Accounting 311 Cost

Solutions for Homework ** Accounting 311 Cost ** CHAPTER 1 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. 1-5 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. 1-14 The Institute of Management Accountants (IMA) sets standards of ethical conduct for management accountants in the following areas: Competence Confidentiality Integrity Credibility 1-29 (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. 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. 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. CHAPTER 2 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 Manufacturing companies typically have one or more of the following three types of inventory: Direct materials inventory. Direct materials in stock and awaiting use in the manufacturing process. Work-in-process inventory. Goods partially worked on but not yet completed. Also called work in progress. Finished goods inventory. Goods completed but not yet sold. 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 D or I V or F A D V B I F C D F D D F E D V F I V G D V H I F 2-22 (15–20 min.) Variable costs and fixed costs. 1. 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 = $150,000 101 to 200 tons of capacity per day = $300,000 201 to 300 tons of capacity per day = $450,000 2. 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 Tons Mined per Month Fixed Unit Cost per Ton Variable Unit Cost per Ton Total Unit Cost per Ton (1) (2) = (1) × 25 (3) = FC ÷ (2) (4) (5) = (3) + (4) (a) 180 4,500 $300,000 ÷ 4,500 = $66.67 $130 $196.67 (b) 220 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. 2-23 (20 min.) Variable costs, fixed costs, relevant range. 1. Since the production capacity is 4,000 jaw breakers per month, the current annual relevant range of output is 0 to 4,000 jaw breakers × 12 months = 0 to 48,000 jaw breakers. 2. Current annual fixed manufacturing costs within the relevant range are $1,000 × 12 = $12,000 for rent and other overhead costs, plus $6,000 ÷ 10 = $600 for depreciation, totaling $12,600. The variable costs, the materials, are 10 cents per jaw breaker, or $3,600 ($0.10 per jaw breaker × 3,000 jaw breakers per month × 12 months) for the year. 3. If demand changes from 3,000 to 6,000 jaw breakers per month, or from 3,000 × 12 = 36,000 to 6,000 × 12 = 72,000 jaw breakers per year, Yumball will need a second machine. Assuming Yumball buys a second machine identical to the first machine, it will increase capacity from 4,000 jaw breakers per month to 8,000. The annual relevant range will be between 4,000 × 12 = 48,000 and 8,000 × 12 = 96,000 jaw breakers. Assume the second machine costs $6,000 and is depreciated using straight-line depreciation over 10 years and zero residual value, just like the first machine. This will add $600 of depreciation per year. Fixed costs for next year will increase to $13,200, $12,600 from the current year + $600 (because rent and other fixed overhead costs will remain the same at $12,000). That is, total fixed costs for next year equal $600 (depreciation on first machine) + $600 (depreciation on second machine) + $12,000 (rent and other fixed overhead costs). The variable cost per jaw breaker next year will be 90% × $0.10 = $0.09. Total variable costs equal $0.09 per jaw breaker × 72,000 jaw breakers = $6,480. 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) 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. Electricity used at GE 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. Depreciation on Google’s computer equipment—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. Electricity 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. 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. 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). Bottled water consumed by Google’s engineers—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. 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. 2-29 (20 min.) Flow of Inventoriable Costs. (All numbers below are in millions). 1. Direct materials inventory 8/1/2008 $ 90 Direct materials purchased 360 Direct materials available for production 450 Direct materials used 375 Direct materials inventory 8/31/2008 $ 75 2. Total manufacturing overhead costs $ 480 Subtract: Variable manufacturing overhead costs (250) Fixed manufacturing overhead costs for August $ 230 3. Total manufacturing costs $ 1,600 Subtract: Direct materials used (from requirement 1) (375) Total manufacturing overhead costs (480) Direct manufacturing labor costs for August $ 745 4. Work-in-process inventory 8/1/2008 $ 200 Total manufacturing costs 1,600 Work-in-process available for production 1,800 Subtract: Cost of goods manufactured (moved into FG) (1,650) Work-in-process inventory 8/31/2008 $ 150 5. Finished goods inventory 8/1/2008 $ 125 Cost of goods manufactured (moved from WIP) 1,650 Finished goods available for sale in August $ 1,775 6. Finished goods available for sale in August (from requirement 5) $ 1,775 Subtract: Cost of goods sold (1,700) Finished goods inventory 8/31/2008 $ 75 2-30 (20 min.) Computing cost of goods purchased and cost of goods sold. (1) Marvin Department Store Schedule of Cost of Goods Purchased For the Year Ended December 31, 2008 (in thousands) Purchases $155,000 Add transportation-in 7,000 162,000 Deduct: Purchase return and allowances $4,000 Purchase discounts 6,000 10,000 Cost of goods purchased $152,000 (2) Marvin Department Store Schedule of Cost of Goods Sold For the Year Ended December 31, 2008 (in thousands) Beginning merchandise inventory 1/1/2008 $ 27,000 Cost of goods purchased (above) 152,000 Cost of goods available for sale 179,000 Ending merchandise inventory 12/31/2008 34,000 Cost of goods sold $145,000 2-32 (25–30 min.) Income statement and schedule of cost of goods manufactured. Howell Corporation Income Statement for the Year Ended December 31, 2009 (in millions) Revenues $950 Cost of goods sold: Beginning finished goods, Jan. 1, 2009 $ 70 Cost of goods manufactured (below) 645 Cost of goods available for sale 715 Ending finished goods, Dec. 31, 2009 55 660 Gross margin 290 Marketing, distribution, and customer-service costs 240 Operating income $ 50 Howell Corporation Schedule of Cost of Goods Manufactured for the Year Ended December 31, 2009 (in millions) Direct materials costs: Beginning inventory, Jan. 1, 2009 $ 15 Purchases of direct materials 325 Cost of direct materials available for use 340 Ending inventory, Dec. 31, 2009 20 Direct materials used $320 Direct manufacturing labor costs 100 Indirect manufacturing costs: Indirect manufacturing labor 60 Plant supplies used 10 Plant utilities 30 Depreciation––plant and equipment 80 Plant supervisory salaries 5 Miscellaneous plant overhead 35 220 Manufacturing costs incurred during 2009 640 Add beginning work-in-process inventory, Jan. 1, 2009 10 Total manufacturing costs to account for 650 Deduct ending work-in-process, Dec. 31, 2009 5 Cost of goods manufactured $645 2-33 (15–20 min.) Interpretation of statements (continuation of 2-32). 1. The schedule in 2-32 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 2009. 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. 2-36 (20 min.) Labor cost, overtime and idle time. 1.(a) Total cost of hours worked at regular rates 42 hours × 12 per hour $ 504.00 42 hours × 12 per hour 504.00 43 hours × 12 per hour 516.00 40 hours × 12 per hour 480.00 2,004.00 Minus idle time (5.2 hours × $12 per hour) 62.40 Direct manufacturing labor costs $1,941.60 (b) Idle time = 5.2 hours × 12 per hour = (c) Overtime and holiday premium. $62.40 Week 1: Overtime (42-40) hours × Premium, $6 per hour $ 12.00 Week 2: Overtime (42-40) hours ×Premium, $6 per hour 12.00 Week 3: Overtime (43-40) hours × Premium, $6 per hour 18.00 Week 4: Holiday 8 hours × Premium, $12 per hour 96.00 Total overtime and holiday premium $138.00 (d) Total earnings in May Direct manufacturing labor costs $1,941.60 Idle time 62.40 Overtime and holiday premium 138.00 Total earnings $2,142.00 2. Idle time caused by equipment breakdowns and scheduling mixups is an indirect cost of the job because it is not related to a specific job. 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. 2-37 (30–40 min.) Fire loss, computing inventory costs. 1. Finished goods inventory, 2/26/2009 = $50,000 2. Work-in-process inventory, 2/26/2009 = $28,000 3. Direct materials inventory, 2/26/2009 = $62,000 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: Prime costs (given) = $294,000 Direct materials used = $294,000 – Direct manufacturing labor costs = $294,000 – $180,000 = $114,000 Conversion costs = Direct manufacturing labor costs ÷ 0.6 $180,000 ÷ 0.6 = $300,000 Indirect manuf. costs = $300,000 – $180,000 = $120,000 (or 0.40 $300,000) Schedule of Computations Direct materials, 1/1/2009 $ 16,000 Direct materials purchased 160,000 Direct materials available for use 176,000 Direct materials, 2/26/2009 3 = 62,000 Direct materials used ($294,000 – $180,000) 114,000 Direct manufacturing labor costs 180,000 Prime costs 294,000 Indirect manufacturing costs 120,000 Manufacturing costs incurred during the current period 414,000 Add work in process, 1/1/2009 34,000 Manufacturing costs to account for 448,000 Deduct work in process, 2/26/2009 2 = 28,000 Cost of goods manufactured 420,000 Add finished goods, 1/1/2009 30,000 Cost of goods available for sale (given) 450,000 Deduct finished goods, 2/26/2009 1 = 50,000 Cost of goods sold (80% of $500,000) $400,000 Some students 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): Work in Process Finished Goods Cost of Goods Sold BI 34 BI 30 DM used 114 COGM 420 -------> 420 COGS 400 ---->400 DL 180 OH 120 Available To account for 448 for sale 450 EI 28 EI 50 CHAPTER 3 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. 3-16 (10 min.) CVP computations. Variable Fixed Total Operating Contribution Contribution Revenues Costs Costs Costs Income Margin Margin % a. $2,000 $ 500 $300 $ 800 $1,200 $1,500 75.0% b. 2,000 1,500 300 1,800 200 500 25.0% c. 1,000 700 300 1,000 0 300 30.0% d. 1,500 900 300 1,200 300 600 40.0% 3-17 (10–15 min.) CVP computations. 1a. Sales ($30 per unit × 200,000 units) $6,000,000 Variable costs ($25 per unit × 200,000 units) 5,000,000 Contribution margin $1,000,000 1b. Contribution margin (from above) $1,000,000 Fixed costs 800,000 Operating income $ 200,000 2a. Sales (from above) $6,000,000 Variable costs ($16 per unit × 200,000 units) 3,200,000 Contribution margin $2,800,000 2b. Contribution margin $2,800,000 Fixed costs 2,400,000 Operating income $ 400,000 Operating income is expected to increase by $200,000 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. Patel’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. 