CHAPTER 1 THE MANAGER AND MANAGEMENT ACCOUNTING See the front matter of this Solutions Manual for suggestions regarding your choices of assignment material for each chapter. 1-1 Management accounting measures, analyzes and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization. It focuses on internal reporting and is not restricted by generally accepted accounting principles (GAAP). Financial accounting focuses on reporting to external parties such as investors, government agencies, and banks. It measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP). Other differences include (1) management accounting emphasizes the future (not the past), and (2) management accounting influences the behavior of managers and other employees (rather than primarily reporting economic events). 1-2 Financial accounting is constrained by generally accepted accounting principles. Management accounting is not restricted to these principles. The result is that • management accounting allows managers to charge interest on owners’ capital to help judge a division’s performance, even though such a charge is not allowed under GAAP, • management accounting can include assets or liabilities (such as “brand names” developed internally) not recognized under GAAP, and • management accounting can use asset or liability measurement rules (such as present values or resale prices) not permitted under GAAP. 1-3 Management accountants can help to formulate strategy by providing information about the sources of competitive advantage—for example, the cost, productivity, or efficiency advantage of their company relative to competitors or the premium prices a company can charge relative to the costs of adding features that make its products or services distinctive. 1-4
The business functions in the value chain are • Research and development—generating and experimenting with ideas related to new products, services, or processes. • Design of products and processes—the detailed planning, engineering, and testing of products and processes. • Production—procuring, transporting, storing and assembling resources to produce a product or deliver a service. • Marketing—promoting and selling products or services to customers or prospective customers. • Distribution—processing orders and shipping products or services to customers. • Customer service—providing after-sales service to customers.
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1-5 Supply chain describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers, regardless of whether those activities occur in the same organization or in other organizations. Cost management is most effective when it integrates and coordinates activities across all companies in the supply chain as well as across each business function in an individual company’s value chain. Attempts are made to restructure all cost areas to be more cost-effective. 1-6 “Management accounting deals only with costs.” This statement is misleading at best, and wrong at worst. Management accounting measures, analyzes, and reports financial and nonfinancial information that helps managers define the organization’s goals, and make decisions to fulfill them. Management accounting also analyzes revenues from products and customers in order to assess product and customer profitability. Therefore, while management accounting does use cost information, it is only a part of the organization’s information recorded and analyzed by management accountants. 1-7 Management accountants can help improve quality and achieve timely product deliveries by recording and reporting an organization’s current quality and timeliness levels and by analyzing and evaluating the costs and benefits—both financial and non-financial—of new quality initiatives such as TQM, relieving bottleneck constraints or providing faster customer service. 1-8 The five-step decision-making process is (1) identify the problem and uncertainties (2) obtain information (3) make predictions about the future (4) make decisions by choosing among alternatives and (5) implement the decision, evaluate performance and learn. 1-9 Planning decisions focus on selecting organization goals and strategies, predicting results under various alternative ways of achieving those goals, deciding how to attain the desired goals, and communicating the goals and how to attain them to the entire organization. Control decisions focus on taking actions that implement the planning decisions, deciding how to evaluate performance, and providing feedback and learning to help future decision making. 1-10
The three guidelines for management accountants are 1. Employ a cost-benefit approach. 2. Recognize behavioral and technical considerations. 3. Apply the notion of “different costs for different purposes”.
1-11 Agree. A successful management accountant requires general business skills (such as understanding the strategy of an organization) and people skills (such as motivating other team members) as well as technical skills (such as computer knowledge, calculating costs of products, and supporting planning and control decisions).
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The new controller could reply in one or more of the following ways: (a) Demonstrate to the plant manager how he or she could make better decisions if the plant controller was viewed as a resource rather than a deadweight. In a related way, the plant controller could show how the plant manager’s time and resources could be saved by viewing the new plant controller as a team member. (b) Demonstrate to the plant manager a good knowledge of the technical aspects of the plant. This approach may involve doing background reading. It certainly will involve spending much time on the plant floor speaking to plant personnel. (c) Show the plant manager examples of the new plant controller’s past successes in working with line managers in other plants. Examples could include • assistance in preparing the budget, • assistance in analyzing problem situations and evaluating financial and nonfinancial aspects of different alternatives, and • assistance in submitting capital budget requests. (d) Seek assistance from the corporate controller to highlight to the plant manager the importance of many tasks undertaken by the new plant controller. This approach is a last resort but may be necessary in some cases.
1-13 The controller is the chief management accounting executive. The corporate controller reports to the chief financial officer, a staff function. Companies also have business unit controllers who support business unit managers or regional controllers who support regional managers in major geographic regions. 1-14 The Institute of Management Accountants (IMA) sets standards of ethical conduct for management accountants in the following four areas: • Competence • Confidentiality • Integrity • Credibility 1-15
Steps to take when established written policies provide insufficient guidance are (a) Discuss the problem with the immediate superior (except when it appears that the superior is involved). (b) Clarify relevant ethical issues by confidential discussion with an IMA Ethics Counselor or other impartial advisor. (c) Consult your own attorney as to legal obligations and rights concerning the ethical conflicts.
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(15 min.) Value chain and classification of costs, computer company. Cost Item a. b. c. d. e. f. g. h.
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(15 min.) Value chain and classification of costs, pharmaceutical company. Cost Item a. b. c. d. e. f. g. h.
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Value Chain Business Function Design of products and processes Marketing Customer Service Research and Development Marketing Production Marketing Distribution
(15 min.) Value chain and classification of costs, fast food restaurant. Cost Item a. b. c. d. e. f. g. h.
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Value Chain Business Function Production Distribution Design of products and processes Research and Development Customer Service or Marketing Design of products and processes (or Research and Development) Marketing Production
Value Chain Business Function Production Distribution Marketing Marketing Marketing Production Design of products and processes (or Research and Development) Customer service
(15 min.) Key success factors. Change in Operations/ Management Accounting a. b. c. d. e.
Key Success Factor Innovation Cost and Quality Time Time and Cost Cost
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(10-15 min.) Planning and control decisions. Action a. b. c. d. e.
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(15 min.) Five-step decision-making process, manufacturing. Action a. b. c. d. e. f. g.
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Decision Planning Control Control Planning Planning
Step in Decision-Making Process Obtain information Make predictions about the future Identify the problem and uncertainties Implement the decision, evaluate performance, and learn Make predictions about the future Make decisions by choosing among alternatives Obtain information
(15 min.) Five-step decision-making process, service firm. Action a. b. c. d. e. f.
Step in Decision-Making Process Obtain information Identify the problem and uncertainties Obtain information and/or make predictions about the future Make predictions about the future Obtain information Make decisions by choosing among alternatives
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(10–15 min.) Professional ethics and reporting division performance.
1. Miller’s ethical responsibilities are well summarized in the IMA’s “Standards of Ethical Conduct for Management Accountants” (Exhibit 1-7 of text). Areas of ethical responsibility include the following: • competence • confidentiality • integrity • credibility The ethical standards related to Miller’s current dilemma are integrity, competence and credibility. Using the integrity standard, Miller should carry out duties ethically and communicate unfavorable as well as favorable information and professional judgments or opinions. Competence demands that Miller perform her professional duties in accordance with relevant laws, regulations, and technical standards and provide decision support information that is accurate. Credibility requires that Miller report information fairly and objectively and disclose deficiencies in internal controls in conformance with organizational policy and/or applicable law. Miller should refuse to book the $200,000 of sales until the goods are shipped. Both financial accounting and management accounting principles maintain that sales are not complete until the title is transferred to the buyer. 2. Miller should refuse to follow Maloney's orders. If Maloney persists, the incident should be reported to the corporate controller. Support for line management should be wholehearted, but it should not require unethical conduct. 1-24
(15 min.) Planning and control decisions, Internet company.
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Planning decisions a. Decision to raise monthly subscription fee c. Decision to upgrade content of online services (later decision to inform subscribers and upgrade online services is an implementation part of control) e. Decision to decrease monthly subscription fee starting in November. Control decisions b. Decision to inform existing subscribers about the rate of increase—an implementation part of control decisions d. Dismissal of VP of Marketing—performance evaluation and feedback aspect of control decisions
2. Other planning decisions that may be made at WebNews.com: decision to raise or lower advertising fees; decision to charge a fee from on-line retailers when customers click-through from WebNews.com to the retailers’ websites. Other control decisions that may be made at WebNews.com: evaluating how customers like the new format for the weather information, working with an outside vendor to redesign the website, and evaluating whether the waiting time for customers to access the website has been reduced.
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(20 min.) Strategic decisions and management accounting.
1. The strategies the companies are following in each case are: a. Low price strategy b. Differentiated product strategy c. Low price strategy d. Differentiated product strategy 2. Examples of information the management accountant can provide for each strategic decision follow. a. Cost to manufacture and sell the cell phone Productivity, efficiency and cost advantages relative to competition Prices of competitive cell phones Sensitivity of target customers to price and quality The production capacity of Roger Phones and its competitors b.
Cost to develop, produce and sell new software Premium price that customers would be willing to pay due to product uniqueness Price of basic software Price of closest competitive software Cash needed to develop, produce and sell new software
c.
Cost of producing the “store-brand” lip gloss Productivity, efficiency and cost advantages relative to competition Prices of competitive products Sensitivity of target customers to price and quality How the market for lip gloss is growing
d.
Cost to produce and sell new line of gourmet bologna Premium price that customers would be willing to pay due to product uniqueness Price of basic meat product Price of closest competitive product
1-26 1. 2. 3. 4. 5. 6. 7. 8. 9.
(15 min.) Management accounting guidelines.
Cost-benefit approach Behavioral and technical considerations Different costs for different purposes Cost-benefit approach Behavioral and technical considerations Cost-benefit approach Behavioral and technical considerations Different costs for different purposes Behavioral and technical considerations
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(15 min.) Role of controller, role of chief financial officer.
1. Activity Managing accounts payable Communicating with investors Strategic review of different lines of businesses Budgeting funds for a plant upgrade Managing the company’s short-term investments Negotiating fees with auditors Assessing profitability of various products Evaluating the costs and benefits of a new product design
Controller X
CFO X X
X X X X X
2. As CFO, Perez will be interacting much more with the senior management of the company, the board of directors, auditors, and the external financial community. Any experience he can get with these aspects will help him in his new role as CFO. George Perez can be better positioned for his new role as CFO by participating in strategy discussions with senior management, by preparing the external investor communications and press releases under the guidance of the current CFO, by attending courses that focus on the interaction and negotiations between the various business functions and outside parties such as auditors and, either formally or on the job, getting training in issues related to investments and corporate finance.
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(30 min.) Pharmaceutical company, budgeting, ethics.
1. The overarching principles of the IMA Statement of Ethical Professional Practice are Honesty, Fairness, Objectivity and Responsibility. The statement’s corresponding “Standards for Ethical Conduct…” require management accountants to • • • •
Perform professional duties in accordance with relevant laws, regulations, and technical standards. Refrain from engaging in any conduct that would prejudice carrying out duties ethically. Communicate information fairly and objectively. Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations.
The idea of capitalizing some of the company’s R&D expenditures is a direct violation of the IMA’s ethical standards above. This transaction would not be “in accordance with relevant laws, regulations, and technical standards”. Generally Accepted Accounting Principles require research and development costs to be expensed as incurred. Even if Johnson believes his transaction is justifiable, it violates the profession’s technical standards and would be unethical. The other “year-end” actions occur in many organizations and fall into the “gray” to “acceptable” area. Much depends on the circumstances surrounding each one, however, such as the following: a. Stop all research and development efforts on the drug Lyricon until after year-end. This change would delay the drug going to market by at least six months. It is also possible that in the meantime a PharmaCor competitor could make it to market with a similar drug. While this solution may solve the budget short-fall in this year, it could result in a significant loss of future profits for PharmaCor in the long-run, especially if a competitor is able to obtain a patent on a similar drug before PharmaCor. b. Sell off rights to the drug, Markapro. The company had not planned on doing this because, under current market conditions, it would get less than fair value. It would, however, result in a onetime gain that could offset the budget short-fall. Of course, all future profits from Markapro would be lost. Again, this solution may solve the company’s short-term budget crisis; but could result in the loss of future profits for PharmaCor in the long-run. 2. While it is not uncommon for companies to sacrifice long-term profits for short-term gains, it may not be in the best interest of the company’s shareholders. In the case of PharmaCor, the CFO is primarily concerned with “maximizing shareholder wealth” in the immediate future (third quarter only), but not in the long-term. Because this executive’s incentive pay and even employment may be based on his ability to meet short-term targets, he may not be acting in the best interest of the shareholders in the long-run. Johnson definitely faces an ethical dilemma. It is not unethical on Johnson’s part to want to please his new boss, nor is it unethical that Johnson wants to make a good impression on his first days at his new job; however, Johnson must still act within the ethical standards required by
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his profession. Taking illegal and/or unethical action by capitalizing R&D to satisfy the demands of his new supervisor, James Clark, is unacceptable. Although not strictly unethical, I would recommend that Johnson not agree to slow down the R&D efforts on Lyricon or sell off the rights to Markapro. Each of these appears to sacrifice the overall economic interests of PharmaCor for short-run gain. Johnson should argue against doing this but not resign if Clark insists that these actions be taken. If, however, Clark asks Johnson to capitalize R&D, he should raise this issue with the chair of the Audit Committee after informing Clark that he is doing so. If the CFO still insists on Johnson capitalizing R&D, he should resign rather than engage in unethical behavior.
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(30–40 min.) Professional ethics and end-of-year actions.
1. The possible motivations for the snack foods division wanting to take end-of-year actions include: (a) Management incentives. Gourmet Foods may have a division bonus scheme based on one-year reported division earnings. Efforts to front-end revenue into the current year or transfer costs into the next year can increase this bonus. (b) Promotion opportunities and job security. Top management of Gourmet Foods likely will view those division managers that deliver high reported earnings growth rates as being the best prospects for promotion. Division managers who deliver “unwelcome surprises” may be viewed as less capable. (c) Retain division autonomy. If top management of Gourmet Foods adopts a “management by exception” approach, divisions that report sharp reductions in their earnings growth rates may attract a sizable increase in top management supervision. 2.
The “Standards of Ethical Conduct . . . ” require management accountants to • Perform professional duties in accordance with relevant laws, regulations, and technical standards. • Refrain from engaging in any conduct that would prejudice carrying out duties ethically. • Communicate information fairly and objectively.
Several of the “end-of-year actions” clearly are in conflict with these requirements and should be viewed as unacceptable by Taylor. (b) The fiscal year-end should be closed on midnight of December 31. “Extending” the close falsely reports next year’s sales as this year’s sales. (c) Altering shipping dates is falsification of the accounting reports. (f) Advertisements run in December should be charged to the current year. The advertising agency is facilitating falsification of the accounting records. The other “end-of-year actions” occur in many organizations and fall into the “gray” to “acceptable” area. However, much depends on the circumstances surrounding each one, such as the following: (a) If the independent contractor does not do maintenance work in December, there is no transaction regarding maintenance to record. The responsibility for ensuring that packaging equipment is well maintained is that of the plant manager. The division controller probably can do little more than observe the absence of a December maintenance charge. (d) In many organizations, sales are heavily concentrated in the final weeks of the fiscal year-end. If the double bonus is approved by the division marketing manager, the division controller can do little more than observe the extra bonus paid in December. (e) If TV spots are reduced in December, the advertising cost in December will be reduced. There is no record falsification here. (g) Much depends on the means of “persuading” carriers to accept the merchandise. For example, if an under-the-table payment is involved, or if carriers are pressured to accept merchandise, it is clearly unethical. If, however, the carrier receives no extra consideration and willingly agrees to accept the assignment because it sees potential sales opportunities in December, the transaction appears ethical. 1-11
Each of the (a), (d), (e), and (g) “end-of-year actions” may well disadvantage Gourmet Foods in the long run. For example, lack of routine maintenance may lead to subsequent equipment failure. The divisional controller is well advised to raise such issues in meetings with the division president. However, if Gourmet Foods has a rigid set of line/staff distinctions, the division president is the one who bears primary responsibility for justifying division actions to senior corporate officers. 3. If Taylor believes that Ryan wants her to engage in unethical behavior, she should first directly raise her concerns with Ryan. If Ryan is unwilling to change his request, Taylor should discuss her concerns with the Corporate Controller of Gourmet Foods. She could also initiate a confidential discussion with an IMA Ethics Counselor, other impartial adviser, or her own attorney. Taylor also may well ask for a transfer from the snack foods division if she perceives Ryan is unwilling to listen to pressure brought by the Corporate Controller, CFO, or even President of Gourmet Foods. In the extreme, she may want to resign if the corporate culture of Gourmet Foods is to reward division managers who take “end-of-year actions” that Taylor views as unethical and possibly illegal. It was precisely actions along the lines of (b), (c), and (f) that caused Betty Vinson, an accountant at WorldCom to be indicted for falsifying WorldCom’s books and misleading investors.
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1-30 (30 min.) Professional ethics and end-of-year actions. 1. The possible motivations for Controller, Todd Allen to modify the division’s year-end earnings are: (i) Job security and promotion. The company’s CFO will likely reward him for meeting the company’s performance expectations. Alternately, the Allen may be penalized, perhaps even by losing his job if the performance expectations are not met. (ii) Management incentives. Allen’s bonus may be based on the division’s ability to meet certain profit targets. If the Consumer Products division has already met its profit target for the year, the Controller may personally benefit if new printing equipment is sold off and replaced with the discarded equipment that no longer meets current safety standards, or if operating income is manipulated by questionable revenue and/or expense recognition. 2. The overarching principles of the IMA Statement of Ethical Professional Practice are Honesty, Fairness, Objectivity and Responsibility. The statement’s corresponding “Standards for Ethical Conduct…” require management accountants to • Perform professional duties in accordance with relevant laws, regulations, and technical standards. • Refrain from engaging in any conduct that would prejudice carrying out duties ethically. • Communicate information fairly and objectively. • Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations. Several of the “year-end” actions are clearly are in conflict with the statement’s principles and required standards and should be viewed as unacceptable. (c) Subscription revenue received in December in advance for magazines that will be sent out in January is a liability. Showing it as revenue falsely reports next year’s revenue as this year’s revenue. (d) Reversing the division’s Allowance for Bad Debt Expense would violate Generally Accepted Accounting Principles unless the bad debt allowance is currently overstated. Recording this transaction would result in an overstatement of income and could potentially mislead investors. (e) Booking advertising revenues that relate to January in December falsely reports next year’s revenue as this year’s revenue. The other “year-end” actions occur in many organizations and fall into the “gray” to “acceptable” area. Much depends on the circumstances surrounding each one, however, such as the following: (a) Cancelling two of the division’s least profitable magazines, resulting in the layoff of twenty-five employees. While employee layoffs may be necessary for the business to survive, the layoff decision could result in economic hardship for those employees who lose their jobs, as well as result in employee morale problems for the rest of the division. Most companies would prefer to avoid causing hardship for their existing employees due to layoffs unless absolutely necessary for the survival of the business as a whole.
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(b) Selling the new printing equipment that was purchased in January and replacing it with discarded equipment from one of the company’s other divisions. The previously discarded equipment no longer meets current safety standards. Again, while this method may result in a short-term solution for the Controller and the Production Manager personally, this decision may actually harm the corporation financially as a whole, not to mention the potential resulting injuries to production workers from hazardous equipment. This method would be also be ethically questionable and would likely violate the IMA’s ethical standards of integrity and credibility. (f) Switching from declining balance to straight line depreciation to reduce depreciation expense in the current year. Many companies switch their depreciation policy from one method to another. Deacon Publishing could argue that straight-line depreciation better represents the decrease in the economic value of the asset compared to the declining balance method. Straight-line depreciation may also be more in line with what its competitors do. If, however, the company changes to straight-line depreciation with the sole purpose of reducing expenses to meet its profit goals, such behavior would be unacceptable. The Standards of Ethical Behavior require management accountants to communicate information fairly and objectively and to carry out duties ethically. 3. Allen should directly raise his concerns first with the CFO, especially if the pressure from the CFO is so great that the only course of action on the part of the controller is to otherwise behave unethically. If the CFO refuses to change his direction, then the controller should raise these issues with the CEO, and next to the Audit Committee and the Board of Directors, after informing the CFO that he is doing so. The Controller could also initiate a confidential discussion with an IMA Ethics Counselor, other impartial adviser, or his/her own attorney. In the extreme, the Controller may want to resign if the corporate culture of Deacon Publishing is to reward executives who take year-end actions that the Controller views as unethical and possibly illegal. It was precisely actions along the lines of (c), (d) and (e) that caused Betty Vinson, an accountant at WorldCom, to be indicted for falsifying WorldCom’s books and misleading investors.
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(40 min.) Global company, ethical challenges.
1. The overarching principles of the IMA Statement of Ethical Professional Practice are Honesty, Fairness, Objectivity and Responsibility. The statement’s corresponding “Standards for Ethical Conduct…” require management accountants to • Perform professional duties in accordance with relevant laws, regulations, and technical standards. • Refrain from engaging in any conduct that would prejudice carrying out duties ethically. • Communicate information fairly and objectively. • Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations. Several of the suggestions made by Hamsen’s staff are clearly in conflict with the statement’s principles and required standards and should be viewed as unacceptable. c. Pressure current customers to take early delivery of goods before the end of the year so that more revenue can be reported on this year’s financial statements. This tactic, commonly known as channel stuffing, merely results in shifting future period revenues into the current period. The overstatement of revenue in the current period may mislead investor’s to believe that the company’s financial well being is better than the actual results achieved. This practice would violate the IMA’s standards of credibility and integrity. Channel stuffing is frequently considered a fraudulent practice. e. Record the executive year-end bonus compensation for the current year in the next year when it is paid until after the December fiscal year-end. Generally Accepted Accounting Principles requires expenses to be recorded (accrued) when incurred, not when paid (cash basis accounting). Therefore, failure to record the executives’ yearend bonus would violate the IMA’s standards of credibility and integrity. f. Recognize sales revenues on orders received, but not shipped as of the end of the year. Generally Accepted Accounting Principles requires income to be recorded (accrued) when the four criteria of revenue recognition have been met: 1.
The company has completed a significant portion of the production and sales effort.
2.
The amount of revenue can by objectively measured.
3.
The major portion of the costs has been incurred, and the remaining costs can be reasonably estimated.
4.
The eventual collection of the cash is reasonably assured.
Because criteria 1 and 3 have not been met at the time the order is placed the revenue should not be recognized until after year-end. Therefore, recording next year’s revenue in the current year would be a violation of Generally Accepted Accounting Principles and would be falsifying revenue. This would be a violation of the IMA’s standards of credibility and integrity and may be considered fraudulent. The other “year-end” actions occur in many organizations and fall into the “gray” to
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“acceptable” area. Much depends on the circumstances surrounding each one, however, such as the following: a. Stop all transatlantic shipping efforts. The start-up costs for the new operations are hurting current profit margins. While this method may result in better short-term financial results for Bredahl, it may do harm to the long-term financial condition of the corporation as a whole. b. Make deep cuts in pricing through the end of the year to generate additional revenue. Again, this is only a short-term tactic to improve this year’s financial results. Investors may be content in the short-run, but in the long run the new shipping company will see reduced margins from these actions. d. Sell-off distribution equipment prior to year-end. The sale would result in one-time gains that could offset the company’s lagging profits. The owned equipment could be replaced with leased equipment at a lower cost in the current year. While this course of action does not necessarily violate the IMA’s code of ethical standards, it may be only a short-term tactic to improve this year’s financial results. Hamsen will need to weigh his options long-term to make the most cost effective decision for his company. g. Establish corporate headquarters in Ireland before the end of the year, lowering the company’s corporate tax rate from 28% to 12.5%. Hamsen may have other legitimate reasons for relocating his company to Ireland, but doing so only to reduce his tax liability would likely be considered an evasion of taxes in the company’s home country. Hamsen should seek the advice of skilled consultants in the area of international tax before making any such move. The company could face large fines and even criminal charges for evading corporate income taxes of the home country. 2. It is possible that any of the “year-end” actions that fall into the “gray” area may be good for investors, depending on the credible evidence which supports the management decision. For example, replacing owned equipment with leased equipment may result in both short-term gains for the company and long-term cost reduction. If so, this decision would be in the best interest of the investors. If the decision only results in short-term gains, but higher costs in the long-run, then the decision may not be in the best long-term interest of the company’s investors and should not be implemented solely to prop up short-term earnings. Those decisions that clearly violate the IMA code of ethical standards (c, e, and f) would never be in the best interest of the investor. These options would result in misleading financial statements and could result in the demise of the company or even in criminal charges, as was the case with companies such as Enron and WorldCom. If Hamsen asks the management accountant to take any of the actions that are clearly unethical, he should raise this issue with the chair of the Audit Committee after informing Hamsen that he is doing so. If Hamsen still insists on the management accountant taking these actions, he should resign rather than engage in unethical behavior.
