ 3,000) Absorption manufacturing costs (3,000 x $1,100) Beginning inventory (1,000 x $900) Variable selling expenses (4,000 x ($2,000 x 0.10))

$8,000,000 $300 $800 $3,300,000 $900,000 $800,000

AFN COMPANY Income Statement For the Year Ended December 31, 2010 Absorption Costing _______________________________________________________________ Sales $8,000,000 Less: COGS Inventory, beginning $900,000 Plus Cost of goods manufactured 3,300,000 Cost of goods available for sale 4,200,000 Less: Inventory, ending --Cost of goods sold 4,200,000 Gross profit 3,800,000 Less: Selling and Administration Selling costs 800,000 Administrative costs 600,000 1,400,000 Net Income $2,400,000

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PROBLEM 8-20A (Continued) (c) Fixed manufacturing overhead in ending inventory, 2009: [1,000 x ($2,400,000 ÷ 4,000)]

$600,000

Reconciliation, 2009 Variable costing net income Plus: Fixed MOH deferred in ending inventory Absorption costing net income

$1,500,000 600,000 $2,100,000

Reconciliation, 2010 Variable costing net income Less: Fixed MOH released from beginning inventory Absorption costing net income

$3,000,000 600,000 $2,400,000

In 2009, with variable costing, fixed manufacturing overhead of $2.4 million is expensed. Under absorption costing, only $1.8 million is expensed through cost of goods sold, and the balance ($600,000) becomes part of the ending inventory. Therefore, absorption costing net income is $600,000 more than variable costing net income. In the following year, all the units that were in inventory at the end of 2009 are sold. This results in an additional $600,000 cost of goods sold under the absorption costing method, and absorption costing net income is $600,000 less than variable costing net income. Over the two years, when sales were equal to production, the two cumulative net incomes are equal. ($1,500,000 + $3,000,000 = $2,100,000 + $2,400,000)

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(d) Income parallels sales under variable costing as seen in the increase in net income in 2009 when 1,000 additional units were sold. In contrast, under absorption costing, income parallels production as seen in the higher net income in 2010 when production exceeded sales by 1,000 tons.

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PROBLEM 8-21A (a)

BASIC ELECTRIC MOTORS DIVISION Income Statement For the Year Ended 2009 Absorption Costing _______________________________________________________________ Units produced Units sold

50,000 50,000

Sales ($30) Less: Cost of goods sold ($20; $17) Gross profit Less: Selling and Administration (50,000 x $2) + $40,000 Net Income

80,000 50,000

$1,500,000 $1,500,000 1,000,000 850,000 500,000 650,000 140,000 $360,000

140,000 $510,000

(b)

BASIC ELECTRIC MOTORS DIVISION Income Statement For the Year Ended 2009 Variable Costing _______________________________________________________________ Units produced Units sold

50,000 50,000

Sales ($30) Less: Variable cost of goods sold ($12) Variable selling and admin ($2) Contribution margin Less: Fixed manufacturing Fixed selling and admin Net Income

. 1-32

80,000 50,000

$1,500,000 $1,500,000 600,000 600,000 100,000 100,000 800,000 800,000 400,000 400,000 40,000 40,000 $360,000 $360,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 8-21A (Continued) (c) If the company produces 80,000 units, but only sells 50,000 units, then 30,000 units will remain in ending inventory. Under absorption costing these 30,000 units will each include $5 of fixed manufacturing overhead—a total of $150,000. However, under variable costing, fixed manufacturing overhead is expensed when incurred. This accounts for the $150,000 difference ($510,000 – $360,000) in net income. This is summarized as: Net income under absorption costing Less: Fixed manufacturing overhead included in ending inventory (30,000 units x $5) Net income under variable costing

$510,000 150,000 $360,000

(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 in our example, under variable costing the company’s net income is $360,000 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.

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PROBLEM 8-22A (a)

Per unit product cost: $25 + $30 + $5 + ($60,000 ÷ 1,500) = $100

ALTA PRODUCTS LTD. Income Statement Month ended August 31, 2009 Absorption Costing ______________________________________________________________ Sales (1,200 x $150) $180,000 Less: COGS Inventory, beginning $ --Plus: Cost of goods manufactured 150,000 Cost of goods available for sale 150,000 Less: Inventory, ending 30,000 Cost of goods sold 120,000 Gross profit 60,000 Less: Selling and Administration Selling costs 10,800 Administrative costs 45,000 55,800 Net Income $4,200

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PROBLEM 8-22A (Continued) (b)

ALTA PRODUCTS LTD. Income Statement Month ended August 31, 2009 Variable Costing ______________________________________________________________ Sales Less: Variable COGS Inventory, beginning $ --Plus Cost of goods manufactured 90,000 Cost of goods available for sale 90,000 Less: Inventory, ending 18,000 Variable cost of goods sold 72,000 Variable selling and administrative 10,800 Contribution Margin Less: fixed costs ($60,000 + $45,000) Net Income

$180,000

82,800 97,200 105,000 $(7,800)

(c) Fixed overhead cost per unit = $60,000 ÷ 1,500 = $40 per unit Reconciliation Operating income under absorption costing Less: Fixed costs deferred in inventory (300 x $40) Operating income under variable costing

. 1-35

$ 4,200 12,000 $(7,800)

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PROBLEM 8-22A (Continued) (d)

ALTA PRODUCTS LTD. Income Statement Month ended August 31, 2009 Throughput Costing ______________________________________________________________ Sales (1,200 units x $150) $180,000 Less: COGS (1,200 units x $25) 30,000 Throughput contribution margin 150,000 Less: Operating expenses Variable COGS (1,500 x ($30 + $5)) $52,500 Variable S&A (6% x Sales) 10,800 Fixed ($60,000 + $45,000) 105,000 168,300 Net Income before tax $(18,300)

(e)

Reconciliation, 2009 Variable costing net income Less: costs deferred in ending inventory [($30 + $5 ) x 300 units] Throughput costing net income

$(7,800) 10,500 $(18,300)

(f) The proponents of variable costing appeal to the cost avoidance criterion as a necessary condition for asset recognition. The incurrence of fixed manufacturing costs this period will not allow the firm to avoid or eliminate them next period, so fixed manufacturing costs should not be recognized as assets. It is also pointed out that use of absorption costing can lead to manipulation of the net income figure by managing levels of production and inventory.

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PROBLEM 8-22A (Continued) The proponents of absorption costing argue that the finished goods should bear a fair share of all the costs that were incurred to bring the goods to saleable condition, and that all costs should be properly included in inventory. Under Canadian generally accepted accounting principles, either absorption costing or variable costing is acceptable, provided the selected method is used consistently. However, it is argued that in the long run, variable costing can be misleading for purposes of long-run costing and pricing.

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PROBLEM 8-23A (a) Variable Costing Income Statement _____________________________________________________________ Year 1 Year 2 Sales in units 4,000 5,000 Sales ($500) $2,000,000 $2,500,000 Less: Variable costs ($320) 1,280,000 1,600,000 Contribution Margin 720,000 900,000 1 Less: fixed costs 80,000 280,0002 Net Income $440,000 $550,000 1

$180,000 + $100,000

(b)

$210,000 + $140,000

Ending inventory, Year 1: (6,000 – 4,000) Fixed MOH per unit: ($180,000 ÷ 6,000) Reconciliation

2,000 units $30 Year 1

Year 2

Variable costing net income $440,000 Plus: Fixed MOH deferred in ending inventory (2,000 units x $30) 60,000 Less: Fixed MOH released from beginning inventory (2,000 units x $30) Absorption costing net income $500,000

$550,000

60,000 $490,000

(c) Amanjeet lost her bonus because the company uses absorption costing. Since production was lower than sales in Year 2 and there was no inventory at year end, under absorption costing, all of Year 2's fixed overhead costs are expensed as well as the fixed overhead costs that were deferred into inventory as a result of production being greater than sales in Year 1.

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PROBLEM 8-23A (Continued) Variable costing more accurately measures performance. Income for a period is not affected by changes in absorption of fixed overhead costs resulting from building or reducing inventory. Other things remaining equal, profits move in the same direction as sales when variable costing is in use. It follows management's thinking more closely than does absorption costing, and subsequently, management finds it easier to understand and to use variable cost reports. Another reason for Amanjeet not receiving a bonus is the higher Fixed Manufacturing costs of production over the prior year. For the 6,000 units produced in Year 1 the fixed manufacturing costs were $180,000 whereas for the 3,000 units produced in Year 2 the fixed manufacturing costs (before factoring in the fixed manufacturing OH released from the units of beginning inventory) were $210,000 an increase of $30,000 (which would account for more than 1/5 of the shortfall of the 25% targeted increase in Net Income).

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PROBLEM 8-24A Unit product costs: Absorption Direct materials $1,000,000 Direct labour 750,000 Variable manufacturing overhead 450,000 Fixed manufacturing overhead 800,000 $3,000,000 Cost per unit (20,000 units)

$150.00

Variable TPC $1,000,000 $1,000,000 750,000 450,000 $2,200,000 $1,000,000 $110.00

$50.00

(a)

XANTRA Corp. Income Statement Year ended December 31, 2009 Absorption Costing ______________________________________________________________ Production in units 20,000 Sales in units 18,000 Sales (18,000 x $200) Less: COGS Inventory, beginning Plus: Cost of goods manufactured ($150) Cost of goods available for sale Less: Inventory, ending ($150) Cost of goods sold Gross profit Less: Marketing costs Variable Fixed Net Income

. 1-40

$3,600,000 $ --3,000,000 3,000,000 300,000 2,700,000 900,000 180,000 200,000

380,000 $520,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 8-24A (Continued) (b)

XANTRA Corp. Variable Costing Income Statement Year ended December 31, 2009 ______________________________________________________________ Production in units 20,000 Sales in units 18,000 Sales ($200) Less: Variable COGS Inventory, beginning Plus Cost of goods manufactured ($110) Cost of goods available for sale Less: Inventory, ending ($110) Variable cost of goods sold Variable marketing Contribution Margin Less: fixed costs ($800,000 + $200,000) Net Income

$3,600,000 $ --2,200,000 2,200,000 220,000 1,980,000 180,000

2,160,000 1,440,000 1,000,000 $440,000

(c) Reconciliation Variable costing net income Plus: Fixed MOH deferred in ending inventory (2,000 units x $40) Absorption costing net income (d)

Break-even (BE) point: SP (X) – VC (X) = FC Where SP is the selling price X is the number of units VC is the variable cost $200(X) - ($110X + $10X) = $800,000 + $200,000 $80X = $1,000,000 X = 12,500 units

. 1-41

$440,000 80,000 $520,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 8-24A (Continued) (e)

XANTRA Corp. Income Statement Year ended December 31, 2009 Throughput Costing ______________________________________________________________ Production in units 20,000 Sales in units 18,000 Sales ($200) Less: COGS ($50) Throughput contribution margin Less: Operating expenses Variable COGS ($750,000 + $450,00) Variable Marketing Fixed ($800,000 + $200,000) Net Income

(f)

Reconciliation Throughput costing net income Plus: costs deferred in ending inventory [2,000 x ($37.50 + $22.50)] Variable costing net income

. 1-42

$3,600,000 900,000 2,700,000 $1,200,000 180,000 1,000,000

2,380,000 $320,000

$320,000 120,000 $440,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 8-25A (a) Due to the shutdown arising from the material shortage, the firm has had to reduce inventory. In effect, fixed costs from beginning inventory are being expensed in the current period, and the firm has been unable to defer current period fixed costs because it has been unable to restore inventory levels. (b) If the firm can restore inventory levels in the last month, they will be able to defer some of the current period's fixed costs and can eliminate the fixed overhead adjustment. You may wish to raise the issue of whether manipulating earnings in this way is ethical. Indicate that most managers feel it is ethical provided there is a real action taken--actually increasing inventories. However, it is still manipulation. (c) A variable cost statement would not be affected by the changing inventory. First determine variable costs for both statements. Variable cost, Jan 1 = Total cost less fixed costs = $212,000 - $30,000 = $182,000 As a percentage of sales = $182,000 ÷ $268,000 = 68% Because sales and variable costs have remained constant, the November statement will also reflect 68% variable costs. Variable cost, Nov = 68% x $294,800 = $200,464

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PROBLEM 8-25A (Continued) SUN COMPANY Variable Costing Income Statement Forecast of Operating Results ______________________________________________________________ Year 1 Year 2 Sales $268,000 $294,800 Less: Variable costs 182,000 200,464 Contribution Margin 86,000 94,336 Less: fixed costs 70,200 71,540 Net Income $15,800 $22,796

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PROBLEM 8-26A (a) In order to apply variable costing to the Daniels Tool & Die operations, it is necessary to first remove fixed manufacturing costs from the inventory values and the cost of goods sold. Fixed MOH per unit = $25,000 ÷ 25,000 DLH = $1.00 per DLH Beginning finished goods inventory: Using absorption costing $18,000 Less: Fixed MOH included 1,050 hours x $1.00 1,050 Using variable costing $16,950 Ending finished goods inventory Using absorption costing Less: Fixed MOH included 820 hours x $1.00 Using variable costing Beginning work in process inventory: Using absorption costing Less: Fixed MOH included 1,600 hours x $1.00 Using variable costing

. 1-45

$14,000 820 $13,180

$48,000 1,600 $46,400

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 8-26A (Continued) Ending work in process inventory Using absorption costing Less: Fixed MOH included 2,100 hours x $1.00 Using variable costing

$64,000 2,100 $61,900

Variable cost of goods manufactured: Raw materials put into production Direct labour [23,000 x ($150,000 ÷ 25,000)] Variable overhead [23,000 x ($155,000 ÷ 25,000)] Total variable manufacturing costs Plus: Variable beginning work in process Less: Variable ending work in process Variable cost of goods manufactured

$370,000 138,000 142,600 650,600 46,400 697,000 61,900 $635,100

Variable cost of goods sold: Variable beginning finished goods inventory Plus: Variable cost of goods manufactured Variable cost of goods available for sale Less: Variable ending finished goods inventory Variable cost of goods sold

$16,950 635,100 $652,050 13,180 $638,870

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PROBLEM 8-26A (Continued) Daniels Tools & Die Corporation Variable Costing Income Statement For the year ended December 31, 2009

Sales Less: Variable costs Cost of goods sold Sales commissions Contribution margin Less: Manufacturing overhead Selling ($95,000 - $50,750) Administrative Operating income

$1,015,000 $638,870 50,750 37,400 44,250 75,000

689,620 325,380

156,650 $168,730

(b) The difference in the operating income of $270 is caused by the different treatment of fixed manufacturing overhead. Under absorption costing, fixed overhead costs are assigned to inventory and are not expensed until the goods are sold. Under variable costing, these costs are treated as expenses in the period incurred. Since the direct labour hours in the work in process and finished goods inventories had a net increase of 270 hours, the absorption costing operating profit is higher because the fixed factory overhead associated with the increased labour hours in inventory is not expensed when absorption costing is used. Variable costing net income Plus: FMOH deferred in work in process Inventory [$1.00 x (2,100 - 1,600)]

. 1-47

$168,730 500 169,230

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PROBLEM 8-26A (Continued) Less: FMOH released from finished goods inventory [$1.00 x (1,050 - 820)] Absorption costing net income

230 $169,000

(c) The advantages of using variable costing follow. • The fixed manufacturing costs are reported at incurred values, not at absorbed values, which increases the likelihood of better control over fixed costs. • Profits are directly influenced by changes in sales volume and not by changes in inventory levels. • Contribution margin by product line, territory, department, or division is emphasized and more readily ascertainable. The disadvantages of using variable costing follow. • Variable costing is not recommended for tax reporting, for external financial reporting; therefore, companies need to adjust variable costing amounts for these purposes. • Costs other than variable costs (i.e., fixed costs and total production costs) may be ignored when making decisions, especially long-term decisions. • With the advancement of factory technology and the movement toward a fully automated factory, the fixed factory overhead may be a significant portion of the production costs. To ignore these significant costs in inventory valuation may not be acceptable.

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SOLUTIONS TO PROBLEMS—Set B PROBLEM 8-27B (a) (1) Direct material Direct labour Variable manufacturing overhead Fixed Manufacturing overhead ($150,000 ÷ 50,000) Manufacturing cost per unit (2)

$10.00 10.00 5.00 3.00 $28.00

SPONGEFUN PRODUCTS Absorption Costing Income Statement For the Month Ended July 31, 2009 ____________________________________________________________ Sales (46,000 units x $60) $2,760,00 0 Less: COGS (46,000 units x $28) 1,288,000 Gross profit 1,472,000 Less: Variable S&A (46,000 units x $8) $368,000 Fixed S&A 300,000 668,000 Net Income $804,000 (b) (1) Direct materials Direct labour Variable manufacturing overhead Manufacturing cost per unit

. 1-49

$10.00 10.00 5.00 $25.00

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PROBLEM 8-27B (Continued) (2)

SPONGEFUN PRODUCTS Variable Costing Income Statement For the Month Ended July 31, 2009 _______________________________________________________________ Sales (46,000 units x $60) $2,760,000 Less: variable costs Variable COGS (46,000 units x $25) $1,150,000 Variable S&A (46,000 units x $8) 368,000 1,518,000 Contribution margin 1,242,000 Less: fixed costs ($150,000 + $300,000) 450,000 Net Income before tax $792,000 (c) When production exceeds sales, absorption costing net income will exceed variable costing net income by an amount equal to the fixed overhead rate times the number of units in ending inventory. The difference in net income is $12,000 ($804,000 – $792,000) which equals the 4,000 units in ending inventory times the $3 fixed overhead rate.

(d) (1) Throughput manufacturing cost consists of direct material only, so per unit rate would be $10.

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PROBLEM 8-27B (Continued) (2)

SPONGEFUN PRODUCTS Income Statement For the Month Ended July 31, 2009 Throughput Costing ____________________________________________________________ Sales (46,000 units x $60) $2,760,000 Less: COGS (46,000 units x $10) 460,000 Throughput contribution margin 2,300,000 Less: Operating expenses Variable COGS (50,000 units x ($10 + $5)) $750,000 Variable S&A (46,000 units x $8) 368,000 Fixed ($150,000 + $300,000) 450,000 1,568,000 Net Income before tax $732,000 (e) The difference is $60,000 which is the per unit deferred variable conversion costs times the number of units in ending inventory, or 4,000 x (direct labour, $10 + variable MOH, $5).

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PROBLEM 8-28B ZAKI METAL COMPANY Variable Costing Income Statement For the Year Ended December 31, 2009

(a)

Required calculations for variable costing 2009: Sales ($80 x 30,000 km) Per unit variable manufacturing costs: ($80 x 0.25) Variable manufacturing costs (40,000 x $20) Ending inventory (40,000 manufactured – 30,000 sold) Variable selling expenses (30,000 x $6)

$2,400,000 $20 $800,000 10,000 km $180,000

ZAKI METAL COMPANY Variable Costing Income Statement For the Year Ended December 31, 2009

Sales $2,400,000 Less: Variable COGS Inventory, beginning $ --Plus Cost of goods manufactured 800,000 Cost of goods available for sale 800,000 Less: Inventory, ending 200,000 Variable cost of goods sold 600,000 Variable selling 180,000 780,000 Contribution Margin 1,620,000 Less: fixed costs Fixed manufacturing costs 1,200,000 Fixed administrative costs 200,000 1,400,000 Net Income $220,000 . 1-52

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PROBLEM 8-28B (Continued) Required calculations for variable costing, 2010: Sales ($80 x 40,000 units) Per unit variable manufacturing costs: ($80 x 0.25) Variable manufacturing costs (30,000 x $20) Beginning inventory (10,000 units x $20 per unit) Ending inventory (10,000 + 30,000 – 40,000) Variable selling expenses (40,000 x $6)

$3,200,000 $20 $600,000 $200,000 --$240,000

ZAKI METAL COMPANY Variable Costing Income Statement For the Year Ended December 31, 2010

Sales $3,200,000 Less: Variable COGS Inventory, beginning $200,000 Plus Cost of goods manufactured 600,000 Cost of goods available for sale 800,000 Less: Inventory, ending --Variable cost of goods sold 800,000 Variable selling and administrative 240,000 1,040,000 Contribution Margin 2,160,000 Less: fixed costs Fixed manufacturing costs 1,200,000 Fixed administrative costs 200,000 1,400,000 Net Income $760,000

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PROBLEM 8-28B (Continued)

(b)

Required calculations for absorption costing 2009: Sales ($80 x 30,000 units) Per unit variable manufacturing costs: ($80 x 0.25) Per unit fixed manufacturing costs: ($1,200,000 ÷ 40,000) Absorption manufacturing costs (40,000 x $50) Ending inventory (40,000 – 30,000) x $50 Selling expenses (30,000 x $6) ZAKI METAL COMPANY Absorption Costing Income Statement For the Year Ended December 31, 2009

Sales $2,400,000 Less: COGS Inventory, beginning $ --Plus Cost of goods manufactured 2,000,000 Cost of goods available for sale 2,000,000 Less: Inventory, ending 500,000 Cost of goods sold 1,500,000 Gross profit 900,000 Less: Selling and Administration Selling costs 180,000 Administrative costs 200,000 380,000 Net Income $520,000

. 1-54

$2,400,000 $20 $30 $2,000,000 $500,000 $180,000

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PROBLEM 8-28B (Continued) Required calculations for absorption costing for 2010: Sales ($80 x 40,000 units) Per unit variable manufacturing costs: ($80 x 0.25) Per unit fixed manufacturing costs: ($1,200,000 ÷ 30,000) Absorption manufacturing costs (30,000 x $60) Beginning inventory (10,000 x $50) Variable selling expenses (40,000 x $6)

$3,200,000 $20 $40 $1,800,000 $500,000 $240,000

ZAKI METAL COMPANY Absorption Costing Income Statement For the Year Ended December 31, 2010

Sales $3,200,000 Less: COGS Inventory, beginning $500,000 Plus Cost of goods manufactured 1,800,000 Cost of goods available for sale 2,300,000 Less: Inventory, ending --Cost of goods sold 2,300,000 Gross profit Less: Selling and Administration Selling costs Administrative costs Net Income

. 1-55

900,000 240,000 200,000

440,000 $460,000

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PROBLEM 8-28B (Continued) (c) Fixed manufacturing overhead in ending inventory, 2009: (10,000 x $30)

$300,000

Reconciliation, 2009 Variable costing net income Plus: Fixed MOH deferred in ending inventory Absorption costing net income

$220,000 300,000 $520,000

Reconciliation, 2010 Variable costing net income Less: Fixed MOH released from beginning inventory Absorption costing net income

$760,000 300,000 $460,000

(d) Income parallels sales under variable costing as seen in the increase in net income in 2010 when 10,000 additional units were sold. In contrast, under absorption costing, income parallels production as seen in the higher net income in 2009 when production exceeded sales by 10,000 km.

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PROBLEM 8-29B (a)

HARRISON PUMPS DIVISION Absorption Costing Income Statement For the Year Ended 2009 _______________________________________________________________ Units produced 60,000 100,000 Sales ($20.00) Less: Cost of Goods Sold ($13.00; $11.40) Gross Profit Less: Selling and Administration Variable ($1.00) Fixed Total fixed costs Operating income

. 1-57

$1,200,000 780,000 420,000

$1,200,000 684,000 516,000

60,000 30,000 90,000 $330,000

60,000 30,000 90,000 $426,000

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PROBLEM 8-29B (Continued) (b)

HARRISON PUMPS DIVISION Variable Costing Income Statement For the Year Ended 2009 _____________________________________________________________ Units produced

60,000

100,000

Sales ($20.00) $1,200,000 $1,200,000 Less: Variable cost of goods sold ($9.00) 540,000 540,000 Variable selling and admin ($1.00) 60,000 60,000 600,000 600,000 Contribution margin 600,000 600,000 Less: Fixed manufacturing Fixed selling and admin

240,000 30,000 270,000 $330,000

Net Income (c)

240,000 30,000 270,000 $330,000

If the company produces 100,000 units, but only sells 60,000 units, then 40,000 units will remain in ending inventory. Under absorption costing these 40,000 units will each include $2.40 of fixed manufacturing overhead—a total of $96,000. However, under variable costing fixed manufacturing overhead is expensed when incurred. This accounts for the $96,000 difference ($426,000 – $330,000) in net income. This is summarized as shown below. Net income under absorption costing Less: Fixed manufacturing overhead included in ending inventory (40,000 units X $2.40 per unit) Net income under variable costing

. 1-58

$426,000 96,000 $330,000

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PROBLEM 8-29B (Continued) (d) Variable costing has a number of advantages over absorption costing for decision making and evaluation purposes. • The use of variable costing is consistent with cost-volume-profit and incremental analysis. • Net income computed under variable costing is unaffected by changes in production levels. Note that in our example, under variable costing the company’s net income is $330,000 no matter what the level of production is. • 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. • The presentation of fixed and variable cost components separately on 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.

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PROBLEM 8-30B (a)

Unit product costs: Absorption costing Total variable production costs Fixed MOH ($120,000 ÷ 30,000) Cost per unit

$20.00 4.00 $ 24.00

ALLERDYCE CORPORATION LTD. Absorption Costing Income Statement For the Years Ended December 31 _______________________________________________________________ Total 2008 2009 60,000 Units Sold 25,000 35,000 Sales ($35.00) Less: Cost of Goods Sold ($24) Gross Profit Less: Marketing costs Operating income

$875,000 600,000 275,000 50,000 $225,000

. 1-60

$1,225,000 $2,100,000 840,000 1,440,000 385,000 660,000 50,000 100,000 $335,000 $560,000

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PROBLEM 8-30B (Continued) (b)

ALLERDYCE CORPORATION LTD. Variable Costing Income Statement For the Years Ended December 31 _______________________________________________________________ Total 2008 2009

Units Sold

25,000

Sales ($35.00) Less: Variable COGS ($20) Contribution margin Less: fixed costs ($120,000 + $50,000) Operating income

$875,000 $1,225,000 $2,100,000 500,000 700,000 1,200,000 375,000 525,000 900,000 170,000 170,000 340,000 $205,000 $355,000 $560,000

(c)

35,000

Ending inventory—2008: 30,000 produced – 25,000 sold Ending inventory—2009: 5,000 + 30,000 – 35,000 FMOH per unit: $120,000 ÷ 30,000 units

60,000

5,000 units nil units $4.00 /unit

Reconciliation of net income 2008 Variable costing net income

$205,000

Plus: FMOH stored in ending inventory (5,000 x $4) Less: FMOH released in beginning inventory (5,000 x $4) Absorption costing net income

. 1-61

20,000

$225,000

2009 $355,000 -

(20,000) 335,000

Total $560,000 20,000

(20,000) $560,000

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PROBLEM 8-31B (a)

Contribution margin per unit: Sales Less: Variable costs Manufacturing Selling and Administration

$25.00 $9.00 6.00

Contribution margin per unit

15.00 $10.00

Fixed costs: Fixed manufacturing overhead Adjust for under (over) applied fixed overhead Fixed manufacturing costs

July $595,000

Total selling and administrative Less: variable selling and administrative (70,000 x $6) Fixed selling and admin costs Total fixed costs (same each month)

620,000

(35,000) 560,000

420,000 200,000 $760,000

Break-even = $760,000 ÷ $10 = 76,000 units or 76,000 x $25 = $1,900,000

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PROBLEM 8-31B (Continued) (b)(1)

Sales in units

ABSCORP LTD. Variable Costing Income Statements July Aug 70,000 75,000

Sales ($25) $1,750,000 Variable production costs ($15) 1,050,000 Contribution margin 700,000 Less: Fixed costs 760,000 Operating income $(60,000) (2) Inventory values Beginning inventory Plus: units manufactured Units available for sale Less: units sold Ending inventory

July 5,000 85,000 90,000 70,000 20,000

Sep 80,000

$1,875,000 $2,000,000 1,125,000 1,200,000 750,000 800,000 760,000 760,000 $(10,000) $40,000

Aug 20,000 80.000 100,000 75,000 25,000

Sep 25,000 60,000 85,000 80,000 5,000

Fixed MOH per unit Total fixed MOH costs

July $560,000

Total Aug Sep $560,000 $560,000 $1,680,000

Budgeted production

80,000

240,000

Per unit cost

$7.00

(2) Reconciliation of net income Variable costing net income Plus: FMOH deferred—end. inv.

July Aug $(60,000) $(10,000) 140,000 175,000

Less: FMOH released in beg. Inv. Absorption costing net income

(35,000) $45,000

. 1-63

Sep $40,000 35,000

(140,000) (175,000) $25,000 $(100,000)

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PROBLEM 8-31B (Continued)

(3) In July, production exceeded sales by 15,000 units and, as a result, $105,000 ($7 x 15,000 units) of fixed manufacturing overhead costs were converted to inventory assets on the balance sheet under absorption costing. In August, production exceeded sales by 5,000 units and, as a result, $35,000 ($7 x 5,000 units) of fixed manufacturing overhead costs were converted to inventory assets on the balance sheet under absorption costing. In September, sales exceeded production by 20,000 units and, as a result, $140,000 ($7 x 20,000 units) of inventory assets were converted to expenses on the income statement under absorption costing.

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PROBLEM 8-32B (a)

Fixed MOH per unit = $600,000 ÷ 2,000 units = $300. Absorption costing net income Variable costing net income

$400,000 310,000

Difference

$90,000

Since absorption costing net income exceeds variable costing net income, this means sales must have been less than production, and $90,000 fixed manufacturing overhead was deferred in the ending inventory at $300 per unit. $90,000 ÷ $300 = 300 units If 300 units are left in finished goods ending inventory, and there was no beginning inventory, then sales must have been 1,700 units (2,000 – 300 = 1,700). (b) Contribution margin = net income + fixed costs Contribution margin = $310,000 + $1,000,000 = $1,310,000

(c) Gross margin = net income + selling and administrative expenses Gross margin = $400,000 + $400,000 = $800,000 (d) Variable costs = Sales - contribution margin Variable costs = $3,400,000 - $1,310,000 = $2,090,000 Cost per unit = $2,090,000 ÷ 1,700 = $1,229.41 (e) Absorption costs = Sales - gross profit Absorption costs = $3,400,000 - $800,000 = $2,600,000 Cost per unit = $2,600,000 ÷ 1,700 = $1,529.41

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PROBLEM 8-33B

Variable cost per unit: Direct material (2 kg. X $10 per kg.) Direct labour (1 hr x $8 per hr) Variable MOH [($15,000 - $6,000) ÷ 18,000 units] Variable manufacturing cost per unit Variable selling and admin [($40,000 - $4,000) ÷ 10,000]

$20.00 8.00 0.50 28.50 3.60 $32.10

WINGFOOT CO. Variable Costing Income Statement For the Year Ended June 30, 2009

Sales in units

10,000

Sales ($100) $1,000,000 Less: Variable COGS ($28.50) $285,000 Variable selling and administrative ($3.60) 36,000 321,000 Contribution Margin 679,000 Less: fixed costs Fixed manufacturing overhead 6,000 Fixed administrative costs 4,000 10,000 Operating income before tax $669,000 Income tax (40%) 267,600 Net income $401,400

. 1-66

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PROBLEM 8-34B (a) In order to apply variable costing to the Portland Optics operations, it is necessary to first remove fixed manufacturing costs from the inventory values and the cost of goods sold. Beginning finished goods inventory: Using absorption costing Less: Fixed MOH included 1,080 hours x ($130,000 ÷ 32,500) Using variable costing Ending finished goods inventory Using absorption costing Less: Fixed MOH included 550 hours x ($176,000 ÷ 44,000) Using variable costing Beginning work in process inventory: Using absorption costing Less: Fixed MOH included 1,400 hours x $4.00 Using variable costing Ending work in process inventory Using absorption costing Less: Fixed MOH included 2,500 hours x $4.00 Using variable costing

. 1-67

$25,000 4,320 $20,680

$14,000 2,200 $11,800

$34,000 5,600 $28,400

$60,000 10,000 $50,000

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PROBLEM 8-34B (Continued) Variable cost of goods manufactured: Raw materials put into production Direct labour Variable overhead [42,000 x ($198,000 ÷ 44,000)] Total variable manufacturing costs Plus: Variable beginning work in process Less: Variable ending work in process Variable cost of goods manufactured

$210,000 435,000 189,000 834,000 28,400 862,400 50,000 $812,400

$ 20,680 812,400 830,080 11,800 $821,280

. 1-68

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PROBLEM 8-34B (Continued) PORTLAND OPTICS INC. Variable Costing Income Statement For the year ended December 31, 2009 Sales Less: Variable costs Cost of goods sold Sales commissions Contribution margin Less: Manufacturing overhead Selling ($190,000 - $121,600) Administrative

$1,520,000 $821,280 121,600 175,000 68,400 187,000

Operating income

942,880 577,120

430,400 $146,720

(b) Two of the several advantages of using variable costing rather than absorption costing are as follows. • Financial statements using variable costing are more easily understood because they show that profits move in the same direction as sales. This effect is more logical than that shown with absorption costing, where profit is affected by changes in inventory. • Variable costing facilitates the analysis of cost-volume-profit relationships by separating fixed and variable costs on the income statement.

. 1-69

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SOLUTIONS TO CASES CASE 8-35 (a) Sales (10,000 seats x $480) Variable costs (10,000 seats x $180) Contribution margin Fixed costs Net income

$4,800,000 1,800,000 3,000,000 2,200,000 $800,000

(b) Contribution margin ratio = $3,000,000 ÷ $4,800,000 = 62.5% Break-even point in dollars = $2,200,000 ÷ 0.625 = $3,520,000 Margin of safety ratio = ($4,800,000 – $3,520,000) ÷ $4,800,000 = 26.7% Degree of operating leverage = $3,000,000 ÷ $800,000 = 3.75 (c) Sales (10,000 seats x $480) Variable costs (10,000 seats x $80) Contribution margin Fixed costs Net income

$4,800,000 800,000 4,000,000 3,200,000 $800,000

(d) Contribution margin ratio = $4,000,000 ÷ $4,800,000 = 83.3% Break-even point in dollars = $3,200,000 ÷ .833 = $3,841,537 Margin of safety ratio = ($4,800,000 – $3,841,537) ÷ $4,800,000 = 20% Degree of operating leverage = $4,000,000 ÷ $800,000 = 5.00

. 1-70

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CASE 8-35 (Continued) (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 $3,520,000 to $3,841,537 and reduce its margin of safety from 26.7% to 20%. This means that under the old system sales could fall by 26.7% percent before the company would operate at a loss, whereas under the automated system they could only fall by 20%. 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 3.75 to 5.00. This means that with a change in sales, the change in net income would be 1.33 (5 ÷ 3.75) 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.

. 1-71

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CASE 8-36 (a)

Variable manufacturing overhead: Other materials—indirect Electricity usage—factory Water usage—factory Other labour—indirect Total variable overhead Manufacturing cost per unit: Direct materials—rubber Direct labour—ball makers Variable manufacturing overhead Manufacturing cost per unit

. 1-72

$1.40 0.50 0.15 0.27 $2.32 $2.75 5.60 2.32 $10.67

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CASE 8-36 (Continued) (b) BIG SPORTS MANUFACTURING Variable Costing Income Statement For the Year Ended December 31, 2009 Sales in units

72,500

Sales ($18) $1,305,000 Less: Variable COGS Beginning inventory (85,000 x $9.67) $821,950 Units produced (35,000 x $10.67) 373,450 Total available for sale 1,195,400 1 Ending inventory 494,325 Variable cost of goods sold 701,075 Variable sell & admin ($0.40) 29,000 730,075 Contribution Margin 574,925 Less: fixed costs Fixed manufacturing overhead 210,000 Fixed administrative costs 83,000 293,000 Operating income before tax $281,925

Ending inventory = (12,500 x $9.67) + (35,000 x $10.67)

(c)

Throughput costing per unit: Direct material—rubber

$2.75

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CASE 8-36 (Continued) (d) This solution is prepared based on the assumption that the inventory system in use is first-in, first-out; and the $1.00 increase in variable manufacturing costs from 2008 to 2009 was not caused by any increase in the cost of the direct material. That is, the direct material rate remained the same for both years. BIG SPORTS MANUFACTURING Throughput Costing Income Statement For the Year Ended December 31, 2009

Sales in units

72,500

Sales ($18) Less: Throughput COGS ($2.75) Throughput contribution margin Less: Operating expenses Variable COGS ($5.60 + $2.32) Variable S&A ($0.40) Fixed Net Income before tax

(e)

$1,305,000 199,375 1,105,625 $277,200 29,000 293,000

599,200 $506,425

Unit product costs: Absorption costing Total variable production costs-from (a) Fixed MOH ($210,000 ÷ 35,000) Cost per unit for 2009

$10.67 6.00 $16.67

Total variable production costs for 2008 Fixed MOH Cost per unit for 2008

$9.67 4.00 $13.67

. 1-74

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CASE 8-36 (Continued) (f) BIG SPORTS MANUFACTURING Absorption Costing Income Statement For the Year Ended December 31, 2009 Sales in units

72,500

Sales ($18) $1,305,000 Less: COGS Beginning inventory (85,000 x $13.67) $1,161,950 Units produced (35,000 x $16.67) 583,450 Total available for sale 1,745,400 Ending inventory 754,325 991,075 Gross Margin 313,925 Less: selling and administrative costs Variable ($0.40) 29,000 Fixed 83,000 112,000 Operating income $201,925 Ending inventory = (12,500 x $13.67) + (35,000 x $16.67) (g)

(1) Reconciliation of net income Variable costing net income Plus: FMOH deferred in ending inventory (12,500 x $4) + (35,000 x $6) Less: FMOH released in beginning inventory (85,000 x $4) Absorption costing net income

$281,925 260,000 (340,000) $201,925

(2) Break-even point = fixed costs ÷ CM ratio* $293,000 ÷ (574,925 ÷ $1,305,000) = $666,000 (rounded) $666,000 ÷ $18 = 37,000 units *Cannot use CM per unit because variable costs are two different amounts

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CASE 8-36 (Continued)

(3) Mr. Swetkowski is right in his thinking that variable costing has many advantages over the more traditional absorption costing technique. However, his conclusion that absorption costing should be stopped at Big Sports Manufacturing is incorrect. The company can learn many things about themselves by preparing the variable costing income statement, however they cannot simply discard absorption costing altogether. Absorption costing is recommended for external financial statements produced under generally accepted accounting principles (GAAP). With these standards in place, it would be better for Big Sports Manufacturing to produce both sets of financial statements.

. 1-76

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CASE 8-37

(a)

Per unit manufacturing costs: Direct material Direct labour Variable manufacturing overhead Total variable unit cost Plus: fixed manufacturing overhead ($2,500,000 ÷ 60,000 units) Plus: fixed manufacturing overhead ($2,500,000 ÷ 50,000 units)

2008 $80.00 40.00 35.00 155.00 41.67

$196.67 Cost of goods sold: 2008 Beginning finished goods inventory Plus: cost of goods manufactured (60,000 x $196.67)--rounded Cost of goods available for sale Less: ending inventory [(60,000 - 54,000) x 196.67] Cost of goods sold

Cost of goods sold: 2009 Beginning finished goods inventory Plus: cost of goods manufactured (50,000 x $205.00) Cost of goods available for sale Less: ending inventory [(110,000 - 108,000) x 205.00] Cost of goods sold

. 1-77

2009 $80.00 40.00 35.00 155.00

11,800,000 11,800,000 1,180,000 $10,620,000

$1,180,000 10,250,000 11,430,000 410,000 $11,020,000

50.00 $205.00

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CASE 8-37 (Continued) WEI NAN COMPANY Absorption Costing Income Statement For the Years Ended December 31 ______________________________________________________________ 2008 2009 Sales in units 54,000 54,000 Sales ($250 per unit) Cost of goods sold: Gross Profit Less: selling and administrative costs [(54,000 x $30) + $300,000] Net income

$13,500,000 10,620,000 2,880,000

$13,500,000 11,020,000 2,480,000

1,920,000 $960,000

1,920,000 $560,000

(b)

WEI NAN COMPANY Variable Costing Income Statement For the Years Ended December 31 ______________________________________________________________

Sales in units Sales ($250 per unit) Variable costs: Cost of goods sold ($155) Selling ($30) Total variable costs Contribution margin Less: Fixed costs Manufacturing overhead Selling Total fixed costs Net Income

. 1-78

2008 54,000

2009 54,000

$13,500,000

8,370,000 1,620,000 9,990,000 3,510,000

2,500,000 300,000 2,800,000 $710,000

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CASE 8-37 (Continued) (c)

Reconciliation of net income: 2008 $710,000

Variable costing net income Plus: FMOH deferred in ending inventory (6,000 x $41.67); (2,000 x $50.00) 250,000 Less: FMOH released in beginning inventory (6,000 x $41.67) Absorption costing net income $960,000 (d)

2009 $710,000 100,000 (250,000) $560,000

WEI NAN COMPANY Throughput Costing Income Statement For the Years Ended December 31

Sales in units Sales ($250); ($250) Less: Throughput COGS ($80); ($80) Throughput contribution margin Less: Operating expenses Variable COGS ($75 x 60,000; 50,000) Variable S&A ($30); ($30) Fixed ($2,500,000 + $300,000) Net Income

. 1-79

2008 54,000

2009 54,000

$13,500,000 4,320,000 9,180,000

4,500,000 1,620,000 2,800,000 8,920,000 $260,000

3,750,000 1,620,000 2,800,000 8,170,000 $1,010,000

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CASE 8-37 (Continued) (e)

Reconciliation of net income: 2008 $260,000

Throughput costing net income Plus: Costs deferred in ending inventory (6,000 x $75); (2,000 x $75) 450,000 Less: costs released in beginning inventory (6,000 x $75) Variable costing net income $710,000

. 1-80

2009 $1,010,000 150,000 (450,000) $710,000

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CASE 8-38

(a)

Per unit manufacturing costs: Direct material Direct labour (0.25 x $24) Variable manufacturing overhead Plus: fixed manufacturing overhead ($132,000 ÷ 30,000 units)

Abs. $2.00 6.00 4.00

Var. $2.00 6.00 4.00

4.40 $16.40 $12.00

(b)

DDD GOLF LTD Variable Costing Income Statement For the Month Ended May 31, 2009 ______________________________________________________________ Sales in units 28,000 Sales ($20 per unit) Variable costs: Cost of goods sold ($12) Selling ($2) Contribution margin Less: Fixed costs ($132,000 + $40,000) Net Income

. 1-81

$560,000 $336,000 56,000

392,000 168,000 172,000 $(4,000)

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CASE 8-38 (Continued) DDD GOLF LTD Absorption Costing Income Statement For the Month Ended May 31, 2009 ______________________________________________________________ Sales in units 28,000 Sales ($20 per unit) Less: cost of good sold ($16.40) Gross profit Less: Selling ($40,000 + ($2 x 28,000)) Net Income

(c)

$560,000 459,200 100,800 96,000 $4,800

Reconciliation of net income Variable costing net income Plus: FMOH deferred in ending inventory (7,000 x $4.40) Less: FMOH released in beginning inventory* (5,000 x $4.40) Absorption costing net income

*assuming costs in April were exactly the same as in May

. 1-82

$(4,000) 30,800 (22,000) $4,800

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CASE 8-39 (a)

(1) Determination of beginning inventory: Sales = $2,400,000 ÷ $24 per unit = Plus ending inventory Goods available for sale Goods manufactured (100,000 + 45,000) Finished goods, beginning inventory

100,000 80,000 180,000 145,000 35,000

HUBER CORPORATION Absorption Costing Income Statement For the Month Ended November 30, 2009 ______________________________________________________________ Sales in units 100,000 Sales ($24 per unit) Less: cost of good sold ($16) Gross profit Less: Selling Net income before overhead adjustment Less: overhead adjustment ((150,000 – 145,000) x $4) Net Income

(2) Reconciliation of net income: Variable costing net income Plus: FMOH deferred in ending inventory (80,000 x $4) Less: FMOH released in beginning inventory (35,000 x $4) Absorption costing net income

. 1-83

$2,400,000 1,600,000 800,000 400,000 400,000 20,000 $380,000

$200,000 320,000 (140,000) $380,000

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CASE 8-39 (Continued) (b) Variable cost statements are consistent with cost-volume-profit analysis, making it easier to compare planned and actual results. In addition, variable cost income becomes a function of sales only; it is not affected by changes in inventory levels.

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CASE 8-40 (a) CM per unit = Sales per unit – variable costs CM = $5.00 – ($1.00 + $2.00) = $2.00 Total fixed costs = (100,000 x $0.25) + (100,000 x $0.65) Total fixed costs = $90,000 Break-even in units = Fixed costs ÷ CM per unit Break-even in units = $90,000 ÷ $2.00 = 45,000 units (b)

RICKUSE LIMITED Variable Costing Income Statement ______________________________________________________________

Sales (110,000 x $5) $550,000 Variable cost (110,000 x $3.00) 330,000 Contribution margin 220,000 Less: Fixed costs Manufacturing overhead $25,000 Selling and Administrative 65,000 90,000 Net income $130,000 (c) RICKUSE LIMITED Absorption Costing Income Statement ______________________________________________________________ Sales (110,000 x $5) Less: cost of good sold 110,000 x $1.25) Gross profit Less: Selling (110,000 x $2) + 65,000 Net income before overhead adjustment Plus: overhead adjustment ((120,000 – 100,000) x $0.25) Net Income

. 1-85

$550,000 137,500 412,500 285,000 127,500 5,000 $132,500

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CASE 8-41 (a) Beginning inventories are carried at a full cost of $8 per unit. The 2009 cost of goods sold is made up of 600,000 X $8 = $4,800,000 of beginning inventory costs and $8,320,000 - $4,800,000 = $3,520,000 of current period costs (400,000 units at $8.80). The fixed overhead rate per unit is given as $3.30; thus the $495,000 under-applied fixed overhead implies the firm produced $495,000 ÷ $3.30 = 150,000 units below their target level. The target level must be $3,300,000 ÷ $3.30 = 1,000,000 units, so they produced 850,000 units. With these observations, we can determine that the level of inventory dropped by 150,000 units (sales of 1,000,000 less production of 850,000). The explanation for the decreased income is due to two factors. First, in 2008, the firm was able to defer considerable fixed costs into inventory by producing 600,000 - 300,000 = 300,000 more units than were sold. In the current period, more units were sold than produced, so "extra" fixed costs were incurred. Second, the firm treats the volume variance as a period cost. In 2008, production exceeded the planned level by $600,000 ÷ $3.00 = 200,000 units, yielding the overapplied fixed overhead, but in 2009 production fell below the planned level, yielding the $495,000 under-applied fixed overhead.

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CASE 8-41 (Continued) (b)

BBG CORPORATION Variable Costing Income Statement ______________________________________________________________ Sales Variable cost: 600,000 x $5.00 from 2008 400,000 x $5.50 from 2009 Contribution margin Less: Fixed costs Manufacturing overhead Selling and Administrative Net income

(c)

Reconciliation of net income: Variable costing net income Plus: FMOH deferred in ending inventory (450,000 x $3.30) Less: FMOH released in beginning inventory (600,000 x $3) Absorption costing net income

. 1-87

$11,200,000 $3,000,000 2,200,000

$3,300,000 1,500,000

$1,200,000 1,485,000 (1,800,000) $885,000

5,200,000 6,000,000

4,800,000 $1,200,000

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CASE 8-42 (a) The division’s net income increased by $200,000 ($600,000 – $400,000). This represents a 50% increase over the previous year ($200,000 ÷ $400,000). Thus Scott’s bonus would be 50 X $5,000 = $250,000. (b) In 2008 the number of units produced and sold were equal. When this occurs variable costing and absorption costing provide the same CASE 8-41 (Continued)results. Thus, in 2008 net income under variable costing would have been $400,000. In 2009 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 2008 to 2009, and the selling price, variable cost per unit, and total fixed costs didn’t change, the division’s net income in 2009 would equal its 2008 income of $400,000. (c) In part (b) it was determined that the division’s net income would have been $400,000 in 2009 under variable costing. Since this is the same as 2005 net income, Scott would not receive a bonus. (d) If Scott intentionally overproduced inventory in order to increase his bonus, then his actions were unethical. Based on the information provided, we can’t actually determine Scott’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.

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CASE 8-41 (Continued) In order to eliminate any potential conflicts of interest between Scott 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 Scott might have to over-produce, as well as providing useful information for other internal management decision making.