3-23 (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 Solution Exhibit 3-23A shows the PV graph. Solution Exhibit 3-23A PV Graph for Media Publishers 2a. = = = 252,708 copies sold (rounded up) 2b. Target OI = = = = 397,112 copies sold (rounded up) 3a. Decreasing the normal bookstore margin to 20% of the listed bookstore price of $30 has the following effects: SP = $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 CMU = $24.00 – $7.60 = $16.40 per copy = = = 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: SP = $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 CMU= $28.00 – $8.20 = $19.80 per copy = = 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. 3-24 (10 min.) CVP analysis, margin of safety. 1. Breakeven point revenues = Contribution margin percentage = = 0.40 or 40% 2. Contribution margin percentage = 0.40 = 0.40 SP = SP – $15 0.60 SP = $15 SP = $25 3. Breakeven sales in units = Revenues ÷ Selling price = $1,500,000 ÷ $25 = 60,000 units Margin of safety in units = sales in units – Breakeven sales in units = 80,000 – 60,000 = 20,000 units Revenues, 80,000 units $25 $2,000,000 Breakeven revenues 1,500,000 Margin of safety $ 500,000 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. Breakeven point under Option 2 $500Q $350Q (0.10 $500Q) = 0 100Q = 0 Q = 0 2. 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 and Option 2 = $10,000 For Q > 100, say, 101 carpets, Option 1 gives operating income = ($150 101) $5,000 = $10,150 Option 2 gives operating income = $100 101 = $10,100 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. Degree of operating leverage = Under Option 1, degree of operating leverage = = 1.5 Under Option 2, degree of operating leverage = = 1.0 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. 3-35 (20–25 min.) CVP analysis. 1. Selling price $16.00 Variable costs per unit: Purchase price $10.00 Shipping and handling 2.00 12.00 Contribution margin per unit (CMU) $ 4.00 Breakeven point in units = = = 150,000 units Margin of safety (units) = 200,000 – 150,000 = 50,000 units 2. Since Galaxy is operating above the breakeven point, any incremental contribution margin will increase operating income dollar for dollar. Increase in units sales = 10% × 200,000 = 20,000 Incremental contribution margin = $4 × 20,000 = $80,000 Therefore, the increase in operating income will be equal to $80,000. Galaxy’s operating income in 2008 would be $200,000 + $80,000 = $280,000. 3. Selling price $16.00 Variable costs: Purchase price $10 × 130% $13.00 Shipping and handling 2.00 15.00 Contribution margin per unit $ 1.00 Target sales in units = = = 800,000 units Target sales in dollars = $16 × 800,000 = $12,800,000 3-47 (20 min.) Gross margin and contribution margin. 1. Ticket sales ($20 500 attendees) $10,000 Variable cost of dinner ($10a500 attendees) $5,000 Variable invitations and paperwork ($1b 500) 500 5,500 Contribution margin 4,500 Fixed cost of dinner 6,000 Fixed cost of invitations and paperwork 2,500 8,500 Operating profit (loss) $ (4,000) a $5,000/500 attendees = $10/attendee b $500/500 attendees = $1/attendee 2. Ticket sales ($20 1,000 attendees) $20,000 Variable cost of dinner ($10 1,000 attendees) $10,000 Variable invitations and paperwork ($1 1,000) 1,000 11,000 Contribution margin 9,000 Fixed cost of dinner 6,000 Fixed cost of invitations and paperwork 2,500 8,500 Operating profit (loss) $ 500 3-48 (30 min.) Ethics, CVP analysis. 1. Contribution margin percentage = = = = 40% Breakeven revenues = = = $5,400,000 2. If variable costs are 52% of revenues, contribution margin percentage equals 48% (100% 52%) Breakeven revenues = = = $4,500,000 3. Revenues $5,000,000 Variable costs (0.52 $5,000,000) 2,600,000 Fixed costs 2,160,000 Operating income $ 240,000 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. CHAPTER 10 10-1 The two assumptions are 1. Variations in the level of a single activity (the cost driver) explain the variations in the related total costs. 2. Cost behavior is approximated by a linear cost function within the relevant range. A linear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity forms a straight line. 10-17 (15 min.) Identifying variable-, fixed-, and mixed-cost functions. 1. See Solution Exhibit 10-17. 2. Contract 1: y = $50 Contract 2: y = $30 + $0.20X Contract 3: y = $1X where X is the number of miles traveled in the day. 3. Contract Cost Function 1 2 3 Fixed Mixed Variable Solution Exhibit 10-17 Plots of Car Rental Contracts Offered by Pacific Corp. 10-18 (20 min.) Various cost-behavior patterns. 1. K 2. B 3. G 4. J Note that A is incorrect because, although the cost per pound eventually equals a constant at $9.20, the total dollars of cost increases linearly from that point onward. 5. I The total costs will be the same regardless of the volume level. 6. L 7. F This is a classic step-cost function. 