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CHAPTER 2 AN INTRODUCTION TO COST TERMS AND PURPOSES 2-1 A cost object is anything for which a separate measurement of costs is desired. Examples include a product, a service, a project, a customer, a brand category, an activity, and a department. Direct costs of a cost object are related to the particular cost object and can be traced to 2-2 that cost object in an economically feasible (cost-effective) way. Indirect costs of a cost object are related to the particular cost object but cannot be traced to that cost object in an economically feasible (cost-effective) way. Cost assignment is a general term that encompasses the assignment of both direct costs and indirect costs to a cost object. Direct costs are traced to a cost object while indirect costs are allocated to a cost object. Managers believe that direct costs that are traced to a particular cost object are more 2-3 accurately assigned to that cost object than are indirect allocated costs. When costs are allocated, managers are less certain whether the cost allocation base accurately measures the resources demanded by a cost object. Managers prefer to use more accurate costs in their decisions. 2-4
Factors affecting the classification of a cost as direct or indirect include • the materiality of the cost in question, • available information-gathering technology, • design of operations
2-5 A variable cost changes in total in proportion to changes in the related level of total activity or volume. An example is a sales commission that is a percentage of each sales revenue dollar. A fixed cost remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume. An example is the leasing cost of a machine that is unchanged for a given time period (such as a year) regardless of the number of units of product produced on the machine. 2-6 A cost driver is a variable, such as the level of activity or volume, that causally affects total costs over a given time span. A change in the cost driver results in a change in the level of total costs. For example, the number of vehicles assembled is a driver of the costs of steering wheels on a motor-vehicle assembly line. 2-7 The relevant range is the band of normal activity level or volume in which there is a specific relationship between the level of activity or volume and the cost in question. Costs are described as variable or fixed with respect to a particular relevant range. A unit cost is computed by dividing some amount of total costs (the numerator) by the 2-8 related number of units (the denominator). In many cases, the numerator will include a fixed cost that will not change despite changes in the denominator. It is erroneous in those cases to multiply the unit cost by activity or volume change to predict changes in total costs at different activity or volume levels.
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2-9 Manufacturing-sector companies purchase materials and Ashtonnents and convert them into various finished goods, for example automotive and textile companies. Merchandising-sector companies purchase and then sell tangible products without changing their basic form, for example retailing or distribution. Service-sector companies provide services or intangible products to their customers, for example, legal advice or audits. 2-10
Manufacturing companies have one or more of the following three types of inventory: 1. Direct materials inventory. Direct materials in stock and awaiting use in the manufacturing process. 2. Work-in-process inventory. Goods partially worked on but not yet completed. Also called work in progress. 3. Finished goods inventory. Goods completed but not yet sold.
2-11 Inventoriable costs are all costs of a product that are considered as assets in the balance sheet when they are incurred and that become cost of goods sold when the product is sold. These costs are included in work-in-process and finished goods inventory (they are “inventoried”) to accumulate the costs of creating these assets. Period costs are all costs in the income statement other than cost of goods sold. These costs are treated as expenses of the accounting period in which they are incurred because they are expected not to benefit future periods (because there is not sufficient evidence to conclude that such benefit exists). Expensing these costs immediately best matches expenses to revenues. 2-12 Direct material costs are the acquisition costs of all materials that eventually become part of the cost object (work in process and then finished goods), and can be traced to the cost object in an economically feasible way. Direct manufacturing labor costs include the compensation of all manufacturing labor that can be traced to the cost object (work in process and then finished goods) in an economically feasible way. Manufacturing overhead costs are all manufacturing costs that are related to the cost object (work in process and then finished goods), but cannot be traced to that cost object in an economically feasible way. Prime costs are all direct manufacturing costs (direct material and direct manufacturing labor). Conversion costs are all manufacturing costs other than direct material costs. 2-13 Overtime premium is the wage rate paid to workers (for both direct labor and indirect labor) in excess of their straight-time wage rates. Idle time is a subclassification of indirect labor that represents wages paid for unproductive time caused by lack of orders, machine breakdowns, material shortages, poor scheduling, and the like. 2-14 A product cost is the sum of the costs assigned to a product for a specific purpose. Purposes for computing a product cost include • pricing and product mix decisions, • contracting with government agencies, and • preparing financial statements for external reporting under generally accepted accounting principles. 2-2
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Three common features of cost accounting and cost management are: • calculating the costs of products, services, and other cost objects • obtaining information for planning and control and performance evaluation • analyzing the relevant information for making decisions
2-16
(15 min.) Computing and interpreting manufacturing unit costs.
1. Direct material cost Direct manuf. labor costs Manufacturing overhead costs Total manuf. costs Fixed costs allocated at a rate of $15M ÷ $50M (direct mfg. labor) equal to $0.30 per dir. manuf. labor dollar (0.30 × $16; 26; 8) Variable costs Units produced (millions) Cost per unit (Total manuf. costs ÷ units produced) Variable manuf. cost per unit (Variable manuf. costs ÷ Units produced)
2.
Based on total manuf. cost per unit ($1.2240 × 150; $1.0733 × 190; $0.6571 × 220) Correct total manuf. costs based on variable manuf. costs plus fixed costs equal Variable costs ($1.1856 × 150; $1.0213 × 190; $0.64 × 220) Fixed costs Total costs
Supreme $ 89.00 16.00 48.00 153.00
(in millions) Deluxe $ 57.00 26.00 78.00 161.00
Regular $60.00 8.00 24.00 92.00
Total $206.00 50.00 150.00 406.00
4.80 $148.20 125
7.80 $153.20 150
2.40 $89.60 140
15.00 $391.00
$1.2240
$1.0733
$0.6571
$1.1856
$1.0213
$0.6400
Supreme
(in millions) Deluxe
Regular
Total
$183.60
$203.93
$144.56
$532.09
$177.84
$194.05
$140.80
$512.69 15.00 $527.69
The total manufacturing cost per unit in requirement 1 includes $15 million of indirect manufacturing costs that are fixed irrespective of changes in the volume of output per month, while the remaining variable indirect manufacturing costs change with the production volume. Given the unit volume changes for August 2011, the use of total manufacturing cost per unit from the past month at a different unit volume level (both in aggregate and at the individual product level) will overestimate total costs of $532.09 million in August 2011 relative to the correct total manufacturing costs of $527.69 million calculated using variable manufacturing cost per unit times units produced plus the fixed costs of $15 million.
2-3
2-17 (15 min.) Direct, indirect, fixed and variable costs. 1. Yeast – direct, variable Flour- direct, variable Packaging materials –direct (or could be indirect if small and not traced to each unit), variable Depreciation on ovens –indirect, fixed (unless “units of output” depreciation, which then would be variable) Depreciation on mixing machines–indirect, fixed (unless “units of output” depreciation, which then would be variable) Rent on factory building – indirect, fixed Fire Insurance on factory building–indirect, fixed Factory utilities – indirect, probably some variable and some fixed (e.g. electricity may be variable but heating costs may be fixed) Finishing department hourly laborers – direct, variable (or fixed if the laborers are under a union contract) Mixing department manager – indirect, fixed Materials handlers –depends on how they are paid. If paid hourly and not under union contract, then indirect, variable. If salaried or under union contract then indirect, fixed Custodian in factory –indirect, fixed Night guard in factory –indirect, fixed Machinist (running the mixing machine) –depends on how they are paid. If paid hourly and not under union contract, then indirect, variable. If salaried or under union contract then indirect, fixed Machine maintenance personnel – indirect, probably fixed, if salaried, but may be variable if paid only for time worked and maintenance increases with increased production Maintenance supplies – indirect, variable Cleaning supplies – indirect, most likely fixed since the custodians probably do the same amount of cleaning every night 2. If the cost object is Mixing Department, then anything directly associated with the Mixing Department will be a direct cost. This will include: • Depreciation on mixing machines • Mixing Department manager • Materials handlers (of the Mixing Department) • Machinist (running the mixing machines) • Machine Maintenance personnel (of the Mixing Department) • Maintenance supplies (if separately identified for the Mixing Department) Of course the yeast and flour will also be a direct cost of the Mixing Department, but it is already a direct cost of each kind of bread produced.
2-4
2-18
(15–20 min.) Classification of costs, service sector.
Cost object: Each individual focus group Cost variability: With respect to the number of focus groups There may be some debate over classifications of individual items, especially with regard to cost variability. Cost Item A B C D E F G H
D or I D I I I D I D I
V or F V F Va F V F V Vb
a
Some students will note that phone call costs are variable when each call has a separate charge. It may be a fixed cost if Consumer Focus has a flat monthly charge for a line, irrespective of the amount of usage. b Gasoline costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple purposes, and detailed records may be required to examine how costs vary with changes in one of the many purposes served.
2-19
(15–20 min.) Classification of costs, merchandising sector.
Cost object: Videos sold in video section of store Cost variability: With respect to changes in the number of videos sold There may be some debate over classifications of individual items, especially with regard to cost variability. Cost Item A B C D E F G H
D or I D I D D I I I D
2-5
V or F F F V F F V F V
2-20
(15–20 min.) Classification of costs, manufacturing sector.
Cost object: Type of car assembled (Corolla or Geo Prism) Cost variability: With respect to changes in the number of cars assembled There may be some debate over classifications of individual items, especially with regard to cost variability. Cost Item A B C D E F G H
2-21
D or I D I D D D I D I
V or F V F F F V V V F
(20 min.) Variable costs, fixed costs, total costs.
1. Minutes/month Plan A ($/month) Plan B ($/month) Plan C ($/month)
0 0 15 22
50 100 150 200 240 300 327.5 350 400 450 510 540 600 650 5 10 15 20 24 30 32.75 35 40 45 51 54 60 65 15 15 15 15 15 19.80 22 23.80 27.80 31.80 36.60 39 43.80 47.80 22 22 22 22 22 22 22 22 22 22 22 23.50 26.50 29
60
Total Cost
50 40 Plan A Plan B Plan C
30 20 10 0 0
100
200
300
400
500
600
Number of long-distance minutes
2. In each region, Ashton chooses the plan that has the lowest cost. From the graph (or from calculations)*, we can see that if Ashton expects to use 0–150 minutes of long-distance each month, she should buy Plan A; for 150–327.5 minutes, Plan B; and for over 327.5 minutes, Plan C. If Ashton plans to make 100 minutes of long-distance calls each month, she should choose Plan A; for 240 minutes, choose Plan B; for 540 minutes, choose Plan C. *Let x be the number of minutes when Plan A and Plan B have equal cost $0.10x = $15 x = $15 ÷ $0.10 per minute = 150 minutes. Let y be the number of minutes when Plan B and Plan C have equal cost $15 + $0.08 (y – 240) = $22 $0.08 (y – 240) = $22 – $15 = $7 $7 = 87.5 y – 240 = $0.08 y = 87.5 + 240 = 327.5 minutes
2-6
2-22 1.
(15–20 min.) Variable costs and fixed costs. Variable cost per ton of beach sand mined Subcontractor $ 80 per ton Government tax 50 per ton Total $130 per ton Fixed costs per month 0 to 100 tons of capacity per day 101 to 200 tons of capacity per day 201 to 300 tons of capacity per day
= = =
$150,000 $300,000 $450,000
2. $450,000 Costs $300,000
$650,000
Tota l Fixed
Tota l Va riable C osts
$975,000
$325,000
2,500
5,000
$150,000
100
7,500
Tons Mine d
200
300
Tons of Cap acity p er Day
The concept of relevant range is potentially relevant for both graphs. However, the question does not place restrictions on the unit variable costs. The relevant range for the total fixed costs is from 0 to 100 tons; 101 to 200 tons; 201 to 300 tons, and so on. Within these ranges, the total fixed costs do not change in total. 3. Tons Mined per Day (1) (a) 180
(b) 220
Tons Mined per Month (2) = (1) × 25 4,500
Fixed Unit Cost per Ton (3) = FC ÷ (2) $300,000 ÷ 4,500 = $66.67
Variable Unit Cost per Ton (4) $130
Total Unit Cost per Ton (5) = (3) + (4) $196.67
5,500
$450,000 ÷ 5,500 = $81.82
$130
$211.82
The unit cost for 220 tons mined per day is $211.82, while for 180 tons it is only $196.67. This difference is caused by the fixed cost increment from 101 to 200 tons being spread over an increment of 80 tons, while the fixed cost increment from 201 to 300 tons is spread over an increment of only 20 tons.
2-7
2-23 (20 min.) Variable costs, fixed costs, relevant range. 1. The production capacity is 4,100 jaw breakers per month. Therefore, the current annual relevant range of output is 0 to 4,100 jaw breakers × 12 months = 0 to 49,200 jaw breakers. 2. Current annual fixed manufacturing costs within the relevant range are $1,200 × 12 = $14,400 for rent and other overhead costs, plus $9,000 ÷ 10 = $900 for depreciation, totaling $15,300. The variable costs, the materials, are 30 cents per jaw breaker, or $13,680 ($0.30 per jaw breaker × 3,800 jaw breakers per month × 12 months) for the year. 3. If demand changes from 3,800 to 7,600 jaw breakers per month, or from 3,800 × 12 = 45,600 to 7,600 × 12 = 91,200 jaw breakers per year, Sweetum will need a second machine. Assuming Sweetum buys a second machine identical to the first machine, it will increase capacity from 4,100 jaw breakers per month to 8,200. The annual relevant range will be between 4,100 × 12 = 49,200 and 8,200 × 12 = 98,400 jaw breakers. Assume the second machine costs $9,000 and is depreciated using straight-line depreciation over 10 years and zero residual value, just like the first machine. This will add $900 of depreciation per year. Fixed costs for next year will increase to $16,200 from $15,300 for the current year + $900 (because rent and other fixed overhead costs will remain the same at $14,400). That is, total fixed costs for next year equal $900 (depreciation on first machine) + $900 (depreciation on second machine) + $14,400 (rent and other fixed overhead costs). The variable cost per jaw breaker next year will be 90% × $0.30 = $0.27. Total variable costs equal $0.27 per jaw breaker × 91,200 jaw breakers = $24,624. If Sweetum decides to not increase capacity and meet only that amount of demand for which it has available capacity (4,100 jaw breakers per month or 4,100 × 12 = 49,200 jaw breakers per year), the variable cost per unit will be the same at $0.30 per jaw breaker. Annual total variable manufacturing costs will increase to $0.30 × 4,100 jaw breakers per month × 12 months = $14,760. Annual total fixed manufacturing costs will remain the same, $15,300.
2-8
2-24 (20 min.) Cost drivers and value chain. 1. Identify customer needs (what do smartphone users want?) — Design of products and processes Perform market research on competing brands — Design of products and processes Design a prototype of the HCP smartphone — Design of products and processes Market the new design to cell phone companies — Marketing Manufacture the HCP smartphone — Production Process orders from cell phone companies — Distribution Package the HCP smartphones — Production Deliver the HCP smartphones to the cell phone companies — Distribution Provide online assistance to cell phone users for use of the HCP smartphone — Customer Service Make design changes to the HCP smartphone based on customer feedback — Design of products and processes 2. Value Chain Category Activity Cost driver Identify customer needs Number of surveys returned and processed Design of from competing smartphone users products and processes Perform market research on Hours spent researching competing market competing brands brands Number of surveys returned and processed from competing smartphone users Design a prototype of the HCP Engineering hours spent on initial product smartphone design Make design changes to the Number of design changes smartphone based on customer feedback Production
Manufacture the HCP smartphones Package the HCP smartphones
Machine hours required to run the production equipment Number of smartphones shipped by HCP
Marketing
Market the new design to cell phone companies
Number of cell phone companies purchasing the HCP smartphone
Distribution
Process orders from cell phone companies
Number of smartphone orders processed Number of deliveries made to cell phone companies Number of deliveries made to cell phone companies
Deliver the HCP smartphones to cell phone companies Customer Service
Number of smartphones shipped by HCP Customer Service hours
Provide on-line assistance to cell phone users for use of the HCP smartphone
2-9
2-25
(10–15 min.) Cost drivers and functions.
1. Function 1. Accounting 2. Human Resources 3. Data processing 4. Research and development 5. Purchasing 6. Distribution 7. Billing
Representative Cost Driver Number of transactions processed Number of employees Hours of computer processing unit (CPU) Number of research scientists Number of purchase orders Number of deliveries made Number of invoices sent
Function 1. Accounting 2. Human Resources 3. Data Processing 4. Research and Development 5. Purchasing 6. Distribution 7. Billing
Representative Cost Driver Number of journal entries made Salaries and wages of employees Number of computer transactions Number of new products being developed Number of different types of materials purchased Distance traveled to make deliveries Number of credit sales transactions
2.
2-10
2-26
(20 min.) Total costs and unit costs
1. Number of attendees 0 Variable cost per person ($9 caterer charge – $5 student door fee) $4 Fixed Costs $1,600 Variable costs (number of attendees × variable cost per person) 0 Total costs (fixed + variable) $1,600
100
200
300
400
500
600
$4 $1,600
$4 $1,600
$4 $1,600
$4 $1,600
$4 $1,600
$4 $1,600
400 $2,000
800 $2,400
1,200 $2,800
1,600 $3,200
2,000 $3,600
2,400 $4,000
Fixed, Variable and Total Cost of Graduation Party 5000
Costs ($)
4000
3000
Fixed costs Variable costs Total cost
2000
1000
0 0
100
200
300
400
500
600
Number of attendees
2. Number of attendees Total costs (fixed + variable) Costs per attendee (total costs ÷ number of attendees)
0
100
200
300
400
500
600
$1,600
$2,000
$2,400
$2,800
$3,200
$3,600
$4,000
$20.00
$12.00
$9.33
$ 8.00
$ 7.20
$ 6.67
As shown in the table above, for 100 attendees the total cost will be $2,000 and the cost per attendee will be $20. 3. As shown in the table in requirement 2, for 500 attendees the total cost will be $3,600 and the cost per attendee will be $7.20.
2-11
4. Using the calculations shown in the table in requirement 2, we can construct the cost-perattendee graph shown below:
Cost per Attendee ($)
25 20 15 10 5 0 0
100
200
300
400
500
600
700
Number of Attendees
As president of the student association requesting a grant for the party, you should not use the per unit calculations to make your case. The person making the grant may assume an attendance of 500 students and use a low number like $7.20 per attendee to calculate the size of your grant. Instead, you should emphasize the fixed cost of $1,600 that you will incur even if no students or very few students attend the party, and try to get a grant to cover as much of the fixed costs as possible as well as a variable portion to cover as much of the $4 variable cost to the student association for each person attending the party. 2-27 (25 min.) Total and unit cost, decision making. 1.
Total Manufacturing Costs
$70,000 $60,000
Fixed Costs
$50,000 $40,000
Variable Costs
$30,000 Total Manufacturing Costs
$20,000 $10,000 $0 0
5,000
10,000
Number of Flanges
Note that the production costs include the $28,000 of fixed manufacturing costs but not the $10,000 of period costs. The variable cost is $1 per flange for materials, and $2.80 per flange ($28 per hour divided by 10 flanges per hour) for direct manufacturing labor for a total of $3.80 per flange.
2-12
2. The inventoriable (manufacturing) cost per unit for 5,000 flanges is $3.80 × 5,000 + $28,000 = $47,000 Average (unit) cost = $47,000 ÷ 5,000 units = $9.40 per unit. This is below Flora’s selling price of $10 per flange. However, in order to make a profit, Gayle’s Glassworks also needs to cover the period (non-manufacturing) costs of $10,000, or $10,000 ÷ 5,000 = $2 per unit. Thus total costs, both inventoriable (manufacturing) and period (non-manufacturing), for the flanges is $9.40 + $2 = $11.40. Gayle’s Glassworks cannot sell below Flora’s price of $10 and still make a profit on the flanges. Alternatively, At Flora’s price of $10 per flange: Revenue $10 × 5,000 Variable costs $3.80 × 5,000 Fixed costs Operating loss
= =
$50,000 19,000 38,000 $ (7,000)
Gayle’s Glassworks cannot sell below $10 per flange and make a profit. At Flora’s price of $10 per flange, the company has an operating loss of $7,000. 3. If Gayle’s Glassworks produces 10,000 units, then total inventoriable cost will be: Variable cost ($3.80 × 10,000) + fixed manufacturing costs, $28,000 = total manufacturing costs, $66,000.
Average (unit) inventoriable (manufacturing) cost will be $66,000 ÷ 10,000 units = $6.60 per flange Unit total cost including both inventoriable and period costs will be ($66,000 +$10,000) ÷ 10,000 = $7.60 per flange, and Gayle’s Glassworks will be able to sell the flanges for less than Flora and still make a profit. Alternatively, At Flora’s price of $10 per flange: Revenue $10 × 10,000 Variable costs $3.80 × 10,000 Fixed costs Operating income
= =
$100,000 38,000 38,000 $ 24,000
Gayle’s Glassworks can sell at a price below $10 per flange and still make a profit. The company earns operating income of $24,000 at a price of $10 per flange. The company will earn operating income as long as the price exceeds $7.60 per flange. The reason the unit cost decreases significantly is that inventoriable (manufacturing) fixed costs and fixed period (nonmanufacturing) costs remain the same regardless of the number of units produced. So, as Gayle’s Glassworks produces more units, fixed costs are spread over more units, and cost per unit decreases. This means that if you use unit costs to make decisions about pricing, and which product to produce, you must be aware that the unit cost only applies to a particular level of output. 2-13
2-28
(20–30 min.) Inventoriable costs versus period costs.
1. Manufacturing-sector companies purchase materials and components and convert them into different finished goods. Merchandising-sector companies purchase and then sell tangible products without changing their basic form. Service-sector companies provide services or intangible products to their customers—for example, legal advice or audits. Only manufacturing and merchandising companies have inventories of goods for sale. 2. Inventoriable costs are all costs of a product that are regarded as an asset when they are incurred and then become cost of goods sold when the product is sold. These costs for a manufacturing company are included in work-in-process and finished goods inventory (they are “inventoried”) to build up the costs of creating these assets. Period costs are all costs in the income statement other than cost of goods sold. These costs are treated as expenses of the period in which they are incurred because they are presumed not to benefit future periods (or because there is not sufficient evidence to conclude that such benefit exists). Expensing these costs immediately best matches expenses to revenues. 3. (a) Perrier mineral water purchased for resale by Safeway—inventoriable cost of a merchandising company. It becomes part of cost of goods sold when the mineral water is sold. (b) Electricity used for lighting at GE refrigerator assembly plant—inventoriable cost of a manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a refrigerator finished good. (c) Depreciation on Google’s computer equipment used to update directories of web sites—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. (d) Electricity used to provide lighting for Safeway’s store aisles—period cost of a merchandising company. It is a cost that benefits the current period and it is not traceable to goods purchased for resale. (e) Depreciation on GE’s assembly testing equipment—inventoriable cost of a manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a refrigerator finished good. (f) Salaries of Safeway’s marketing personnel—period cost of a merchandising company. It is a cost that is not traceable to goods purchased for resale. It is presumed not to benefit future periods (or at least not to have sufficiently reliable evidence to estimate such future benefits). (g) Perrier mineral water consumed by Google’s software engineers—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. (h) Salaries of Google’s marketing personnel—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost.
2-14
2-29
(20 min.) Computing cost of goods purchased and cost of goods sold.
1a.