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-8

Part One: (a) Absorption costing Sales 50,000 x 42.50 Cost of goods sold 50,000 x (9.75+18.69) * Fixed manufacturing overhead Gross Profit Variable selling expenses 50,000 x 3.41 Fixed selling and administrative expenses Net income

2,125,000 1,422,000 703,000 170,500 157,000 375,500

* fixed overhead per unit of production is 971,880/52,000 = 18.69; variable cost per unit of production is 2.00+5.75+2.00 = 9.75 (b) Variable Costing Sales Variable cost of goods sold Variable selling and administrative expenses Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net Income

50,000 x 42.50 50,000 x 9.75 50,000 x 3.41

2,125,000 487,500 170,500 1,467,000 971,880 157,000 338,120

(c ) Throughput costing Sales 50,000 x 42.5 2,125,000 Variable cost of goods sold: * 100,000 Throughput contribution margin 2,025,000 Other Operating costs 1,702,380 Net Income 322,620 * The variable cost of goods (materials only) sold is 100,000 (50,000 x 2.00) . 1-90

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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WCP-8 (Continued) (d) Normal Costing Budgeted production volume Fixed manufacturing costs Predetermined overhead rate

971,880/57,000

57,000 971,880 $ 17.05

The current production is 52,000 units + the expected increase in budgeted sales is 5,000 units = 57,000 units Absorption product costs based on predetermined Fixed overhead rate: Direct materials Direct labour Variable overhead Fixed overhead predetermined rate Total product cost per unit

Sales 50,000 x 42.50 Cost of goods sold 50,000 x 26.80 Unfavourable volume (57,000-52,000) x 17.05 variance Gross profit Variable selling and 50,000 x 3.41 administrative expenses Fixed selling and administrative expenses Net income

. 1-91

2.00 5.75 2.00 17.05 26.80

2,125,000 1,340,000 85,250 699,750 170,500 157,000 372,250

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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WCP-8 (Continued) Part Two (a ) The difference in net income between absorption costing ($375,500) and variable costing ($338,120) is $37,380. This can be explained by the difference between production and sales volumes ie.2,000 units. This defers fixed manufacturing costs to the following year (2,000 x 18.69) = 37,380

(b) The difference in net income between variable costing ($338,120) and throughput costing (322,620) is $15,500. This can be explained as the deferral of labour and variable overhead expenses into the following year i.e. 2,000 units x (2.00+ 5.75) = 15,500 (c ) The difference in net income between normal costing ( $372,250) and variable costing ($338,120) is $34,130. This can be explained in terms of the fixed overhead deferred into the following year (i.e. 2,000 x 17.05 = 34,130). Note: the difference between these two values ($30) is due to rounding.

. 1-92

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. 1-93

CHAPTER 9 Pricing ASSIGNMENT CLASSIFICATION TABLE Brief Questions Exercises

Exercises

1. Compute a target cost when the market determines a product’s price.

1, 2

12, 13, 14

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

Define “transfer price” and its role in an organization.

11, 12

Study Objectives

5. Determine a transfer price using the negotiated, costbased, and market-based approaches.

13, 14, 15, 16, 17

6. Explain issues involved in transferring goods between divisions in different countries with different tax rates.

*7. Determine prices using absorption-cost pricing and variable-cost pricing.

19, 20

7, 8, 9

A Problems

B Problems

14, 15, 16, 17, 18, 27

30, 31, 32. 33

45, 46, 47

19, 20, 21

22, 23, 24, 25, 26

35, 36, 37, 38, 39, 40, 41, 44

49, 50, 51, 52, 53, 54, 57, 58

22, 24, 25, 26

35, 36, 37, 38, 39, 40, 41, 44

49, 50, 51, 52, 53, 54, 57, 58

10, 11

27, 28, 29

32, 42, 43

55, 56

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

. 9-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number 30A

Description Use cost-plus pricing to determine various amounts.

Difficulty Level Simple

Time Allotted (min.)

31A

Use cost-plus pricing to determine various amounts.

Simple

20–30

32A

Moderate

20–30

33A

Use cost-plus pricing to determine various amounts. . Use cost-plus pricing to determine various amounts.

Simple

20–30

34A

Use time-and-material pricing to determine bill.

Simple

20–30

35A

Determine minimum transfer price under different situations.

Moderate

20–30

36A

Determine the minimum transfer price with no excess capacity and with excess capacity.

Moderate

30–40

37A

Determine the minimum transfer price with no excess capacity.

Moderate

30-40

38A

Determine the minimum transfer price under different situations.

Moderate

20–30

39A

Determine the minimum transfer price under different situations.

Moderate

20–30

40A

Determine the minimum transfer price under different situations.

Challenging

20–30

41A

Determine the transfer price for goal congruence.

Challenging

20–30

42A

Compute various amounts using the absorption-cost and variable-cost approaches.

Simple

20–30

43A

Compute the target price using the absorption-cost and variable-cost approaches.

Simple

30-40

44A

Determine the minimum transfer price under different situations.

Moderate

30–40

45B

Use cost-plus pricing to determine various amounts.

Simple

20-30

46B

Use cost-plus pricing to determine various amounts.

Moderate

20-30

47B

Use cost-plus pricing to determine various amounts.

Simple

20-30

. 9-2

20–30

48B

Use time-and-material pricing to determine bill.

Simple

20-30

Difficulty Level

Time Allotted (min.)

ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number

Description

49B

Determine the minimum transfer price with no excess capacity and with excess capacity.

Moderate

30-40

50B

Determine the minimum transfer price under different situations.

Moderate

20-30

51B

Determine the minimum transfer price with no excess capacity.

Moderate

20-30

52B

Determine the minimum transfer price under different situations.

Simple

20-30

53B

Determine the minimum transfer price under different situations.

Simple

20-30

54B

Determine the transfer price for goal congruence.

Challenging

30-40

55B

Compute the target price using absorption-cost pricing and variable-cost pricing.

Simple

20-30

56B

Compute various amounts using absorption-cost pricing and variable-cost pricing.

Moderate

30-40

57B

Determine the minimum transfer price under different situations.

Moderate

20-30

58B

Determine transfer prices under different situations.

Challenging

30-40

. 9-3

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Study Objective

For Instructor Use Only

Knowledge

Comprehension

*1. Compute a target cost when the market determines a product’s price.

Q2, BE1

*2. Compute a target selling price using cost-plus pricing.

Q3, Q5, Q6

Q4 Q7 Q8 BE2 BE3 BE4 BE5

*3. Use time-and-material pricing to determine the cost of services provided.

Q9, Q10

BE6 E19 E20

4. Define transfer price and its role Q12 in an organization.

Application E12, E13, E14 E14 E15 E16 E17 E18 E27

P30A P31A P32A P33A P45A P46A P47A

E21 P34A P48A

Q11

E22 P37A P50B E23 P38A P51B E24 P39A P52B E25 P40A P53B E26 P41A P54B P35A P44A P57B P36A P49B P58B

*5. Determine a transfer price using Q13, Q14, the negotiated, cost-based, and Q15, Q16, market-based approaches. Q17

*6. Explain issues involved in transferring goods between divisions in different countries with different tax rates. *7. Determine prices using absorption-cost pricing and variable-cost pricing.

BE7 P36A P50B BE8 P37A P51B BE9 P38A P52B E22 P39A P53B E24 P40A P54B E25 P41A P57B E26 P44A P58B P35A P49B Q18

Q19

Analysis

P53B

Q20 BE10 BE11

E27 E28 E29

P32A P42A P43A P55B P56B

Synthesis

Evaluation

BLOOM’ S TAXONOMY TABLE

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

9-4

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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: Cost plus the markup percentage times the cost.

4. 5.

Target selling price = Cost + $22.10 = $17 +

(Mark-up percentage x Cost) (30% X $17)

The basic formula to compute the mark-up percentage is: Mark-up 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 20 $80

The mark-up percentage is computed as follows: $6 = 7.5% $80 8.

Variable cost per unit ....................................................................................................... Fixed cost per unit ........................................................................................................... Desired ROI per unit ........................................................................................................ Target selling price ..........................................................................................................

$15 9 6 $30

The mark-up percentage is: $6 = 25% $24 9.

Time-and-material pricing is most often used in service industries. It involves two pricing rates, one for the labour 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.

. 9-5

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Questions Chapter 9 (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 may lead to poor decisions that 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 mark-up 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 mark-up percentage using variable-cost pricing would be: $3 + $9 = 80% $15

. 9-6

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 In order to obtain a profit of $14 per drive, Podrive must set its target cost at $31 per drive ($45 – $14). 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 labour ............................................................................................ Variable manufacturing overhead .......................................................... Fixed manufacturing overhead .............................................................. Variable selling and administrative expenses....................................... Fixed selling and administrative expenses ........................................... Total unit cost .................................................................................. Target selling price: $56 + (0.32 x $56) = $73.92

BRIEF EXERCISE 9-3 ROI per unit = (0.18 x $10,000,000) ÷ 50,000 units = $36.00

BRIEF EXERCISE 9-4 The mark-up percentage would be: $30 = 18.52% $36 + $24 + $18 + $42 + $14 + $28 . 9-7

$12 8 6 14 4 12 $56

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BRIEF EXERCISE 9-5 The mark-up percentage is equal to Desired ROI per unit divided by total unit cost. Desired ROI per unit = (0.20 x $1,500,000) = $30 Total unit cost = ($1,100,000 + $100,000) ÷ 10,000 = $120 The mark-up percentage = $30 ÷ $120 = 25% BRIEF EXERCISE 9-6 Swayze’s total bill would equal: (10.5 hours x $45) + $700 + ($700 x 40%) = $1,452.50 BRIEF EXERCISE 9-7 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 = $19 + ($42 – $19) = $42. When a division that is working at full capacity must transfer products to another division, the transfer price should always be the outside market price, or the price the producing division uses to sell its product to the external market.

. 9-8

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BRIEF EXERCISE 9-8 If the division has excess capacity, then its opportunity cost is zero. In this case, the minimum transfer price is: Minimum transfer price = $19 + $0 = $19. When a division has capacity to produce all the units demanded by the receiving division, the minimum selling price should be equal to the variable costs in the product cost. BRIEF EXERCISE 9-9 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 + ($42 – $19) = $47.

*BRIEF EXERCISE 9-10 The mark-up 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 must be covered by the mark-up. Mark-up percentage

$30 + ($14 + $28) = 60% $36 + $24 + $18 + $42

*BRIEF EXERCISE 9-11 The mark-up 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 must be covered by the mark-up. Mark-up percentage

$30 + ($42 + $28) = 108.7% $36 + $24 + $18 + $14

. 9-9

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SOLUTIONS TO EXERCISES EXERCISE 9-12 (a)

The target cost formula is: Target cost = Market price – Desired profit. In this case, the market price is $15 and the desired profit is $4.50 (30% x $15). Therefore the target cost is $10.50 ($15.00 – $4.50).

(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 9-13 The following formula may be used to determine return on investment Return on investment = Investment x ROI percentage = $8,500,000 x 20% = $1,700,000 Return on investment per unit is then $17 ($1,700,000 ÷ 100,000) The target cost = $90 - $17 = $73 EXERCISE 9-14 (a)

(1) In this case the selling price would be $125 ($100 + [$100 X 25%]). The problem with the $125 is that it is unlikely that Mucky Duck will be able to sell any All-Body suits at that price. Market research seems to indicate that it will sell for only $110. (2) One way that Mucky Duck 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 $110 level.

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EXERCISE 9-14 (Continued) (b) In this case the amount would be the selling price of $110. (c)

The highest acceptable cost would be the target cost. The target cost is $85 as shown below:

Target cost = Market price – Desired profit = $110 – $25 = $85 EXERCISE 9-15 (a) Total cost per unit: Per Unit Direct materials .......................................................................... $17 Direct labour .............................................................................. 8 Variable manufacturing overhead ............................................ 11 Fixed manufacturing overhead ($360,000 ÷ 30,000) ................................................................ 12 Variable selling and administrative expenses ......................... 4 Fixed selling and administrative expenses ($150,000 ÷ 30,000) ................................................................. 5 $57 (b) Target selling price = $57 + (40% x $57) = $79.80 EXERCISE 9-16 (a) Total cost per unit: Per Unit Direct materials .......................................................................... $ 7.00 Direct labour .............................................................................. 9.00 Variable manufacturing overhead ............................................ 15.00 Fixed manufacturing overhead ($3,300,000 ÷ 500,000)............................................................ 6.60 Variable selling and administrative expenses ......................... 14.00 Fixed selling and administrative expenses ($1,500,000 ÷ 500,000) ............................................................ 3.00 $54.60 (b) Desired ROI per unit = (25% x $24,000,000) ÷ 500,000 = $12

. 9-11

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EXERCISE 9-16 (Continued) (c) Mark-up percentage using total cost per unit: $12 ÷ $54.60 = 21.98% (d) Target selling price = $54.60 + ($54.60 x 21.98%) = $66.60 EXERCISE 9-17 (a)

Total cost per session: Direct materials Direct labour 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 $2,058,000) ÷ 1,000 = $411.60

(c)

Mark-up percentage on total cost per session = $411.60 ÷ $1,960 = 21%

(d)

Target price per session = $1,960 + ($1,960 x 21%) = $2,371.60

EXERCISE 9-18 (a)

Fixed MOH per unit = $1,800,000 ÷ 3,000 = $600 per unit Fixed S & A expenses per unit = $327,000 ÷ 3,000 = $109 per unit

(b)

Desired ROI per unit = (0.20 x $49,600,000) ÷ 3,000 = $3,307 per unit

. 9-12

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EXERCISE 9-18 (Continued) (c) Direct materials .......................................................................... Direct labour .............................................................................. 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 55 109 1,506 3,307 $4,813

EXERCISE 9-19 (a)

Total budgeted time costs Budgeted hours of repair time Per hour cost Plus: profit margin Rate to be charged per hour of labour

(b)

Material loading percentage: $75,500 ÷ $400,000 = 18.875% + 25% = 43.875%

(c)

Job: Lindy Corporation—Rebuild spot welder Labour: 40 hours x $72 per hour Material charges: Invoice cost Material loading charge at 43.875% Total for labour and material

. 9-13

$281,200 7,600 $37.00 35.00 $72.00

$2,880.00 $2,500.00 1,096.88

3,596.88 $6,476.88

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EXERCISE 9-20 (a)

Labour charge: ($193,000 ÷ 6,000) + $38 = $32.17 + $38 = $70.17

(b)

Material loading % = ($88,000 ÷ $700,000) + 100% = 112.57%

(c)

Job: R. J. Builders—new home Labour: 80 hours x $70.17 per hour Material charges: Invoice cost Material loading charge at 112.57% Total for labour and material

$5,613.60 $40,000.00 45,028.00

85,028.00 $90,641.60

EXERCISE 9-21 (a)

Labour cost: $345,600 ÷ 12,000 = $28.80 Profit margin = $68.80 - $28.80 = $40.00

(b)

Material loading % = $165,060 ÷ $1,260,000 = 13.10% Profit margin = 93.10% - 13.10% = 80.00%

(c)

Labour: 150 hours x $68.80 per hour Material charges: Invoice cost Material loading charge at 93.10% Total for labour and material

. 9-14

$10,320.00 $60,000.00 55,860.00

115,860.00 $126,180.00

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EXERCISE 9-22 (a)

Given that the Small Motor Division has excess capacity, the minimum transfer price is the variable cost of $8.00 per unit.

(b)

Given no excess capacity, the minimum transfer price is $30, which is its variable cost ($8) plus the lost contribution margin ($30 - $8) on external sales.

(c)

The level of capacity plays a significant role in determining the appropriate transfer price. If a division has no excess capacity, it would not want to sell its product below a selling price that it could 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 9-23 (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 Cycle Division would reduce costs by $25,000 as follows: Current cost for body frame = $300 New price for body frame = $275 Cost savings = $300 - $275 = $25 x 1,000 units (2) The effect on FrameBody is that it makes $25 on each frame sold as shown below: Selling price for the body frame = $275 Incremental cost for the body frame = $250 (variable cost) Thus the FrameBody Division also gains $25,000 ($25 x 1,000). (3) As a result, the overall income from TravelFast increases $50,000 ($25,000 from Cycle Division and $25,000 from FrameBody).

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EXERCISE 9-23 (Continued) (b) (1) The answer would not change from (a)(1). Cycle Division would gain $25,000 if it purchased the frames from FrameBody. (2) However, FrameBody would incur a loss of $75,000: Lost contribution margin per cycle: $350 - $275 = $75 Total for 1,000 units = $75 x 1,000 = $75,000 (3) The effect on the overall income to TravelFast is a net loss of $50,000 ($25,000 increase from Cycle Division less $75,000 decrease from FrameBody). EXERCISE 9-24 (a) The minimum transfer price that NuVox should accept is: variable cost plus lost contribution margin, or ($34 – $4) + ($85 – $34) = $81 (b) The lost contribution margin per unit to the company is: Contribution margin lost by NuVox [($85 – $34) – $4] ........... Increased contribution margin to vehicle division from cost savings ($80 – $34).............................................. Net loss in contribution margin...............................................

$47 46 $ 1

Total lost contribution margin is $1 x 200,000 units = $200,000 (c) If management insists that it wants NuVox to provide the stereo units, and NuVox 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 NuVox by not giving them adequate credit for their contribution to the corporation’s contribution margin.

. 9-16

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EXERCISE 9-25 The minimum transfer price on this special order would be: ($135 – $6) + ($50 – $29) = $150. 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 9-26 (a) Minimum transfer price = ($126 – $6) + $0 = $120 (b) Minimum transfer price = ($126 – $6) + (160 – $126) = $154 (c) No. By forcing the Appraisal Department to accept the $150 per appraisal price, management is penalizing the Appraisal department. If they sold externally they could earn $34 while internally it would cost only $30; ($150 - $120) or $4,800 (1,200 units x $4.00) in total loss. *EXERCISE 9-27 Desired ROI per unit = (25% X $24,000,000) ÷ 500,000 = $12 Fixed MOH per unit = $3,300,000 ÷ 500,000 = $6.60 Fixed selling and admin per unit = $1,500,000 ÷ 500,000 = $3.00 (a) Absorption-cost pricing mark-up percentage

(b) Variable-cost pricing mark-up percentage

$12 + ($6.60 + $3) = 48% ($7 + $9 + $15 + $14)

$12 + ($14 + $3) = 77.13% ($7 + $9 + $15 + $6.60)

. 9-17

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*EXERCISE 9-28 (a)

Absorption-cost pricing mark-up percentage

(b)

Variable-cost pricing mark-up percentage

$20 + ($9 + $15) = 51.76% ($21 + $26 + $16 + $22)

$20 + ($22 + $15) = 79.17% ($21 + $26 + $16 + $9)

*EXERCISE 9-29 (a) Fixed MOH per unit = $1,800,000 ÷ 3,000 = $600 Fixed selling and admin per unit = $327,000 ÷ 3,000 = $109 (b)

Desired ROI per unit = (20% X $49,600,000) ÷ 3,000 = $3,307

(c)

Absorption-cost pricing $3,307 + ($55 + $109) = = 258.644% mark-up percentage $380 + $290 + $72 + $600 Target selling price = $1,342 + ($1,342 X 258.644%) = $4,813.00

(d) Variable-cost pricing mark-up percentage

$3,307 + ($600 + $109) = 503.89% $380 + $290 + $72 + $55

Target selling price = $797 + ($797 x 503.890%) = $4,813.00

. 9-18

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SOLUTIONS TO PROBLEMS—SET A PROBLEM 9-30A (a)

Total variable costs Materials Labour Indirect manufacturing costs Variable marketing costs

Total fixed costs Fixed indirect costs Administrative costs

$200,000 320,000 120,000 40,000 $680,000

$160,000 80,000 $240,000

Unit price = ($680,000 + $240,000) ÷ 4,000 = $230 Proof: [$230 + ($230 x 0.20)] x 500 = $138,000 (b)

Total variable manufacturing costs Materials $200,000 Labour 320,000 Indirect manufacturing costs 120,000 $640,000 Unit price = $640,000 ÷ 4,000 = $160 Proof: [$160 + ($160 x 0.20)] x 500 = $96,000

(c) With a capacity of 9,000 units, and regular production of only 4,000 units, AGC has plenty of excess capacity to produce the windshields for the transit authority. Their incremental cost of production in this case would be equal to the variable cost of producing the units, which is $160. However, they will want to earn some profit on the sale, so they would need to charge more than $160. On the other hand, the

. 9-19

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PROBLEM 9-30A (Continued) transit authority is not prepared to pay for costs that have not been incurred, so will reject the $230 amount. The most appropriate cost should be somewhere in between the two extremes. PROBLEM 9-31A

(a)

Total variable cost per unit Direct materials Direct labour Variable manufacturing overhead Variable S&A expenses

Total fixed costs Fixed manufacturing overhead Selling and admin expenses

$20 42 10 5 $77

$1,440,000 1,040,000 $2,480,000

Per unit fixed cost = $2,480,000 ÷ 80,000 = $31 Total cost per unit = $77 + $31 = $108 (b)

Desired ROI = $108 x 30% = $32.40

(c) Target selling price = $108.00 + $32.40 = $140.40 (d) Per unit variable cost = $77 (same as above) Per unit fixed cost = $2,480,000 ÷ 60,000 = $41.33 Total cost per unit = $77.00 + $41.33 = $118.33

. 9-20

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PROBLEM 9-32A

(a) (1) The minimum selling price that would not affect net income would be equal to the variable cost per unit. Direct materials Direct labour Variable overhead: 40%1 x $20,000

$50,000 80,000 8,000 $138,000

($1.5m – $0.9m) ÷ $1.5m = 40% (2) Accept the offer—as net income will increase by $12,000. Selling price Less: cost Net increase in income

$150,000 138,000 $12,000

(b) There are several advantages to using the variable-cost approach to pricing. (1) It provides the type of data that is consistent with costvolume-profit analysis used by management to make decisions about changes in volume and price. (2) It shows the incremental costs of accepting special orders. And (3) It avoids the allocation of fixed costs to products, which could be confusing when determining avoidable costs. A major disadvantage of the variable cost approach is its short-run focus. In the long run, a company must sell its products at a price sufficient to cover its total costs, including fixed costs. If it cannot obtain a price in excess of its full costs of production, the company will not remain economically viable. Another disadvantage is that the basic accounting data that is required to use this approach is not readily accessible, and must be determined outside of the normal financial reporting. . 9-21

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PROBLEM 9-33A

(a)

Total cost per unit Direct materials Direct labour Variable manufacturing overhead Variable S&A expenses Fixed MOH: ($600,000 ÷ 50,000) Fixed S&A: ($400,000 ÷ 50,000)

$50 25 20 18 12 8 $133

Desired ROI per unit = ($1,200,000 x 25%) ÷ 50,000 = $6 Mark-up percentage = $6 ÷ $133 = 4.51% Target selling price = $133 + $6 = $139

(b)

Total cost per unit Direct materials Direct labour Variable manufacturing overhead Variable S&A expenses Fixed MOH: ($600,000 ÷ 40,000) Fixed S&A: ($400,000 ÷ 40,000)

$50 25 20 18 15 10 $138

Desired ROI per unit = ($1,200,000 x 25%) ÷ 40,000 = $7.50 Mark-up percentage = $7.50 ÷ $138 = 5.43% Target selling price = $138 + $7.50 = $145.50

. 9-22

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PROBLEM 9-34A

(a)

(b)

(c)

Labour rate: $154,000 ÷ 5,000 hours Required profit per hour

Material loading charge %: $57,000 ÷ $100,000 = Required profit

$30.80 5.00 $35.80

57% 30% 87%

ST-CYR’S ELECTRONIC REPAIR SHOP Time and Material Price Quotation January 5, 2009

Labour: 20 hours x $35.80 per hour Material charges: Invoice cost Material loading charge at 87% Total for labour and material

. 9-23

$716.00 $500.00 435.00

935.00 $1,651.00

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PROBLEM 9-35A

(a)

The minimum transfer price for Division B would be variable costs, which are $7.00 per unit ($8.00, variable cost - $1.00, 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 = $7.00 (as in (a)) Opportunity cost = (($8 - $6) x 20,000) ÷ 10,000 = $4.00 Therefore the minimum transfer price should be $11.00 ($7 + $4) The maximum price would still be the external price paid by Division A, which is $10 per unit.

(c)

The number of lamps produced above capacity is 5,000; therefore, the opportunity cost will apply only to these 5,000 units. Variable costs = $7.00 (as in (a)) Opportunity cost = (($12 - $8) x 5,000) ÷ 15,000 = $1.33 Therefore the minimum transfer price should be $8.33 ($7 + $1.33) The maximum price would still be the external price paid by Division A, which is $10 per unit.

. 9-24

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PROBLEM 9-36A

(a) (1) Assuming no available capacity, the printing operation’s variable cost is $0.006 per page and its opportunity cost is $0.004 ($0.010 – $0.006) per page. The minimum transfer price would be $0.010 ($0.006 + $0.004). Therefore, the printing operation would not accept the internal transfer price of $0.007. (2) Assuming that the printing operation has available capacity, the printing operation’s variable cost is $0.006 and its opportunity cost is $0. The minimum transfer price would be $0.006 ($0.006 + $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 $0.001 ($0.007 – $0.006) 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. (b) 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. (c) The printing operation would lose: ($0.01 – $0.007) X 500 pages X 1,200 copies

= $1,800

Business Books would save: ($0.009 – $0.007) X 500 pages X 1,200 copies = $1,200 Overall loss to the company as a whole: $1,200 - $1,800 = $(600). . 9-25

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PROBLEM 9-37A

(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 – $4). The opportunity cost would be $8.50 ($22.50 – $14.00). Therefore, the minimum transfer price would be $18.50 ($10.00 + $8.50). Since the $20.00 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 Decrease in contribution margin, per chip Total lost contribution for 40,000 units

$21.00 20.00 $1.00 $(40,000)

Lost contribution margin by Chip Division: Unit contribution margin on internal sales ($20.00 - $10.00) Unit contribution margin on external sales ($22.50 - $14.00) Decrease in contribution margin, per unit Total lost contribution for 40,000 units Overall lost contribution margin for company

. 9-26

$10.00 8.50 $1.50 (60,000) $(100,000)

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PROBLEM 9-38A (a)

Contribution margin from selling 10,000 logs: [44.50 – (22.50 + 4.50)] x 10,000 = $175,000 Contribution margin from selling 10,000 poles: [90.00 – (22.50 + 4.50) – (35.00 + 4.50 + 2.50)] x 10,000 = $210,000 The net increase in contribution margin is $35,000. It would be beneficial for Wood Inc, as a whole, to transfer the logs at $29.50.

(b)

The transfer of logs at $29.50, instead of selling them externally at $44.50, will have the effect of transferring profits from the harvesting division to the sawing division. Since the two divisions are evaluated as profit centres, based on the contribution margin, the harvesting division will be penalized to the benefit of the sawing division.

(c)

The minimum transfer price is equal to the variable cost of $27.00 ($22.50 + $4.50). The maximum transfer price is equal to the market price of $44.50. The appropriate transfer price is the market price of $44.50 per log because the harvesting division is operating at full capacity and is a profit centre.

. 9-27

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PROBLEM 9-39A

(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 $85 ($50 + $35) and the opportunity cost would be $45 ($95 – $50). Therefore, the minimum transfer price would be $130 ($85 + $45). Since this is higher than the $105 transfer price, the Commcentre Manufacturing Division should reject the offer. (b) Assuming no available capacity, and that in order to produce the 10,000 special pagers, 14,000 standard pagers would be forgone, the minimum variable cost would be ($50 + $35) or $85 and the opportunity cost would be: [($95 - $50) x 14,000] ÷ 10,000 = $63 Therefore, the minimum transfer price would be $148 [($50 + $35) + $63]. Since the $160 transfer price being offered exceeds the minimum transfer price of $148, the Commcentre Manufacturing Division should accept the offer. (c) Assuming that the Commcentre Manufacturing Division has available capacity, variable cost would be $85 ($50 + $35) and the opportunity cost would be zero. Therefore, the minimum transfer price would be $85 ($85 + $0). Since the $105 transfer price being offered exceeds the $85 minimum transfer price, the offer should be accepted.

. 9-28

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PROBLEM 9-40A (a)

Per unit:

Sales Less: Costs Variable costs Transfer costs Total costs Contribution to income

Division A

Division B

Total Company

$1,400

$2,400

1,040

1,200 1,400 2,600 $(200)

2,240

1,040 $360

2,240 $160

(b)

The opportunity cost is the contribution margin from the market sales. 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) Maintain price, no transfers [500 x ($1,400 – $1,040)] = $180,000 (ii) Cut price, no transfers [(1,000 x (80% x $1,400)) - $1,040,000] = $80,000 (iii) Maintain price and transfers [500 x ($1,400 – $1,040)] + [500 x ($2,400 – $2,240)] = $260,000 The firm is better off by maintaining the current market price for Division A's product and transferring 500 units to Division B (Situation iii). A transfer price within the range of $1,040 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).

. 9-29

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PROBLEM 9-41A (a)

The Glass Division will earn the most profit at a level of 13,000 units. Volume

11,000

12,000

13,000

14,000

Revenue Cost (Vol. x cost/case) Profit

$135,300 117,810 $17,490

$144,000 126,240 $17,760

$152,750 134,550 $18,200

$158,900 142,520 $16,380

The Filling Division will earn the most profit at a level of 14,000 units, if they transfer the bottles internally. They will not be able to produce more than 14,000 units because they are limited by the Glass Division’s capacity. Volume

11,000

12,000

13,000

14,000

Revenue

$418,000

$450,600

$483,600

$515,200

Cost (Vol. x cost/case) Transfer cost Total cost Profit

267,520 135,300 402,820 $15,180

289,080 144,000 433,080 $17,520

310,830 152,750 463,580 $20,020

332,640 158,900 491,540 $23,660

The profit for the whole company will be optimized at a level of 14,000 units. Volume Revenue Less: Costs Glass Division Filling Division Total cost Profit

11,000 $418,000

12,000 $450,600

13,000 $483,600

14,000 $515,200

117,810 267,520 385,330 $32,670

126,240 289,080 415,320 $35,280

134,550 310,830 445,380 $38,220

142,520 332,640 475,160 $40,040

. 9-30

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PROBLEM 9-41A (Continued) (b) Market price is inappropriate whenever it does not reflect the firm's opportunity costs. For example if the supplying division cannot sell its total capacity on the open market, the market price will not fit, or if there are cost savings from dealing internally rather than externally.

. 9-31

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*PROBLEM 9-42A (a) Absorption-cost pricing: Computation of unit manufacturing cost and target selling price Direct materials ......................................................................... Direct labour.............................................................................. Variable manufacturing overhead ........................................... Fixed manufacturing overhead ($1,400,000 ÷ 80,000) ............ Unit manufacturing cost ................................................... Mark-up: 50% X $87.50 ............................................................ Target selling price ...................................................................

$ 20.00 40.00 10.00 17.50 87.50 43.75 $131.25

The mark-up of $43.75 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 labour.............................................................................. Variable manufacturing overhead ........................................... Variable selling and administrative expense .......................... Unit total variable cost ...................................................... Mark-up: 75% X $75 ................................................................. Target selling price ...................................................................

$ 20.00 40.00 10.00 5.00 75.00 56.25 $131.25

The mark-up of $56.25 per unit must cover fixed manufacturing and fixed selling and administrative costs plus provide a desired return on investment.

. 9-32

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*PROBLEM 9-43A

Absorption-cost pricing (a) Computation of unit manufacturing cost: Direct materials ........................................................................ Direct labour ............................................................................ Variable manufacturing overhead .......................................... Fixed manufacturing overhead ($120,000 ÷ 4,000) ................ Total manufacturing cost ................................................

Per Unit $100 70 20 30 $220

ROI per unit = (0.30 x $700,000) ÷ 4,000 = $52.50 Variable selling and administration per unit = $10 Fixed selling and administration per unit = ($102,000 ÷ 4,000) = $25.50 Mark-up % = ($52.50 + $10 + $25.50) ÷ $220 = 40% (b) Target price: $220 + [40% X $220) = $308 Proof of 30% ROI under absorption-cost pricing: WEATHER GUARD WINDOWS INC. Budgeted Absorption-Cost Income Statement (Tinted Window) Revenues (4,000 units x $308.00) Cost of goods sold (4,000 units x $220) Gross profit Selling and Admin [(4,000 units x $10) + $102,000] Net Income

$1,232,000 880,000 352,000 142,000 $210,000

Desired ROI = $210,000 ÷ $700,000 = 30% Mark-up percentage = ($210,000 + $142,000) ÷ $880,000 = 40% . 9-33

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*PROBLEM 9-43A (Continued) Variable-cost pricing (c) Computation of unit variable-cost: Direct materials ...................................................................... Direct labour........................................................................... Variable manufacturing overhead ........................................ Variable selling and administrative expenses ..................... Total variable cost ..........................................................

Per Unit $100 70 20 10 $200

ROI per unit = (0.30 x $700,000) ÷ 4,000 = $52.50 Fixed manufacturing overhead per unit = ($120,000 ÷ 4,000) = $30.00 Fixed selling and administration per unit = ($102,000 ÷ 4,000) = $25.50 Mark-up % = ($52.50 + $30 + $25.50) ÷ $200 = 54% (d) Target price: $200 + [54% X $200) = $308 Proof of 30% ROI under variable-cost pricing: WEATHER GUARD WINDOWS INC. Budgeted Variable-Cost Income Statement (Tinted Window) Revenues (4,000 units x $308.00) Variable costs (4,000 units x $200) Contribution margin Fixed costs ($120,000 + $102,000) Net Income

$1,232,000 800,000 432,000 222,000 $210,000

Desired ROI = $210,000 ÷ $700,000 = 30% Mark-up percentage = $210,000 + $222,000 ÷ $800,000 = 54%

. 9-34

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*PROBLEM 9-43A (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.

. 9-35

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PROBLEM 9-44A (a) Based on the general approach to transfer pricing, if the Screen Division has excess capacity to produce all the monitors required, the minimum transfer price would be equal to the incremental variable costs—in this case, $280. (b) If the Screen Division is forced to transfer monitors to the Laptop Division at incremental cost, all the profit from the “sale” of the monitors will appear in the Laptop Division statements. Several undesirable actions may be generated by this situation, such as: (1) The Screen Division, because they are not allowed to show any profit on their sales, may not be motivated to produce quality products, or deliver the products on time, which does not contribute to successful operations for the whole company. (2) Because the incremental costs are all being transferred to the Laptop Division, the Screen Division may not be motivated to work on keeping costs down, which reduces the profit for the whole company. This is intensified when managers feel they do not have autonomy to make their own decisions, and therefore, are not accountable for their actions. (3) This system of transfer pricing does not allow for the performance of the managers and divisions to be evaluated based on profits. If the Screen division only sells monitors to the Laptop Division, they will only recover variable costs, and they will always show a loss equal to their fixed costs. (c) A negotiated transfer price system will split the profits between divisions, thereby eliminating the problems as described in part (b). This system provides a sound basis for establishing transfer prices because both divisions are better off if they both use the proper decision rules.

. 9-36

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SOLUTIONS TO PROBLEMS—SET B PROBLEM 9-45B

(a)

Total variable cost per unit Direct materials Direct labour Variable manufacturing overhead Variable S&A expenses

Total fixed costs Fixed manufacturing overhead Selling and admin expenses

$18 30 9 4 $61

$1,440,000 1,080,000 $2,520,000

Per unit fixed cost = $2,520,000 ÷ 90,000 = $28 Total cost per unit = $61 + $28 = $89 (b)

Desired mark-up = $89 x 25% = $22.25

(c) Target selling price = $89.00 + $22.25 = $111.25 (d) Per unit variable cost = $61 (same as above) Per unit fixed cost = $2,520,000 ÷ 80,000 = $31.50 Total cost per unit = $61.00 + $31.50 = $92.50

. 9-37

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PROBLEM 9-46B (a)

Total variable costs Materials Labour Indirect manufacturing costs Variable marketing costs Total fixed costs Fixed indirect costs Administrative costs

$192,000 304,000 128,000 32,000 $656,000 $176,000 64,000 $240,000

Unit price = ($656,000 + $240,000) ÷ 4,000 = $224 Proof: [$224 + ($224 x 0.20)] x 500 = $134,400 (b)

Total variable manufacturing costs Materials $192,000 Labour 304,000 Indirect manufacturing costs 128,000 $624,000 Unit price = $624,000 ÷ 4,000 = $156 Proof: [$156 + ($156 x 0.20)] x 500 = $93,600

(c) With a capacity of 9,000 units, and regular production of only 4,000 units, CFC has plenty of excess capacity to produce the racks for the transit authority. Their incremental cost of production in this case would be equal to the variable cost of producing the units, which is $156. However, they will want to earn some profit on the sale, so they would need to charge more than $156. On the other hand, the transit authority is not prepared to pay for costs that are not relevant to their product, so will reject the $224 amount. The most appropriate cost should be somewhere in between the two extremes.

. 9-38

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PROBLEM 9-47B

(a)

Total cost per unit Direct materials Direct labour Variable manufacturing overhead Variable S&A expenses Fixed MOH: ($450,000 ÷ 50,000) Fixed S&A: ($360,000 ÷ 50,000)

$38.00 24.00 18.00 12.00 9.00 7.20 $108.20

Desired ROI per unit = ($1,500,000 x 20%) ÷ 50,000 = $6.00 Mark-up percentage = $6.00 ÷ $108.20 = 5.55% Target selling price = $108.20 + $6.00 = $114.20

(b)

Total cost per unit Direct materials Direct labour Variable manufacturing overhead Variable S&A expenses Fixed MOH: ($450,000 ÷ 40,000) Fixed S&A: ($360,000 ÷ 40,000)

$38.00 24.00 18.00 12.00 11.25 9.00 $112.25

Desired ROI per unit = ($1,500,000 x 20%) ÷ 40,000 = $7.50 Mark-up percentage = $7.50 ÷ $112.25 = 6.68% Target selling price = $112.25 + $7.50 = $119.75

. 9-39

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PROBLEM 9-48B

(a)

(b)

(c)

Labour rate: $156,600 ÷ 6,000 hours Required profit per hour

Material loading charge %: $53,600 ÷ $200,000 = Required profit

$26.10 7.00 $33.10

26.8% 50.0% 76.8%

ZIP’S AUTO BODY Time and Material Price Quotation January 10, 2009

Labour: 61 hours x $33.10 per hour Material charges: Invoice cost Material loading charge at 76.8% Total for labour and material

. 9-40

$2,019.10 $4,200.00 3,225.60

7,425.60 $9,444.70

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PROBLEM 9-49B (a) (1) Assuming no available capacity, the studio’s variable cost is $600 and its opportunity cost is $500 ($1,100 – $600). The minimum transfer price would be $1,100 ($500 + $600). Therefore, the studio would not accept the internal transfer price of $800. (2) Assuming that the studio has available capacity, the studio’s variable cost is $600 and its opportunity cost is $0. The minimum transfer price would be $600 ($600 + $0). Therefore, in this case, the recording studio should accept the offer to record internally. The $800 transfer price would provide a contribution margin of $200 ($800 – $600) per hour. Depending on its bargaining strength, the studio might want to ask for a transfer price higher than $800, since the company is saving money at any price below the $1,000 price that the record label pays to outside recording studios. (b) The advantages of having all of the company’s recording 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 studio to record internal work when it doesn’t feel it is in its best interest are: (1) the studio manager loses control over the studio’s performance, resulting in a loss of morale, and (2) the profitability of the studio, as well as the company as a whole, will decline. (c) The record label would save: ($1,000 – $800) X 80 hours = $16,000 The recording studio would lose: ($1,100 – $800) X 80 hours = $24,000 Therefore, the company as a whole would suffer a loss in contribution margin of $8,000 ($24,000 – $16,000). . 9-41

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PROBLEM 9-50B (a)

Using the general transfer-pricing approach, the minimum transfer price is $270, the variable costs. Because the Airbag Division is currently working at 75% of capacity it will not lose any external sales by making the transfer. Therefore, its opportunity cost is zero.

(b)

Transferring products internally at incremental cost has the following properties. • Goal congruence—is achieved because the Safety Division will pay the incremental costs instead of buying from an outsider at higher price. • Division performance—will be affected because transfer price does not exceed full costs. By selling at incremental costs and not full costs, the Airbag Division will show a loss. This loss, the result of the incremental cost-based transfer price, is not a good measure of the economic performance of the division. • Division autonomy—would not exist because when the transfer price is rule-based, the Airbag Division has no negotiating power in setting the transfer price.

(c)

The Airbag Division has excess capacity that it can use to supply airbags to the Safety Division. The Airbag Division will be willing to supply the airbags only if the transfer price equals or exceeds $270, its incremental costs of manufacturing the airbags. The Safety Division will be willing to buy airbags from the Airbag Division only if the price does not exceed $300 per airbag, the price at which the Safety division can buy airbags in the market from outside suppliers. Within the price range each division will be willing to transact with the other. Within the negotiated price range of $270 to $300, each division will be willing to transact with the other, which will eliminate the problems described in part (b).

. 9-42

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PROBLEM 9-51B

(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 $2.70 ($3.20 – $0.50). The opportunity cost would be $1.40 ($4.60 – $3.20). Therefore, the minimum transfer price would be $4.10 ($2.70 + $1.40). Since the $4.00 transfer price offered by the Pump Division is less than the minimum transfer price, the Washer Division should not sell the washer internally. (b) If the Washer Division rejects the offer, the contribution margin earned by the Washer Division is $1.40, while the additional cost the Pump Division would have to pay externally would be only $0.30. The advantage ($1.10 x 50,000 units) is calculated as follows: Pump Division: Cost of buying externally, per unit Cost of buying internally, per unit Decrease in contribution margin, per chip Total lost contribution for 50,000 units

Washer Division: Unit contribution margin on external sales ($4.60 - $3.20) Increased contribution for 50,000 units Overall increased contribution margin for company

. 9-43

$4.30 4.00 $0.30 $(15,000)

$1.40 70,000 $55,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 9-52B

(a) Assuming no available capacity, variable cost of the special engine would be $96 ($55 + $41) and the opportunity cost would be $33 ($88 – $55). Therefore, the minimum transfer price would be $129 ($96 + $33). Since this is higher than the $110 transfer price, the Heartland Engine Division should reject the offer. (b) Assuming no available capacity, and that in order to produce the 8,500 special units, 12,000 standard units would be forgone, the minimum variable cost would be $96 ($55 + $41) and the opportunity cost would be: (($88 - $55) x 12,000) ÷ 8,500 = $46.59 Therefore, the minimum transfer price would be $142.59 [($55 + $41) + $46.59]. Since the $170 transfer price being offered exceeds the minimum transfer price of $142.59, the Heartland Engine Division should accept the offer. (c) Assuming that the Heartland Engine Division has available capacity, variable cost would be $96 ($55 + $41) and the opportunity cost would be zero. Therefore, the minimum transfer price would be $96 ($96 + $0). Since the $110 transfer price being offered exceeds the $96 minimum transfer price, the offer should be accepted.

. 9-44

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PROBLEM 9-53B

(a)

Comput Industries is fixing the transfer price below the market price to minimize total taxes paid on profits. Since Heavencomput is located in a tax shelter, it is more profitable for the company as a whole to make as much profit as possible in that subsidiary. Taxation authorities are aware of this situation, and this is why transfer-pricing rules require the use of market value.

(b)

Since the two subsidiaries are evaluated as profit centres, the consequences of the transfer pricing policy are important. Transferpricing affects the distribution of profits among the subsidiaries, and since division managers' compensation is affected by divisional profits, Cancomput is penalized. It should be considered as a cost centre because it has no control over the price of the component. On the other hand, Heavencomput is making more profit than it actually generates because of the transfer-pricing policy.

(c)

Many transfer pricing methods can be used, such as market-based transfer prices, variable-cost transfer prices, full-cost transfer prices, or negotiated transfer prices. Another solution is to use a double price, one for the tax and the other for the performance measure.

. 9-45

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PROBLEM 9-54B

(a) Net income calculations (in 000’s) Revenue Costs: Bottles Perfume Total costs Net Income

(b)

Bottle $10,020

Perfume $63,900

Corp. $63,900

7,200

10,020 48,420 58,440 $5,460

7,200 48,420 55,620 $8,280

7,200 $2,820

The optimal production volume for each division and the corporation are determined below: (1)

Bottle Division: 6,000,000 units

Revenue Costs: Bottles Perfume Total costs Net Income

(2)

2,000 $4,000

4,000 $7,000

6,000 $10,020

3,200

5,200

7,200

3,200 $800

5,200 $1,800

7,200 $2,820

Perfume Division: 4,000,000 units

Revenue Costs: Bottles Perfume Total costs Net Income

2,000 $25,000

4,000 $45,600

6,000 $63,900

4,000 16,400 20,400 $4,600

7,000 32,400 39,400 $6,200

10,020 48,420 58,440 $5,460

. 9-46

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PROBLEM 9-54B (Continued) (3) Corporation: 6,000,000 units Revenue Costs: Bottles Perfume Total costs Net Income

2,000 $25,000

4,000 $45,600

6,000 $63,900

3,200 16,400 19,600 $5,400

5,200 32,400 37,600 $8,000

7,200 48,420 55,620 $8,280

While the Bottle Division and the company as a whole can optimize their profit by producing and selling 6 million units, the Perfume Division should sell 4 million units to make the highest net profit. This illustrates the importance of having transfer prices that will motivate managers to act in the best interest of the corporation, and to make decisions that address the operations of the company as a whole, instead of focusing on only their division.

. 9-47

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*PROBLEM 9-55B (a) Absorption-cost pricing: Computation of unit manufacturing cost and target selling price Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead ($1,440,000 ÷ 90,000) Unit manufacturing cost Mark-up: 50% X $73.00 Target selling price

$18.00 30.00 9.00 16.00 73.00 36.50 $109.50

The mark-up of $36.50 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 labour Variable manufacturing overhead Variable selling and administrative expenses Unit variable manufacturing cost Mark-up: 80% X $61.00 Target selling price

$18.00 30.00 9.00 4.00 61.00 48.80 $109.80

The mark-up of $48.80 per unit must cover fixed manufacturing and fixed selling and administrative costs plus provide a desired return on investment.

. 9-48

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*PROBLEM 9-56B (a) Absorption-cost pricing: Computation of unit manufacturing cost Direct materials Direct labour Variable manufacturing overhead Fixed manufacturing overhead ($180,000 ÷ 3,000) Unit manufacturing cost

$140 80 40 60 $320

Desired ROI per unit = (0.30 x $700,000) ÷ 3,000 = $70 Variable selling and administration per unit: $20 Fixed selling and administration per unit: $90,000 ÷ 3,000 = $30 Mark-up percentage = ($70 + $20 + $30) ÷ $320 = 37.5% (b) Target price: $320 + [37.5% x $320) = $440 Proof of 30% ROI under absorption-cost pricing: SANTANA FURNITURE INC. Budgeted Absorption-Cost Income Statement (Leather Recliner Sofa) Revenues (3,000 units x $440) Cost of goods sold (3,000 units x $320) Gross profit Selling and Admin [(3,000 units x $20) + $90,000] Net Income

$1,320,000 960,000 360,000 150,000 $210,000

Desired ROI = $210,000 ÷ $700,000 = 30% Mark-up percentage = ($210,000 + $150,000) ÷ $960,000 = 37.5% . 9-49

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*PROBLEM 9-56B (Continued) (c)

Variable-cost pricing Computation of unit variable cost Direct materials Direct labour Variable manufacturing overhead Variable selling and administration Unit manufacturing cost

$140 80 40 20 $280

Desired ROI per unit = (0.30 x $700,000) ÷ 3,000 = $70 Fixed manufacturing overhead per unit: $180,000 ÷ 3,000 = $60 Fixed selling and administration per unit: $90,000 ÷ 3,000 = $30 Mark-up percentage = ($70 + $60 + $30) ÷ $280 = 57.143% (d) Target price: $280 + (57.143% x $280) = $440 Proof of 30% ROI under variable-cost pricing: SANTANA FURNITURE INC. Budgeted Variable-Cost Income Statement (Leather Recliner Sofa) Revenues (3,000 units x $440) Variable costs (3,000 units x $280) Contribution margin Fixed costs ($180,000 + $90,000) Net Income

$1,320,000 840,000 480,000 270,000 $210,000

Desired ROI = $210,000 ÷ $700,000 = 30% Mark-up percentage = ($210,000 + $270,000) ÷ $840,000 = 57.143%

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*PROBLEM 9-56B (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 variable-cost based and therefore 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.

. 9-51

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PROBLEM 9-57B

(a)

The minimum transfer price for Division B would be variable costs, which are $27.00 per unit ($29.00, variable cost - $2.00, variable selling expense that can be avoided in sales are internal). The maximum price would be the external price paid by Division A, which is $30 per unit.

(b)

Minimum transfer price = variable costs + opportunity cost Variable costs = $27.00 (as in (a)) Opportunity cost = (($18 - $15) x 20,000) ÷ 10,000 = $6.00 Therefore the minimum transfer price should be $33.00 ($27 + $6) The maximum price would still be the external price paid by Division A, which is $30 per unit. When the minimum transfer price is greater than the market value of the unit, then there should be no internal transfer.

