Managerial Accounting (Solutions) - 1

Chapter 1
Managerial Accounting and the

Business
Environment
Solutions to Questions
1-1 Managerial accounting is concerned
with providing information to managers for
use within the organization. Financial
accounting is concerned with providing
information to stockholders, creditors, and
others outside of the organization.
1-2 Essentially, managers carry out three
major activities in an organization: planning,
directing and motivating, and controlling. All
three activities involve decision making.
1-3 he !lanning and "ontrol "ycle
involves formulating plans, implementing
plans, measuring performance, and
evaluating di#erences $etween planned and
actual performance.
1-4 A line position is directly related to
the achievement of the $asic o$jectives of
the organization. A sta# position is not
directly related to the achievement of those
o$jectives% rather, it is supportive, providing
services and assistance to other parts of the
organization.
1-5 &n contrast to 'nancial accounting,
managerial accounting: ()* focuses on the
needs of the manager% (+* places more
emphasis on the future% (,* emphasizes
relevance and -e.i$ility, rather than
precision% (/* emphasizes the segments of
an organization% (0* is not governed $y
1AA!% and (2* is not mandatory.
1- A num$er of $ene'ts accrue from
reduced setup time. First, reduced setup
time allows a company to produce in smaller
$atches, which in turn reduces the level of
inventories. 3econd, reduced setup time
allows a company to spend more time
producing goods and less time getting ready
to produce. hird, the a$ility to rapidly
change from making one product to making
another allows the company to respond
more 4uickly to customers. Finally, smaller
$atches make it easier to spot
manufacturing pro$lems $efore they result
in a large num$er of defective units.
1-! he main $ene'ts of a successful 5&
system are reductions in: ()* funds tied up
in inventories% (+* space re4uirements% (,*
throughput time% and (/* defects.
1-" 6M generally approaches
improvement in a series of small steps that
are planned and implemented $y teams of
front7line workers. !rocess 8eengineering
involves completely redesigning $usiness
processes from the ground up9often with
the use of outside consultants.
1-# &f !rocess 8eengineering is
successful, fewer workers are needed. &f
management responds $y laying o#
workers, morale will almost certain su#er.
1-1$ 3ome $ene'ts from improvement
e#orts come from cost reductions, $ut the
primary $ene't is often an increase in
capacity. At non7constraints, increases in
capacity just add to the already7e.isting
e.cess capacity. herefore, improvement
e#orts should ordinarily focus on the
constraint.
: he Mc1raw7;ill "ompanies, &nc., +<<2.
3olutions Manual, "hapter ) )
1-11 &f people generally did not act
ethically in $usiness, no one would trust
anyone else and people would $e reluctant
to enter into $usiness transactions. he
result would $e less funds raised in capital
markets, fewer goods and services availa$le
for sale, lower 4uality, and higher prices.
: he Mc1raw7;ill "ompanies, &nc., +<<2.
3olutions Manual, "hapter ) +
E%ercise 1-1 ()< minutes*
). =ine
+. >irecting and motivating
,. ?udgets
/. !lanning
0. 3ta#
2. >ecentralization
@. !recision% Aonmonetary data
B. Managerial accounting% Financial accounting
C. Feed$ack
)<. "ontroller
)). !erformance report
)+. "hief Financial DEcer
: he Mc1raw7;ill "ompanies, &nc., +<<2. All rights reserved.
3olutions Manual, "hapter ) ,
). otal 4uality management% !rocess reengineering
+. 5ust7&n7ime
,. Aonconstraint
/. ?enchmarking
0. 3etup
2. "onstraint
@. Aon7value7added activities
B. ?usiness process
3olutions Manual, "hapter ) /
E%ercise 1-3 ()0 minutes*
&f cashiers routinely shortchanged customers whenever the
opportunity presented itself, most of us would $e careful to count
our change $efore leaving the counter. &magine what e#ect this
would have on the line at your favorite fast7food restaurant. ;ow
would you like to wait in line while each and every customer
la$oriously counts out his or her changeF Additionally, if you canGt
trust the cashiers to give honest change, can you trust the cooks
to take the time to follow health precautions such as washing
their handsF &f you canGt trust anyone at the restaurant would you
even want to eat outF
1enerally, when we $uy goods and services in the free market,
we assume we are $uying from people who have a certain level of
ethical standards. &f we could not trust people to maintain those
standards, we would $e reluctant to $uy. he net result of
widespread dishonesty would $e a shrunken economy with a
lower growth rate and fewer goods and services for sale at a
lower overall level of 4uality.
3olutions Manual, "hapter ) 0
&ro'lem 1-4 (,< minutes*
). 3ee the organization chart on the following page.
+. =ine positions include the university president, academic vice7
president, the deans of the four colleges, and the dean of the
law school. &n addition, the department heads (as well as the
faculty* are in line positions. he reason is that their positions
are directly related to the $asic purpose of the university,
which is education. (=ine positions are shaded on the
organization chart.*
All other positions on the organization chart are sta#
positions. he reason is that these positions are indirectly
related to the educational process, and e.ist only to provide
service or support to the line positions.
,. All positions would have need for accounting information of
some type. For e.ample, the manager of central purchasing
would need to know the level of current inventories and
$udgeted allowances in various areas $efore doing any
purchasing% the vice7president for admissions and records
would need to know the status of scholarship funds as students
are admitted to the university% the dean of the $usiness college
would need to know hisHher $udget allowances in various areas,
as well as information on cost per student credit hour% and so
forth.
3olutions Manual, "hapter ) 2
&ro'lem 1-4 (continued*
). Drganization chart:
: he Mc1raw7;ill "ompanies, &nc., +<<,. All rights reserved.
3olutions Manual, "hapter ) @
!resident
Academic
Iice
!resident
Iice
!resident,
Au.iliary
3ervices
Iice
!resident,
Admissions
J 8ecords
Iice
!resident,
Financial
3ervices
("ontroller*
Iice
!resident,
!hysical
!lant
>ean,
?usiness
>ean,
;umanities
>ean,
Fine Arts
>ean,
Engineering
J
6uantitative
Methods
>ean,
=aw 3chool
Manager,
"entral
!urchasing
Manager,
Kniversity
!ress
Manager,
Kniversity
?ookstore
Manager,
"omputer
3ervices
Manager,
Accounting
J Finance
Manager,
1rounds J
"ustodial
3ervices
Manager,
!lant J
Maintenance
(>epartments
*
(>epartments
*
(>epartments
*
(>epartments
*
&ro'lem 1-5 (+< minutes*
). Failure to report the o$solete nature of the inventory would
violate the 3tandards of Ethical "onduct as follows:
Competence
L !erform duties in accordance with relevant technical
standards.
L !repare complete reports using relia$le information.
L ?y failing to write down the value of the o$solete inventory,
!erlman would not $e preparing a complete report using
relia$le information. &n addition, generally accepted
accounting principles (1AA!* re4uire the write7down of
o$solete inventory.
(ntegrit)
L Avoid con-icts of interest.
L 8efrain from activities that prejudice the a$ility to perform
duties ethically.
L 8efrain from su$verting the legitimate goals of the
organization.
L 8efrain from discrediting the profession.
Mem$ers of the management team, of which !erlman is a part,
are responsi$le for $oth operations and recording the results of
operations. 3ince the team will $ene't from a $onus, increasing
earnings $y ignoring the o$solete inventory is clearly a con-ict
of interest. !erlman would also $e concealing unfavora$le
information and su$verting the goals of the organization.
Furthermore, such $ehavior is a discredit to the profession.
3olutions Manual, "hapter ) )0
*'+ectivit)
L "ommunicate information fairly and o$jectively.
L >isclose all relevant information.
L ;iding the o$solete inventory impairs the o$jectivity and
relevance of 'nancial statements.
(KnoEcial "MA solution*
+. As discussed a$ove, the ethical course of action would $e for
!erlman to insist on writing down the o$solete inventory. his
would not, however, $e an easy thing to do. Apart from
adversely a#ecting her own compensation, the ethical action
may anger her colleagues and make her very unpopular. aking
the ethical action would re4uire considera$le courage and self7
assurance.
3olutions Manual, "hapter ) )2
&ro'lem 1- (,< minutes*
). =ine authority is directly related to the achievement of an
organizationGs $asic o$jectives. =ine managers have formal
authority to direct operations.
3ta# assists line management in the achievement of an
organizationGs $asic o$jectives. !ersons with sta# authority
provide support services. 3ta# managers typically have
advisory authority $ecause of their particular e.pertise.
+. Mark 5ohnsonGs responsi$ility for maintaining the production
schedule involves line authority. 5ohnson would $e directly
concerned with meeting the companyGs primary o$jective of
producing metal parts.
5ohnsonGs responsi$ility to consult with production supervisors
is a sta# role $ecause he apparently cannot order changes in
those consultations, only advise. 5ohnsonGs supervision of new
alloy testing and his role regarding the use of new alloys in
product development is $asically a sta# function as well. ;e
has limited authority regarding the use of new alloys $ecause
his authority applies only to product development and not to
production.
,. Mark 5ohnson may e.perience several con-icts $ecause he has
$een given $oth line and sta# authority.
First, 5ohnson may initially 'nd it diEcult to communicate with
the production supervisors $ecause he operates out of a sta#
position.
3econd, a con-ict could easily develop if the supervisors lacked
a clear understanding of 5ohnsonGs responsi$ilities and
authorities. he supervisors could resent apparent sta#
interference and refuse to discuss their pro$lems with 5ohnson,
making the meetings fruitless. he supervisors working on the
new contract may fail to perceive 5ohnsonGs line authority and
refuse to follow his orders.
hird, 5ohnson might have diEculty in understanding the
nature of his position and jo$. 5ohnson might also 'nd it diEcult
to distinguish $etween his sta# capacity and line capacity. For
3olutions Manual, "hapter ) )@
instance, 5ohnson might have diEculty in remaining o$jective if
any production pro$lems develop in the alloys he tested.
(KnoEcial "MA 3olution, adapted*
3olutions Manual, "hapter ) )B
&ro'lem 1-! (+< minutes*
). &f all automotive service shops routinely tried to sell parts and
services to customers that they didnGt really need, most
customers would eventually 'gure this out. hey would then $e
reluctant to accept the word of the service representative that
a particular pro$lem needs to $e corrected9even when a real
pro$lem e.ists. Either the work would not $e done, or
customers would learn to diagnose and repair pro$lems
themselves, or customers would hire an independent e.pert to
verify that the work is really needed. All three of these
alternatives impose costs and hassles on customers.
+. As argued a$ove, if customers could not trust their service
representatives, they would $e reluctant to follow the service
representativeGs advice. hey would $e inclined not to
authorize work even when it is really necessary. And, more
customers would learn to do automotive repairs and
maintenance themselves. Moreover, customers would $e
unwilling to pay as much for work that is done since customers
would have reason to $elieve that the work may $e
unnecessary. hese two e#ects would reduce demand for
automotive repair services. he reduced demand would reduce
employment in the industry and would lead to lower overall
pro'ts.