8. K 9. C 10-19 (30 min.) Matching graphs with descriptions of cost and revenue behavior. (1) (6) A step-cost function. (9) (2) (8) (10) It is data plotted on a scatter diagram, showing a linear variable cost function with constant variance of residuals. The constant variance of residuals implies that there is a uniform dispersion of the data points about the regression line. (3) (8) 10-20 (15 min.) Account analysis method. 1. Variable costs: Car wash labor $260,000 Soap, cloth, and supplies 42,000 Water 38,000 Electric power to move conveyor belt 72,000 Total variable costs $412,000 Fixed costs: Depreciation $ 64,000 Salaries 46,000 Total fixed costs $110,000 Some costs are classified as variable because the total costs in these categories change in proportion to the number of cars washed in Lorenzo’s operation. Some costs are classified as fixed because the total costs in these categories do not vary with the number of cars washed. If the conveyor belt moves regardless of the number of cars on it, the electricity costs to power the conveyor belt would be a fixed cost. 2. Variable costs per car = = $5.15 per car Total costs estimated for 90,000 cars = $110,000 + ($5.15 × 90,000) = $573,500 10-23 (15–20 min.) Estimating a cost function, high-low method. 1. The key point to note is that the problem provides high-low values of X (annual round trips made by a helicopter) and YX (the operating cost per round trip). We first need to calculate the annual operating cost Y (as in column (3) below), and then use those values to estimate the function using the high-low method. Cost Driver: Annual Round- Trips (X) Operating Cost per Round-Trip Annual Operating Cost (Y)   (1) (2) (3) = (1) (2) Highest observation of cost driver 2,000 $300 $600,000 Lowest observation of cost driver 1,000 $350 $350,000 Difference 1,000   $250,000         Slope coefficient = $250,0001,000 = $250 per round-trip Constant = $600,000 – ($250 2,000) = $100,000 The estimated relationship is Y = $100,000 + $250 X; where Y is the annual operating cost of a helicopter and X represents the number of round trips it makes annually. 2. The constant a (estimated as $100,000) represents the fixed costs of operating a helicopter, irrespective of the number of round trips it makes. This would include items such as insurance, registration, depreciation on the aircraft, and any fixed component of pilot and crew salaries. The coefficient b (estimated as $250 per round-trip) represents the variable cost of each round trip—costs that are incurred only when a helicopter actually flies a round trip. The coefficient b may include costs such as landing fees, fuel, refreshments, baggage handling, and any regulatory fees paid on a per-flight basis. 3. If each helicopter is, on average, expected to make 1,200 round trips a year, we can use the estimated relationship to calculate the expected annual operating cost per helicopter: Y = $100,000 + $250 X X = 1,200 Y = $100,000 + $2501,200 = $100,000 + $300,000 = $400,000 With 10 helicopters in its fleet, Reisen’s estimated operating budget is 10$400,000 = $4,000,000. 10-39 (30min.) Multiple regression (continuation of 10-38). 1. Solution Exhibit 10-39 presents the regression output for setup costs using both number of setups and number of setup-hours as independent variables (cost drivers). SOLUTION EXHIBIT 10-39 Regression Output for Multiple Regression for Setup Costs Using Both Number of Setups and Number of Setup-Hours as Independent Variables (Cost Drivers) 2. Economic plausibility A positive relationship between setup costs and each of the independent variables (number of setups and number of setup-hours) is economically plausible. Goodness of fit r2 = 86%, Adjusted r2 = 81% Standard error of regression =$14,392 Excellent goodness of fit. Significance of Independent Variables The t-value of 0.46 for number of setups is not significant at the 0.05 level. The t-value of 4.68 for number of setup-hours is significant at the 0.05 level. Specification analysis of estimation assumptions Assuming linearity, constant variance, and normality of residuals, the Durbin-Watson statistic of 1.36 suggests the residuals are independent. However, we must be cautious when drawing inferences from only 9 observations. 3. Multicollinearity is an issue that can arise with multiple regression but not simple regression analysis. Multicollinearity means that the independent variables are highly correlated. The correlation feature in Excel’s Data Analysis reveals a coefficient of correlation of 0.56 between number of setups and number of setup-hours. Since the correlation is less than 0.70, the multiple regression does not suffer from multicollinearity problems. 