(c)

The number of ties produced above capacity is 5,000; therefore, the opportunity cost will apply only to these 5,000 units. Variable costs = $27.00 (as in (a)) Opportunity cost = (($35 - $29) x 5,000) ÷ 15,000 = $2.00 Therefore the minimum transfer price should be $29 ($27 + $2) The maximum price would still be the external price paid by Division A, which is $30 per unit.

. 9-52

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PROBLEM 9-58B (a)

Per unit:

Sales Less: Costs Variable costs Transfer costs Total costs Contribution to income

Div A

Div B

Company

$2,400

$3,400

2,040

1,200 2,400 3,600 $(200)

3,240

2,040 $360

3,240 $160

Although Division B is showing a negative contribution, the total company is showing an increase. Therefore, transfers should be made at market prices less any avoidable costs. In the current situation, with the managers having full autonomy, Division B would probably not accept the market-based transfer price. (b)

If Division A can sell all of its product in the open market, then the transfer price would be the market price: Minimum transfer price = variable cost + opportunity cost. $2,040 + ($2,400 - $2,040) = $2,400 or market price

(c) (i) Maintain price, no transfers [500 x ($2,400 - $2,040)] = $180,000 Increase (ii) Cut price, no transfers [1,000 x ($2,120- $2,040)] = $80,000 Increase (ii) Maintain price and transfer 500 units to B (500 x ($2,400 - $2040)) + (500 x ($3,400 – $3,240)) = $260,000 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 $2,040 to $2,400 would be needed to motivate both divisional managers to engage in the transfers. An optimal transfer price cannot be determined from the information . 9-53

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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given (even with full information, the best transfer price in the range may not be determinable).

. 9-54

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SOLUTIONS TO CASES CASE 9-59B (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 incentive 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 $2 per set. The bearing division would find this very undesirable. Instead of making a profit of $13 ($35 – $22) per set, it would just be breaking even. The overall company would be worse off because it would be losing $13 per set of profit and only making $2 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.

. 9-55

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(a)

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CASE 9-60 Since the total production can be sold on the market, the transfer price should be equal to the market price, $225. If the transfer price is set below the market price, Vancouver's performance would be lower and Kamloops' would be better.

(b)

Since Vancouver has some excess capacity (3,000 units), the minimum transfer price would be equal to variable costs, $140. However, if the transfer price is equal to $140, Vancouver would not earn any additional profit. The difference between the transfer price and $140 will represent an increase in Vancouver's profits. For instance, if the transfer price is set at $175, the increase in Vancouver's profit would represent $105,000 [3,000 x ($175 – $140)].

(c)

Since Vancouver has some excess capacity (2,000 units), the minimum transfer price for these units should be equal to variable costs, $140. The other 1,000 units should be transferred at a price at least equal to variable costs + opportunity costs. Opportunity costs here are equal to the contribution margin of the units sold on the market. Thus, the transfer price for these units should be $140 + ($225 - $140) = $225. The first 2,000 units should be sold at $140 and the other 1,000 units at $225. Or, use the transfer pricing formula as follows. Transfer price = variable costs + opportunity costs Variable costs per unit = $140 Opportunity costs per unit = [($225 - $140) x 1,000] ÷ 3,000 = $28.33 Transfer price = $140 + $28.33 = $168.33

(d)

Advantages: • can generate savings for the divisions and the firm • can promote collaboration between divisions Disadvantages: • are time-consuming • can produce conflicts between divisions

. 9-56

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CASE 9-61 (a)

Variable cost of raw diamonds = 75% x $60 = $45 Contribution margin from selling 300,000 kilograms of raw diamonds: ($75 – $45) x 300,000 = $9,000,000 Contribution margin from selling 300,000 kilograms of polished diamonds: [$175 – $45 – (10 + 30 + 20)] x 300,000 = $21,000,000 Net increase in contribution margin is $12,000,000. Therefore, it is beneficial for Solco to transfer the raw diamonds at $60 per kilogram. Another approach Selling 1 kilogram of polished diamonds increases revenues by $100 (from $75 to $175) while variable costs increase by $60 (from $45 to $105), so there is a net increase in income of $40 x 300,000 = $12,000,000.

(b)

In the case where there is excess capacity, it is sometimes acceptable to sell below full cost but above variable costs. This provides for a positive contribution margin, which increases income. In this situation, the full cost policy is justified because the mining division is operating at full capacity.

(c)

Minimum transfer price is equal to variable costs of $45 (75% x $60), and the maximum transfer price is the market price of $75.

(d)

The appropriate transfer price is the market price of $75 per kilogram because the mining division is operating at full capacity.

(e)

If the mining division was not operating at full capacity, the appropriate transfer price would be between $45 and $75.

. 9-57

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CASE 9-62

(a)

Variable costs: Compressor Other materials Direct labour Variable overhead Variable selling

$70.00 37.00 30.00 45.00 18.00 $200.00

Fixed costs: Fixed overhead Fixed selling Fixed administrative

$480,000 285,000 570,000 $1,335,000

New selling price = $400 - $20 = $380 New sales volume = 15,000 + 2,400 = 17,400 Sales – Variable costs – fixed costs = Net income ($380 x 17,400) – ($200 x 17,400) – $1,335,000 = $1,797,000 Yes, the firm should reduce its selling price. Income will increase by $1,797,000 - $1,665,000 = $132,000. (b)

If the compressor division supplies WindAir with 17,400 compressors, the minimum transfer price would be variable cost plus opportunity cost. Variable cost = ($12.00 - $1.50) + $8.00 + $10.00 = $28.50.

. 9-58

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CASE 9-62 (Continued) The raw materials for the new compressor will cost $1.50 less than the previous units, and the variable selling expenses will be avoided if the compressor division supplies WindAir. Opportunity cost = (CM on external sales lost) ÷ (# of units supplied to WindAir). The total demand for units is 64,000 for external sale plus 17,400 for transfer to WindAir. The compressor division has the capacity to produce 75,000 compressors. In order to supply WindAir, the compressor division would have to give up 6,400 external sales units (64,000 + 17,400 – 75,000). Variable cost of current sales = $12 + $8 + $10 + $6 = $36 Opportunity cost = [($100 - $36) x 6,400] ÷ 17,400 = $23.54 The minimum transfer price would be $28.50 + $23.54 = $52.04. The $50 price offered by WindAir is less than the minimum transfer price; therefore, the compressor division should reject the offer. They would be losing about $35,500 [($52.04 - $50.00) x 17,400]. (c)

Cost savings from the internal transfer: [($70.00 - $28.50) x 17,400] Lost CM from forgone external sales: [($100 - $36) x 6,400] Corporate advantage from internal sales

$722,100 409,600 $312,500

Yes, the corporation (and Wind Air) would be better off making the internal transfer. However, to motivate the compressor unit to make the sale, Wind Air will have to offer a price in excess of the minimum transfer price of $52.04. Note that, at any price less than $70, Wind Air is better off.

. 9-59

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CASE 9-63 (a)

Using the general transfer-pricing approach, the minimum transfer price is equal to the variable costs of $4.60, ($1.60 + $2.00 + $1.00) if the transistor division has excess capacity, or the market price of $7.40 if the transistor division is operating at full capacity.

(b)

The maximum transfer price at which the systems division would buy the transistor from the internal division is the market price $7.40 per unit.

(c)

Transferring products internally at incremental cost ($4.60) instead of paying an outside source $5.80 has the following properties if the transistor division has excess capacity. • Goal congruence—Yes, it will be achieved because the buying division will pay the incremental costs instead of buying from an outsider at the higher price of $5.80. • Division performance—No, because the transfer price does not exceed full costs. By selling at incremental costs and not full costs, the transistor division will show a loss. This loss, the result of the incremental cost-based transfer price, is not a good measure of the economic performance of the division.

(d)

The board division has excess capacity that it can use to supply its products to the systems division. The board division will be willing to sell its products internally only if the transfer price equals or exceeds $27, its incremental costs of manufacturing the unit. The systems division will be willing to buy PCBs internally only if the price does not exceed $36.75 per PCB, which is equal to the marked-up price not the market price (because this board is not sold externally). At a negotiated transfer price of $33 per unit, the board division realizes a profit of $3.60 per board ($33.00 — $29.40), and the systems division realizes a reduction in cost of $3.75 per board ($36.75 - 33.00). Within the price range each division will be willing to transact with the other.

. 9-60

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CASE 9-63 (Continued) The negotiated transfer price has the following advantages. • Goal congruence—will be achieved. • Division performance—Yes, because both the buying and selling divisions have participated in the negotiations and are likely to believe they have agreed on the best deal possible. • Division autonomy—Yes, determining transfer prices by division managers will enhance the autonomy of the divisions.

. 9-61

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CASE 9-64 (a) Jay 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 Jay 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 labour Variable overhead Variable selling and administrative expenses

Basic $0.25 0.00 0.10

Deluxe $0.75 0.40 0.20

Premium $1.05 2.40 0.20

0.10 $0.45

0.10 $1.45

0.10 $3.75

Fixed overhead per unit: $112,500 ÷ 45,000 = $2.50

. 9-62

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CASE 9-64 (Continued) Fixed selling and administrative per unit: $121,500 ÷ 45,000 = $2.70 Desired ROI per unit: ($324,000 x 0.25) ÷ 45,000 = $1.80 Computation of selling price (45,000 units) Basic $0.45 5.20 5.65 1.80 $7.45

Variable cost per unit Fixed cost per unit Total unit cost Desired ROI per unit Target selling price

Deluxe $1.45 5.20 6.65 1.80 $8.45

Prem. $3.75 5.20 8.95 1.80 $10.75

Income statement for Year 1 (c)

Revenues: Basic ($7.45 x 3,000) Deluxe ($8.45 x 31,000) Premium ($10.75 x 9,000) Less: variable costs Basic ($0.45 x 3,000) Deluxe ($1.45 x 31,000) Premium ($3.75 x 9,000) Contribution margin Less: fixed costs ($112,500 + $121,500) Net income

$22,350 261,950 96,750 1,350 44,950 33.750

$381,050

80,050 301,000 234,500 $67,000

ROI = $67,000 ÷ $324,000 = 20.68%; his desired ROI was 25%. (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 amortization 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 deluxe and premium. . 9-63

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CASE 9-65

(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) Giant services many different locations. If it loses money for a while on one location, it can make it up on other locations. Mosquito 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 Giant’s actions are anti-competitive, it can take Giant to court. The problem is that anti-competitive behaviour is difficult to prove, and legal remedies are slow. It is likely that Mosquito 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 Giant’s. This way, it might not have caused Giant 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 behaviour is difficult to say. On the one hand, it can be argued that Giant 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. . 9-64

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-9 (a)

Total Hours Per Hour Total Cost / = Charge Labour wages $ 240,000 5,760 $ 41.67 Clerical and accountant wages 60,000 5,760 10.42 Other overhead 53,950 5,760 9.37 Total hourly cost 353,950 5,760 $ 61.46 Profit margin 12.00 Rate charged per hour of labour $ 73.46 (b)

Supervisor's salary Clerical and accountant wages Drainage supplies manager Other overhead

Material Total Invoice Material Loading Cost for Loading Charges Materials Percentage $ 60,000 4,000 40,000 21,000 $125,000

Profit margin Material loading percentage

$ 642,000

19.47% 15.00% 34.47%

(c)

. 9-65

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WCP-9 (Continued) Waterways Corporation Time and Materials Price Quote for Sports Field Drainage Labour charges (480 hours @ $73.46) Material charges Cost of materials Material loading charge (34.47% x $80,000) Total price for sports field drainage

. 9-66

$ 35,260.80 $ 80,000 $ 27,576

107,576.00 $ 142,836.80

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LEGAL NOTICE Copyright © 2009 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved. The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence. The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.

. 9-67

CHAPTER 10 Budgetary Planning ASSIGNMENT CLASSIFICATION TABLE Exercises

A Problems

B Problems

1, 2

2. State the essentials of effective budgeting.

3, 4

3. Identify the budgets that comprise the master budget.

5, 6, 7, 8, 9

11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 21

28, 29, 30, 31, 32, 33, 35, 36, 37, 39

40, 41, 42, 43, 46, 47, 48, 49

4. Describe the sources for preparing the budgeted income statement.

10, 11, 12, 13, 8 14, 15, 16, 17, 18

21, 27

28, 29, 31, 35, 37

40, 42, 43, 47

5. Explain the principal sections of a cash budget.

19, 20,

22, 23, 24, 25, 26

32, 33, 34, 35, 36, 37, 38, 39

44, 45, 46, 48, 50

6. Explain the applicability 21, 22 of budgeting in nonmanufacturing companies

25, 26, 27

Study Objectives

Questions

1. Indicate the benefits of budgeting.

Brief Exercises

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

43, 47, 48

10-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

28A

Prepare a budgeted income statement and supporting budgets.

Moderate

40-50

29A

Prepare sales, production, direct materials, direct labour, and income statement budgets.

Moderate

40-50

30A

Prepare production and direct labour budgets.

Simple

20–30

31A

Prepare sales and production budgets and compute the cost per unit under two plans.

Moderate

30-40

32A

Compute cash disbursements for one month.

Moderate

20-30

33A

Prepare a cash budget for two months.

Moderate

30-40

34A

Prepare a cash budget for a month.

Moderate

30-40

35A

Prepare purchases and income statement budgets for a merchandiser.

Simple

20–30

36A

Prepare a raw materials purchase budget in dollars.

Simple

20-30

37A

Prepare a budgeted income statement and balance sheet.

Challenging

50-60

38A

Prepare a cash budget for a year.

Moderate

40-50

39A

Prepare a cash budget.

Challenging

30-40

40B

Prepare a budgeted income statement and supporting budgets.

Moderate

40-50

41B

Prepare sales, production, direct materials, direct labour, and income statement budgets.

Moderate

40-50

42B

Prepare sales and production budgets and compute the cost per unit under two plans.

Moderate

30-40

43B

Prepare a merchandise purchases budget and a budgeted income statement

Simple

20-30

44B

Prepare a cash budget for a year.

Moderate

30-40

45B

Prepare cash receipts, disbursements, and a cash budget for two months.

Moderate

30-40

10-2

ASSIGNMENT CHARACTERISTICS TABLE (Continued) 46B

Prepare a cash budget

Moderate

30–40

47B

Prepare a purchases budget and budgeted income statements.

Moderate

30-40

48B

Compute purchases and disbursements for a merchandiser.

Simple

15-20

49B

Prepare production and direct labour budgets.

Moderate

20-30

50B

Prepare a cash budget for a month.

Moderate

20-30

10-3

Study Objective

Knowledge

Comprehension

1. Indicate the benefits of budgeting.

Q1, E11

2. State the essentials of effective budgeting.

Q4, E11

Application

3. Identify the budgets that Q5, Q7,Q8 comprise the master budget.

Q6, Q9, E11

BE2 E15 BE3 E16 BE4 E17 BE5 E18 BE6 E19 BE7 E21 E12 E13 E14

4. Describe the sources for Q18 preparing the budgeted income statement.

Q10, Q11

Q12 BE8 P35A Q13 E21 P37A Q14 E27 P40B Q15 P28A P43B Q16 P29A P47B Q17

5. Explain the principal sections of a cash budget.

6. Explain the applicability Q21 of budgeting in nonmanufacturing companies

P28A P40B BE1, P29A P41B P49B P30A P43B P32A P46B P33A P47B P35A P48B P36A P37A P39A

Q20, BE9, E22, E23, E24, E25, E26, P32A, P33A, P35A, P36A, P37A, P38A, P39A, P44B, P45B, P46B, P48B

Q19

Q22

Analysis

BE10, E25, E26, E27, P43B, P47B, P48B

Synthesis

Evaluation

P31A, P42B

P34A, P50B

BLOOM’ S TAXONOMY TABLE

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

10-3

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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 means 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) res earch 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. Accounting becomes the translator of the budget and communicates the budget to all areas of responsibility. It also prepares periodic performance 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 ar e impossible. The most common budget period is one year.

. 10-2

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Questions Chapter 10 (Continued) 6.

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 s, and 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, so it costs more. Another disadvantage of participative budgeting is that it may enable managers to game the system through such practices as budgetary slack.

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 budget is developed within the framework of a sales forecast, which shows projected sales for the industry, and the company’s expected share of these sales.

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 170,000 (160,000 + 20,000 –10,000 = 170,000). 13. The desired ending direct materials units are 9,000 (54,000 + 7,000 –52,000 = 9,000). 14. Total budgeted direct labour costs are $720,000 (90,000 x .5 x $16 = $720,000).

. 10-3

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Questions Chapter 10 (Continued) 15. (a) Manufacturing overhead rate based on direct labour cost is 55% [$168,000 + $162,000 = $330,000; $330,000 ÷ (160,000 X 1/4 X $15/hr.) = 55%]. (b) Manufacturing overhead rate per direct labour hour is $8.25 ($330,000 ÷ 40,000). 16. The first quarter budgeted selling and administrative expenses are $80,000 [(10% x 200,000) + $60,000]. The second quarter total is $85,000 [(10% X $250,000) + $60,000]. 17. The budgeted cost per unit of product is $46 ($10 + $20 + $16). Gross profit per unit is $23 ($69 –$46). Total budgeted gross profit is $575,000 (25,000 X $23). 18.

The supporting schedules are the budgets for sales, direct materials, direct labour, 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—$400,000 x 45% = $180,000. February—$400,000 x 50% = $200,000. March—$400,000 x 4% = $16,000.

21.

We determine cost of goods sold by taking beginning inventory, adding purchases, and then subtracting ending inventory. So the formula for required purchases would be:: Budgeted cost of goods sold + desired ending merchandise inventory – beginning merchandise inventory = required merchandise purchases.

22.

In a service enterprise, expected revenues can be obtained from expected output or expected input. The former is based on anticipated billings of clients for services rendered. The latter is based on expected billable time of the professional staff.

. 10-4

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 Sales Budget Production Budget

Direct Materials Budget

Direct Labour Budget

Manufacturing Overhead Budget

Operating Budgets

Budgeted Balance Sheet

Financial Budgets

Selling and Administrative Expense Budget Budgeted Income Statement

Capital Expenditure Budget

Cash Budget

. 10-5

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BRIEF EXERCISE 10-2 MALTZ COMPANY Sales Budget For the Year Ending December 31, 2009 Quarter Unit sales Unit price Total sales

1 10,000 $70 $700,000

2 12,000 $70 $840,000

3 14,000 $70 $980,000

4 18,000 $70 $1,260,000

Year 54,000 $70 $3,780,000

BRIEF EXERCISE 10-3 MALTZ COMPANY Production Budget For the Six Months Ending June 30, 2009 Quarter Expected unit sales Add: Desired ending finished goods 1, 3 Total required units Less: Beginning finished goods inventory 2 Required productions in units 1

12,000 X 20%

10,000 X 20%

. 10-6

1 10,000 2,400 12,400 2,000 10,400 3

2 12,000 2,800 14,800 2,400 12,400

14,000 X 20%

Total 22,000 2,800 24,800 2,000 22,800

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BRIEF EXERCISE 10-4 GOMEZ COMPANY Direct Materials Budget For the Month Ending January 31, 2010 Units to be produced Direct materials per unit Total kilograms required for production Add: desired ending inventory (20% x 5,500 x 2) Total materials required Less: beginning materials inventory Direct materials purchases Cost of kilogram Total cost of direct materials purchases

4,000 2 8,000 2,200 10,200 1,600 8,600 $6.00 $51,600

BRIEF EXERCISE 10-5 TRACEY COMPANY Direct Labour Budget For the Six Months Ending June 30, 2009 Quarter 1 5,000 1.8 9,000 $14.00 $126,000

Units to be produced Direct labour hours per unit Total direct labour hours required Direct labour cost per hour Total direct labour cost

. 10-7

2 6,000 1.8 10,800 $14.00 $151,200

Total 11,000 1.8 19,800 $14.00 $277,200

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BRIEF EXERCISE 10-6 SAVAGE INC. Manufacturing Overhead Budget For the Year Ending December 31, 2009 Quarter Variable costs Fixed costs Total

1 $20,000 35,000 $55,000

2 $24,000 35,000 $59,000

3 $28,000 35,000 $63,000

4 $32,000 35,000 $67,000

Year $104,000 140,000 $244,000

BRIEF EXERCISE 10-7 RADO COMPANY Selling and Administrative Expense Budget For the Year Ending December 31, 2009 Quarter Variable costs Fixed costs Total

1 $25,000 40,000 $65,000

2 $30,000 40,000 $70,000

. 10-8

3 $35,000 40,000 $75,000

4 $40,000 40,000 $80,000

Year $130,000 160,000 $290,000

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BRIEF EXERCISE 10-8 RAJIV COMPANY Budgeted Income Statement For the Year Ending December 31, 2009 Sales Cost of goods sold (50,000 X $22) Gross profit Selling and administrative expenses Income before income taxes Income tax expense Net income

$2,000,000 1,100,000 900,000 300,000 600,000 150,000 $450,000

BRIEF EXERCISE 10-9 CHOW INDUSTRIES Schedule of Budgeted Cash Receipts For the First Quarter

Cash/Credit (70%, 30%) January, $200,000 February, $260,000 March, $310,000

Collections from Customers January February March $140,000

$140,000

. 10-9

$60,000 182,000 $242,000

$78,000 217,000 $295,000

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BRIEF EXERCISE 10-10 REEBLES WHOLESALERS Statement of Budgeted Purchases For the month of April Budgeted cost of goods sold ($400,000 x 60%) Add: Desired ending inventory ($475,000 x 60% x 20%) Total inventory required Less: Beginning inventory ($400,000 X 60% X 20%) Required merchandise purchases for April

. 10-10

$240,000 57,000 297,000 48,000 $249,000

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SOLUTIONS TO EXERCISES EXERCISE 10-11 MEMO To Jack Bruno, President From: Student Re: Budgeting I am glad Black Rose 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 labour 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 formalize their goals. 2. It provides definite objectives for evaluating performance. 3. It creates an early warning system for potential problems. 4. It facilitates the coordination of activities within the business. 5. It results in greater management awareness of the entity’s overall operations. 6. It motivates personnel throughout the organization to meet planned objectives. In order maximize these benefits, it is essential that budgeting takes 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 assumptions, please contact me. . 10-11

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EXERCISE 10-12 VOSSER ELECTRONICS INC. Sales Budget For the Six Months Ending June 30, 2009 Product XQ-103 Sales in units Unit selling price Total sales of XQ-103

Quarter 1 20,000 $12.00 $240,000

Product XQ-104 Sales in units Unit selling price Total sales of XQ-103

Total 45,000 $12.00 $540,000

Quarter 1 12,000 $25.00 $300,000

All Products Total sales

2 25,000 $12.00 $300,000

2 15,000 $25.00 $375,000

Total 27,000 $25.00 $675,000

Quarter 1 $540,000

. 10-11

2 $675,000

Total $1,215,000

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EXERCISE 10-13 ROCHE AND YOUNG, CAs Service Revenue Budget For the Year Ending December 31, 2009 Quarter Auditing 1 Billable hours 2,200 Rate $80.00 Total revenue $176,000

2 1,600 $80.00 $128,000

3 2,000 $80.00 $160,000

4 2,400 $80.00 $192,000

Year 8,200 $80.00 $656,000

4 2,500 $90.00 $225,000

Year 9,900 $90.00 $891,000

Quarter Tax: 1 Billable hours 3,000 Rate $90.00 Total revenue $270,000

2 2,400 $90.00 $216,000

3 2,000 $90.00 $180,000

Quarter Consulting: 1 Billable hours 1,500 Rate $100.00 Total revenue $150,000

2 1,500 $100.00 $150,000

3 1,500 $100.00 $150,000

4 1,500 $100.00 $150,000

Year 6,000 $100.00 $600,000

Total Revenue $596,000

$494,000

$490,000

$567,000

$2,147,000

EXERCISE 10-14 WAYANS COMPANY Production Budget-- Product HD-240 For the Year Ending December 31, 2009 Quarter Unit Sales Add: ending Inventory1 Total required Less: beg. inventory Total 1

1 5,000 3,500 8,500 2,500 6,000

50% of next quarter’s sales.

2 7,000 4,000 11,000 3,500 7,500 2

3 8,000 5,000 13,000 4,000 9,000

4 10,000 3,250 13,250 5,000 8,250

50% x (5,000 x 130%).

. 10-12

Year 30,000 3,250 33,250 2,500 30,750

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EXERCISE 10-15 SAMANO INDUSTRIES Direct Materials Purchases Budget (kg) For the Quarter Ending March 31, 2010

Jan. 10,000 5 50,000 12,000 62,000 9,000 53,000 $2.00 $106,000

Units to be produced Kilograms per unit Total required for production Add: desired ending inventory1 Total materials required Less: beginning inventory Direct materials purchases Cost of kilogram Total cost of materials purchases 1 2

Feb. 8,000 5 40,000 7,500 47,500 12,000 35,500 $2.00 $71,000

Mar. 5,000 5 25,000 6,0002 31,000 7,500 23,500 $2.00 $47,000

30% of next month’s production needs (kg) 30% x 4,000 units x 5 kg per unit

EXERCISE 10-16 (a)

CHINLEE COMPANY Production Budget For the Six Months Ending June 30, 2010

Quarter Expected unit sales Add: Desired ending finished goods 1, 2 Total required units Less: Beginning finished goods inventory 3 Required productions in units 1

6,000 x 30%

7,000 x 30%

1 5,000 1,800 6,800 1,500 5,300

5,000; 6,000 x 30%

. 10-13

2 6,000 2,100 8,100 1,800 6,300

Total 11,000 2,100 13,100 1,500 11,600

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EXERCISE 10-16 (Continued) (b)

CHINLEE COMPANY Direct Materials Budget For the Six Months Ending June 30, 2010

Quarter 1 5,300 3 15,900 9,450 25,350 7,950 17,400 $4.00 $69,600

Units to be produced Direct materials per unit Total required for production Add: desired ending inventory1, 2 Total materials required Less: beginning inventory3 Direct materials purchases Cost per kilogram Total cost of materials purchases

2 6,300 3 18,900 10,875 29,775 9,450 20,325 $4.00 $81,300

Total 11,600 3 34,800 10,875 45,675 7,950 37,725 $4.00 $150,900

50% of next month’s production needs 50% x 7,250 units x 3 kg per unit 3 50% x current month’s production needs 1 2

EXERCISE 10-17 PACER, INC. Direct Labour Budget For the Year Ending December 31, 2009 Quarter 1 2 Units to produce 20,000 25,000 DLH per unit 1.2 1.2 DLH required 24,000 30,000 DL cost per hour $15 $15 Total by quarter $360,000 $450,000 Total for the year = $2,058,000 . 10-14

3 35,000 1.2 42,000 $16 $672,000

4 30,000 1.2 36,000 $16 $576,000

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EXERCISE 10-18 KEYSER COMPANY Manufacturing Overhead Budget For the Year Ending December 31, 2009 Quarter Units to produce DLHs per unit DLHs required Variable cost per unit1 Total variable Fixed costs2 Total MOH 1

Year

10,000 1.5 15,000

12,000 1.5 18,000

14,000 1.5 21,000

16,000 1.5 24,000

52,000 1.5 78,000

$2.40 $36,000 63,000 $99,000

$2.40 $43,200 63,000 $106,200

$2.40 $50,400 63,000 $113,400

$2.40 $57,600 63,000 $120,600

$2.40 $187,200 252,000 $439,200

($0.70 + $1.20 + $0.50)

($35,000 + $16,000 + $12,000)

EXERCISE 10-19 LOCKWOOD COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2009 Quarter

1 2

1 Budgeted sales (20,000; 22,000 x $20) $400,000

2 $440,000

Total

Variable expenses (10%1 of sales) Fixed expenses2 Total selling & admin. Expense

$44,000 23,100 $67,100

$84,000 46,200 $130,200

$40,000 23,100 $63,100

(commissions, 5% + delivery, 2% + advertising, 3%) ($10,000 + $6,000 + $4,200 + $1,500 + $800 + $600)

. 10-15

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EXERCISE 10-20 (a)

TYSON CHANDLER COMPANY Production Budget—198Z For the Two Months Ending February 28, 2009

Expected unit sales Add: Desired ending finished goods 1, 2 Total required units Less: Beginning finished goods inventory 3 Required production in units 1

12,000 x 25%

13,000 x 25%

Month Jan Feb 10,000 12,000 3,000 3,250 13,000 15,250 2,500 3,000 10,500 12,250

Total 22,000 3,250 25,250 2,500 22,750

10,000; 12,000 x 25%

(b) TYSON CHANDLER COMPANY Direct Materials Budget (kgs) For the Month Ending January 31, 2009

Units to be produced Direct materials per unit Total required for production Add: desired ending inventory1 Total materials required Less: beginning inventory2 Materials purchases in units Cost per kilogram Total cost of materials purchases 1 2

Total 10,500 2 21,000 9,800 30,800 8,400 22,400 $3.00 $67,200

40% of next month’s production needs, (40% x 12,250 x 2) 40% x current month’s production needs

. 10-16

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EXERCISE 10-21 (a) HAVEN COMPANY Computation of Cost of Goods Sold For the Year Ending December 31, 2009

Cost of one unit of finished goods: Direct materials (2 kgs x $5.00) Direct labour (3 hours x $12.00) Manufacturing overhead (3 hours x $6.00) Cost of one unit of finished goods Number of units sold Cost of goods sold

$10.00 36.00 18.00 $64.00 30,000 $1,920,000

(b) HAVEN COMPANY Budgeted Income Statement For the Year Ending December 31, 2009

Sales (30,000 units x $80) Less: cost of goods sold (from part (a)) Gross profit Selling and administrative expenses Income before income taxes Income tax expense ($280,000 x 30%) Net income

. 10-17

$2,400,000 1,920,000 480,000 200,000 280,000 84,000 $196,000

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EXERCISE 10-22 NUNEZ COMPANY Cash Budget For the Two Months Ending February 28, 2009 Month Beginning cash balance Add: cash receipts Collections from customers Sale of marketable securities Total receipts Total available cash Less: Disbursements Direct material Direct labour Manufacturing overhead1 Selling and administrative expenses Total disbursements Excess (deficiency) of available cash over cash disbursements Financing: Borrowing Repayment Total financing Ending cash balance 1

Jan $46,000

Feb $26,000

Total $46,000

85,000 10,000 95,000 141,000

150,000 -150,000 176,000

235,000 10,000 245,000 291,000

50,000 30,000 20,000 15,000 115,000

70,000 45,000 24,000 20,000 159,000

120,000 75,000 44,000 35,000 274,000

26,000

17,000

---$26,000

3,000 -3,000 $20,000

3,000

Deduct non-cash item, amortization $1,000

. 10-18

3,000 $20,000

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EXERCISE 10-23 PINK MARTINI CORPORATION Cash Budget For the First Quarter Ending March 31, 2009 Beginning cash balance Add: cash receipts Collections from customers Sale of equipment Total receipts Total available cash Less: Disbursements Direct material Direct labour Manufacturing overhead Selling and administrative expenses Purchase of securities Total disbursements Excess of cash receipts over cash disbursements Financing: Borrowing Repayment Total financing Ending cash balance

. 10-19

$31,000 180,000 3,500 183,500 214,500 41,000 70,000 35,000 45,000 12,000 203,000 11,500 13,500 -13,500 $25,000

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EXERCISE 10-24 (a) NU COMPANY Schedule of Expected Collections from Customers For the Month Ending March 31, 2009 January—credit sales ($220,000 x 60% x 36%) February—credit sales ($220,000 x 60% x 50%) March—cash sales ($270,000 x 40%) March—credit sales ($270,000 x 60% x 10%) Total expected collections from customers

$47,520 66,000 108,000 16,200 $237,720

(b) NU COMPANY Schedule of Expected Payments for Direct Materials For the Month Ending March 31, 2009 February—credit purchases ($35,000 x 50% x 60%) March—cash payments ($41,000 x 50%) March—credit payments ($41,000 x 50% x 40%) Total expected payments

. 10-20

$10,500 20,500 8,200 $39,200

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EXERCISE 10-25 (a) ENVIRONMENTAL LANDSCAPING INC. For the Quarter Ending March 31, 2009 (1) Schedule of Expected Collections from Clients

November ($90,000) December ($80,000) January ($100,000) February ($120,000) March ($130,000) Total collections

January $9,000 24,000 60,000

February

$93,000

$110,000

$8,000 30,000 72,000

March

$10,000 36,000 78,000 $124,000

Quarter $9,000 32,000 100,000 108,000 78,000 $327,000

(2) Schedule of Expected Payments for Landscaping Supplies January $8,400 4,800

February

December ($14,000) January ($12,000) February ($15,000) March ($18,000) Total payments $13,200 EXERCISE 10-25 (Continued)

$7,200 6,000 $13,200

March

$9,000 7,200 $16,200

Quarter $8,400 12,000 15,000 7,200 $42,600

(b) (1) Accounts receivable at March 31, 2009: February ($120,000 X 10%) + March ($130,000 X 40%) = $64,000 (2) Accounts payable at March 31, 2009: ($18,000 X 60%) = $10,800

. 10-21

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EXERCISE 10-26 PISANI DENTAL CLINIC Cash Budget For the Two Quarters Ending June 30, 2009 Quarters Beginning cash balance Add: cash receipts Collections from clients Interest from investments Sale of equipment Total receipts Total available cash Less: Disbursements Professional salaries Overhead Selling and administrative expenses1 Income tax Purchase of equipment Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Interest expense Less: Repayment Total financing Ending cash balance 1

1 $30,000

2 $25,000

Total $30,000

230,000 -15,000 245,000 275,000

380,000 5,000 -385,000 410,000

610,000 5,000 15,000 630,000 660,000

140,000 75,000 47,000 --262,000

140,000 100,000 67,000 4,000 50,000 361,000

280,000 175,000 114,000 4,000 50,000 623,000

13,000

49,000

37,000

12,000 --12,000 $25,000

-(300) (12,000) (12,300) $36,700

12,000 (300) (12,000) (300) $36,700

Remove non-cash item: $3,000 Amortization

. 10-22

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EXERCISE 10-27 (a)

BIG JIM STORES Merchandise Purchases Budget For the Month Ending June 30, 2009

Budgeted cost of goods sold ($500,000 x 70%) .................. Add: Desired ending merchandise inventory ($600,000 x 70% x 40%) ..................................................... Total ........................................................................................ Less: Beginning merchandise inventory ($350,000 x 40%) ..................................................... Required merchandise purchases .......................................

(b)

$350,000 168,000 518,000 140,000 $378,000

BIG JIM STORES Budgeted Income Statement For the Month Ending June 30, 2009

Sales .................................................................. Cost of goods sold Inventory, June 1....................................... Purchases .................................................. Cost of goods available for sale .............. Less: Inventory, June 30 ......................... Cost of goods sold .................................... Gross profit .......................................................

. 10-23

$500,000 $140,000 378,000 518,000 168,000 350,000 $150,000

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SOLUTIONS TO PROBLEMS—SET A PROBLEM 10-28A

TILGER FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2009 Quarter Expected sales in units Unit selling price Total sales

1 28,000 $60.00 $1,680,000

2 42,000 $60.00 $2,520,000

Six Months 70,000 $60.00 $4,200,000

TILGER FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2009 Quarter Expected unit sales Add: Desired ending finished goods Total required units Less: Beginning finished goods inventory Required productions in units

. 10-24

1 28,000 12,000 40,000 8,000 32,000

2 42,000 18,000 60,000 12,000 48,000

Six Months 70,000 18,000 88,000 8,000 80,000

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PROBLEM 10-28A (Continued) TILGER FARM SUPPLY COMPANY Direct Materials Budget—Gumm For the Six Months Ending June 30, 2009 Quarter Units to be produced Direct materials per unit Total required for production Add: desired ending inventory Total materials required Less: beginning inventory Direct materials purchases Cost per kilogram Total cost of materials purchases

1 32,000 4 128,000 10,000 138,000 9,000 129,000 $4.00 $516,000

2 48,000 4 192,000 13,000 205,000 10,000 195,000 $4.00 $780,000

Six Months 80,000 4 320,000 13,000 333,000 9,000 324,000 $4.00 $1,296,000

TILGER FARM SUPPLY COMPANY Direct Labour Budget For the Six Months Ending June 30, 2009 Quarter 1 32,000 0.25 8,000 $14.00 $112,000

Units to be produced Direct labour hours per unit Total required for production Direct labour cost per hour Total cost of direct labour

. 10-25

2 48,000 0.25 12,000 $14.00 $168,000

Six Months 80,000 0.25 20,000 $14.00 $280,000

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PROBLEM 10-28A (Continued) TILGER FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2009 Quarter Expected sales Variable costs (15% x Sales) Fixed costs Total selling and admin, costs

1 $1,680,000

2 $2,520,000

Six Months $4,200,000

$252,000 175,000 $427,000

$378,000 175,000 $553,000

$630,000 350,000 $980,000

TILGER FARM SUPPLY COMPANY Budgeted Cost of Goods Sold For the Six Months Ending June 30, 2009 Cost of one unit of finished goods: Direct materials--Gumm (4 kgs x $4.00) Direct materials--Tarr (6 kgs x $1.50) Direct labour (0.25 hours x $14.00) Manufacturing overhead (150% x $3.50) Cost of one unit of finished goods Number of units sold Cost of goods sold

$16.00 9.00 3.50 5.25 $33.75 70,000 $2,362,500

TILGER FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2009 Sales (70,000 units x $60) Less: cost of goods sold (from above) Gross profit Selling and administrative expenses Income before income taxes Income tax expense (30%) Net income . 10-26

$4,200,000 2,362,500 1,837,500 980,000 857,500 257,250 $600,250

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PROBLEM 10-29A (a)

GREISH INC. Sales Budget For the Year Ending December 31, 2009

Expected sales in units Unit selling price Total sales (b)

LN 35 400,000 $20.00 $8,000,000

Total

$13,000,000

GREISH INC. Production Budget For the Year Ending December 31, 2009

Expected sales in units Add: Desired ending finished goods Total required units Less: Beginning finished goods inventory Required productions in units (c)

LN 40 200,000 $25.00 $5,000,000

LN 35 400,000 25,000 425,000 30,000 395,000

LN 40 200,000 15,000 215,000 10,000 205,000

Total

600.000

GREISH INC. Direct Materials Budget For the Year Ending December 31, 2009

Units to be produced Direct materials per unit Total required for production Add: desired ending inventory Total materials required Less: beginning inventory Direct materials purchases Cost per kilogram Total cost of material purchases

LN 35 395,000 2 790,000 30,000 820,000 40,000 780,000 $3.00 $2,340,000

. 10-27

LN 40 205,000 3 615,000 15,000 630,000 10,000 620,000 $4.00 $2,480,000

Total

$4,820,000

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PROBLEM 10-29A (Continued) (d)

GREISH INC. Direct Labour Budget For the Year Ending December 31, 2009

Units to be produced Direct labour hours per unit Total required for production Direct labour cost per hour Total cost of direct labour

(e)

LN 35 395,000 0.40 158,000 $12.00 $1,896,000

LN 40 205,000 0.60 123,000 $12.00 $1,476,000

Total

$3,372,000

GREISH INC. Budgeted Income Statement For the Year Ending December 31, 2009

Sales Cost of goods sold Gross profit Less: Selling & Admin costs Income before income tax Income tax expense (30%) Net income COGS, LN35: $12 x 400,000 COGS, LN40: $21 x 200,000

LN 35 $8,000,000 4,800,000 3,200,000 1,200,000 $2,000,000

LN 40 $5,000,000 4,200,000 800,000 700,000 $100,000

Total $13,000,000 9,000,000 4,000,000 1,900,000 2,100,000 630,000 $1,470,000

Selling & Admin, LN35: $660,000 + $540,000 Selling & Admin, LN40: $360,000 + $340,000

. 10-28

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PROBLEM 10-30A (a) CHOO-FOO COMPANY Production Budget For the quarter ending March 31, 2009

Estimated unit sales Add: ending Inventory1 Total required Less: beg. inventory Total 1

Jan 10,000 16,000 26,000 16,000 10,000

Feb 12,000 12,500 24,500 16,000 8,500

Mar 8,000 13,500 21,500 12,500 9,000

Total 30,000 13,500 43,500 16,000 27,500

100% of next month’s unit sales + 50% of the following month’s unit sales CHOO-FOO COMPANY Direct Labour Budget For the quarter ending March 31, 2009

Production in units DLH per unit Total hours required Rate per hour Total

(b)

Jan 10,000 2.0 20,000 $8.00 $160,000

Feb 8,500 2.0 17,000 $8.00 $136,000

Mar Total 9,000 1.5 13,500 $8.00 $108,000 $404,000

The sales data in the production budget will also be used in preparing the pro forma income statement. The inventory data will be used in preparing pro forma balance sheets. The production requirements will also be used for budgeting materials acquisition and variable overhead items and preparing budgeted statements of cost of goods manufactured and sold. The labour costs in the direct labour budget will be used in the cash budget.

. 10-29

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PROBLEM 10-31A

(a)

COLT INDUSTRIES Sales Budget For the Year Ending December 31, 2010 Plan A 760,000 $8.40 $6,384,000

Expected sales in units Unit selling price Total sales

Plan B 950,000 $7.50 $7,125,000

2009 level of sales: $6,400,000 ÷ $8.00 per unit = 800,000 units Plan A: 800,000 – (5% x 800,000) Plan B: 800,000 + 150,000 (b)

COLT INDUSTRIES Production Budget For the Year Ending December 31, 2010

Expected sales in units Add: Desired ending finished goods 1 Total required units Less: Beginning finished goods Required production 1

760,000 X 5%

. 10-30

Plan A 760,000 38,000 798,000 40.000 758,000

Plan B 950,000 50,000 1,000,000 40,000 960,000

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PROBLEM 10-31A (Continued) (c)

COLT INDUSTRIES Cost per unit For the Year Ending December 31, 2010 Number of units produced

Plan A 758,000

Plan B 960,000

Total variable costs ($4.251) Total fixed costs Total costs

$3,221,500 1,895,000 $5,116,500

$4,080,000 1,895,000 $5,975,000

$6.75

$6.22

Per unit cost 1

$1.80 + $1.25 + $1.20

There is a difference in per unit costs because in Plan B, the fixed costs are spread over a larger number of units.

(d)

COLT INDUSTRIES Budgeted Gross Profit For the Year Ending December 31, 2010 Expected number of units sold

Plan A 760,000

Plan B 950,000

Expected sales Budgeted cost of goods sold Gross profit

$6,384,000 5,130,000 $1,254,000

$7,125,000 5,909,000 $1,216,000

Plan A should be accepted because it produces a slightly higher gross profit than Plan B.

. 10-31

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PROBLEM 10-32A First calculate the steel requirements for January and February.

Budgeted sales Plus: ending inventory (25% x next mo.) Production needs Less: Beginning inventory Production requirements Steel per unit (kilograms) Steel required for production (kilograms)

Chairs Jan Feb 100 120 30 20 130 140 25 30 105 110 4.0 4.0

Stools Jan Feb 60 80 20 15 80 95 15 20 65 75 5.0 5.0

420

325

440

375

Requirements for Jan: 420 + 325 = 745; Feb: 440 + 375 = 815 Now calculate the quantity and cost of purchases in January and February.

Steel required for production Plus: ending inventory Production needs Less: beginning inventory Steel purchases (kilograms)

Jan 745 150 895 150 745

Feb 815 150 965 150 815

Rounded to purchasing lots Cost per kilogram Total cost for steel purchases

750 $0.25 $187.50

850 $0.25 $212.50

Finally, calculate cash disbursements for February based on the pattern of payment. Cash disbursements for February 50% in the current month (Feb--$212.50) $106.25 50% in the month following (Jan--$187.50) 93.75 $200.00 . 10-32

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PROBLEM 10-33A

(a) (1)

Expected Collections from Customers (50%, 30%, 20%)

January

February

November ($260,000)................................ December ($320,000) ................................ January ($350,000) ................................... February ($400,000) .................................. Total collections ..............................

$ 52,000 96,000 175,000 0000,000 $323,000

(2)

-64,000 105,000 200,000 $369,000

Expected Payments for Direct Materials (60%, 40%)

January

February

December ($100,000) ................................ January ($110,000) ................................... February ($130,000) .................................. Total payments ................................

$40,000 66,000 000,000 $106,000

. 10-33

-44,000 78,000 $122,000

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PROBLEM 10-33A (Continued) (b)

LORCH COMPANY Cash Budget For the Two Months Ending February 28, 2010

Beginning cash balance Add: cash receipts Collections from credit sales Collection of notes receivable Proceeds from sale of securities Total receipts Total available cash Less: Disbursements Direct materials Direct labour Manufacturing overhead Selling and administrative expenses1 Owner’s withdrawal Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Interest expense Less: Repayment Total financing Ending cash balance 1

Jan $60,000

Feb $54,000

Total $60,000

323,000 15,000 -338,000 398,000

369,000 -6,000 375,000 429,000

692,000 15,000 6,000 713,000 773,000

106,000 90,000 70,000 78,000 -344,000

122,000 100,000 75,000 85,000 5,000 387,000

228,000 190,000 145,000 163,000 5,000 731,000

54,000

42,000

----$54,000

8,000 --8,000 $50,000

Non-cash item, amortization of $1,000 has been deducted.

. 10-34

42,000 8,000 --50,000 $50,000

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PROBLEM 10-34A (a) HARRINGTON COMPANY Cash Budget For the Month Ended July 31, 2009

Beginning cash balance Add: cash receipts Total available cash Less: Disbursements Merchandise purchases Operating expenses Purchase of equipment Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Interest expense Less: Repayment Total financing Ending cash balance

$45,000 89,000 134,000 56,200 36,800 20,500 113,500 20,500 4,500 --4,500 $25,000

Cash disbursements of $113,500 plus the desired ending cash balance of $25,000 exceeds the $134,000 total cash available by $4,500. Therefore, Harrington Company will have to borrow $4,500.

(b)

. 10-35

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 favourable than if the funds are needed on short notice.

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PROBLEM 10-35A

(a)

RIDDER COMPANY Westwood Store Merchandise Purchases Budget For the Months of July and August, 2009

Budgeted cost of goods sold Add: Desired ending inventory1 Total value of merchandise required Less: Beginning inventory Merchandise purchases required

July

August

$600,000 132,000 732,000 120,000 612,000

$660,000 145,200 805,200 132,000 673,200

Ending inventory = 20% x next month’s cost of goods sold COGS for September = $880,000 x 110% x 75% 1

. 10-36

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PROBLEM 10-35A (Continued) (b)

RIDDER COMPANY Westwood Store Budgeted Income Statement For the Months of July and August, 2009

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 .............................................................. Amortization ................................................ Utilities ......................................................... Insurance ..................................................... Total ...................................................... Income from operations ..................................... Income tax expense (30%) ................................. Net income .......................................................... *5% of sales **3% of sales ***4% of sales

. 10-37

July

August

$800,000

$880,000

120,000 612,000 732,000 132,000 600,000 200,000

132,000 673,200 805,200 145,200 660,000 220,000

30,000 40,000 24,000 32,000 5,000 800 600 500 132,900 67,100 20,130 $ 46,970

30,000 44,000 26,400 35,200 5,000 800 600 500 142,500 77,500 23,250 $ 54,250

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PROBLEM 10-36A

May raw materials purchases:

Finished goods ending inv. Plus: Sales in units Total units required Less: beginning inventory Units to be produced Raw materials per unit Units of raw material required Plus: ending inventory1, 2 Raw materials required Less: beginning inventory Raw materials to be purchased Raw material per unit cost Cost of raw materials to be purchased 1 2

April

May

June

2,230 2,550 4,780 2,000 2,780 2.0 5,560 2,922 8,482 3,336 5,146 $4.00

2,190 2,475 4,665 2,230 2,435 2.0 4,870 3,012 7,882 2,922 4,960 $4.00

2,310 2,390 4,700 2,190 2,510 2.0 5,020 3,240 8,260 3,012 5,248 $4.00

$20,584

$19,840

$20,992

ending inventory of raw materials = 60% of next month’s requirements ending inventory of raw materials for June: 2,700 units x 2 x60%

. 10-38

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PROBLEM 10-37A

KURIAN INDUSTRIES Budgeted Income Statement For the Year Ending December 31, 2010

Sales (8,000 X $35) ................................................... Cost of goods sold Finished goods inventory, January 1 .............. Cost of goods manufactured ($69,400 + $56,600 + $54,000)....................... Cost of goods available for sale ...................... Finished goods inventory, December 31 (3,000 X $181)................................................. Cost of goods sold .................................... Gross profit............................................................... Selling and administrative expenses ...................... Income from operations........................................... Interest expense ....................................................... Income before income taxes ................................... Income tax expense (30%) ....................................... Net income ................................................................ 1

Per unit rate is given as $18.