3olutions Manual, "hapter ) )C
&ro'lem 1-" (,< minutes*
). Ao, "harlie would not $e justi'ed in ignoring the situation. First,
the Standards of Ethical Conduct for Management Accountants
states that the management accountant must MAvoid actual or
apparent con-icts of interest and advise all appropriate parties
of any potential con-ict.N &f 5.?. insists on continuing the
relationship with A7), "harlie has a responsi$ility to advise $oth
the corporate counsel and O&OGs ?oard of >irectors.
3econd, as the companyGs controller, "harlie has a
responsi$ility to ensure that the 5& approach is properly
implemented. From the data given in the pro$lem, it does not
appear that A7) Oarehouse 3ales is the $est or most
dependa$le supplier availa$le. Drders are late and not
complete, and there is no way to ensure proper 4uality since
nearly all orders are shipped directly from the manufacturer.
he present arrangement with A7) negates most of the $ene'ts
that can accrue
from 5&.
"harlieGs 'rst step should $e to verify the accuracy of his
information. ;e states that A7)Gs markup is ,<P, $ut he does
not indicate how he o$tained this 'gure. Also, the adverse
'nancial impact on O&O is dependent in part on the price it
would have to pay directly to the manufacturers as compared
to the price $eing paid to A7). hat is, can O&O purchase
directly from the manufacturers for the same price as given to
jo$$ers, who handle huge volumes of goodsF &f not, then the
adverse 'nancial impact of $uying through A7) may, in fact, $e
very small, since O&O may have to pay a$out the same price
either way.
"harlieGs second step should $e to discuss the potential legal
rami'cations on a con'dential $asis with O&OGs corporate
counsel. ?efore meeting with the corporate counsel, "harlie
may wish to discretely determine if ony, the purchasing agent,
and 5.?., the president, worked together in their prior
employment. (8emem$er that $oth have $een with O&O for
've years.* Armed with the information o$tained from the
discussion with counsel, "harlie should review the situation
again with 5.?., e.plaining more directly his concerns a$out the
3olutions Manual, "hapter ) +<
apparent con-ict of interest and ask that the ?oard of >irectors
approve the continued use of A7) as a supplier.
3olutions Manual, "hapter ) +)
&ro'lem 1-" (continued*
&f 5.?. refuses to follow this course of action, "harlieGs only
alternative is to su$mit a memorandum to the ?oard of
>irectors. 5.?. should $e noti'ed of this action in advance. he
memorandum should present only the facts. &f the ?oard
approves the continued relationship with A7), "harlie may
possi$ly conclude that his concerns a$out an apparent con-ict
of interest do not represent an actual con-ict. his presumes
that legal counsel has advised the ?oard that the arrangement
with A7) does not violate any laws and that the company has
made ade4uate disclosures in its pu$lic 'lings. Dnly "harlie can
make the decision as to whether or not he can continue at O&O
under these circumstances.
3olutions Manual, "hapter ) ++
,roup E%ercise 1-#
3tudentsG answers will depend on the speci'c e.periences they
had while working.
3olutions Manual, "hapter ) +,
Chapter 2
Cost -erms. Concepts. and Classi/cations
2-1 he three major elements of
product costs in a manufacturing company
are direct materials, direct la$or, and
manufacturing overhead.
2-2
a0 >irect materials are an integral part
of a 'nished product and their costs can
$e conveniently traced to it.
'0 &ndirect materials are generally
small items of material such as glue and
nails. hey may $e an integral part of a
'nished product $ut their costs can $e
traced to the product only at great cost or
inconvenience. &ndirect materials are
ordinarily classi'ed as manufacturing
overhead.
c0 >irect la$or includes those la$or
costs that can $e easily traced to
particular products. >irect la$or is also
called Mtouch la$or.N
d0 &ndirect la$or includes the la$or
costs of janitors, supervisors, materials
handlers, and other factory workers that
cannot $e conveniently traced to
particular products. hese la$or costs are
incurred to support production, $ut the
workers involved do not directly work on
the product.
e0 Manufacturing overhead includes all
manufacturing costs e.cept direct
materials and direct la$or.
2-3 A product cost is any cost involved
in purchasing or manufacturing goods. &n
the case of manufactured goods, these
costs consist of direct materials, direct
la$or, and manufacturing overhead. A
period cost is a cost that is taken directly
to the income statement as an e.pense in
the period in which it is incurred.
2-4 he income statement of a
manufacturing company di#ers from the
income statement of a merchandising
company in the cost of goods sold section.
he merchandising company sells 'nished
goods that it has purchased from a
supplier. hese goods are listed as
M!urchasesN in the cost of goods sold
section. 3ince the manufacturing company
produces its goods rather than $uying
them from a supplier, it lists M"ost of
1oods ManufacturedN in place of
M!urchases.N Also, the manufacturing
company identi'es its inventory in this
section as MFinished 1oods &nventory,N
rather than as MMerchandise &nventory.N
2-5 he schedule of cost of goods
manufactured lists the manufacturing
costs that have $een incurred during the
period. hese costs are organized under
the three major categories of direct
materials, direct la$or, and manufacturing
overhead. he total costs incurred are
adjusted for any change in the Oork in
!rocess inventory to determine the cost of
goods manufactured (i.e. 'nished* during
the period.
he schedule of cost of goods
manufactured ties into the income
statement through the "ost of 1oods 3old
section. he cost of goods manufactured is
added to the $eginning Finished 1oods
inventory to determine the goods
availa$le for sale. &n e#ect, the cost of
goods manufactured takes the place of the
M!urchasesN account in a merchandising
'rm.
2- A manufacturing company has
three inventory accounts: 8aw Materials,
Oork in !rocess, and Finished 1oods. A
3olutions Manual, "hapter ) +/
merchandising company generally
identi'es its inventory account simply as
Merchandise &nventory.
2-! 3ince product costs accompany
units of product into inventory, they are
sometimes called inventoria$le costs. he
-ow is from direct materials, direct la$or,
and manufacturing overhead to Oork in
!rocess. As goods are completed, their
cost is removed from Oork in !rocess and
transferred to Finished 1oods. As goods
are sold, their cost is removed from
Finished 1oods and transferred to "ost of
1oods 3old. "ost of 1oods 3old is an
e.pense on the income statement.
2-" Qes, costs such as salaries and
depreciation can end up as assets on the
$alance sheet if these are manufacturing
costs. Manufacturing costs are inventoried
until the associated 'nished goods are
sold. hus, if some units are still in
inventory, such costs may $e part of
either Oork in !rocess inventory or
Finished 1oods inventory at the end of a
period.
2-# "ost $ehavior refers to how a cost
will react or respond to changes in the
level of activity.
2-1$ Ao. A varia$le cost is a cost that
varies, in total, in direct proportion to
changes in the level of activity. A varia$le
cost is constant per unit of product. A
'.ed cost is '.ed in total, $ut will vary
inversely on an average per7unit $asis
with changes in the level of activity.
2-11 Ohen '.ed costs are involved, the
average cost of a unit of product will
depend on the num$er of units $eing
manufactured. As production increases,
the average cost per unit will fall as the
'.ed cost is spread over more units.
"onversely, as production declines, the
average cost per unit will rise as the '.ed
cost is spread over fewer units.
2-12 Manufacturing overhead is an
indirect cost since these costs cannot $e
easily and conveniently traced to
particular units of products.
2-13 A di#erential cost is a cost that
di#ers $etween alternatives in a decision.
An opportunity cost is the potential $ene't
that is given up when one alternative is
selected over another. A sunk cost is a
cost that has already $een incurred and
cannot $e altered $y any decision taken
now or in the future.
2-14 Ao% di#erential costs can $e either
varia$le or '.ed. For e.ample, the
alternatives might consist of purchasing
one machine rather than another to make
a product. he di#erence in the '.ed costs
of purchasing the two machines would $e
a di#erential cost.
2-15
>irect la$or cost
(,/ hours R)0 per hour* ......................
R0)
<
Manufacturing overhead cost
(2 hours R)0 per hour* ........................ C<
otal wages earned..................................... R2<
<
2-1
>irect la$or cost
(/0 hours R)/ per hour* ......................
R2,
<
(0 hours R@ per hour* .......................... ,0
otal wages earned..................................... R22
0
2-1! "osts associated with the 4uality of
conformance can $e $roken down into
prevention costs, appraisal costs, internal
failure costs, and e.ternal failure costs.
!revention costs are incurred in an e#ort
to keep defects from occurring. Appraisal
costs are incurred to detect defects $efore
they can create further pro$lems. &nternal
and e.ternal failure costs are incurred as a
result of producing defective units.
2-1" otal 4uality costs are usually
minimized $y increasing prevention and
appraisal costs in order to reduce internal
and e.ternal failure costs. otal 4uality
costs usually decrease as prevention and
appraisal costs increase.
2-1# 3hifting the focus to prevention and
away from appraisal is usually the most
3olutions Manual, "hapter ) +0
e#ective way to reduce total 4uality costs.
&t is usually more e#ective to prevent
defects than to attempt to '. them after
they have occurred.
2-2$ First, a 4uality cost report helps
managers see the 'nancial conse4uences
of defects. 3econd, the report may help
managers identify the most important
areas for improvement. hird, the report
helps managers see whether 4uality costs
are appropriately distri$uted among
prevention, appraisal, internal failure, and
e.ternal failure costs.
2-21 Most accounting systems do not
track and accumulate the costs of 4uality.
&t is particularly diEcult to get a feel for
the magnitude of 4uality costs since they
are incurred in many departments
throughout the organization.
). he cost of a hard7drive installed in a computer: direct
materials cost.
+. he cost of advertising in the Puget Sound Computer User
newspaper: marketing and selling cost.
,. he wages of employees who assem$le computers from
components: direct la$or cost.
/. 3ales commissions paid to the companyGs salespeople:
marketing and selling cost.
0. he wages of the assem$ly shopGs supervisor: manufacturing
overhead cost.
2. he wages of the companyGs accountant: administrative cost.
@. >epreciation on e4uipment used to test assem$led computers
$efore release to customers: manufacturing overhead cost.
B. 8ent on the facility in the industrial park: a com$ination of
manufacturing overhead, administrative, and marketing and
selling cost. he rent would most likely $e prorated on the $asis
of the amount of space occupied $y manufacturing,
administrative, and marketing operations.
3olutions Manual, "hapter + +@
Produc
t Cost
Perio
d
Cost
). >epreciation on salespersonsG cars.................. S
+. 8ent on e4uipment used in the factory............ S
,. =u$ricants used for maintenance of
machines....................................................... S
/. 3alaries of 'nished goods warehouse
personnel....................................................... S
0. 3oap and paper towels used $y factory
workers at the end of a shift.......................... S
2. Factory supervisorsG salaries............................ S
@. ;eat, water, and power consumed in the
factory........................................................... S
B. Materials used for $o.ing products for
shipment overseas (units are not normally
$o.ed*............................................................ S
C. Advertising costs.............................................. S
)<. OorkersG compensation insurance on factory
employees..................................................... S
)). >epreciation on chairs and ta$les in the
factory lunchroom.......................................... S
)+. he wages of the receptionist in the
administrative oEces..................................... S
),. =ease cost of the corporate jet used $y the
companyTs e.ecutives.................................... S
)/. 8ent on rooms at a Florida resort for holding
the annual sales conference.......................... S
)0. Attractively designed $o. for packaging the
companyGs product9$reakfast cereal............ S
3olutions Manual, "hapter + +B
"y$er1ames
&ncome 3tatement
3ales................................................... R),/0<,<<
<
"ost of goods sold:
?eginning merchandise inventory..... R +/<,<<
<
Add: !urchases................................. C0<,<<
<
1oods availa$le for sale.................... ),)C<,<<
<
>educt: Ending merchandise
inventory........................................