Marvin Department Store Schedule of Cost of Goods Purchased For the Year Ended December 31, 2011 (in thousands)
Purchases Add transportation-in
$155,000 7,000 162,000
Deduct: Purchase returns and allowances Purchase discounts
$4,000 6,000
Cost of goods purchased 1b.
$152,000 Marvin Department Store Schedule of Cost of Goods Sold For the Year Ended December 31, 2011 (in thousands)
Beginning merchandise inventory 1/1/2011 Cost of goods purchased (see above) Cost of goods available for sale Ending merchandise inventory 12/31/2011 Cost of goods sold 2.
10,000
$ 27,000 152,000 179,000 34,000 $145,000
Marvin Department Store Income Statement Year Ended December 31, 2011 (in thousands)
Revenues Cost of goods sold (see above) Gross margin Operating costs Marketing, distribution, and customer service costs Utilities General and administrative costs Miscellaneous costs Total operating costs Operating income
$280,000 145,000 135,000
$37,000 17,000 43,000 4,000 101,000 $ 34,000
2-15
2-30
(20 min.) Cost of goods purchased, cost of goods sold, and income statement.
1a.
Montgomery Retail Outlet Stores Schedule of Cost of Goods Purchased For the Year Ended December 31, 2011 (in thousands)
Purchases Add freight—in
$260,000 10,000 270,000
Deduct: Purchase returns and allowances Purchase discounts
$11,000 9,000
Cost of goods purchased 1b.
$250,000 Montgomery Retail Outlet Stores Schedule of Cost of Goods Sold For the Year Ended December 31, 2011 (in thousands)
Beginning merchandise inventory 1/1/2011 Cost of goods purchased (see above) Cost of goods available for sale Ending merchandise inventory 12/31/2011 Cost of goods sold 2.
20,000
$ 45,000 250,000 295,000 52,000 $243,000
Montgomery Retail Outlet Stores Income Statement Year Ended December 31, 2011 (in thousands)
Revenues Cost of goods sold (see above) Gross margin Operating costs Marketing and advertising costs Building depreciation Shipping of merchandise to customers General and administrative costs Total operating costs Operating income
$320,000 243,000 77,000 $24,000 4,200 2,000 32,000 62,200 $ 14,800
2-16
2-31
(20 min.) Flow of Inventoriable Costs.
(All numbers below are in millions). 1. Direct materials inventory 10/1/2011 Direct materials purchased Direct materials available for production Direct materials used Direct materials inventory 10/31/2011
$
$
2. Total manufacturing overhead costs Subtract: Variable manufacturing overhead costs Fixed manufacturing overhead costs for October 2011 3. Total manufacturing costs Subtract: Direct materials used (from requirement 1) Total manufacturing overhead costs Direct manufacturing labor costs for October 2011 4. Work-in-process inventory 10/1/2011 Total manufacturing costs Work-in-process available for production Subtract: Cost of goods manufactured (moved into FG) Work-in-process inventory 10/31/2011
$ $
105 365 470 (385) 85
450 (265) 185
$ 1,610 (385) (450) $ 775
$
230 1,610 1,840 (1,660) $ 180
5. Finished goods inventory 10/1/2011 Cost of goods manufactured (moved from WIP) Cost of finished goods available for sale in October 2011
130 1,660 $ 1,790
6. Finished goods available for sale in October 2011 (from requirement 5) Subtract: Cost of goods sold Finished goods inventory 10/31/2011
$ 1,790 (1,770) $ 20
2-17
$
2-32 1.
(30–40 min.) Cost of goods manufactured. Canseco Company Schedule of Cost of Goods Manufactured Year Ended December 31, 2011 (in thousands)
Direct materials cost Beginning inventory, January 1, 2011 $ 22,000 Purchases of direct materials 75,000 Cost of direct materials available for use 97,000 Ending inventory, December 31, 2011 26,000 Direct materials used Direct manufacturing labor costs Indirect manufacturing costs Indirect manufacturing labor 15,000 Plant insurance 9,000 Depreciation—plant building & equipment 11,000 Repairs and maintenance—plant 4,000 Total indirect manufacturing costs Manufacturing costs incurred during 2011 Add beginning work-in-process inventory, January 1, 2011 Total manufacturing costs to account for Deduct ending work-in-process inventory, December 31, 2011 Cost of goods manufactured (to Income Statement)
2.
$ 71,000 25,000
39,000 135,000 21,000 156,000 20,000 $136,000
Canseco Company Income Statement Year Ended December 31, 2011 (in thousands)
Revenues Cost of goods sold: Beginning finished goods, January 1, 2011 Cost of goods manufactured Cost of goods available for sale Ending finished goods, December 31, 2011 Cost of goods sold Gross margin Operating costs: Marketing, distribution, and customer-service costs General and administrative costs Total operating costs Operating income
2-18
$300,000 $ 18,000 136,000 154,000 23,000 131,000 169,000 93,000 29,000 122,000 $ 47,000
2-33
(30–40 min.) Cost of goods manufactured, income statement, manufacturing company. Piedmont Corporation Schedule of Cost of Goods Manufactured Year Ended December 31, 2011 (in thousands)
Direct materials costs Beginning inventory, January 1, 2011 $ 65,000 Purchases of direct materials 128,000 Cost of direct materials available for use 193,000 Ending inventory, December 31, 2011 34,000 Direct materials used Direct manufacturing labor costs Indirect manufacturing costs Indirect manufacturing labor 48,000 Indirect materials 14,000 Plant insurance 2,000 Depreciation—plant building & equipment 21,000 Plant utilities 12,000 Repairs and maintenance—plant 8,000 Equipment lease costs 32,000 Total indirect manufacturing costs Manufacturing costs incurred during 2011 Add beginning work-in-process inventory, January 1, 2011 Total manufacturing costs to account for Deduct ending work-in-process inventory, December 31, 2011 Cost of goods manufactured (to Income Statement)
$159,000 106,000
137,000 402,000 83,000 485,000 72,000 $413,000
Piedmont Corporation Income Statement Year Ended December 31, 2011 (in thousands) Revenues Cost of goods sold: Beginning finished goods, January 1, 2011 Cost of goods manufactured Cost of goods available for sale Ending finished goods, December 31, 2011 Cost of goods sold Gross margin Operating costs: Marketing, distribution, and customer-service costs General and administrative costs Total operating costs Operating income
2-19
$600,000 $123,000 413,000 536,000 102,000 434,000 166,000 62,000 34,000 96,000 $ 70,000
2-34
(25–30 min.) Income statement and schedule of cost of goods manufactured. Howell Corporation Income Statement for the Year Ended December 31, 2011 (in millions)
Revenues Cost of goods sold Beginning finished goods, Jan. 1, 2011 Cost of goods manufactured (below) Cost of goods available for sale Ending finished goods, Dec. 31, 2011 Gross margin Marketing, distribution, and customer-service costs Operating income
$950 $ 70 645 715 55
660 290 240 $ 50
Howell Corporation Schedule of Cost of Goods Manufactured for the Year Ended December 31, 2011 (in millions) Direct materials costs Beginning inventory, Jan. 1, 2011 Purchases of direct materials Cost of direct materials available for use Ending inventory, Dec. 31, 2011 Direct materials used Direct manufacturing labor costs Indirect manufacturing costs Indirect manufacturing labor Plant supplies used Plant utilities Depreciation––plant and equipment Plant supervisory salaries Miscellaneous plant overhead Manufacturing costs incurred during 2011 Add beginning work-in-process inventory, Jan. 1, 2011 Total manufacturing costs to account for Deduct ending work-in-process, Dec. 31, 2011 Cost of goods manufactured
2-20
$ 15 325 340 20 $320 100 60 10 30 80 5 35
220 640 10 650 5 $645
2-35
(15–20 min.)
Interpretation of statements (continuation of 2-32).
1. The schedule in 2-34 can become a Schedule of Cost of Goods Manufactured and Sold simply by including the beginning and ending finished goods inventory figures in the supporting schedule, rather than directly in the body of the income statement. Note that the term cost of goods manufactured refers to the cost of goods brought to completion (finished) during the accounting period, whether they were started before or during the current accounting period. Some of the manufacturing costs incurred are held back as costs of the ending work in process; similarly, the costs of the beginning work in process inventory become a part of the cost of goods manufactured for 2011. 2. The sales manager’s salary would be charged as a marketing cost as incurred by both manufacturing and merchandising companies. It is basically an operating cost that appears below the gross margin line on an income statement. In contrast, an assembler’s wages would be assigned to the products worked on. Thus, the wages cost would be charged to Work-in-Process and would not be expensed until the product is transferred through Finished Goods Inventory to Cost of Goods Sold as the product is sold. 3. The direct-indirect distinction can be resolved only with respect to a particular cost object. For example, in defense contracting, the cost object may be defined as a contract. Then, a plant supervisor working only on that contract will have his or her salary charged directly and wholly to that single contract. 4.
Direct materials used = $320,000,000 ÷ 1,000,000 units = $320 per unit Depreciation on plant equipment = $80,000,000 ÷ 1,000,000 units = $80 per unit
5. Direct materials unit cost would be unchanged at $320 per unit. Depreciation cost per unit would be $80,000,000 ÷ 1,200,000 = $66.67 per unit. Total direct materials costs would rise by 20% to $384,000,000 ($320 per unit × 1,200,000 units), whereas total depreciation would be unaffected at $80,000,000. 6. Unit costs are averages, and they must be interpreted with caution. The $320 direct materials unit cost is valid for predicting total costs because direct materials is a variable cost; total direct materials costs indeed change as output levels change. However, fixed costs like depreciation must be interpreted quite differently from variable costs. A common error in cost analysis is to regard all unit costs as one—as if all the total costs to which they are related are variable costs. Changes in output levels (the denominator) will affect total variable costs, but not total fixed costs. Graphs of the two costs may clarify this point; it is safer to think in terms of total costs rather than in terms of unit costs.
2-21
2-36
(25–30 min.) Income statement and schedule of cost of goods manufactured. Calendar Corporation Income Statement for the Year Ended December 31, 2011 (in millions)
Revenues Cost of goods sold Beginning finished goods, Jan. 1, 2011 Cost of goods manufactured (below) Cost of goods available for sale Ending finished goods, Dec. 31, 2011 Gross margin Marketing, distribution, and customer-service costs Operating income (loss)
$355 $ 47 228 275 11
264 91 94 $ (3)
Calendar Corporation Schedule of Cost of Goods Manufactured for the Year Ended December 31, 2011 (in millions) Direct material costs Beginning inventory, Jan. 1, 2011 Direct materials purchased Cost of direct materials available for use Ending inventory, Dec. 31, 2011 Direct materials used Direct manufacturing labor costs Indirect manufacturing costs Plant supplies used Property taxes on plant Plant utilities Indirect manufacturing labor costs Depreciation––plant and equipment Miscellaneous manufacturing overhead costs Manufacturing costs incurred during 2011 Add beginning work-in-process inventory, Jan. 1, 2011 Total manufacturing costs to account for Deduct ending work-in-process inventory, Dec. 31, 2011 Cost of goods manufactured (to income statement)
2-22
$ 32 84 116 8 $108 42 4 2 9 27 6 15
63 213 18 231 3 $228
2-37 1.
2.
(15–20 min.)Terminology, interpretation of statements (continuation of 2-34). Direct materials used Direct manufacturing labor costs Prime costs
$108 million 42 million $150 million
Direct manufacturing labor costs Indirect manufacturing costs Conversion costs
$ 42 million 63 million $105 million
Inventoriable costs (in millions) for Year 2011 Plant utilities Indirect manufacturing labor Depreciation—plant and equipment Miscellaneous manufacturing overhead Direct materials used Direct manufacturing labor Plant supplies used Property tax on plant Total inventoriable costs Period costs (in millions) for Year 2011 Marketing, distribution, and customer-service costs
$ 9 27 6 15 108 42 4 2 $213 $ 94
3. Design costs and R&D costs may be regarded as product costs in case of contracting with a governmental agency. For example, if the Air Force negotiated to contract with Lockheed to build a new type of supersonic fighter plane, design costs and R&D costs may be included in the contract as product costs. 4.
Direct materials used = $108,000,000 ÷ 2,000,000 units = $54 per unit Depreciation on plant and equipment = $6,000,000 ÷ 2,000,000 units = $3 per unit
5. Direct materials unit cost would be unchanged at $108. Depreciation unit cost would be $6,000,000 ÷ 3,000,000 = $2 per unit. Total direct materials costs would rise by 50% to $162,000,000 ($54 per unit × 3,000,000 units). Total depreciation cost of $6,000,000 would remain unchanged. 6. In this case, equipment depreciation is a variable cost in relation to the unit output. The amount of equipment depreciation will change in direct proportion to the number of units produced. (a) Depreciation will be $2 million (2 million × $1) when 2 million units are produced. (b) Depreciation will be $3 million (3 million × $1) when 3 million units are produced.
2-23
2-38
(20 min.) Labor cost, overtime and idle time.
1.(a) Total cost of hours worked at regular rates 44 hours × $20 per hour 43 hours × $20 per hour 48 hours × $20 per hour 46 hours × $20 per hour Minus idle time (3.5 hours × $20 per hour) (6.4 hours × $20 per hour) (5.8 hours × $20 per hour) (2 hours × $20 per hour) Total idle time Direct manufacturing labor costs
$ 880 860 960 920 3,620 70 128 116 40 354 $3,266
(b) Idle time = 17.7 hours × $20 per hour = (c) Overtime and holiday premium. Week 1: Overtime (44 – 40) hours × Premium, $10 per hour Week 2: Overtime (43 – 40) hours × Premium, $10 per hour Week 3: Overtime (48 – 40) hours × Premium, $20 per hour Week 4: Overtime (46 – 40) hours × Premium, $10 per hour Week 4: Holiday 8 hours × 2 days × Premium, $20 per hour Total overtime and holiday premium (d) Total earnings in December Direct manufacturing labor costs Idle time Overtime and holiday premium Total earnings
$ 354 $
40 30 160 60 320 $ 610
$3,266 354 610 $4,230
2. Idle time caused by regular machine maintenance, slow order periods, or unexpected mechanical problems is an indirect cost of the product because it is not related to a specific product. Overtime premium caused by the heavy overall volume of work is also an indirect cost because it is not related to a particular job that happened to be worked on during the overtime hours. If, however, the overtime is the result of a demanding “rush job,” the overtime premium is a direct cost of that job.
2-24
2-39
(30–40 min.) Missing records, computing inventory costs.
1. 2. 3.
Finished goods inventory, 3/31/2011 = $210,000 Work-in-process inventory, 3/31/2011 = $190,000 Direct materials inventory, 3/31/2011 = $85,000
This problem is not as easy as it first appears. These answers are obtained by working from the known figures to the unknowns in the schedule below. The basic relationships between categories of costs are: Manufacturing costs added during the period (given) $840,000 Conversion costs (given) $660,000 Direct materials used = Manufacturing costs added – Conversion costs = $840,000 – $660,000 = $180,000 Cost of goods manufactured = Direct Materials Used × 4 = $180,000 × 4 = $720,000 Schedule of Computations Direct materials, 3/1/2011 (given) $ 25,000 Direct materials purchased (given) 240,000 Direct materials available for use 265,000 Direct materials, 3/31/2011 3= 85,000 Direct materials used 180,000 Conversion costs (given) 660,000 Manufacturing costs added during the period (given) 840,000 Add work in process, 3/1/2011 (given) 70,000 Manufacturing costs to account for 910,000 Deduct work in process, 3/31/2011 2= 190,000 Cost of goods manufactured (4 × $180,000) 720,000 Add finished goods, 3/1/2011 320,000 Cost of goods available for sale 1,040,000 Deduct finished goods, 3/31/2011 1= 210,000 Cost of goods sold (80% × $1,037,500) $830,000 Some instructors may wish to place the key amounts in a Work in Process T-account. This problem can be used to introduce students to the flow of costs through the general ledger (amounts in thousands): Direct Materials BI 25 Purch 240 DM used 180 EI 85
Work in Process BI 70 DM used COGM 720 (840–660) 180 Conversion 660 To account for 910 EI
190
BI
Available for sale EI
2-25
Finished Goods 320 720 COGS 830
1,040 210
Cost of Goods Sold 830
2-40
(30 min.) Comprehensive problem on unit costs, product costs.
1. If 2 pounds of direct materials are used to make each unit of finished product, 123,000 units × 2 lbs., or 246,000 lbs. were used at $0.60 per pound of direct materials ($147,600 ÷ 246,000 lbs.). (The direct material costs of $147,600 are direct materials used, not purchased.) Therefore, the ending inventory of direct materials is 2,400 lbs. × $0.60 = $1,440. 2. Direct materials costs Direct manufacturing labor costs Plant energy costs Indirect manufacturing labor costs Other indirect manufacturing costs Cost of goods manufactured
Manufacturing Costs for 123,000 units Fixed Total Variable $147,600 $ – $147,600 38,400 – 38,400 2,000 – 2,000 14,000 19,000 33,000 14,000 25,000 11,000 $33,000 $246,000 $213,000
Average unit manufacturing cost:
$246,000 ÷ 123,000 units = $2.00 per unit $26,000 (given) = $2.00 per unit = 13,000 units
Finished goods inventory in units:
3.
Units sold in 2011 = Beginning inventory + Production – Ending inventory = 0 + 123,000 –13,000 = 110,000 units Selling price in 2011 = $594,000 ÷ 110,000 = $5.40 per unit
4. Denver Office Equipment Income Statement Year Ended December 31, 2011 (in thousands)
Revenues (110,000 units sold × $5.40) Cost of units sold: Beginning finished goods, Jan. 1, 2011 Cost of goods manufactured Cost of goods available for sale Ending finished goods, Dec. 31, 2011 Gross margin Operating costs: Marketing, distribution, and customer-service costs Administrative costs Operating income
2-26
$594,000 $ 0 246,000 246,000 26,000
176,000 56,000
220,000 374,000
232,000 $142,000
Note: Although not required, the full set of unit variable costs is: Direct materials cost Direct manufacturing labor cost Plant energy cost Indirect manufacturing labor cost Other indirect manufacturing cost
$1.200 0.312 0.016 0.114 0.089
Marketing, distribution, and customer-service costs
$1.041 per unit sold
2-27
= $1.731 per unit manufactured
2-41
1.
(20-25 min.) Classification of costs; ethics. Warehousing costs Units produced $3, 250, 000 = = $16.25 per unit. 200, 000 units
Warehousing costs per unit =
If the $3,250,000 is treated as period costs, the entire amount would be expensed during the year as incurred. If it is treated as a product cost, it would be “unitized” at $16.25 per unit and expensed as each unit of the product is sold. Therefore, if only 180,000 of the 200,000 units are sold, only $2,925,000 ($16.25 per unit × 180,000 units) of the $3,250,000 would be expensed in the current period. The remaining $3,250,000 – $2,925,000 = $325,000 would be inventoried on the balance sheet until a later period when the units are sold. The value of finished goods inventory can also be calculated directly to be $325,000 ($16.25 per unit × 20,000 units). 2. No. With respect to classifying costs as product or period costs, this determination is made by Generally Accepted Accounting Principles (GAAP). It is not something that can be justified by the plant manager or plant controller. Even though these costs are in fact related to the product, they are not direct costs of manufacturing the product. GAAP requires that research and development, as well as all costs related to warehousing and distribution of goods be classified as period costs, and be expensed in the period they are incurred. 3.
Scott Hewitt would improve his personal bonus and take-home pay by 10% × $325,000 = $32,500
4. The controller should not reclassify costs as product costs just so the plant can reap shortterm benefits, including the increase in Hewitt’s personal year-end bonus. Research and development costs, costs related to the shipping of finished goods and costs related to warehousing finished goods are all period costs under generally accepted accounting principles, and must be treated as such. Changing this classification on Old World’s financial statements would violate generally accepted accounting principles and would likely be considered fraudulent. The idea of costs being classified as product costs versus period costs is to properly reflect on the income statement those costs that are directly related to manufacturing (costs incurred to transform one asset, direct materials into another asset, finished goods) and to properly reflect on the balance sheet those costs that will provide a future benefit (inventory). The controller should not be intimidated by Hewitt. Hewitt stands to personally benefit from the reclassification of costs. The controller should insist that he must adhere to generally accepted accounting principles so as not to submit fraudulent financial statements to corporate headquarters. If Hewitt insists on the reclassification, the controller should raise the issue with the chief financial officer after informing Hewitt that he is doing so. If, after taking all these steps, there is continued pressure to modify the numbers, the controller should consider resigning from the company rather than engage in unethical behavior.
2-28
2-42
(20–25 min.) Finding unknown amounts.
Let G = given, I = inferred Step 1: Use gross margin formula Revenues Cost of goods sold Gross margin
Case 1 $ 32,000 G A 20,700 I $ 11,300 G
Case 2 $31,800 G 20,000 G C $11,800 I
Step 2: Use schedule of cost of goods manufactured formula Direct materials used Direct manufacturing labor costs Indirect manufacturing costs Manufacturing costs incurred Add beginning work in process, 1/1 Total manufacturing costs to account for Deduct ending work in process, 12/31 Cost of goods manufactured
$ 8,000 G 3,000 G 7,000 G 18,000 I 0G 18,000 I 0G $ 18,000 I
$ 12,000 G 5,000 G D 6,500 I 23,500 I 800 G 24,300 I 3,000 G $ 21,300 I
$ 4,000 G 18,000 I 22,000 I B1,300 I $ 20,700 I
$ 4,000 G 21,300 I 25,300 I 5,300 G $ 20,000 G
Step 3: Use cost of goods sold formula Beginning finished goods inventory, 1/1 Cost of goods manufactured Cost of goods available for sale Ending finished goods inventory, 12/31 Cost of goods sold For case 1, do steps 1, 2, and 3 in order. For case 2, do steps 1, 3, and then 2.
2-29
CHAPTER 3 COST-VOLUME-PROFIT ANALYSIS NOTATION USED IN CHAPTER 3 SOLUTIONS SP: Selling price VCU: Variable cost per unit CMU: Contribution margin per unit FC: Fixed costs TOI: Target operating income 3-1 Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the units sold, selling price, variable cost per unit, or fixed costs of a product. 3-2 1. 2. 3. 4.
The assumptions underlying the CVP analysis outlined in Chapter 3 are Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units sold. Total costs can be separated into a fixed component that does not vary with the units sold and a variable component that changes with respect to the units sold. When represented graphically, the behaviors of total revenues and total costs are linear (represented as a straight line) in relation to units sold within a relevant range and time period. The selling price, variable cost per unit, and fixed costs are known and constant.
3-3 Operating income is total revenues from operations for the accounting period minus cost of goods sold and operating costs (excluding income taxes): Costs of goods sold and operating Operating income = Total revenues from operations – costs (excluding income taxes) Net income is operating income plus nonoperating revenues (such as interest revenue) minus nonoperating costs (such as interest cost) minus income taxes. Chapter 3 assumes nonoperating revenues and nonoperating costs are zero. Thus, Chapter 3 computes net income as: Net income = Operating income – Income taxes 3-4 Contribution margin is the difference between total revenues and total variable costs. Contribution margin per unit is the difference between selling price and variable cost per unit. Contribution-margin percentage is the contribution margin per unit divided by selling price. 3-5 Three methods to express CVP relationships are the equation method, the contribution margin method, and the graph method. The first two methods are most useful for analyzing operating income at a few specific levels of sales. The graph method is useful for visualizing the effect of sales on operating income over a wide range of quantities sold.
3-1
3-6 Breakeven analysis denotes the study of the breakeven point, which is often only an incidental part of the relationship between cost, volume, and profit. Cost-volume-profit relationship is a more comprehensive term than breakeven analysis. 3-7 CVP certainly is simple, with its assumption of output as the only revenue and cost driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic depends on the decision context. In some cases, these assumptions may be sufficiently accurate for CVP to provide useful insights. The examples in Chapter 3 (the software package context in the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can provide such insights. In more complex cases, the basic ideas of simple CVP analysis can be expanded. 3-8 An increase in the income tax rate does not affect the breakeven point. Operating income at the breakeven point is zero, and no income taxes are paid at this point. 3-9 Sensitivity analysis is a “what-if” technique that managers use to examine how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes. The advent of the electronic spreadsheet has greatly increased the ability to explore the effect of alternative assumptions at minimal cost. CVP is one of the most widely used software applications in the management accounting area. 3-10
Examples include: Manufacturing––substituting a robotic machine for hourly wage workers. Marketing––changing a sales force compensation plan from a percent of sales dollars to a fixed salary. Customer service––hiring a subcontractor to do customer repair visits on an annual retainer basis rather than a per-visit basis.