. 10-39

$280,000 $30,000 180,000 210,000 54,000 156,000 124,000 76,000 48,000 3,500 44,500 13,350 $ 31,150

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PROBLEM 10-37A (Continued) KURIAN INDUSTRIES Budgeted Balance Sheet December 31, 2010

Assets Current assets Cash .................................................................. Accounts receivable ($84,000 X 40%) ............ Finished goods inventory (3,000 units X $18) ........................................ Total current assets ................................. Property, plant, and equipment Equipment ($40,000 + $19,000) ....................... Less: Accumulated amortization ($10,000 + $4,000) ............................. Total assets ..............................................

9,750 33,600 54,000 97,350

$59,000 14,000

45,000 $142,350

Liabilities and Shareholders’ Equity Liabilities Notes payable ($25,000 – $8,000).................... Accounts payable ($8,500* + $5,700) .............. Income taxes payable ...................................... Total liabilities .......................................... Shareholders’ equity Common shares ............................................... Retained earnings ($30,000 + $31,150 – $5,000) ........................ Total shareholders’ equity ....................... Total liabilities and shareholders’ equity .................................................... *$17,000 X 50%

. 10-40

$ 17,000 14,200 5,000 36,200

$50,000 56,150 106,150 $142,350

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PROBLEM 10-38A THE BIG SISTER COMPANY Cash Budget For the Four Quarters Ending December 31

Beginning cash balance Plus: receipts Accounts Receivable Credit sales—1st Credit sales—2nd Credit sales—3rd Credit sales—4th Total cash receipts Total cash available Less: disbursements Material purchases Direct labour Factory overhead Sell & admin expenses Purchase of equipment Total cash disbursement Excess (deficiency) Financing: Borrowing Less: Repayment Less: Interest 1, 2, 3 Total financing Ending cash balance

1 $25,000 150,000 320,000

470,000 495,000 400,000 350,000 340,000 35,000 1,125,000 (630,000)

Quarter 2 3 $10,000 $11,250 160,000 200,000

100,000 320,000

4 $10,938

160,000 320,000 480,000 490,938

360,000 370,000

420,000 431,250

100,000 35,000 70,000 205,000 165,000

100,000 35,000 135,000 296,250

100,000 35,000 150,000 285,000 205,938

150,000 3,750 153,750 $11,250

275,000 10,312 285,312 $10,938

185,000 9,250 194,194 $11,688

640,000

640,000 $10,000

Interest: $150,000 x 5% x 6/12 interest: $275,000 x 5% x 9/12 3 Interest: $185,000 x 5% x 12/12 2

. 10-41

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PROBLEM 10-39A (a) ROTECH CO. Cash Budget For the Second Quarter Ended June 30, 2009

Beginning cash balance Add: cash receipts Collections from Q1 ($600,000 x 45%) Collections from Q2 ($400,000 x 50%) Total cash receipts Total available cash Less: Disbursements Merchandise purchases1 ($150,000 + $150,000) Factory overhead Payroll Selling costs (2% x $400,000) Administrative costs Dividends Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Repayment Total financing Ending cash balance 1

$45,000 270,000 200,000 470,000 515,000 300,000 15,000 29,000 8,000 15,000 20,000 387,000 128,000 ---$128,000

60% x ($400,000 + ($800,000 x 25%) – ($400,000 x 25%)) = $300,000 Payment from first quarter: $300,000 x 50% Payment from this quarter: $300,000 x 50%

. 10-42

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PROBLEM 10-39A (Continued) (b)

Advantages of budgeting include the following: • aids planning by helping management identify problems before they occur • compatible with management by exception • communicates top management's plans and goals • compatible with management by objectives • aids subsequent performance evaluation • brings planning to the forefront • provides a means of allocating resources within the firm

. 10-43

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SOLUTIONS TO PROBLEMS—SET B PROBLEM 10-40B WAHLEN FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2009 Quarter Expected sales in units Unit selling price Total sales

1 40,000 $60.00 $2,400,000

2 60,000 $60.00 $3,600,000

Six Months 100,000 $60.00 $6,000,000

WAHLEN FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2009 Quarter Expected unit sales Add: Desired ending finished goods Total required units Less: Beginning finished goods inventory Required productions in units

. 10-44

1 40,000 15,000 55,000 10,000 45,000

2 60,000 20,000 80,000 15,000 65,000

Six Months 100,000 20,000 120,000 10,000 110,000

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PROBLEM 10-40B (Continued) WAHLEN FARM SUPPLY COMPANY Direct Materials Budget—Crup For the Six Months Ending June 30, 2009 Quarter Units to be produced Direct materials per unit Total required for production Add: desired ending inventory Total materials required Less: beginning inventory Direct materials purchases Cost per kilogram Total cost of purchases

1 45,000 6 270,000 12,000 282,000 9,000 273,000 $4.00 $1,092,000

2 65,000 6 390,000 15,000 405,000 12,000 393,000 $4.00 $1,572,000

Six Months 110,000 6 660,000 15,000 675,000 9,000 666,000 $4.00 $2,664,000

WAHLEN FARM SUPPLY COMPANY Direct Labour Budget For the Six Months Ending June 30, 2009 Quarter 1 45,000 0.25 11,250 $12.00 $135,000

Units to be produced Direct labour hours per unit Total required for production Direct labour cost per hour Total cost of direct labour

. 10-45

2 65,000 0.25 16,250 $12.00 $195,000

Six Months 110,000 0.25 27,500 $12.00 $330,000

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PROBLEM 10-40B (Continued) WAHLEN FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2009 Quarter Expected sales Variable costs (10% x Sales) Fixed costs Total selling and admin, costs

1 $2,400,000

2 $3,600,000

Six Months $6,000,000

$240,000 150,000 $390,000

$360,000 150,000 $510,000

$600,000 300,000 $900,000

WAHLEN FARM SUPPLY COMPANY Budgeted Cost of Goods Sold For the Six Months Ending June 30, 2009 Cost of one unit of finished goods: Direct materials--Grup (6 kgs x $4.00) Direct materials--Dert (10 kgs x $1.50) Direct labour (0.25 hours x $12.00) Manufacturing overhead (100% x $3.00) Cost of one unit of finished goods Number of units sold Cost of goods sold

$24.00 15.00 3.00 3.00 $45.00 100,000 $4,500,000

WAHLEN FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2009 Sales (100,000 units x $60) Less: cost of goods sold (from above) Gross profit Selling and administrative expenses Income before income taxes Income tax expense (30%) Net income

. 10-46

$6,000,000 4,500,000 1,500,000 900,000 600,000 180,000 $420,000

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PROBLEM 10-41B (a)

QUINN INC. Sales Budget For the Year Ending December 31, 2010

Expected sales in units Unit selling price Total sales (b)

JB 50 300,000 $20.00 $6,000,000

Total

$11,400,000

QUINN INC. Production Budget For the Year Ending December 31, 2010

Expected sales in units Add: Desired ending finished goods Total required units Less: Beginning finished goods inventory Required productions in units (c)

JB 60 180,000 $30.00 $5,400,000

JB 50 300,000 30,000 330,000 20,000 310,000

JB 60 180,000 25,000 205,000 15,000 190,000

Total

500.000

QUINN INC. Direct Materials Budget For the Year Ending December 31, 2010

JB 50 310,000 2 620,000 50,000 670,000 40,000 630,000 $2.00 $1,260,000

. 10-47

JB 60 190,000 3 570,000 20,000 590,000 10,000 580,000 $3.00 $1,740,000

Total

$3,000,000

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PROBLEM 10-41B (Continued) (d)

QUINN INC. Direct Labour Budget For the Year Ending December 31, 2010

Units to be produced Direct labour hours per unit Total required for production Direct labour cost per hour Total cost of direct labour

(e)

JB 50 310,000 0.50 155,000 $12.00 $1,860,000

JB 60 190,000 0.75 142,500 $12.00 $1,710,000

Total

$3,570,000

QUINN INC. Budgeted Income Statement For the Year Ending December 31, 2010

Sales Cost of goods sold Gross profit Less: Selling & Admin costs Income before income tax Income tax expense (30%) Net income COGS, JB 50: $11 x 300,000 COGS, JB 60: $20 x 180,000

JB 50 $6,000,000 3,300,000 2,700,000 980,000 $1,720,000

JB 60 $5,400,000 3,600,000 1,800,000 820,000 $980,000

Total $11,400,000 6,900,000 4,500,000 1,800,000 2,700,000 810,000 $1,890,000

Selling & Admin, JB50: $560,000 + $420,000 Selling & Admin, JB60: $440,000 + $380,000

. 10-48

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PROBLEM 10-42B

(a)

LITWIN INDUSTRIES Sales Budget For the Year Ending December 31, 2010 (1) Plan A 630,0001 $7.60 $4,788,000

Expected sales in units Unit selling price Total sales

(2) Plan B 800,0002 $6.653 $5,320,000

700,000 x 90% 700,000 + 100,000 3 $7.00 x 95% 2

(b)

LITWIN INDUSTRIES Production Budget For the Year Ending December 31, 2010

Expected sales in units Add: Desired ending finished goods Total required units Less: Beginning finished goods Required production

. 10-49

(1) Plan A 630,000 90,000 720,000 70.000 650,000

(2) Plan B 800,000 100,000 900,000 70,000 830,000

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PROBLEM 10-42B (Continued) (c)

LITWIN INDUSTRIES Cost per unit For the Year Ending December 31, 2010 Number of units produced

(1) Plan A 650,000

(2) Plan B 830,000

Total variable costs ($4.00)1 Total fixed costs Total costs

$2,600,000 975,000 $3,575,000

$3,320,000 975,000 $4,295,000

$5.50

$5.17

Per unit cost

There is a difference in per unit costs because in Plan B, the fixed costs are spread over a larger number of units. 1

(d)

variable cost per unit = $2.00 + $1.50 + $0.50 LITWIN INDUSTRIES Budgeted Gross Profit For the Year Ending December 31, 2010

Expected number of units sold

Plan A 630,000

Plan B 800,000

Expected sales Budgeted cost of goods sold 1, 2 Gross profit

$4,788,000 3,465,000 $1,323,000

$5,320,000 4,136,000 $1,184,000

Plan A should be accepted because it produces a slightly higher gross profit than Plan B. 1 2

630,000 x $5.50 800,000 x $5.17

. 10-50

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PROBLEM 10-43B (a)

ZOË’S FASHION FOOTWEAR LTD. Merchandise Purchases Budget For the Month Ending June 30, 2009 Budgeted cost of goods sold ($80,000 x 40%) Add: Desired ending merchandise inventory ($100,000 x 40% x 200%) Total merchandise needs Less: Beginning merchandise inventory ($80,000 x 40% x 2) Required merchandise purchases

(b)

80,000 112,000 64,000 $48,000

ZOË’S FASHION FOOTWEAR LTD. Budgeted Income Statement For the Month Ending June 30, 2009 Sales Less: cost of goods sold Gross profit Less: Selling and administrative expenses Variable (20% x $80,000) Fixed Income before income taxes Income tax expense (40%) Net income

. 10-51

$32,000

$80,000 32,000 48,000 $16,000 20,000

36,000 12,000 4,800 $7,200

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PROBLEM 10-44B THE BIG BOY COMPANY Cash Budget For the Four Quarters Ending December 31

1 $23,000 130,000 260,000

390,000 413,000 360,000 350,000 430,000 50,000 1,190,000 (777,000)

Quarter 2 3 $8,000 $8,400 130,000 500,000

250,000 260,000

4 $13,100

130,000 260,000 390,000 403,100

630,000 638,000

510,000 518,400

100,000 50,000 150,000 300,000 338,000

100,000 50,000 150,000 368,400

100,000 50,000 50,000 200,000 203,100

320,000 9,600 329,600 $8,400

340,000 15,300 355,300 $13,100

125,000 7,500 132,500 $70,600

785,000

785,000 $8,000

Interest: $320,000 x 6% x 6/12 Interest: $340,000 x 6% x 9/12 3 Interest: $125,000 x 6% x 12/12 2

. 10-52

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PROBLEM 10-45B

(a) (1)

Expected Collections from Customers (60%, 30%, 10%)

January

February

November ($200,000)................................ December ($280,000) ................................ January ($320,000) ................................... February ($400,000) .................................. Total collections ..............................

$20,000 84,000 192,000 0000,000 $296,000

(2)

-28,000 96,000 240,000 $364,000

Expected Payments for Direct Materials (30%, 70%)

January

February

December ($90,000) .................................. January ($80,000) ..................................... February ($110,000) .................................. Total payments ................................

$63,000 24,000 000,000 $87,000

. 10-53

-56,000 33,000 $89,000

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PROBLEM 10-45B (Continued) (b)

NIGH COMPANY Cash Budget For the Two Months Ending February 28, 2010

Beginning cash balance Add: cash receipts Collections from credit sales Collection of interest receivable Proceeds from sale of securities Total receipts Total available cash Less: Disbursements Direct materials Direct labour Manufacturing overhead Selling and administrative expenses Purchase of land Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Interest expense Less: Repayment Total financing Ending cash balance

. 10-54

Jan $60,000

Feb $52,000

Total $60,000

296,000 3,000 -299,000 359,000

364,000 -5,000 369,000 421,000

660,000 3,000 5,000 668,000 728,000

87,000 85,000 60,000 75,000 -307,000

89,000 115,000 75,000 80,000 20,000 379,000

176,000 200,000 135,000 155,000 20,000 686,000

52,000

42,000

----$52,000

8,000 --8,000 $50,000

8,000 --50,000 $50,000

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PROBLEM 10-46B (a) RAYMOND CO. Cash Budget For the Second Quarter Ended June 30, 2009

Beginning cash balance Add: cash receipts Collections from Q1 ($400,000 x 45%) Collections from Q2 ($400,000 x 50%) Total cash receipts Total available cash Less: Disbursements Merchandise purchases1 ($100,000 + $100,000) Factory overhead Payroll Selling costs (2% x $400,000) Administrative costs Dividends Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Repayment Total financing Ending cash balance 1

$25,000 180,000 200,000 380,000 405,000 200,000 10,000 30,000 8,000 10,000 20,000 278,000 127,000 ---$127,000

40% x ($400,000 + ($800,000 x 25%) – ($400,000 x 25%)) = $200,000 Payment from first quarter: $200,000 x 50% Payment from this quarter: $200,000 x 50%

. 10-55

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PROBLEM 10-46B (Continued) (c)

. 10-56

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• PROBLEM 10-47B

(a)

URBINA COMPANY Westwood Store Merchandise Purchases Budget For the Months of July and August, 2009

Budgeted cost of goods sold (64% x sales) Add: Desired ending inventory1 Total value of merchandise required Less: Beginning inventory Merchandise purchases required

July $256,000 72,000 328,000 64,000 $264,000

Ending inventory = 25% x next month’s cost of goods sold COGS for September = $500,000 x 64% 1

. 10-57

August $288,000 80,000 368,000 72,000 $296,000

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PROBLEM 10-47B (Continued) (b)

URBINA COMPANY Westwood Store Budgeted Income Statement For the Months of July and August, 2009

July Sales ................................................................ $400,000 Cost of goods sold Beginning inventory ................................ 64,000 Purchases ................................................ 264,000 Cost of goods available for sale ............. 328,000 Less: Ending inventory .......................... 72,000 Cost of goods sold .................................. 256,000 Gross profit ..................................................... 144,000 Operating expenses Sales salaries............................................... 40,000 Advertising* ................................................. 16,000 Delivery expense** ...................................... 8,000 Sales commissions*** ................................. 12,000 Rent .............................................................. 3,000 Amortization ................................................ 700 Utilities ......................................................... 500 Insurance ..................................................... 300 Total ...................................................... 80,500 Income from operations ..................................... 63,500 Income tax expense (30%) ................................. 19,050 Net income .......................................................... $ 44,450 *4% of sales **2% of sales ***3% of sales

. 10-58

August $450,000 72,000 296,000 368,000 80,000 288,000 162,000 40,000 18,000 9,000 13,500 3,000 700 500 300 85,000 77,000 23,100 $ 53,900

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PROBLEM 10-48B (a)

Sales for April: in units Plus: desired ending inventory (2 x 15,000) Total units required Less: beginning inventory (2 x 14,000) Units to be purchased Cost per unit Total cost of inventory purchases

14,000 30,000 44,000 28,000 16,000 $10.00 $160,000

(b)

March ($150,0001 x 1/3 x 97%) April ($160,000 x 2/3 x 97%)

$48,500 103,467 $151,967

March purchases: 13,000 + (2 x 14,000) – (2 x 13,000) x $10.00

. 10-59

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PROBLEM 10-49B (a) RADDINGTON INC. Production Budget For the quarter ending March 31, 2009

Estimated unit sales Add: ending Inventory1 Total required Less: beg. inventory Total 1

Jan 15,000 24,500 39,500 24,000 15,500

Feb 18,000 20,000 38,000 24,500 13,500

Mar 13,000 21,000 34,000 20,000 14,000

Total 46,000 21,000 67,000 24,000 43,000

100% of next month’s sales + 50% of the following month’s sales RADDINGTON INC. Direct Labour Budget For the quarter ending March 31, 2009

Production in units DLH per unit Total hours required Rate per hour Total

(c)

Jan 15,500 2.0 31,000 $18.00 $558,000

Feb 13,500 2.0 27,000 $18.00 $486,000

Mar 14,000 1.5 21,000 $18.00 $378,000

Total

$1,422,000

. 10-60

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PROBLEM 10-50B (a) KARI COMPANY Cash Budget For the Month Ended July 31, 2009 Beginning cash balance Add: cash receipts Total available cash Less: Disbursements Merchandise purchases Operating expenses Purchase of equipment Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Interest expense Less: Repayment Total financing Ending cash balance

$75,000 125,000 200,000 87,200 56,800 25,500 169,500 30,500 4,500 --4,500 $35,000

Cash disbursements of $169,500 plus the desired ending cash balance of $35,000 exceeds the $200,000 total cash available by $4,500. Therefore, Kari Company will have to borrow $4,500.

(c)

. 10-61

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SOLUTIONS TO CASES CASE 10-51 (a) The budget at Peters 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:

. 10-62

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.

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CASE 10-51 (Continued) (b) Peters Corporation should consider the adoption of a “bottom to top” (participative) budget process. This means 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 timeconsuming, 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. 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:

. 10-63

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)

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CASE 10-52 HOWE LTD. Cash Budget For the Month Ended Jan 31

Beginning cash balance Add: cash receipts Collections from Nov ($35,000 x 45%) Collections from Dec ($40,000 x 50%) Total cash receipts Total available cash Less: Disbursements Accounts payable—from December ($6,667 x 98%) Merchandise purchases1 ($25,000 x 2/3 x 98%) Operating costs (($50,000 x 30%) - $3,000) Purchase of equipment Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Repayment Total financing Ending cash balance 1

$2,120 15,750 20,000 35,750 37,870 6,534 16,333 12,000 10,800 45,667 (7,797) 8,797 -8,797 $1,000

Inventory costs, $5.00 per unit = 50% of sales, $10.00 per unit Merchandise purchases: January ($50,000 x 50%) = $25,000

Cash disbursements exceed cash receipts by $7,797 if Howe purchases the new microcomputer system. In order for them to meet their $1,000 minimum cash balance and purchase the new equipment, they will have to borrow $8,797.

. 10-64

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CASE 10-53 (a)

Cash disbursements for February Purchases required-Jan Sales 11,900 Desired ending inventory¹ 14,820 Total required 26,720 Less: beginning inventory² 15,470 Total purchases required (units) 11,250 Per unit cost $ 20.00 Total purchases required $225,000

Feb 11,400 15,600 27,000 14,820

Mar 12,000 15,860 27,860 15,600

12,180 $ 20.00 $243,600

12,260 $ 20.00 $245,200

¹ 130% of next month's inventory ² 130% of current month's inventory Cash disbursements for inventory-from January ($225,000 x (100% - 54%)) for February ($243,600 x 54%)

$ 103,500 131,544

Cash disbursements for other expenses-from January (($357,000 x 15%) - $2,000) x 46% for February (($342,000 x 15%) - $2,000) x 54%) Total disbursements for February (b)

23,713 26,622 $ 285,379

Cash receipts for January From December: Within the discount period: ($363,000 x 60% x 97%) After the discount period: ($363,000 x 25%) From November: (354,000 x 9%) Total cash receipts

(d)

$211,266 90,750 31,860 $333,876

The units to be purchased in March are 12,260 as shown in Part (a).

. 10-65

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CASE 10-54 SPORTS FANATIC CO. Pro Forma Income Statement For the month of January Sales Less: cost of goods sold (75% of sales) Gross profit Less: Operating expenses Bad debt expense ($220,000 x 2%) Amortization ($216,000 ÷ 12) Other expenses Net income before income taxes

$220,000 165,000 55,000 $4,400 18,000 22,600

45,000 $10,000

SPORTS FANATIC CO. Cash budget For the month of January Beginning cash balance Add: cash receipts Accounts receivable—from December Collections from January ($220,000 x 60%) Total cash receipts Total available cash Less: Disbursements Accounts payable—from December Other costs Total disbursements Excess (deficiency) of cash available over cash disbursements Financing: Borrowing Less: Repayment Total financing Ending cash balance . 10-66

$22,000 76,000 132,000 208,000 230,000 162,000 22,600 184,600 45,400 ---$45,400

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CASE 10-54 (Continued) SPORTS FANATIC CO. Pro Forma Balance Sheet As at January 31

Assets

(1) (2) (3) (4) (5) (6)

Cash Accounts receivable (net of allowance for doubtful accounts, $4,400) Inventory Property, plant and equipment (net of $698,000 amortization) Total assets

$ 45,400 (1)

852,000 (4) $1,101,000

Liability and Shareholders' Equity Accounts payable Common Shares Retained earnings Total liabilities and shareholders' equity

$ 153,000 (5) 800,000 148,000 (6) $1,101,000

83,600 (2) 120,000 (3)

Cash balance from cash budget on previous page 38% of January sales, $220,000; allowance is 2% 80% of next month’s sales, $200,000 x 75% cost of goods Previous balance, $870,000 - $18,000 amortization for month (20% of January sales + 80% of February sales) x 75% Previous retained earnings, $138,000 + $10,000 net income

. 10-67

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CASE 10-55 (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 labour

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.

Amortization

To reduce amortization, 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. Prasad & Green 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. . 10-68

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CASE 10-56 ÉLECTRONIQUE INSTRUMENTS Cash Budget For the Second Quarter Ended June 30,2009 Quarter May June

April Beg. cash balance Plus: cash receipts (1) From 2 mos. Prior From 1 mo. prior Total cash receipts Total cash available Less: disbursements For parts (2b) For wages (3) For S&A (4) Property tax (5) Income tax (6) Total disbursements Excess (deficiency) Financing: Plus: Borrowing Less: Investment Total financing Ending cash balance

Total

$100,000

800,000 1,080,000 1,880,000 1,980,000

720,000 1,320,000 2,040,000 2,140,000

880,000 1,500,000 2,380,000 2,480,000

2,400,000 3,900,000 6,300,000 6,400,000

1,004,000 440,000 150,000

1,156,000 500,000 150,000

1,310,000 560.000 150,000 60,000

244,800 1,838,800 141,200

1,806,000 334,000

2,080,000 400,000

3,470,000 1,500,000 450,000 60,000 244,800 5,724,800 675,200

(41,200) (41,200) $100,000

(234,000) (234,000) $100,000

(300,000) (300,000) $100,000

(575,200) (575,200) $100,000

. 10-69

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CASE 10-56 (Continued) (1) Cash Receipts April: From February ($2,000,000 x 40%) From March ($1,800,000 x 60%) May: From March ($1,800,000 x 40%) From April ($2,200,000 x 60%) June: From April ($2,200,000 x 40%) From May ($2,500,000 x 60%)

$800,000 1,080,000

1,880,000

$720,000 1,320,000

2,040,000

$880,000 1,500,000

2,380,000

$400,000 540,000

$940,000

360,000 660,000

1,020,000

440,000 750,000

1,190,000

500,000 840,000

1,340,000

(2a) Purchases (Parts) February: From February ($2,000,000 x 40% x 50%) From March ($1,800,000 x 60% x 50%) March: From March ($1,800,000 x 40% x 50%) From April ($2,200,000 x 60% x 50%) April: From April ($2,200,000 x 40% x 50%) From May ($2,500,000 x 60% x 50%) May: From May ($2,500,000 x 40% x 50%) From June ($2,800,000 x 60% x 50%) (2b) Cash disbursements for parts April: From February ($940,000 x 20%) From March ($1,020,000 x 80%) May: From March ($1,020,000 x 20%) From April ($1,190,000 x 80%) June: From April ($1,190,000 x 20%) . 10-70

$188,000 816,000 $1,004,000 204,000 952,000 238,000

1,156,000

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1,072,000

1,310,000

(3) Cash disbursements for wages April: ($2,200,000 x 20%) May: ($2,500,000 x 20%) June: ($2,800,000 x 20%)

$440,000 500,000 560,000 $1,500,000

(4) Cash disbursements for general and admin expenses Total costs for the year Less: non-cash amortization Cash expenditures for the year Less: non-uniform property taxes Annual cash disbursements divided evenly over 12 months Monthly disbursement (5) Property taxes: 25% x $240,000 (6) Income tax: 40% x $612,000

. 10-71

2,640,000 600,000 2,040,000 240,000 1,800,000 ÷ 12 $150,000

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CASE 10-57 (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 speechmaking.

. 10-72

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-10 (a)Sales budget

Waterways Corporation Sales Budget For the first quarter of 2010 First Quarter January February March Expected unit sales 113,333 112,500 116,667 Unit selling price $ 12 $ 12 $ 12 Total sales $ 1,359,996 $ 1,350,000 $ 1,400,004

Quarter 342,500 $ 12 $ 4,110,000

(b)Production budget Waterways Corporation Production Budget For the first quarter of 2010 First Quarter January February March Quarter Expected unit sales 113,333 112,500 116,667 342,500 Add: Desired ending finished goods units 11,250 11,667 12,500* 12,500 Total required units 124,583 124,167 129,167 355,000 Less: Beginning finished goods units 11,333** 11,250 11,667 11,333 Required production units 113,250 112,917 117,500 343,667 * 12,500 is 10% of April’s budgeted unit sales ** 11,333 is 10% of January’s unit sales . 10-73

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(c)Direct materials budget Waterways Corporation Direct Materials Budget For the first quarter of 2010 First Quarter January February March Units to be produced 113,250 112,917 117,500 (from part b) Direct materials per unit* 1.13 1.13 1.13 Total kilograms needed 127,973 127,596 132,775 for production Add: Desired ending 6,380 6,639 7,133 direct materials (Kg) ** Total materials required 134,353 134,235 139,908 Less: Beginning direct 5,575 6,380 6,639 materials (kg) *** Direct materials 128,778 127,855 133,269 purchases Cost per kg $ 1.31 $ 1.31 $1.31 Total cost of direct $168,700 $167,490 $174,582 materials purchases Material

Quantity

Metal Plastic Rubber Total Cost per kg

180 g 700 g 250 g 1.130 kg $1.31

Cost Per Kg $3.27 $0.87 $1.13

Quarter 343,667 1.13 388,344 7,133 395,477 5,575 389,902 $1.31 $510,772

Cost per unit $0.59 $0.61 $0.28 $1.48

* Direct materials per unit ** Desired ending direct materials are equal to 5% of the next month’s material needs. April planned production needs are 126,250 units; each unit needs 1.13 kg. 126,250 x 5% x 1.13 = 7133 [April units to be produced: Expected sales units (125,000) plus 10% of May’s sales units (13,750) less March’s ending unit inventory (12,500) = 126,250]. . 10-74

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*** Actual inventory

(d)Direct labour budget Waterways Corporation Direct Labour Budget For the first quarter of 2010 First Quarter January February March Quarter Units to be produced 113,250 112,917 117,500 343.667 (from part b) Direct labour time (hours per unit) 0.2 0.2 0.2 0.2 Total required direct 22,650 22,583 23,500 68,733 labour-hours Direct labour cost per hour $8.00 $8.00 $8.00 $8.00 Total direct labour cost $181,200 $180,664 $188,000 $549,864

. 10-75

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Manufacturing overhead budget Waterways Corporation Manufacturing Overhead Budget For the first quarter of 2010 First Quarter January February March

Variable costs Indirect materials (30¢ per hour) Indirect labour (50¢ per hour) Utilities (45¢ per hour) Maintenance (25¢ per hour) Total variable costs Fixed costs Salaries Amortization Property taxes Insurance Maintenance Fixed manufacturing overhead Total manufacturing overhead

Quarter

$ 6,795

$ 6,775

$ 7,050

$ 20,620

11,325

11,292

11,750

34,367

10,193 5,663

10,162 5,646

10,575 5,875

30,930 17,183

$ 33,976

$ 33,875

$35,250

$103,100

42,000 16,800 2,500 1,200 1,300 $ 63,800

126,000 50,400 7,500 3,600 3,900 $191,400

$ 97,776

$ 97,675

$ 99,050

$294,500

Total manufacturing $294,500 overhead Direct labour hours (from 22,650 22,583 23,500 68,733 part d) Predetermined overhead rate for the quarter $294,500 / 68,733 hours = $4.28

. 10-76

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(f)Selling and administrative expense budget Waterways Corporation Selling and Administrative Expense Budget For the first quarter of 2010 First Quarter January February March Quarter Budget sales in units (from part a) 113,333 112,500 116,667 342,500 Variable expenses per unit $1.62 $1.62 $1.62 $1.62 Total variable S & A expense $ 183,599 $ 182,250 $ 189,001 $ 554,850 Fixed expenses: Advertising $ 15,000 $ 15,000 $ 15,000 $ 45,000 Insurance 1,400 1,400 1,400 4,200 Salaries 72,000 72,000 72,000 216,000 Amortization 2,500 2,500 2,500 7,500 Other 3,000 3,000 3,000 9,000 Total fixed expenses $ 93,900 $ 93,900 $ 93,900 $ 281,700 Total S & A expenses $ 277,499 $ 276,150 $ 282,901 $ 836,550

. 10-77

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(g)Collections from customers Schedule of Expected Collections from Customers January February March Accounts receivable, 12/31/09 $ 183,750 January ($1,359,996) 1,155,997* $ 203,999 February ($1,350,000) 1,147,500 $ 202,500 March ($1,400,004) 1,190,003 Total cash collections

$ 1,339,747

$ 1,351,499 $ 1,392,503

* 85% of sales collected in month of sale (.85  $1,359,996) 15% of sales collected in month after sale (.15  $1,359,996) (h)Payments for direct materials Schedule of Expected Payments for Direct Materials January Accounts payable, 12/31/09 January ($168,675) February ($167,468) March ($174,559) Total payments

February

$120,595.00 84,337.50

March

Quarter $120,595.00

84,337.50 83,734.00

168,675.00 83,734.00 167,488.00 87,279.50 87,2479.50

$ 204,932.50 $ 168,071.50 $171,013.50 $544,017.50

Purchase payments 50% in month of purchase and 50% in month after purchase

. 10-78

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(i)Cash budget Waterways Corporation Cash Budget For the first quarter of 2010 First Quarter January February Beginning cash balance Add: Receipts Collections from customers Total available cash Less: Disbursements Direct materials Direct labour Manufacturing overhead* Selling and administrative* Equipment purchase Dividends Total disbursements Excess (deficiency) of available cash over cash disbursements Financing: Borrowings Repayments Interest Ending cash balance

March

Quarter

$ 100,500

$ 800,640

$ 819,841 $ 100,500

1,339,747 1,440,247

1,351,499 2,152,139

1,392,503 4,083,749 2,212,344 4,184,249

204,932 181,200

168,072 180,667

171,014 188,000

544,018 549,867

80,976

80,875

82,250

244,100

274,999

280,401

12,500 754,607

273,650 500,000 12,500 1,215,764

685,640

936,375

829,050 500,000 12,500 37,500 734,165 2,704,536

1,478,179 1,479,713

115,000

115,000 115,000 1,534

115,000 1,534** $ 800,640

• *Adjusted for amortization . 10-79

$ 819,841

$1,478,179 $1,478,179

** $115,000 @8%x2/12

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Legal Notice

. 10-80

CHAPTER 11 Budgetary Control and Responsibility Accounting ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Exercises

A Problems

B Problems

Study Objectives

Questions

1. Describe the concept of budgetary control.

1, 2

2. Evaluate the usefulness of static budget reports.

3, 4, 5

1, 2, 3

13, 14, 20

35, 36

3. Explain the development of flexible budgets and the usefulness of flexible budget reports.

6, 7, 8, 9, 10, 11, 12

3, 4, 5

13, 15, 16, 17, 18, 19, 20, 21, 22

32, 33, 34, 35, 36

4. Describe the concept of responsibility accounting.

13, 14, 15, 16, 17, 18, 24

5. Indicate the features of responsibility reports for cost centres.

19, 21, 24

32, 35, 36, 40, 43

46, 47, 48

6. Identify the content of responsibility reports for profit centres.

20, 21

25, 26

37, 43

7. Explain the basis and formula used in evaluating performance in investment centres.

22, 23, 24

8, 9, 10

26, 27, 28, 29

38, 39, 42, 43, 44, 45

50, 51, 52, 54

*8. Explain the difference between ROI and residual income.

25, 26

11, 12

30, 31

41, 42, 43, 44, 45

51, 52, 53, 54, 56

46, 47, 48, 55

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

. 11-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

32A

Prepare a flexible budget and a budget report for manufacturing overhead.

Simple

20–30

33A

Prepare a flexible budget report for a cost centre.

Simple

15-20

34A

Prepare a flexible budget, budget report, and graph for manufacturing overhead

Moderate

30–40

35A

Prepare a flexible budget report; compare flexible and fixed budgets

Moderate

30–40

36A

State the total budgeted cost formula, and prepare flexible budget reports for two time periods

Moderate

40–50

37A

Prepare a responsibility report for a profit centre.

Simple

20–30

38A

Prepare a responsibility report for an investment centre, and compute ROI.

Simple

20–30

39A

Discuss the impact of ROI and residual income on manager performance.

Moderate

20–30

40A

Prepare reports for cost centres under responsibility accounting, and comment on the performance of managers

Moderate

30–40

41A

Compute ROI and residual income and discuss the impact on manager performance

Simple

20–30

42A

Compute ROI and residual income and discuss the impact on manager performance

Moderate

20–30

43A

Compute ROI and residual income, identify responsibility centres, and discuss the impact on manager performance.

Moderate

20–30

44A

Compare ROI and residual income with supporting calculations

Moderate

15-20

45A

Compare and contrast performances under ROI and residual income.

Moderate

30-40

46B

Prepare a flexible budget and budget report for manufacturing overhead

Simple

30-40

. 11-2

47B

Prepare a flexible budget, budget report, and graph for manufacturing overhead.

Moderate

30-40

48B

Prepare flexible budget reports for varying situations using the total budgeted cost formula.

Moderate

30-40

49B

Prepare a responsibility report for a profit centre

Simple

20-30

50B

Prepare a responsibility report for an investment centre, and compute ROI

Moderate

20-30

51B

Compare ROI and residual income with supporting calculations.

Moderate

15-20

52B

Compute ROI and residual income and rank department performances

Simple

20-30

53B

Discuss the impact of ROI and residual income on manager performance.

Moderate

20-30

54B

Compare and contrast performances under ROI and residual income.

Moderate

30-40

55B

Prepare a flexible budget report for a cost centre.

Simple

20-30

56B

Compute ROI and residual income and discuss the impact on manager performance.

Simple

15-20

. 11-3

Study Objective

Knowledge

Comprehension

Application

Analysis

Synthesis

Evaluation

1. Describe the concept of budgetary control.

E13

Q1, Q2

2. Evaluate the usefulness of static budget reports.

E13

Q3, Q4, Q5

BE1 BE2

E14, P35A, P36A, P48B

BE3, E20

3. Explain the development of flexible budgets and the usefulness of flexible budget reports.

Q9, Q12, E13

Q6, Q7, Q8, Q10,

Q11 BE4 P33A P55B

BE5 E15 E16 E18

BE3, E20, P34A, P47B

4. Describe the concept of responsibility accounting. 5. Indicate the features of responsibility reports for cost centres.

Q13 Q14

Q15 Q16

Q17 Q18

Q19

E17 P32A E19 P35A E21 P36A E22 P46B P48B

E23, P40A BE6

E24, E19, E21, P32A, P36A, P40A P46B, P48B

P34A, P47B

6. Identify the content of responsibility reports for profit centres.

Q20, Q21

BE7

E25 P43A E26 P49B P37A

7. Explain the basis and formula used in evaluating performance in investment centres.

Q22, Q23, Q24

BE8 BE9 BE10

E26, E27, E28. E29, P39A, P42A, P43A, P52B

P38A, P44A, P45A, P50B, P51B, P54B

BE11 BE12

E30, E31, P41A, P42A, P43A, P52B, P53B, P56B

P44A, P45A, P51B, P54B

*8. Explain the difference between ROI and residual income.

Q25

BLOOM’ S TAXONOMY TABLE

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

11-4

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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 Joe’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 $4,250 over budget ($65,000 – $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 $300 under budget ($6,500 – $6,200).

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.

Alou Company can say that total budgeted costs are $25,000 fixed plus $6 per direct labor hour [($85,000 – $25,000) ÷ 10,000].

. 11-5

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Questions Chapter 11 (Continued) 11.

(a) At 9,000 hours, total budgeted costs are $56,000, or [$40,000 + ($2 X 9,000)]. (b) At 12,345 hours, total budgeted costs are $64,690, or [$40,000 + ($2 X 12,345)].

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.

Ann 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 non-controllable at that level.

16.

Responsibility reports differ from budget reports in two respects: (1) a distinction is made between controllable and non-controllable 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 centres: (a) A cost centre incurs costs (and expenses) but does not generate revenues. (b) A profit centre incurs costs (and expenses) and also generates revenues. (c) An investment centre 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 centre. (b) Variable and fixed costs are not identified in the report.

20.

Direct fixed costs relate specifically to one centre and are incurred for the sole benefit of that centre. An indirect fixed cost relates to the company’s overall activities and is incurred for the benefit of more than one profit centre. Both types of fixed costs are controllable. A direct fixed cost is controllable by a specific centre manager and an indirect fixed cost is controllable by an officer higher up in the organization.

. 11-6

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Questions Chapter 11 (Continued) 21.

Controllable margin is contribution margin less controllable fixed costs in a profit centre. The purpose of controllable margin is to provide a basis for evaluating the manager’s effectiveness in controlling revenues and costs.

22. The primary basis for evaluating the performance of the manager of an investment centre 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.

. 11-7

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11-1 WESTPHAL COMPANY Sales Budget Report For the Quarter Ended March 31, 2009

Product Line

Budget

Actual

Difference

Garden-Tools

$310,000

$304,000

$6,000 U

BRIEF EXERCISE 11-2 WESTPHAL COMPANY Sales Budget Report For the Quarter Ended June 30, 2009

Product Line

Second Quarter Budget Actual Difference

Garden-Tools $380,000 $383,000

$3,000 F

Year to Date Budget Actual Difference $690,000 $687,000

$3,000 U

BRIEF EXERCISE 11-3 (a)

Direct Labour

HINSDALE COMPANY Static Direct Labour Budget Report For the Month Ended January 31, 2009

Budget $200,000 (10,000 X $20)

. 11-8

Actual $203,000

Difference $3,000 U

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BRIEF EXERCISE 11-3 (Continued) (b)

HINSDALE COMPANY Flexible Direct Labour Budget Report For the Month Ended January 31, 2009

Direct Labour

Budget

Actual

Difference

$208,000 (10,400 X $20)

$203,000

$5,000 F

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 11-4 DUKANE COMPANY Monthly Flexible Manufacturing Budget For the Year 2009 Activity level: units Variable costs: Direct materials ($4) Direct labour ($6) Overhead ($8) Total variable costs Fixed costs: Amortization 1 Supervision 2 Total fixed costs Total costs 1

$2 x 1,200,000 ÷ 12

80,000

100,000

120,000

$320,000 480,000 640,000 1,440,000

$400,000 600,000 800,000 1,800,000

$480,000 720,000 960,000 2,160,000

200,000 100,000 300,000 $1,740,000

200,000 100,000 300,000 $2,100,000

200,000 100,000 300,000 $2,460,000

$1 x 1,200,000 ÷ 12

. 11-9

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BRIEF EXERCISE 11-5 DUKANE COMPANY Manufacturing Budget Report For the Month Ended March 31, 2009 Budget

Actual

Difference Favourable F Unfavourable U

Units produced Variable costs Direct materials Direct labour Overhead Total variable costs Fixed costs: Amortization Supervision Total fixed costs Total costs

100,000

$400,000 600,000 800,000 1,800,000

$425,000 590,000 805,000 1,820,000

$25,000 10,000 5,000 20,000

200,000 100,000 300,000 $2,100,000

200,000 100,000 300,000 $2,120,000

$20,000

U F U U

Costs were not entirely controlled as evidenced by the unfavourable difference between budgeted and actual for variable costs. BRIEF EXERCISE 11-6 OSAKA COMPANY Assembly Department Manufacturing Overhead Cost Responsibility Report For the Month Ended April 30, 2009 Favourable F Unfavourable U

Controllable Cost Indirect materials Indirect labour Utilities Supervision Total

Budget $15,000 20,000 10,000 5,000 $50,000

. 11-10

Actual $14,300 20,800 10,750 5,000 $50,850

Difference $700 F 800 U 750 U -$850

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BRIEF EXERCISE 11-7 ADVENT MANUFACTURING COMPANY Water Division Responsibility Report For the Year Ended December 31, 2009 Favourable F Unfavourable U

Sales Variable costs Contribution margin Controllable fixed costs Controllable margin

Budget $2,000,000 1,000,000 1,000,000 300,000 $700,000

Actual $2,080,000 1,050,000 1,030,000 310,000 $720,000

Difference $80,000 F 50,000 U 30,000 F 10,000 U $20,000 F

BRIEF EXERCISE 11-8 SANJAY COMPANY Plastics Division Responsibility Report For the Year Ended December 31, 2009

Favourable F Unfavourable U

Contribution margin Controllable fixed costs Controllable margin

Budget $700,000 300,000 $400,000

Actual $715,000 309,000 $406,000

Difference $15,000 F 9,000 U $6,000 F

20.0%1

20.3%2

0.3%3

¹ ($400,000 ÷ $2,000,000) ² ($406,000 ÷ $2,000,000) ³ ($6,000 ÷ $2,000,000) . 11-11

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BRIEF EXERCISE 11-9 III III III

24% ($1,200,000 ÷ $5,000,000) 25% ($2,000,000 ÷ $8,000,000) 32% ($3,200,000 ÷ $10,000,000)

BRIEF EXERCISE 11-10 III

Increase in sales: $300,000 ($2,000,000 x 15%) This will cause an increase in contribution margin and controllable margin: $225,000 ($300,000 x 75%) The new ROI is 28.5% ($1,425,000 ÷ $5,000,000).

III

A decrease in costs results in a corresponding increase in controllable margin. The new ROI is 27.5% ($2,200,000 ÷ $8,000,000).

III

A decrease in average operating assets reduces the denominator. The new ROI is 33.3% ($3,200,000 ÷ $9,600,000).

*BRIEF EXERCISE 11-11 Controllable Margin ÷ Average Operating Assets = ROI $600,000 ÷ $3,000,000 = 20% Controllable Margin – (Minimum Rate of Return x Average Operating Assets) = Residual Income $600,000 – (9% x $3,000,000) = $330,000

*BRIEF EXERCISE 11-12 Controllable Margin ÷ Average Operating Assets = ROI $800,000 ÷ $3,200,000 = 25% Controllable Margin – (Minimum Rate of Return x Average Operating Assets) = Residual Income $800,000 – (16% x $3,200,000) = $288,000 . 11-12

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SOLUTIONS TO EXERCISES EXERCISE 11-13 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 11-14 (a)

PARGO COMPANY Selling Expense Report For March

Month

Budget

By Month Actual Difference

January February March

$30,000 $35,000 $40,000

$31,000 $34,500 $47,000

$1,000 U $ 500 F $7,000 U

Year-to-Date Actual Difference

Budget

$30,000 $ 31,000 $65,000 $ 65,500 $105,000 $112,500

$1,000 U $ 500 U $7,500 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 (3.3% in January and 1.4% in February), and require no action. When the March results are examined, however, the fact that the difference is 17.5% 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.

. 11-13

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EXERCISE 11-15 RANEY COMPANY Monthly Manufacturing Overhead Flexible Budget For the Year 2009 Activity level: DLH Variable costs: Indirect labour ($1) Indirect materials ($0.50) Utilities ($0.40) Total variable costs Fixed costs: Supervision Amortization Property taxes Total fixed costs Total costs

7,000

8,000

9,000

10,000

$7,000 3,500 2,800 13,300

$8,000 4,000 3,200 15,200

$9,000 4,500 3,600 17,100

$10,000 5,000 4,000 19,000

4,000 1,500 800 $6,300 $19,600

4,000 1,500 800 $6,300 $21,500

4,000 1,500 800 $6,300 $23,400

4,000 1,500 800 $6,300 $25,300

EXERCISE 11-16 (a)

RANEY COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended July 31, 2009 Favourable F Unfavourable U

Direct labour hours Variable costs Indirect labour Indirect materials Utilities Total variable costs Fixed costs: Supervision Amortization Property Tax Total fixed costs Total costs

Budget 9,000

Actual 9,000

Difference

$9,000 4,500 3,600 17,100

$8,700 4,300 3,200 16,200

$300 200 400 900

4,000 1,500 800 6,300 $23,400

4,000 1,500 800 6,300 $22,500

-$900 F

. 11-14

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EXERCISE 11-16 (Continued) (b)

RANEY COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended July 31, 2009

Favourable F Unfavourable U

Direct labour hours Variable costs Indirect labour ($1.00) Indirect materials ($0.50) Utilities ($0.40) Total variable costs Fixed costs: Supervision Amortization Property Tax Total fixed costs Total costs

Budget 8,500

Actual 8,500

Difference

$8,500 4,250 3,400 16,150

$8,700 4,300 3,200 16,200

$200 50 200 50

4,000 1,500 800 6,300 $22,450

4,000 1,500 800 6,300 $22,500

-$50 U

U U F 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, 2.4% of budgeted cost for indirect labor and 1.2% for indirect materials, they might be considered immaterial.

. 11-15

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EXERCISE 11-17 VINCENT COMPANY Monthly Flexible Selling Expense Budget For the Year 2009 Activity level: Sales Variable costs: Commissions (5%) Advertising (4%) Travelling (3%) Delivery (2%) Total variable costs Fixed costs: Sales salaries Amortization Insurance Total fixed costs Total costs

$170,000

$180,000

$190,000

$200,000

$8,500 6,800 5,100 3,400 23,800

$9,000 7,200 5,400 3,600 25,200

$9,500 7,600 5,700 3,800 26,600

$10,000 8,000 6,000 4,000 28,000

34,000 7,000 1,000 $42,000 $65,800

34,000 7,000 1,000 $42,000 $67,200

34,000 7,000 1,000 $42,000 $68,600

34,000 7,000 1,000 $42,000 $70,000

. 11-16

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EXERCISE 11-18 (a)

VINCENT COMPANY Flexible Budget Performance Report For the Month of March 2009

Favourable F Unfavourable U

Sales Variable costs Sales commissions Advertising Travel Delivery Total variable costs Fixed costs: Sales salaries Amortization Insurance Total fixed costs Total costs

Budget $170,000

Actual $170,000

Difference

$8,500 6,800 5,100 3,400 23,800

$9,200 7,000 5,100 3,500 24,800

$700 200 -100 1,000

34,000 7,000 1,000 42,000 $65,800

34,000 7,000 1,000 42,000 $66,800

-$1,000 U

. 11-17

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EXERCISE 11-18 (Continued) (b)

VINCENT COMPANY Selling Expense Flexible Budget Performance Report For the Month Ended March 31, 2009

Favourable F Unfavourable U

Sales Variable costs Sales commissions Advertising Travel Delivery Total variable costs Fixed costs: Sales salaries Amortization Insurance Total fixed costs Total costs

Budget $180,000

Actual $180,000

Difference

$9,000 7,200 5,400 3,600 25,200

$9,200 7,000 5,100 3,500 24,800

$200 200 300 100 400

34,000 7,000 1,000 42,000 $67,200

34,000 7,000 1,000 42,000 $66,800

-$400 F

U F F F 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 $1,000 but at $180,000 of sales, the manager was under budget (favorable) by $400.