)@<,<<
<
),<+<,<<
<
1ross margin....................................... /,<,<<<
=ess operating e.penses:
3elling e.pense................................. +)<,<<<
Administrative e.pense.................... )B<,<<
<
,C<,<<
<
Aet operating income.......................... R /<,<<
<
3olutions Manual, "hapter + +C
=ompac !roducts
3chedule of "ost of 1oods Manufactured
>irect materials:
?eginning raw materials inventory..... R
2<,<<<
Add: !urchases of raw materials......... 2C<,<<
<
8aw materials availa$le for use.......... @0<,<<<
>educt: Ending raw materials
inventory..........................................
/0,<<
<
8aw materials used in production....... R @<0,<<
<
>irect la$or........................................... ),0,<<<
Manufacturing overhead....................... ,@<,<<
<
otal manufacturing costs..................... ),+)<,<<
<
Add: ?eginning work in process
inventory............................................
)+<,<<
<
),,,<,<<
<
>educt: Ending work in process
inventory............................................
),<,<<
<
"ost of goods manufactured................. R),+<<,<
<<
3olutions Manual, "hapter + ,<
A few of these costs may generate de$ate. For e.ample, some
may argue that the cost of advertising a Madonna rock concert is
a varia$le cost since the num$er of people who come to the rock
concert depends on the amount of advertising. ;owever, one can
argue that if the price is within reason, any Madonna rock concert
in Aew Qork "ity will $e sold out and the function of advertising is
simply to let people know the event will $e happening. Moreover,
while advertising may a#ect the num$er of persons who
ultimately $uy tickets, the causation is in one direction. &f more
people $uy tickets, the advertising costs donGt go up.
Cost Behavior
Variable Fixed
). S7ray 'lm used in the radiology la$ at
Iirginia Mason ;ospital in 3eattle........... S
+. he costs of advertising a Madonna rock
concert in Aew Qork "ity.......................... S
,. 8ental cost of a Mc>onaldGs restaurant
$uilding in ;ong Uong.............................. S
/. he electrical costs of running a roller
coaster at Magic Mountain....................... S
0. !roperty ta.es on your local cinema.......... S
2. "ommissions paid to salespersons at
Aordstrom............................................... S
@. !roperty insurance on a "oca7"ola
$ottling plant........................................... S
B. he costs of synthetic materials used to
make Aike running shoes........................ S
C. he costs of shipping !anasonic
televisions to retail stores........................ S
)<. he cost of leasing an ultra7scan
diagnostic machine at the American
;ospital in !aris....................................... S
3olutions Manual, "hapter + ,)
E%ercise 2- ()0 minutes*
Cost Costing obect
!irect
Cost
"ndirec
t Cost
)
.
he wages of
pediatric nurses
he pediatric
department S
+
.
!rescription drugs A particular patient
S
,
.
;eating the hospital he pediatric
department S
/
.
he salary of the
head of pediatrics
he pediatric
department S
0
.
he salary of the
head of pediatrics
A particular pediatric
patient S
2
.
;ospital chaplainGs
salary
A particular patient
S
@
.
=a$ tests $y outside
contractor
A particular patient
S
B
.
=a$ tests $y outside
contractor
A particular
department S
3olutions Manual, "hapter + ,+
E%ercise 2-! ()0 minutes*
"tem
!i#erenti
al Cost
$pportunit
% Cost
Sun&
Cost
)
.
"ost of the old S7ray
machine................................ S
+
.
he salary of the head of the
8adiology >epartment..........
,
.
he salary of the head of the
!ediatrics >epartment...........
/
.
"ost of the new color laser
printer................................... S
0
.
8ent on the space occupied
$y 8adiology.........................
2
.
he cost of maintaining the
old machine.......................... S
@
.
?ene'ts from a new >AA
analyzer................................ S
B
.
"ost of electricity to run the
S7ray machines..................... S
Aote: he costs of the salaries of the head of the 8adiology
>epartment and !ediatrics >epartment and the rent on the space
occupied $y 8adiology are neither di#erential costs, nor
opportunity costs, nor sunk costs. hese are costs that do not
di#er $etween the alternatives and are therefore irrelevant in the
decision, $ut they are not sunk costs since they occur in the
future.
3olutions Manual, "hapter + ,,
E%ercise 2-" ()0 minutes*
). Ao. &t appears that the overtime spent completing the jo$ was
simply a matter of how the jo$ happened to $e scheduled.
Knder these circumstances, an overtime premium pro$a$ly
should not $e charged to a customer whose jo$ happens to fall
at the end of the dayGs schedule.
+. >irect la$or cost: C hours V R)/ per hour..... R)+2
1eneral overhead cost: ) hour V R@ per
hour...........................................................
@
otal la$or cost............................................. R),,
,. A charge for an overtime premium might $e justi'ed if the
customer re4uested a MrushN order that caused the overtime.
3olutions Manual, "hapter + ,/
E%ercise 2-# ()0 minutes*
).
Preventio
n Cost
Appraisa
l Cost
"nternal
Failure
Cost
External
Failure
Cost
a. !roduct testing................. S
$. !roduct recalls................. S
c. 8ework la$or and
overhead....................... S
d. 6uality circles.................. S
e. >owntime caused $y
defects.......................... S
f. "ost of 'eld servicing...... S
g. &nspection of goods.......... S
h. 6uality engineering......... S
i. Oarranty repairs.............. S
j. 3tatistical process
control........................... S
k. Aet cost of scrap.............. S
l. >epreciation of test
e4uipment..................... S
m. 8eturns and allowances
arising from poor
4uality........................... S
n. >isposal of defective
products........................ S
o. echnical support to
suppliers........................ S
p. 3ystems development..... S
4. Oarranty replacements.... S
r. Field testing at customer
site................................ S
s. !roduct design................. S
+. !revention costs and appraisal costs are incurred in an e#ort to
keep poor 4uality of conformance from occurring. &nternal and
e.ternal failure costs are incurred $ecause poor 4uality of
conformance has occurred.
3olutions Manual, "hapter + ,0
E%ercise 2-1$ (,< minutes*
).
Mason "ompany
>irect materials:
8aw materials inventory, $eginning.......... R @,<<<
Add: !urchases of raw materials............... ))B,<<<
8aw materials availa$le for use................. )+0,<<<
>educt: 8aw materials inventory, ending.. )0,<<<
8aw materials used in production............. R))<,<<
<
>irect la$or.................................................. @<,<<<
Manufacturing overhead:
&ndirect la$or............................................. ,<,<<<
Maintenance, factory e4uipment............... 2,<<<
&nsurance, factory e4uipment.................... B<<
8ent, factory facilities................................ +<,<<<
3upplies.................................................... /,+<<
>epreciation, factory e4uipment............... )C,<<<
otal overhead costs.................................... B<,<<<
otal manufacturing costs............................ +2<,<<<
Add: Oork in process, $eginning.................. )<,<<<
+@<,<<<
>educt: Oork in process, ending................. 0,<<<
"ost of goods manufactured........................ R+20,<<
<
+. he cost of goods sold section of Mason "ompanyGs income
statement:
Finished goods inventory, $eginning..... R+<,<<<
Add: "ost of goods manufactured......... +20,<<<
1oods availa$le for sale........................ +B0,<<<
>educt: Finished goods inventory,
ending................................................
,0,<<<
"ost of goods sold................................. R+0<,<<
<
3olutions Manual, "hapter + ,2
Selling and
Cost Behavior
Administrati
ve
Produc
t
Cost "tem Variable Fixed Cost Cost
). ;am$urger $uns at
a OendyGs outlet.... S S
+. Advertising $y a
dental oEce........... S S
,. Apples processed
and canned $y >el
Monte..................... S S
/. 3hipping canned
apples from a >el
Monte plant to
customers.............. S S
0. &nsurance on a
?ausch J =om$
factory producing
contact lenses........ S S
2. &nsurance on &?MGs
corporate
head4uarters.......... S S
@. 3alary of a
supervisor
overseeing
production of
printers at
;ewlett7!ackard..... S S
B. "ommissions paid
to Encyclopedia
?ritannica
salespersons.......... S S
C. >epreciation of
factory lunchroom
facilities at a
1eneral Electric
plant....................... S S
)< 3teering wheels S S
3olutions Manual, "hapter + ,@
. installed in ?MOs...
3olutions Manual, "hapter + ,B
E%ercise 2-12 (,< minutes*
). a.?atteries purchased................................................... B,<<<
?atteries drawn from inventory................................. @,2<<
?atteries remaining in inventory................................ /<<
"ost per $attery......................................................... V R)<
"ost in 8aw Materials &nventory at April ,<............... R/,<<<
$.?atteries used in production (@,2<< X )<<*................ @,0<<
Motorcycles completed and transferred to Finished
1oods (C<P V @,0<< Y 2,@0<*................................ 2,@0<
Motorcycles still in Oork in !rocess at April ,<........... @0<
"ost per $attery......................................................... V R)<
"ost in Oork in !rocess &nventory at April ,<............. R@,0<<
c.Motorcycles completed and transferred to Finished
1oods (see a$ove*.................................................. 2,@0<
Motorcycles sold during the month (@<P V 2,@0< Y
/,@+0*..................................................................... /,@+0
Motorcycles still in Finished 1oods at April ,<........... +,<+0
"ost per $attery......................................................... V R)<
"ost in Finished 1oods &nventory at April ,<.............. R+<,+0<
d.Motorcycles sold during the month (a$ove*............... /,@+0
"ost per $attery......................................................... V R)<
"ost in "ost of 1oods 3old at April ,<........................ R/@,+0<
e.?atteries used in salespersonsG motorcycles.............. )<<
"ost per $attery......................................................... V R)<
"ost in 3elling E.pense at April ,<............................ R ),<<<
+. 8aw Materials &nventory9$alance sheet
Oork in !rocess &nventory9$alance sheet
Finished 1oods &nventory9$alance sheet
"ost of 1oods 3old9income statement
3elling E.pense9income statement
3olutions Manual, "hapter + ,C
). >irect la$or cost: ,) hours V R)/ per hour........... R/,/
Manufacturing overhead cost: C hours V R)/ per
hour....................................................................
)+2
otal cost............................................................... R02<
+. >irect la$or cost: /B hours V R)/ per hour........... R2@+
Manufacturing overhead cost: B hours V R@ per
hour....................................................................
02
otal cost............................................................... R@+B
,. A company could treat the cost of fringe $ene'ts relating to
direct la$or workers as part of manufacturing overhead. his
approach spreads the cost of such fringe $ene'ts over all units
of output. Alternatively, the company could treat the cost of
fringe $ene'ts relating to direct la$or workers as additional
direct la$or cost. his latter approach charges the costs of
fringe $ene'ts to speci'c jo$s rather than to all units of output.