3-11
Examples include: Manufacturing––subcontracting a component to a supplier on a per-unit basis to avoid purchasing a machine with a high fixed depreciation cost. Marketing––changing a sales compensation plan from a fixed salary to percent of sales dollars basis. Customer service––hiring a subcontractor to do customer service on a per-visit basis rather than an annual retainer basis.
3-12 Operating leverage describes the effects that fixed costs have on changes in operating income as changes occur in units sold, and hence, in contribution margin. Knowing the degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes. 3-13 CVP analysis is always conducted for a specified time horizon. One extreme is a very short-time horizon. For example, some vacation cruises offer deep price discounts for people who offer to take any cruise on a day’s notice. One day prior to a cruise, most costs are fixed. The other extreme is several years. Here, a much higher percentage of total costs typically is variable.
3-2
CVP itself is not made any less relevant when the time horizon lengthens. What happens is that many items classified as fixed in the short run may become variable costs with a longer time horizon. 3-14 A company with multiple products can compute a breakeven point by assuming there is a constant sales mix of products at different levels of total revenue. 3-15 Yes, gross margin calculations emphasize the distinction between manufacturing and nonmanufacturing costs (gross margins are calculated after subtracting variable and fixed manufacturing costs). Contribution margin calculations emphasize the distinction between fixed and variable costs. Hence, contribution margin is a more useful concept than gross margin in CVP analysis. 3-16
a. b. c. d. 3-17
(10 min.) CVP computations. Revenues $2,000 2,000 1,000 1,500
Variable Costs $ 500 1,500 700 900
Fixed Costs $300 300 300 300
Total Costs $ 800 1,800 1,000 1,200
Operating Income $1,200 200 0 300
Contribution Margin $1,500 500 300 600
Contribution Margin % 75.0% 25.0% 30.0% 40.0%
(10–15 min.) CVP computations. 1a.
Sales ($68 per unit × 410,000 units) Variable costs ($60 per unit × 410,000 units) Contribution margin
$27,880,000 24,600,000 $ 3,280,000
1b.
Contribution margin (from above) Fixed costs Operating income
$3,280,000 1,640,000 $1,640,000
2a.
Sales (from above) Variable costs ($54 per unit × 410,000 units) Contribution margin
$27,880,000 22,140,000 $ 5,740,000
2b.
Contribution margin Fixed costs Operating income
$5,740,000 5,330,000 $ 410,000
3. Operating income is expected to decrease by $1,230,000 ($1,640,000 − $410,000) if Ms. Schoenen’s proposal is accepted. The management would consider other factors before making the final decision. It is likely that product quality would improve as a result of using state of the art equipment. Due to increased automation, probably many workers will have to be laid off. Garrett’s management will have to consider the impact of such an action on employee morale. In addition, the proposal increases the company’s fixed costs dramatically. This will increase the company’s operating leverage and risk. 3-3
3-18
(35–40 min.) CVP analysis, changing revenues and costs.
1a.
SP VCU CMU FC
= 6% × $1,500 = $90 per ticket = $43 per ticket = $90 – $43 = $47 per ticket = $23,500 a month
Q
=
FC $23,500 = $47 per ticket CMU
= 500 tickets 1b.
Q
=
FC + TOI $23,500 + $17,000 = $47 per ticket CMU
=
$40,500 $47 per ticket
= 862 tickets (rounded up) 2a.
SP VCU CMU FC
= $90 per ticket = $40 per ticket = $90 – $40 = $50 per ticket = $23,500 a month
Q
=
FC $23,500 = $50 per ticket CMU
= 470 tickets 2b.
Q
=
FC + TOI $23,500 + $17,000 = $50 per ticket CMU
=
$40,500 $50 per ticket
= 810 tickets 3a.
SP VCU CMU FC Q
= $60 per ticket = $40 per ticket = $60 – $40 = $20 per ticket = $23,500 a month FC $23,500 = $20 per ticket CMU = 1,175 tickets =
3-4
3b.
Q
=
FC + TOI $23,500 + $17,000 = $20 per ticket CMU
=
$40,500 $20 per ticket
= 2,025 tickets The reduced commission sizably increases the breakeven point and the number of tickets required to yield a target operating income of $17,000:
Breakeven point Attain OI of $10,000
6% Commission (Requirement 2) 470 810
Fixed Commission of $60 1,175 2,025
4a. The $5 delivery fee can be treated as either an extra source of revenue (as done below) or as a cost offset. Either approach increases CMU $5: SP VCU CMU FC
= $65 ($60 + $5) per ticket = $40 per ticket = $65 – $40 = $25 per ticket = $23,500 a month
Q
=
FC $23,500 = $25 per ticket CMU
= 940 tickets 4b.
Q
=
FC + TOI $23,500 + $17,000 = $25 per ticket CMU
=
$40,500 $25 per ticket
= 1,620 tickets The $5 delivery fee results in a higher contribution margin which reduces both the breakeven point and the tickets sold to attain operating income of $17,000.
3-5
3-19
(20 min.) CVP exercises.
Orig. 1. 2. 3. 4. 5. 6. 7. 8.
Revenues
Variable Costs
Contribution Margin
Fixed Costs
Budgeted Operating Income
$10,000,000G 10,000,000 10,000,000 10,000,000 10,000,000 10,800,000e 9,200,000g 11,000,000i 10,000,000
$8,000,000G 7,800,000 8,200,000 8,000,000 8,000,000 8,640,000f 7,360,000h 8,800,000j 7,600,000l
$2,000,000 2,200,000a 1,800,000b 2,000,000 2,000,000 2,160,000 1,840,000 2,200,000 2,400,000
$1,800,000G 1,800,000 1,800,000 1,890,000c 1,710,000d 1,800,000 1,800,000 1,980,000k 1,890,000m
$200,000 400,000 0 110,000 290,000 360,000 40,000 220,000 510,000
Gstands for given.
a$2,000,000 × 1.10; b$2,000,000 × 0.90; c$1,800,000 × 1.05; d$1,800,000 × 0.95; e$10,000,000 × 1.08; f$8,000,000 × 1.08; g$10,000,000 × 0.92; h$8,000,000 × 0.92; i$10,000,000 × 1.10; j$8,000,000 × 1.10; k$1,800,000 × 1.10; l$8,000,000 × 0.95; m$1,800,000 × 1.05
3-20
(20 min.) CVP exercises.
1a.
[Units sold (Selling price – Variable costs)] – Fixed costs = Operating income [5,000,000 ($0.50 – $0.30)] – $900,000 = $100,000
1b.
Fixed costs ÷ Contribution margin per unit = Breakeven units $900,000 ÷ [($0.50 – $0.30)] = 4,500,000 units Breakeven units × Selling price = Breakeven revenues 4,500,000 units × $0.50 per unit = $2,250,000 or, Selling price -Variable costs Contribution margin ratio = Selling price $0.50 - $0.30 = 0.40 = $0.50 Fixed costs ÷ Contribution margin ratio = Breakeven revenues $900,000 ÷ 0.40 = $2,250,000
2.
5,000,000 ($0.50 – $0.34) – $900,000
= $ (100,000)
3.
[5,000,000 (1.1) ($0.50 – $0.30)] – [$900,000 (1.1)]
= $ 110,000
4.
[5,000,000 (1.4) ($0.40 – $0.27)] – [$900,000 (0.8)]
= $ 190,000
5.
$900,000 (1.1) ÷ ($0.50 – $0.30)
=
4,950,000 units
6.
($900,000 + $20,000) ÷ ($0.55 – $0.30)
=
3,680,000 units
3-6
3-21
(10 min.) CVP analysis, income taxes.
1. Monthly fixed costs = $48,200 + $68,000 + $13,000 = Contribution margin per unit = $27,000 – $23,000 – $600 = Monthly fixed costs $129,200 = = Breakeven units per month = Contribution margin per unit $3,400 per car
$129,200 $ 3,400
2. Tax rate Target net income
40% $51,000
38 cars
Target net income $51,000 $51,000 = = = $85,000 1 - tax rate (1 − 0.40) 0.60 Quantity of output units Fixed costs + Target operating income $129, 200 + $85,000 = = 63 cars required to be sold = Contribution margin per unit $3, 400 Target operating income =
3-22
(20–25 min.) CVP analysis, income taxes.
1. Variable cost percentage is $3.40 ÷ $8.50 = 40% Let R = Revenues needed to obtain target net income
R – 0.40R – $459,000 =
$107,100 1 − 0.30
0.60R = $459,000 + $153,000 R = $612,000 ÷ 0.60 R = $1,020,000 Fixed costs + Target operating income Contribution margin percentage Target net income $107,100 Fixed costs + $459, 000 + 1 − Tax rate 1 − 0.30 = $1, 020, 000 Target revenues = = Contribution margin percentage 0.60 or, Target revenues =
Proof:
2.a.
Revenues Variable costs (at 40%) Contribution margin Fixed costs Operating income Income taxes (at 30%) Net income
$1,020,000 408,000 612,000 459,000 153,000 45,900 $ 107,100
Customers needed to break even: Contribution margin per customer = $8.50 – $3.40 = $5.10 Breakeven number of customers = Fixed costs ÷ Contribution margin per customer = $459,000 ÷ $5.10 per customer = 90,000 customers 3-7
2.b.
Customers needed to earn net income of $107,100: Total revenues ÷ Sales check per customer $1,020,000 ÷ $8.50 = 120,000 customers
3.
Using the shortcut approach: Change in net income
New net income
Unit ⎛ Change in ⎞ ⎛ ⎞ = ⎜ number of ⎟ × ⎜ contribution ⎟ × (1 − Tax rate ) ⎜ customers ⎟ ⎜ margin ⎟ ⎝ ⎠ ⎝ ⎠ = (170,000 – 120,000) × $5.10 × (1 – 0.30) = $255,000 × 0.7 = $178,500 = $178,500 + $107,100 = $285,600
Alternatively, with 170,000 customers, Operating income = Number of customers × Selling price per customer – Number of customers × Variable cost per customer – Fixed costs = 170,000 × $8.50 – 170,000 × $3.40 – $459,000 = $408,000 Net income = Operating income × (1 – Tax rate) = $408,000 × 0.70 = $285,600 The alternative approach is: Revenues, 170,000 × $8.50 Variable costs at 40% Contribution margin Fixed costs Operating income Income tax at 30% Net income
$1,445,000 578,000 867,000 459,000 408,000 122,400 $ 285,600
3-23
(30 min.) CVP analysis, sensitivity analysis.
1.
SP = $30.00 × (1 – 0.30 margin to bookstore) = $30.00 × 0.70 = $21.00 VCU = $ 4.00 variable production and marketing cost 3.15 variable author royalty cost (0.15 × $21.00) $ 7.15 CMU = $21.00 – $7.15 = $13.85 per copy FC = $ 500,000 fixed production and marketing cost 3,000,000 up-front payment to Washington $3,500,000
3-8
Solution Exhibit 3-23A shows the PV graph.
SOLUTION EXHIBIT 3-23A PV Graph for Media Publishers
$4,000
FC = $3,500,000 CMU = $13.85 per book sold
3,000
Operating income (000’s)
2,000
1,000
0
Units sold 100,000
200,000
-1,000
300,000
400,000
252,708 units
-2,000
-3,000
$3.5 million
-4,000
2a. Breakeven FC = number of units CMU $3,500,000 = $13.85 = 252,708 copies sold (rounded up) 2b.
Target OI =
FC + OI CMU
$3,500,000 + $2,000,000 $13.85 $5,500,000 = $13.85 = 397,112 copies sold (rounded up) =
3-9
500,000
3a. Decreasing the normal bookstore margin to 20% of the listed bookstore price of $30 has the following effects: = $30.00 × (1 – 0.20) = $30.00 × 0.80 = $24.00 VCU = $ 4.00 variable production and marketing cost + 3.60 variable author royalty cost (0.15 × $24.00) $ 7.60
SP
CMU = $24.00 – $7.60 = $16.40 per copy Breakeven FC = number of units CMU $3,500,000 = $16.40 = 213,415 copies sold (rounded up) The breakeven point decreases from 252,708 copies in requirement 2 to 213,415 copies. 3b. Increasing the listed bookstore price to $40 while keeping the bookstore margin at 30% has the following effects: = $40.00 × (1 – 0.30) = $40.00 × 0.70 = $28.00 VCU = $ 4.00 variable production and marketing cost + 4.20 variable author royalty cost (0.15 × $28.00) $ 8.20 SP
CMU= $28.00 – $8.20 = $19.80 per copy Breakeven $3,500,000 number of units = $19.80 = 176,768 copies sold (rounded up) The breakeven point decreases from 252,708 copies in requirement 2 to 176,768 copies. 3c. The answers to requirements 3a and 3b decrease the breakeven point relative to that in requirement 2 because in each case fixed costs remain the same at $3,500,000 while the contribution margin per unit increases.
3-10
(10 min.) CVP analysis, margin of safety. Fixed costs 1. Breakeven point revenues = Contribution margin percentage $660,000 = 0.60 or 60% Contribution margin percentage = $1,100,000 Selling price − Variable cost per unit 2. Contribution margin percentage = Selling price SP − $16 0.60 = SP 0.60 SP = SP – $16 0.40 SP = $16 SP = $40 3. Breakeven sales in units = Revenues ÷ Selling price = $1,100,000 ÷ $40 = 27,500 units Margin of safety in units = Sales in units – Breakeven sales in units = 95,000 – 27,500 = 67,500 units
3-24
Revenues, 95,000 units × $40 Breakeven revenues Margin of safety
$3,800,000 1,100,000 $2,700,000
3-25
(25 min.) Operating leverage.
1a.
Let Q denote the quantity of carpets sold Breakeven point under Option 1 $500Q − $350Q = $5,000 $150Q = $5,000 Q = $5,000 ÷ $150 = 34 carpets (rounded up)
1b.
2.
Breakeven point under Option 2 $500Q − $350Q − (0.10 × $500Q) 100Q Q
= = =
0 0 0
Operating income under Option 1 = $150Q − $5,000 Operating income under Option 2 = $100Q
Find Q such that $150Q − $5,000 = $100Q $50Q = $5,000 Q = $5,000 ÷ $50 = 100 carpets Revenues = $500 × 100 carpets = $50,000 For Q = 100 carpets, operating income under both Option 1 ($150 × 100 – $5,000) and Option 2 ($100 × 100) = $10,000
3-11
For Q > 100, say, 101 carpets, Option 1 gives operating income = ($150 × 101) − $5,000 = $10,150 = $10,100 Option 2 gives operating income = $100 × 101 So Color Rugs will prefer Option 1. For Q < 100, say, 99 carpets, Option 1 gives operating income = ($150 × 99) − $5,000 = $9,850 Option 2 gives operating income = $100 × 99 = $9,900 So Color Rugs will prefer Option 2. 3.
Contribution margin Operating income Contribution margin per unit × Quantity of carpets sold = Operating income Under Option 1, contribution margin per unit = $500 – $350, so $150 × 100 Degree of operating leverage = = 1.5 $10,000 Under Option 2, contribution margin per unit = $500 – $350 – 0.10 × $500, so $100 × 100 Degree of operating leverage = = 1.0 $10,000 Degree of operating leverage =
4. The calculations in requirement 3 indicate that when sales are 100 units, a percentage change in sales and contribution margin will result in 1.5 times that percentage change in operating income for Option 1, but the same percentage change in operating income for Option 2. The degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes.
3-12
3-26
(15 min.) CVP analysis, international cost structure differences.
Variable Variable Sales Price Annual Manufacturing Marketing and Contribution to Retail Fixed Cost per Distribution Cost Margin Breakeven Breakeven Country Outlets Costs Rug per Rug Per Rug Units Revenues (1) (2) (3) (4) (5)=(1)–(3)–(4) (6)=(2) ÷ (5) (6) × (1) Singapore $250.00 $ 9,000,000 $75.00 $25.00 $150.00 60,000 $15,000,000 Brazil $250.00 8,400,000 60.00 15.00 175.00 48,000 12,000,000 United States $250.00 12,400,000 82.50 12.50 155.00 80,000 20,000,000
Requirement 1
Operating Income for Budgeted Sales of 75,000 Rugs (7)=[75,000 × (5)]–(2) $2,250,000 4,725,000 (775,000)
Requirement 2
Brazil has the lowest breakeven point since it has both the lowest fixed costs ($8,400,000) and the lowest variable cost per unit ($75.00). Hence, for a given selling price, Brazil will always have a higher operating income (or a lower operating loss) than Singapore or the U.S. The U.S. breakeven point is 80,000 units. Hence, with sales of only 75,000 units, it has an operating loss of $775,000.
3-13
3-27
(30 min.) Sales mix, new and upgrade customers.
1. SP VCU CMU
New Customers $275 100 175
Upgrade Customers $100 50 50
The 60%/40% sales mix implies that, in each bundle, 3 units are sold to new customers and 2 units are sold to upgrade customers. Contribution margin of the bundle = 3 × $175 + 2 × $50 = $525 + $100 = $625 $15, 000, 000 Breakeven point in bundles = = 24,000 bundles $625 Breakeven point in units is: 72,000 units Sales to new customers: 24,000 bundles × 3 units per bundle Sales to upgrade customers: 24,000 bundles × 2 units per bundle 48,000 units Total number of units to breakeven (rounded) 120,000 units Alternatively, Let S = Number of units sold to upgrade customers 1.5S = Number of units sold to new customers Revenues – Variable costs – Fixed costs = Operating income [$275 (1.5S) + $100S] – [$100 (1.5S) + $50S] – $15,000,000 = OI $512.5S – $200S – $15,000,000 = OI Breakeven point is 120,000 units when OI = $0 because $312.5S = $15,000,000 S = 48,000 units sold to upgrade customers 1.5S = 72,000 units sold to new customers BEP = 120,000 units
Check Revenues ($275 × 72,000) + ($100 × 48,000) Variable costs ($100 × 72,000) + ($50 × 48,000) Contribution margin Fixed costs Operating income
3-14
$24,600,000 9,600,000 15,000,000 15,000,000 $ 0
2.
When 220,000 units are sold, mix is: Units sold to new customers (60% × 220,000) Units sold to upgrade customers (40% × 220,000) Revenues ($275 × 132,000) + ($100 × 88,000) Variable costs ($100 × 132,000) + ($50 × 88,000) Contribution margin Fixed costs Operating income
3a.
132,000 88,000 $45,100,000 17,600,000 27,500,000 15,000,000 $12,500,000
At New 40%/Upgrade 60% mix, each bundle contains 2 units sold to new customers and 3 units sold to upgrade customers. Contribution margin of the bundle = 2 × $175 + 3 × $50 = $350 + $150 = $500 $15, 000, 000 = 30,000 bundles Breakeven point in bundles = $500 Breakeven point in units is: Sales to new customers: 30,000 bundles × 2 unit per bundle 60,000 units Sales to upgrade customers: 30,000 bundles × 3 unit per bundle 90,000 units Total number of units to breakeven 150,000 units Alternatively, = Number of units sold to new customers Let S then 1.5S = Number of units sold to upgrade customers [$275S + $100 (1.5S)] – [$100S + $50 (1.5S)] – $15,000,000 = OI = $15,000,000 425S – 175S 250S = $15,000,000 S = 60,000 units sold to new customers 1.5S = 90,000 units sold to upgrade customers BEP = 150,000 units Check Revenues ($275 × 60,000) + ($100 × 90,000) $25,500,000 10,500,000 Variable costs ($100 × 60,000) + ($50 × 90,000) Contribution margin 15,000,000 Fixed costs 15,000,000 Operating income $ 0
3b. At New 80%/ Upgrade 20% mix, each bundle contains 4 units sold to new customers and 1 unit sold to upgrade customers. Contribution margin of the bundle = 4 × $175 + 1 × $50 = $700 + $50 = $750 $15, 000, 000 = 20,000 bundles Breakeven point in bundles = $750 Breakeven point in units is: Sales to new customers: 80,000 units 20,000 bundles × 4 units per bundle 20,000 units Sales to upgrade customers: 20,000 bundles × 1 unit per bundle Total number of units to breakeven 100,000 units 3-15
Alternatively, Let S = Number of units sold to upgrade customers then 4S= Number of units sold to new customers [$275 (4S) + $100S] – [$100 (4S) + $50S] – $15,000,000 = OI 1,200S – 450S = $15,000,000 750S = $15,000,000 S = 20,000 units sold to upgrade customers 4S = 80,000 units sold to new customers 100,000 units Check Revenues ($275 × 80,000) + ($100 × 20,000) Variable costs ($100 × 80,000) + ($50 × 20,000) Contribution margin Fixed costs Operating income
$24,000,000 9,000,000 15,000,000 15,000,000 $ 0
3c. As Data increases its percentage of new customers, which have a higher contribution margin per unit than upgrade customers, the number of units required to break even decreases:
Requirement 3(a) Requirement 1 Requirement 3(b)
New Customers 40% 60 80
3-16
Upgrade Customers 60% 40 20
Breakeven Point 150,000 120,000 100,000
3-28
(30 min.) Sales mix, three products.
1.
Coffee $2.50 1.25 $1.25
SP VCU CMU
Bagels $3.75 1.75 $2.00
The sales mix implies that each bundle consists of 4 cups of coffee and 1 bagel. Contribution margin of the bundle = 4 × $1.25 + 1 × $2 = $5.00 + $2.00 = $7.00 Breakeven point in bundles =
Fixed costs $7, 000 = = 1, 000 bundles Contribution margin per bundle $7.00
Breakeven point is: Coffee: 1,000 bundlex × 4 cups per bundle = 4,000 cups Bagels: 1,000 bundles × 1 bagel per bundle = 1,000 bagels Alternatively, Let S = Number of bagels sold 4S = Number of cups of coffee sold Revenues – Variable costs – Fixed costs = Operating income [$2.50(4S) + $3.75S] – [$1.25(4S) + $1.75S] – $7,000 = OI $13.75S – $6.75S – $7,000 = OI $7.00 S=$7,000 S = 1,000 units of the sales mix or S =1,000 bagels sold 4S=4,000 cups of coffee sold Breakeven point, therefore, is 1,000 bagels and 4,000 cups of coffee when OI = 0 Check Revenues ($2.50 × 4,000) + ($3.75 × 1,000) Variable costs ($1.25 × 4,000) + ($1.75 × 1,000) Contribution margin Fixed costs Operating income
2. SP VCU CMU
Coffee $2.50 1.25 $1.25
$13,750 6,750 7,000 7,000 $ 0
Bagels $3.75 1.75 $2.00
The sales mix implies that each bundle consists of 4 cups of coffee and 1 bagel. Contribution margin of the bundle = 4 × $1.25 + 1 × $2 = $5.00 + $2.00 = $7.00 Breakeven point in bundles 3-17
=
Fixed costs + Target operating income $7, 000 + $28, 000 = = 5, 000 bundles Contribution margin per bundle $7.00
Breakeven point is: Coffee: 5,000 bundles × 4 cups per bundle = 20,000 cups Bagels: 5,000 bundles × 1 bagel per bundle = 5,000 bagels Alternatively, Let S = Number of bagels sold 4S = Number of cups of coffee sold Revenues – Variable costs – Fixed costs = Operating income [$2.50(4S) + $3.75S] – [$1.25(4S) + $1.75S] – $7,000 = OI [$2.50(4S) + $3.75S] – [$1.25(4S) + $1.75S] – $7,000 = 28,000 $13.75S – $6.75S = 35,000 $7.00 S=$35,000 S = 5,000 units of the sales mix or S =5,000 bagels sold 4S=20,000 cups of coffee sold The target number of units to reach an operating income before tax of $28,000 is 5,000 bagels and 20,000 cups of coffee. Check Revenues ($2.50 × 20,000) + ($3.75 × 5,000) Variable costs ($1.25 × 20,000) + ($1.75 × 5,000) Contribution margin Fixed costs Operating income
3. SP VCU CMU
Coffee $2.50 1.25 $1.25
Bagels $3.75 1.75 $2.00
$68,750 33,750 35,000 7,000 $28,000 Muffins $3.00 0.75 $2.25
The sales mix implies that each bundle consists of 3 cups of coffee, 2 bagels and 1 muffin Contribution margin of the bundle = 3 × $1.25 + 2 × $2 + 1 × $2.25 = $3.75 + $4.00 + $2.25 = $10.00 Breakeven point in bundles =
Fixed costs $7, 000 = = 700 bundles Contribution margin per bundle $10.00
Breakeven point is: Coffee: 700 bundles × 3 cups per bundle = 2,100 cups Bagels: 700 bundles × 2 bagels per bundle = 1,400 bagels Muffins: 700 bundles × 1 muffin per bundle = 700 muffins 3-18
Alternatively, Let S = Number of muffins sold 2S = Number of bagels sold 3S = Number of cups of coffee sold Revenues – Variable costs – Fixed costs = Operating income [$2.50(3S) + $3.75(2S) +3.00S] – [$1.25(3S) + $1.75(2S) + $0.75S] – $7,000 = OI $18.00S – $8S – $7,000 = OI $10.00 S=$7,000 S = 700 units of the sales mix or S =700 muffins 2S=1,400 bagels 3S=2,100 cups of coffee Breakeven point, therefore, is 2,100 cups of coffee 1,400 bagels, and 700 muffins when OI = 0 Check Revenues ($2.50 × 2,100) + ($3.75 × 1,400) +($3.00 × 700) Variable costs ($1.25 × 2,100) + ($1.75 × 1,400) +($0.75 × 700) Contribution margin Fixed costs Operating income
$12,600 5,600 7,000 7,000 $ 0
Bobbie should definitely add muffins to her product mix because muffins have the highest contribution margin ($2.25) of all three products. This lowers Bobbie’s overall breakeven point. If the sales mix ratio above can be attained, the result is a lower breakeven revenue ($12,600) of the options presented in the problem.