4. The simple regression model using the number of setup-hours as the independent variable achieves a comparable r2 to the multiple regression model. However, the multiple regression model includes an insignificant independent variable, number of setups. Adding this variable does not improve Williams’ ability to better estimate setup costs. Bebe should use the simple regression model with number of setup-hours as the independent variable to estimate costs. CHAPTER 11 11-23 (10 min.) Selection of most profitable product. Only Model 14 should be produced. The key to this problem is the relationship of manufacturing overhead to each product. Note that it takes twice as long to produce Model 9; machine-hours for Model 9 are twice that for Model 14. Management should choose the product mix that maximizes operating income for a given production capacity (the scarce resource in this situation). In this case, Model 14 will yield a $9.50 contribution to fixed costs per machine hour, and Model 9 will yield $9.00: Model 9 Model 14 Selling price Variable costs per unit (total cost – FMOH) Contribution margin per unit Relative use of machine-hours per unit of product Contribution margin per machine hour $100.00 82.00 $ 18.00 ÷ 2 $ 9.00 $70.00 60.50 $ 9.50 ÷ 1 $ 9.50 11-28 (30 min.) Equipment upgrade versus replacement. Based on the analysis in the table below, TechMech will be better off by $180,000 over three years if it replaces the current equipment. Over 3 years Difference  Comparing Relevant Costs of Upgrade and Upgrade Replace in favor of Replace  Replace Alternatives (1) (2) (3) = (1) – (2) Cash operating costs       $140; $80 per desk 6,000 desks per yr. 3 yrs. $2,520,000 $1,440,000 $1,080,000 Current disposal price (600,000) 600,000 One time capital costs, written off periodically as depreciation 2,700,000 4,200,000 (1,500,000) Total relevant costs $5,220,000 $5,040,000 $ 180,000 Note that the book value of the current machine ($900,000) would either be written off as depreciation over three years under the upgrade option, or, all at once in the current year under the replace option. Its net effect would be the same in both alternatives: to increase costs by $900,000 over three years, hence it is irrelevant in this analysis. 2. Suppose the capital expenditure to replace the equipment is $X. From requirement 1, column (2), substituting for the one-time capital cost of replacement, the relevant cost of replacing is $1,440,000 – $600,000 + $X. From column (1), the relevant cost of upgrading is $5,220,000. We want to find X such that $1,440,000 – $600,000 + $X < $5,220,000 (i.e., TechMech will favor replacing) Solving the above inequality gives us X < $5,220,000 – $840,000 = $4,380,000. TechMech would prefer to replace, rather than upgrade, if the replacement cost of the new equipment does not exceed $4,380,000. Note that this result can also be obtained by taking the original replacement cost of $4,200,000 and adding to it the $180,000 difference in favor of replacement calculated in requirement 1. 3. Suppose the units produced and sold over 3 years equal y. Using data from requirement 1, column (1), the relevant cost of upgrade would be $140y + $2,700,000, and from column (2), the relevant cost of replacing the equipment would be $80y – $600,000 + $4,200,000. TechMech would want to upgrade if $140y + $2,700,000 < $80y – $600,000 + $4,200,000 $60y < $900,000 y < $900,000 $60 = 15,000 units or upgrade when y < 15,000 units (or 5,000 per year for 3 years) and replace when y > 15,000 units over 3 years. When production and sales volume is low (less than 5,000 per year), the higher operating costs under the upgrade option are more than offset by the savings in capital costs from upgrading. When production and sales volume is high, the higher capital costs of replacement are more than offset by the savings in operating costs in the replace option. 4. Operating income for the first year under the upgrade and replace alternatives are shown below:   Year 1   Upgrade Replace   (1) (2) Revenues (6,000 $500) $3,000,000 $3,000,000 Cash operating costs   $140; $80 per desk 6,000 desks per year 840,000 480,000 Depreciation ($900,000a + $2,700,000)3; $4,200,0003 1,200,000 1,400,000 Loss on disposal of old equipment (0; $900,000 – $600,000) 0 300,000 Total costs 2,040,000 2,180,000 Operating Income $ 960,000 $ 820,000 aThe book value of the current production equipment is $1,500,000 35 = $900,000; it has a remaining useful life of 3 years. First-year operating income is higher by $140,000 under the upgrade alternative, and Dan Doria, with his one-year horizon and operating income-based bonus, will choose the upgrade alternative, even though, as seen in requirement 1, the replace alternative is better in the long run for TechMech. This exercise illustrates the possible conflict between the decision model and the performance evaluation model. 11-31 (30 min.) Relevant costs, opportunity costs. 1. Easyspread 2.0 has a higher relevant operating income than Easyspread 1.0. Based on this analysis, Easyspread 2.0 should be introduced immediately: Easyspread 1.0 Easyspread 2.0 Relevant revenues $160 $195 Relevant costs: Manuals, diskettes, compact discs $ 0 $30 Total relevant costs 0 30 Relevant operating income $160 $165 Reasons for other cost items being irrelevant are: Easyspread 1.0 Manuals, diskettes—already incurred Development costs—already incurred Marketing and administrative—fixed costs of period Easyspread 2.0 Development costs—already incurred Marketing and administration—fixed costs of period Note that total marketing and administration costs will not change whether Easyspread 2.0 is introduced on July 1, 2009, or on October 1, 2009. 