3olutions Manual, "hapter + /<
Product Cost
Period
'sellin
g
(ame of the Cost
Variabl
e Cost
Fixe
d
Cost
!irect
Material
s
!irec
t
)abor
Manufac
turing
$verhea
d
and
admin
*+ Cost
$ppor
tunit%
Cost
Sun
&
Cost
8ental revenue forgone,
R,<,<<< per year.................... S
>irect materials cost, RB< per
unit......................................... S S
8ental cost of warehouse,
R0<< per month...................... S S
8ental cost of e4uipment,
R/,<<< per month................... S S
>irect la$or cost, R2< per unit... S S
>epreciation of the anne.
space, RB,<<< per year........... S S S
Advertising cost, R0<,<<< per
year........................................ S S
3upervisorTs salary, R),0<<
per month............................... S S
Electricity for machines, R).+<
per unit................................... S S
3hipping cost, RC per unit......... S S
8eturn earned on S
/) Managerial Accounting, ))th Edition
investments, R,,<<< per
year........................................
/+ Managerial Accounting, ))th Edition
Aote to the &nstructor: here may $e some e.ceptions to the answers $elow. he purpose of
this pro$lem is to get the student to start thin&ing a$out cost $ehavior and cost purposes%
therefore, try to avoid lengthy discussions a$out how a particular cost is classi'ed.
Variable
or Selling
Administr
ative
Manufacturin
g
'Product+
Cost
Cost "tem Fixed Cost Cost
!irec
t "ndirect
). !roperty ta.es, factory........................... F S
+. ?o.es used for packaging detergent
produced $y the company................... I S
,. 3alespersonsG commissions.................... I S
/. 3upervisorGs salary, factory.................... F S
0. >epreciation, e.ecutive autos................ F S
2. Oages of workers assem$ling
computers........................................... I S
@. &nsurance, 'nished goods warehouses... F S
B. =u$ricants for machines......................... I S
C. Advertising costs.................................... F S
)<. Microchips used in producing
calculators........................................... I S
)). 3hipping costs on merchandise sold...... I S
)+. Magazine su$scriptions, factory
lunchroom........................................... F S
/, Managerial Accounting, ))th Edition
),. hread in a garment factory.................. I S
)/. ?illing costs............................................ I SZ
)0. E.ecutive life insurance......................... F S
// Managerial Accounting, ))th Edition
Variable
or Selling
Administr
ative
Manufacturin
g
'Product+
Cost
Cost "tem Fixed Cost Cost
!irec
t "ndirect
)2. &nk used in te.t$ook production............. I S
)@. Fringe $ene'ts, assem$ly7line workers... I SZZ
)B. Qarn used in sweater production............ I S
)C. Oages of receptionist, e.ecutive
oEces.................................................. F S
Z "ould $e administrative cost.
ZZ "ould $e indirect cost.
/0 Managerial Accounting, ))th Edition
Cost Behavior
,o Units of
Product
Cost "tem Variable Fixed !irect "ndirect
). Electricity used in operating machines................ S S
+. 8ent on a factory $uilding................................... S S
,. "loth used in drapery production........................ S S
/. !roduction superintendentGs salary..................... S S
0. Oages of la$orers assem$ling a product............. S S
2. >epreciation of air puri'cation e4uipment used
in furniture production...................................... S S
@. 5anitorial salaries................................................. S S
B. !eaches used in canning fruit............................. S S
C. =u$ricants needed for machines......................... S S
)<. 3ugar used in soft drink production.................... S S
)). !roperty ta.es on the factory.............................. S S
)+. Oages of workers painting a product.................. S S
),. >epreciation on cafeteria e4uipment.................. S S
)/. &nsurance on a $uilding used in producing
helicopters........................................................ S S
)0. "ost of rotor $lades used in producing
helicopters........................................................ S S
/2 Managerial Accounting, ))th Edition
&ro'lem 2-1! (,< minutes*
). otal wages for the week:
8egular time: /< hours V R+< per hour............ RB<<
Dvertime: 2 hours V R,< per hour.................... )B<
otal wages......................................................... RCB<
Allocation of total wages:
>irect la$or: /2 hours V R+< per hour.............. RC+<
Manufacturing overhead: 2 hours V R)< per
hour............................................................... 2<
otal wages......................................................... RCB<
+. otal wages for the week:
8egular time: /< hours V R+< per hour............ R B<<
Dvertime: B hours V R,< per hour.................... +/<
otal wages......................................................... R),</<
Allocation of total wages:
>irect la$or: /0 hours V R+< per hour.............. R C<<
&dle time: , hours V R+< per hour.................. R2<
Dvertime premium: B hours V R)< per hour. . B< )/<
otal wages......................................................... R),</<
,. otal wages and fringe $ene'ts for the week:
8egular time: /< hours V R+< per hour............. R B<<
Dvertime: )< hours V R,< per hour.................. ,<<
Fringe $ene'ts: 0< hours V R2 per hour........... ,<<
otal wages and fringe $ene'ts...................... R),/<<
Allocation of wages and fringe $ene'ts:
>irect la$or: /B hours V R+< per hour.............. R C2<
&dle time: + hours V R+< per hour.................. R /<
Dvertime premium: )< hours V R)< per
hour............................................................. )<<
Fringe $ene'ts: 0< hours V R2 per hour......... ,<< //<
otal wages and fringe $ene'ts........................... R),/<<
3olutions Manual, "hapter + /@
&ro'lem 2-1! (continued*
/. Allocation of wages and fringe $ene'ts:
>irect la$or:
Oage cost: /B hours V R+< per hour.............. RC2<
Fringe $ene'ts: /B hours V R2 per hour......... +BB R),+/B
&dle time: + hours V R+< per hour.................. /<
Dvertime premium: )< hours V R)< per
hour............................................................. )<<
Fringe $ene'ts: + hours V R2 per hour........... )+ )0+
otal wages and fringe $ene'ts........................ R),/<<
3olutions Manual, "hapter + /B
&ro'lem 2-1" (2< minutes*
). Flore. "ompany
6uality "ost 8eport
,his -ear )ast -ear
Amount
Percent
of Sales Amount
Percent
of Sales
!revention costs:
6uality engineering...... R 0@< <.@2 R /+< <.02
3ystems development. . @0< ).<< /B< <.2/
3tatistical process
control........................
................................... )B< <.+/ < <.<<
otal prevention costs..... ),0<< +.<< C<< ).+<
Appraisal costs
&nspection..................... C<< ).+< @0< ).<<
!roduct testing............. ),+<< ).2< B)< ).epreciation of
testing e4uipment...... +/< <.,+ +)< <.+B
otal appraisal costs........ +,/<< ,.+< ),B<< +./<
&nternal failure costs:
Aet cost of scrap........... ),)+0 ).0< 2,< <.B/
8ework la$or................. ),0<< +.<< ),<0< )./<
>isposal of defective
products..................... C@0 ).,< @+< <.C2
otal internal failure
costs............................. ,,2<< /.B< +,/<< ,.+<
E.ternal failure costs:
"ost of 'eld servicing. . . C<< ).+< ),+<< ).2<
Oarranty repairs........... ),<0< )./< ,,2<< /.B<
!roduct recalls.............. @0< ).<< +,)<< +.B<
otal e.ternal failure
costs............................. +,@<< ,.2< 2,C<< C.+<
otal 4uality cost............. R)<,+<< ),.2< R)+,<<< )2.<<
3olutions Manual, "hapter + /C
&ro'lem 2-1" (continued*
+.
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
$14,000
Last Year This Year
Q
u
a
l
i
t
y

C
o
s
t
s

(
i
n

t
h
o
u
s
a
n
d
s
)
External Failure
Internal Failure
Appraisal
Prevention
0
2
4
6
8
10
12
14
16
18
Last Year This Year
Q
u
a
l
i
t
y

C
o
s
t
s

a
s

a

P
e
r
c
e
n
t
a
g
e

o
f

S
a
l
e
s
External Failure
Internal Failure
Appraisal
Prevention
3olutions Manual, "hapter + 0<
,. he overall impact of the companyGs increased emphasis on
4uality over the past year has $een positive in that total 4uality
costs have decreased from )2P of sales to ),.2P of sales.
>espite this improvement, the company still has a poor
distri$ution of 4uality costs. he $ulk of the 4uality costs in
$oth years is tracea$le to internal and e.ternal failure, rather
than to prevention and appraisal. Although the distri$ution of
these costs is poor, the trend this year is toward more
prevention and appraisal as the company has given more
emphasis on 4uality.
!ro$a$ly due to the increased spending on prevention and
appraisal activities during the past year, internal failure costs
have increased $y one half, going from R+./ million to R,.2
million. he reason internal failure costs have gone up is that,
through increased appraisal activity, defects are $eing caught
and corrected $efore products are shipped to customers. hus,
the company is incurring more cost for scrap, rework, and so
forth, $ut it is saving huge amounts in 'eld servicing, warranty
repairs, and product recalls. E.ternal failure costs have fallen
sharply, decreasing from R2.C million last year to just R+.@
million this year.
&f the company continues its emphasis on prevention and
appraisal9and particularly on prevention9its total 4uality
costs should continue to decrease in future years. Although
internal failure costs are increasing for the moment, these costs
should decrease in time as $etter 4uality is designed into
products. Appraisal costs should also decrease as the need for
inspection, testing, and so forth decreases as a result of $etter
engineering and tighter process control.
3olutions Manual, "hapter + 0)
&ro'lem 2-1# (,< minutes*
).
Product Cost
Period
'sellin
g
(ame of the Cost
Vari
able
Cost
Fixe
d
Cost
!irec
t
Mate
rials
!irec
t
)abo
r
Mfg*
$ver
head
and
admin
+ Cost
$ppor
tunit%
Cost
Sun
&
Cost
3taciTs current salary, R,,B<<
per month............................... S S
?uilding rent, R0<< per
month..................................... S S
"lay and glaze, R+ per pot........ S S
Oages of production workers,
RB per pot............................... S S
Advertising, R2<< per month..... S S
3ales commission, R/ per pot. . . S S
8ent of production
e4uipment, R,<< per month... S S
=egal and 'ling fees, R0<<........ S S S
8ent of sales oEce, R+0< per
month..................................... S S
!hone for taking orders, R/<
per month............................... S S
&nterest lost on savings
account, R),+<< per year...... S S
0+ Managerial Accounting, ))th Edition
+. he R0<< cost of incorporating the $usiness is not a di#erential cost. Even though the
cost was incurred to start the $usiness, it is a sunk cost. Ohether 3taci produces pottery
or stays in her present jo$, she will have incurred this cost.
0, Managerial Accounting, ))th Edition
&ro'lem 2-2$ ()0 minutes*
). he controller is correct in his viewpoint that the salary cost
should $e classi'ed as a selling (marketing* cost. he duties
descri$ed in the pro$lem have nothing to do with
manufacturing a product, $ut rather deal with moving .nished
units from the factory to distri$ution warehouses. 3elling costs
include all costs necessary to secure customer orders and to
get the 'nished product into the hands of customers.
"oordination of shipments of 'nished units from the factory to
distri$ution warehouses falls in this category.
+. Ao, the president is not correct. he reported net operating
income for the year will di#er depending on how the salary cost
is classi'ed. &f the salary cost is classi'ed as a selling e.pense
all of it will appear on the income statement as a period cost.