. 11-18

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

EXERCISE 11-19 (a)

Weygandt, Kimmel, Kieso, Aly

SUBLETTE COMPANY

Manufacturing Overhead Flexible Budget Report For the first Quarter Ended March 31, 2009

Favourable F Unfavourable U

Variable costs Indirect materials Indirect labour Utilities Maintenance Total variable costs Fixed costs: Supervisory salaries Amortization Property taxes Maintenance Total fixed costs Total costs (b)

Budget

Actual

Difference

$12,000 10,000 8,000 6,000 36,000

$13,800 9,600 8,700 4,900 37,000

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

36,000 7,000 8,000 5,000 56,000 $92,000

36,000 7,000 8,200 5,000 56,200 $93,200

--200 U -200 U $1,200 U

U F U F U

SUBLETTE COMPANY Manufacturing Overhead Responsibility Report For the Quarter Ended March 31, 2009 Favourable F Unfavourable U

Indirect materials Indirect labour Utilities Maintenance-variable Maintenance-fixed Supervisory salaries Total

Budget

Actual

Difference

$12,000 10,000 8,000 6,000 5,000 36,000 $77,000

$13,800 9,600 8,700 4,900 5,000 36,000 $93,200

$1,800 400 700 1,100 --$1,000

. 11-19

U F U F

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 11-20 (a)

DUNHAM COMPANY Selling Expense Flexible Budget Report Clothing Department For the Month Ended October 31, 2009

Favourable F Unfavourable U

Sales in units Variable costs: Sales commissions (25%) Advertising (10%) Travel (45%) Free Samples (20%) Total variable costs Fixed costs: Rent Sales salaries Office salaries Amortization Total fixed costs Total costs

Budget $10,000

Actual $10,000

Difference

$2,500 1,000 4,500 2,000 10,000

$2,600 850 4,000 1,300 8,750

$100 150 500 700 1,250

1,500 1,200 800 500 4,000 $14,000

1,500 1,200 800 500 4,000 $12,750

-----$1,250 F

U F F F F

(b) Kajsa should not have been reprimanded. As shown in the flexible budget report, variable costs were $1,250 below budget.

. 11-20

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 11-21 (a) PRONTO PLUMBING COMPANY Home Plumbing Services Segment Responsibility Report For the Quarter Ended March 31, 2009 Favourable F Unfavourable U

Service revenue Variable costs: Materials and supplies Wages Gas & oil Total variable costs Contribution margin Controllable fixed costs: Supervisory salaries Insurance Amortization—equipment Total fixed costs Net Income

Budget $25,000

Actual $26,000

Difference $1,000 F

$1,500 3,000 2,700 7,200 17,800

$1,200 3,300 3,400 7,900 18,100

$300 300 700 700 300

F U U U F

9,000 4,000 1,600 14,600 $3,200

9,400 3,500 1,300 14,200 $3,900

400 500 300 400 $700

U F F F F

. 11-21

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

(b)

Weygandt, Kimmel, Kieso, Aly

MEMO

TO:

Paul Pronto

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. I hope these suggested guidelines will be helpful in establishing the performance reporting system to be used by Pronto Plumbing Company.

. 11-22

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 11-22 (a) Fabricating Department:

Y = $40,000 + $2.20x $40,000 fixed costs plus total variable costs of $2.20 per direct labour hour [($150,000 – $40,000) ÷ 50,000].

Assembling Department:

Y = $30,000 + $1.60x $30,000 fixed costs plus total variable costs of $1.60 per direct labour hour [($110,000 – $30,000) ÷ 50,000].

(b) Fabricating Department = $40,000 + ($2.20 X 53,000) = $156,600. Assembling Department = $30,000 + ($1.60 X 47,000) = $105,200. (c)

$300

Total Budgeted Cost Line

250

Costs in (000)

200 Budgeted Variable Costs

150

100

50 Budgeted Fixed Costs

40 0

Direct Labour Hours in (000) . 11-23

90 100

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 11-23 (a) To Vancouver Department Manager—Finishing Controllable Costs: Direct materials Direct labour Manufacturing overhead Total

Budget $45,000 82,000 49,200 $176,200

(b) To Assembly Plant Manager—Vancouver Controllable Costs: Vancouver office Departments: Machining Finishing Total

Actual $41,000 83,000 51,000 $175,000

Fav/Unfav $4,000 F 1,000 U 1,800 U $1,200 F

Month: July, 2009

Budget $92,000

Actual $95,000

Fav/Unfav $3,000 U

216,000 176,200 $484,200

220,000 175,000 $490,000

4,000 U 1,200 F $5,800 U

Month: July, 2009

Month: July, 2009 Budget $130,000

Actual $132,000

Fav/Unfav $2,000 U

421,000 496,500 484,200 $1,531,700

424,000 494,000 490,000 $1,540,000

3,000 2,500 5,800 $8,300

. 11-24

U F U U

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 11-24 (a) CREDE COMPANY Mixing Department Responsibility Report For the Month Ended January 31, 2009

Favourable F Unfavourable U

Controllable Cost

Budget

Actual

Difference

Indirect materials Indirect labour Lubricants Maintenance Utilities Total

$7,500 12,000 1,700 3,500 5,000 $29,700

$10,200 12,200 1,650 3,500 6,500 $34,050

$2,700 200 50 -1,500 $4,350

(b)

U U F U U

Most likely, when management examined the responsibility report for January, they would determine that the differences were insignificant for indirect labor (1.7% of budget), lubricants (2.9%), and maintenance (0%) and require no action. However, the differences for indirect materials (36%), and utilities (30%) 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 11-25 (a) (a) Controllable margin ($240,000 – $100,000) (b) Variable costs ($600,000 – $240,000) (c) Contribution margin ($450,000 – $330,000) (d) Controllable fixed costs ($120,000 – $90,000) (e) Controllable fixed costs ($180,000 – $96,000) (f) Sales ($250,000 + $180,000)

. 11-25

$140,000 360,000 120,000 30,000 84,000 430,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 11-25 (Continued) (b) LONGHEAD MANUFACTURING INC. Women’s Shoe Division Responsibility Report For the Month Ended June 30, 2009 Favourable F Unfavourable U

Sales Variable costs Contribution margin Controllable fixed costs Controllable margin EXERCISE 11-26 (a)

Budget $600,000 360,000 240,000 100,000 $140,000

Actual $600,000 370,000 230,000 100,000 $130,000

Difference $ -10,000 U 10,000 U --$10,000 U

BRANDON McCARTHY COMPANY Sports Equipment Division Responsibility Report For the Year ended December 31, 2009 Favourable F Unfavourable U

Sales Variable costs: Cost of goods sold Selling and admin Total variable costs Contribution margin Controllable fixed costs: Cost of goods sold Selling and admin Total fixed costs Controllable cost margin

Budget $900,000

Actual $880,000

Difference $20,000 U

440,000 60,000 500,000 400,000

409,000 61,000 470,000 410,000

31,000 1,000 30,000 10,000

F U F F

100,000 90,000 190,000 $210,000

105,000 67,000 172,000 $238,000

5,000 23,000 18,000 $28,000

U F F F

(b) $238,000/$1,000,000 = 23.8% . 11-26

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 11-27 (a) Controllable margin = ($3,000,000 – $1,950,000 – $600,000) = $450,000 ROI = $450,000 ÷ $5,000,000 = 9% (b) 1.

Contribution margin is $3,000,000 – $1,950,000 = $1,050,000 Contribution margin percentage is 35%, or ($1,050,000 ÷ $3,000,000) Increase in controllable margin = $320,000 X 35% = $112,000 ROI = ($450,000 + $112,000) ÷ $5,000,000 = 11.2%

($450,000 + $100,000) ÷ $5,000,000 = 11%

$450,000 ÷ ($5,000,000 – $200,000) = 9.4%

EXERCISE 11-28 (a) MEDINA AND HALEY DENTAL CLINIC Preventive Services Responsibility Report For the Month Ended May 31, 2009 Favourable F Unfavourable U

Service revenue Variable costs: Filling materials Novocain Supplies Dental assistant wages Utilities Total variable costs Contribution margin Controllable fixed costs: Dentist salary Amortization—equipment Total fixed costs Net Income

Budget $39,000

Actual $40,000

Difference $1,000 F

4,900 3,800 2,250 2,500 450 13,900 25,100

5,000 4,000 2,000 2,500 500 14,000 26,000

100 200 250 -50 100 900

9,500 6,000 15,500 $9,600

10,000 6,000 16,000 $10,000

500 U -500 U $400 F

Return on investment* 12.0% 12.5% *Use average investment = ($82,400 + $77,600) ÷ 2 = $80,000 . 11-27

U U F U U F

0.5% F

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 11-28 (Continued) (b) MEMO TO: Drs. Martin Medina and Cybil Haley 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 centre, showing the amount available to go towards covering controllable fixed costs. It does not report only those costs controllable by the manager of the centre. Instead, it includes both controllable and common fixed costs. This results in the centre appearing to be unprofitable. It does not indicate the return on investment earned by the centre.

All of these deficiencies have been addressed in the recommended responsibility report attached. As can be seen from that report, the Preventive Services centre is profitable. The service revenues generated in this centre 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 centre and that it exceeds the budget goal.

. 11-28

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 11-29 Planes: ROI = Controllable margin ÷ Average operating assets 12% = Controllable margin ÷ $25,000,000 Controllable margin = $25,000,000 X 12% = $3,000,000 (g) Contribution margin = Controllable margin + Controllable fixed costs Contribution margin = $3,000,000 + $1,500,000 = $4,500,000 (d) Service revenue = Contribution margin + Variable costs Service revenue = $4,500,000 + $5,500,000 = $10,000,000 (a) Taxis: ROI = Controllable margin ÷ Average operating assets 10% = $80,000 ÷ Average operating assets Average operating assets = $80,000 ÷ 0.10 = $800,000 (h) Controllable fixed costs = Contribution margin – Controllable margin Controllable fixed costs = $200,000 – $80,000 = $120,000 (e) Variable costs = Service revenue – Contribution margin Variable costs = $500,000 – $200,000 = $300,000 (c) Limos: ROI = Controllable margin ÷ Average operating assets ROI = $240,000 ÷ $1,600,000 = 15% (i) Controllable fixed costs = Contribution margin – Controllable margin Controllable fixed costs = $480,000 – $240,000 = $240,000 (f) Service revenue = Contribution margin + Variable costs Service revenue = $480,000 + $320,000 = $800,000 (b)

. 11-29

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*EXERCISE 11-30 (a)

North Division: ROI = $150,000 ÷ $1,000,000 = 15% West Division: ROI = $400,000 ÷ $2,000,000 = 20% South Division: ROI = $225,000 ÷ $1,500,000 = 15%

(b)

North Division: Residual Income = $150,000 – (0.13 X $1,000,000) = $20,000 West Division: Residual Income = $400,000 – (0.16 X $2,000,000) = $80,000 South Division: Residual Income = $225,000 – (0.10 X $1,500,000) = $75,000

(c)

If ROI is used to measure performance, only the North Division (with a 15% ROI) and the South Division (with a 15% ROI) would make the additional investment that provides a 19% ROI. The West Division presently earns a 20% return ($400,000 ÷ $2,000,000), and therefore would decline the investment.

(d) 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 11-31 (a) Average operating assets = Controllable margin ÷ ROI Average operating assets = $200,000 ÷ 0.25 = $800,000 (b) (Controllable margin – Residual income) ÷ Average operating assets = Minimum rate of return Minimum rate of return = ($200,000 – $90,000) ÷ $800,000 = 13.75% (c) Residual income + (Minimum rate of return x Average operating assets) = Controllable margin Controllable margin = $200,000 + ($1,000,000 x 0.13) = $330,000 (d) ROI = Controllable margin ÷ Average operating assets ROI = $330,000 ÷ $1,000,000 = 33%

. 11-30

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO PROBLEMS—SET A PROBLEM 11-32A

(a)

ALCORE COMPANY Monthly Manufacturing Overhead Flexible Budget For the Year ended December 31, 2009

Activity level Variable costs: Indirect materials ($0.20)1 Indirect labour ($0.30)2 Repairs ($0.10)3 Utilities ($0.21)4 Lubricants ($0.04)5 Total variable costs Fixed costs: Supervision Amortization Insurance Rent Property taxes Total fixed costs Total costs

18,000

20,000

22,000

24,000

$3,600 5,400 1,800 3,780 720 $15,300

$4,000 6,000 2,000 4,200 800 17,000

$4,400 6,600 2,200 4,620 880 18,700

$4,800 7,200 2,400 5,040 960 20,400

6,000 3,000 1,000 750 500 11,250 $26,550

6,000 3,000 1,000 750 500 11,250 $28,250

6,000 3,000 1,000 750 500 11,250 $29,950

6,000 3,000 1,000 750 500 11,250 $31,650

$48,000 ÷ 240,000 DLH $72,000 ÷ 240,000 DLH 3 $24,000 ÷ 240,000 DLH 4 $50,000 ÷ 240,000 DLH 5 $ 9,600 ÷ 240,000 DLH 2

. 11-31

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 11-32A (Continued) (b)

ALCORE COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended January 31, 2009 Favourable F Unfavourable U

Activity: direct labour hrs Variable costs: Indirect materials Indirect labour Repairs Utilities Lubricants Total variable costs Fixed costs: Supervision Amortization Insurance Rent Property taxes Total fixed costs Total costs

Budget 20,000

Actual 20,000

Difference --

$4,000 6,000 2,000 4,200 800 17,000

$3,600 6,200 1,600 3,300 830 15,530

400 200 400 900 30 1,470

6,000 3,000 1,000 750 500 11,250 $28,250

6,000 3,000 1,000 800 500 11,300 $26,830

----

F U F F U F

50 U -50 U $1,420 F

(c) The overall performance of management was quite favourable. Management may want to investigate the variances for repairs and utilities, as both are showing variances greater than 20%.

. 11-32

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 11-33A (a)

KITCHEN CARE INC. Flexible Production Cost Budget

Activity level: units Variable costs: Manufacturing ($6.00) Administrative ($3.00) Selling ($1.00) Total variable costs Fixed costs: Manufacturing Administrative Total fixed costs Total costs

(b)

90,000

100,000

110,000

$540,000 270,000 90,000 900,000

$600,000 300,000 100,000 1,000,000

$660,000 330,000 110,000 1,100,000

150,000 80,000 230,000 $1,130,000

150,000 80,000 230,000 $1,230,000

150,000 80,000 230,000 $1,330,000

$250,000 calculation in units: Let (x) represent number of units Sales price(x) = Variable costs(x) + Fixed costs + Profit Sales price(x) = Variable costs(x) + $230,000 + $250,000 (Sales price – Variable costs)(x) = $480,000 ($15 – $10)(x) = $480,000 $5(x) = $480,000 x = 96,000 units to be sold

. 11-33

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 11-34A

(a)

HIGH ARCTIC MANUFACTURING COMPANY Flexible Monthly Manufacturing Overhead Budget Assembly Department For the Year 2009

Activity level: direct labour hrs Variable costs: Indirect labour ($1.20)1 Indirect materials ($0.70)2 Utilities ($0.30)3 Maintenance ($0.20)4 Total variable costs Fixed costs: Supervision Amortization Insurance and taxes Total fixed costs Total costs

22,500

25,000

27,500

30,000

$27,000 15,750 6,750 4,500 $54,000

$30,000 17,500 7,500 5,000 60,000

$33,000 19,250 8,250 5,500 66,000

$36,000 21,000 9,000 6,000 72,000

12,500 10,000 5,000 27,500 $81,500

12,500 10,000 5,000 27,500 $87,500

12,500 10,000 5,000 27,500 $93,500

12,500 10,000 5,000 27,500 $99,500

$360,000 ÷ 300,000 $210,000 ÷ 300,000 3 $90,000 ÷ 300,000 4 $60,000 ÷ 300,000 2

. 11-34

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PROBLEM 11-34A (Continued) (b)

HIGH ARCTIC MANUFACTURING COMPANY Assembly Department Manufacturing Overhead Budget Report (Flexible) For the Month Ended July 31, 2009 Favourable F Unfavourable U

Activity: direct labour hrs Variable costs: Indirect labour Indirect materials Utilities Maintenance Total variable costs Fixed costs: Supervision Amortization Insurance and taxes Total fixed costs Total costs

Budget 27,500

Actual 27,500

Difference --

$33,000 19,250 8,250 5,500 66,000

$32,000 17,000 8,100 5,400 62,500

1,000 2,250 150 100 3,500

12,500 10,000 5,000 27,500 $93,500

12,500 10,000 5,000 27,500 $90,000

----$3,500 F

F F F F F

(c) Based on the above budget report, control over costs was effective. For variable costs, all differences were favourable. For fixed costs, there were no differences between budgeted and actual costs. However, as we will see in the next chapter, just because the variances are all favourable, it does not mean that the causes should not be investigated. Sometimes a favourable variance could mean a decline in quality of the product. (d) The formula is fixed costs of $27,500 plus total variable costs of $2.40 per direct labour hour, or Y = 27,500 + 2.40x

. 11-35

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 11-34A (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 Labour Hours in (000)

. 11-36

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 11-35A

(a)

DOGGONE GROOMERS Flexible Budget

Activity level: direct labour hrs Variable costs: Grooming supplies ($4.00) Direct labour ($12.00) Overhead ($1.00) Total variable costs Fixed costs: Overhead Total costs

550

600

700

$2,200 6,600 550 9,350

$2,400 7,200 600 10,200

$2,800 8,400 700 11,900

8,000 $17,350

8,000 $18,200

8,000 $19,900

(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) $17,350 ÷ 550 = $31.55 $18,200 ÷ 600 = $30.33 $19,900 ÷ 700 = $28.43 (d) Cost formula is $8,000 + $17.00(x), where (x) = direct labour hours Total cost = $8,000 + ($17.00 x 650) = $19,050. Number of clients = 650 hrs ÷ 1.25 hrs/client = 520 Cost per client = $19,050 ÷ 520 = $36.63 Charge per client = $36.63 x 1.40 = $51.28

. 11-37

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PROBLEM 11-36A

(a) The formula is fixed costs $20,000 plus total variable costs of $2.70 per unit ($135,000 ÷ 50,000 units), or Y = 20,000 + 2.70x (b)

LAESECKE COMPANY Packaging Department Budget Report (Flexible) For the Month Ended May 31, 2009 Favourable F Unfavourable U

Activity: units Variable costs*: Direct materials ($0.90) Direct labour ($1.00) Indirect materials ($0.30) Indirect labour ($0.25) Utilities ($0.15) Maintenance ($0.10) Total variable costs Fixed costs: Rent Supervision Amortization Total fixed costs Total costs

Budget 55,000

Actual 55,000

Difference --

$49,500 55,000 16,500 13,750 8,250 5,500 148,500

$47,000 53,000 15,200 13,000 7,100 5,200 140,500

$2,500 2,000 1,300 750 1,150 300 8,000

8,000 7,000 5,000 20,000 $168,500

8,000 7,000 5,000 20,000 $160,500

----$8,000 F

F F F F F F F

This report provides a better basis for evaluating performance because the budget is based on the level of activity actually achieved. *Note that the per unit variable costs are computed by taking the budgeted amount of cost at the 50,000 unit level and dividing that amount by 50,000. For example, direct materials per unit is $0.90 or $45,000 ÷ 50,000. . 11-38

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PROBLEM 11-36A (Continued) (c)

LAESECKE COMPANY Packaging Department Budget Report (Flexible) For the Month Ended June 30, 2009 Favourable F Unfavourable U

Budget 40,000

Actual 40,000

Difference --

$36,000 40,000 12,000 10,000 6,000 4,000 108,000

$37,600 42,400 12,160 10,400 5,680 4,160 112,400

$1,600 2,400 160 400 320 160 4,400

8,000 7,000 5,000 20,000 $128,000

8,000 7,000 5,000 20,000 $132,400

----$4,400 U

U U U U F U U

*Note that the actual variable costs in June were 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%, for example, Direct materials $47,000 X 80% = $37,600 Direct labour $53,000 X 80% = $42,400 Indirect materials $15,200 X 80% = $12,160 Indirect labour $13,000 X 80% = $10,400 Utilities $7,100 X 80% = $5,680 Maintenance $5,200 X 80% = $4,160

. 11-39

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PROBLEM 11-37A

(a)

KORENE MANUFACTURING INC. Home Appliance Division Responsibility Report For the Year Ended December 31, 2009 Favourable F Unfavourable U

Sales Cost of goods sold: Variable costs Controllable fixed costs Total COGS Gross margin Selling & Admin: Variable costs Controllable fixed costs Total S & A Controllable margin

Budget $2,400,000

Actual $2,310,000

Difference $90,000 U

1,200,000 200,000 1,400,000 1,000,000

1,240,000 192,000 1,432,000 878,000

40,000 8,000 32,000 122,000

U F U U

240,000 60,000 300,000 $700,000

232,000 66,000 298,000 $580,000

8,000 6,000 2,000 $120,000

F U F U

(b) The manager did not effectively control revenues and costs. Contribution margin was $122,000 unfavourable and controllable margin was $120,000 unfavourable. Contribution margin was unfavourable primarily because sales were $90,000 under budget and variable cost of goods sold was $40,000 over budget. Apparently, the manager was unable to control variable cost of goods sold when sales failed to meet budget expectations. (c) Two costs are excluded from the report: (1) non-controllable fixed costs and (2) indirect fixed costs, because neither cost is controllable by the Home Appliance Division Manager.

. 11-40

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PROBLEM 11-38A

(a)

CHUDZIK MANUFACTURING COMPANY Lawn Mower Division Responsibility Performance Report For the Year Ended December 31, 2009 (in thousands of dollars) Favourable F Unfavourable U

Sales Cost of goods sold: Variable costs Controllable fixed costs Total COGS Gross margin Selling & Admin: Variable costs Controllable fixed costs Total S & A Controllable margin

Budget $2,950

Actual $2,800

Difference $150 U

1,320 270 1,590 1,360

1,400 270 1,670 1,130

80 U -80 U 230 U

350 130 480 $880

300 130 430 $700

50 F -50 F $180 U

(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 $80,000 unfavourable. Finally, the reasons for the favourable variable selling and administrative expenses would be discussed. It is conceivable that an inadequate selling effort contributed to the lower sales. (c) (1) [$880,000 + ($1,320,000 X 15%)] ÷ $5,000,000 = 21.6%. (2) $880,000 ÷ [$5,000,000 – ($5,000,000 X 20%)] = 22.0%. (3) ($880,000 + $200,000) ÷ $5,000,000 = 21.6%. . 11-41

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PROBLEM 11-39A ROI Division A (see below) Division B (see below) Division C (see below)

GBV 12.5% 11.3% 20.0%

RI NBV 25.0% 28.3% 25.0%

GBV $20,000 $10,000 $25,000

Division A ROI—GBV: $100,000 ÷ $800,000 = 12.5% ROI—NBV: $100,000 ÷ ($800,000 - $400,000) = 25% RI—GBV: $100,000 – (10% x $800,000) = $20,000 RI—NBV: $100,000 – (10% x $400,000) = $60,000

Division B ROI—GBV: $85,000 ÷ $750,000 = 11.3% ROI—NBV: $85,000 ÷ ($750,000 - $450,000) = 28.3% RI—GBV: $85,000 – (10% x $750,000) = $10,000 RI—NBV: $85,000 – (10% x $300,000) = $55,000 Division C ROI—GBV: $50,000 ÷ $250,000 = 20.0% ROI—NBV: $50,000 ÷ ($250,000 - $50,000) = 25.0% RI—GBV: $50,000 – (10% x $250,000) = $25,000 RI—NBV: $50,000 – (10% x $200,000) = $30,000

The vice-president of Division A used Residual income with NBV. The vice-president of Division B used ROI with NBV. The vice-president of Division C used ROI with GBV.

. 11-42

NBV $60,000 $55,000 $30,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 11-40A

(a) To Winnipeg Department Manager—Cutting Manufacturing Costs: Indirect labour Indirect materials Maintenance Utilities Supervision Total

Budget $70,000 46,000 18,000 17,000 20,000 $171,000

No. 1 Actual $73,000 46,700 20,500 20,100 22,000 $182,300

To Division Production Manager—Winnipeg Controllable Costs: Winnipeg Division Departments: Cutting Shaping Finishing Total

No. 2

Budget $51,000

Actual $52,500

Fav/Unfav $1,500 U

171,000 148,000 208,000 $578,000

182,300 158,000 210,000 $602,800

11,300 10,000 2,000 $24,800

To Vice President—Production Controllable Costs: Vice-President’s office Divisions: Winnipeg Calgary Sudbury Total

Fav/Unfav $3,000 U 1,700 U 2,500 U 3,100 U 2,000 U $11,300 U

U U U U

No. 3 Budget $64,000

Actual $65,000

578,000 673,000 715,000 $2,030,000

602,800 676,000 722,000 $2,065,800

. 11-43

Fav/Unfav $1,000 U 24,800 3,000 7,000 $35,800

U U U U

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PROBLEM 11-40A (Continued)

To President Controllable Costs: President Vice-Presidents: Production Marketing Finance Total

No. 4 Budget $74,200

Actual $76,400

2,030,000 130,000 105,000 $2,339,200

2,065,800 133,600 109,000 $2,384,800

Fav/Unfav $2,200 U 35,800 3,600 4,000 $45,600

U U U U

(b) (1) Based on dollar amounts and variance percentages, within the Winnipeg division the rankings of the department managers were: (1) Finishing, (2) Shaping, and (3) Cutting. (2) At the division manager level, the rankings were: (1) Calgary, (2) Sudbury, and (3) Winnipeg. (3) 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, 1.8%U; (2) Marketing, 2.8%U; and (3) Finance, 2.9%U.

. 11-44

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*PROBLEM 11-41A

(a)

(1) ROI = Controllable Margin ÷ Average Operating Assets ROI = $2,460,000 ÷ $12,300,000 ROI = 20% (2) Residual Income = Controllable Margin – (Minimum Rate of Return x Average Operating Assets) Residual Income = $2,460,000 – (16% X $12,300,000) Residual Income = $2,460,000 – $1,968,000 = $492,000

(b)

The management of the Miramichi Division would clearly have accepted the investment opportunity it had in 2009 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 Miramichi Division had used ROI as the performance measure, the decision would be to reject the project because the ROI of 19% is less than Mirimachi’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.

. 11-45

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*PROBLEM 11-42A

(a)

(1) ROI = Controllable Margin ÷ Average Operating Assets ROI = $4,920,000 ÷ $24,600,000¹ ROI = 20% ¹ Average operating assets = (($25,200,000 ÷ 105%) + $25,200,000) ÷ 2 = $24,600,000 (2) Residual Income = Controllable Margin – (Minimum Rate of Return x Average Operating Assets) Residual Income = $4,920,000 – (15% X $24,600,000) Residual Income = $4,920,000 – $3,690,000 = $1,230,000

(b)

The management of Presser Division would have been more likely to accept the contemplated capital acquisition if RI was used as the performance measure because the investment would have increased both the division's income and the management bonuses. If using ROI as a performance measure, management of Presser division is likely to reject any investment that would lower the overall ROI (20 percent in 2009). Even though the return is higher than the required minimum, this would lower bonuses.

(c)

Presser Division must be able to control all items related to profits and investment if it is to be evaluated fairly as an investment centre using either ROI or RI as performance measures. Presser Division must control all elements of the business except the cost of invested capital, which would be controlled by Lawton Industries.

. 11-46

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*PROBLEM 11-43A

(a)

Residual Income = Controllable Margin – (Minimum Rate of Return x Average Operating Assets) Residual Income = ($150m - $117.5m) – (14% x $250m) Residual Loss = $2.5m

(b)

Division S has an internal market and should be treated as a profit centre if the transfer prices are market-based. If transfer prices are cost-based, the division should be treated as a cost centre. Division F has both an internal and an external market, and should be treated as an investment centre if the divisional manager is responsible for investment; otherwise, the division should be treated as a profit centre and transfer prices should be based on market prices. Division D should be treated as a cost centre because it has only one internal customer and the divisional manager has no responsibility in making decisions on prices and investment.

(c)

. 11-47

Using ROI to evaluate Mr. Goodman is not appropriate because he has no control over the amounts invested in Division D or the selling price of the engines.

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*PROBLEM 11-44A (a)

The Electronics Division would probably reject the investment because it would reduce their ROI, negatively affecting their bonuses. ROI without investment: 25%; ROI of investment: $1,200,000 ÷ $6,000,000 = 20% If the Electronics Division built the new plant, their return on the investment would be 20%, which is 5% less than what they are earning right now. Their overall ROI would decline.

(b)

. 11-48

Yes, they would be more willing to build the plant, because any investment that earns more than the required rate of return (20% vs. 18%) will increase their residual income which will increase their bonuses.

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*PROBLEM 11-45A (a)

By breaking up the ROI calculation into two separate components, it is easier to see what factors are affecting the ROI. This helps managers to more easily determine how their decisions and actions related to those components will impact their ROI.

(b)

(1) Company C Sales = Average operating assets x assets turnover Sales = $5,000,000 x 4 = $20,000,000 (a) Net operating income = Sales x profit margin Net operating income = $20,000,000 x 0.5% = $100,000 (b) Return on investment = profit margin x assets turnover ROI = 0.5% x 4 = 2% (i) Residual income = operating income – (RRR x investment) RI (Loss) = $100,000 – (10% x $5,000,000) = ($400,000) (l) Company B Profit margin = net operating income ÷ Sales Profit margin = $150,000 ÷ $750,000 = 20% (e) Asset turnover = ROI ÷ profit margin Asset turnover = 2% ÷ 20% = 0.10 (g) Average operating assets = Sales ÷ asset turnover Average operating assets = $750,000 ÷ 10 = $7,500,000 (c) RI = operating income – (RRR x investment) RI (Loss) = $150,000 – (10% x $7,500,000) = ($600,000) (k)

. 11-49

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*PROBLEM 11-45A (Continued) Company A Profit margin = net operating income ÷ Sales Profit margin = $180,000 ÷ $1,500,000 = 12% (d) Asset turnover = Sales ÷ average operating assets Asset turnover = $1,500,000 ÷ $750,000 = 2 (f) ROI = profit margin x asset turnover ROI = 12% x 2 = 24% (h) RI = net operating income – (RRR x investment) RI = $180,000 – (10% x $750,000) = $105,000 (j) (2) Based on ROI, the companies would rank A at 24%, followed by both B and C at 2%. When looking at residual income, A again comes out on top, with B showing a residual loss of $600,000. Despite a profit margin of 20%, Company B has very large average operating assets, which causes the ROI to be lower, and also requires a larger amount of required return to be deducted from operating income when determining residual income. Company C is also showing a residual loss, but in this case it is a result of their very low profit margin (0.5%), and relatively high average operating assets.

. 11-50

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SOLUTIONS TO PROBLEMS—SET B PROBLEM 11-46B (a)

OAKLEY COMPANY Flexible Monthly Manufacturing Overhead Budget For the Year ended December 31, 2009

Activity level-direct labour hrs Variable costs: Indirect labour ($0.35) Indirect material ($0.25) Repairs ($0.15) Utilities ($0.20) Lubricants ($0.05) Total variable costs Fixed costs: Supervision Amortization Insurance Rent Property taxes Total fixed costs Total costs

27,000

30,000

33,000

36,000

$9,450 6,750 4,050 5,400 1,350 27,000

$10,500 7,500 4,500 6,000 1,500 30,000

$11,550 8,250 4,950 6,600 1,650 33,000

$12,600 9,000 5,400 7,200 1,800 36,000

7,500 5,000 2,500 2,000 1,500 18,500 $45,500

7,500 5,000 2,500 2,000 1,500 18,500 $48,500

7,500 5,000 2,500 2,000 1,500 18,500 $51,500

7,500 5,000 2,500 2,000 1,500 18,500 $54,500

¹ Variable cost per unit was calculated by dividing the total annual variable overhead costs by the estimated number of direct labour hours to be worked during the year. For example: Indirect labour per unit = $126,000 ÷ 360,000 = $0.35

. 11-51

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PROBLEM 11-46B (Continued) (b)

OAKLEY COMPANY Packaging Department Manufacturing Overhead Budget Report (Flexible) For the Month Ended October 31, 2009 Favourable F Unfavourable U

Activity: direct labour hrs Variable costs: Indirect labour Indirect materials Repairs Utilities Lubricants Total variable costs Fixed costs: Supervision Amortization Insurance Rent Property taxes Total fixed costs Total costs

Budget 27,000

Actual 27,000

Difference --

$9,450 6,750 4,050 5,400 1,350 27,000

$10,360 6,400 4,000 5,700 1,640 28,100

910 350 50 300 290 1,100

7,500 5,000 2,500 2,000 1,500 18,500 $45,500

7,500 5,000 2,470 2,000 1,500 18,470 $46,570

---

U F F U U U

30 F --30 F $1,070 U

(c) The overall performance of management was slightly unfavourable. However, none of the unfavourable differences exceeded 10% of budget except for lubricants (21%). Management should investigate the lubricants variance.

. 11-52

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PROBLEM 11-47B

(a)

FINESSE COMPANY Flexible Monthly Manufacturing Overhead Budget Ironing Department For the Year 2009

Activity level Variable costs: Indirect labour ($0.40) Indirect material ($0.50) Utilities ($0.30) Repairs ($0.20) Total variable costs Fixed costs: Supervision Amortization Insurance Rent Total fixed costs Total costs

35,000

40,000

45,000

50,000

$14,000 17,500 10,500 7,000 49,000

$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

3,500 1,500 1,000 2,000 8,000 $57,000

3,500 1,500 1,000 2,000 8,000 $64,000

3,500 1,500 1,000 2,000 8,000 $71,000

3,500 1,500 1,000 2,000 8,000 $78,000

. 11-53

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PROBLEM 11-47B (Continued)

(b)

FINESSE COMPANY Ironing Department Manufacturing Overhead Budget Report (Flexible) For the Month Ended June 30, 2009

Favourable F Unfavourable U

Activity: direct labour hrs Variable costs: Indirect labour ($0.40; $0.43) Indirect material ($0.50; $0.49) Utilities ($0.30; $0.32) Repairs ($.20; $0.24) Total variable costs Fixed costs: Supervision Amortization Insurance Rent Total fixed costs Total costs

Budget 42,000

Actual 42,000

Difference --

$16,800 21,000 12,600 8,400 58,800

$18,060 20,580 13,440 10,080 62,160

$1,260 420 840 1,680 3,360

3,500 1,500 1,000 2,000 8,000 $66,800

3,500 1,500 1,000 2,000 8,000 $70,160

-----$3,360 U

U F U U U

(c) The manager was ineffective in controlling variable costs ($3,360 U or 5.0%). Fixed costs were effectively controlled. (d) The formula is fixed costs of $8,000 plus total variable costs of $1.40 per direct labour hour, or Y = 8,000 + 1.40x.

. 11-54

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PROBLEM 11-47B (Continued)

(e)

Total Budgeted Cost Line

$80 70

Costs in (000)

60 50 Budgeted Variable Costs

40 30 20 10

Budgeted Fixed Costs

Direct Labour Hours in (000)

. 11-55

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PROBLEM 11-48B (a) The formula is fixed costs $36,000 plus variable costs of $2.80 per unit ($168,000 ÷ 60,000 units). (b)

YAEGER COMPANY Assembling Department Budget Report (Flexible) For the Month Ended August 31, 2009 Favourable F Unfavourable U

Activity: units Variable costs*: Direct materials ($0.80) Direct labour ($0.90) Indirect materials ($0.40) Indirect labour ($0.30) Utilities ($0.25) Maintenance ($0.15) Total variable costs Fixed costs: Rent Supervision Amortization Total fixed costs Total costs

Budget 58,000

Actual 58,000

Difference --

$46,400 52,200 23,200 17,400 14,500 8,700 162,400

$47,000 51,300 24,200 17,500 14,900 9,200 164,100

$600 900 1,000 100 400 500 1,700

12,000 17,000 7,000 36,000 $198,400

12,000 17,000 7,000 36,000 $200,100

----$1,700 U

U F U U U U U

This report provides a better basis for evaluating performance because the budget is based on the level of activity actually achieved. The manager should not be pleased because every variable cost was over budget except for direct labour. *Note, the per unit variable costs are computed by taking the budget amount at the 60,000 units level and dividing it by 60,000. For example, direct materials per unit is $0.80 or $48,000 ÷ 60,000. Then, the per unit costs are multiplied by 58,000 to get flexible budget amounts. . 11-56

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PROBLEM 11-48B (Continued) (c)

YAEGER COMPANY Assembling Department Budget Report (Flexible) For the Month Ended September 30, 2009 Favourable F Unfavourable U

Budget 64,000

Actual 64,000

$51,200 57,600 25,600 19,200 16,000 9,600 179,200

$51,700 56,430 26,620 19,250 16,390 10,120 180,510

12,000 17,000 7,000 36,000 $215,200

12,000 17,000 7,000 36,000 $216,510

Difference -1

$500 1,170 1,020 50 390 520 1,310

U F U U U U U

----$1,310 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 labour.

Variable costs for September were 10% more than August. For example: Direct materials in September = $47,000 x 110% = $51,700

. 11-57

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PROBLEM 11-49B (a)

HENNING MANUFACTURING INC. Patio Furniture Division Responsibility Report For the Year Ended December 31, 2009 Favourable F Unfavourable U

Sales Cost of goods sold: Variable costs Controllable fixed costs Total COGS Gross margin Selling & Admin: Variable costs Controllable fixed costs Total S & A Controllable margin

Budget $2,500,000

Actual $2,560,000

Difference $60,000 F

1,300,000 200,000 1,500,000 1,000,000

1,259,000 206,000 1,465,000 1,095,000

41,000 6,000 35,000 95,000

F U F F

220,000 50,000 270,000 $730,000

227,000 52,000 279,000 $816,000

7,000 2,000 9,000 $86,000

U U U F

(b) The manager effectively controlled revenues and costs. Contribution margin was $95,000 favourable and controllable margin was $86,000 favourable. Contribution margin was favourable primarily because sales were $60,000 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 unfavourable difference of $9,000 was more than offset by the favourable difference in variable costs. (c) Two costs are excluded from the report: (1) non-controllable fixed costs and (2) indirect fixed costs, because neither cost is controllable by the patio furniture Division Manager. . 11-58

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PROBLEM 11-50B

(a)

ALOSIO MANUFACTURING COMPANY Home Division Responsibility Report For the Year Ended December 31, 2009 (in thousands of dollars) Favourable F Unfavourable U

Sales Cost of goods sold: Variable costs Controllable fixed costs Total COGS Gross margin Selling & Admin: Variable costs Controllable fixed costs Total S & A Controllable margin

Budget $1,400

Actual $1,500

Difference $100 F

640 170 810 590

700 170 870 630

60 U -60 U 40 F

100 80 180 $410

125 80 205 $425

25 U -25 U $15 F

(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 unfavourable difference of $60,000 in the variable cost of goods sold. This difference would be less if the budget was “flexed”, that is, variable cost of goods sold budget was adjusted to the same level as actual sales.

. 11-59

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PROBLEM 11-50B (Continued) (c) (1) If variable cost of goods sold decreases by 6%, controllable margin will increase by 6% of variable cost of goods sold. [$425,000 + ($700,000 x 6%)] ÷ $2,500,000 = $18.68%

(2) Average operating assets are reduced by 10%. $425,000 ÷ ($2,500,000 x 90%) = $18.89%

(3) If contribution margin increases by $90,000, controllable margin will also increase by the same amount. ($425,000 + $90,000) ÷ $2,500,000 = 20.6%

. 11-60

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*PROBLEM 11-51B

(a)

ROI = Operating income ÷ Average operating assets ROI = $850,000 ÷ $5,000,000 ROI = 17% If Mason Industries uses ROI to evaluate division managers, FTED might be reluctant to build the new plant because it would mean their ROI would go down, giving the impression that performance was deteriorating. Any investment with an ROI less than their current ROI of 24% will most likely be rejected.

(b)

Residual income = Controllable margin – (minimum rate of return x average operating assets) Residual income = $850,000 – (15% x $5,000,000) = $100,000 The management of FTEC Division would have been more likely to accept the contemplated capital acquisition if residual income was used as the performance measure because the investment would have increased both the division's income and the management bonuses. When using ROI as a performance measure, management is likely to reject any investment that would lower the overall ROI (24 percent in 2009), even though the return is higher than the required rate of return, because this would lower bonus awards.

. 11-61

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*PROBLEM 11-52B

Operating income = Sales – Cost of goods sold – operating expenses Department 1: $200,000 - $150,000 - $15,000 = $35,000 Department 2: $90,000 - $35,000 - $23,500 = $31,500 Department 3: $1,500,000 - $1,173,000 - $195,000 = $132,000 Department 4: $1,250,000 - $750,000 - $276,000 = $224,000 (a)

ROI = Operating income ÷ Average operating assets

Department 1 2 3 4

(b)

Operating Income $35,000 31,500 132,000 224,000

Current Investment $175,000 210,000 1,100,000 1,400,000

ROI 20% 15% 12% 16%

Rank 1 3 4 2

Residual income = Operating income – (minimum rate of return x average operating assets)

Department 1 2 3 4

Operating Income $35,000 31,500 132,000 224,000

Current Investment $175,000 210,000 1,100,000 1,400,000

RI* $17,500 10,500 22,000 84,000

Rank 3 4 2 1

*Minimum required rate of return is 10%. (c)

. 11-62

The rankings are different. When the return on investment of two departments equals or exceeds the required return, the department with the larger investment will have a larger residual income.

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*PROBLEM 11-53B

Determination of net book value for each division:

Gross book value (GBV) Less: Accumulated Amortization* Net book value

A 400,000

B $380,000

C $250,000

200,000

190,000

125,000

$200,000

$190,000

$125,000

*Accumulated amortization = (GBV ÷ 20 years) x 10 years Determination of return on investment: Controllable Division Income A $47,500 B $46,000 C $30,800

Return on Investment GBV ROI NBV ROI $400,000 11.88% $200,000 23.75% $380,000 12.11% $190,000 24.21% $250,000 12.32% $125,000 24.64%

Determination of residual income:

Division A B C

Operating Income $47,500 $46,000 $30,800

GBV $400,000 $380,000 $250,000

Residual Income RI** NBV $7,500 $200,000 $8,000 $190,000 $5,800 $125,000

RI** $27,500 $27,000 $18,300

**Residual income calculated based on cost of capital of 10%. The vice-president of Division A chose residual income with NBV. The vice-president of Division B chose residual income with GBV. The vice-president of Division C chose return on investment with either GBV or NBV.

. 11-63

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*PROBLEM 11-54B (a) The two separate components highlight certain aspects of profitability that are not revealed by the single calculation. First, the importance of turnover as a key to profits is stressed. Second, the importance of profit margin is made explicit. The distinction emphasizes that overall profitability may be achieved by different strategies, and that it may be of benefit to trade off turnover for margin, or vice versa, in order to maximize return. (b) (1) (h) ROI = net operating income ÷ average operating assets ROI = $100,000 ÷ $500,000 = 20%

. 11-64

(f)

Asset turnover = sales ÷ average operating assets Asset turnover = $1,000,000 ÷ $500,000 = 2

(d)

ROI = profit margin x asset turnover 20% = profit margin x 2 Profit margin = 20% ÷ 2 = 10%

(j)

Residual income = net operating income – (minimum required rate of return x average operating assets) Residual income = $100,000 – (10% x $500,000) = $50,000

(c)

ROI = net operating income ÷ average operating assets 1% = $50,000 ÷ average operating assets Average operating assets = $50,000 ÷ 1% = $5,000,000

(g)

Asset turnover = Sales ÷ average operating assets Asset turnover = $500,000 ÷ $5,000,000 Asset turnover = 0.10

(e)

ROI = profit margin x asset turnover 1% = profit margin x 0.10 Profit margin = 1% ÷ 0.10 = 10%

(k)

Residual income = net operating income – (minimum required rate of return x average operating assets) Residual income = $50,000 – (10% x $5,000,000) = $(450,000)

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*PROBLEM 11-54B (Continued) (i)

ROI = profit margin x asset turnover ROI = 0.5% x 2 = 1%

(a)

Asset turnover = Sales ÷ average operating assets 2 = Sales ÷ $5,000,000 Sales = $5,000,000 x 2 = $10,000,000

(b)

Profit margin = net operating income ÷ sales 0.5% = net operating income ÷ $10,000,000 Net operating income = $10,000,000 x 0.5% = $50,000

(l)

Residual income = net operating income – (minimum required rate of return x average operating assets) Residual income = $50,000 – (10% x $5,000,000) = $(450,000)

(2) Given the disparity in size between Company A and the other two companies, ROI is probably a superior measure for a comparison. By either measure, Company A has superior performance, but the magnitude of the superiority is shown more strongly by the ROI calculation ("20 times higher") than by the RI calculation ("10 times higher"). In the case of comparing Companies B and C, their performance by either measure is equal, but using the decomposed ROI calculation provides insight into the different ways the companies are achieving the same result. Without knowing more about the nature of their respective operations, one cannot draw any firm conclusions, but it may be that Company B's asset turnover ratio shows a highly inefficient use of capital, or that the very low margin of Company C shows highly inefficient day-to-day operations resulting in overly high expenses.

. 11-65

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PROBLEM 11-55B (a) Activity level: units Variable costs: Manufacturing ($7.00) Administrative ($3.00) Selling ($2.00) Total variable costs Fixed costs: Manufacturing Administrative Total fixed costs Total costs

(b)

90,000

100,000

110,000

$630,000 270,000 180,000 1,080,000

$700,000 300,000 200,000 1,200,000

$770,000 330,000 220,000 1,320,000

250,000 100,000 350,000 $1,430,000

250,000 100,000 350,000 $1,550,000

250,000 100,000 350,000 $1,670,000

$750,000 after taxes = $750,000 ÷ (1 – .40) = $1,250,000 before tax Let (x) represent number of units Sales price(x) = Variable costs(x) + Fixed costs + Profit Sales price(x) = Variable costs(x) + $350,000 + $1,250,000 (Sales price – Variable costs)(x) = $1,600,000 ($28 – $12)(x) = $1,600,000 $16(x) = $1,600,000 x = 100,000 units to be sold

. 11-66

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*PROBLEM 11-56B (a)

(1) ROI = Controllable Margin ÷ Average Operating Assets ROI = $5,000,000 ÷ $25,000,000 ROI = 20% (2) Residual Income = Controllable Margin – (Minimum Rate of Return x Average Operating Assets) Residual Income = $5,000,000 – (18% X $25,000,000) Residual Income = $5,000,000 – $4,500,000 = $500,000

(b)

. 11-67

The management of the Division would have been more likely to accept the investment if RI was used as the performance measure because the investment would have increased both the division's income and the management bonuses. If ROI is used as a performance measure, management is likely to reject any investment that would lower the overall ROI (20 percent in 2009). Even though the return is higher than the required minimum, this would lower bonuses.

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SOLUTIONS TO CASES CASE 11-57

(a) (1) 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 2,920 or approximately 13% (2,920 days ÷ 21,900 days), and the boarding fee decreased from $25 1 per day to $202 per day, a decrease of 20% ($5 ÷ $25). Together these resulted in a $167,900 decrease in sales revenue, a decrease of approximately 31% ($167,900 ÷ $547,500). 1 2

$547,500 ÷ 21,900 days = $25 per day $379,600 ÷ 18,980 days = $20 per day

(2) Management did a poor job of 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 $25,196 [$193,815 x 13%]. However, variable expenses only declined by $14,335 or about 7.4% ($14,335 ÷ $193,815). 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 $5,000 and this includes the additional expenses incurred in advertising and entertainment. (3) 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.

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CASE 11-57 (Continued) (b)

Z-BAR PASTURES Income Statement Flexible Budget Report For the Year Ended December 31, 2009

Favourable F Unfavourable U

Level of activity: board-days Sales Less: variable costs Feed Veterinary fees Blacksmith fees Supplies Total variable costs Contribution margin Less: fixed costs Amortization Insurance Utilities Repairs and maintenance Labour Advertisement Entertainment Total fixed costs Net income

Budget 18,980

Actual 18,980

Difference --

$474,500

$379,600

$94,900 U

94,900 56,940 5,694 13,286 170,820 303,680

104,390 58,838 6,074 10,178 179,480 200,120

9,490 1,898 380 3,108 8,660 103,560

U U U F U U

40,000 11,000 14,000 11,000 96,000 8,000 5,000 185,000 $118,680

40,000 11,000 12,000 10,000 88,000 12,000 7,000 180,000 $20,120

--2,000 1,000 8,000 4,000 2,000 5,000 $98,560

F F F U U F U

(c) (1) The primary causes of the decrease in net income are the decreases in boarding rates and volume. The average daily rate charged was $20 = ($379,600 ÷ 18,980). This rate resulted in a decrease in sales revenue of $94,900 or 20% = ($94,900 ÷ $474,500).