2. Other factors to be considered: Customer satisfaction. If 2.0 is significantly better than 1.0 for its customers, a customer driven organization would immediately introduce it unless other factors offset this bias towards “do what is best for the customer.” Quality level of Easyspread 2.0. It is critical for new software products to be fully debugged. Easyspread 2.0 must be error-free. Consider an immediate release only if 2.0 passes all quality tests and can be fully supported by the salesforce. Importance of being perceived to be a market leader. Being first in the market with a new product can give Basil Software a “first-mover advantage,” e.g., capturing an initial large share of the market that, in itself, causes future potential customers to lean towards purchasing Easyspread 2.0. Moreover, by introducing 2.0 earlier, Basil can get quick feedback from users about ways to further refine the software while its competitors are still working on their own first versions. Moreover, by locking in early customers, Basil may increase the likelihood of these customers also buying future upgrades of Easyspread 2.0. Morale of developers. These are key people at Basil Software. Delaying introduction of a new product can hurt their morale, especially if a competitor then preempts Basil from being viewed as a market leader. 11-34 (35–40 min.) Dropping a product line, selling more units. The incremental revenue losses and incremental savings in cost by discontinuing the Tables product line follows: Difference: Incremental (Loss in Revenues) and Savings in Costs from Dropping Tables Line Revenues Direct materials and direct manufacturing labor Depreciation on equipment Marketing and distribution General administration Corporate office costs Total costs Operating income (loss) $(500,000) 300,000 0 70,000 0 0 370,000 $(130,000) Dropping the Tables product line results in revenue losses of $500,000 and cost savings of $370,000. Hence, Grossman Corporation’s operating income will be $130,000 lower if it drops the Tables line. Note that, by dropping the Tables product line, Home Furnishings will save none of the depreciation on equipment, general administration costs, and corporate office costs, but it will save variable manufacturing costs and all marketing and distribution costs on the Tables product line. 2. Grossman’s will generate incremental operating income of $128,000 from selling 4,000 additional tables and, hence, should try to increase table sales. The calculations follow: Incremental Revenues (Costs) and Operating Income Revenues $500,000 Direct materials and direct manufacturing labor (300,000) Cost of equipment written off as depreciation (42,000)* Marketing and distribution costs (30,000)† General administration costs 0** Corporate office costs 0** Operating income $128,000 *Note that the additional costs of equipment are relevant future costs for the “selling more tables decision” because they represent incremental future costs that differ between the alternatives of selling and not selling additional tables. †Current marketing and distribution costs which varies with number of shipments = $70,000 – $40,000 = $30,000. As the sales of tables double, the number of shipments will double, resulting in incremental marketing and distribution costs of (2 $30,000) – $30,000 = $30,000. **General administration and corporate office costs will be unaffected if Grossman decides to sell more tables. Hence, these costs are irrelevant for the decision. 3. Solution Exhibit 11-34, Column 1, presents the relevant loss of revenues and the relevant savings in costs from closing the Northern Division. As the calculations show, Grossman’s operating income would decrease by $140,000 if it shut down the Northern Division (loss in revenues of $1,500,000 versus savings in costs of $1,360,000). Grossman will save variable manufacturing costs, marketing and distribution costs, and division general administration costs by closing the Northern Division but equipment-related depreciation and corporate office allocations are irrelevant to the decision. Equipment-related costs are irrelevant because they are past costs (and the equipment has zero disposal price). Corporate office costs are irrelevant because Grossman will not save any actual corporate office costs by closing the Northern Division. The corporate office costs that used to be allocated to the Northern Division will be allocated to other divisions. 4. Solution Exhibit 11-34, Column 2, presents the relevant revenues and relevant costs of opening the Southern Division (a division whose revenues and costs are expected to be identical to the revenues and costs of the Northern Division). Grossman should open the Southern Division because it would increase operating income by $40,000 (increase in relevant revenues of $1,500,000 and increase in relevant costs of $1,460,000). The relevant costs include direct materials, direct manufacturing labor, marketing and distribution, equipment, and division general administration costs but not corporate office costs. Note, in particular, that the cost of equipment written off as depreciation is relevant because it is an expected future cost that Grossman will incur only if it opens the Southern Division. Corporate office costs are irrelevant because actual corporate office costs will not change if Grossman opens the Southern Division. The current corporate staff will be able to oversee the Southern Division’s operations. Grossman will allocate some corporate office costs to the Southern Division but this