;owever, if the salary cost is classi'ed as a manufacturing
(product* cost, then it will $e added to Oork &n !rocess
&nventory along with other manufacturing costs for the period.
o the e.tent that goods are still in process at the end of the
period, part of the salary cost will remain with these goods in
the Oork in !rocess &nventory account. Dnly that portion of the
salary cost that has $een assigned to 'nished units will leave
the Oork &n !rocess &nventory account and $e transferred into
the Finished 1oods &nventory account. &n like manner, to the
e.tent that goods are unsold at the end of the period, part of
the salary cost will remain with these goods in the Finished
1oods &nventory account. Dnly the portion of the salary that
has $een assigned to 'nished units that are sold during the
period will appear on the income statement as an e.pense
(part of "ost of 1oods 3old* for the period. he remainder of
the salary costs will $e on the $alance sheet as part of
inventories.
3olutions Manual, "hapter + 0/
&ro'lem 2-21 ()0 minutes*
!irect or
"ndirect Cost of
the Meals/$n/
0heels
Program
!irect or
"ndirect Cost
of Particular
Seniors
Served b% the
Meals/$n/
0heels
Program
Variable or Fixed
1ith 2espect to
the (umber of
Seniors Served
b% the Meals/$n/
0heels Program
"tem !escription !irect "ndirect
!irec
t "ndirect
Variabl
e Fixed
a. he cost of leasing the meals7on7wheels
van.............................................................. S S S
$. he cost of incidental supplies such as salt,
pepper, napkins, and so on......................... S SZ S
c. he cost of gasoline consumed $y the
meals7on7wheels van.................................. S S S
d. he rent on the facility that houses
Madison 3eniors "are "enter, including
the meals7on7wheels program.................... S SZ S
e. he salary of the part7time manager of the
meals7on7wheels program.......................... S S S
f. >epreciation on the kitchen e4uipment
used in the meals7on7wheels program........ S S S
g. he hourly wages of the caregiver who
drives the van and delivers the meals........ S S S
h. he costs of complying with health safety
regulations in the kitchen........................... S S S
i. he costs of mailing letters soliciting S S S
00 Managerial Accounting, ))th Edition
donations to the meals7on7wheels
program......................................................
Zhese costs could $e direct costs of serving particular seniors.
02 Managerial Accounting, ))th Edition
&ro'lem 2-22 (/0 minutes*
). An analysis of the companyGs 4uality cost report is presented
$elow:
,his -ear )ast -ear
Amoun
t Percent3 Amount Percent3
!revention costs:
Machine
maintenance.......... R )+< +.0 +<., R@< ).@ )<./
raining suppliers...... )< <.+ ).@ < <.< <.<
6uality circles........... +< <./ ,./ < <.< <.<
otal prevention
costs......................... )0< ,.) +0./ @< ).@ )<./
Appraisal costs:
&ncoming
inspection............... /< <.B 2.B +< <.0 ,.<
Final testing.............. C< ).C )0., B< ).C )).C
otal appraisal costs.... ),< +.@ ++.< )<< +./ )/.C
&nternal failure costs:
8ework...................... ),< +.@ ++.< 0< ).+ @.0
3crap........................ @< ).0 )).C /< ).< 2.<
otal internal failure
costs......................... +<< /.+ ,,.C C< +.) ),./
E.ternal failure
costs:
Oarranty repairs....... ,< <.2 0.) C< +.) ),./
"ustomer returns...... B< ).@ ),.2 ,+< @.2 /@.B
otal e.ternal failure
costs......................... ))< +., )B.2 /)< C.B 2).+
otal 4uality cost......... R 0C<
)+.
,
)<<.
< R2@<
)2.
< )<<.<
otal production cost. . .
R/,B<
<
R/,+<
<
Z !ercentage 'gures may not add down due to rounding.
3olutions Manual, "hapter + 0@
From the a$ove analysis it would appear that Mercury, &nc.Gs
program has $een successful.
o otal 4uality costs have declined from )2.<P to )+.,P as a
percentage of total production cost. &n dollar amount, total
4uality costs went from R2@<,<<< last year to R0C<,<<< this
year.
o E.ternal failure costs, those costs signaling customer
dissatisfaction, have declined from C.BP of total production
costs to +.,P. hese declines in warranty repairs and
customer returns should result in increased sales in the
future.
o Appraisal costs have increased from +./P to +.@P of total
production cost.
o &nternal failure costs have increased from +.)P to /.+P of
production costs. his increase has pro$a$ly resulted from
the increase in appraisal activities. >efective units are now
$eing spotted more fre4uently $efore they are shipped to
customers.
o !revention costs have increased from ).@P of total
production cost to ,.)P and from )<./P of total 4uality costs
to +0./P. he RB<,<<< increase is more than o#set $y
decreases in other 4uality costs.
+. he initial e#ect of emphasizing prevention and appraisal was
to reduce e.ternal failure costs and increase internal failure
costs. he increase in appraisal activities resulted in catching
more defective units $efore they were shipped to customers.
As a conse4uence, rework and scrap costs increased. &n the
future, an increased emphasis on prevention should result in a
decrease in internal failure costs. And as defect rates are
reduced, resources devoted to appraisal can $e reduced.
,. o measure the cost of not implementing the 4uality program,
management could assume that sales and market share would
continue to decline and then calculate the lost pro't. Dr,
management might assume that the company will have to cut
3olutions Manual, "hapter + 0B
its prices to hang on to its market share. he impact on pro'ts
of lowering prices could $e estimated.
3olutions Manual, "hapter + 0C
). A cost that is classi'ed as a period cost will $e recognized on
the income statement as an e.pense in the current period. A
cost that is classi'ed as a product cost will $e recognized on
the income statement as an e.pense (i.e., cost of goods sold*
only when the associated units of product are sold. &f some
units are unsold at the end of the period, the costs of those
unsold units are treated as assets. herefore, $y reclassifying
period costs as product costs, the company is a$le to carry
some costs forward in inventories that would have $een treated
as current e.penses.
+. he discussion $elow is divided into two parts91allantGs
actions to postpone e.penditures and the actions to reclassify
period costs as product costs.
he decision to postpone e.penditures is highly 4uestiona$le. &t
is one thing to postpone e.penditures due to a cash $ind% it is
4uite another to postpone e.penditures in order to hit a pro't
target. !ostponing these e.penditures may have the e#ect of
ultimately increasing future costs and reducing future pro'ts. &f
orders to the companyGs suppliers are changed, it may disrupt
the suppliersG operations. he additional costs may $e passed
on to 1allantGs company and may create ill will and a feeling of
mistrust. !ostponing maintenance on e4uipment is particularly
4uestiona$le. he result may $e $reakdowns, ineEcient andHor
unsafe operations, and a shortened life for the machinery.
&nterestingly, in a survey of 2/C managers reported in
Management Accounting, only )+P stated that it is unethical to
defer e.penses and there$y manipulate 4uarterly earnings. he
proportion who felt it was unethical increased to +/P when it
involved annual earnings. Another /)P said that deferring
e.penses is a 4uestiona$le practice when it involved 4uarterly
reports and ,0P said this when annual reports were involved.
Finally, /@P said that it is completely ethical to manipulate
4uarterly reports in this way and /)P gave the green light for
annual reports. (3ee Oilliam 5. ?runs, 5r. and Uenneth A.
Merchant, Mhe >angerous Morality of Managing Earnings,N
Management Accounting, August )CC<, pp. ++7+0*
3olutions Manual, "hapter + 2<
1allantGs decision to reclassify period costs is not ethical9
assuming that there is no intention of disclosing in the 'nancial
reports this reclassi'cation. 3uch a reclassi'cation would $e a
violation of the principle of consistency in 'nancial reporting
and is a clear attempt to mislead readers of the 'nancial
reports. Although some may argue that the overall e#ect of
1allantGs action will $e a MwashN9that is, pro'ts gained in this
period will simply $e taken from the ne.t period9the trend of
earnings will $e a#ected. ;opefully, the auditors would
discover any such attempt to manipulate annual earnings and
would refuse to issue an un4uali'ed opinion due to the lack of
consistency. ;owever, recent accounting scandals may lead to
some skepticism a$out how forceful auditors have $een in
enforcing tight accounting standards.
3olutions Manual, "hapter + 2)
&ro'lem 2-24 (2< minutes*
).
Meriwell "ompany
>irect materials:
8aw materials inventory, $eginning...... R C,<<<
Add: !urchases of raw materials........... )+0,<<<
8aw materials availa$le for use............. ),/,<<<
>educt: 8aw materials inventory,
ending................................................ 2,<<<
8aw materials used in production.........
R)+B,<<
<
>irect la$or.............................................. @<,<<<
>epreciation, factory............................. +@,<<<
Ktilities, factory..................................... B,<<<
Maintenance, factory............................. /<,<<<
3upplies, factory................................... )),<<<
&nsurance, factory................................. /,<<<
&ndirect la$or......................................... )0,<<<
otal overhead costs................................ )<0,<<<
otal manufacturing costs........................ ,<,,<<<
Add: Oork in process inventory,
$eginning.............................................. )@,<<<
,+<,<<<
>educt: Oork in process inventory,
ending................................................... ,<,<<<
"ost of goods manufactured....................
R+C<,<<
<
3olutions Manual, "hapter + 2+
+.
Meriwell "ompany
&ncome 3tatement
3ales........................................................ R0<<,<<<
"ost of goods sold:
Finished goods inventory, $eginning..... R+<,<<<
Add: "ost of goods manufactured......... +C<,<<<
1oods availa$le for sale........................ ,)<,<<<
ending................................................ /<,<<< +@<,<<<
1ross margin........................................... +,<,<<<
3elling e.penses................................... B<,<<<
Administrative e.penses....................... ))<,<<< )C<,<<<
Aet operating income.............................. R/<,<<<
,. >irect materials: R)+B,<<< [ )<,<<< units Y R)+.B< per unit.
Factory >epreciation: R+@,<<< [ )<,<<< units Y R+.@< per unit.
/. >irect materials:
Knit cost: R)+.B< (unchanged*
otal cost: )0,<<< units V R)+.B< per unit Y R)C+,<<<.
Factory >epreciation:
Knit cost: R+@,<<< [ )0,<<< units Y R).B< per unit.
otal cost: R+@,<<< (unchanged*
0. Knit cost for depreciation dropped from R+.@< to R).B<,
$ecause of the increase in production $etween the two years.
3ince '.ed costs do not change in total as the activity level
changes, they will decrease on a unit $asis as the activity level
rises.
3olutions Manual, "hapter + 2,
).
Cost Behavior
Selling or
Administrati
ve Product Cost
Cost "tem
Variabl
e Fixed Cost !irect
"ndirec
t
Factory la$or, direct................. R))B,<<
<
R))B,<<
<
Advertising............................... R0<,<<< R0<,<<<
Factory supervision..................