3-19
3-29
CVP, Not for profit
1.
Ticket sales per concert Variable costs per concert: Guest performers Marketing and advertising Total variable costs per concert Contribution margin per concert Fixed costs Salaries Mortgage payments ($2,000 × 12) Total fixed costs Less donations Net fixed costs
Breakeven point in units =
$ 2,500 $ 1,000 500 1,500 $ 1,000 $50,000 24,000 $74,000 40,000 $34,000
$34,000 Net fixed costs = 34 concerts = $1,000 Contribution margin per concert
Check
Donations Revenue ($2,500 × 34) Total revenue
$ 40,000 85,000 125,000
Less variable costs Guest performers ($1,000 × 34) Marketing and advertising ($500 × 34) Total variable costs Less fixed costs Salaries Mortgage payments Total fixed costs Operating income 2.
$34,000 17,000 51,000 $50,000 24,000 74,000 $ 0
Ticket sales per concert Variable costs per concert: Guest performers Marketing and advertising Total variable costs per concert Contribution margin per concert Fixed costs Salaries ($50,000 + $40,000) Mortgage payments ($2,000 × 12) Total fixed costs Less donations Net fixed costs 3-20
$ 2,500 $1,000 500 1,500 $ 1,000 $90,000 24,000 $114,000 40,000 $ 74,000
Breakeven point in units =
$74,000 Net fixed costs = 74 concerts = $1,000 Contribution margin per concert
Check
Donations Revenue ($2,500 × 74) Total revenue
$ 40,000 185,000 225,000
Less variable costs Guest performers ($1,000 × 74) Marketing and advertising ($500 × 74) Total variable costs Less fixed costs Salaries Mortgage payments Total fixed costs Operating income
$74,000 37,000 111,000 $90,000 24,000 $
Operating Income if 60 concerts are held Donations Revenue ($2,500 × 60) Total revenue
114,000 0
$ 40,000 150,000 190,000
Less variable costs Guest performers ($1,000 × 60) Marketing and advertising ($500 × 60) Total variable costs Less fixed costs Salaries Mortgage payments Total fixed costs Operating income (loss)
$60,000 30,000 90,000 $90,000 24,000 114,000 $ (14,000)
The Music Society would not be able to afford the new marketing director if the number of concerts were to increase to only 60 events. The addition of the new marketing director would require the Music Society to hold at least 74 concerts in order to breakeven. If only 60 concerts were held, the organization would lose $14,000 annually. The Music Society could look for other contributions to support the new marketing director’s salary or perhaps increase the number of attendees per concert if the number of concerts could not be increased beyond 60. 3.
Ticket sales per concert Variable costs per concert: Guest performers Marketing and advertising Total variable costs per concert Contribution margin per concert 3-21
$ 2,500 $ 1,000 500 1,500 $ 1,000
Fixed costs Salaries ($50,000 + $40,000) Mortgage payments ($2,000 × 12) Total fixed costs Deduct donations Net fixed costs Breakeven point in units =
$90,000 24,000 $114,000 60,000 $ 54,000
Net fixed costs $54,000 = = 54 concerts Contribution margin per concert $1,000
Check
Donations Revenue ($2,500 × 54) Total revenue
$ 60,000 135,000 195,000
Less variable costs Guest performers ($1,000 × 54) Marketing and advertising ($500 × 54) Total variable costs Less fixed costs Salaries Mortgage payments Total fixed costs Operating income
$54,000 27,000 81,000 $90,000 24,000 114,000 $ 0
3-22
3-30
(15 min.) Contribution margin, decision making.
1.
Revenues Deduct variable costs: Cost of goods sold Sales commissions Other operating costs Contribution margin
$600,000 $300,000 60,000 30,000
390,000 $210,000
$210,000 = 35% $600,000
2.
Contribution margin percentage =
3.
Incremental revenue (15% × $600,000) = $90,000 Incremental contribution margin (35% × $90,000) Incremental fixed costs (advertising) Incremental operating income
$31,500 13,000 $18,500
If Mr. Lurvey spends $13,000 more on advertising, the operating income will increase by $18,500, decreasing the operating loss from $49,000 to an operating loss of $30,500. Proof (Optional): Revenues (115% × $600,000) Cost of goods sold (50% of sales) Gross margin
$690,000 345,000 345,000
Operating costs: Salaries and wages Sales commissions (10% of sales) Depreciation of equipment and fixtures Store rent Advertising Other operating costs: ⎛ $30,000 ⎞ Variable ⎜ × $690, 000 ⎟ ⎝ $600,000 ⎠ Fixed Operating income
3-23
$170,000 69,000 20,000 54,000 13,000 34,500 15,000
375,500 $ (30,500)
3-31
(20 min.) Contribution margin, gross margin and margin of safety.
1.
Mirabella Cosmetics Operating Income Statement, June 2011 Units sold Revenues Variable costs Variable manufacturing costs Variable marketing costs Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed marketing & administration costs Total fixed costs Operating income 2.
10,000 $100,000 $ 55,000 5,000 60,000 40,000 $ 20,000 10,000 30,000 $ 10,000
$40,000 = $4 per unit 10,000 units Fixed costs $30, 000 Breakeven quantity = = = 7,500 units Contribution margin per unit $4 per unit Revenues $100, 000 = = $10 per unit Selling price = Units sold 10,000 units Breakeven revenues = 7,500 units × $10 per unit = $75,000 Contribution margin per unit =
Alternatively, Contribution margin percentage =
Breakeven revenues =
Contribution margin $40, 000 = = 40% Revenues $100, 000
Fixed costs $30, 000 = = $75, 000 Contribution margin percentage 0.40
3. Margin of safety (in units) = Units sold – Breakeven quantity = 10,000 units – 7,500 units = 2,500 units 4.
Units sold Revenues (Units sold × Selling price = 8,000 × $10) Contribution margin (Revenues × CM percentage = $80,000 × 40%) Fixed costs Operating income Taxes (30% × $2,000) Net income
3-24
8,000 $80,000 $32,000 30,000 2,000 600 $ 1,400
3-32 (30 min.) Uncertainty and expected costs. 1. Monthly Number of Orders 350,000 450,000 550,000 650,000 750,000
Cost of Current System $2,500,000 + $50(350,000) = $20,000,000 $2,500,000 + $50(450,000) = $25,000,000 $2,500,000 + $50(550,000) = $30,000,000 $2,500,000 + $50(650,000) = $35,000,000 $2,500,000 + $50(750,000) = $40,000,000
Monthly Number of Orders 350,000 450,000 550,000 650,000 750,000
Cost of Partially Automated System $10,000,000 + $40(350,000) = $24,000,000 $10,000,000 + $40(450,000) = $28,000,000 $10,000,000 + $40(550,000) = $32,000,000 $10,000,000 + $40(650,000) = $36,000,000 $10,000,000 + $40(750,000) = $40,000,000
Monthly Number of Orders 350,000 450,000 550,000 650,000 750,000
Cost of Fully Automated System $20,000,000 + $25(350,000) = $28,750,000 $20,000,000 + $25(450,000) = $31,250,000 $20,000,000 + $25(550,000) = $33,750,000 $20,000,000 + $25(650,000) = $36,250,000 $20,000,000 + $25(750,000) = $38,750,000
2. Current System Expected Cost: $20,000,000 × 0.15 = $ 3,000,000 25,000,000 × 0.20 = 5,000,000 30,000,000 × 0.35 = 10,500,000 35,000,000 × 0.20 = 7,000,000 40,000,000 × 0.10 = 4,000,000 $29,500,000 Partially Automated System Expected Cost: $24,000,000 × 0.15 = $ 3,600,000 28,000,000 × 0.20 = 5,600,000 32,000,000 × 0.35 = 11,200,000 36,000,000 × 0.20 = 7,200,000 40,000,000 × 0.10 = 4,000,000 $31,600,000 Fully Automated System Expected Cost: $28,750,000 × 0.15 = $ 4,312,500 31,250,000 × 0.20 = 6,250,000 33,750,000 × 0.35 = 11,812,500 36,250,000 × 0.20 = 7,250,000 38,750,000 × 0.10 = 3,875,000 $33,500,000
3-25
3. Foodmart should consider the impact of the different systems on its relationship with suppliers. The interface with Foodmart’s system may require that suppliers also update their systems. This could cause some suppliers to raise the cost of their merchandise. It could force other suppliers to drop out of Foodmart’s supply chain because the cost of the system change would be prohibitive. Foodmart may also want to consider other factors such as the reliability of different systems and the effect on employee morale if employees have to be laid off as it automates its systems.
3-33
(15–20 min.) CVP analysis, service firm.
1.
Revenue per package Variable cost per package Contribution margin per package
$5,000 3,700 $1,300
Breakeven (packages) = Fixed costs ÷ Contribution margin per package $520,000 = 400 tour packages = $1,300 per package 2.
Contribution margin ratio =
Contribution margin per package $1,300 = = 26% Selling price $5,000
Revenue to achieve target income = (Fixed costs + target OI) ÷ Contribution margin ratio = Number of tour packages to earn $91,000 operating income
$520,000 + $91,000 = $2,350,000, or 0.26 =
$520, 000 + $91, 000 = 470 tour packages $1,300
Revenues to earn $91,000 OI = 470 tour packages × $5,000 = $2,350,000. 3.
Fixed costs = $520,000 + $32,000 = $552,000 Breakeven (packages) =
Fixed costs Contribution margin per package
Contribution margin per package = =
Fixed costs Breakeven (packages) $552,000 = $1,380 per tour package 400 tour packages
Desired variable cost per tour package = $5,000 – $1,380 = $3,620 Because the current variable cost per unit is $3,700, the unit variable cost will need to be reduced by $80 to achieve the breakeven point calculated in requirement 1. Alternate Method: If fixed cost increases by $32,000, then total variable costs must be reduced by $32,000 to keep the breakeven point of 400 tour packages. Therefore, the variable cost per unit reduction = $32,000 ÷ 400 = $80 per tour package. 3-26
3-34
(30 min.) CVP, target operating income, service firm.
1.
Revenue per child Variable costs per child Contribution margin per child Breakeven quantity =
=
2.
Target quantity =
= 3.
$580 230 $350
Fixed costs Contribution margin per child $5,600 = 16 children $350
Fixed costs + Target operating income Contribution margin per child $5,600 + $10,500 = 46 children $350
Increase in rent ($3,150 – $2,150) Field trips Total increase in fixed costs Divide by the number of children enrolled Increase in fee per child
$1,000 1,300 $2,300 ÷ 46 $ 50
Therefore, the fee per child will increase from $580 to $630. Alternatively, New contribution margin per child =
$5,600 + $2,300 + $10,500 = $400 46
New fee per child = Variable costs per child + New contribution margin per child = $230 + $400 = $630
3-27
3-35
(20–25 min.)
1.
Selling price Variable costs per unit: Production costs Shipping and handling Contribution margin per unit (CMU)
CVP analysis. $300 $120 5
125 $175
Fixed costs $1,260,000 = = 7,200 units Contribution margin per unit $175 Margin of safety (units) = 10,000 – 7,200 = 2,800 units Breakeven point in units =
2. Since fixed costs remain the same, any incremental increase in sales will increase contribution margin and operating income dollar for dollar. Increase in units sales = 10% × 10,000 = 1,000 Incremental contribution margin = $175 × 1,000 = $175,000 Therefore, the increase in operating income will be equal to $175,000. Technology Solutions’s operating income in 2011 would be $490,000 + $175,000 = $665,000. 3.
Selling price Variable costs: Production costs $120 × 130% Shipping and handling ($5 – ($5 × 0.20)) Contribution margin per unit Target sales in units =
$300 $156 4
160 $140
FC + TOI $1,260,000 + $490,000 = = 12,500 units CMU $140
Target sales in dollars = $300 × 12,500 = $3,750,000
3-28
3-36
(30–40 min.) CVP analysis, income taxes.
1.
Revenues – Variable costs – Fixed costs =
Target net income 1 − Tax rate
Let X = Net income for 2011 20,000($25.00) – 20,000($13.75) – $135,000 = $500,000 – $275,000 – $135,000 =
X 1 − 0.40 X
0.60 $300,000 – $165,000 – $81,000 = X X = $54,000
Alternatively, Operating income = Revenues – Variable costs – Fixed costs = $500,000 – $275,000 – $135,000 = $90,000
Income taxes = 0.40 × $90,000 = $36,000 Net income = Operating income – Income taxes = $90,000 – $36,000 = $54,000 2.
Let Q = Number of units to break even $25.00Q – $13.75Q – $135,000 = 0 Q = $135,000 ÷ $11.25 = 12,000 units
3.
Let X = Net income for 2012 22,000($25.00) – 22,000($13.75) – ($135,000 + $11,250)
=
$550,000 – $302,500 – $146,250
=
$101,250
=
X 1 − 0.40 X 0.60 X
0.60 X = $60,750
4.
Let Q = Number of units to break even with new fixed costs of $146,250 $25.00Q – $13.75Q – $146,250 Q = $146,250 ÷ $11.25 Breakeven revenues = 13,000 × $25.00
5.
= 0 = 13,000 units = $325,000
Let S = Required sales units to equal 2011 net income $25.00S – $13.75S – $146,250 =
$54,000 0.60
$11.25S = $236,250 S = 21,000 units Revenues = 21,000 units × $25 = $525,000
6.
Let A = Amount spent for advertising in 2012 $550,000 – $302,500 – ($135,000 + A) =
$60,000
0.60 $550,000 – $302,500 – $135,000 – A = $100,000 $550,000 – $537,500 = A A = $12,500
3-29
3-37 (25 min.) CVP, sensitivity analysis. Contribution margin per pair of shoes = $60 – $25 = $35 Fixed costs = $100,000 Units sold = Total sales ÷ Selling price = $300,000 ÷ $60 per pair= 5,000 pairs of shoes 1. Variable costs decrease by 20%; Fixed costs increase by 15% $300,000 Sales revenues 5,000 × $60 100,000 Variable costs 5,000 × $25 × (1 – 0.20) Contribution margin 200,000 Fixed costs $100,000 x 1.15 115,000 Operating income $ 85,000 2. Increase advertising (fixed costs) by $30,000; Increase sales 20% $360,000 Sales revenues 5,000 × 1.20 × $60.00 × × Variable costs 5,000 1.20 $25.00 150,000 Contribution margin 210,000 Fixed costs ($100,000 + $30,000) 130,000 Operating income $ 80,000 3. Increase selling price by $10.00; Sales decrease 10%; Variable costs increase by $7 $315,000 Sales revenues 5,000 × 0.90 × ($60 + $10) 144,000 Variable costs 5,000 × 0.90 × ($25 + $7) Contribution margin 171,000 Fixed costs 100,000 Operating income $ 71,000 4. Double fixed costs; Increase sales by 60% Sales revenues 5,000 × 1.60 × $60 Variable costs 5,000 × 1.60 × $25 Contribution margin Fixed costs $100,000 × 2 Operating income
$480,000 200,000 280,000 200,000 $ 80,000
Alternative 1 yields the highest operating income. Choosing alternative 1 will give Brown a 13.33% increase in operating income [($85,000 – $75,000)/$75,000 = 13.33%], which is less than the company’s 25% targeted increase. Alternatives 2 and 4 also generate more operating income for Brown, but they too do not meet Brown’s target of 25% increase in operating income. Alternative 3 actually results in lower operating income than under Brown’s current cost structure. There is no reason, however, for Brown to think of these alternatives as being mutually exclusive. For example, Brown can combine actions 1 and 2, automate the machining process and advertise. This will result in a 26.67% increase in operating income as follows:
3-30
Sales revenue 5,000 × 1.20 × $60 Variable costs 5,000 × 1.20 × $25 × (1 – 0.20) Contribution margin Fixed costs $100,000 × 1.15 + $30,000 Operating income
$360,000 120,000 240,000 145,000 $ 95,000
The point of this problem is that managers always need to consider broader rather than narrower alternatives to meet ambitious or stretch goals.
3-38
(20–30 min.) CVP analysis, shoe stores.
1. CMU (SP – VCU = $30 – $21) a. Breakeven units (FC ÷ CMU = $360,000 ÷ $9 per unit) b. Breakeven revenues (Breakeven units × SP = 40,000 units × $30 per unit)
$
2. Pairs sold Revenues, 35,000 × $30 Total cost of shoes, 35,000 × $19.50 Total sales commissions, 35,000 × $1.50 Total variable costs Contribution margin Fixed costs Operating income (loss)
35,000 $1,050,000 682,500 52,500 735,000 315,000 360,000 $ (45,000)
3. Unit variable data (per pair of shoes) Selling price Cost of shoes Sales commissions Variable cost per unit Annual fixed costs Rent Salaries, $200,000 + $81,000 Advertising Other fixed costs Total fixed costs
9.00 40,000
$1,200,000
$ $
30.00 19.50 0 19.50
$
60,000 281,000 80,000 20,000 $ 441,000
CMU, $30 – $19.50 a. Breakeven units, $441,000 ÷ $10.50 per unit b. Breakeven revenues, 42,000 units × $30 per unit
3-31
$
10.50 42,000 $1,260,000
4. Unit variable data (per pair of shoes) Selling price Cost of shoes Sales commissions Variable cost per unit Total fixed costs
$
30.00 19.50 1.80 $ 21.30 $ 360,000
CMU, $30 – $21.30 a. Break even units = $360,000 ÷ $8.70 per unit b. Break even revenues = 41,380 units × $30 per unit 5. Pairs sold Revenues (50,000 pairs × $30 per pair) Total cost of shoes (50,000 pairs × $19.50 per pair) Sales commissions on first 40,000 pairs (40,000 pairs × $1.50 per pair) Sales commissions on additional 10,000 pairs [10,000 pairs × ($1.50 + $0.30 per pair)] Total variable costs Contribution margin Fixed costs Operating income
$
8.70 41,380 (rounded up) $1,241,400
50,000 $1,500,000 $ 975,000 60,000 18,000 $1,053,000 $ 447,000 360,000 $ 87,000
Alternative approach: Breakeven point in units = 40,000 pairs Store manager receives commission of $0.30 on 10,000 (50,000 – 40,000) pairs. Contribution margin per pair beyond breakeven point of 10,000 pairs = $8.70 ($30 – $21 – $0.30) per pair. Operating income = 10,000 pairs × $8.70 contribution margin per pair = $87,000.
3-32
3-39
(30 min.) CVP analysis, shoe stores (continuation of 3-38). Salaries + Commission Plan
No. of CM units sold per Unit (1) (2) 40,000 $9.00 42,000 9.00 44,000 9.00 46,000 9.00 48,000 9.00 50,000 9.00 52,000 9.00 54,000 9.00 56,000 9.00 58,000 9.00 60,000 9.00 62,000 9.00 64,000 9.00 66,000 9.00
CM (3)=(1) × (2) $360,000 378,000 396,000 414,000 432,000 450,000 468,000 486,000 504,000 522,000 540,000 558,000 576,000 594,000
Fixed Costs (4) $360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000
Operating Income (5)=(3)–(4) 0 18,000 36,000 54,000 72,000 90,000 108,000 126,000 144,000 162,000 180,000 198,000 216,000 234,000
Higher Fixed Salaries Only CM per Unit (6) $10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50
3-33
Operating CM Fixed Costs Income (7)=(1) × (6) (8) (9)=(7)–(8) $420,000 $441,000 $ (21,000) 441,000 441,000 0 462,000 441,000 21,000 483,000 441,000 42,000 504,000 441,000 63,000 525,000 441,000 84,000 546,000 441,000 105,000 567,000 441,000 126,000 588,000 441,000 147,000 609,000 441,000 168,000 630,000 441,000 189,000 651,000 441,000 210,000 672,000 441,000 231,000 693,000 441,000 252,000
Difference in favor of higher-fixedsalary-only (10)=(9)–(5) $(21,000) (18,000) (15,000) (12,000) (9,000) (6,000) (3,000) 0 3,000 6,000 9,000 12,000 15,000 18,000
1. See preceding table. The new store will have the same operating income under either compensation plan when the volume of sales is 54,000 pairs of shoes. This can also be calculated as the unit sales level at which both compensation plans result in the same total costs: Let Q = unit sales level at which total costs are same for both plans $19.50Q + $360,000 + $81,000 = $21Q + $360,000 $1.50 Q = $81,000 Q = 54,000 pairs 2. When sales volume is above 54,000 pairs, the higher-fixed-salaries plan results in lower costs and higher operating incomes than the salary-plus-commission plan. So, for an expected volume of 55,000 pairs, the owner would be inclined to choose the higher-fixed-salaries-only plan. But it is likely that sales volume itself is determined by the nature of the compensation plan. The salary-plus-commission plan provides a greater motivation to the salespeople, and it may well be that for the same amount of money paid to salespeople, the salary-plus-commission plan generates a higher volume of sales than the fixed-salary plan. 3.
Let TQ = Target number of units For the salary-only plan, $30.00TQ – $19.50TQ – $441,000 $10.50TQ TQ TQ For the salary-plus-commission plan, $30.00TQ – $21.00TQ – $360,000 $9.00TQ TQ TQ
= $168,000 = $609,000 = $609,000 ÷ $10.50 = 58,000 units = $168,000 = $528,000 = $528,000 ÷ $9.00 = 58,667 units (rounded up)
The decision regarding the salary plan depends heavily on predictions of demand. For instance, the salary plan offers the same operating income at 58,000 units as the commission plan offers at 58,667 units. 4.
WalkRite Shoe Company Operating Income Statement, 2011 Revenues (48,000 pairs × $30) + (2,000 pairs × $18) Cost of shoes, 50,000 pairs × $19.50 Commissions = Revenues × 5% = $1,476,000 × 0.05 Contribution margin Fixed costs Operating income
3-34
$1,476,000 975,000 73,800 427,200 360,000 $ 67,200
3-40
(40 min.) Alternative cost structures, uncertainty, and sensitivity analysis.