allocation represents corporate office costs that are already currently being allocated to some other division. Because actual total corporate office costs do not change, they are irrelevant to the division. SOLUTION EXHIBIT 11-34 Relevant-Revenue and Relevant-Cost Analysis for Closing Northern Division and Opening Southern Division (Loss in Revenues) and Savings in Costs from Closing Northern Division (1) Incremental Revenues and (Incremental Costs) from Opening Southern Division (2) Revenues $(1,500,000) $1,500,000 Variable direct materials and direct manufacturing labor costs 825,000 (825,000) Equipment cost written off as depreciation 0 (100,000) Marketing and distribution costs 205,000 (205,000) Division general administration costs 330,000 (330,000) Corporate office costs 0 0 Total costs 1,360,000 (1,460,000) Effect on operating income (loss) $ (140,000) $ 40,000 11-35 (30–40 min.) Make or buy, unknown level of volume. 1. The variable costs required to manufacture 150,000 starter assemblies are Direct materials $200,000 Direct manufacturing labor 150,000 Variable manufacturing overhead 100,000 Total variable costs $450,000 The variable costs per unit are $450,000 ÷ 150,000 = $3.00 per unit. Let X = number of starter assemblies required in the next 12 months. The data can be presented in both “all data” and “relevant data” formats: All Data Relevant Data Alternative 1: Make Alternative 2: Buy Alternative 1: Make Alternative 2: Buy Variable manufacturing costs Fixed general manufacturing overhead Fixed overhead, avoidable Division 2 manager’s salary Division 3 manager’s salary Purchase cost, if bought from Tidnish Electronics Total $ 3X 150,000 100,000 40,000 50,000 – $340,000 + $ 3X – $150,000 – 50,000 – 4X $200,000 + $ 4X $ 3X – 100,000 40,000 50,000 – $190,000 + $ 3X – – – $50,000 – 4X $50,000 + $ 4X The number of units at which the costs of make and buy are equivalent is All data analysis: $340,000 + $3X = $200,000 + $4X X = 140,000 or Relevant data analysis: $190,000 + $3X = $50,000 + $4X X = 140,000 Assuming cost minimization is the objective, then • If production is expected to be less than 140,000 units, it is preferable to buy units from Tidnish. • If production is expected to exceed 140,000 units, it is preferable to manufacture internally (make) the units. • If production is expected to be 140,000 units, Oxford should be indifferent between buying units from Tidnish and manufacturing (making) the units internally. 2. The information on the storage cost, which is avoidable if self-manufacture is discontinued, is relevant; these storage charges represent current outlays that are avoidable if self-manufacture is discontinued. Assume these $50,000 charges are represented as an opportunity cost of the make alternative. The costs of internal manufacture that incorporate this $50,000 opportunity cost are All data analysis: $390,000 + $3X Relevant data analysis: $240,000 + $3X The number of units at which the costs of make and buy are equivalent is All data analysis: $390,000 + $3X = $200,000 + $4X X = 190,000 Relevant data analysis: $240,000 + $3X = $50,000 + $4X X = 190,000 If production is expected to be less than 190,000, it is preferable to buy units from Tidnish. If production is expected to exceed 190,000, it is preferable to manufacture the units internally. CHAPTER 4 (10 min) Job order costing, process costing. Job costing l. Job costing Process costing m. Process costing Job costing n. Job costing Process costing o. Job costing Job costing p. Job costing Process costing q. Job costing Job costing r. Process costing Job costing (but some process costing) s. Job costing Process costing t. Process costing Process costing u. Job costing Job costing 4-21 (2025 min.) Job costing, consulting firm. 1. Budgeted indirect-cost rate = $13,000,000 ÷ $5,000,000 = 260% of professional labor costs 2. At the budgeted revenues of $20,000,000, Taylor’s operating income of $2,000,000 equals 10% of revenues. Markup rate = $20,000,000 ÷ $5,000,000 = 400% of direct professional labor costs 3. Budgeted costs Direct costs: Director, $200 3 $ 600 Partner, $100 16 1,600 Associate, $50 40 2,000 Assistant, $30 160 4,800 $ 9,000 Indirect costs: Consulting support, 260% $9,000 23,400 Total costs $32,400 As calculated in requirement 2, the bid price to earn a 10% income-to-revenue margin is 400% of direct professional costs. Therefore, Taylor should bid 4 $9,000 = $36,000 for the Red Rooster job. Bid price to earn target operating income-to-revenue margin of 10% can also be calculated as follows: Let R = revenue to earn target income R – 0.10R = $32,400 0.90R = $32,400 R = $32,400 ÷ 0.90 = $36,000 or, Direct costs $ 9,000 Indirect costs 23,400 Operating income 3,600 Bid price $36,000 4-33 (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 job-costing system. 