/<,<<<
R/<,<<
<
!roperty ta.es, factory
$uilding.................................. ,,0<< ,,0<<
3ales commissions................... B<,<<< B<,<<<
&nsurance, factory.................... +,0<< +,0<<
>epreciation, oEce
e4uipment............................. /,<<< /,<<<
=ease cost, factory
e4uipment............................. )+,<<< )+,<<<
&ndirect materials, factory........ 2,<<< 2,<<<
>epreciation, factory
$uilding.................................. )<,<<< )<,<<<
1eneral oEce supplies............. ,,<<< ,,<<<
1eneral oEce salaries.............. 2<,<<< 2<,<<<
>irect materials used............... C/,<<< C/,<<<
Ktilities, factory........................ +<,<<
<
+<,<<
<
3olutions Manual, "hapter + 2/
otal costs................................ R,+),<<
<
R)B+,<<
< R)C@,<<<
R+)+,<<
<
RC/,<<
<
3olutions Manual, "hapter + 20
+.
>irect................................................ R+)+,<<
<
&ndirect.............................................. C/,<<
<
otal.................................................. R,<2,<<
<
R,<2,<<< [ +,<<< sets Y R)0, per
set
,. he average product cost per set would increase. his is
$ecause the '.ed costs would $e spread over fewer units,
causing the average cost per unit to rise.
/. a. Qes, the president may e.pect a minimum price of R)0,,
which is the average cost to manufacture one set. ;e might
e.pect a price even higher than this to cover a portion of the
administrative costs as well. he $rother7in7law pro$a$ly is
thinking of cost as including only direct materials, or, at
most, direct materials and direct la$or. >irect materials alone
would $e only R/@ per set, and direct materials and direct
la$or would $e only R)<2.
$. he term is opportunity cost. he full, regular price of a set
might $e appropriate here, since the company is operating at
full capacity, and this is the amount that must $e given up
($ene't forgone* to sell a set to the $rother7in7law.
3olutions Manual, "hapter , 2@
).
3wift "ompany
For the Month Ended August ,)
>irect materials:
8aw materials inventory, August ).......... R B,<<
<
Add: !urchases of raw materials.............. )20,<<
<
8aw materials availa$le for use............... )@,,<<<
August ,)..............................................
),,<<
<
8aw materials used in production............ R)2<,<<<
>irect la$or................................................ @<,<<<
&ndirect la$or cost.................................... )+,<<<
Ktilities (2epreciation, factory e4uipment............. +),<<<
&nsurance (@0P V R/,<<<*....................... ,,<<<
8ent on facilities (B<P V R0<,<<<*.......... /<,<<
<
otal overhead costs.................................. B0,<<<
otal manufacturing costs.......................... ,)0,<<<
Add: Oork in process inventory, August ). . )2,<<<
,,),<<<
August ,)................................................
+),<<<
"ost of goods manufactured...................... R,)<,<<<
3olutions Manual, "hapter , 2B
+.
3wift "ompany
&ncome 3tatement
3ales.......................................................... R/0<,<<
<
=ess cost of goods sold:
Finished goods inventory, August )......... R
/<,<<<
Add: "ost of goods manufactured............ ,)<,<<
<
1oods availa$le for sale.......................... ,0<,<<<
August ,)..............................................
2<,<<
<
+C<,<<<
1ross margin.............................................. )2<,<<<
Ktilities (/epreciation, sales e4uipment................ )B,<<<
&nsurance (+0P V R/,<<<*....................... ),<<<
8ent on facilities (+<P V R0<,<<<* ......... )<,<<<
3elling and administrative salaries.......... ,+,<<<
Advertising.............................................. @0,<<
<
)/+,<<<
Aet operating income................................ R
)B,<<<
,. &n preparing the income statement for August, 3am failed to
distinguish $etween product costs and period costs, and he
also failed to recognize the changes in inventories $etween the
$eginning and end of the month. Dnce these errors have $een
corrected, the 'nancial condition of the company looks much
$etter and selling the company may not $e advisa$le.
3olutions Manual, "hapter , 2C
&ro'lem 2-2! (2< minutes*
). 3uperior "ompany
For the Qear Ended >ecem$er ,)
>irect materials:
8aw materials inventory, $eginning...... R
/<,<<<
Add: !urchases of raw materials........... +C<,<<<
8aw materials availa$le for use............ ,,<,<<<
ending................................................
)<,<<<
8aw materials used in production......... R,+<,<<
<
>irect la$or.............................................. C,,<<< Z
&nsurance, factory................................. B,<<<
Ktilities, factory..................................... /0,<<<
&ndirect la$or......................................... 2<,<<<
"leaning supplies, factory..................... @,<<<
8ent, factory $uilding............................ )+<,<<<
Maintenance, factory............................ ,<,<<<
otal overhead costs................................ +@<,<<<
otal manufacturing costs (given*............ 2B,,<<<
$eginning..............................................
/+,<<< Z
@+0,<<<
ending...................................................
,0,<<<
"ost of goods manufactured.................... R2C<,<<
<
he cost of goods sold section of the income statement follows:
Finished goods inventory, $eginning....... R
0<,<<<
Add: "ost of goods manufactured........... 2C<,<<< Z
1oods availa$le for sale (given*.............. @/<,<<<
ending..................................................
B<,<<< Z
3olutions Manual, "hapter , @<
"ost of goods sold (given*....................... R22<,<<
<
Z hese items must $e computed $y working $ackwards up
through the statements.
3olutions Manual, "hapter , @)
+. >irect materials: R,+<,<<< [ /<,<<< units Y RB per unit.
8ent, factory $uilding: R)+<,<<< [ /<,<<< units Y R, per unit.
,. Per Unit ,otal
>irect materials........ RB.<< (3ame* R/<<,<<< ZZ ("hanged
*
8ent, factory
$uilding..................
R+./< Z ("hanged
*
R)+<,<<< (3ame*
Z R)+<,<<< [ 0<,<<< units Y R+./< per unit.
ZZ RB per unit V 0<,<<< units Y R/<<,<<<.
/. he unit cost for rent dropped from R,.<< to R+./<, $ecause of
the increase in production $etween the two years. 3ince '.ed
costs do not change in total as the activity level changes, they
will decrease on a unit $asis as the activity level rises.
3olutions Manual, "hapter , @+
).
Iisic "orporation
>irect materials:
8aw materials inventory, $eginning............... R
+<,<<<
Add: !urchases of raw materials.................... /B<,<<
<
8aw materials availa$le for use..................... 0<<,<<<
>educt: 8aw materials inventory, ending...... ,<,<<
<
8aw materials used in production.................. R/@<,<<
<
>irect la$or...................................................... C<,<<<
&ndirect la$or................................................. B0,<<<
?uilding rent (B<P V R/<,<<<* ..................... ,+,<<<
Ktilities, factory.............................................. )<B,<<<
8oyalty on patent (R).0< per unit V +C,<<<
units*...........................................................
/,,0<<
Maintenance, factory..................................... C,<<<
8ent on e4uipment
R@,<<< \ (R<.,< per unit V +C,<<< units* ...
)0,@<<
Dther factory overhead costs......................... 2,B<
<
otal overhead costs......................................... ,<<,<<
<
otal manufacturing costs................................ B2<,<<<
Add: Oork in process inventory, $eginning....... 0<,<<
<
C)<,<<<
>educt: Oork in process inventory, ending...... /<,<<
<
"ost of goods manufactured............................ RB@<,<<
<
3olutions Manual, "hapter , @,
+. a. o compute the num$er of units in the 'nished goods
inventory at the end of the year, we must 'rst compute the
num$er of units sold during the year.
otal sales R),,<<,<<<
Y Y +2,<<< units sold
Knit selling price R0< per unit sold
Knits in the 'nished goods inventory,
$eginning.....................................................
<
Knits produced during the year...................... +C,<<<
Knits availa$le for sale................................... +C,<<<
Knits sold during the year (a$ove* ................ +2,<<<
Knits in the 'nished goods inventory,
ending..........................................................
,,<<<
$. he average production cost per unit during the year would
$e:
g "ost of oods manufactured RB@<,<<<
Y Y R,< per unit
Aum$er of units produced +C,<<< units
hus, the cost of the units in the 'nished goods inventory at
the end of the year would $e: ,,<<< units V R,< per unit Y
RC<,<<<.
3olutions Manual, "hapter , @/
,. Iisic "orporation
&ncome 3tatement
3ales....................................................... R),,<<,<<<
Finished goods inventory, $eginning..... R <
Add: "ost of goods manufactured......... B@<,<<<
1oods availa$le for sale........................ B@<,<<<
Finished goods inventory, ending......... C<,<<< @B<,<<<
1ross margin........................................... 0+<,<<<
Advertising........................................... )<0,<<<
Entertainment and travel...................... /<,<<<
?uilding rent (+<P V R/<,<<<*............. B,<<<
3elling and administrative salaries....... +)<,<<<
Dther selling and administrative
e.pense.............................................
)@,<<< ,B<,<<<
Aet operating income............................. R)/<,<<<
3olutions Manual, "hapter , @0
&ro'lem 2-2# (/0 minutes*
Case 4 Case 5 Case 6 Case 7
>irect materials............. R/,0<< R2,<<< R0,<<< R,,<<<
>irect la$or................... C,<<< Z ,,<<< @,<<< /,<<<
Manufacturing
overhead..................... 0,<<< /,<<< B,<<< Z C,<<<
otal manufacturing
costs........................... )B,0<< ),,<<< Z +<,<<< )2,<<< Z
?eginning work in
process inventory....... +,0<< +,<<< Z ,,<<< /,0<< Z
Ending work in process
inventory.................... (,,<<<*Z
(),<<<
*
(/,<<<
*
(,,<<<
*
"ost of goods
manufactured............. R)B,<<<
R)/,<<
<
R)C,<<
< Z
R)@,0<
<
3ales............................. R,<,<<<
R+),<<
<
R,2,<<
<
R/<,<<
<
?eginning 'nished
goods inventory.......... ),<<< +,0<< ,,0<< Z +,<<<
"ost of goods
manufactured............. )B,<<< )/,<<< )C,<<< Z )@,0<<
1oods availa$le for
sale............................. )C,<<< Z )2,0<< Z ++,0<< Z )C,0<< Z
Ending 'nished goods
inventory.................... (+,<<<*Z
(),0<<
*
(/,<<<
*
(,,0<<
*
"ost of goods sold......... )@,<<< )0,<<< Z )B,0<< )2,<<< Z
1ross margin................. ),,<<< 2,<<< Z )@,0<< +/,<<< Z
Dperating e.penses...... (C,<<<*Z
(,,0<<
*
()+,0<<
* Z
()0,<<<
* Z
Aet operating income.... R/,<<< R+,0<< Z R0,<<< RC,<<<
Z Missing data in the pro$lem.
3olutions Manual, "hapter , @2
Case 2-3$ (2< minutes*
he following cost items are needed $efore a schedule of cost of
goods manufactured can $e prepared:
Materials used in production:
!rime cost.............................................. R/)<,<<
<
=ess direct la$or cost.............................. )B<,<<<
>irect materials cost.............................. R+,<,<<
<
Manufacturing overhead cost:
>irect la$or cost R)B<,<<<
Y
!ercentage of conversion cost ,<PZ
Y R2<<,<<< total conversion cost
Z)<<P X @<P Y ,<P.
"onversion cost..................................... R2<<,<<<
=ess direct la$or cost............................. )B<,<<<
Manufacturing overhead cost................. R/+<,<<<
"ost of goods manufactured:
1oods availa$le for sale......................... RB)<,<<<
=ess 'nished goods inventory,
$eginning.............................................