1. Contribution margin per page assuming current fixed leasing agreement
= $0.15 – $0.03 – $0.04 = $0.08 per page
Fixed costs = $1,000 Breakeven point =
Fixed costs $1, 000 = = 12,500 pages Contribution margin per page $0.08 per page
Contribution margin per page assuming $10 per 500 page = $0.15–$0.02a – $0.03 – $.04 = $0.06 per page commission agreement Fixed costs = $0 Breakeven point =
Fixed costs $0 = = 0 pages Contribution margin per page $0.06 per page
(i.e., Stylewise makes a profit no matter how few pages it sells) a $10/500 pages = $0.02 per page 2. Let x denote the number of pages Stylewise must sell for it to be indifferent between the fixed leasing agreement and commission based agreement. To calculate x we solve the following equation. $0.15 x – $0.03 x – $0.04 x – $1,000 = $0.15 x – $0.02 x – $0.03 x – $.04 x $0.08 x – $1,000 = $0.06 x $0.02 x = $1,000 x = $1,000 ÷ $0.02 = 50,000 pages For sales between 0 to 50,000 pages, Stylewise prefers the commission based agreement because in this range, $0.06 x > $0.08 x – $1,000. For sales greater than 50,000 pages, Stylewise prefers the fixed leasing agreement because in this range, $0.08 x – $1,000 > $.06 x . 3. Fixed leasing agreement Pages Variable Revenue Sold Costs (1) (2) (3) 20,000 20,000 × $.15=$ 3,000 20,000 × $.07=$1,400 40,000 40,000 × $.15=$ 6,000 40,000 × $.07=$2,800 60,000 × $.07=$4,200 60,000 60,000 × $.15=$ 9,000 80,000 80,000 × $.15=$12,000 80,000 × $.07=$5,600 100,000 100,000 × $.15=$15,000 100,000 × $.07=$7,000 Expected value of fixed leasing agreement
3-35
Fixed Costs (4) $1,000 $1,000 $1,000 $1,000 $1,000
Operating Income (Loss) (5)=(2)–(3)–(4) $ 600 $2,200 $3,800 $5,400 $7,000
Probability (6) 0.20 0.20 0.20 0.20 0.20
Expected Operating Income (7)=(5) × (6) $ 120 440 760 1,080 1,400 $3,800
Commission-based leasing agreement: Variable Pages Costs Sold Revenue (3) (1) (2) 20,000 20,000 × $.15=$ 3,000 20,000 × $.09=$1,800 40,000 40,000 × $.15=$ 6,000 40,000 × $.09=$3,600 60,000 60,000 × $.15=$ 9,000 60,000 × $.09=$5,400 80,000 × $.09=$7,200 80,000 80,000 × $.15=$12,000 100,000 100,000 × $.15=$15,000 100,000 × $.09=$9,000 Expected value of commission based agreement
Operating Income (4)=(2)–(3) $1,200 $2,400 $3,600 $4,800 $6,000
Probability (5) 0.20 0.20 0.20 0.20 0.20
Expected Operating Income (6)=(4) × (5) $ 240 480 720 960 1,200 $3,600
Stylewise should choose the fixed cost leasing agreement because the expected value is higher than under the commission-based leasing agreement. The range of sales is high enough to make the fixed leasing agreement more attractive.
3-36
3-41 (20-30 min.) CVP, alternative cost structures. 1.
Variable cost per computer = $100 + ($15 × 10) + $50 = $300 Contribution margin per computer = Selling price –Variable cost per computer = $500 – $300 = $200 Breakeven point = Fixed costs ÷ Contribution margin per computer = $4,000 ÷ $200 = 20 computers (per month)
2.
Target number of computers =
=
Fixed costs + Target operating income Contribution margin per computer
$4,000 + $5,000 = 45 computers $200
3.
Contribution margin per computer = Selling price – Variable cost per computer = $500 – $200 – $50 = $250 Fixed costs = $4,000 Fixed costs $4, 000 Breakeven point = = = 16 computers Contribution margin per computer $250
4.
Let x be the number of computers for which PC Planet is indifferent between paying a monthly rental fee for the retail space and paying a 20% commission on sales. PC Planet will be indifferent when the profits under the two alternatives are equal. $500 x – $300 x – $4,000 = $500 x – $300 x – $500 (0.20) x $200 x – $4,000 = $100 x $100 x = $4,000 x = 40 computers
For sales between 0 and 40 computers, PC Planet prefers to pay the 20% commission because in this range, $100 x > $200 x – $4,000. For sales greater than 40 computers, the company prefers to pay the monthly fixed rent of $4,000 because $200 x – $4,000 > $100 x
3-37
3-42
(30 min.)
CVP analysis, income taxes, sensitivity.
1a.To breakeven, Agro Engine Company must sell 1,200 units. This amount represents the point where revenues equal total costs. Let Q denote the quantity of engines sold. Revenue = Variable costs + Fixed costs $3,000Q = $500Q + $3,000,000 $2,500Q = $3,000,000 Q = 1,200 units Breakeven can also be calculated using contribution margin per unit. Contribution margin per unit = Selling price – Variable cost per unit = $3,000 – $500 = $2,500 Breakeven = Fixed Costs ÷ Contribution margin per unit = $3,000,000 ÷ $2,500 = 1,200 units 1b. To achieve its net income objective, Agro Engine Company must sell 2,000 units. This amount represents the point where revenues equal total costs plus the corresponding operating income objective to achieve net income of $1,500,000. Revenue = Variable costs + Fixed costs + [Net income ÷ (1 – Tax rate)] $3,000Q = $500Q + $3,000,000 + [$1,500,000 ÷ (1 − 0.25)] $3,000Q = $500Q + $3,000,000 + $2,000,000 Q = 2,000 units 2. To achieve its net income objective, Agro Engine Company should select alternative c, where fixed costs are reduced by 20% and selling price is reduced by 10% resulting in 1,700 additional units being sold through the end of the year. This alternative results in the highest net income and is the only alternative that equals or exceeds the company’s net income objective of $1,500,000. Calculations for the three alternatives are shown below. Alternative a Revenues = Variable costs = Operating income Net income = a
($3,000 × 300) + ($2,400a × 2,000) = $5,700,000 $500 × 2,300b = $1,150,000 = $5,700,000 − $1,150,000 − $3,000,000 = $1,550,000 $1,550,000 × (1 − 0.25) = $1,162,500
$3,000 – ($3,000 × 0.20) = ;
b
300 units + 2,000 units.
3-38
Alternative b Revenues = Variable costs = Operating income Net income =
($3,000 × 300) + ($2,750c × 1,800) = $5,850,000 ($500 × 300) + ($450d × 1,800) = $960,000 = $5,850,000 − $960,000 − $3,000,000 = $1,890,000 $1,890,000 × (1 − 0.25) = $1,417,500
c
$3,000 – $250; d$450.
Alternative c Revenues Variable costs Operating income Net income
= = = =
($3,000 × 300) + ($2,700e× 1,700) = $5,490,000 $500 × 2000f = $1,000,000 $5,490,000 − $1,000,000 − $2,400,000g = $2,090,000 $2,090,000 × (1 − 0.25) = $1,567,500
e
$3,000 – (0.10 × $3,000) = $3,000 – $300; f300units + 1,700 units; $3,000,000 – (0.20 × $3,000,000)
g
3-39
3-43
(30 min.) Choosing between compensation plans, operating leverage.
1. We can recast Marston’s income statement to emphasize contribution margin, and then use it to compute the required CVP parameters. Marston Corporation Income Statement For the Year Ended December 31, 2011 Using Sales Agents $26,000,000
Revenues Variable Costs Cost of goods sold—variable Marketing commissions Contribution margin Fixed Costs Cost of goods sold—fixed Marketing—fixed Operating income
$11,700,000 4,680,000 2,870,000 3,420,000
Contribution margin percentage ($9,620,000 ÷ 26,000,000; $11,700,000 ÷ $26,000,000) Breakeven revenues ($6,290,000 ÷ 0.37; $8,370,000 ÷ 0.45) Degree of operating leverage ($9,620,000 ÷ $3,330,000; $11,700,000 ÷ $3,330,000)
16,380,000 9,620,000 6,290,000 $ 3,330,000
Using Own Sales Force $26,000,000 $11,700,000 2,600,000 2,870,000 5,500,000
14,300,000 11,700,000 8,370,000 $ 3,330,000
37%
45%
$17,000,000
$18,600,000
2.89
3.51
The calculations indicate that at sales of $26,000,000, a percentage change in sales and contribution margin will result in 2.89 times that percentage change in operating income if Marston continues to use sales agents and 3.51 times that percentage change in operating income if Marston employs its own sales staff. The higher contribution margin per dollar of sales and higher fixed costs gives Marston more operating leverage, that is, greater benefits (increases in operating income) if revenues increase but greater risks (decreases in operating income) if revenues decrease. Marston also needs to consider the skill levels and incentives under the two alternatives. Sales agents have more incentive compensation and hence may be more motivated to increase sales. On the other hand, Marston’s own sales force may be more knowledgeable and skilled in selling the company’s products. That is, the sales volume itself will be affected by who sells and by the nature of the compensation plan.
2.
3.
Variable costs of marketing Fixed marketing costs
Operating income = Revenues −
= 15% of Revenues = $5,500,000
Fixed Variable Variable − Fixed − marketing − marketing manuf. costs manuf. costs costs costs
Denote the revenues required to earn $3,330,000 of operating income by R, then
3-40
R − 0.45R − $2,870,000 − 0.15R − $5,500,000 = $3,330,000 R − 0.45R − 0.15R = $3,330,000 + $2,870,000 + $5,500,000 0.40R = $11,700,000 R = $11,700,000 ÷ 0.40 = $29,250,000
3-44
(15–25 min.) Sales mix, three products.
1. Sales of A, B, and C are in ratio 20,000 : 100,000 : 80,000. So for every 1 unit of A, 5 (100,000 ÷ 20,000) units of B are sold, and 4 (80,000 ÷ 20,000) units of C are sold. Contribution margin of the bundle = 1 × $3 + 5 × $2 + 4 × $1 = $3 + $10 + $4 = $17 $255,000 Breakeven point in bundles = = 15,000 bundles $17 Breakeven point in units is: Product A: 15,000 bundles × 1 unit per bundle 15,000 units Product B: 15,000 bundles × 5 units per bundle 75,000 units Product C: 15,000 bundles × 4 units per bundle 60,000 units Total number of units to breakeven 150,000 units Alternatively, Let Q = Number of units of A to break even 5Q = Number of units of B to break even 4Q = Number of units of C to break even Contribution margin – Fixed costs = Zero operating income $3Q + $2(5Q) + $1(4Q) – $255,000 $17Q Q 5Q 4Q Total 2.
Contribution margin: A: 20,000 × $3 B: 100,000 × $2 C: 80,000 × $1 Contribution margin Fixed costs Operating income
= 0 = $255,000 = 15,000 ($255,000 ÷ $17) units of A = 75,000 units of B = 60,000 units of C = 150,000 units $ 60,000 200,000 80,000 $340,000 255,000 $ 85,000
3-41
3.
Contribution margin A: 20,000 × $3 B: 80,000 × $2 C: 100,000 × $1 Contribution margin Fixed costs Operating income
$ 60,000 160,000 100,000 $320,000 255,000 $ 65,000
Sales of A, B, and C are in ratio 20,000 : 80,000 : 100,000. So for every 1 unit of A, 4 (80,000 ÷ 20,000) units of B and 5 (100,000 ÷ 20,000) units of C are sold. Contribution margin of the bundle = 1 × $3 + 4 × $2 + 5 × $1 = $3 + $8 + $5 = $16 $255,000 Breakeven point in bundles = = 15,938 bundles (rounded up) $16 Breakeven point in units is: Product A: 15,938 bundles × 1 unit per bundle 15,938 units Product B: 15,938 bundles × 4 units per bundle 63,752 units Product C: 15,938 bundles × 5 units per bundle 79,690 units Total number of units to breakeven 159,380 units Alternatively, Let Q = Number of units of A to break even 4Q = Number of units of B to break even 5Q = Number of units of C to break even Contribution margin – Fixed costs = Breakeven point $3Q + $2(4Q) + $1(5Q) – $255,000 $16Q Q 4Q 5Q Total
= 0 = $255,000 = 15,938 ($255,000 ÷ $16) units of A (rounded up) = 63,752 units of B = 79,690 units of C = 159,380 units
Breakeven point increases because the new mix contains less of the higher contribution margin per unit, product B, and more of the lower contribution margin per unit, product C.
3-42
3-45 (40 min.) Multi-product CVP and decision making. 1. Faucet filter: Selling price Variable cost per unit Contribution margin per unit
$80 20 $60
Pitcher-cum-filter: Selling price Variable cost per unit Contribution margin per unit
$90 25 $65
Each bundle contains 2 faucet models and 3 pitcher models. So contribution margin of a bundle = 2 × $60 + 3 × $65 = $315
Breakeven Fixed costs $945,000 point in = = = 3,000 bundles Contribution margin per bundle $315 bundles Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,000 bundles × 2 units per bundle = 6,000 units Pitcher models: 3,000 bundles × 3 units per bundle = 9,000 units Total number of units to breakeven 15,000 units Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 6,000 units× $80 per unit = $ 480,000 Pitcher models: 9,000 units× $90 per unit = 810,000 Breakeven revenues $1,290,000
Alternatively, weighted average contribution margin per unit = Breakeven point =
$945,000 = 15,000 units $63
2 × 15,000 units = 6,000 units 5 3 Pitcher-cum-filter: ×15,000 units = 9,000 units 5 Breakeven point in dollars Faucet filter: 6,000 units × $80 per unit = $480,000 Pitcher-cum-filter: 9,000 units× $90 per unit = $810,000 Faucet filter:
2. Faucet filter: Selling price Variable cost per unit Contribution margin per unit
$80 15 $65
3-43
(2 × $60) + (3 × $65) = $63 5
Pitcher-cum-filter: Selling price Variable cost per unit Contribution margin per unit
$90 16 $74
Each bundle contains 2 faucet models and 3 pitcher models. So contribution margin of a bundle = 2 × $65 + 3 × $74 = $352
Breakeven Fixed costs $945,000 + $181, 400 point in = = = 3, 200 bundles Contribution margin per bundle $352 bundles Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,200 bundles× 2 units per bundle = 6,400 units Pitcher models: 3,200 bundles × 3 units per bundle = 9,600 units Total number of units to breakeven 16,000 units Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 6,400 bundles× $80 per unit = $ 512,000 864,000 Pitcher models: 9,600 bundles× $90 per unit = Breakeven revenues $1,376,000 Alternatively, weighted average contribution margin per unit = Breakeven point =
$945,000 + $181,400 = 16, 000 units $70.40
(2 × $65) + (3 × $74) = $70.40 5
2 × 16,000 units = 6,400 units 5 3 Pitcher-cum-filter: × 16, 000 units = 9, 600 units 5 Breakeven point in dollars: Faucet filter: 6,400 units × $80 per unit = $512,000 Pitcher-cum-filter: 9,600 units× $90 per unit = $864,000 Faucet filter:
3. Let x be the number of bundles for Pure Water Products to be indifferent between the old and new production equipment. Operating income using old equipment = $315 x – $945,000 Operating income using new equipment = $352 x – $945,000 – $181,400 At point of indifference: $315 x – $945,000 = $352 x – $1,126,400 $352 x – $315 x = $1,126,400 – $945,000 $37 x = $181,400 x = $181,400 ÷ $37 = 4,902.7 bundles = 4,903 bundles (rounded) 3-44
Faucet models = 4,903 bundles × 2 units per bundle = 9,806 units Pitcher models = 4,903 bundles× 3 units per bundle = 14,709 units Total number of units 24,515 units Let x be the number of bundles,
When total sales are less than 24,515 units (4,903 bundles), $315x − $945,000 > $352x − $1,126,400, so Pure Water Products is better off with the old equipment. When total sales are greater than 24,515 units (4,903 bundles), $352x − $1,126,400 > $315x − $945,000, so Pure Water Products is better off buying the new equipment. At total sales of 30,000 units (6,000 bundles), Pure Water Products should buy the new production equipment. Check $352 × 6,000 – $1,126,400 = $985,600 is greater than $315 × 6,000 –$945,000 = $945,000.
3-46
(20–25 min.) Sales mix, two products.
1. Sales of standard and deluxe carriers are in the ratio of 187,500 : 62,500. So for every 1 unit of deluxe, 3 (187,500 ÷ 62,500) units of standard are sold. Contribution margin of the bundle = 3 × $10 + 1 × $20 = $30 + $20 = $50 $2, 250, 000 = 45,000 bundles Breakeven point in bundles = $50 Breakeven point in units is: Standard carrier: 45,000 bundles × 3 units per bundle 135,000 units Deluxe carrier: 45,000 bundles × 1 unit per bundle 45,000 units Total number of units to breakeven 180,000 units Alternatively, Let Q = Number of units of Deluxe carrier to break even 3Q = Number of units of Standard carrier to break even Revenues – Variable costs – Fixed costs = Zero operating income $28(3Q) + $50Q – $18(3Q) – $30Q – $2,250,000 = $84Q + $50Q – $54Q – $30Q = $50Q = Q = 3Q =
0 $2,250,000 $2,250,000 45,000 units of Deluxe 135,000 units of Standard
The breakeven point is 135,000 Standard units plus 45,000 Deluxe units, a total of 180,000 units.
3-45
4. Incorrect reporting of environmental costs with the goal of continuing operations is unethical. In assessing the situation, the specific “Standards of Ethical Conduct for Management Accountants” (described in Exhibit 1-7) that the management accountant should consider are listed below. Competence Clear reports using relevant and reliable information should be prepared. Preparing reports on the basis of incorrect environmental costs to make the company’s performance look better than it is violates competence standards. It is unethical for Bush not to report environmental costs to make the plant’s performance look good. Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. Bush may be tempted to report lower environmental costs to please Lemond and Woodall and save the jobs of his colleagues. This action, however, violates the responsibility for integrity. The Standards of Ethical Conduct require the management accountant to communicate favorable as well as unfavorable information. Credibility The management accountant’s Standards of Ethical Conduct require that information should be fairly and objectively communicated and that all relevant information should be disclosed. From a management accountant’s standpoint, underreporting environmental costs to make performance look good would violate the standard of objectivity.
Bush should indicate to Lemond that estimates of environmental costs and liabilities should be included in the analysis. If Lemond still insists on modifying the numbers and reporting lower environmental costs, Bush should raise the matter with one of Lemond’s superiors. If after taking all these steps, there is continued pressure to understate environmental costs, Bush should consider resigning from the company and not engage in unethical behavior.
3-48
3-49
(35 min.) Deciding where to produce. Peoria
Selling price Variable cost per unit Manufacturing Marketing and distribution Contribution margin per unit (CMU) Fixed costs per unit Manufacturing Marketing and distribution Operating income per unit
Moline $150.00
$72.00 14.00 30.00 19.00
86.00 64.00 49.00 $ 15.00
CMU of normal production (as shown above) CMU of overtime production ($64 – $3; $48 – $8) 1. Annual fixed costs = Fixed cost per unit × Daily production rate × Normal annual capacity ($49 × 400 units × 240 days; $29.50 × 320 units × 240 days) Breakeven volume = FC ÷ CMU of normal production ($4,704,000 ÷ $64; $2,265,600 ÷ 48) 2. Units produced and sold Normal annual volume (units) (400 × 240; 320 × 240) Units over normal volume (needing overtime) CM from normal production units (normal annual volume × CMU normal production) (96,000 × $64; 76,800 × 48) CM from overtime production units (0; 19,200 × $40) Total contribution margin Total fixed costs Operating income Total operating income
$150.00 $88.00 14.00 15.00 14.50
102.00 48.00 29.50 $ 18.50
$64
$48
61
40
$4,704,000
$2,265,600
73,500 units
47,200 units
96,000
96,000
96,000 0
76,800 19,200
$6,144,000
$3,686,400
0 6,144,000 4,704,000 $1,440,000
768,000 4,454,400 2,265,600 $2,188,800 $3,628,800
3. The optimal production plan is to produce 120,000 units at the Peoria plant and 72,000 units at the Moline plant. The full capacity of the Peoria plant, 120,000 units (400 units × 300 days), should be used because the contribution from these units is higher at all levels of production than is the contribution from units produced at the Moline plant.
3-49
Contribution margin per plant: Peoria, 96,000 × $64 Peoria 24,000 × ($64 – $3) Moline, 72,000 × $48 Total contribution margin Deduct total fixed costs Operating income
$ 6,144,000 1,464,000 3,456,000 11,064,000 6,969,600 $ 4,094,400
The contribution margin is higher when 120,000 units are produced at the Peoria plant and 72,000 units at the Moline plant. As a result, operating income will also be higher in this case since total fixed costs for the division remain unchanged regardless of the quantity produced at each plant.
3-50
CHAPTER 4 JOB COSTING 4-1
Cost pool––a grouping of individual indirect cost items. Cost tracing––the assigning of direct costs to the chosen cost object. Cost allocation––the assigning of indirect costs to the chosen cost object. Cost-allocation base––a factor that links in a systematic way an indirect cost or group of indirect costs to cost objects.
4-2 In a job-costing system, costs are assigned to a distinct unit, batch, or lot of a product or service. In a process-costing system, the cost of a product or service is obtained by using broad averages to assign costs to masses of identical or similar units. 4-3 An advertising campaign for Pepsi is likely to be very specific to that individual client. Job costing enables all the specific aspects of each job to be identified. In contrast, the processing of checking account withdrawals is similar for many customers. Here, process costing can be used to compute the cost of each checking account withdrawal. 4-4 The seven steps in job costing are: (1) identify the job that is the chosen cost object, (2) identify the direct costs of the job, (3) select the cost-allocation bases to use for allocating indirect costs to the job, (4) identify the indirect costs associated with each cost-allocation base, (5) compute the rate per unit of each cost-allocation base used to allocate indirect costs to the job, (6) compute the indirect costs allocated to the job, and (7) compute the total cost of the job by adding all direct and indirect costs assigned to the job. Major cost objects that managers focus on in companies using job costing are a product 4-5 such as a specialized machine, a service such as a repair job, a project such as running the Expo, or a task such as an advertising campaign. 4-6 Three major source documents used in job-costing systems are (1) job cost record or job cost sheet, a document that records and accumulates all costs assigned to a specific job, starting when work begins (2) materials requisition record, a document that contains information about the cost of direct materials used on a specific job and in a specific department; and (3) labor-time sheet, a document that contains information about the amount of labor time used for a specific job in a specific department. 4-7 The main advantages of using computerized source documents for job cost records are the accuracy of the records and the ability to provide managers with instantaneous feedback to help control job costs. 4-8 a. b.
Two reasons for using an annual budget period are The numerator reason––the longer the time period, the less the influence of seasonal patterns in overhead costs, and The denominator reason––the longer the time period, the less the effect of variations in output levels or quantities of the cost-allocation bases on the allocation of fixed costs.
4-1
4-9 Actual costing and normal costing differ in their use of actual or budgeted indirect cost rates: Normal Actual Costing Costing Direct-cost rates Actual rates Actual rates Indirect-cost rates Actual rates Budgeted rates Each costing method uses the actual quantity of the direct-cost input and the actual quantity of the cost-allocation base. 4-10 A house construction firm can use job cost information (a) to determine the profitability of individual jobs, (b) to assist in bidding on future jobs, and (c) to evaluate professionals who are in charge of managing individual jobs. 4-11 The statement is false. In a normal costing system, the Manufacturing Overhead Control account will not, in general, equal the amounts in the Manufacturing Overhead Allocated account. The Manufacturing Overhead Control account aggregates the actual overhead costs incurred while Manufacturing Overhead Allocated allocates overhead costs to jobs on the basis of a budgeted rate times the actual quantity of the cost-allocation base. Underallocation or overallocation of indirect (overhead) costs can arise because of (a) the Numerator reason––the actual overhead costs differ from the budgeted overhead costs, and (b) the Denominator reason––the actual quantity used of the allocation base differs from the budgeted quantity. 4-12 Debit entries to Work-in-Process Control represent increases in work in process. Examples of debit entries under normal costing are (a) direct materials used (credit to Materials Control), (b) direct manufacturing labor billed to job (credit to Wages Payable Control), and (c) manufacturing overhead allocated to job (credit to Manufacturing Overhead Allocated). 4-13 Alternative ways to make end-of-period adjustments to dispose of underallocated or overallocated overhead are as follows: (i) Proration based on the total amount of indirect costs allocated (before proration) in the ending balances of work in process, finished goods, and cost of goods sold. (ii) Proration based on total ending balances (before proration) in work in process, finished goods, and cost of goods sold. (iii) Year-end write-off to Cost of Goods Sold. (iv) The adjusted allocation rate approach that restates all overhead entries using actual indirect cost rates rather than budgeted indirect cost rates. 4-14 A company might use budgeted costs rather than actual costs to compute direct labor rates because it may be difficult to trace direct labor costs to jobs as they are completed (for example, because bonuses are only known at the end of the year). 4-15 Modern technology of electronic data interchange (EDI) is helpful to managers because it ensures that a purchase order is transmitted quickly and accurately to suppliers with minimum paperwork and costs.