. 11-69

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CASE 11-57 (Continued) Given that it is “an extremely competitive business,” if Z-Bar Pastures had not reduced rates, boarding days almost certainly would have declined even more. (2) Management did a poor job of controlling variable expenses. These expenses in total were $8,660 over budget or 5%, or ($8,660 ÷ $170,820). 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). (3) As noted in part (a), management’s competitive probably were sound.

decisions

stay

(d) Given that the industry is “extremely competitive,” management should consider two options. One, become the lowest cost operator. If Z-Bar Pastures is the company with the lowest operating costs, it can under-price 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 Z-Bar 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 Z-Bar Pastures is the “best” boarding stable in Saskatchewan, the company will take customers away from its competitors. Also, if Z-Bar Pastures is perceived as the “best,” many customers will be willing to pay a premium for its boarding service, and Z-Bar Pastures will be able to raise its rates. (Gillette is an example of this strategy.)

. 11-70

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CASE 11-58

(a) Sara Sutton—Profit Centre: 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 amortization costs either. As a profit centre manager she might have control of the insurance, but she probably does not. Gilbert Lewis—Cost Centre: Responsible for inventory cost, advertising, sales personnel, printing, and travel. As a cost centre 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 amortization. Jose Lopez—Investment Centre: Responsible for all items shown. (b) Sara Sutton Budget differences: The inventory cost is 30% ($45,000 ÷ $150,000) above budget and so should definitely be brought to her attention. Travel is 25% ($5,000 ÷ $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 amortization should not be brought to her attention because she does not control those costs. Gilbert Lewis Budget differences: The inventory cost, which is 20% ($20,000 ÷ $100,000) above budget, should definitely be brought to his attention. Travel costs are 33% ($10,000 ÷ $30,000) below budget. This should probably be brought to his attention, so that he can make sure that the purpose that was to have been served by travel is being adequately served by other means. The 67% ($20,000 ÷ $30,000) increase in rent and 10% ($10,000 ÷ $100,000) decrease in amortization 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

. 11-71

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CASE 11-58 (Continued) differences that are not the responsibility of the various managers are still within the scope of top management’s responsibility. Jose Lopez Budget differences: As manager of an investment centre, Mr. Lopez 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 5% 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 20% ($2,000 ÷ $10,000) increase in rent is only a $2,000 increase, so it could be included, though it might be left out as immaterial. The 50% ($20,000 ÷ $40,000) increase in amortization should definitely be included.

. 11-72

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CASE 11-59 (a) Hideko Shitake should be able to control all the variable expenses and the fixed expenses of supervision (but not her portion) and inspection. Insurance and amortization ordinarily are not the responsibility of the department manager. (b) The total variable cost per unit is $28 ($56,000 ÷ 2,000). The total cost during the month to manufacture 1,500 units is variable costs $42,000 (1,500 X $28) plus fixed costs ($36,000) or $78,000 ($42,000 + $36,000). (c)

DILLONS COMPANY Production Department Manufacturing Overhead Budget Report (Flexible) For the Month Ended Favourable F Unfavourable U

Level of activity: units

Budget 1,500

Actual 1,500

Difference --

Variable costs1 Indirect materials 21,000 28,200 7,200 Indirect labour 9,000 13,500 4,500 Maintenance expenses 7,500 8,200 700 Manufacturing supplies 4,500 5,100 600 Total variable costs 42,000 55,000 13,000 Fixed costs Supervision 18,000 19,300 1,300 Inspection costs 1,000 1,200 200 Insurance expenses 2,000 2,200 200 Amortization 15,000 14,700 300 Total fixed costs 36,000 37,400 1,400 Total costs $78,000 $92,400 $14,400 To determine budget amount, divide costs by 2,000 units (the static budgeted volume) and then multiple by 1,500 (actual volume). . 11-73

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CASE 11-59 (Continued) (d) A production department is a cost centre. Thus, the report should include only the costs that are controllable by the production manager. This report is shown in Illustration 11-21. In this type of report, no distinction is made between variable and fixed costs.

DILLONS COMPANY Production Department Manufacturing Overhead Responsibility Report For the Month Ended

Favourable F Unfavourable U

Controllable cost Indirect materials Indirect labour Maintenance expense Manufacturing supplies Supervision Inspection costs Total

Budget

Actual

Difference

21,000 9.000 7,500 4,500 18,000 1,000 $61,000

28,200 13,500 8,200 5,100 19,300 1,200 $75,500

7,200 4,500 700 600 1,300 200 $14,500

. 11-74

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CASE 11-59 (Continued)

To: From: Subject:

Ms. Hideko Shitake, 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 $14,500 or 28.4% over budget. As you can see, actual costs were over budget for every cost item, and in two instances, costs were significantly over budget (Indirect materials 34% and Indirect labour 50%). Hideko, 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.

. 11-75

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CASE 11-60

(a) Return on investment is not a good performance measure for the division because division management has very little control over either net income or investment. Sales revenue is totally controlled by central management (they control both prices and quantities). In addition, it appears that division management does not have authority to alter the level of investment in the firm. While one might also mention problems with the allocation of costs and working capital on the basis of sales, and the use of net book value, these problems are trivial relative to the fact that division management has no authority to control the major factors in the performance measure. (b) The division should be treated as a cost centre (it is not even a profit centre). Apparently, the only control division management can exert is on providing the products at an efficient cost given timing and quality constraints. The division's performance should thus be measured relative to a well prepared flexible budget.

. 11-76

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*CASE 11-61

(a)

(1)

Average operating assets = [($15.75m ÷ 105%) + $15.75m] ÷ 2 Average operating assets = $15.375m ROI = Income before taxes ÷ average operating assets ROI = $1.845m ÷ $15.375m = 12%

(2)

Residual income = Income before taxes – (minimum required rate of return x average operating assets) Residual income = $1.845m – (11% x $15.375m) = $153,750

(b)

The management of Reigis Steel would have been more likely to accept the contemplated capital acquisition if residual income was used as the performance measure because the investment would have increased both the division's wealth and the management bonuses. When using ROI as a performance measure, the management of Reigis is likely to reject any investment that would lower the overall ROI (12 percent in 2009), even though the return is higher than the required minimum, because this would lower bonus awards.

(c)

Reigis must be able to control all items related to profits and investment if it is to be evaluated fairly as an investment centre using either ROI or RI as performance measures. Reigis must control all elements of the business except the cost of invested capital, which would be controlled by Raddington Industries.

. 11-77

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CASE 11-62

(a)

Current ROI = segment income ÷ average operating assets Current ROI = $2.5m ÷ $12.5m = 20%

(b)

ROI with new proposal ROI = ($2.5m + $0.2m) ÷ ($12.5m + $1.1m) = 19.85% In this case, the manager would probably reject the new proposal as it would lower the divisional ROI from 20% to 19.85%. This would be the case particularly if the manager's performance evaluation and compensation were based heavily on achieved ROI. However, if it were based on residual income (RI), as long as the new proposal had a rate of return greater than the cost of capital, the manager would accept it.

(c)

For the manager to accept the proposal, the investment must return at least 20%. ROI = segment income ÷ average operating assets 20% = $200,000 ÷ average operating assets Average operating assets = $200,000 ÷ 20% = $1,000,000

(d)

Current residual income = $2.5m – (10% x $12.5m) = $1.25m Residual income with new proposal = ($2.5m + $0.2m) – [10% x ($12.5m + $1.1m) = $1.34m Improvement in residual income = $1.34m - $1.25m = $900,000 If the manager was being evaluated using residual income, she would accept the proposal because it would increase her evaluation base.

. 11-78

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CASE 11-63

(a)

Edmonton has the highest ROI, at 21.1%. The ranking is Edmonton, Toronto, Montreal, Vancouver and then Halifax.

Plant Location Vancouver Edmonton Toronto Montreal Halifax (b)

Operating Income $ 277,650 1,158,650 339,525 116,050 8,400

Operating Assets $ 4,550,000 5,500,000 2,000,000 700,000 300,000

ROI 6.1% 21.1% 17.0% 16.6% 2.8%

Edmonton also has the highest residual income, at $608,650. The ranking in this case is Edmonton, Toronto, Montreal, Halifax and then Vancouver.

Plant Location Vancouver Edmonton Toronto Montreal Halifax

Operating Income $ 277,650 1,158,650 339,525 116,050 8,400

Operating Assets* $ 4,550,000 5,500,000 2,000,000 700,000 300,000

Residual Income $ (177,350) 608,650 139,525 46,050 (21,600)

*minimum required rate of return is 10% (c)

The rankings are the same for Edmonton, Toronto and Montreal because when the ROI is greater than the required rate of return (in this case > 10%), the plant with the largest investment will have the largest residual income.

. 11-79

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CASE 11-64 (a) The stakeholders in this ethical situation are:  The employees and managers of each investment centre.  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 behaviour in an attempt to meet the objectives. Managers should also be given a say in setting the objectives. Currently, corporate management is setting objectives. Managers of responsibility centres should be directly involved in setting the budget goals for their areas of responsibility. If the goals are partly “their” goals, they may be more motivated to behave in a more ethical manner. Lastly, the company should not be holding employees accountable for meeting objectives over which the employees have no control. As long as corporate management continues to set the objectives, they cannot hold employees accountable for meeting them.

. 11-80

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-11 (a)

Waterways Corporation Manufacturing Overhead Flexible Budget For the Month of March 2010 Production in units 115,500 116,500 117,500 118,500 119,500 Variable costs Indirect materials($.06/unit a) $ 6,930 $ 6,990 $ 7,050 $ 7,110 $ 7,170 Indirect labour ($.10/unit b) 11,550 11,650 11,750 11,850 11,950 Utilities ($.09/unit c) 10,395 10,485 10,575 10,665 10,755 Maintenance ($.05/unit d) 5,775 5,825 5,875 5,925 5,975 Fixed Costs Salaries 42,000 42,000 42,000 42,000 42,000 Depreciation 16,800 16,800 16,800 16,800 16,800 Property taxes 2,500 2,500 2,500 2,500 2,500 Insurance 1,200 1,200 1,200 1,200 1,200 Janitorial 1,300 1,300 1,300 1,300 1,300 Total budgeted costs $ 98,450 $ 98,750 $ 99,050 $99,350 $ 99,650 Unit costs are based on the static budget costs. a. $7,050 / 117,500 units = $0.06 / unit b. $11,750 / 117,500 units = $0.10 / unit c. $10,575 / 117,500 units = $0.09 / unit d. $5,875 / 117,500 units = $0.05 / unit

. 11-81

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(b)

Waterways Corporation Manufacturing Overhead Flexible Budget Report For the Month of March 2010 Difference Budget Actual Favorable Production in units 118,500 118,500 Unfavorable Variable costs $ Indirect materials $ 7,110 7,100 $ 10 F Indirect labour

11,850 11,825

25 F

Utilities

10,665 10,700

35 U

Maintenance Fixed Costs

5,925 5,900

25 F

Salaries

42,000 42,000

Depreciation

16,800 16,800

Property taxes

2,500 2,500

Insurance

1,200 1,200

Janitorial Total budgeted costs

1,300 1,300 $ $ 99,350 99,325

. 11-82

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(c)

Waterways Corporation Responsibility Report Manufacturing Overhead For the Month of March 2010

Controllable Cost Budget Indirect materials $ 7,110 Indirect labour 11,850 Utilities 10,665 Maintenance 5,925 $ 35,550

. 11-83

Difference Favorable Actual Unfavorable $ 7,100 $ 10 F 11,825 $ 25 F 10,700 $ 35 U 5,900 $ 25 F $ 35,525 $ 25 F

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. 11-84

CHAPTER 12 Standard Costs and Balanced Scorecard ASSIGNMENT CLASSIFICATION TABLE Questions

Brief Exercises

Exercises

1. Distinguish between a standard and a budget.

1, 2

12, 30

2. Identify the advantages of standard costs.

3. Describe how companies set standards.

4, 5, 6, 7, 8, 9

2, 3

12, 13, 14, 17

4. State the formulas for determining direct materials and direct labour variances.

10, 11

4, 5

15, 16, 17, 18, 19, 20, 21, 24, 31

35, 36,37, 38, 39, 40, 41, 42, 44, 46

47, 48, 49, 50, 51, 52, 55, 56, 57, 58

5. State the formula for determining total manufacturing overhead variances.

12, 13, 14,15, 16, 17

6, 7, 8

22, 23, 24, 25, 26, 31

35, 36, 37, 38, 39, 40, 41, 42, 43, 44, 45, 46

47, 48, 49, 50, 51, 52, 53, 54, 55, 56, 57, 58

6. Discuss the reporting of variances.

18, 19

20, 21, 22, 24, 27, 28

7. Prepare an income statement for management under a standard costing system.

37, 42, 44

55.

8. Describe the balanced scorecard approach to performance evaluation.

20, 21, 22

*9. Identify the features of a standard cost accounting system.

23, 24

10, 11

31, 32, 33, 34

57, 58

Study Objectives

. 12-1

A Problems

B Problems

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

35A

Determine amounts from the variance report.

Moderate

30–40

36A

Compute variances.

Simple

20–30

37A

Compute variances and prepare an income statement.

Simple

30–40

38A

Prepare a flexible budget, determine standard costs, and compute variances.

Moderate

30–40

39A

Compute variances, identify significant variances, and discuss causes..

Moderate

20-30

40A

Compute various amounts from standard costs and variances..

Moderate

30–40

41A

Answer questions about variances.

Moderate

30–40

42A

Compute variances and prepare an income statement.

Moderate

30–40

43A

Compute variances.

Simple

20-30

*44A

Journalize and post standard cost entries and prepare an income statement.

Moderate

40-50

45A

Compute overhead variances and discuss their meaning.

Moderate

20-30

46A

Compute variances.

Moderate

20-30

47B

Compute variances.

Simple

20-30

48B

Compute variances and identify significant variances.

Moderate

20-30

49B

Compute variances.

Simple

30–40

50B

Answer questions about variances.

Moderate

20-30

51B

Compute variances.

Simple

20-30

52B

Determine amounts from the variance report.

Moderate

30–40

53B

Compute variances.

Simple

20-30

54B

Compute overhead variances and discuss their meaning.

Moderate

30–40

. 12-2

ASSIGNMENT CHARACTERISTICS TABLE (Continued) 55B

Compute variances and prepare an income statement.

Moderate

30–40

56B

Compute variances and prepare an income statement.

Simple

30–40

*57B

Journalize and post standard cost entries and prepare an income statement.

Moderate

40-50

*58B

Compute variances and prepare journal entries.

Moderate

30–40

. 12-3

Study Objective

Knowledge Comprehension

Distinguish between a standard and a budget.

Identify the advantages of standard costs.

Describe how companies set standards.

Q6, Q8

State the formulas for determining direct materials and direct labour variances.

Q10, Q11

State the formula for determining the total manufacturing overhead variance.

Q17

Discuss the reporting of variances.

Q18, Q19

Prepare an income statement for management under a standard costing system.

Describe the balanced scorecard approach to performance evaluation.

*9.

Identify the features of a standard cost accounting system.

Q1, Q2, E30

Q20

Application

Analysis

BE1, E12 E12

Q4, Q5, Q7, Q9

BE2 BE3

E12 E13

E14 E17

BE4 BE5, E15 E16 E17 E18

E20 P44A P55B E21 P46A P56B P35A P47B P57B P36A P49B P58B P37A P51B P40A P52B

E19 P39A P50B E24 P41A E31 P42A P38A P48B

Q15, Q16

BE6 BE7 BE8 Q12 Q13 Q14

E25 P44A E26 P46A P35A P47B P36A P49B P40A P51B P43A P52B

E22 P39A P50B E23 P41A P54B E24 P42A E31 P45A P38A P48B

Q24

E27

E22 E28 E21 P39A

E29 P55B P37A P56B P44A

P42A

Q21 Q22 E30

BE9

Q23

BE10 E33 P46A BE11 E34 P57B E32 P44A P58B

P38A

P53B P55B P56B P57B P58B

E31

Synthes is

Evaluation

BLOOM’ S TAXONOMY TABLE

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

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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 Employment Standards Act, or provincial Human Rights Codes, 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 is 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 labour 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 favourable cost variance has a positive connotation. It suggests efficiencies in incurring manufacturing costs and in using direct materials, direct labour, and manufacturing overhead. An

. 12-5

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Questions Chapter 12 (Continued) unfavourable 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. 10.

(a) (1) actual price. (b) (3) actual quantity. (c) (5) standard price.

11.

(1) – (3) = total labour variance; (1) – (2) = labour price variance; and (2) – (3) = labour quantity variance.

12.

Overhead applied = (standard hours x standard rate) = $8 x 27,000 = $216,000.

13.

Overhead controllable variance = actual overhead costs ($218,000) – 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 $3 = $84,000) = total budgeted ($219,000). Thus, the controllable variance is $1,000 favourable.

14.

The overhead volume variance is the fixed overhead rate ($3) x [normal capacity hours – standard hours allowed (28,000 – 27,000)] = $3,000 unfavourable.

15.

The purpose of calculating 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).

16.

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.

17.

Mia should include the following points about overhead variances: (1) (2) (3) (4)

(2) standard price. (4) standard price. (6) standard quantity.

Standard hours allowed are used in each of the variances. Budgeted costs for the controllable variance are derived from the flexible budget. The controllable variance generally pertains to variable costs. The volume variance pertains solely to fixed costs.

18.

Variances should be reported to appropriate levels of management as soon as poss ible. The principle of “management by exception” may be used with variance reports.

19.

The purchasing department would be responsible for an unfavourable materials price variance when it paid more than the standard price for the materials. The purchasing department would also be responsible for an unfavourable materials quantity variance if it purchased materials of inferior quality which caused an excess use of materials.

. 12-6

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Questions Chapter 12 (Continued) 20.

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 how well the company is performing from the viewpoint of those people who buy and use 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.

21. Sanjiv is not correct. The balanced scorecard does not replace financial measures. I nstead, it integrates both financial and non-financial measures. In fact, financial measures are very critical to the balanced scorecard, since they represent the final “destination” of all the company’s efforts. 22.

The possibilities for non-financial 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 province, 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.

*23. (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 var iance is unfavourable and (2) a credit balance when the labour quantity variance is favourable. *24. (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.

. 12-7

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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 12-1 (a) Standards are stated as a per unit amount. Thus, the standards are materials $2.40 ($1,200,000 ÷ 500,000) and labour $3.20 ($1,600,000 ÷ 500,000). (b) Budgets are stated as a total amount. Thus, the budgeted costs for the year are materials $1,200,000 and labour $1,600,000.

BRIEF EXERCISE 12-2 (a) Standard materials price per unit = $2.50 ($2.20 + $0.20 + $0.10). (b) Standard materials quantity per unit = 3 kilograms (2.6 + 0.4). (c) Standard materials cost per unit = $7.50 ($2.50 x 3). BRIEF EXERCISE 12-3 (a) Standard direct labour rate per hour = $14.00 ($12.00 + $0.80 + $1.20). (b) Standard direct labour hours per unit = 1.6 hours (1.2 + 0.25 + 0.15). (c) Standard labour cost per unit = $22.40 ($14.00 x 1.6). BRIEF EXERCISE 12-4 Actual per unit price: $16,160 ÷ 3,200 kilograms = $5.05 Standard quantity allowed: 1,500 units x 2 kilograms = 3,000 kilograms Total materials variance = $1,160 U Materials price variance = $160 U Materials quantity variance = $1,000 U

. 12-8

(3,200 x $5.05) – (3,000 x $5.00). (3,200 x $5.05) – (3,200 x $5.00). (3,200 x $5.00) – (3,000 x $5.00).

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BRIEF EXERCISE 12-5 Total labour variance = $2,050 U (2,100 x $10.50) – (2,000 x $10.00). Labour price variance = $1,050 U (2,100 x $10.50) – (2,100 x $10.00). Labour quantity variance = $1,000 U (2,100 x $10.00) – (2,000 x $10.00). BRIEF EXERCISE 12-6 Applied overhead = (standard quantity allowed x standard rate) = (20,000 x $6.00) = $120,000 Total Overhead Variance = Actual overhead – Applied overhead = $115,000 – 120,000 = $5,000F BRIEF EXERCISE 12-7 Budgeted overhead = (20,000 x $4.00) + $50,000 = $130,000 Overhead controllable variance = actual overhead – budgeted overhead = $115,000 – 130,000 = 15,000F BRIEF EXERCISE 12-8 Fixed overhead rate = $50,000 ÷ 25,000 = $2.00 per hour Overhead volume variance = Fixed OH rate x (25,000 – 20,000 hours) = $2 x 5,000 = $10,000U BRIEF EXERCISE 12-9 (1) (2) (3) (4)

. 12-9

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

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*BRIEF EXERCISE 12-10 (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 (5,500 x $2) .................

11,600

900 11,100 600 11,000

*$12,000 ÷ 6,000 *BRIEF EXERCISE 12-11 (a) Factory Labour ............................................................ Labour Price Variance ........................................ Wages Payable ....................................................

25,200

(b) Work in Process Inventory (3,100 x $8.401)............... Labour Quantity Variance ................................... Factory Labour ....................................................

26,040

$25,200 ÷ 3,000

. 12-10

1,200 24,000 840 25,200

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SOLUTIONS TO EXERCISES EXERCISE 12-12 (a) Direct materials: (2,000 x 3) x $6 = $36,000 Direct labour: (2,000 x 0.50) x $14 = $14,000 Overhead: $14,000 x 70% = $9,800 (b) Direct materials: 3 x $6 = $18.00 Direct labour: 1/2 x $14 = 7.00 Overhead: $7 x 70% = 4.90 Standard cost: $29.90 (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 inventories is simplified and clerical costs are reduced. EXERCISE 12-13 First, determine standard usage considering waste:

. 12-11

Ingredient

Amount

Percent waste

Grape concentrate (90 ÷ 200) Sugar (27 ÷ 200) Lemons (60 ÷ 200) Yeast tablets (50 ÷ 200) Nutrient tablets (50 ÷ 200) Water (75 ÷ 200)

0.45 ltr 0.135 kg 0.3 units 0.25 tabs 0.25 tabs 0.375 ltr

4% 10% 20% 0% 0% 0%

Standard usage 0.469 ltrs 0.15 kg 0.375 units 0.25 tabs 0.25 tabs 0.375 ltrs

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EXERCISE 12-13 (Continued) Next determine per unit cost:

Ingredient

Standard usage

Standard price

Unit cost

0.469 0.150 0.375 0.250 0.250 0.375

$1.35 0.60 0.60 0.25 0.20 0.10

$0.633 0.090 0.225 0.063 0.050 0.037 $1.098

Grape concentrate (litres) Sugar (kilograms) Lemons (units) Yeast tablets (units) Nutrient tablets (units) Water (litres) Total standard cost per litre

EXERCISE 12-14 Direct materials cost per unit: Regular cost of material Less: early payment discount (2%) Net material cost Plus: freight costs Direct material cost per kilogram Material per unit (4.5 + 0.5)

$4.00 0.08 3.92 0.25 4.17 x5

$20.85

Direct labour cost per unit: Cost per hour Fringe benefits Cost per hour hours per unit (2.0 + 0.2)

12.00 3.00 15.00 x 2.2

33.00

Manufacturing overhead (2.2 hrs x $6.00) Total standard cost per unit

. 12-12

13.20 $67.05

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EXERCISE 12-15 (a) Material variance = (AQ x AP) – (SQ x SP) (28,000 x $4.70) – [(9,000 x 3) x $5.00] = $131,600 - $135,000 = $3,400F Materials price variance: = (AQ x AP) – (AQ x SP) (28,000 x $4.70) – (28.000 x $5.00) = $131,600 - $140,000 = $8,400F Materials quantity variance: = (AQ x SP) – (SQ x SP) (28,000 x $$5.00) – (27,000 x $5.00) = $140,000 - $135,000 = $5,000U (b) Material variance = (AQ x AP) – (SQ x SP) (26,200 x $5.20) – [(9,000 x 3) x $5.00] = $136,240 - $135,000 = $1,240U Materials price variance: = (AQ x AP) – (AQ x SP) (26,200 x $5.20) – (26,200 x $5.00) = $136,240 - $131,000 = $5,240U Materials quantity variance: = (AQ x SP) – (SQ x SP) (26,200 x $5.00) – (27,000 x $5.00) = $131,000 - $135,000 = $4,000F EXERCISE 12-16 (a) Total labour variance: (AH x AR) – (SH x SR) (40,800 x $12.10) – [(10,000 x 4) x $12.00] = $493,680 – $480,000 = $13,680U (b) Labour price variance: (AH x AR) – (AH x SR) (40,800 x $12.10) – (40,800 x $12.00) = $493,680 – $489,600 = $4,080U Labour quantity variance: (AH x SR) – (SH x SR) (40,800 x $12.00) – (40,000 x $12.00) = $489,600 – $480,000 = $9,600U . 12-13

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EXERCISE 12-16 (Continued) (c) Labour price variance: (AH x AR) – (AH x SR) (40,800 x $12.10) – (40,800 x $12.20) = $493,680 – $497,760 = $4,080F Labour quantity variance: (AH x SR) – (SH x SR) (40,800 x $12.20) – (42,000 x $12.20) = $497,760 – $512,400 = $14,640F EXERCISE 12-17 (a)

(b)

(c)

(d)

Standard direct hours per oil change: Actual time spent on the oil change (hours) Plus: set-up and down time (10% x actual) Cleanup and rest periods (30%)

1.00 0.10 0.30

1.40

Direct labour hourly rate Cost per hour Plus: Fringe benefits (25% of rate) Payroll taxes (10%)

10.00 2.50 1.00

$13.50

Direct labour cost per oil change (1.4 hours x $13.50)

$18.90

Labour quantity variance: (AH x SR) – (SH x SR) (1.5 x $13.50) – (1.4 x $13.50) = $20.25 – $18.90 = $1.35U

EXERCISE 12-18 Actual per unit materials cost: $4,940 ÷ 1,900 kg = $2.60/kg Actual direct labour rate per hour: $8,120 ÷ 700 = $11.60 Direct materials standard quantity: 230 units x 8 kg = 1,840 kg Direct labour standard quantity: 230 units x 3 hr = 690 hours . 12-14

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EXERCISE 12-18 (Continued) Material variance = (AQ x AP) – (SQ x SP) (1,900 x $2.60) – (1,840 x $2.50) = $4,940 - $4,600 = $340U Materials price variance: = (AQ x AP) – (AQ x SP) (1,900 x $2.60) – (1,900 x $2.50) = $4,940 - $4,750 = $190U Materials quantity variance: = (AQ x SP) – (SQ x SP) (1,900 x $2.50) – (1,840 x $2.50) = $4,750 - $4,600 = $150U Total labour variance: (AH x AR) – (SH x SR) (700 x $11.60) – (690 x $12.00) = $8,120 – $8,280 = $160F Labour price variance: (AH x AR) – (AH x SR) (700 x $11.60) – (700 x $12.00) = $8,120 – $8,400 = $280F Labour quantity variance: (AH x SR) – (SH x SR) (700 x $12.00) – (690 x $12.00) = $8,400 – $8,280 = $120U

. 12-15

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EXERCISE 12-18 (Continued) (Not Required) Materials Variance Matrix (1)

(2)

(3)

Actual Quantity X Actual Price 1,900 X $2.60 = $4,940

Actual Quantity X Standard Price 1,900 X $2.50 = $4,750

Standard Quantity X Standard Price 1,840 X $2.50 = $4,600

Price Variance (1) – (2) $4,940 – $4,750 = $190 U

Quantity Variance (2) – (3) $4,750 – $4,600 = $150 U

Total Variance (1) – (3) $4,940 – $4,600 = $340 U

Labour Variance Matrix (1)

(2)

(3)

Actual Hours X Actual Rate 700 X $11.60 = $8,120

Actual Hours X Standard Rate 700 X $12.00 = $8,400

Standard Hours X Standard Rate 690 X $12.00 = $8,280

Price Variance (1) – (2) $8,120 – $8,400 = $280 F

Quantity Variance (2) – (3) $8,400 – $8,280 = $120 U

Total Variance (1) – (3) $8,120 – $8,280 = $160 F

. 12-16

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EXERCISE 12-19 Direct materials standard quantity: 1,070 units x 2 kg = 2,140 kg (a)

Material variance = (AQ x AP) – (SQ x SP) $10,900 – (2,140 x $5.00) = $10,900 - $10,700 = $200U Materials price variance: = (AQ x AP) – (AQ x SP) $10,900 – (2,300 x $5.00) = $10,900 - $11,500 = $600F Materials quantity variance: = (AQ x SP) – (SQ x SP) (2,300 x $5.00) – (2,140 x $5.00) = $11,500 - $10,700 = $800U

(b) One possible cause of an unfavourable 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 be a favourable materials price variance. Substandard materials could cause work slowdowns and delays, causing an unfavourable labour quantity variance. Therefore, the purchase of substandard materials could cause all three variances mentioned. EXERCISE 12-20 GARNER TOOL & DIE COMPANY Direct Labour Variance Report For the Month Ended March 31, 2008 Job No.

Actual Hours

Standard Hours

Quantity Actual Standard Price (a) (1) (2) Variance Rate Rate Variance (b) Explanation

A257 A258 A259

220 450 300

225 430 300

$100.00 F $20.00 (400.00) U $22.00 ( 0) $20.50

$20.00 $20.00 $20.00

A260

115 110 Totals

100.00) U $18.00 $ 400.00) U

$20.00

. 12-17

$ 0 Repeat job 900.00 U Rush job 150.00 U Replacement worker 230.00 F New trainee $820.00 U

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(1)

Actual costs ÷ actual hours Standard costs ÷ standard hours

(2)

EXERCISE 12-21 (a)

Material variance = (AQ x AP) – (SQ x SP) (1,225 x $128) – (1,200 x $130) = $156,800 - $156,000 = $800U Materials price variance: = (AQ x AP) – (AQ x SP) (1,225 x $128) – (1,225 x $130) = $156,800 – $159,250 = $2,450F Materials quantity variance: = (AQ x SP) – (SQ x SP) (1,225 x $130) – (1,200 x $130) = $159,250 - $156,000 = $3,250U Total labour variance: (AH x AR) – (SH x SR) (4,200 x $13) – (4,300 x $12.00) = $54,600 – $51,600 = $3,000U Labour price variance: (AH x AR) – (AH x SR) (4,200 x $13) – (4,200 x $12.00) = $54,600 – $50,400 = $4,200U Labour quantity variance: (AH x SR) – (SH x SR) (4,200 x $12.00) – (4,300 x $12.00) = $50,400 – $51,600 = $1,200F

(b) The unfavourable 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 unfavourable labour 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 unfavourable labour . 12-18

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variance may also occur when workers are paid higher wages than expected. The manager who authorized the wage increase is responsible for this variance. EXERCISE 12-22 (a) Item Variable overhead................................... Fixed overhead ....................................... Total overhead ........................................

Amount $33,000 19,800 $52,800

Hours 16,500 16,500 16,500

Rate $2.00 1.20 $3.20

(b) Total overhead variance: Actual overhead – Applied overhead $54,000 – [(4,000 x 4) x $3.20] = $54,000 – $51,200 = $2,800U Overhead controllable variance: Actual overhead – Budgeted overhead $54,000 – [((4,000 x 4) x $2.00) + $19,800] = $54,000 – $51,800 = $2,200U Overhead volume variance: Fixed overhead rate x (Normal capacity – Standard hours allowed) $1.20 x [16,500 – (4,000 x 4)] = $1.20 x 500 = $600U (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.

. 12-19

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EXERCISE 12-23

(a) (1) Total actual overhead cost

Overhead Budgeted

Overhead Controllable + Variance

= ($18,000 + $13,200) +

$1,500

= $32,700 (2) Actual variable overhead cost

= Actual Overhead – Fixed Overhead = $32,700 –

$13,200

= $19,500 (3) Variable overhead cost applied

= 2,000 hours x $9 = $18,000

(4) Fixed overhead cost applied

= 2,000 hours x $6 = $12,000

(5) Overhead volume variance

 Normal Standard   Overhead X  Capacity – Hours   Hours Rate Allowed 

Fixed

(2,200* –

2,000)

= $1,200 U *$13,200 ÷ $6 per hour = 2,200 hours (b)

Number of loans processed = Standard hours allowed ÷ Standard hours per application = 2,000 ÷ 2 = 1,000 loans processed

. 12-20

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EXERCISE 12-24 (a) Predetermined overhead rate = $200,000 ÷ 20,000 = $10/hour Total overhead variance = Actual overhead – Applied overhead Total overhead variance = $18,800 – (1,800 x $10) = $800U Overhead controllable variance = Actual – Budgeted overhead $18,800 – $17,600 = $1,200U Fixed overhead rate: (5,000 x 12) ÷ 20,000 = $3.00 Normal monthly capacity: 20,000 ÷ 12 = 1,667 hours Overhead volume variance = Fixed overhead rate x [normal capacity – standard hours allowed] = $3.00 x (1,666.67 – 1,800) = $400F (b) The cause of an unfavorable controllable variance could be higher than expected use of indirect materials, indirect labour, 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.

EXERCISE 12-25 Total overhead variance = Actual overhead – Applied overhead = $213,000 – (52,000 x $4) = $5,000U Overhead controllable variance = Actual – Budgeted overhead = $213,000 – [(52,000 x $3) + (54,000 x $1)] = $213,000 – $210,000 = $3,000U

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EXERCISE 12-25 (Continued) Overhead volume variance = Fixed overhead rate x [normal capacity – standard hours allowed] = $1.00 x (54,000 – 52,000) = $2,000U EXERCISE 12-26 (a) Predetermined overhead rates: Amount Variable overhead ................................... $200,000 Fixed overhead ....................................... $600,000 Total overhead ........................................ $800,000

Hours 100,000 100,000 100,000

Rate $2.00 6.00 $8.00

(b) Applied overhead = standard hours allowed x overhead rate = (90,000 units x 1 hour) x $8.00 = $720,000 (c) Total overhead variance: Actual overhead – Applied overhead $786,000 – $720,000 = $66,000U EXERCISE 12-27 (a) IMPERIAL LANDSCAPING Variance Report – Purchasing Department For the Current Month

Project

Actual Kilograms Purchased

Actual Price(1)

Ames Korman Stilles

500 400 500

$2.35 2.40 2.60

Total price variance

(2) Standard Price (2) Price Variance (a) $2.50 2.50 2.50

$75 F 40 F 50 U

Explanation Purchased poor quality seeds Seeds on sale Price increased

$65 F

(a)

MPV = AQ X (AP – SP) (1)Actual costs ÷ actual quantity (2)Standard costs ÷ standard quantity.

. 12-22

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EXERCISE 12-27(Continued) (b) IMPERIAL LANDSCAPING Variance Report – Production Department For the Current Month Project

Actual Kgs

Standard Kgs

Standard Price

Quantity Variance (b)

Explanation

Ames Korman Stilles

500 400 500

460 410 480

$2.50 2.50 2.50

$100 U 25 F 50 U

Purchased poor quality seeds Purchased higher quality seeds New employee

Total quantity variance

$125 U

(b)MQV = SP X (AQ – SQ)

EXERCISE 12-28 ARCHANGEL CORPORATION Variance Report – Purchasing Department For Week Ended January 9, 2009 Type of Materials

Quantity Purchased

Actual Price

Standard Price

Price Variance

Explanation

Rogue 11 Storm 17 Beast 27

26,000 lbs. 7,000 oz. 22,000 units.

$5.20 $3.40 $0.45

$5.00 $3.25 $0.47

$5,200 U $1,050 U $ 440 F

Price increase Rush order Bought larger quantity

26,000 = $5,200 ÷ ($5.20 – $5.00). $5,200 U because the actual price ($5.20) exceeds the standard price ($5.00). $1,050 ÷ 7,000 = $0.15; $3.25 + $0.15 = $3.40 $440 ÷ 22,000 = $0.02; $0.45 + $0.02 = $0.47

. 12-23

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EXERCISE 12-29 CARLOS COMPANY Income Statement For the Month Ended January 31, 2009 Sales (8,000 x $8) Less: cost of goods sold (8,000 x $6) Gross profit (at standard) Variances: Materials price Materials quantity Labour price Labour quantity Overhead Gross profit (actual) Less: selling and administrative expenses Net income

. 12-24

$64,000 48,000 16,000 $1,250 (700) 525 725 800

2,600 13,400 6,000 $7,400

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EXERCISE 12-30 (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. (2) Variance—(a) The difference between total actual costs and total standard costs. (3) Learning and growth perspective—(d) A viewpoint employed in the balanced scorecard to evaluate how well a company develops and retains its employees. (4) Nonfinancial measures —(e) An evaluation tool that is not based on dollars. (5) Customer perspective—(f) A viewpoint employed in the balanced scorecard to evaluate the company from the perspective of those people who buy and use its products or services. (6) Internal process perspective—(h) A viewpoint employed in the balanced scorecard to evaluate the efficiency and effectiveness of the company’s value chain. (7) Ideal standards—(g) An optimum level of performance under perfect operating conditions. (8) Normal standards—(b) An efficient level of performance that is attainable under expected operating conditions. *EXERCISE 12-31 (a) $130,000 ($128,000 + $2,000). (b) $127,000 ($130,000 – $3,000). (c) $141,500 ($140,000 + $1,500). (d) $139,100 ($140,000 – $900). (e) $166,200 ($165,000 + $1,200).

. 12-25

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*EXERCISE 12-32 Raw Materials Inventory (1,900 x $2.50)............................ Materials Price Variance (1,900 x $0.10) ........................... Accounts Payable (1,900 x $2.60) ..............................

4,750 190

Work in Process Inventory (1,840* x $2.50) ...................... Materials Quantity Variance (60 x $2.50)........................... Raw Materials Inventory (1,900 x $2.50) ....................

4,600 150

4,940

4,750

*230 X 8 Factory Labour (700 x $12) ................................................ Labour Price Variance (700 x $0.40) .......................... Wages Payable (700 x $11.60) ....................................

8,400

Work in Process Inventory (690* x $12) ............................ Labour Quantity Variance (10 x $12) ................................. Factory Labour (700 x $12).........................................

8,280 120

280 8,120

8,400

*230 X 3 *EXERCISE 12-33 (a) Manufacturing Overhead ....................................... Cash, Accounts Payable, etc. ........................

213,000

Work in Process Inventory (52,000 x $4) .............. Manufacturing Overhead ...............................

208,000

(b) Overhead Controllable Variance ........................... Overhead Volume Variance................................... Manufacturing Overhead ............................... *$213,000 – [(52,000 x $3) + $54,000] **$1 x (54,000 – 52,000)

. 12-26

213,000

208,000 3,000* 2,000** 5,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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*EXERCISE 12-34 1.

Raw Materials Inventory (18,000 x $4.25) ................. Materials Price Variance (18,000 x $0.25)................. Accounts Payable (18,000 x $4.50) ...................

76,500 4,500

Work in Process Inventory (17,600 x $4.25) ............. Materials Quantity Variance (400 x $4.25) ................ Raw Materials Inventory (18,000 x $4.25) .........

74,800 1,700

Factory Labour (15,200 x $5.50)................................ Labour Price Variance (15,200 x $.70) .............. Wages Payable (15,200 x $4.80) ........................

83,600

Work in Process Inventory (15,400 x $5.50) ............. Labour Quantity Variance (200 x $5.50)............ Factory Labour (15,200 x $5.50) ........................

84,700

Work in Process Inventory (84,700 X 100%) ............ Manufacturing Overhead ...................................

84,700

. 12-27

81,000

76,500 10,640 72,960 1,100 83,600 84,700

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO PROBLEMS—SET A PROBLEM 12-35A

(a)

Number of units = Total standard cost ÷ standard cost per unit Number of units = $405,000 ÷ $18.00 (6 kg x $3 per kg) = 22,500

(b)

AQ = [(SQ x SP) ± Quantity variance] ÷ SP AQ = ($405,000 + $9,000) ÷ $3.00 per kg = 138,000 kilograms

(c)

AP = [(AQ x SP) ± Price variance] ÷ AQ AP = [(138,000 x $3) - $6,900] = $407,100 ÷ 138,000 kg = $2.95/kg

(d)

AH = [(SH x SR) ± Efficiency variance] ÷ SR AH = ($90,000 + $7,000) ÷ $5.00/hr = 19,400 hours

(e)

AR = [(AH x SP) ± Rate variance] ÷ AH AP = [(19,400 x $5) + $4,850] = $101,850 ÷ 19,400 hr = $5.25/hr

(f)

Actual variable overhead cost = (AH x VOH rate) ± Spending variance Actual variable overhead cost = (19,400 x $3) - $1,300 = $56,900

(g)

Budgeted fixed cost = Standard cost ± Volume variance Budgeted fixed cost = $126,000 + $14,000 = $140,000

(h)

Denominator hours = Budgeted fixed cost ÷ FOH rate Denominator hours = $140,000 ÷ $7.00 = 20,000 hours

Note: students may find this question less challenging if they use the matrix as show on the next page. Start by filling in all the numbers you know, and then break each one into its components using the information from the standard cost card. This works well for materials and labour, but is less effective for overhead variances.

. 12-28

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-35A (Continued) Materials Variance Matrix (1)

(2)

(3)

Actual Quantity X Actual Price 138,000 x 2.95 = 407,100

Actual Quantity X Standard Price 138,000 x 3 = 414,000

Standard Quantity X Standard Price 22,500 x 6 x 3 = 405,000

Price Variance (1) – (2) $6,900 F

Quantity Variance (2) – (3) $9,000 U

Total Variance (1) – (3) $2,100 U

Labour Variance Matrix (1)

(2)

(3)

Actual Hours X Actual Rate 19,400 x $5.25 = 101,850

Actual Hours X Standard Rate 19,400 x $5 = 97,000

Standard Hours X Standard Rate 22,500 x 0.8 x $5 = 90,000

Price Variance (1) – (2) 4,850 U

Quantity Variance (2) – (3) 7,000 U

Total Variance (1) – (3) S11,850 U

. 12-29

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-36A Actual per unit materials cost: $73,500 ÷ 15,000 kg = $4.90/kg (AP) Standard quantity of materials: 7,600 units x 2 kg = 15,200 kg (SQ) Actual per unit direct labour cost: $181,780 ÷ 14,900 = $12.20 (AR) Standard quantity of labour: 7,600 x 2 hours = 15,200 hours (SH) Total actual overhead: $88,990 + $44,000 = $132,990 Total variable applied overhead: 15,000 x $6.00 = $90,000 Total fixed applied overhead: 15,000 x $3.00 = $45,000 (a) Total materials variance = (AQ x AP) – (SQ x SP) (15,000 x $4.90) – (15,200 x $5.00) $73,500 – $76,000 =

$2,500 F

Materials price variance = (AQ x AP) – (AQ x SP) (15,000 x $4.90) – (15,000 x $5.00) $73,500 – $75,000 =

$1,500 F

Materials quantity variance = (AQ x SP) – (SQ x SP) (15,000 x $5.00) – (15,200 x $5.00) $75,000 – $76,000 = $1,000 F Total labour variance = (AH x AR) – (SH x SR) (14,900 x $12.20) – (15,200 x $12.00) $181,780 – $182,400 =

$620 F

Labour price variance = (AH x AR) – (AH x SR) (14,900 x $12.20) – (14,900 x $12.00) $181,780 – $178,800 =

$2,980 U

Labour quantity variance = (AH x SR) – (SH x SR) (14,900 x $12.00) – (15,200 x $12.00) $178,800 – $182,400 =

$3,600 F

. 12-30

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-36A (Continued) (b) Total overhead variance = Actual Overhead – Overhead Applied ($88,990 + $44,000) – (15,200 x $9.00) $132,900 – $136,800 = $3,900 F (c) Overhead controllable variance = Actual O.H. – Budgeted O.H. ($88,990 + $44,000) – (15,200 x $6.00) + (15,000 x $3.00) = $3,300 F

Overhead volume variance = Fixed Overhead Rate x (Normal capacity – Standard Hours Allowed) $3.00 x (15,000 – 15,200) = $600 F

. 12-31

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-37A (a) Total materials variance = (AQ x AP) – (SQ x SP) (17,500 x $3.40) – (18,000 x $3.00) $59,500 – $54,000 =

$5,500 U

Materials price variance = (AQ x AP) – (AQ x SP) (17,500 x $3.40) – (17,500 x $3.00) $59,500 – $52,500 =

$7,000 U

Materials quantity variance = (AQ x SP) – (SQ x SP) (17,500 x $3.00) – (18,000 x $3.00) $52,500 – $54,000 = $1,500 F Total labour variance = (AH x AR) – (SH x SR) (2,900 x $11.80) – (3,000 x $12.50) $34,220 – $37,500 =

$3,280 F

Labour price variance = (AH x AR) – (AH x SR) (2,900 x $11.80) – (2,900 x $12.50) $34,220 – $36,250 =

$2,030 F

Labour quantity variance = (AH x SR) – (SH x SR) (2,900 x $12.50) – (3,000 x $12.50) $36,250 – $37,500 =

$1,250 F

(b) Total overhead variance = Actual Overhead – Overhead Applied $87,500 – (3,000 x $31.00) $87,500 – $93,000 = $5,500 F (c) Overhead controllable variance = Actual O.H. – Budgeted O.H. $87,500 –[(3,000 x $20.00) + $30,800] $87,500 – $90,800 = $3,300 F Overhead volume variance = Fixed Overhead Rate x (Normal capacity – Standard Hours Allowed) $11.00 x (2,800 – 3,000) = $2,200 F . 12-32

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-37A (Continued)

(d)

SORIANO MANUFACTURING COMPANY Income Statement For the Month Ended July 31, 2009

Sales ................................................................... Cost of goods sold (at standard) ...................... Gross profit (at standard).................................. Variances Materials price ............................................ Materials quantity....................................... Labour price ............................................... Labour quantity .......................................... Overhead controllable ............................... Overhead volume ....................................... Total variance—favourable ................ Gross profit (actual) .......................................... Selling and administrative expenses ............... Net income ......................................................... 1

$240,000 184,5001 55,500 $7,000 (1,500) (2,030) (1,250) (3,300) (2,200) 3,280 58,780 25,000 $33,780

Materials, $54,000 (18,000 x $3) + Direct labour, $37,500 (3,000 x 12.50) + 1Overhead applied, $93,000.

. 12-33

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-38A

(a) Flexible budget for 8,000 units

Variable overhead costs Indirect labour Utilities Labour-related costs Laboratory maintenance Total variable overhead

Cost Per Unit

Total Cost

$1.80 0.40 1.50 1.10 $4.80

$14,400 3,200 12,000 8,800 38,400

Fixed overhead costs Supervisor Amortization Base utilities Insurance Total fixed overhead Total overhead costs

(b)

$30,000 28,000 9,000 2,000 69,000 $107,400

Standard cost card for one water test: Standard Quantity Price 2.00 $3.80 1/6 22.80

Direct materials Direct labour (hr) Overhead: Variable ($48,000 ÷ 10,000) Fixed ($69,000 ÷ 10,000)

. 12-34

Cost $7.60 3.80 4.80 6.90 $23.10

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-38A (Continued) (c)

Total materials variance = (AQ x AP) – (SQ x SP) (19,000 x $3.70) – (18,000 x $3.80) $70,300 – $68,400 =

$1,900 U

Materials price variance = (AQ x AP) – (AQ x SP) (19,000 x $3.70) – (19,000 x $3.80) $70,300 – $72,200 =

$1,900 F

Materials quantity variance = (AQ x SP) – (SQ x SP) (19,000 x $3.80) – (18,000 x $3.80) $72,200 – $68,400 = $3,800 U Total labour variance = (AH x AR) – (SH x SR) $37,646 – [(9,000 x 1/6) x $22.80] $37,646 – $34,200 =

$3,446 U

Labour rate variance = (AH x AR) – (AH x SR) $37,646 – (1,623 x $22.80) $37,646 – $37,004.40 =

$642 U

Labour efficiency variance = (AH x SR) – (SH x SR) (1,623 x $22.80) – (1,500 x $22.80) $37,004 – $34,200 = $2804 U (d) Total overhead variance = Actual Overhead – Overhead Applied $45,200 – (9,000 x $4.80) $45,200 – $43,200 = $2,000 U VOH spending variance = Actual O.H. – (AH x VOH rate) $45,200 – (1,623 x 6 x $4.80) $45,200 – $46,742 = $1,542 F VOH efficiency variance = (AH x VOH rate) – (SH x SR) (1,623 x 6 x $4.80) – [(1,500 x 6) x $4.80] $46,742 – $43,200 = $3,542 U . 12-35

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-39A (a) (1) Materials Variance Matrix (1)

(2)

(3)

Actual Quantity X Actual Price

Actual Quantity X Standard Price

Standard Quantity X Standard Price

57,000 X $7.20 = $410,400

57,000 X $6.80 = $387,600

11,800 X 5 X $6.80 = $401,200

Price Variance (1) – (2) $410,400 – $387,600 = $22,800U

Quantity Variance (2) – (3) $387,600 – $401,200 = 13,600F

Total Variance (1) – (3) $410,400 – $401,200 = $9,200U

(2) Labour Variance Matrix (1)

(2)

(3)

Actual Hours X Actual Rate

Actual Hours X Standard Rate

Standard Hours X Standard Rate

11,200 X $11.20 = $125,440

11,200 X $11.50 = $128,800

11,800 X 1 X $11.50 = $135,700

Rate Variance (1) – (2) $125,440 – $128,800 = $3,360F

Efficiency Variance (2) – (3) $128,800 – $135,700 = $6,900F

Total Variance (1) – (3) $125,440 – $135,700 = $10,260F

. 12-36

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-39A (Continued) Total overhead variance = Actual Overhead – Overhead Applied ($90,000 + $37,000) – (11,800 x $9.30) $127,000 – $109,740 = $17,260 U Overhead controllable variance = Actual O.H. – Budgeted O.H. $127,000 – [(11,800 x $3.00) + $94,500] $127,000 – $129,900 = $2,900 F Overhead volume variance = Fixed Overhead Rate x (Normal capacity – Standard Hours Allowed) $6.30 x (15,000 – 11,800) = $20,160 U (b) The overhead volume variance is the only variance that is above 6%. Management will probably want to look into why production was only about 80% of normal capacity, unless it was planned that way.