/0,<<<
"ost of goods manufactured.................. R@20,<<<
he easiest way to proceed from this point is to place all known
amounts in a partially completed schedule of cost of goods
manufactured and a partially completed income statement. hen
'll in the missing amounts $y analysis of the availa$le data.
3olutions Manual, "hapter , @@
Case 2-3$ (continued*
>irect materials:
8aw materials inventory, $eginning.................
R
)B,<<<
Add: !urchases of raw materials......................
+C<,<<
<
8aw materials availa$le for use....................... ,<B,<<<
>educt: 8aw materials inventory, ending........ A
8aw materials used in production (see
a$ove*........................................................... +,<,<<<
>irect la$or cost.................................................
)B<,<<
<
Manufacturing overhead cost (see a$ove*.........
/+<,<<
<
otal manufacturing costs.................................. B,<,<<<
Add: Oork in process inventory, $eginning.........
20,<<
<
BC0,<<<
>educt: Oork in process inventory, ending........ ?
"ost of goods manufactured (see a$ove*...........
R@20,<<
<
herefore, MAN (8aw materials inventory, ending* would $e
R@B,<<<% and M?N (Oork in process inventory, ending* would $e
R),<,<<<.
3ales...........................................................
R),+<<,<<
<
Finished goods inventory, $eginning.........
R
/0,<<<
Add: "ost of goods manufactured (see
a$ove*.................................................... @20,<<<
1oods availa$le for sale............................ B)<,<<<
ending.................................................... "
@+<,<<
<
1ross margin...............................................
R /B<,<<
<
ZR),+<<,<<< V ()<<P X /<P* Y R@+<,<<<.
3olutions Manual, "hapter , @B
herefore, M"N (Finished goods inventory, ending* would $e
RC<,<<<. he procedure outlined a$ove is just one way in which
the solution to the case can $e approached. 3ome may wish to
start at the $ottom of the income statement (with gross
margin* and work upwards from that point. Also, the solution
can $e o$tained $y use of 7accounts.
3olutions Manual, "hapter , @C
Case 2-31 (2< minutes*
). Ao distinction has $een made $etween period e.penses and
product costs on the income statement 'led $y the companyGs
accountant. !roduct costs (e.g., direct materials, direct la$or,
and manufacturing overhead* should $e assigned to inventory
accounts and -ow through to the income statement as cost of
goods sold only when 'nished products are sold. 3ince there
were ending inventories, some of the product costs should
appear on the $alance sheet as assets rather than on the
income statement as e.penses.
+. 3olar echnology, &nc.
For the 6uarter Ended March ,)
>irect materials:
8aw materials inventory, $eginning....... R <
Add: !urchases of raw materials............. ,2<,<<<
8aw materials availa$le for use.............. ,2<,<<<
ending..................................................
)<,<<<
8aw materials used in production........... R,0<,<<<
>irect la$or............................................... @<,<<<
Maintenance, production........................ /,,<<<
&ndirect la$or.......................................... )+<,<<<
"leaning supplies, production................. @,<<<
8ental cost, facilities (Bepreciation, production e4uipment...... )<<,<<<
otal overhead costs................................. /)<,<<<
otal manufacturing costs......................... B,<,<<<
$eginning...............................................
<
B,<,<<<
ending....................................................
0<,<<<
"ost of goods manufactured..................... R@B<,<<<
3olutions Manual, "hapter , B<
Case 2-31 (continued*
,. ?efore an income statement can $e prepared, the cost of the
B,<<< $atteries in the ending 'nished goods inventory must $e
determined. Altogether, the company produced /<,<<<
$atteries during the 4uarter% thus, the production cost per
$attery would $e:
"ost of goods manufactured R@B<,<<<
Y YR)C.0< per unit
?atteries produced during the 4uarter /<,<<< units
3ince B,<<< $atteries (/<,<<< X ,+,<<< Y B,<<<* were in the
'nished goods inventory at the end of the 4uarter, the total
cost of this inventory would $e:
B,<<< units V R)C.0< per unit Y R)02,<<<.
Oith this 'gure and other data from the case, the companyGs
income statement for the 4uarter can $e prepared as follows:
3olar echnology, &nc.
&ncome 3tatement
3ales (,+,<<< $atteries*........................ RC2<,<<
<
Finished goods inventory, $eginning... R <
Add: "ost of goods manufactured ...... @B<,<<
<
1oods availa$le for sale..................... @B<,<<<
ending..............................................
)02,<<
<
2+/,<<<
1ross margin......................................... ,,2,<<<
3elling and administrative salaries..... ))<,<<<
Advertising......................................... C<,<<<
8ental cost, facilities (+epreciation, oEce e4uipment........... +@,<<<
Ktilities ()<P V RB<,<<<*................... B,<<<
ravel, salespersons........................... /<,<< +C<,<<<
3olutions Manual, "hapter , B)
<
Aet operating income........................... R
/2,<<<
3olutions Manual, "hapter , B+
/. Ao, the insurance company pro$a$ly does not owe 3olar
echnology R++2,<<<. he key 4uestion is how McostN was
de'ned in the insurance contract. &t is most likely that the
insurance contract limits reim$ursement for losses to those
costs that would normally $e considered product costs9in
other words, direct materials, direct la$or, and manufacturing
overhead. he R++2,<<< 'gure is overstated since it includes
elements of selling and administrative e.penses as well as all
of the product costs. he R++2,<<< 'gure also does not
recognize that some costs incurred during the period are in the
ending 8aw Materials and Oork in !rocess inventory accounts,
as e.plained in part ()* a$ove. he insurance companyGs
lia$ility is pro$a$ly just R)02,<<<, which is the amount of cost
associated with the ending Finished 1oods inventory as shown
in part (,* a$ove.
3olutions Manual, "hapter , B,
,roup E%ercise 2-32
). his statement re-ects FordGs focus on reducing costs.
!roducing cars in di#erent colors adds to costs and reduces
output in a variety of ways. First, changing colors on the
production line involves considera$le setups, during which time
nothing can $e painted. he old color must $e purged from
paint lines $efore the new color can $e applied. And di#erent
colors mean larger paint inventories and9perhaps most
importantly9larger inventories of 'nished autos. ?y producing
the Model in only one color, Ford was a$le to keep costs low
and to keep throughput up9thus keeping its costs low.
;owever, the market was eventually willing to pay for more
colors and Ford was slow to adapt to this change.
+. As stated in the pro$lem, further eEciencies could $e achieved
$y implementing standardized work procedures, specializing
work, and using machines to enhance the productivity of
individual workers.
,. here are indeed limits to lowering costs9they canGt go $elow
zero. Dne might think that the lowest limit is the cost of raw
materials used in production. ;owever, even this cost can $e
pushed down over time as more eEcient means of producing
raw materials are developed.
/. he most o$vious application of mass production concepts to
university education has $een the increase in the num$er of
students in classes9with large lecture classes now $eing the
norm in many introductory courses. ;ospitals have applied the
concepts of mass production $y developing standardized
procedures and $y specializing in certain areas such as cardiac
care or cancer treatment. Airlines have applied mass
production concepts $y increasing the size of the jets they -y
and $y reducing the time re4uired to service a jet $etween
-ights.
3olutions Manual, "hapter , B/
,roup E%ercise 2-33
). A '.ed cost is normally de'ned as a cost that remains
constant, in total, regardless of changes in the level of activity.
A varia$le cost is normally de'ned as a cost that varies, in
total, in direct proportion to changes in the level of activity.
+. he relevant measure of activity for a steel company is
pro$a$ly the volume of steel produced. Fi.ed costs for a steel
company include factory rent and depreciation, property ta.es,
many administrative costs, salaries, and periodic depreciation
of e4uipment. Iaria$le costs include the cost of raw materials,
some energy costs, some la$or costs, and some supply costs.
,. A num$er of di#erent measures of activity could $e used at a
hospital. 3ome hospitals use a measure called patient7days,
which counts a patient in the hospital for one day as a patient7
day. Fi.ed costs at a hospital include the rental and
depreciation of $uildings, administrative salaries, utilities,
insurance, and the costs of e4uipment. Iaria$le costs include
the costs of drugs and supplies and some la$or costs.
Kniversities often use credit7hours or the total num$er of
students enrolled as the measure of activity. Fi.ed costs for a
university include the costs of $uildings, salaries, utilities,
grounds maintenance, and so on. Iaria$le costs are minimal.
A measure of activity at an auto manufacturer might $e the
num$er of cars produced. Fi.ed costs for an auto manufacturer
include the costs of $uildings and e4uipment, insurance,
salaries, and utilities. Iaria$le costs include raw materials and
perhaps some la$or.
/. As the volume of steel produced increases, total '.ed costs
remain the same% the '.ed cost per unit decreases% total
varia$le costs increase% the varia$le cost per unit remains the
same% total cost increases (due to the increase in total varia$le
cost*% and the average unit cost decreases ($ecause of the
decline in the '.ed cost per unit*.
3olutions Manual, "hapter , B0
,roup E%ercise 2-33 (continued*
0. he following graph depicts how total costs $ehave as a
function of how many tons of steel are produced.
2. he following graph depicts how average costs per unit $ehave
as a function of how many tons of steel are produced.
@. Dnce capacity has $een set, total '.ed costs and varia$le costs
per unit remain the same while the average '.ed cost per unit
drops and the total varia$le cost increases as demand (output*
increases.
3olutions Manual, "hapter , B2
otal cost
otal varia$le cost
otal '.ed cost
R
ons
Average total cost per
unit
Iaria$le cost per
unit
Average '.ed cost per
unit
R
ons
Chapter 3
S)stems 1esign2 3o'-*rder Costing
3-1 ?y de'nition, overhead consists of
costs that cannot practically $e traced to
products or jo$s. herefore, if they are to $e
assigned to products or jo$s, overhead
costs must $e allocated rather than traced.
3-2 5o$7order costing is used in
situations where many di#erent products or
services are produced each period. Each
product (or jo$* is di#erent from all others
and re4uires separate costing. !rocess
costing is used in situations where a single,
homogeneous product, such as cement,
$ricks, or gasoline, is produced for long
periods.
3-3 he jo$ cost sheet is used to record
all costs that are assigned to a particular
jo$. hese costs include direct materials
costs traced to the jo$, direct la$or costs
traced to the jo$, and manufacturing
overhead costs applied to the jo$. Ohen a
jo$ is completed, the jo$ cost sheet is used
to compute the unit product cost. he jo$
cost sheet is also a control document for:
()* determining how many units have $een
sold and determining the cost of these
units% and (+* determining how many units
are still in inventory at the end of a period
and determining the cost of these units on
the $alance sheet.
3-4 A predetermined overhead rate is
used to apply overhead to jo$s. &t is
computed $efore a period $egins $y
dividing the periodGs estimated total
manufacturing overhead $y the periodGs
estimated total amount in the allocation
$ase. hereafter, overhead is applied to
jo$s $y multiplying the predetermined
overhead rate $y the actual amount of the
allocation $ase that is incurred for each jo$.
he most common allocation $ase is direct
la$or7hours.