4-2
4-16 a. b. c. d. e. f. g. h. i. j. k.
(10 min) Job order costing, process costing.
Job costing Process costing Job costing Process costing Job costing Process costing Job costing Job costing (but some process costing) Process costing Process costing Job costing
l. Job costing m. Process costing n. Job costing o. Job costing p. Job costing q. Job costing r. Process costing s. Job costing t. Process costing u. Job costing
4-3
4-17
1.
(20 min.) Actual costing, normal costing, accounting for manufacturing overhead.
Budgeted manufacturing overhead rate
Actual manufacturing overhead rate
=
Budgeted manufacturing overhead costs Budgeted direct manufacturing labor costs
=
$2, 700, 000 = 1.80 or 180% $1,500, 000
=
Actual manufacturing overhead costs Actual direct manufacturing labor costs
$2, 755, 000 = 1.9 or 190% $1, 450, 000 Costs of Job 626 under actual and normal costing follow: =
2.
Direct materials Direct manufacturing labor costs Manufacturing overhead costs $30,000 × 1.90; $30,000 × 1.80 Total manufacturing costs of Job 626 3.
Total manufacturing overhead allocated under normal costing =
Actual Costing
Normal Costing
$ 40,000 30,000
$ 40,000 30,000
57,000 $127,000
54,000 $124,000
Actual manufacturing × Budgeted labor costs overhead rate
= $1,450,000 × 1.80 = $2,610,000 Underallocated manufacturing = overhead
Actual manufacturing – Manufacturing overhead costs overhead allocated
= $2,755,000 − $2,610,000 = $145,000 There is no under- or overallocated overhead under actual costing because overhead is allocated under actual costing by multiplying actual manufacturing labor costs and the actual manufacturing overhead rate. This, of course equals the actual manufacturing overhead costs. All actual overhead costs are allocated to products. Hence, there is no under- or overallocated overhead.
4-4
4-18
(20 -30 min.) Job costing, normal and actual costing.
1.
Budgeted indirectcost rate
=
Budgeted indirect costs (assembly support) $8,300,000 = Budgeted direct labor-hours 166,000 hours
= $50 per direct labor-hour Actual indirectcost rate
=
$6,520,000 Actual indirect costs (assembly support) = Actual direct labor-hours 163,000 hours
= $40 per direct labor-hour These rates differ because both the numerator and the denominator in the two calculations are different—one based on budgeted numbers and the other based on actual numbers. 2a.
Normal costing Direct costs Direct materials Direct labor Indirect costs Assembly support ($50 × 960; $50 × 1,050) Total costs 2b. Actual costing Direct costs Direct materials Direct labor Indirect costs Assembly support ($40 × 960; $40 × 1,050) Total costs
Laguna Model
Mission Model
$106,760 36,950 143,710
$127,550 41,320 168,870
48,000 $191,710
52,500 $221,370
$106,760 36,950 143,710
$127,550 41,320 168,870
38,400 $182,110
42,000 $210,870
3. Normal costing enables Amesbury to report a job cost as soon as the job is completed, assuming that both the direct materials and direct labor costs are known at the time of use. Once the 960 direct labor-hours are known for the Laguna Model (June 2011), Amesbury can compute the $191,710 cost figure using normal costing. Amesbury can use this information to manage the costs of the Laguna Model job as well as to bid on similar jobs later in the year. In contrast, Amesbury has to wait until the December 2011 year-end to compute the $182,110 cost of the Laguna Model using actual costing. Although not required, the following overview diagram summarizes Amesbury Construction’s job-costing system.
4-5
INDIRECT COST POOL
}
COST ALLOCATION BASE
}
COST OBJECT: RESIDENTIAL HOME
}
DIRECT COSTS
}
Assembly Support
Direct Labor-Hours
Indirect Costs Direct Costs
Direct Materials
4-6
Direct Manufacturing Labor
4-19
(10 min.) Budgeted manufacturing overhead rate, allocated manufacturing overhead.
1.
Budgeted manufacturing overhead rate =
= 2.
Manufacturing overhead allocated
=
Actual machine-hours
Budgeted manufacturing overhead Budgeted machine hours $4, 200, 000 = $24 per machine-hour 175, 000 machine-hours ×
Budgeted manufacturing overhead rate
= 170,000 × $24 = $4,080,000 3. Since manufacturing overhead allocated is greater than the actual manufacturing overhead costs, Gammaro overallocated manufacturing overhead: Manufacturing overhead allocated Actual manufacturing overhead costs Overallocated manufacturing overhead
4-7
$4,080,000 4,050,000 $ 30,000
4-20
(20-30 min.) Job costing, accounting for manufacturing overhead, budgeted rates.
1.
An overview of the product costing system is
}
INDIRECT COST POOL
}
COST ALLOCATION BASE
Machining Department Manufacturing Overhead
Assembly Department Manufacturing Overhead
Machine-Hours
Direct Manuf. Labor Cost
}
Indirect Costs
COST OBJECT: PRODUCT
}
DIRECT COST
Direct Costs
Direct Materials
Direct Manufacturing Labor
Budgeted manufacturing overhead divided by allocation base: Machining overhead: Assembly overhead:
$1,800,000 = $36 per machine-hour 50,000 $3,600,000 = 180% of direct manuf. labor costs $2,000,000
2.
Machining department, 2,000 hours × $36 Assembly department, 180% × $15,000 Total manufacturing overhead allocated to Job 494
3.
Machining $2,100,000
Assembly $ 3,700,000
1,980,000 — $ 120,000
— 3,960,000 $ (260,000)
Actual manufacturing overhead Manufacturing overhead allocated, $36 × 55,000 machine-hours 180% × $2,200,000 Underallocated (Overallocated)
4-8
$72,000 27,000 $99,000
4-21
(20−25 min.) Job costing, consulting firm.
1.
Budgeted indirect-cost rate for client support can be calculated as follows: Budgeted indirect-cost rate = $13,600,000 ÷ $5,312,500 = 256% of professional labor costs
INDIRECT COST POOL
}
Client Consulting Consulting Support Support
COST ALLOCATION BASE
}
Professional Professional Labor LaborCosts Costs
COST OBJECT: JOB FOR CONSULTING CLIENT
DIRECT COSTS
2.
}
Indirect Costs Direct Costs
}
Professional Labor
At the budgeted revenues of $21,250,000 Taylor’s operating income of $2,337,500 equals 11% of revenues. Markup rate = $21,250,000 ÷ $5,312,500 = 400% of direct professional labor costs
4-9
3.
Budgeted costs Direct costs: $ 792 Director, $198 × 4 Partner, $101 × 17 1,717 Associate, $49 × 42 2,058 5,508 Assistant, $36 × 153 Indirect costs: Consulting support, 256% × $10,075 Total costs
$10,075 25,792 $35,867
As calculated in requirement 2, the bid price to earn an 11% income-to-revenue margin is 400% of direct professional costs. Therefore, Taylor should bid 4 × $10,075 = $40,300 for the Red Rooster job. Bid price to earn target operating income-to-revenue margin of 11% can also be calculated as follows: Let R = revenue to earn target income R – 0.11R = $35,867 0.89R = $35,867 R = $35,867 ÷ 0.89 = $40,300 Or Direct costs Indirect costs Operating income (0.11 × $40,300) Bid price
4-10
$10,075 25,792 4,433 $40,300
4-22
(15–20 min.) Time period used to compute indirect cost rates.
1. (1) (2) (3) (4)
Pools sold Direct manufacturing labor hours (0.5 × Row 1) Fixed manufacturing overhead costs Budgeted fixed manufacturing overhead rate per direct manufacturing labor hour ($10,500 ÷ Row 2)
1 700
2 500
Quarter 3 150
4 150
Annual 1,500
350
250
75
75
750
$10,500
$10,500
$10,500
$10,500
$42,000
$30
$42
$140
$140
$56
Direct material costs ($7.50 × 500 pools; 150 pools) Direct manufacturing labor costs ($16 × 250 hours; 75 hours) Variable manufacturing overhead costs ($12 × 250 hours; 75 hours) Fixed manufacturing overhead costs ($42 × 250 hours; $140 × 75 hours) Total manufacturing costs Divided by pools manufactured each quarter Manufacturing cost per pool
Budgeted Costs Based on Quarterly Manufacturing Overhead Rate 2nd Quarter 3rd Quarter $ 3,750 $ 1,125 4,000
1,200
3,000
900
10,500 $21,250 ÷ 500 $ 42.50
10,500 $13,725 ÷ 150 $ 91.50
2.
Direct material costs ($7.50 × 500 pools; 150 pools) Direct manufacturing labor costs ($16 × 250 hours; 75 hours) Variable manufacturing overhead costs ($12 × 250 hours; 75 hours) Fixed manufacturing overhead costs ($56 × 250 hours; 75 hours) Total manufacturing costs Divided by pools manufactured each quarter Manufacturing cost per pool
4-11
Budgeted Costs Based on Annual Manufacturing Overhead Rate 2nd Quarter 3rd Quarter $ 3,750 $1,125 4,000
1,200
3,000
900
14,000 $24,750 ÷ 500 $ 49.50
4,200 $7,425 ÷ 150 $49.50
3. Prices based on quarterly budgeted manufacturing overhead rates calculated in requirement 1 ($42.50 × 130%; $91.50 × 130%) Price based on annual budgeted manufacturing overhead rates calculated in requirement 2 ($49.50 × 130%; $49.50 × 130%)
2nd Quarter
3rd Quarter
$55.25
$118.95
$64.35
$64.35
Splash should use the budgeted annual manufacturing overhead rate because capacity decisions are based on longer annual periods rather than quarterly periods. Prices should not vary based on quarterly fluctuations in production. Splash could vary prices based on market conditions and demand for its pools. In this case, Splash would charge higher prices in quarter 2 when demand for its pools is high. Pricing based on quarterly budgets would cause Splash to do the opposite— to decrease rather than increase prices!
4-12
4-23
1.
(10–15 min.) Accounting for manufacturing overhead. Budgeted manufacturing overhead rate =
$7,500, 000 250,000 machine-hours
= $30 per machine-hour 2.
Work-in-Process Control Manufacturing Overhead Allocated (245,000 machine-hours × $30 per machine-hour = $7,350,000)
7,350,000 7,350,000
3. $7,350,000– $7,300,000 = $50,000 overallocated, an insignificant amount of actual manufacturing overhead costs $50,000 ÷ $7,300,000 = 0.68%. Manufacturing Overhead Allocated Manufacturing Department Overhead Control Cost of Goods Sold
4-13
7,350,000 7,300,000 50,000
4-24
(35−45 min.) Job costing, journal entries.
Some instructors may also want to assign Exercise 4-25. It demonstrates the relationships of the general ledger to the underlying subsidiary ledgers and source documents. 1.
An overview of the product costing system is:
INDIRECT COST POOL
}
}
COST ALLOCATION BASE
Manufacturing Overhead
Direct Manufacturing Labor Costs
}
Indirect Costs
COST OBJECT: PRINT JOB
}
DIRECT COST
Direct Costs
Direct Materials
4-14
Direct Manuf. Labor
2. & 3. This answer assumes COGS given of $4,020 does not include the writeoff of overallocated manufacturing overhead. 2.
(1)
Materials Control Accounts Payable Control (2) Work-in-Process Control Materials Control (3) Manufacturing Overhead Control Materials Control (4) Work-in-Process Control Manufacturing Overhead Control Wages Payable Control (5) Manufacturing Overhead Control Accumulated Depreciation––buildings and manufacturing equipment (6) Manufacturing Overhead Control Miscellaneous accounts (7) Work-in-Process Control Manufacturing Overhead Allocated (1.60 × $1,300 = $2,080) (8) Finished Goods Control Work-in-Process Control (9) Accounts Receivable Control (or Cash) Revenues (10) Cost of Goods Sold Finished Goods Control (11) Manufacturing Overhead Allocated Manufacturing Overhead Control Cost of Goods Sold
4-15
800 800 710 710 100 100 1,300 900 2,200 400 400 550 550 2,080 2,080 4,120 4,120 8,000 8,000 4,020 4,020 2,080 1,950 130
3. Bal. 1/1/2011 (1) Accounts Payable Control (Purchases) Bal. 12/31/2011
Bal. 1/1/2011 (2) Materials Control (Direct materials) (4) Wages Payable Control (Direct manuf. labor) (7) Manuf. Overhead Allocated Bal. 12/31/2011
Bal. 1/1/2011 (8) WIP Control (Goods completed) Bal. 12/31/2011
(10) Finished Goods Control (Goods sold) Bal. 12/31/2011
Materials Control 100 (2) Work-in-Process Control (Materials used) 800 (3) Manufacturing Overhead Control (Materials used) 90 Work-in-Process Control 60 (8) Finished Goods Control (Goods completed) 710
100
4,120
1,300 2,080 30 Finished Goods Control 500 (10) Cost of Goods Sold
4,020
4,120 600 Cost of Goods Sold (11) Manufacturing Overhead 4,020 Allocated (Adjust for overallocation) 3,890
Manufacturing Overhead Control (11) To close (3) Materials Control 100 (Indirect materials) (4) Wages Payable Control 900 (Indirect manuf. labor) (5) Accum. Deprn. Control 400 (Depreciation) (6) Accounts Payable Control 550 (Miscellaneous) Bal. 0
(11) To close
710
Manufacturing Overhead Allocated 2,080 (7) Work-in-Process Control (Manuf. overhead allocated) Bal.
4-16
130
1,950
2,080 0
4-25
(35 minutes) Journal entries, T-accounts, and source documents.
1. i. Direct Materials Control 124,000 Accounts Payable Control Source Document: Purchase Invoice, Receiving Report Subsidiary Ledger: Direct Materials Record, Accounts Payable
124,000
ii. Work in Process Control a 122,000 Direct Materials Control 122,000 Source Document: Material Requisition Records, Job Cost Record Subsidiary Ledger: Direct Materials Record, Work-in-Process Inventory Records by Jobs iii. Work in Process Control 80,000 Manufacturing Overhead Control 54,500 Wages Payable Control 134,500 Source Document: Labor Time Sheets, Job Cost Records Subsidiary Ledger:, Manufacturing Overhead Records, Employee Labor Records, Work-inProcess Inventory Records by Jobs iv. Manufacturing Overhead Control 129,500 Salaries Payable Control 20,000 Accounts Payable Control 9,500 Accumulated Depreciation Control 30,000 Rent Payable Control 70,000 Source Document: Depreciation Schedule, Rent Schedule, Maintenance wages due, Invoices for miscellaneous factory overhead items Subsidiary Ledger: Manufacturing Overhead Records v. Work in Process Control 200,000 Manufacturing Overhead Allocated ($80,000 × $2.50) Source Document: Labor Time Sheets, Job Cost Record Subsidiary Ledger: Work-in-Process Inventory Records by Jobs
200,000
vi. Finished Goods Control b 387,000 Work in Process Control 387,000 Source Document: Job Cost Record, Completed Job Cost Record Subsidiary Ledger: Work-in-Process Inventory Records by Jobs, Finished Goods Inventory Records by Jobs vii. Cost of Goods Sold c 432,000 Finished Goods Control Source Document: Sales Invoice, Completed Job Cost Record Subsidiary Ledger: Finished Goods Inventory Records by Jobs
4-17
432,000
viii.
Manufacturing Overhead Allocated Manufacturing Overhead Control ($129,500 + $54,500) Cost of Goods Sold Source Document: Prior Journal Entries
200,000 184,000 16,000
ix. Administrative Expenses 7,000 Marketing Expenses 120,000 Salaries Payable Control 30,000 Accounts Payable Control 90,000 Accumulated Depreciation, Office Equipment 7,000 Source Document: Depreciation Schedule, Marketing Payroll Request, Invoice for Advertising, Sales Commission Schedule. Subsidiary Ledger: Employee Salary Records, Administration Cost Records, Marketing Cost Records.
Beginning direct Ending direct Materials used = materials inventory + Purchases – materials inventory
a
= $9,000 + $124,000 − $11,000 = $122,000 b
Cost of Beginning WIP Ending WIP + Manufacturing – inventory goods manufactured = inventory cost
= $6,000 + ($122,000 + $80,000 + $200,000) − $21,000 = $387,000 Beginning finished Ending finished Cost of goods sold = goods inventory + Cost of goods – goods inventory manufactured
c
= $69,000 + $387,0000 − $24,000 = $432,000
4-18
2.
T-accounts Direct Materials Control 9,000 (2) Work-in-Process Control Bal. 1/1/2011 (Materials used) (1) Accounts Payable Control 124,000 (Purchases) Bal. 12/31/2011 11,000 Bal. 1/1/2011 (2) Materials Control (Direct materials used) (3) Wages Payable Control (Direct manuf. labor) (5) Manuf. Overhead Allocated Bal. 12/31/2011 Bal. 1/1/2011 (6) WIP Control (Cost of goods manuf.) Bal. 12/31/2011 (7) Finished Goods Control (Goods sold)
Work-in-Process Control 6,000 (6) Finished Goods Control (Cost of goods manufactured) 122,000
387,000
80,000 200,000 21,000 Finished Goods Control 69,000 (7) Cost of Goods Sold
432,000
387,000 24,000 Cost of Goods Sold (8) Manufacturing Overhead 432,000 Allocated (Adjust for overallocation)
Manufacturing Overhead Control (8) To close (3) Wages Payable Control 54,500 (Indirect manuf. labor) (4) Salaries Payable Control 20,000 (Maintenance) (4) Accounts Payable Control 9,500 (Miscellaneous) (4) Accum. Deprn. Control 30,000 (Depreciation) (4) Rent Payable Control 70,000 (Rent) Bal. 0 (8) To close
122,000
Manufacturing Overhead Allocated 200,000 (5) Work-in-Process Control (Manuf. overhead allocated) Bal.
4-19
16,000
184,000
200,000 0
4-26
(45 min.) Job costing, journal entries.
Some instructors may wish to assign Problem 4-24. It demonstrates the relationships of journal entries, general ledger, subsidiary ledgers, and source documents. 1.
2. (1) (2) (3) (4) (5) (6) (7) (8) (9) (10a) (10b)
An overview of the product-costing system is INDIRECT COST POOL
}
Manufacturing Overhead
COST ALLOCATION BASE
}
Machine-Hours
COST OBJECT PRODUCT
}
DIRECT COSTS
}
Indirect Costs Direct Costs
Direct Materials
Direct Manuf. Labor
Amounts in millions. Materials Control Accounts Payable Control Work-in-Process Control Materials Control Manufacturing Department Overhead Control Materials Control Work-in-Process Control Wages Payable Control Manufacturing Department Overhead Control Wages Payable Control Manufacturing Department Overhead Control Accumulated Depreciation Manufacturing Department Overhead Control Various liabilities Work-in-Process Control Manufacturing Overhead Allocated Finished Goods Control Work-in-Process Control Cost of Goods Sold Finished Goods Control Accounts Receivable Control (or Cash ) Revenues
4-20
150 150 145 145 10 10 90 90 30 30 19 19 9 9 63 63 294 294 292 292 400 400
The posting of entries to T-accounts is as follows:
Bal (1) Bal.
Materials Control 12 (2) 150 (3) 7
Bal. (9) Bal.
Finished Goods Control 6 (10a) 294 8
(3) (5) (6) (7)
Manufacturing Department Overhead Control 10 (11) 30 19 9
145 10
292
150
Accumulated Depreciation (6)
19
Work-in-Process Control 2 (9) 145 90 63 6
(10a) (11)
Cost of Goods Sold 292 5
Accounts Receivable Control (10b) 400
Wages Payable Control (4) (5)
90 30
Various Liabilities (7)
9
Revenues (10b)
400
The ending balance of Work-in-Process Control is $6. 3.
294
Manufacturing Overhead Allocated (11) 63 (8) 63
68
Accounts Payable Control (1)
Bal. (2) (4) (8) Bal.
(11) Manufacturing Overhead Allocated Cost of Goods Sold Manufacturing Department Overhead Control Entry posted to T-accounts in Requirement 2.
4-21
63 5 68
4-27
(15 min.)
Job costing, unit cost, ending work in progress.
1. Direct manufacturing labor rate per hour Manufacturing overhead cost allocated per manufacturing labor-hour Direct manufacturing labor costs Direct manufacturing labor hours ($273,000 ÷ $26; $208,000 ÷ $26) Manufacturing overhead cost allocated (10,500 × $20; 8,000 × $20) Job Costs May 2011 Direct materials Direct manufacturing labor Manufacturing overhead allocated Total costs
$26 $20 Job M1 $273,000
Job M2 $208,000
10,500
8,000
$210,000
$160,000
Job M1 $ 78,000 273,000 210,000 $561,000
Job M2 $ 51,000 208,000 160,000 $419,000
2. Number of pipes produced for Job M1 Cost per pipe ($561,000 ÷ 1,100)
1,100 $510
3. Finished Goods Control Work-in-Process Control
561,000 561,000
4. Rafael Company began May 2011 with no work-in-process inventory. During May, it started and finished M1. It also started M2, which is still in work-in-process inventory at the end of May. M2’s manufacturing costs up to this point, $419,000, remain as a debit balance in the Work-in-Process Inventory account at the end of May 2011.
4-22
4-28
1.
(20−30 min.) Job costing; actual, normal, and variation from normal costing. Actual direct cost rate for professional labor = $59 per professional labor-hour Actual indirect cost rate =
$735,000 17,500 hours
= $42 per professional labor-hour
Budgeted direct cost rate for professional labor
=
$990,000 18,000 hours
= $55 per professional labor-hour
Budgeted indirect cost rate =
$774,000 18,000 hours
= $43 per professional labor-hour
Direct-Cost Rate Indirect-Cost Rate
2.
Direct Costs Indirect Costs Total Job Costs
(a) (b) Actual Normal Costing Costing $59 $59 (Actual rate) (Actual rate) $42 $43 (Actual rate) (Budgeted rate)
(c) Variation of Normal Costing $55 (Budgeted rate) $43 (Budgeted rate)
(a) (b) (c) Actual Normal Variation of Costing Costing Normal Costing $59 × 160 = $ 9,440 $59 × 160 = $ 9,440 $55 × 160 = $ 8,800 $42 × 160 = 6,720 $43 × 160 = 6,880 $43 × 160 = 6,880 $15,680 $16,160 $16,320
All three costing systems use the actual professional labor time of 160 hours. The budgeted 150 hours for the Pierre Enterprises audit job is not used in job costing. However, Chico may have used the 150 hour number in bidding for the audit. The actual costing figure of $16,160 is less than the normal costing figure of $16,320 because the actual indirect-cost rate ($42) is less than the budgeted indirect-cost rate ($43). The normal costing figure of $16,320 is more than the variation of normal costing (based on budgeted rates for direct costs) figure of $15,680, because the actual direct-cost rate ($59) is more than the budgeted direct-cost rate ($55).
4-23
Although not required, the following overview diagram summarizes Chico’s job-costing system. INDIRECT COST POOL
COST ALLOCATION BASE
COST OBJECT: JOB FOR AUDITING PIERRE & CO.
Audit Support
Professional Labor-Hours
Indirect Costs Direct Costs
DIRECT COST Professional Labor
4-24
4-29
1.