. 12-37

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-40A

(a)

Materials price variance = AQ(AP – SP) AQ x ($0.99 - $1.00) = 600 Actual quantity = $600 ÷ $0.01 = 60,000 litres

(b)

Materials quantity variance = SP(AQ – SQ) $1,600 = $1.00[AQ – (5,000 x 20)] Actual quantity used = (5,000 x 20) + 1,600 = 101,600

(c)

Labour rate variance = AH(AR – SR) $7,400 = AH($10.50 - $10.00) Actual hours worked = $7,400 ÷ $0.50 = 14,800 hours

(d)

Labour efficiency variance = SR(AH – SH) = $10.00[14,800 – (5,000 x 3)] = $2,000F

(e)

Variable overhead efficiency variance = Overhead rate x (AH – SH) = [$(750,000 ÷ 50,000) ÷ 3] x (14,800 – 15,000) = ($15.00 per unit ÷ 3 hours per unit) x (–200 hours) = $5.00 x (–200) = $1,000F

(f)

Actual variable overhead = (AH x overhead rate) + unfavourable spending variance = (14,800 x $5.00) + $1,800 = $75,800

(g)

Fixed overhead budget variance = actual overhead – budgeted overhead = $88,000 – ($1,050,000 ÷ 12) = $88,000 - $87,500 = $500U

(h)

Fixed overhead volume variance = budgeted overhead – (SH x fixed overhead rate) = $87,500 – [15,000 x (($1,050,000 ÷ 50,000) ÷ 3) = $87,500 – (15,000 x $7.00) = $17,500F

. 12-38

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-41A (a)

MPV = AQ x (AP – SP) $7,100 = 142,000 x ($0.90 – SP) SP = [($142,000 x $0.90) – $7,100] ÷ 142,000 SP = $0.85

(b)

MQV = SP x (AQ – SQ) SQ/unit = (142,000 + 5,600) ÷ 36,000 = 4.1 kilograms

(c)

SH = 36,000 x 4/3 = 48,000 standard hours allowed

(d)

LEV = SR x (AH – SH) $8,400 = $12 x (AH – 48,000) AH = [(48,000 x $12) + $8,400] ÷ $12 AH = 48,700

(e)

AR = SR – (LRV ÷ AH) AR = $12.00 – ($9,740 ÷ 48,700) AR = $12.00 – $0.20 = $11.80

(f)

$327,600 ÷ 42,000 = $7.80 PDOHR per direct labour hour.

(g) Direct materials (kg) Direct labour (hr) Overhead: (hr)

(h)

Standard Quantity Price 4.1 $0.85 4/3 $12.00 4/3 $7.80

Cost $3.485 16.000 10.400 $29.885

Overhead applied = SH allowed x PDOHR Overhead applied = 48,000 x $7.80 = $374,400

. 12-39

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-41A (Continued) (i)

Total costs assigned to work in progress: Direct materials (36,000 x 4.1 kg x $0.85) Direct labour (36,000 x $16) Overhead: (from (h) Or: 36,000 units at $29.885

. 12-40

$125,460 576,000 374,400 $1,075,860

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-42A (a) Total materials variance = (AQ x AP) – (SQ x SP) (2,020 x $2.10) – (2,000 x $2.00) $4,242 – $4,000 =

$242 U

Materials price variance = AQ x (AQ – SP) 2,020 x ($2.10 - $2.00)

$202 U

Materials quantity variance = SP x (AQ – SQ) $2.00 x (2,020 – 2,000)

$40 U

Total labour variance = (AH x AR) – (SH x SR) (995 x $21) – (1,000 x $20) $20,895 – $20,000 =

$895 U

Labour price variance = AH x (AR – SR) 995 x ($21 - $20) =

$995 U

Labour quantity variance = SR x (AH – SH) $20 x (995 – 1,000) =

$100 F

Total overhead variance = Actual Overhead – Overhead Applied ($8,100 + $3,400) – (2,000 x 0.5 x $11) $11,500 – $11,000 = $500 U Overhead controllable variance = Actual O.H. – Budgeted O.H. $11,500 – [(2,000 x 0.5 x $8.00) + $3,600] $11,500 – $11,600 = $100 F Overhead volume variance = Fixed Overhead Rate x (Normal capacity – Standard Hours Allowed) $3.00 x (1,200 – 1,000) = $600 U

. 12-41

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-42A (Continued) (b) HI-TEK LABS Income Statement For the Month Ended May 31, 2009

Service revenue ............................................................. Cost of service provided (at standard) ($17.50 x 2,000) .......................................................... Gross profit (at standard) ............................................. Variances Materials price ........................................................ Materials quantity .................................................. Labour price ........................................................... Labour quantity ...................................................... Overhead controllable ........................................... Overhead volume ................................................... Total variance—unfavourable ....................... Gross profit (at actual) .................................................. Selling and administrative expenses ........................... Net income .....................................................................

$45,000 35,000 10,000 $202 40 995 (100) (100) 600 1,637 8,363 2,000 $6,363

(c) The unfavourable materials price variance could be caused by price increases, using a different shipping method, or purchasing higher quality materials. The unfavourable materials quantity variance could be caused by inexperienced workers, carelessness, or faulty test procedures. The unfavourable labour price variance could be caused by rising labour costs, or assigning the wrong workers to perform the tests. The unfavourable overhead volume variance could be caused by a lack of test orders, the inefficient use of direct labour hours or overestimating normal capacity.

. 12-42

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-43A

Budgeted fixed overhead is $135,000 x 0.20 = $27,000 Budgeted variable overhead is $135,000 x 0.80 = $108,000 The fixed overhead rate is $27,000 ÷ (9,000 x 2) = $1.50/hour The variable overhead rate is $108,000 ÷ (9,000 X 2) = $6.00/hour (a) Variable overhead spending variance = Actual Overhead – (Actual hours x variable overhead rate) = $108,500 – (17,200 x $6.00) = $108,500 – $103,200 = $5,300U

(b)

Variable overhead efficiency variance = Variable overhead rate x (Actual hours – Standard hours allowed) = $6.00 x [17,200 – (8,500 x 2)] = $1,200U

(c)

Fixed overhead budget variance = actual overhead – budgeted overhead = $28,000 – [(9,000 x 2) x $1.50] = $28,000 – $27,000 = $1,000U

(d)

Fixed overhead volume variance = Fixed overhead rate x (Normal capacity – Standard hours allowed) = $1.50 x [18,000 – (8,500 x 2)] = $1,500U

. 12-43

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*PROBLEM 12-44A (a) 1.

Raw Materials Inventory (6,100 x $4.00) ........ Materials Price Variance ......................... [6,100 x ($3.60 – $4.00)] Accounts Payable (6,100 x $3.60)...........

24,400

Work in Process Inventory ............................. [3,900 x 1.4) x $4.00] Materials Quantity Variance ........................... [(6,100 – 5,460) x $4.00] Raw Materials Inventory..........................

21,840

Factory Labour (3,800 x $9.00) ....................... Labour Price Variance .................................... [3,800 x ($9.25 – $9.00)] Wages Payable (3,800 x $9.25) ...............

34,200 950

Work in Process Inventory (3,900 x $9.00) .... Labour Quantity Variance ....................... [(3,900 – 3,800) x $9.00] Factory Labour (3,800 x $9.00) ..............

35,100

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

73,650

Work in Process Inventory (3,900 x $17.40) .. Manufacturing Overhead ........................

67,860

Finished Goods Inventory (3,900 x $32.00) ... Work in Process Inventory .....................

124,800

. 12-44

2,440 21,960

2,560 24,400

35,150

900 34,200

73,650

67,860

124,800

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-44 A (Continued) 8.

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

250,000

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

124,800

250,000

Selling and Administrative Expenses ............... Accounts Payable .......................................

124,800 61,000 61,000

Raw Materials (b) Inventory (1) 24,400 (2) 24,400

Materials Price Variance (1)2,440

Work in Process Inventory (2) 21,840 (7) 124,800 (4) 35,100 (6) 67,860

Factory Labour (3) 34,200 (4) 34,200

Materials Quantity Variance (2) 2,560

Finished Goods Inventory (7) 124,800 (8)124,800

Manufacturing Overhead (5) 73,650 (6) 67,860

Labour Price Variance (3) 950

Cost of Goods Sold (8) 124,800

Labour Quantity Variance (4) 900 (c) Overhead Volume Variance (1) ....................................... Overhead Controllable Variance (2) ....................... Manufacturing Overhead ....................................... (1) (2)

6,000 210 5,790

$10 x [4,500 (normal capacity) – 3,900 (standard hours allowed)]. [(3,900 x $7.40) + ($10 x 4,500)] – $73,650.

. 12-45

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*PROBLEM 12-44A (Continued) (d)

FAYMAN MANUFACTURING COMPANY Income Statement For the Month Ended January 31, 2009 Sales ....................................................................... Cost of goods sold at standard (3,900 x $32) ...... Gross profit (at standard) .............................. Variances Materials price ................................................ Materials quantity ........................................... Labour price ................................................... Labour quantity .............................................. Overhead controllable.................................... Overhead volume ........................................... Total variance—unfavourable ................ Gross profit (actual)............................................... Selling and administrative expenses ................... Net income .............................................................

. 12-46

$250,000 124,800 125,200 $(2,440) (2,560 ( 950 (900) (210) 6,000 5,960 119,240 61,000 $58,240

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-45A (a)

The average capacity is 80% of practical capacity, which means practical capacity = 16,000 ÷ 0.80 = 20,000 direct labour hours. Variable rate = total budgeted overhead ÷ flexible level of activity Variable rate = $80,000 ÷ 16,000 = $5.00 Fixed rate = total budgeted overhead ÷ denominator level of activity Fixed rate = $120,000 ÷ 20,000 = $6.00 Total overhead rate = $5.00 + $6.00 = $11.00

(b)

If expected activity is used as the denominator level of activity, fixed overhead rate would be $120,000 ÷ (20,000 x 60%) = $10.00. Overhead rate = fixed rate + variable rate = $10.00 + $5.00 = $15.00

(c)

Combined spending variance = Actual combined overhead – (AH x VOH rate) – fixed overhead budget Combined spending variance = $15,750 – (1,050 x $5.00) – ($120,000 ÷ 12 months) = $15,750 - $5,250 - $10,000 = $500U.

(d)

(1) Volume variance using rate at expected level of activity = Fixed overhead rate x (Expected level of activity – standard level of activity) = $10.00 x [((20,000 x 60%) ÷ 12) – 1,075] = $750F (2) Volume variance using rate at practical capacity = Fixed overhead rate x (practical capacity – standard level of activity) = $6.00 x [20,000 ÷ 12) – 1,075] = $3,550F

. 12-47

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-45A (Continued) (e) The volume variance based on expected activity indicates that during January the firm operated at greater than expected capacity. Consequently, fixed overhead was over-absorbed. The variance based on practical capacity indicates that during January capacity was not fully utilized (of course that was expected). The use of practical capacity does not allow management to interpret the volume variance as a measure of effectiveness relative to initial plans.

. 12-48

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-46A Calculate missing figures: Actual per unit materials cost: $242,000 ÷ 110,000 = $2.20 per metre Standard materials allowed: 4,500 x 24 metres = 108,000 metres Actual DL hours worked: 2,980 + 5,130 + 2,890 = 11,000 hours Standard DL hours allowed: (1,000 + 1,500 + (2,000 x 60%)) x 3 = 11,100 Standard machine hours allowed: $117,600 ÷ $2.80 = 42,000 Actual machine hours used: ($117,600 + $8,400) ÷ $2.80 = 45,000 Fixed overhead budget: $302,100 – $2,100 = $300,000 Fixed overhead rate: $300,000 ÷ 40,000 = $7.50 per hour (a) Total materials variance = (AQ x AP) – (SQ x SP) (110,000 x $2.20) – (108,000 x $2.00) $242,000 – $216,000 =

$26,000 U

Materials price variance = AQ x (AQ – SP) 110,000 x ($2.20 - $2.00)

$22,000 U

Materials quantity variance = SP x (AQ – SQ) $2.00 x (110,000 – 108,000)

$4,000 U

(b) Total labour variance = (AH x AR) – (SH x SR) (11,000 x $12.50) – (11,100 x $12) $137,500 – $133,200 =

$4,300 U

Labour price variance = AH x (AR – SR) 11,000 x ($12.50 - $12.00) =

$5,500 U

Labour quantity variance = SR x (AH – SH) $12.00 x (11,000 – 11,100) =

$1,200 F

. 12-49

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-46A (Continued) (c) Total variable OH variance = Actual Overhead – Overhead Applied $117,000 – (42,000 x $2.80) = $600 F VOH spending variance = Actual O.H. – (AH x VOH rate) $117,000 – (45,000 x $2.80) = $9,000 F VOH efficiency variance = (AH x VOH rate) – (SH x VOH rate) (45,000 x $2.80) – (42,000 x $2.80) = $8,400 U

(d)

Fixed overhead budget variance: Actual – Budgeted overhead $302,100 – $300,000 = $2,100 U Fixed overhead volume variance: Fixed overhead rate x (Normal capacity – standard hours allowed) $7.50 x (40,000 – 42,000 ) = $15,000 F Total fixed budget variances = $15,000 – $$2,100 = $12,900 F

(e)

Under-applied (over-applied) overhead = sum of all overhead variances: $12,900 + $600 = $13,500 over-applied

. 12-50

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO PROBLEMS—SET B PROBLEM 12-47B Materials Variance Matrix (1)

(2)

(3)

Actual Quantity X Actual Price 5,100 X $7.30 = $37,230

Actual Quantity X Standard Price 5,100 X $7.00 = $35,700

Standard Quantity X Standard Price 4,800 X $7.00 = $33,600

Price Variance (1) – (2) $37,230 – $35,700 = $1,530U

Quantity Variance (2) – (3) $35,700 – $33,600 = $2,100U

Total Variance (1) – (3) $37,230 – $33,600 = $3,630U

Labour Variance Matrix (1)

(2)

(3)

Actual Hours X Actual Rate 7,000 X $12.50 = $87,500

Actual Hours X Standard Rate 7,000 X $12.00 = $84,000

Standard Hours X Standard Rate 4,800 X 1.5 X $12.00 = $86,400

Rate Variance (1) – (2) $87,500 – $84,000 = $3,500U

Efficiency Variance (2) – (3) $84,000 – $86,400 = $2,400F

Total Variance (1) – (3) $87,500 – $86,400 = $1,100U . 12-51

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 12-47B (Continued) (b) Total overhead variance = Actual Overhead – Overhead Applied = ($56,170 + $19,680) – [7,200¹ x ($7.50 + $2.50)] = $75,850 – $72,000 = $3,850U (c) Overhead controllable variance = Actual Overhead – Overhead Budgeted = ($56,170 + $19,680) – [(7,200 x $7.50) + $18,750] = $75,850 – $72,750 = $3,100U Overhead volume variance = Fixed Overhead Rate x (Normal capacity hours – Standard Hours Allowed) = $2.50 x (7,500 – 7,200) = $750U ¹ 4,800 units x 1.5 hours per unit

. 12-52

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-48B (a) Materials Variance Matrix (1)

(2)

(3)

Actual Quantity X Actual Price 90,500 X $4.10 = $371,050

Actual Quantity X Standard Price 90,500 X $4.30 = $389,150

Standard Quantity X Standard Price 11,200 X 8 X $4.30 = $385,280

Price Variance (1) – (2) $371,050 – $389,150 = $18,100F

Quantity Variance (2) – (3) $389,150 – $385,280 = $3,870U

Total Variance (1) – (3) $371,050 – $385,280 = $14,230F

Labour Variance Matrix (1)

(2)

(3)

Actual Hours X Actual Rate 14,300 X $14.10 = $201,630

Actual Hours X Standard Rate 14,300 X $13.50 = $193,050

Standard Hours X Standard Rate 11,200 X 1.2 X $13.50 = $181,440

Rate Variance (1) – (2) $201,630 – $193,050 = $8,580U

Efficiency Variance (2) – (3) $193,050 – $181,440 = $11,610U

Total Variance (1) – (3) $201,630 – $181,440 = $20,190U . 12-53

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-48B (Continued) Total overhead variance = Actual Overhead – Overhead Applied = ($37,000 + $49,000) – (11,200 x 1.2 x $6.00) = $86,000 – $80,640 = $5,360U Overhead controllable variance = Actual Overhead – Overhead Budgeted = $86,000 – [(11,200 x 1.2 x $2.50) + $49,000] = $86,000 – $82,600 = $3,400U Overhead volume variance = Fixed Overhead Rate x (Normal capacity hours – Standard Hours Allowed) = $3.50 x (14,000 – 13,440) = $1,960U

(b) The materials price variance is 4.6% higher than standard. The actual price for materials of $4.10 is $0.20 below the standard price of $4.30. This is above the threshold set by management for investigation. The variance for labour is also significant. The labour price variance is 4.4% from standard ($0.60 ÷ $13.50), and the labour efficiency variance is 3.4% above standard (860 hrs ÷ 13,440 hrs).

. 12-54

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-49B Direct materials price variance (given)

$200 F

Direct materials efficiency variance (given) Direct labour price variance: $36,000 ÷ $4.80 = 7,500 hours

$610 F

7,500 x ($4.80 – $5.00) = Direct labour efficiency variance: Total variance – price variance =

$1,500 F

$500F – $1,500F = Variable overhead efficiency variance:

$1,000 U $190 U

Because overhead is applied using direct labour hours, the standard quantity for variable overhead efficiency variance will be the same as for direct labour hours. The labour efficiency variance is $1,000 and the rate was $5.00 per hour; this represents 200 standard hours ($1,000 ÷ $5.00 per hour). The variable overhead efficiency variance = 200 hours x VOH rate. The VOH rate = $9,500 ÷ 10,000 hours or $0.95 per direct labour hour. Variable overhead spending variance:

$875 U

Total variable overhead variance is represented by over- or underapplied overhead. Spending variance = under-applied overhead – variable overhead efficiency variance, or $1,065U – $190U. Fixed overhead volume variance: Overhead rate = $1.55 – $0.95 = $0.60 Actual quantity of hours = 7,500 Standard number of hours = 7,500 – 200 Denominator level of activity = 10,000 $0.60 x (10,000 – 7,300) = Fixed overhead budget variance:

$1,620 U

($2,256 – $1,065) v $1,620 =

$429 F

. 12-55

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-50B (a) MPV = AQ x (AP – SP) –$2,620 = 131,000 x ($0.92 – SP) SP = $0.94 OR ($0.92 + ($2,620 ÷ 131,000) = $0.94) (b) MQV = SP x (AQ – SQ) $4,700 = $0.94 x (131,000 – SQ) SQ = 126,000 or (126,000 ÷ 30,000) = 4.2 kg per unit (c) Standard hours allowed are 45,000 (30,000 x 1.5). (d) LQV = SP x (AH – SH) $7,200 = $12.00 x (AH – 45,000) AH = 45,600 (e) LPV = AH x (AP – SP) –$10,650 = 45,600 x (AP - $12.00) AP = $11.76644 (f)

$350,000 ÷ 50,000 = $7.00 predetermined overhead rate per direct labour hour.

(g) Direct materials (kg) Direct labour (hr) Overhead: (hr)

(h)

Standard Quantity Price 4.2 $0.94 1.5 $12.00 1.5 $7.00

Cost $3.948 18.000 10.500 $32.448

Overhead applied = SH allowed x PDOHR Overhead applied = 45,000 x $7.00 = $315,000

. 12-56

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-51 B (Continued) (i)

Total costs assigned to work in progress: Direct materials (30,000 x 4.2 kg x $0.94) Direct labour (30,000 x $18) Overhead: (from (h) Or: 30,000 units at $32.448

. 12-57

$118,440 540,000 315,000 $973,440

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-51B Calculate amounts not given: Actual direct labour rate: $125,511 ÷ 24,610 = $5.10 Standard hours allowed: 1,604 x 15 = 24,060 hrs Manufacturing overhead rate: 200% x $5.00 = $10.00 Denominator level of activity: $247,500 ÷ $10.00 = 24,750 hrs Variable PDOHR: $74,250 ÷ 24,750 = $3.00 per hour Fixed PDOHR: $10.00 – $3.00 = $7.00 per hour (a)

Labour price variance = (AH x AR) – (AH x SR) = (24,610 x $5.10) – (24,610 x $5.00) = $2,461U Labour quantity variance = (AH x SR) – (SH x SR) = (24,610 x $5.00) – (24,060 x $5.00) = $123,050 – $120,300 = $2,750U

(b)

VOH spending = actual variable overhead – (AH x SR) = $61,300 – (24,610 x $3.00) = $12,530F VOH efficiency = SR x (AH – SH) = $3.00 (24,610 – 24,060) = $1,650U

(c)

FOH spending variance = actual overhead – budgeted overhead = $186,000 – $173,250 = $12,750U FOH volume variance = overhead rate x (budgeted level of activity – standard level of activity) = $7.00 x (24,750 – 24,060) = $4,830

. 12-58

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-52B (a) (SQ x SP) = # of units produced x standard material per unit x per unit direct material cost $450,000 = # of units x 3kg x $6.00 # of units = 25,000 (b) (SQ x SP) – MQV-F = AQ x SP $450,000 – $9,000 = AQ x $6.00 AQ = 73,500 (c) (AQ x SP) + MPV-U = AQ x AP $441,000 + $6,900 = 73,500 x AP AP = $6.09 Materials Variance Matrix (1)

(2)

(3)

Actual Quantity X Actual Price 73,500 X (c) = $447,900

Actual Quantity X Standard Price (b) X $6.00 = $441,000

Standard Quantity X Standard Price (a) X 3 X $6.00 = $450,000

Price Variance (1) – (2) $447,900 – $441,000 = $6,900U

Quantity Variance (2) – (3) $441,000 – $450,000 = $9,000F

Total Variance (1) – (3) $447,900 – $450,000 = $2,100F

(d)

(SH x SR) – LEV-F = AH x SP $250,000 – $7,000 = AH x $5.00 AH = 48,600 for graphic presentation, see the next page

(e)

(AH x SR) – LRV-F = AH x AR

. 12-59

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-52B (Continued) $243,000 – $4,860 = 48,600 x AR AR = $4.90 for graphic presentation, see the next page

Labour Variance Matrix (1)

(2)

(3)

Actual Hours X Actual Rate 48,600 X (e) = $238,140

Actual Hours X Standard Rate (d) X $5.00 = $243,000

Standard Hours X Standard Rate (25,000 X 2) X $5.00 = $250,000

Rate Variance (1) – (2) $238,140 – $243,000 = $4,860F

Efficiency Variance (2) – (3) $243,000 – $250,000 = $7,000F

Total Variance (1) – (3) $238,140 – $250,000 = $11,860F

(f) (1) PDVOH rate = Total standard cost ÷ Standard hours PDVOH rate = $150,000 ÷ 50,000 = $3.00 per hour (2) AH x PDVOH rate = 48,600 x $3.00 = $145,800 (3) (AH x PDVOH rate) + spending variance = Actual VOH incurred $145,800 + $1,300 = $147,100 Please note: The table given in the text shows $364,000 as the total standard fixed overhead cost. This amount should be $336,000. (g) (1) Fixed overhead budget = Total standard cost + volume variance = ($336,000 + $14,000) = $350,000 For graphic presentation of (f) and (g) see the next page. . 12-60

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-52B (Continued) VOH Variance Matrix (1)

(2)

(3)

Variable overhead incurred $147,100 (f)(3)

Actual Hours X PDVOH rate 48,600 X $3.00 = (f)(2)

Standard Hours X PDVOH rate 25,000 X 2 X (f)(1) = $150,000

Spending Variance (1) – (2) $147,100 – $145,800 = $1,300U

Efficiency Variance (2) – (3) $145,800 – $150,000 = $4,200F

Total Variance (1) – (3) $147,100 – $150,000 = $2,900F

FOH Variance Matrix (1)

(2)

(3)

Fixed overhead incurred $350,500

Fixed overhead Budget (g)(1) $350,000

Standard Hours X PDFOH rate $336,000

Budget Variance (1) – (2) $350,500 – $350,000 = $500U

Volume Variance (2) – (3) $350,000 – $336,000 = $14,000U

Total Variance (1) – (3) $350,500 – $336,000 = $14,500U

. 12-61

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-53B Additional computations: PDVOH rate = ($405,000 x 70%) ÷ (8,100 x 3) = $11.67 per hour PDFOH rate = ($405,000 x 30%) ÷ (8,100 x 3) = $5.00 per hour Standard quantity allowed: 8,000 x 3 = 24,000 hours Normal capacity: 8,100 x 3 = 24,300 Budgeted fixed overhead = $405,000 x 30% = $121,500 (a) Variable overhead spending variance = Actual overhead – (AH x SR) = $288,500 – (24,500 x $11.67) = $2,585 U (b) VOH efficiency variance = SR x (AQ – SQ) = $11.67 x (24,500 – 24,000) = $5,835 U (c) FOH spending variance = Actual overhead – budgeted overhead = $123,000 – ($405,000 x 30%) = $1,500 U (d) FOH volume variance = PDFOH rate x (normal capacity – standard hours allowed) = $5.00 x (24,300 – 24,000) = $1,500 U

. 12-62

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-54B (a)

The average capacity is 75% of practical capacity, which means practical capacity = 13,500 ÷ 0.75 = 18,000 direct labour hours. Variable rate = total budgeted overhead ÷ flexible level of activity Variable rate = $60,750 ÷ 13,500 = $4.50 Fixed rate = total budgeted overhead ÷ denominator level of activity Fixed rate = $81,000 ÷ 18,000 = $4.50 Total overhead rate = $4.50 + $4.50 = $9.00

(b)

If expected activity is used as the denominator level of activity, fixed overhead rate would be $81,000 ÷ (18,000 x 60%) = $7.50. Overhead rate = fixed rate + variable rate = $7.50 + $4.50 = $12.00

(c)

Combined spending variance = Actual combined overhead – (AH x VOH rate) – fixed overhead budget = $11,635 – (1,050 x $4.50) – ($81,000 ÷ 12) = $11,635 - $4,725 - $6,750 = $160U

(d) (1)

Volume variance using rate at expected level of activity = Fixed overhead rate x (Expected level of activity – standard level of activity) = $7.50 x [((18,000 x 60%) ÷ 12) – 1,075] = $1,312.50F

(2) Volume variance using rate at practical capacity = Fixed overhead rate x (practical capacity – standard level of activity) = $4.50 x [18,000 ÷ 12) – 1,075] = $1,912.50U

. 12-63

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-54B (Continued) The volume variance based on expected activity indicates that during January the firm operated at greater than expected capacity. Consequently, fixed overhead was over-absorbed. The variance based on practical capacity indicates that during January capacity was not fully utilized (of course that was expected). The use of practical capacity does not allow management to interpret the volume variance as a measure of effectiveness relative to initial plans.

. 12-64

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-55B

(a)

Materials price variance: (AQ x AP) – (AQ x SP) (3,050 x $1.40) – (3,050 x $1.50) = $305F Materials quantity variance: (AQ x SP) – (SQ x SP) (3,050 x $1.50) – [(1,500 x 2) x $1.50] = $75U Labour price variance: (AH x AR) – (AH x SR) (1,600 x $23) – (1,600 x $25) = $3,200F Labour quantity variance: (AH x SP) – (SH x SP) (1,600 x $25) – (1,500 x $25) = $2,500U Overhead controllable variance: Actual overhead – budgeted overhead ($7,400 + $14,000) – [(1,500 x $5) + $14,000] = $100F Overhead volume variance: FOH x (normal capacity – standard hours) $10 x [($14,000 ÷ $10) – 1,500) = $1,000F

. 12-65

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 12-55B (Continued) (b) FARM LABS, INC. Income Statement For the Month Ended November 30, 2009

Service revenue ............................................................. Cost of service provided (at standard) (1,500 x $43) ............................................................... Gross profit (at standard) ............................................. Variances Materials price ........................................................ Materials quantity .................................................. Labour price ........................................................... Labour quantity ...................................................... Overhead controllable ........................................... Overhead volume ................................................... Total variance—favourable............................ Gross profit .................................................................... Selling and administrative expenses ........................... Net income .....................................................................

$75,000 64,500 10,500 $(305) 75 (3,200) 2,500 (100) (1,000) (2,030) 12,530 4,000 $8,530

(c) The unfavourable materials quantity variance could be caused by poor quality materials or inexperienced workers or faulty test procedures. The unfavourable labour quantity variance could be caused by inexperienced workers, poor quality materials, or faulty test procedures.

. 12-66

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-56B

(a)

Total materials variance = (AQ x AP) – (SQ x SP) = (10,600 x $2.25) – (10,000 x $2.00) = $23,850 – $20,000 = $3,850U Materials price variance = (AQ x AP) – (AQ x SP) = (10,600 x $2.25) – (10,600 x $2.00) = $23,850 – $21,200 = $2,650U Materials quantity variance = (AQ x SP) – (SQ x SP) = (10,600 x $2.00) – (10,000 x $2.00) = $21,200 – $20,000 = $1,200U Total labour variance = (AH x AR) – (SH x SR) = [14,400 x ($122,400 ÷ 14,400)] – [15,000 x ($120,000 ÷ 15,000)] = $122,400 – $120,000 = $2,400U Labour price variance = (AH x AR) – (AH x SR) = (14,400 x $8.50) – (14,400 x $8.00) = $122,400 – $115,200 = $7,200U Labour quantity variance = (AH x SR) – (SH x SR) = (14,400 x $8.00) – (15,000 x $8.00) = $115,200 – $120,000 = $4,800F

(b)

Total overhead variance = Actual Overhead – Overhead Applied = $184,500 – $189,000 = $4,500F

(c)

Overhead controllable variance = Actual Overhead – Overhead Budgeted = $184,500 – [(15,000 x 3 x $3.00) + (42,500 x $1.20)] = $184,500 – $186,000 = $1,500F Overhead volume variance = Fixed Overhead Rate x (Normal capacity hours – Standard Hours Allowed)

. 12-67

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

PROBLEM 12-56B (Continued)

(d)

= $1.20 x (42,500 – 45,000) = $3,000F FINLEY MANUFACTURING CORPORATION Income Statement For the Month Ended June 30, 2009

Sales ................................................................... Cost of goods sold (at standard) ...................... Gross profit (at standard) .................................. Variances Materials price ............................................ Materials quantity ....................................... Labour price ............................................... Labour quantity .......................................... Overhead controllable................................ Overhead volume ....................................... Total variance—unfavourable ............ Gross profit (actual)........................................... Selling and administrative expenses ............... Net income .........................................................

$400,000 329,000* 71,000 $2,650 1,200 7,200 (4,800) (1,500) (3,000) 1,750 69,250 40,000 $29,250

*Materials (10,000 x $2) + labour $120,000 + overhead applied $189,000.

. 12-68

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*PROBLEM 12-57B

(a) 1.

Raw Materials Inventory (6,250 x $1.00) ............ Materials Price Variance ..................................... [6,250 x ($1.06 – $1.00)] Accounts Payable (6,250 x $1.06) ..............

6,250 375

Work in Process Inventory [(1,950 x 3) x $1] .... Materials Quantity Variance ............................... [(6,250 – 5,850) x $1.00] Raw Materials Inventory .............................

5,850 400

Factory Labour (2,100 x $8)................................ Labour Price Variance ................................ [2,100 x ($8.00 – $7.75)] Wages Payable (2,100 x $7.75) ...................

16,800

Work in Process Inventory ................................. (1,950 x $8.00) Labour Quantity Variance .................................. [(2,100 – 1,950) x $8.00] Factory Labour ............................................

15,600

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

25,800

Work in Process Inventory ................................. [(1,950 x 2) x $6.25] Manufacturing Overhead ............................

24,375

Finished Goods Inventory .................................. (1,950 x $23.50) Work in Process Inventory .........................

45,825

. 12-69

6,625

6,250

525 16,275

1,200 16,800

25,800

24,375

45,825

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*PROBLEM 12-57B (Continued) 8.

(b)

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

70,000

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

45,825

Selling and Administrative Expenses .................... Accounts Payable............................................

70,000

45,825 2,000 2,000

Raw Materials Inventory (1) 6,250 (2) 6,250

Materials Price Variance (1) 375

Work in Process Inventory (2) 5,850 (7) 45,825 (4) 15,600 (6) 24,375

Factory Labour (3) 16,800 (4)16,800

Materials Quantity Variance (2) 400

Finished Goods Inventory (7) 45,825 (8) 45,825

Manufacturing Overhead (5) 25,800 (6) 24,375

Labour Price Variance (3) 525 Labour Quantity Variance (4) 1,200

. 12-70

Cost of Goods Sold (8) 45,825

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*PROBLEM 12-57B (Continued)

(c) Overhead Volume Variance (1) ....................................... Overhead Controllable Variance (2) ............................... Manufacturing Overhead .........................................

675 750 1,425

(1) $2.25 X [4,200 (normal capacity) – 3,900 (standard machine hours allowed)]. (2) $25,800 – $25,050 [Variable $15,600 ($4 per hour x 3,900 standard machine hours allowed for the 1,950 units) + Fixed $9,450 ($2.25 x normal capacity of 4,200 hours)].

(d)

BERMAN CORPORATION Income Statement For the Month Ended January 31, 2009

Sales ........................................................................ Cost of goods sold (at standard) ........................... (1,950 x $23.50) Gross profit (at standard)....................................... Variances Materials price ................................................. Materials quantity............................................ Labour price .................................................... Labour quantity ............................................... Overhead controllable .................................... Overhead volume ............................................ Total variance—unfavourable................. Gross profit (actual) ............................................... Selling and administrative expenses .................... Net income ..............................................................

. 12-71

$70,000 45,825 24,175 $375 400 (525) 1,200 750 675 2,875 21,300 2,000 $19,300

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*PROBLEM 12-58B

(a)

Material price variance = (AQ x AP) – (AQ x SP) = ($106,400) – (95,000 x $1.10) = $1,900U Raw materials inventory Materials price variance Accounts payable

(b)

104,500 1,900 106,400

Materials quantity variance = (AQ x SP) – (SQ x SP) = (93,365¹ x $1.10) – (93,600² x $1.10) = $102,701.50 – $102,960 = $258.50F ¹ Materials used = (24,100 + 40,440 + 28,825) = 93,365 metres ² Materials allowed = 24 metres x (1,000 + 1,700 + 1,200) = 93,600 Labour price variance = (AH x AR) – (AH x SR) = (11,000³ x $7.50) – (11,000 x $7.35) = $1,650U 3

Total direct labour hours = (2,980 + 5,130 + 2,890) = 11,000

Labour quantity variance = (AH x SR) – (SH x SR) = (11,000 x $7.35) – (10,9804 x $7.35) = $80,850 – $80,703 = $147U 4

Total standard hours = [2,700 + (80% x 1,200)] x 3 hours = 10,980

(c)

. 12-72

Work in process (3,900 x 24 x $1.10) Material quantity variance Raw materials inventory (93,365 x $1.10)

102,960.00 258.50 102,701.50

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

*PROBLEM 12-58B (Continued) Work in process (3,660 x 3 x $7.35) Labour price variance Labour quantity variance Factory labour (11,000 x $7.50)

. 12-73

80,703.00 1,650.00 147.00 82,500.00

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO CASES CASE 12-59 (a) When setting a standard for computer/labour hours usage, Agmar Professionals should consider the following factors: (1) A standard set conservatively high may discourage clients from purchasing the model. (2) 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. (3) 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.

(2) 45 hours:

The conservatively high number experienced by one financial institution.

(3) 25 hours:

The optimistic low number experienced by one financial institution.

(4) 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, Agmar Professionals may select 30 hours, given that the company has a high incentive to sell the new model. Consequently, it may make the . 12-74

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

CASE 12-59 (Continued) most sense to pick the lower of the two remaining choices (30 hours). (d) Standard material cost for one model application: User Manuals:

$300 ÷ 20 manuals = $15/application.

Computer Forms:

$50 ÷ 250 forms = $0.20/form $0.20/form x 50 forms = $10/application.

Total standard material cost = $15 + $10 = $25 per model application

. 12-75

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

CASE 12-60 (a) The overhead application rate is $143,500 divided by 5,000 hours, or $28.70 per direct labour hour. (b) The standard direct labour hours are used to apply overhead to production, so the calculation is $28.70 x 4,500, or $129,150. (c) The overhead budgeted for 4,500 direct labour hours is computed below. Fixed:

$22,000 + $13,000 + $27,000 + $8,000 + $3,000 + $1,500 + $500 + $300 = $75,300

Variable: ($12,000 + $43,000 + $10,000 + $2,500 + $700) ÷ 5,000 = $13.64 Fixed Variable (4,500 x $13.64)

$75,300 61,380 $136,680

The variances are: Controllable: Actual ($149,000) – Budgeted ($136,680) = $12,320 U Volume: $15.06*/hr. x (5,000 – 4,500) = $7,530 U *$75,300 ÷ 5,000 hrs. (d) Both variances appear significant. The controllable variance is 9% of budgeted overhead ($12,320 ÷ $136,680), and the volume variance is almost 6% of applied overhead ($7,530 ÷ $129,150). Therefore, both variances should be investigated. (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 labour 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. . 12-76

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 12-61

(a)

Applied overhead per direct labour hour = $20 ÷ 2 = $10

(b)

Standard direct labour hours allowed for units produced = 8,000 units produced x 2 hours standard per unit = 16,000

(c)

Denominator volume = (8,000 ÷ 80%) = 10,000 cartons, or 10,000 x 2 hours per carton = 20,000 direct labour hours

(d)

FOH rate = $125,000 ÷ 10,000 cartons = $12.50 per carton, or $12.50 ÷ 2 = $6.25 per direct labour hour

(e)

Fixed overhead applied = $12.50 x 8,000 = $100,000

(f)

VOH spending variance = Total VOH variance ± efficiency variance = {$61,000 – [8,000 x ($20.00 – $12.50)]} – $5,000 = $4,000F

(g)

AH x SR = (SH x SR) + efficiency variance Actual hours = {[16,000 x ($7.50 ÷ 2)] + $5,000} ÷ $3.75 = $65,000 ÷ $3.75 = 17,333 hours

(h)

Labour efficiency variance = SR x (AH – SH) = $8.00 x (17,333 – 16,000) = $10,664U

(i)

Materials quantity variance = SP x (AQ – SQ) = $100 x [40 – (8,000 x 0.004)] = $100 x 8 = $800U

(j)

Because not enough information is available from the question, we cannot determine the fixed overhead budget variance. If we make the assumption that actual fixed overhead = budgeted fixed overhead ($125,000), then the budget variance = 0.

(k)

FOH volume variance = FOH rate x (denominator level of activity – standard level of activity) = $12.50 x (10,000 – 8,000) = $25,000U

. 12-77

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

CASE 12-62

(Solutions are in 000s). (a)

(1) Direct materials price variance = (AQ x AP) – (AQ x SP) AQ = 1,710 ÷ 95% = 1,800 AP = $4,104 ÷ 1,800 = $2.28 SP = $4,500 ÷ (1,800 ÷ 96%) = $2.40 Materials price variance = 1,800 x ($2.28 - $2.40) = $216F (2) Direct materials efficiency variance = (AQ x SP) – (SQ – SP) SQ = 1,710 ÷ 96% = 1,781.25 Materials efficiency variance = $2.40 x (1,800 – 1,781.25) = $45U

(b)

(1) Direct labour rate variance = (AH x AR) – (AH x SR) AH = 3,276 ÷ $6.50 = 504 hours AR = $6.50 SR = $6.00 Labour rate variance = 504 x ($6.50- $6.00) = $252U (2) Direct labour efficiency variance = (AH x SR) – (SH – SR) SH per unit = 5,400 ÷ $6.00 = 900 hours for 1,800 units, or 0.50 hour per unit Total SH = 1,974 x 0.50 = 987 hours Labour efficiency variance = $6.00 x (504 – 987) = $2,898F

. 12-78

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 12-63 (a)

Direct materials price variance = AQ x (AP – SP) AP = $11,000 ÷ 2,500 = $4.40 per kg Price variance = 2,500 x ($4.40 – $5.00) = $1,500F Direct materials usage variance = SP x (AQ – SQ) SQ = 2,100 x 1 kg = 2,100 kg Usage variance = $5.00 x (2,500 – 2,100) = $2,000U Material Budget variance = $1,500F + $2,000U = $500U, OR = (2,500 x $4.40) – (2,100 x $5.00)

(b)

Labour rate variance = AH x (AR – SR) AR = $18,144 ÷ 4,320 = $4.20 per hour Rate variance = 4,320 x ($4.20 - $4.00) = $864U Labour efficiency variance = SR x (AH – SH) SH = 2,100 x 2 hours per unit = 4,200 Efficiency variance = $4.00 x (4,320 – 4,200) = $480U Labour budget variance = $864U + $480U = $1,344U

(c)

Variable spending variance = actual overhead – (AQ x SR) VOH rate = $19,000 ÷ 4,000 = $4.75 per hour Spending variance = $21,410 – (4,320 x $4.75) = $890U Variable efficiency variance = SR x (AH – SH) = $4.75 x (4,320 – 4,200) = $570U Total variable budget variance = $890U + $570U = $1,460U

(d)

Fixed overhead spending variance = actual – budget = $8,125 - $8,000 = $125U Fixed overhead volume variance = Budget – (SH x SR) SR = $8,000 ÷ 5,000 = $1.60 = $8,000 – (4,200 x $1.60) = $1,280U

. 12-79

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

CASE 12-64

(a) Dan and his fellow painters in the painting department will benefit from Dan’s slow action. 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 Dan will be out of a job. It is in Dan’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.

. 12-80

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTION TO WATERWAYS CONTINUING PROBLEM WCP-12 (a)

Materials Price Variance Actual Quantity less Actual Quantity x Actual Price x Standard Price 128,750 Kg X $1.30 = $167,375

less

128,750 X $1.31* = $168,663

= 1,288 F

* Standard price per kilogram (rounded to nearest cent): Material kg per unit x Price per kg Metal .18 x $3.27= $0.59 Plastic .7 x 0.87= 0.61 Rubber .25 x 1.13.= 0.28 Total 1.13 kg $1.48 = $1.31/kg (b)

Materials Quantity Variance Standard Actual Quantity less Quantity x Standard Price x Standard Price 128,750 kg x $1.31 = $168,663

less

130,515 * x $1.31 = $170,975

* 115,500 units x 1.13 kg per unit = 130,515

. 12-81

= $2,312 F

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

(c)

Total Materials Variance Actual Quantity Standard Quantity less x Actual Price x Standard Price 128,750 KG X $1.30 = $167,375

less

130,515* X $1.31 = $170,975

= $3,600 F

* 115,500 units x 1.13 kg = 130,515

(d)

Actual Hours x Actual Rate 28,875 hrs* x $7.75 = $223,781

Labour Price Variance Actual Hours less x Standard Rate

less

28,875 hours x $8.00 = $231,000

= $7,219 F

* 115,500 units x .25 hrs = 28,875 hrs

(e)

Labour Quantity Variance Actual Hours Standard Hours less x Standard Rate x Standard Rate 28,875 hrs* x $8.00 = $231,000

23,100* x $8.00 = $184,800

less

* 115,500 units x .20 hrs (12min./60min. per hour) = 28,875 hrs

. 12-82

= $46,200 U

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

(f)

Actual Hours x Actual Rate 28,875 hrs x $7.75 = $223,781

Total Labour Variance Less Standard Hours x Standard Rate

less

23,100* x $8.00 = $184,800

= $38,981

(g)

Actual Overhead $118,473 ($54,673 +$63,800)

Total Overhead Variance Overhead Applied* less $98,868 = $19,605 U ($4.28 X 23,100 hours)

* Based on standard hours allowed for 115,500 units, 115,500 X .20hrs = 23,100 hours)

(i)

The labour quantity variance is a concern. Perhaps the labour is not as skilled as it should be. The actual price paid for labour suggests less skill, so it could take workers longer to complete each unit. Or the materials may not meet the proper standard, causing the workers to take longer to complete a unit. It could also mean the machinery being used is not working efficiently. Yet another possibility is that the workers are not being properly supervised and are wasting time doing unproductive activities. The materials quantity variance could suggest that insufficient material is being used in the product (not in keeping with specs) making the product less durable. The large unfavorable overhead variance may be related to the unfavorable labour quantity variance. Extra direct labour hours and inefficient use of machines may result in higher indirect labour costs, more repairs, or higher use of utilities.

. 12-83

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

LEGAL NOTICE

. 12-84

CHAPTER 13 Planning for Capital Investments ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

A Problems

B Problems

10, 11, 16, 17

18, 19, 20, 21, 23, 24, 25, 26, 29

30, 31, 32, 33, 39

4, 5, 6, 7

2, 3, 4, 5, 6 10, 11, 12, 17

18, 19, 20, 21, 23, 24, 25, 26, 27, 28

30, 31, 32, 33, 34, 35, 36, 37, 38, 39

Identify the challenges presented by intangible benefits in capital budgeting.

8, 9

22, 27

Describe the profitability index.

Indicate the benefits of performing a post-audit.

Explain the internal rate of return method.

12, 13, 16

7, 8

13, 14

28, 29

38, 5B

Describe the annual rate of return method.

3, 14, 15

15, 16, 17,

23, 24, 25, 26

31, 33, 39

Study Objectives

Questions

Discuss the capital budgeting evaluation process, and explain the inputs used in capital budgeting.

Describe the cash payback technique.

2, 3

Explain the net present value method.

Exercises

13-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

18A

Calculate initial investment cash payback and net present value.

Simple

20–30

19A

Calculate the net present value and payback period.

Moderate

30–40

20A

Calculate incremental cash flow and net present value.

Simple

20–30

21A

Calculate the initial investment, cash payback, and net present value.

Moderate

30–40

22A

Calculate the net present value and apply the decision rule.

Simple

20–30

23A

Calculate the annual rate of return and net present value, and apply decision rules.

Moderate

30–40

24A

Calculate the payback period, annual rate of return, and net present value, and apply decision rules.

Moderate

20–30

25A

Calculate the payback period, annual rate of return, and net present value, and discuss findings.

Challenging

25-35

26A

Calculate payback, annual rate of return, and net present value.

Moderate

25-35

27A

Calculate the net present value, considering intangible benefits.

Moderate

25-35

28A

Calculate the net present value, profitability index, and internal rate of return.

Moderate

30–40

29A

Calculate the net present value and internal rate of return with sensitivity analysis.

Moderate

35–45

30B

Calculate the net present value and payback period.

Moderate

20–30

31B

Calculate the annual rate of return, payback period, and net present value, and apply decision rules.

Moderate

30–40

32B

Calculate the initial investment, cash payback, and net present value.

Simple

20–30

33B

Calculate the annual rate of return, cash payback, and net present value.

Simple

20–30

13-2

ASSIGNMENT CHARACTERISTICS TABLE (Continued)

34B

Calculate the net present value and apply the decision rule.

Moderate

20–30

35B

Calculate the net present value and apply the decision rule.

Moderate

30–35

36B

Calculate the net present value considering intangible benefits.

Moderate

25-35

37B

Calculate the net present value with sensitivity analysis, and discuss findings.

Moderate

30–40

38B

Calculate the net present value, profitability index, and internal rate of return.

Moderate

25-35

39B

Calculate the payback, annual rate of return, and net present value.

Simple

20–30

13-3

Study Objective

Knowledge

Comprehension

Application

Analysis

P29A, P33B

Synthesis

Evaluation

Discuss the capital budgeting evaluation process, and explain the inputs used in capital budgeting.

Describe the cash payback technique.

Q2, Q3

BE1, E16, E17, P26A

Explain the net present value method.

Q4, Q7

BE3, E17, P26A, BE4, P33B, P39B P37B

Identify the challenges presented Q9 by intangible benefits in capital budgeting.