1. Professional Partner Labor Professional Associate Labor Budgeted compensation per professional Divided by budgeted hours of billable time per professional Budgeted direct-cost rate $ 200,000 ÷1,600 $125 per hour* $80,000 ÷1,600 $50 per hour† *Can also be calculated as = = = $125 †Can also be calculated as = = = $ 50 2. General Support Secretarial Support Budgeted total costs Divided by budgeted quantity of allocation base Budgeted indirect cost rate $1,800,000 ÷ 40,000 hours $45 per hour $400,000 ÷ 8,000 hours $50 per hour 3. Richardson Punch Direct costs: Professional partners, $125 60; $125 30 Professional associates, $50 40; $50 120 Direct costs Indirect costs: General support, $45 100; $45 150 Secretarial support, $50 60; $50 30 Indirect costs Total costs $7,500 2,000 $ 9,500 4,500 3,000 7,500 $17,000 $3,750 6,000 $ 9,750 6,750 1,500 8,250 $18,000 4. Richardson Punch Single direct - Single indirect (from Problem 4-32) Multiple direct – Multiple indirect (from requirement 3 of Problem 4-33) Difference $12,000 17,000 $ 5,000 undercosted $18,000 18,000 $ 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 refined-costing system in Problem 4-32 increases the reported cost in Problem 4-32 for the Richardson job by 41.7% (from $12,000 to $17,000). 4-34 (2025 min.) Proration of overhead. 2. = – = $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) Account Balance (Before Proration) (2) Write-off of $400,000 Underallocated Manufacturing Overhead (3) Account Balance (After Proration) (4) = (2) + (3) 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 $ 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) Account Balance (Before Proration) (2) Proration of $400,000 Underallocated Manufacturing Overhead (3) Account Balance (After Proration) (4) = (2) + (3) Work in Process Finished Goods Cost of Goods Sold Total $ 750,000 1,250,000 8,000,000 $10,000,000 ( 7.5%) (12.5%) (80.0%) 100.0% 0.075 $400,000 = $ 30,000 0.125 $400,000 = 50,000 0.800 $400,000 = 320,000 $400,000 $ 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. Account (1) Account Balance (Before Proration) (2) Allocated Overhead Included in the Account Balance (Before Proration) (3) (4) Proration of $400,000 Underallocated Manufacturing Overhead (5) Account Balance (After Proration) (6) = (2) + (5) Work in Process $ 750,000 $ 240,000a ( 5.33%) 0.0533 $400,000 = $ 21,320 $ 771,320 Finished Goods 1,250,000 660,000b (14.67%) 0.1467 $400,000 = 58,680 1,308,680 Cost of Goods Sold 8,000,000 3,600,000c (80.00%) 0.8000 $400,000 = 320,000 8,320,000 Total $10,000,000 $4,500,000 100.00% $400,000 $10,400,000 a$60 4,000 machine-hours; b$60 11,000 machine-hours; c$60 60,000 machine-hours 3. Alternative (c) is theoretically preferred over (a) and (b). 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 = = $1,800,000 b. = + + $8,000,000 = Direct material used + $1,800,000 + $3,600,000 Direct material used = $2,600,000 2. + Total manufacturing cost = Cost of goods manufactured + Denote Work-in-process on 12/31/2009 by X $320,000 + $8,000,000 = $7,920,000 + X X = $400,000 Work-in-process inventory, 12/31/09 = $400,000. CHAPTER 5 5-16 (20 min.) Cost hierarchy. a. Indirect manufacturing labor costs of $1,200,000 support direct manufacturing labor and are output unit-level costs. Direct manufacturing labor generally increases with output units, and so will the indirect costs to support it. b. Batch-level costs are costs of activities that are related to a group of units of a product rather than each individual unit of a product. Purchase order-related costs (including costs of receiving materials and paying suppliers) of $600,000 relate to a group of units of product and are batch-level costs. c. Cost of indirect materials of $350,000 generally changes with labor hours or machine hours which are unit-level costs. Therefore, indirect material costs are output unit-level costs. d. Setup costs of $700,000 are batch-level costs because they relate to a group of units of product produced after the machines are set up. e. Costs of designing processes, drawing process charts, and making engineering changes for individual products, $900,000, are product-sustaining because they relate to the costs of activities undertaken to support individual products regardless of the number of units or batches in which the product is produced. f. Machine-related overhead costs (depreciation and maintenance) of $1,200,000 are output unit-level costs because they change with the number of units produced. g. Plant management, plant rent, and insurance costs of $950,000 are facility-sustaining costs because the costs of these activities cannot be traced to individual products or services but support the organization as a whole. 2. The complex boom box made in many batches will use significantly more batch-level overhead resources compared to the simple boom box that is made in a few batches. In addition, the complex boom box will use more product-sustaining overhead resources because it is complex. Because each boom box requires the same amount of machine-hours, both the simple and the complex boom box will be allocated the same amount of overhead costs per boom box if Teledor uses only machine-hours to allocate overhead costs to boom boxes. As a result, the complex boom box will be undercosted (it consumes a relatively high level of resources but is reported to have a relatively low cost) and the simple boom box will be overcosted (it consumes a relatively low level of resources but is reported to have a relatively high cost). 3. Using the cost hierarchy to calculate activity-based costs can help Teledor to identify both the costs of individual activities and the cost of activities dema