(20−30 min.) Job costing; actual, normal, and variation from normal costing. Actual direct cost rate for architectural labor = $92 per architectural labor-hour $1, 729,500 34,590
= $50 per architectural labor-hour
$2,880,000 Budgeted direct cost rate = for professional labor 32,000
= $90 per architectural labor-hour
$1,728,000 32,000
= $54 per architectural labor-hour
Actual indirect cost rate =
Budgeted indirect cost rate =
Direct-Cost Rate Indirect-Cost Rate
2.
Direct Costs Indirect Costs Total Job Costs
(a) (b) Actual Normal Costing Costing $92 $92 (Actual rate) (Actual rate) $50 $54 (Actual rate) (Budgeted rate)
(a) Actual Costing $92 × 250 = $23,000 $50 × 250 = 12,500 $35,500
(c) Variation of Normal Costing $90 (Budgeted rate) $54 (Budgeted rate)
(b) (c) Normal Variation of Costing Normal Costing $92 × 250 = $23,000 $90 × 250 = $22,500 $54 × 250 = 13,500 $54 × 250 = 13,500 $36,000 $36,500
All three costing systems use the actual architectural labor time of 250 hours. The budgeted 275 hours for the Champ Tower job is not used in job costing. However, Braden Brothers may have used the budgeted number of hours in bidding for the job.
4-25
4-30 (30 min.) Proration of overhead.
1. Budgeted manufacturing overhead rate
=
Budgeted manufacturing overhead cost Budgeted direct manufacturing labor cost
=
$125, 000 = 50% of direct manufacturing labor cost $250, 000
2. Overhead allocated = 50% × Actual direct manufacturing labor cost = 50% × $228,000 = $114,000 Underallocated manufacturing overhead
=
Actual manufacturing overhead costs
Allocated plant overhead costs
–
= $117,000 – $114,000 = $3,000 Underallocated manufacturing overhead = $3,000 3a. All underallocated manufacturing overhead is written off to cost of goods sold. Both work in process (WIP) and finished goods inventory remain unchanged.
Account WIP Finished Goods Cost of Goods Sold Total
Dec. 31, 2011 Balance (Before Proration) (1) $ 50,700 245,050 549,250 $845,000
Proration of $3,000 Underallocated Manuf. Overhead (2) $ 0 0 3,000 $3,000
Dec. 31, 2011 Balance (After Proration) (3) = (1) + (2) $ 50,700 245,050 552,250 $848,000
3b. Underallocated manufacturing overhead prorated based on ending balances:
Account WIP Finished Goods Cost of Goods Sold Total
Dec. 31, 2011 Account Balance (Before Proration) (1) $ 50,700 245,050 549,250 $845,000
Account Balance as a Percent of Total (2) = (1) ÷ $845,000 0.06 0.29 0.65 1.00
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Proration of $3,000 Underallocated Manuf. Overhead (3) = (2) × $3,000 0.06 × $3,000 = $ 180 0.29 × $3,000 = 870 0.65 × $3,000 = 1,950 $3,000
Dec. 31, 2011 Account Balance (After Proration) (4) = (1) + (3) $ 50,880 245,920 551,200 $848,000
3c. Underallocated manufacturing overhead prorated based on 2011 overhead in ending balances:
Account WIP Finished Goods Cost of Goods Sold Total
a,b,c
Dec. 31, 2011 Account Balance (Before Proration) (1) $ 50,700 245,050 549,250 $845,000
Allocated Manuf. Overhead in Dec. 31, 2011 Balance (Before Proration) (2) $ 10,260a 29,640b 74,100c $114,000
Allocated Manuf. Overhead in Dec. 31, 2011 Balance as a Percent of Total (3) = (2) ÷ $114,000 0.09 0.26 0.65 1.00
Proration of $3,000 Underallocated Manuf. Overhead (4) = (3) × $3,000 0.09 × $3,000 = $ 270 780 0.26 × $3,000 = 0.65 × $3,000 = 1,950 $3,000
Dec. 31, 2011 Account Balance (After Proration) (5) = (1) + (4) $ 50,970 245,830 551,200 $848,000
Overhead allocated = Direct manuf. labor cost × 50% = $20,520; $59,280; $148,200 × 50%
4. Writing off all of the underallocated manufacturing overhead to Cost of Goods Sold (CGS) is usually warranted when CGS is large relative to Work-in-Process and Finished Goods Inventory and the underallocated manufacturing overhead is immaterial. Both these conditions apply in this case. ROW should write off the $3,000 underallocated manufacturing overhead to Cost of Goods Sold Account.
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4-31 (20−30 min)
1.
Job costing, accounting for manufacturing overhead, budgeted rates.
An overview of the job-costing system is: INDIRECT COST POOL
}
}
COST ALLOCATION BASE
Machining Department Manufacturing Overhead
Finishing Department Manufacturing Overhead
Machine-Hours in Machining Dept.
Direct Manufacturing Labor Costs in Finishing Dept.
}
Indirect Costs
COST COSTOBJECT: OBJECT: PRODUCT JOB
}
DIRECT COST
2.
Direct Costs
Direct Materials
Direct Manufacturing Labor
Budgeted manufacturing overhead divided by allocation base: a. Machining Department: $10,660,000 = $52 per machine-hour 205,000 machine-hours b. Finishing Department: $7,372,000 $3,800,000
3.
= 194% of direct manufacturing labor costs
Machining Department overhead, $52 × 130 machine-hours $6,760 Finishing Department overhead, 194% of $1,100 2,134 Total manufacturing overhead allocated $8,894
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4.
Total costs of Job 431: Direct costs: Direct materials––Machining Department ––Finishing Department Direct manufacturing labor —Machining Department —Finishing Department Indirect costs: Machining Department overhead, $52 × 130 Finishing Department overhead, 194% of $1,100 Total costs
$15,500 5,000 400 1,100 $ 6,760 2,134
$22,000
8,894 $30,894
The per-unit product cost of Job 431 is $30,894 ÷ 400 units = $77.235 per unit The point of this part is (a) to get the definitions straight and (b) to underscore that overhead is allocated by multiplying the actual amount of the allocation base by the budgeted rate. 5. Machining Manufacturing overhead incurred (actual) $11,070,000 Manufacturing overhead allocated 210,000 hours × $52 10,920,000 194% of $4,400,000 Underallocated manufacturing overhead $ 150,000 Overallocated manufacturing overhead Total overallocated overhead = $300,000 – $150,000 = $150,000
Finishing $8,236,000
8,536,000 $ 300,000
A homogeneous cost pool is one where all costs have the same or a similar cause-and6. effect or benefits-received relationship with the cost-allocation base. Fasano likely assumes that all its manufacturing overhead cost items are not homogeneous. Specifically, those in the Machining Department have a cause-and-effect relationship with machine-hours, while those in the Finishing Department have a cause-and-effect relationship with direct manufacturing labor costs. Fasano believes that the benefits of using two cost pools (more accurate product costs and better ability to manage costs) exceeds the costs of implementing a more complex system.
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4-32
(15−20 min.) Service industry, job costing, law firm.
1. INDIRECT COST POOL COST ALLOCATION BASE
}
Legal Support
}
Professional Labor-Hours
COST OBJECT: JOB FOR CLIENT
}
DIRECT COST
}
Indirect Costs Direct Costs
Professional Labor
2.
Budgeted professional = Budgeted direct labor compensation per professional labor-hour direct cost rate Budgeted direct labor-hours per professional $104,000 1,600 hours = $65 per professional labor-hour
=
Note that the budgeted professional labor-hour direct-cost rate can also be calculated by dividing total budgeted professional labor costs of $2,600,000 ($104,000 per professional × 25 professionals) by total budgeted professional labor-hours of 40,000 (1,600 hours per professional × 25 professionals), $2,600,000 ÷ 40,000 = $65 per professional labor-hour. 3.
Budgeted total costs in indirect cost pool Budgeted total professional labor-hours $2,200,000 = 1,600 hours per professional × 25 professionals $2,200,000 = 40,000 hours = $55 per professional labor-hour
Budgeted indirect = cost rate
4. Direct costs: Professional labor, $65 × 100; $65 × 150 Indirect costs: Legal support, $55 × 100; $55 × 150
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Richardson
Punch
$ 6,500
$ 9,750
5,500 $12,000
8,250 $18,000
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(25–30 min.) Service industry, job costing, two direct- and indirect-cost categories, law firm (continuation of 4-32).
Although not required, the following overview diagram is helpful to understand Keating’s jobcosting system. INDIRECT COST POOL COST ALLOCATION BASE
}
General Support
Secretarial Support
}
Professional Labor-Hours
Partner Labor-Hours
COST OBJECT: JOB FOR CLIENT
}
DIRECT COST
}
Indirect Costs Direct Costs
Professional Associate Labor
Professional Partner Labor
1. Budgeted compensation per professional Divided by budgeted hours of billable time per professional Budgeted direct-cost rate
Professional Partner Labor $ 200,000
Professional Associate Labor $80,000
÷1,600 $125 per hour*
÷1,600 $50 per hour†
*Can also be calculated as
Total budgeted partner labor costs Total budgeted partner labor - hours
$200,000 × 5 $1,000,000 = 1,600 × 5 8,000
= $125
†
Total budgeted associate labor costs $80,000 × 20 $1,600,000 = = Total budgeted associate labor - hours 1,600 × 20 32,000
= $ 50
Can also be calculated as
2. Budgeted total costs Divided by budgeted quantity of allocation base Budgeted indirect cost rate
4-31
=
General Secretarial Support Support $400,000 $1,800,000 ÷ 40,000 hours ÷ 8,000 hours $45 per hour $50 per hour
3.
Richardson Direct costs: Professional partners, $125 × 60 hr.; $125 × 30 hr. Professional associates, $50 × 40 hr.; $50 × 120 hr. Direct costs Indirect costs: General support, $45 × 100 hr.; $45 × 150 hr. Secretarial support, $50 × 60 hr.; $50 × 30 hr. Indirect costs Total costs
Punch
$3,750
$7,500
6,000
2,000 $ 9,500
4,500
6,750
3,000
1,500 7,500 $17,000
4. Single direct – Single indirect (from Problem 4-32) Multiple direct – Multiple indirect (from requirement 3 of Problem 4-33) Difference
$ 9,750
8,250 $18,000
Richardson
Punch
$12,000
$18,000
17,000
18,000
$ 5,000 undercosted
$ 0 no change
The Richardson and Punch jobs differ in their use of resources. The Richardson job has a mix of 60% partners and 40% associates, while Punch has a mix of 20% partners and 80% associates. Thus, the Richardson job is a relatively high user of the more costly partner-related resources (both direct partner costs and indirect partner secretarial support). The Punch job, on the other hand, has a mix of partner and associate-related hours (1 : 4) that exactly equals the mix of partner and associate hours for the firm as a whole. The refined-costing system in Problem 433 increases the reported cost in Problem 4-32 for the Richardson job by 41.7% (from $12,000 to $17,000) while it happens to correctly cost the Punch job.
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4-34
(20−25 min.) Proration of overhead.
1. Budgeted manufacturing overhead rate is $4,800,000 ÷ 80,000 hours = $60 per machine-hour. 2.
Manufacturing overhead = Manufacturing overhead – Manufacturing overhead underallocated incurred allocated = $4,900,000 – $4,500,000* = $400,000
*$60 × 75,000 actual machine-hours = $4,500,000
a.
Write-off to Cost of Goods Sold
Account (1)
Write-off of $400,000 Underallocated Manufacturing Overhead (3)
Dec. 31, 2011 Account Balance (Before Proration) (2)
Work in Process Finished Goods Cost of Goods Sold Total
$
750,000 1,250,000 8,000,000 $10,000,000
$
0 0 400,000 $400,000
Dec. 31, 2011 Account Balance (After Proration) (4) = (2) + (3) $
750,000 1,250,000 8,400,000 $10,400,000
b. Proration based on ending balances (before proration) in Work in Process, Finished Goods and Cost of Goods Sold.
Account (1) Work in Process Finished Goods Cost of Goods Sold Total
Proration of $400,000 Underallocated Dec. 31, 2011 Manufacturing Account Balance Overhead (Before Proration) (3) (2) $ 750,000 ( 7.5%) 0.075 × $400,000 = $ 30,000 1,250,000 (12.5%) 0.125 × $400,000 = 50,000 8,000,000 (80.0%) 0.800 × $400,000 = 320,000 $10,000,000 100.0% $400,000
Dec. 31, 2011 Account Balance (After Proration) (4) = (2) + (3) $ 780,000 1,300,000 8,320,000 $10,400,000
c. Proration based on the allocated overhead amount (before proration) in the ending balances of Work in Process, Finished Goods, and Cost of Goods Sold. Dec. 31, 2011 Allocated Overhead Dec. 31, 2011 Account Included in Account Balance Dec. 31, 2011 Proration of $400,000 Balance (Before Account Balance Underallocated (After Account Proration) (Before Proration) Manufacturing Overhead Proration) (1) (2) (3) (4) (5) (6) = (2) + (5) a Work in Process $ 750,000 $ 240,000 (5.33%) 0.0533×$400,000 = $ 21,320 $ 771,320 Finished Goods Cost of Goods Sold Total a
1,250,000 8,000,000 $10,000,000
b
660,000
c
3,600,000 $4,500,000
b
(14.67%) 0.1467×$400,000 = 58,680 (80.00%) 0.8000×$400,000 = 320,000 100.00% $400,000 c
$60 × 4,000 machine-hours; $60 × 11,000 machine-hours; $60 × 60,000 machine-hours
4-33
1,308,680 8,320,000 $10,400,000
3. Alternative (c) is theoretically preferred over (a) and (b) because the underallocated amount and the balances in work-in-process and finished goods inventories are material. Alternative (c) yields the same ending balances in work in process, finished goods, and cost of goods sold that would have been reported had actual indirect cost rates been used. Chapter 4 also discusses an adjusted allocation rate approach that results in the same ending balances as does alternative (c). This approach operates via a restatement of the indirect costs allocated to all the individual jobs worked on during the year using the actual indirect cost rate.
4-35
(15 min.) Normal costing, overhead allocation, working backward.
1a.
Manufacturing overhead allocated = 200% × Direct manufacturing labor cost $3,600,000 = 2 × Direct manufacturing labor cost Direct manufacturing labor cost =
b.
$3,600,000 = $1,800,000 2
Total manufacturing = Direct material + Direct manufacturing + Manufacturing used labor cost overhead allocated cost $8,000,000 = Direct material used + $1,800,000 + $3,600,000 Direct material used = $2,600,000
2.
Total Cost of goods Work in process Work in process + manufacturing cost = manufactured + 12/31/2011 1/1/2011 Denote Work in process on 12/31/2011 by X $320,000 + $8,000,000 = $7,920,000 + X X = $400,000 Work-in-process inventory, 12/31/11 = $400,000.
4-34
4-36 (40 min.) Proration of overhead with two indirect cost pools. 1.a. Molding department: Overhead allocated = $4,602 + $957 + $12,489 = $18,048 Overallocated overhead = Actual overhead costs – Overhead allocated = $17,248 – $18,048 = $800 overallocated 1.b. Painting department: Overhead allocated = $2,306 + $1,897 + $24,982 = $29,185 Underallocated overhead = Actual overhead costs – Overhead allocated = $31,485 – $29,185 = $2,300 underallocated 2a. All under/overallocated overhead is written off to cost of goods sold. Both Work in Process and Finished goods inventory remain unchanged.
Account WIP Finished Goods Cost of Goods Sold Total
Account Balance (Before Proration) (1) $ 27,720.00 15,523.20 115,156.80 $158,400.00
Proration of $1,500 Underallocated Overhead (2) 0 0 –$800 + $2,300 $ 1,500
Account Balance (After Proration) (3) = (1) + (2) $ 27,720.00 15,523.20 116,656.80 $159,900.00
2b. Underallocated overhead prorated based on ending balances
Account WIP Finished Goods Cost of Goods Sold Total
Account Balance (Before Proration) (1) $ 27,720.00 15,523.20 115,156.80 $158,400.00
Account Balance as a Percent of Total (2) = (1) ÷ $2,000,000 0.175 0.098 0.727 1.000
Proration of $1,500 Underallocated Overhead (3) = (2) × 10,000 0.175 × $1,500 = $ 262.50 0.098 × $1,500 = 147.00 0.727 × $1,500 = 1,090.50 $1,500.00
Account Balance (After Proration) (4) = (1) + (3) $ 27,982.50 15,670.20 116,247.30 $159,900.00
2c. Under/overallocated overhead prorated based on overhead in ending balances. (Note: overhead must be allocated separately from each department. This can be done using the number of machine hours/direct labor hours as a surrogate for overhead in ending balances.)
4-35
For Molding department:
Account WIP Finished Goods Cost of Goods Sold Total
Allocated Overhead in Account Balance (1) $ 4,602 957 12,489 $18,048
Allocated Overhead in Account Balance as a Percent of Total (2) = (1) ÷ $18,048 0.255 0.053 0.692 1.000
Proration of $800 Overallocated Overhead (3) = (2) × $800 0.255 × $800 = $204.00 0.053 × $800 = 42.40 0.692 × $800 = 553.60 $800.00
Allocated Overhead in Account Balance as a Percent of Total (5) = (4) ÷ $29,185 0.079 0.065 0.856 1.000
Proration of $2,300 Underallocated Overhead (6) = (5) × $2,300 0.079 × $2,300 = $ 181.70 0.065 × $2,300 = 149.50 0.856 × $2,300 = 1,968.80 $2,300.00
For finishing department:
Account WIP Finished Goods Cost of Goods Sold Total
Allocated Overhead in Account Balance (4) $ 2,306 1,897 24,982 $29,185
Account WIP Finished Goods Cost of Goods Sold Total
Account Balance (Before Proration) (7) $27,720.00 15,523.20 115,156.80 $158,400.00
Underallocated/ Overallocated Overhead (8) = (3) – (6) –$204 + $181.70 = $ (22.30) –$42.40 + $149.50 = 107.10 –$553.60 + $1,968.80 = 1,415.20 $1,500.00
Account Balance (After Proration) (9) = (7) + (8) $ 27,697.70 15,630.30 116,572.00 $159,900.00
3. The first method is simple and Cost of Goods Sold accounts for almost 73% of the three account amounts. The amount of overallocated and underallocated overhead is also immaterial. Allocation to the other two accounts is minimal. Therefore, write-off to cost of goods sold is the most cost effective alternative.
4-36
4-37
(35 min.) General ledger relationships, under- and overallocation.
The solution assumes all materials used are direct materials. A summary of the T-accounts for Needham Company before adjusting for under- or overallocation of overhead follows: Direct Materials Control 1-1-2011 Purchases 12-31-2011
Work-in-Process Control
30,000 Material used for 400,000 manufacturing 380,000 50,000
1-1-2011 20,000 Transferred to Direct materials 380,000 finished goods 940,000 Direct manuf. Labor 360,000 Manuf. overhead allocated 480,000 12-31-2011 300,000
Finished Goods Control 1-1-2011 10,000 Cost of goods Transferred in sold from WIP 940,000 12-31-2011 50,000
Cost of Goods Sold Finished goods sold
900,000
Manufacturing Overhead Control
900,000
Manufacturing Overhead Allocated
Manufacturing overhead costs 540,000
Manufacturing overhead allocated to work in process
1.
From Direct Materials Control T-account, Direct materials issued to production = $380,000 that appears as a credit.
2.
Direct manufacturing labor-hours = = Manufacturing overhead allocated
= =
480,000
Direct manufacturing labor costs Direct manufacturing wage rate per hour $360,000 = 24,000 hours $15 per hour Direct manufacturing × Manufacturing overhead rate labor hours 24,000 hours × $20 per hour = $480,000
3.
From the debit entry to Finished Goods T-account, Cost of jobs completed and transferred from WIP = $940,000
4.
From Work-in-Process T-account, Work in process inventory = $20,000 + $380,000 + $360,000 + $480,000 – $940,000 on 12/31/2011 = $300,000
5. From the credit entry to Finished Goods Control T-account, Cost of goods sold (before proration) = $900,000
4-37
6.
Manufacturing overhead underallocated
7.
a. b.
Debits to Manufacturing Credit to Manufacturing – Overhead Allocated Overhead Control = $540,000 – $480,000 = $60,000 underallocated =
Write-off to Cost of Goods Sold will increase (debit) Cost of Goods Sold by $60,000. Hence, Cost of Goods Sold = $900,000 + $60,000 = $960,000. Proration based on ending balances (before proration) in Work in Process, Finished Goods, and Cost of Goods Sold.
Account balances in each account after proration follows:
Account (1) Work in Process Finished Goods Cost of Goods Sold
Account Balance (Before Proration) (2) $ 300,000 (24%) 50,000 ( 4%) 900,000 (72%) $1,250,000 100%
Proration of $60,000 Underallocated Manufacturing Overhead (3) 0.24 × $60,000 = $14,400 0.04 × $60,000 = 2,400 0.72 × $60,000 = 43,200 $60,000
Account Balance (After Proration) (4)=(2)+(3) $ 314,400 52,400 943,200 $1,310,000
8. Needham’s operating income using write-off to Cost of Goods Sold and Proration based on ending balances (before proration) follows:
Revenues Cost of goods sold Gross margin Marketing and distribution costs Operating income/(loss)
Write-off to Cost of Goods Sold
Proration Based on Ending Balances
$1,090,000 960,000 130,000 140,000 $ (10,000)
$1,090,000 943,200 146,800 140,000 $ 6,800
9. If the purpose is to report the most accurate inventory and cost of goods sold figures, the preferred method is to prorate based on the manufacturing overhead allocated component in the inventory and cost of goods sold accounts. Proration based on the balances in Work in Process, Finished Goods, and Cost of Goods Sold will equal the proration based on the manufacturing overhead allocated component if the proportions of direct costs to manufacturing overhead costs are constant in the Work in Process, Finished Goods and Cost of Goods Sold accounts. Even if this is not the case, the prorations based on Work in Process, Finished Goods, and Cost of Goods Sold will better approximate the results if actual cost rates had been used rather than the write-off to Cost of Goods Sold method. Another consideration in Needham’s decision about how to dispose of underallocated manufacturing overhead is the effects on operating income. The write-off to Cost of Goods Sold will lead to an operating loss. Proration based on the balances in Work in Process, Finished Goods, and Cost of Goods Sold will help Needham avoid the loss and show an operating income. The main merit of the write-off to Cost of Goods Sold method is its simplicity. However, accuracy and the effect on operating income favor the preferred and recommended proration approach.
4-38
4-38
(40−55 min.) Overview of general ledger relationships.
1. Adjusting entry for 12/31 payroll. (a) Work-in-Process Control Manufacturing Department Overhead Control Wages Payable Control To recognize payroll costs
3,850 950
(b) Work-in-Process Control Manufacturing Overhead Allocated To allocate manufacturing overhead at 120% × $3,850 = $4,620 on $3,850 of direct manufacturing labor incurred on 12/31
4,620
4,800
4,620
Note: Students tend to forget entry (b) entirely. Stress that a budgeted overhead allocation rate is used consistently throughout the year. This point is a major feature of this problem.
2. a-e An effective approach to this problem is to draw T-accounts and insert all the known figures. Then, working with T-account relationships, solve for the unknown figures. Entries (a) and (b) are posted into the T-accounts that follow.
Beginning balance 12/1 Purchases Balance 12/30 a $1,200 + $65,400 – $7,600 = $59,000 (a)
Materials Control 1,200 59,000a 65,400 7,600
Materials requisitioned
Direct materials requisitioned into work in process during December equals $59,000 because no materials are requisitioned on December 31.
Work-in-Process Control Beginning balance 12/1 5,800 Direct materials $59,000 Direct manf. labor 76,500b Manf. overhead 225,000 227,300 allocated 91,800b Balance 12/30 8,100 (a) Direct manuf. labor 12/31 payroll 3,850 (b) Manuf. overhead allocated 12/31 4,620c Ending balance 12/31 16,570 b
Cost of goods manufactured
Direct manufacturing labor and manufacturing overhead allocated are unknown. Let x = Direct manufacturing labor up to 12/30 payroll, then manufacturing overhead allocated up to 12/30 payroll = 1.20x
4-39