Describe the profitability index.

Q10

Indicate the benefits of performing a post-audit.

Explain the internal rate of return Q12, Q13 method.

Q16

BE7

P29A

BE8 E13 E14

P28A P38B

Describe the annual rate of return Q14, Q15 method.

BE9 E17 E15 P26A E16 P39B

P33B

P23A P24A P25A

P31B

Q5, Q6

BE4

E10, E11, P18A, P19A, P20A, P21A, P23A, P24A, P25A, P30B, P31B, P32B BE2 BE5 BE6 E10 E11 E12

P27A P36B BE5 E12

Q11

P18A P30B P19A P31B P20A P32B P21A P34B P22A P35B P23A P36B P24A P38B P25A P27A P28A

P28A P38B

BE6

BLOOM’ S TAXONOMY TABLE

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

13-4

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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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.

Walter 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 2 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. Both tables are used to determine the current value of cash payments to be received in the future, given an expected rate of return.

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.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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Questions Chapter 13 (Continued) 8.

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 could be 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.

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 projections made when the project was proposed. 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 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 Initial Investment by Net Annual Cash Flow. (2) Use the factor and the present value of an annuity of 1 table to find the internal rate of return. When the annual cash flows are uneven, then trial and error must be used.

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

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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Questions Chapter 13 (Continued) 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 strengths of this method are the simplicity of its calculation and management’s familiarity with the accounting terms used in the computation. A weakness 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 funds from creditors and stockholders. The decision rule is: A project is acceptable if its rate of return is greater than or equal to management’s required rate of return (which often is its cost of capital), and the project is unacceptable when the rate of return is less than the required rate of return.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 $450,000 ÷ $55,000 = 8.18 years; Amortization is a non cash outlay.

BRIEF EXERCISE 13-2

Net annual cash flows: $40,000 x 5.65 Capital investment Net present value

Present Value $226,000 220,000 $6,000

The investment should be made because the net present value is positive.

BRIEF EXERCISE 13-3 Cash Flows Present value of net annual cash flows Present value of salvage value

$25,000 70,000

Capital investment Net present value

10% Present Discount = Value Factor 3.79079 $94,770 0.62092 43,464 $138,234 136,000 $2,234

Since the net present value is positive, the project is acceptable. BRIEF EXERCISE 13-4 Cash Flows Present value of net annual cash flows Present value of salvage value Capital investment Net present value

$35,000 ---

9% Present Discount = Value Factor 5.53482 $193,719 0.50187 --$193,719 200,000 $(6,281)

©. 13-8

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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BRIEF EXERCISE 13-4 (Continued) The reduction in downtime would have to have a present value of at least $6,281 in order for the project to be acceptable. BRIEF EXERCISE 13-5

Project A: Present value of net annual cash flows Present value of salvage value

Cash Flows

$70,000 ---

Capital investment Net present value

9% Present Discount = Value Factor 6.41766 $449,236 0.42241 --$449,236 395,000 $54,236

Profitability index = $449,236 ÷ $395,000 = 1.14

Project B: Present value of net annual cash flows Present value of salvage value

Cash Flows $50,000 ---

Capital investment Net present value

9% Present Discount = Value Factor 6.41766 $320,883 0.42241 --$320,883 270,000 $50,883

Profitability index = $320,883 ÷ $270,000 = 1.19

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.

©. 13-9

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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BRIEF EXERCISE 13-6

Original estimate: Present value of net annual cash flows Present value of salvage value

Cash Flows

$45,000 ---

Capital investment Net present value

Actual results: Present value of net annual cash flows Present value of salvage value Capital investment Net present value

Cash Flows $38,000 ---

10% Present Discount = Value Factor 5.75902 $259,516 0.42410 --$259,516 250,000 $9,156

10% Present Discount = Value Factor 6.49506 $246,812 0.35049 --$246,812 260,000 $(13,188)

The original net present value was projected to be a positive $9,156; however, the revised estimate is a negative $13,188. The project did not turn out as successful as predicted.

BRIEF EXERCISE 13-7 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. $170,000 ÷ $33,740 = 5.03853 By tracing across on the 7-year row we see that the discount factor for 9% is 5.03295. Thus, the internal rate of return on this project is approximately 9%. © . 13-10

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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BRIEF EXERCISE 13-8 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 8% is used. When using the trial and error method, increase the discount factor if the present value is positive, and decrease it if it is negative. Net annual cash flows = $400,000 – $160,000 = $240,000 8% Present x Discount = Value Factor $240,000 7.53608 $1,808,659 600,000 0. 39711 238,266 $2,046,925 2,045,000 $1,925 Cash Flows

Present value of net annual cash flows Present value of salvage value Capital investment Net present value

The 8% internal rate of return exceeds the company’s 7% required rate of return; thus, the project should be accepted.

BRIEF EXERCISE 13-9 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 – $80,000 = $50,000 It’s average investment is: ($490,000 + $10,000) ÷ 2 = $250,000 Therefore, its annual rate of return is: $50,000 ÷ $250,000 = 20% © . 13-11

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO EXERCISES EXERCISE 13-10 (a) The cash payback period is:

$56,000 ÷ $8,000 = 7 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 Present x Discount = Flows Value Factor $8,000 5.74664 $45,973 28,000 0.54027 15,128 61,101 56,000 $5,101

(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 13-11 (a) Cash payback period for AA: Year 1 2 3

Net Annual Cash Flow $ 7,000 9,000 15,000

Cash payback period 2.33 years $21,000 – $16,0001 = $5,0002 $5,000 ÷ $15,0002 = 0.33

Cumulative Cash Flow $ 7,000 16,0001 31,000

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 13-11 (Continued) Cash payback period for BB: 21,000 ÷ (28,500 ÷ 3) = 2.21 years Cash payback period for CC: Year 1 2 3

Net Annual Cash Flow $13,000 10,000 11,000

Cumulative Cash Flow $13,000 23,000 34,000

Cash payback period 1.8 years $21,000 – 13,000 = $8,000 $8,000 ÷ $10,000 = 0.80 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 1.8 years.

(b) Net present value of AA: Discount Factor Year 12% Amount 1 0. 89286 $ 7,000 2 0. 79719 9,000 3 0. 71178 15,000 Present value of cash inflows Investment Net present value

Present Value $6,250 7,175 10,677 $24,102 21,000 $3,102

©. 13-13

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 13-11 (Continued) Net present value of BB: Discount Factor 12%

Amount

Present Value

1-3 2.40183 $ 9,500 Present value of cash inflows Investment Net present value

$ 22,817 22,817 21,000 $1,817

Year

Net present value of CC: Discount Factor 12% 0. 89286 0. 79719

Amount $13,000 10,000

Present Value $11,607 7,972

3 0. 71178 11,000 Present value of cash inflows Investment

7,830 $27,409 21,000

Net present value

$6,409

Year 1 2

Project CC is still the most desirable project. Also, on the basis of net present values, all of the projects are acceptable. Project BB is the least desirable.

©. 13-14

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 13-12

Project A: Present value of net annual cash flows Present value of salvage value

Cash Flows

$15,000 ---

Capital investment Net present value

9% Present Discount = Value Factor 5.53482 $83,022 ----$83,022 78,000 $5,022

Profitability index = $83,022 ÷ $78,000 = 1.064

Project B: Present value of net annual cash flows Present value of salvage value

Cash Flows $31,000 ---

Capital investment Net present value

9% Present Discount = Value Factor 5.53482 $171,579 ----$171,579 190,000 $(18,421)

Profitability index = $171,579 ÷ $190,000 = .90 Machine B has a negative net present value, which means its profitability index is less than one. Machine B should be rejected. Machine A should be purchased, as it has a positive net present value.

©. 13-15

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

Weygandt, Kimmel, Kieso, Aly

EXERCISE 13-13 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. $425,000 ÷ $95,000 = 4.47368 By tracing across on the 6-year row, we see that the discount factor for 9% is 4.48592. Thus, the internal rate of return on this project is approximately 9%. Since this is below the company’s required rate of return, the project should not be accepted.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 13-14 (a)

Project 22A 23A 24A

Net Annual Capital Cash Investment ÷ Flows* = $240,000 ÷ $55,0001 = $270,000 ÷ $54,4002 = $280,000 ÷ $61,0003 =

IRR Factor 4.364 4.963 4.590

Closest Discount Factor 4.35526 4.77158 4.56376

IRR 10% 15% 12%

*(Annual income + Amortization expense) 1 $15,000 + ($240,000 ÷ 6) 2 $24,000 + ($270,000 ÷ 9) 3 $21,000 + ($280,000 ÷ 7) (b) The acceptable projects are 23A and 24A because their rates of return are equal to or greater than the 11% required rate of return. EXERCISE 13-15 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 – $40,000 = $30,000 Its average investment is: $300,000 + $75,000 = $187,500 2 Therefore, its annual rate of return is: $30,000 ÷ $187,500 = 16% EXERCISE 13-16 (a) Cost of hoist: $41,000 + $3,300 + $700 = $45,000. Net annual cash flows: Number of extra mufflers 5 x 52 weeks Contribution margin per muffler ($72 – $34 – $12) Total net annual cash flows (1) x (2) Cash payback period = $45,000 ÷ $6,760 = 6.66 years.

(1) 260 (2) x $26 $6,760

©. 13-17

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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EXERCISE 13-16 (Continued) (b) Average investment: ($45,000 + $3,000) ÷ 2 = $24,000. Annual amortization: ($45,000 – $3,000) ÷ 8 = $5,250. Annual net income: $6,760 – $5,250 = $1,510. Annual rate of return = $1,510 ÷ $24,000 = 6.3% (rounded).

EXERCISE 13-17 (a) (1) Cash payback period: $180,000 ÷ $50,000 = 3.6 years. (2) Annual rate of return: $20,000 ÷ [($180,000 + $0) ÷ 2] = 22.2%.

(b)

Present value of net annual cash flows Less: Capital investment Net present value

Cash Flows $50,000

15% Present Discount = Value Factor 3.78448 $189,224 180,000 $9,224

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO PROBLEMS—SET A PROBLEM 13-18A (a)

Initial investment amount would be the cash price of the new equipment less salvage value of old equipment, plus any increase in working capital $145,000 – $35,000 + $15,000 = $125,000

(b) Cash payback period for investment of $125,000: Year 1 2 3 4 5

Net Annual Cash Flow $25,000 25,000 25,000 25,000 25,000

Cumulative Cash Flow $25,000 50,000 75,000 100,000 125,000

The payback period will be exactly 5 years. (c)

10% Present x Discount = Value Year Factor Cash inflows years 1 to 6 1 – 6 $25,000 4.35526 $153,614 (1) Cash inflows years 7 to 10 7 – 10 10,000 1.78931 17,893 Recover working capital 10 15,000 0.38554 5,783 Salvage value of new equipment 10 10,000 0.38554 3,855 Less: Capital investment 0 145,000 --(145,000) Salvage of old equipment 0 35,000 --35,000 Increase working capital 0 15,000 --(15,000) Net present value $11,413 (1) Factor at 10 years, 6.14457 less factor at 6 years, 4.35526 Cash Flows

(d) Even though the cash payback period is at their maximum payback period of five years, the net present value calculation is more accurate as it takes into account the time value of money. Therefore, BioFarm should go ahead with the purchase. ©. 13-19

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-19A (a)

Cost of goods sold per unit = $576,000 ÷ 18,000 = $32.00 Direct labour is 42% of COGS = 42% x $32.00 = $13.44 Savings in labour is 25% of DL cost = 25% x $13.44 = $3.36 Discount Year Units Amount Factor, 12% 1 18,000 $ 60,480 0.893 2 18,000 60,480 0.797 3 20,000 67,200 0.712 4 20,000 67,200 0.636 5 20,000 67,200 0.567 Present value of annual cash inflows 1-5 Supervision (40,000) 3.605 5 Salvage 10,000 0.567 Net cash flows Initial Investment Net present value

Present Value $54,009 48,203 47,846 42,739 38,102 $230,899 (144,200) 5,670 $81,847 (100,000) $(7,631)

Based on the negative net present value, the company should not purchase the equipment.

(b)

Year Initial investment Less: Cash Flow

1 2 3 4 5

Outflow $ (100,000) (40,000) (40,000) (40,000) (40,000) (40,000)

Inflow $

60,480 60,480 67,200 67,200 67,200

Balance $ (100,000) (79,520) (59,040) (31,840) (4,640) 22,560

Payback period = 4 + ($4,640 ÷ $27,200) = 4.17 years

©. 13-20

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-19A (Continued) Note the salvage value of the equipment was not included in the cash flow for the final year. It would be considered a cash inflow at the end of the year, whereas the other cash flow items were considered to be received uniformly throughout the year. (c)

The salvage value will be received in 2013, so it will be discounted by a factor of 0.567 to determine present value. The incremental salvage value, when discounted by a factor of 0.567, must equal the negative net present value calculated in part (a). The additional inflow will bring the NPV to zero, at which time the investment will be earning exactly 12%. Incremental value = $7,631 ÷ 0.567 = $13,459 Therefore, the total salvage value must be $23,459 ($13,459 + $10,000) for the whole project to earn a 12% return on the investment.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-20A Net present value of expansion of current warehouse (based on incremental analysis), in 000s:

Net cash flows Initial investment Net Present Value

Year 1-10

Discount Factor, 14% 5.216

Amount $4,000¹

Present Value $20,864 (19,000) $1,864

¹ Revenues of $13 million less costs of $9 million Net present value of conversion of current warehouse (based on incremental analysis), in 000s:

Net cash flows Initial investment Net Present Value

Year 1-10

Discount Factor, 14% 5.216

Amount $ 3,000²

Present Value $15,648 (22,000) $(6,352)

²Revenues of $13 million less costs of $10 million Based on the net present value calculations, Saskatoon First should choose the expansion option, as it has a positive net present value.

©. 13-22

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-21A (a)

The initial investment = $2,850,000 – $150,000 = $2,700,000

(b)

Savings on $1.5 million Operating costs (30%) Operating costs (40%)

Years 1-3 4-10

Amount $450,000 600,000

Total $1,350,000 4,200,000 5,550,000

Less: additional costs Operator Net savings

1-10

30,000

300,000 $5,250,000

(c)

Net present value of the investment: Discount Year Factor at 12% Savings: 1-3 2.4018 4-10 3.2484¹ Costs: 1-10 5.6502 Salvage: 10 0.3220 Present value of cash inflows Initial investment

Amount $450,000 600,000 (30,000) 525,000

Present Value $1,080,810 1,949,040 (169,506) 169,050 3,029,394 (2,700,000) $329,394

¹ Factor at 10 years less factor at 3 years: 5.6502 – 2.4018, or Factor at 7 years, discounted by 3 years: 4.5638 x 0.7118 (d)

Initial investment $2,700,000 Less: Savings from years 1-3 [($450,000 – $30,000) x 3] 1,260,000 Less: Savings from years 4-5 [($600,000 – $30,000) x 2] 1,140,000 Balance remaining at the end of year 5 $300,000 Payback period = 5 + (300,000 ÷ 570,000) = 5.5 years (rounded) The company should accept the project, as the payback period is less than their maximum acceptable payback period of 8 years.

©. 13-23

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-22A Net present value of the investment: Savings per unit: 5% of variable costs = 0.05 x $2.40 = $0.12/unit Savings per year: 1,000,000 units x $0.12 = $120,000 Discount Year Factor at 12% Savings 1-5 3.60478 Salvage (new) 5 0.56743 Salvage (old) 0 --Present value of cash inflows Initial investment

Amount $120,000 350,000 230,000

Present Value $432,573 198,600 230,000 861,173 (800,000) $61,173

The president should go ahead and replace the equipment, based on a positive net present value of $61,173.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-23A

(a) Project Main: Average annual cash inflow = Average annual net income + amortization Average annual net income = $65,000 ÷ 5 years = $13,000 Annual amortization = $150,000 ÷ 5 years = $30,000 Payback in years: $150,000 ÷ ($13,000 + $30,000) = 3.49 years Project Lane: Average annual net income = $72,000 ÷ 5 years = $14,400 Annual amortization = $160,000 ÷ 5 years = $32,000 Payback in years: $160,000 ÷ ($14,400 + $32,000) = 3.45 years Project Crane: Average annual net income = $95,000 ÷ 5 years = $19,000 Annual amortization = $200,000 ÷ 5 years = $40,000 Payback in years: $200,000 ÷ ($19,000 + $40,000) = 3.39 years (b) Project Main: Year 1-5

Discount Factor, 15% 3.35216

Year 1-5

Discount Factor, 15% 3.35216

Net cash flows Initial investment Net Present Value 1 $13,000 + ($150,000 ÷ 5) Project Lane: Net cash flows Initial investment Net Present Value 2

($72,000 ÷ 5) + ($160,000 ÷ 5)

Amount $43,0001

Amount $46,4002

Present Value $144,143 (150,000) $(5,857)

Present Value $155,540 (160,000) $(4,460)

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PROBLEM 13-23A (Continued) Project Crane: Net cash flows Initial investment Net Present Value 2

Year 1-5

Discount Factor, 15% 3.35216

Amount $59,0003

Present Value $197,777 (200,000) $(2,223)

($95,000 ÷ 5) + ($200,000 ÷ 5)

(c) Annual rate of return = average net income ÷ average investment Project Main = $13,000 ÷ [($150,000 + $0) ÷ 2] = 17.33%. Project Lane = $14,400 ÷ [($160,000 + $0) ÷ 2] = 18%. Project Crane = $19,000 ÷ [($200,000 + $0) ÷ 2] = 19%.

(d) Project

Cash Payback

Net Present Value

Main Lane Crane

3.49 3.45 3.39

$(5,857) $(4,460) $(2,223)

(3) (2) (1)

Project Crane is the best project.

(3) (2) (1)

Annual Rate of Return 17.33% 18% 19%

(3) (2) (1)

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PROBLEM 13-24A (a)

Total net investment = $20,000 – $2,000 = $18,000 Annual net cash flow = $8,000 Payback period = $18,000 ÷ $8,000 = 2.25 years

(b)

Annual rate of return = annual net income ÷ average investment Amortization $20,000 ÷ 5 years = $4,000 Income tax ($8,000 – $4,000) x 30% = $1,200 Annual net income = $8,000 – $4,000 – $1,200 = $2,800 Average investment = [($20,000 – $2,000) + 0] ÷ 2 = $9,000 Annual rate of return = $2,800 ÷ $9,000 = 31.11%

(d)

Year 1-5

Discount Factor, 10% 3.79079

Amount $8,000

Present Value $30,326 (18,000) $12,326

The new machine should be purchased because the net present value is positive.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-25A

(a)

Sales (10 x 6 x 30 x $12 x 5) Expenses: Driver’s salaries Out-of-pocket Amortization Net income Cash flow

(1) Annual Net Income $108,000

(2) Annual Cash Inflow $108,000

$48,000 $48,000 33,000 33,000 25,000 106,000 --$2,000

81,000 $27,000

(b) (1) Cash payback period = $75,000 ÷ $27,000 = 2.78 years. (2) Annual rate of return = $2,000 ÷ [($75,000 + 0) ÷ 2] = 5.33%

(c) Present value of annual cash inflows ($27,000 X 2.5771*) = $69,582 Capital investment = 75,000 Net present value $ (5,418) *3 years at 8%, PV of ordinary annuity. (d) The computations show that the commuter service is not a wise investment for these reasons: (1) annual net income will only be $2,000, (2) the annual rate of return (5.33%) is less than the cost of capital (8%), (3) the cash payback period is 93% (2.78 ÷ 3) of the useful life of the vans, and (4) net present value is negative.

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PROBLEM 13-26A (a) Initial investment Less: Cash Flow

Year 0 1 2 3

Amount $(105,000) 50,000 45,000 40,000

Balance $(105,000) (55,000) (10,000) 30,000

Payback period = 2 + (10,000 ÷ 40,000) = 2.25 (b)

Average annual net income = ($15,000 + $17,000 + $19,000 + $21,000 + $23,000) ÷ 5 = $19,000 Average investment = ($105,000 + $0) ÷ 2 = $52,500 Annual rate of return = $19,000 ÷ $52,500 = 36.19%

(c)

Discount Year Factor, 15% Amount Net cash flows 1 0.86957 $50,000 2 0.75614 45,000 3 0.65752 40,000 4 0.57175 35,000 5 0.49718 30,000 Present value of cash inflows Initial investment Net Present Value

Present Value $43,479 34,026 26,301 20,011 14,915 138,732 (105,000) $33,732

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PROBLEM 13-27A (a) The net present value based on the original estimates is as follows:

Year Annual cash inflow 1-8 Overhaul 4 Salvage value 8 Present value of cash flows Initial investment Net Present Value

Discount Factor, 9% 5.53482 0.70843 0.50187

Amount $8,000 (5,000) 15,000

Present Value $44,279 (3,542) 7,528 48,265 (60,000) $(11,735)

Based on these estimates, the tow truck should not be purchased. (b) The net present value based on the revised estimates is as follows: Discount Year Factor, 9% Annual cash inflow 1-8 5.53482 Overhaul 4 0.70843 Additional benefits 1-8 5.53482 Salvage value 8 0.50187 Present value of cash flows Initial investment Net Present Value

Amount $8,000 (5,000) 5,000 15,000

Present Value $44,279 (3,542) 27,674 7,528 75,939 (60,000) $15,939

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 $27,674 (the increase in the net present value from a negative $11,735 to a positive $15,939). Reid’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 $11,735. That is the amount by which the original estimate fell short of having a positive net present value. © . 13-30

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PROBLEM 13-28A (a)

OPTION A (1)

Discount Year Factor 11% Annual cash inflow 1-8 5.14612 Cost to rebuild 4 0.65873 Salvage value 8 0.43393 Present value of cash flows Initial investment Net Present Value

Amount $40,000 (60,000) ---

Present Value $205,845 (39,524) --166,321 (160,000) $6,321

Net annual cash flows = $75,000 – $35,000 = $40,000

(2)

Profitability index = $166,321 ÷ $160,000 = 1.04

(3) Because the net present value of the investment at a discount rate of 11% is positive, we know the internal rate of return will be greater than 11%, say 12%. Discount Year Factor 12% Annual cash inflow 1-8 4.96764 Cost to rebuild 4 0.63552 Salvage value 8 0.40388 Present value of cash flows Initial investment Net Present Value

Amount $40,000 (60,000) ---

Net annual cash flows = $75,000 – $35,000 = $40,000

Present Value $198,706 (38,131) --160,575 (160,000) $575

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PROBLEM 13-28A (Continued) OPTION B (1)

Discount Year Factor 11% Annual cash inflow 1-8 5.14612 Cost to rebuild 4 0.65873 Salvage value 8 0.43393 Present value of cash flows Initial investment Net Present Value

Amount $50,000 --12,000

Present Value $257,306 --5,207 262,513 (227,000) $35,513

Net annual cash flows = $80,000 – $30,000 = $50,000 (2) Profitability index = $262,513 ÷ $227,000 = 1.16 (3) Internal rate of return on Option B is 15%, as calculated below: Discount Year Factor 15% Annual cash inflow 1-8 4.48732 Cost to rebuild 4 0.57175 Salvage value 8 0.32690 Present value of cash flows Initial investment Net Present Value

Amount $50,000 --12,000

Present Value $224,366 --3,923 228,289 (227,000) $1,289

Net annual cash flows = $80,000 – $30,000 = $50,000 (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.

©. 13-32

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-29A

(a) Using the original estimates, the net present value is calculated as follows: Discount Year Factor 8% Amount Annual cash inflow 1-20 9.81815 $110,000 Salvage value 20 0.21455 1,500,000 Present value of cash flows Initial investment ($300,000 + $600,000) Net Present Value

Present Value $1,079,997 321,825 1,401,822 (900,000) $501,822

Net annual cash flows = $950,000 – $840,000 (b) Using the revised estimates, the net present value is calculated as follows: Discount Year Factor 8% Amount Annual cash inflow 1-20 9.81815 $30,000 Salvage value 20 0.21455 1,500,000 Present value of cash flows Initial investment ($300,000 + $600,000) Net Present Value

Present Value $294,545 321,825 616,370 (900,000) $(283,630)

Net annual cash flows = $800,000 – $770,000 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 students declines, cash inflows decline, but cash outflows don’t decline proportionately.

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PROBLEM 13-29A (Continued) (c) Using the original estimates, but an 11% discount rate, the net present value is calculated as follows: Discount Year Factor 11% Amount Annual cash inflow 1-20 7.96333 $110,000 Salvage value 20 0.12403 1,500,000 Present value of cash flows Initial investment ($300,000 + $600,000) Net Present Value

Present Value $875,966 186,045 1,062,011 (900,000) $162,011

Net annual cash flows = $950,000 – $840,000 The positive net present value of the project suggests that it should be accepted; obviously, 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%. Discount Year Factor 12% Amount Annual cash inflow 1-5 3.35216 $45,000 Salvage value 5 0.56743 1,300,000 Present value of cash flows Initial investment ($300,000 + $600,000) Net Present Value

Present Value $150,847 737,659 888,506 (900,000) (11,494)

The project had a high internal rate of return, even though the business itself did not appear to be successful, because the property increased significantly in value during the 5-year period.

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SOLUTIONS TO PROBLEMS—SET B PROBLEM 13-30B (b)

Cost of goods sold per unit = $720,000 ÷ 20,000 = $36.00 Direct labour is 65% of COGS = 65% x $36.00 = $23.40 Savings in labour is 25% of DL cost = 25% x $23.40 = $5.85 Discount Year Units Amount* Factor, 12% 1 20,000 $117,000 0.893 2 20,000 117,000 0.797 3 25,000 146,250 0.712 4 25,000 146,250 0.636 5 25,000 146,250 0.567 Present value of annual cash inflows 1-5 Supervision (45,000) 3.605 5 Salvage 15,000 0.567 Net cash flows Initial Investment Net present value

Present Value $104,481 93,249 104,130 93,015 82,924 $477,799 (162,225) 8,505 $324,079 (300,000) $24,079

• Amount = units x per unit savings in labour Based on the positive net present value, the company should purchase the equipment. (b)

Year Initial investment Less: Cash Flow

1 2 3 4 5

Outflow $(300,000) (45,000) (45,000) (45,000) (45,000) (45,000)

Inflow $117,000 117,000 146,250 146,250 146,250

Balance $(300,000) (228,000) (156,000) (54,750) 46,500

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PROBLEM 13-31B (a) Project Brown: Average annual cash inflow = Average annual net income + amortization Average annual net income = $72,000 ÷ 5 years = $14,400 Annual amortization = $200,000 ÷ 5 years = $40,000 Payback in years: $200,000 ÷ ($14,400 + $40,000) = 3.68 years Project Red: Average annual net income = $100,000 ÷ 5 years = $20,000 Annual amortization = $225,000 ÷ 5 years = $45,000 Payback in years: $225,000 ÷ ($20,000 + $45,000) = 3.46 years

Project Yellow: Average annual net income = $115,000 ÷ 5 years = $23,000 Annual amortization = $250,000 ÷ 5 years = $50,000 Payback in years: $250,000 ÷ ($23,000 + $50,000) = 3.42 years

(b) Project Brown: Net cash flows Initial investment Net Present Value

Year 1-5

Discount Factor, 12% 3.60478

Year 1-5

Discount Factor, 12% 3.60478

Project Red: Net cash flows Initial investment Net Present Value

Amount $54,400

Amount $65,000

Present Value $196,100 (200,000) $(3,900)

Present Value $234,311 (225,000) $9,311

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PROBLEM 13-31B (Continued) Project Yellow: Net cash flows Initial investment Net Present Value

Year 1-5

Discount Factor, 12% 3.60478

Amount $73,000

Present Value $263,149 (250,000) $13,149

= $14,400 ÷ [($200,000 + $0) ÷ 2] = 14.4%.

Project Red

= $20,000 ÷ [($225,000 + $0) ÷ 2] = 17.8%.

Project Yellow

= $23,000 ÷ [($250,000 + $0) ÷ 2] = 18.4%.

(d) Project Brown Red Yellow

Cash Payback 3.68 3.46 3.42

(3) (2) (1)

Net Present Value $(3,900) 9,311 13,149

(3) (2) (1)

Annual Rate of Return 14.4% 17.8% 18.4%

Project Yellow is the best project, as it ranks first using all three methods.

(3) (2) (1)

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PROBLEM 13-32B (a)

Initial investment amount would be the cash price of the new equipment less salvage value of old equipment plus increase in working capital $160,000 – $57,500 + $23,000 = $125,500

(b) Cash payback period for investment of $125,500: Year 1 2 3 4 5 6

Net Annual Cash Flow $21,000 21,000 21,000 21,000 21,000 21,000

Cumulative Cash Flow $21,000 42,000 63,000 84,000 105,000 126,000

In year 6, $20,500 or almost 100% of the net annual cash flow ($21,000) would be needed to payback the full initial investment, so we determine that the cash payback period is 6.0 years. (c) 10% Cash Present x Discount = Flows Value Year Factor Cash inflows years 1 to 6 1 - 6 $21,000 4.35526 $91,460 (1) Cash inflows years 7 to 10 7 - 10 28,800 1.78931 51,532 Recover working capital 10 23,000 0.38554 8,867 Salvage value of new equipment 10 40,000 0.38554 15,442 Less: Capital investment 0 160,000 --(160,000) Salvage of old equipment 0 57,500 --57,500 Increase working capital 0 23,000 --(23,000) Net present value $41,871 (1) Factor at 10 years, 6.14457 less factor at 6 years, 4.35526 (d)

Even though the cash payback period of 6.0 years is more than their maximum payback period of five years, the net present value calculation is more accurate as it takes into account the time value of money. Therefore, BioFarm should accept the purchase.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-33B

(a)

Sales (11 x 52 x $125) Expenses: Daycare staff Miscellaneous supplies Amortization Net income Cash flow

(1) Annual Net Income $71,500 $60,000 6,000 4,000

70,000 $1,500

(2) Annual Cash Inflow $71,500 $60,000 6,000 ---

66,000 $5,500

(b) (1) Cash payback period = $20,000 ÷ $5,500 = 3.63 years. (2) Annual rate of return = $1,500 ÷ [($20,000 + 0) ÷ 2] = 15%

Year 1-5

Discount Factor, 10% 3.79079

Amount $5,500

Present Value $20,849 (20,000) $849

(d) The computations show that the proposed day care center is a good investment. Annual rate of return is good and net present value is positive. A minor negative factor is that the cash payback period is 73% or (3.64 ÷ 5) of the useful life of the equipment.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-34B Net present value of the investment: Savings per unit: 10% of variable costs = 0.10 x $0.40 = $0.04/unit Savings per year: 850,000 units x $0.04 = $34,000 Discount Year Factor at 12% Savings 1-5 3.60478 Salvage (new) 5 0.56743 Salvage (old) 0 --Present value of cash inflows Initial investment

Amount $34,000 50,000 30,000

Present Value $122,563 28,372 30,000 180,935 (400,000) $(219,065)

The present value of the cash inflows is significantly smaller than the investment; clearly they should not replace the old machine with the new one. It might also be a good idea to check the company’s estimates, as some of their numbers may be incorrect, leading to this result.

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PROBLEM 13-35B Investment in new equipment Disposal of old equipment Additional training required Net initial investment required

$2,500,000 (260,000) 85,000 $2,325,000

Calculation of net present value: Discount Year Factor, 9% Cash flows 1 0.91743 2 0.84168 3 0.77218 4 0.70843 5 0.64993 6 0.59627 7 0.54703 Maintenance 5 0.64993 Net cash flows from operations: Terminal salvage 7 0.54703 Present value of cash inflows Initial investment Net Present Value

Amount $390,000 400,000 411,000 426,000 434,000 435,000 436,000 (95,000) 380,000

Present Value $357,798 336,672 317,366 301,791 282,070 259,377 238,505 (61,743) 2,031,836 207,871 2,239,707 (2,325,000) $(85,293)

Based on the net present value 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.

©. 13-41

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-36B

(a) The net present value based on the original estimates is as follows: Discount Year Factor, 10% Annual cash inflow 1-10 6.14457 Overhaul 5 0.62092 Salvage value 10 0.38554 Present value of cash flows Initial investment Net Present Value

Amount $12,000 (7,000) 15,000

Present Value $73,735 (4,346) 5,783 75,172 (77,000) $(1,828)

Based on these estimates, the garbage truck should not be purchased. (b) The net present value based on the revised estimates is as follows: Discount Year Factor,10% Annual cash inflow 1-10 6.14457 Overhaul 5 0.62092 Additional benefits 1-10 6.14457 Salvage value 10 0.38554 Present value of cash flows Initial investment Net Present Value

Amount $12,000 (7,000) 2,000 15,000

Present Value $73,735 (4,346) 12,289 5,783 87,461 (77,000) $10,461

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 $12,289 (the increase in the net present value from a negative $1,828 to a positive $10,461). The 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 $1,828. That is the amount by which the original estimate fell short of having a positive net present value. © . 13-42

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-37B

(a) Using the original estimates, the net present value is calculated as follows: Discount Year Factor 11% Amount Annual cash inflow 1-15 7.19087 $160,000 Salvage value 15 0.20900 1,200,000 Present value of cash flows Initial investment ($300,000 + $600,000) Net Present Value

Present Value $1,150,539 250,800 1,401,339 (900,000) $501,339

Net annual cash flows = $920,000 – $760,000 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: Discount Year Factor 11% Amount Annual cash inflow 1-15 7.19087 $50,000 Salvage value 15 0.20900 1,200,000 Present value of cash flows Initial investment ($300,000 + $600,000) Net Present Value

Present Value $359,544 250,800 610,344 (900,000) $(289,656)

Net annual cash flows = $700,000 – $650,000 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 students declines, cash inflows decline, but cash outflows don’t decline proportionately. © . 13-43

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PROBLEM 13-37B (Continued) (c) Using the original estimates, but increasing the discount rate, the net present value is calculated as follows: Discount Year Factor 15% Amount Annual cash inflow 1-15 5.84737 $160,000 Salvage value 15 0.12289 1,200,000 Present value of cash flows Initial investment ($300,000 + $600,000) Net Present Value

Present Value $935,579 147,468 1,083,047 (900,000) $183,047

Net annual cash flows = $920,000 – $760,000 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 will bring the net present value to zero. By looking at the values determined in (a) and (c) above, we estimate the rate might be 12%. Calculate the net present value with a discount rate of 12% Discount Year Factor 12% Amount Annual cash inflow 1-6 4.11141 $84,000 Salvage value 6 0.50663 1,100,000 Present value of cash flows Initial investment ($300,000 + $600,000) Net Present Value

Present Value $345,358 557,293 902,651 (900,000) $2,651

The project had a high internal rate of return, even though the business itself was not generating much in cash inflows, because the property significantly increased in value during the six years.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-38B (a)

OPTION A (1)

Discount Year Factor 9% Annual cash inflow 1-8 5.53482 Cost to rebuild 5 0.64993 Salvage value 8 0.50187 Present value of cash flows Initial investment Net Present Value

Amount $20,000 (26,500) ---

Present Value $110,696 (17,223) --93,473 (90,000) $3,473

Net annual cash flows = $180,000 – $160,000 = $20,000

(2)

Profitability index = $93,743 ÷ $90,000 = 1.04

(3) Because the net present value of the investment at a discount rate of 9% is positive, we know the internal rate of return will be greater than 9%, let’s say 13%. Discount Year Factor 13% Annual cash inflow 1-8 4.79877 Cost to rebuild 5 0.54276 Salvage value 8 0.37616 Present value of cash flows Initial investment Net Present Value

Amount $20,000 (26,500) ---

Present Value $95,975 (14,383) --81,592 (90,000) $(8,408)

Net annual cash flows = $180,000 – $160,000 = $20,000

©. 13-45

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PROBLEM 13-38B (Continued) OPTION B (1)

Discount Year Factor 9% Annual cash inflow 1-8 5.53482 Cost to rebuild 0.64993 Salvage value 8 0.50187 Present value of cash flows Initial investment Net Present Value

Amount $32,000 --27,500

Present Value $177,114 --13,801 190,915 (170,000) $20,915

Net annual cash flows = $140,000 – $108,000 = $32,000 (2) Profitability index = $190,915 ÷ $170,000 = 1.12 (3) Internal rate of return on Option B is 12%, as calculated below: Discount Year Factor 12% Annual cash inflow 1-8 4.96764 Cost to rebuild 0.56743 Salvage value 8 0.40388 Present value of cash flows Initial investment Net Present Value

Amount $32,000 --27,500

Present Value $158,964 --11,107 170,071 (170,000) $71

(b) Although Option A has a lower net present value than Option B, it has a higher internal rate of return, and, it has a higher profitability index, resulting from the much smaller investment base. Therefore, Option A is the preferred project.

©. 13-46

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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PROBLEM 13-39B

(a)

Year Amount Balance Initial investment 0 $(250,000) $(250,000) Less: Cash Flow 1 90,000 (160,000) 2 75,000 (85,000) 3 60,000 (25,000) 4 40,000 15,000 Payback period = 3 + (25,000 ÷ 40,000) = 3.625

(b)

Average annual net income = ($25,000 + $27,000 + $29,000 + $31,000 + $33,000) ÷ 5 = $29,000 Average investment = ($250,000 + $0) ÷ 2 = $125,000 Annual rate of return = $29,000 ÷ $125,000 = 23.2%

(c)

Discount Year Factor, 15% Amount Net cash flows 1 0.86957 $90,000 2 0.75614 75,000 3 0.65752 60,000 4 0.57175 40,000 5 0.49718 30,000 Present value of cash inflows Initial investment Net Present Value

Present Value $78,261 56,710 39,451 22,870 14,915 212,207 (250,000) $(37,793)

©. 13-47

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTIONS TO CASES CASE 13-40

Annual net cash inflow: Sales (10,000; 12,000) x $100 Cost of goods sold (71.5%; 70%) Gross Profit Less: Selling expenses Administrative expenses

Net annual cash flow Amortization Annual net operating income

Old

New

$1,000,000 715,000 285,000

$1,200,000 840,000 360,000

116,000 100,000 216,000

127,600 112,000 239,600

$69,000

$120,400 31,250 $89,150

(a) Annual rate of return: $89,150 ÷ [($125,000 + $0) ÷ 2] = 142.64% (b) Cash payback period = $125,000 ÷ ($120,400) = 1.04 years

Net cash flows Initial investment Net Present Value

Year 1-4

Discount Factor, 15% 2.85498

Amount $51,400

Present Value $146,746 (125,000) $21,746

(d) The new machine should be purchased. Every measurement shows an excellent return.

©. 13-48

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 13-41 TAXI Alternative The City would receive 3% from these incremental revenues: From current drivers—1,750 taxis x 19,200 trips x 20% from the suburbs x 10 km average trip x $0.10 per km = $6,720,000 From new drivers in the suburbs—85 taxis x 19,200 trips x 20% x $7.101 per trip = $2,317,440 From new drivers at airport/city centre—85 taxis x 19,200 trips x 80% x $6.102 per trip = $7,964,160 1

Regular trip, $6.10 + incentive, ($0.10 x 10 km) = $7.10 Flat rate, $1.10 + ($0.50 x 10 km) = $6.10

Total incremental revenue: Current $6,720,000 New-Suburbs 2,317,440 New-Airport/Centre 7,964,160 $17,001,600 City receives 3% $510,048 Total annual saving = $510,048 - $350,000 loss in public transit = $160,048 One time revenue from sale of licenses = 85 x $1,750 = $148,750

Net Present value of the Taxi Option:

Annual revenue Sale of license Net Present Value

Year 1-5 1

Discount Factor, 12% 3.60478 1.00000

Amount $ 160,048 148,750

Present Value $ 576,938 148,750 $ 725,688

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CASE 13-41 (Continued) PUBLIC TRANSIT Option Total incremental revenue: Ticket sales ($1.00 x 1,500,000 rides) Additional salaries ($30,000 x 5) Maintenance

$1,500,000 (150,000) (36,000) $1,314,000

Calculation of net present value:

Year 1-5 5

Annual cash flow Salvage value NPV of cash inflows Less: Initial Investment Net present value

Discount Factor, 12% 3.60478 0.56743

Amount $1,314,000 100,000

Present Value $4,736,681 56,743 $4,793,424 (1,400,000) $3,393,424

It is clear from this net present value analysis, the City should go with the public transit option. But with such a large discrepancy, further investigation should be conducted to make sure the estimates are reasonable.

©. 13-50

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 13-42 Additional annual cash flow: Years Gate receipts Handling expenses McCain’s salary Luc's salary Incremental cash

1 2 $330,000 $300,000 (33,000) (30,000) 15,000 15,000 (60,000) (70,000) $252,000 $215,000

3 4 5 $200,000 $100,000 $40,000 (20,000) (10,000) (4,000) 15,000 15,000 15,000 (80,000) (80,000) (72,000) $115,000 $25,000 $(21,000)

Calculation of net present value:

Year Amount Net annual cash flow 1 $ 252,000 2 215,000 3 115,000 4 25,000 5 (21,000) Residual value of Luc 5 20,000 Payment for Luc 0 (500,000) Net present value of Luc's services

Discount Factor, 10% 0.90909 0.82645 0.75132 0.68301 0.62092 0.62092 1.00000

Present Value $ 229,091 177,687 86,402 17,075 (13,039) 12,418 (500,000) $9,634

The hockey club should acquire the services of Luc because the net present value is positive.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 13-43 (a)

Payback period: Project A: $200,000 ÷ $50,000 = 4 years Project B: 3 + ($30,000 ÷ $75,000) = 3.4 years Year Initial investment 0 Cash inflows 1 2 3 4 5

Amount $(190,000) 40,000 50,000 70,000 75,000 75,000

Balance $ (190,000) (150,000) (100,000) (30,000) 45,000 120,000

Project C: 3 + ($40,000 ÷ $80,000) = 3.5 years Year Initial investment 0 Cash inflows 1 2 3 4 5 Project D: 3.0 years Year Initial investment 0 Cash inflows 1 2 3 4 5

Amount $(250,000) 75,000 75,000 60,000 80,000 100,000

Balance $ (250,000) (175,000) (100,000) (40,000) 40,000 140,000

Amount $(210,000) 75,000 75,000 60,000 40,000 20,000

Balance $ (210,000) (135,000) (60,000) 40,000 60,000

©. 13-52

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 13-43 (Continued) (b)

Net Present Value Project A: NPV = $(19,761) Discount Factor, 12% 3.60478 1.00000

Present Value $180,239 (200,000) $(19,761)

Discount Factor, 12% 0.89286 0.79719 0.71178 0.63552 0.56743 1.00000

Present Value $ 35,714 39,860 49,825 47,664 42,557 (190,000) $ 25,620

Discount Year Amount Factor, 12% Net cash flow 1 $75,000 0.89286 2 75,000 0.79719 3 60,000 0.71178 4 80,000 0.63552 5 100,000 0.56743 Initial investment 0 (250,000) 1.00000 Net present value of the project

Present Value $66,965 59,789 42,707 50,842 56,743 (250,000) $27,046

Year Amount Net Cash Flow 1-5 $ 50,000 Initial investment 0 (200,000) Net present value of the project Project B: NVP = $25,620

Year Amount Net cash flow 1 $ 40,000 2 50,000 3 70,000 4 75,000 5 75,000 Initial investment 0 (190,000) Net present value of the project

Project C: NPV = $27,046

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CASE 14-43 (Continued) Project D: NPV = $(3,769)

Year Amount Net cash flow 1 $ 75,000 2 75,000 3 60,000 4 40,000 5 20,000 Initial investment 0 (210,000) Net present value of the project

(c)

Discount Factor, 12% 0.89286 0.79719 0.71178 0.63552 0.56743 1.00000

Present Value $66,965 59,789 42,707 25,421 11,349 (210,000) $(3,769)

Using net present value analysis, Project C should be funded. Although it has one of the longest payback periods, there are substantial cash inflows after the payback period. This is one of the weaknesses of using payback period alone in making capital investment decisions. As well, before making any type of funding decision, qualitative factors should be considered.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 13-44 Net present value for keeping the old machine:

Year 1-6 1-6 6

Amount $(250,000) (40,000) 10,000

Variable cost Fixed cost Salvage value Initial investment Net present value of the project

Discount Factor, 10% 4.35526 4.35526 0.56447

Present Value $(1,088,815) (174,210) 5,645 --$(1,257,380)

Net present value for buying the new machine:

Year Amount Variable cost 1-6 $(125,000) Fixed cost 1-6 (30,000) Initial investment 0 (340,000) Current disposal 0 40,000 Salvage value 6 10,000 Net present value of the project

Discount Factor, 10% 4.35526 4.35526 1.00000 1.00000 0.56447

Present Value $(544,408) (130,658) (340,000) 40,000 5,645 $(969,421)

The decision should be to purchase the new machine because the net present value of the relevant costs is lower than with the old machine.

©. 13-55

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 13-45 (a) Using the original estimates, the present value is calculated as follows:

Year 1-15 15

Amount $450,000 2,000,000

Net Cash Flow Salvage PV of cash inflows Initial investment Net present value of the project

Discount Factor, 11% 7.19087 0.20900

Present Value $3,235,892 418,000 3,653,892 (4,000,000) $(346,108)

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:

Year Amount Net Cash Flow 1-15 $450,000 Salvage 15 2,000,000 Additional inflows 1-15 280,000 PV of cash inflows Initial investment Net present value of the project

Discount Factor, 11% 7.19087 0.20900 7.19087

Present Value $3,235,892 418,000 2,013,444 5,667,336 (4,000,000) $1,667,336

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CASE 13-45 (Continued) (c) Year 1-15 15

Amount $450,000 2,000,000

Net Cash Flow Salvage PV of cash inflows Initial investment Net present value of the project

Discount Factor, 9% 8.06069 0.27454

Present Value $3,627,311 549,080 4,176,391 (4,000,000) $176,391

Using the original estimates, but the lower discount rate, the net present value is positive, suggesting the project should be accepted.

(d) If James 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.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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CASE 13-46 (a) The stakeholders are: • • • • •

Yourself. Your spouse and children. Employees of Impro Company. Citizens of the town where the company is presently located. The stockholders of Impro 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.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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SOLUTION TO THE WATERWAYS CONTINUING PROBLEM WCP-13 (a) (1)

NET PRESENT VALUE Buy New Backhoes 8% Time Cash Discount Present Period Flow Rate Value Equipment purchase 0 $ 200,000 1 $ (200,000) Salvage value of old equip 0 42,000 1 42,000 Net cash flow 1-8 53,900 5.74664 309,744 Salvage value 8 90,000 0.54027 48,624 Net present value $ 200,368 NET PRESENT VALUE Keep Old Backhoes

Overhaul cost Net cash flow Salvage value Net present value

Time Period 1 1-8 8

8% Cash Discount Flow Rate $ 55,000 0.92593 40,425 5.74664 15,000 0.54027

Present Value $ (50,926) 232,308 8,104 $ 189,486

(2)

PAYBACK METHOD Cost of Capital Investment / Net Annual Cash Flow = Cash Payback Period New Old Cost of Capital $158,000 $55,000 Investment Net annual cash flow $ 53,900 $40,425 Payback time

2.93 years

1.36 years

©. 13-59

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WCP-13 (Continued) (3)

PROFITABILITY INDEX Present Value of Net Cash Flows / Initial Investment = Profitability Index New Old Present Value of Net Cash Flows $358,368 $240,412 Initial investment $158,000 $ 55,000 Profitability index 2.27 4.37 (4)

INTERNAL RATE OF RETURN Investment Required / Net Annual Cash Flows = Internal Rate of Return Factor $158,000 $53,900

= 2.9314

= 1.36 - a much high return than buying $55,000 a new one $40,425 Both of these values are above the factors presented in the text table, so they are above 15% and well over the required 8% discount rate. (b)

Intangible benefits include faster completion of jobs due to the increased speed of the backhoes. The depth and width of the trenches will be more accurate. Also, the new backhoes have considerably more comforts for the operator than the old backhoes. However, there would be time involved in training the operators to use the new backhoes. There may also be some resistance from the operators to change from the machines in which they now feel competent in handling. Because of the increased speed, these operators who are paid on an hourly basis may find their incomes decreased if the increased speed does not also result in increased jobs requiring the use of the backhoes.

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WCP-13 (Continued) (c)

The decision would be a difficult one to make. There is little difference in the net present value, although buying new backhoes is slightly higher. All the other indicators suggest that keeping the old backhoes for another 8 years may be the best decision at this time. However, buying new backhoes would decrease maintenance costs and the time spent on maintenance. This may allow for additional jobs to be added to the schedule. Depreciation would also increase, which would lower income—and therefore income taxes—without affecting actual cash flow. Both decisions would yield a much higher than 8% return on the money invested. Either decision could actually be defended.

Managerial Accounting: Tools for Business Decision-Making, Second Canadian Edition

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