3-5 A sales order is issued after an
agreement has $een reached with a
customer on 4uantities, prices, and
shipment dates for goods. he sales order
forms the $asis for the production order.
he production order speci'es what is to $e
produced and forms the $asis for the jo$
cost sheet. he jo$ cost sheet, in turn, is
used to summarize the various production
costs incurred to complete the jo$. hese
costs are entered on the jo$ cost sheet
from materials re4uisition forms, direct
la$or time tickets, and overhead application
computations.
3- Many production costs cannot $e
traced to a particular product or jo$, $ut
rather are incurred as a result of overall
production activities. herefore, to $e
assigned to products, such costs must $e
allocated to the products in some manner.
E.amples of such costs include utilities,
maintenance on machines, and
depreciation of the factory $uilding. hese
costs are indirect production costs.
3-! &f actual manufacturing overhead
cost is applied to jo$s, then the company
must wait until the end of the accounting
period to apply overhead and to cost jo$s. &f
the company computes the actual overhead
rates more fre4uently to get around this
pro$lem, the rates may -uctuate widely.
Dverhead cost tends to $e incurred
somewhat evenly from month to month
(due to the presence of '.ed costs*,
whereas production activity often
-uctuates. he result would $e high
overhead rates in periods with low activity
3olutions Manual, "hapter , B@
and low overhead rates in periods with high
activity. For these reasons, most companies
use predetermined overhead rates to apply
overhead cost to jo$s.
3-" he measure of activity used as the
allocation $ase should drive the overhead
cost% that is, the $ase should cause the
overhead cost. &f the allocation $ase does
not really cause the overhead, then costs
will $e incorrectly attri$uted to products
and jo$s and their product costs will $e
distorted.
3-# Assigning overhead costs to jo$s
does not ensure a pro't. he units
produced may not $e sold and if they are
sold, they may not in fact $e sold at prices
suEcient to cover all costs. &t is a myth that
assigning costs to products or jo$s ensures
that those costs will $e recovered. "osts are
recovered only $y selling to customers9not
$y allocating costs.
3-1$ he Manufacturing Dverhead
account is credited when overhead cost is
applied to Oork in !rocess. 1enerally, the
amount of overhead applied will not $e the
same as the amount of actual cost incurred,
since the predetermined overhead rate is
$ased on estimates.
3-11 Knderapplied overhead occurs when
the actual overhead cost e.ceeds the
amount of overhead cost applied to Oork in
!rocess inventory during the period.
Dverapplied overhead occurs when the
actual overhead cost is less than the
amount of overhead cost applied to Oork in
!rocess inventory during the period. Knder7
or overapplied overhead is disposed of $y
either closing out the amount to "ost of
1oods 3old or allocating the amount among
"ost of 1oods 3old and ending inventories
in proportion to the applied overhead in
each account. he adjustment for
underapplied overhead increases "ost of
1oods 3old (and inventories* whereas the
adjustment for overapplied overhead
decreases "ost of 1oods 3old (and
inventories*.
3-12 Dverhead may $e underapplied for
several reasons. "ontrol over overhead
spending may $e poor. Dr, some of the
overhead may $e '.ed and the actual
amount of the allocation $ase was less than
estimated at the $eginning of the period. &n
this situation, the amount of overhead
applied to inventory will $e less than the
actual overhead cost incurred.
3-13 Knderapplied overhead implies that
not enough overhead was assigned to jo$s
during the period and therefore cost of
goods sold was understated. herefore,
underapplied overhead is added to cost of
goods sold. =ikewise, overapplied overhead
is deducted from cost of goods sold.
3-14 Qes, overhead should $e applied to
properly value the Oork in !rocess
inventory at year7end. 3ince R2,<<< of
overhead was applied to 5o$ A on the $asis
of RB,<<< of direct la$or cost, the
companyGs predetermined overhead rate
must $e @0P of direct la$or cost. hus,
R,,<<< of overhead should $e applied to 5o$
? at year7end: R/,<<< direct la$or cost
@0P Y R,,<<< applied overhead cost.
3-15
>irect material............................................ R)<,<<<
>irect la$or................................................. )+,<<<
R)+,<<< )+0P...................................... )0,<<<
otal manufacturing cost............................ R,@,<<<
Knit product cost:
R,@,<<< ),<<< units............................. R,@
3-1 A plantwide overhead rate is a single
overhead rate used throughout all
production departments in a plant. 3ome
companies use multiple overhead rates
rather than plantwide rates to more
appropriately allocate overhead costs
among products. Multiple overhead rates
should $e used, for e.ample, in situations
where one department is machine intensive
and another department is la$or intensive.
3-1! Ohen automated e4uipment
replaces direct la$or, overhead increases
and direct la$or decreases. his results in
an increase in the predetermined overhead
rate9particularly if it is $ased on direct
la$or.
3olutions Manual, "hapter , BB
3-1" Ohen the predetermined overhead
rate is $ased on the amount of the
allocation $ase at capacity and the plant is
operated at less than capacity, overhead
will ordinarily $e underapplied. his occurs
$ecause actual activity is less than the
activity the predetermined overhead rate is
$ased on.
3-1# "ritics of current practice advocate
disclosing underapplied overhead on the
income statement as "ost of Knused
"apacity9a period e.pense. his would
highlight the amount rather than $urying it
in other accounts.
3olutions Manual, "hapter , BC
3olutions Manual, "hapter / )/,
a. !rocess costing g. 5o$7order costing
$. 5o$7order costing h. !rocess costingZ
c. !rocess costing i. 5o$7order costing
d. !rocess costing j. !rocess costingZ
e. !rocess costing k. 5o$7order costing
f. 5o$7order costing l. 5o$7order costing
Z 3ome of the companies listed might use either a jo$7order or a
process costing system, depending on how operations are
carried out. For e.ample, a chemical manufacturer would
typically operate with a process costing system, $ut a jo$7order
costing system might $e used if products are manufactured in
relatively small $atches. he same thing might $e true of the
tire manufacturing plant in item Mj.N
3olutions Manual, "hapter / )//
). hese costs would have $een recorded on four di#erent
documents: the materials re4uisition form for 5o$ O/02, the
time ticket for 5amie Knser, the time ticket for Melissa "han,
and the jo$ cost sheet for 5o$ O/02.
+. he costs would have $een recorded as follows:
Materials re4uisition form:
8uanti
t%
Unit
Cost
,otal
Cost
?lank
s
+< R)0.<< R,<<
Ai$s /B< R).+0 2<<
RC<<
ime ticket for 5amie Knser
Starte
d Ended
,ime
Complete
d 2ate
Amoun
t
9ob
(umber
)):<<
AM
+:/0
!M
,.@0 RC.2< R,2.<< O/02
ime ticket for Melissa "han
Starte
d Ended
,ime
Complete
d 2ate
Amoun
t
9ob
(umber
B:)0
AM
)):,<
AM
,.+0 R)+.+< R,C.20 O/02
5o$ "ost 3heet for 5o$ O/02
>irect materials RC<<.<<
>irect la$or:
5amie Knser ,2.<<
Melissa "han ,C.20
RC@0.20
3olutions Manual, "hapter / )/0
he predetermined overhead rate is computed as follows:
Estimated total manufacturing overhead. . . R),/,<<<
[ Estimated total direct la$or hours
(>=;s*...................................................... +<,<<< >=;s
Y !redetermined overhead rate................. R2.@< per >=;
3olutions Manual, "hapter / )/2
a. 8aw Materials.................. B<,<<<
Accounts !aya$le....... B<,<<<
$. Oork in !rocess............... 2+,<<<
Manufacturing
Dverhead........................ C,<<<
8aw Materials............. @),<<<
c. Oork in !rocess............... )<),<<<
Manufacturing
Dverhead........................ )),<<<
Oages !aya$le........... ))+,<<<
d.
Manufacturing
Dverhead........................ )@0,<<<
Iarious Accounts........ )@0,<<<
3olutions Manual, "hapter / )/@
Actual direct la$or7hours......................... )<,B<<
V !redetermined overhead rate.............. R+,./<
Y Manufacturing overhead applied......... R+0+,@+<
3olutions Manual, "hapter / )/B
). Actual manufacturing overhead costs....
R/@,,<<
<
Manufacturing overhead cost applied:
)C,/<< M; V R+0 per M;....................
/B0,<<
<
Dverapplied overhead cost....................
R
)+,<<<
+. "hang "ompany
>irect materials:
8aw materials inventory, $eginning.... R+<,<<<
Add purchases of raw materials.......... /<<,<<<
8aw materials availa$le for use........... /+<,<<<
>educt raw materials inventory,
ending.............................................. ,<,<<<
8aw materials used in production....... ,C<,<<<
=ess indirect materials........................ )0,<<<
R,@0,<<
<
>irect la$or............................................ 2<,<<<
Manufacturing overhead cost applied
to work in process............................... /B0,<<<
otal manufacturing costs...................... C+<,<<<
Add: Oork in process, $eginning............ /<,<<<
C2<,<<<
>educt: Oork in process, ending........... @<,<<<
"ost of goods manufactured..................
RBC<,<<
<
3olutions Manual, "hapter / )/C
E%ercise 3-! (+< minutes*
!arts ) and +.
"ash 8aw Materials
C/,<<< (a* (a* C/,<<< BC,<<< ($*
),+,<<< (c*
)/,,<<< (d*
Oork in !rocess Finished 1oods
($* @B,<<< (f* ,/+,<<<
(c* ))+,<<< ,/+,<<< ,/+,<<< (f*
(e* )0+,<<<
,/+,<<< ,/+,<<< (f*
Manufacturing Dverhead "ost of 1oods 3old
($* )),<<< )0+,<<< (e* (f* ,/+,<<<
(c* +<,<<< (g* ++,<<<
(d* )/,,<<< ,2/,<<<
++,<<< ++,<<< (g*
3olutions Manual, "hapter / )0<
E%ercise 3-" ()< minutes*
). Actual direct la$or7hours...................... )),0<<
V !redetermined overhead rate........... R)B.+<
Y Manufacturing overhead applied......R+<C,,<<
=ess: Manufacturing overhead
incurred............................................. +)0,<<<
R (0,@<<*
Manufacturing overhead
underapplied..................................... R0,@<<
+. 3ince manufacturing overhead is underapplied, the cost of
goods sold would $e increased $y R0,@<< and the gross margin
would decrease $y R0,@<<.
3olutions Manual, "hapter / )0)
). "utting >epartment:
Estimated total manufacturing overhead cost
!redetermined
Y
overhead rate
Estimated total amount of the allocation $ase
R,2<,<<<
Y Y R@.0< per M;
/B,<<< M;s
Finishing >epartment:
!redetermined
Y
overhead rate
R/B2,<<<
)Bepartment: B< M;s V R@.0< per
M;............................................................. R2<<
Finishing >epartment: R)0< V )B<P........... +@<
otal overhead cost applied.......................... RB@<
,. Qes% if some jo$s re4uired a large amount of machine time and
little la$or cost, they would $e charged su$stantially less
overhead cost if a plantwide rate $ased on direct la$or cost
were $eing used. &t appears, for e.ample, that this would $e
true of 5o$ +<, which re4uired considera$le machine time to
complete, $ut re4uired only a small amount of la$or cost.
3olutions Manual, "hapter / )0+
). a. 8aw Materials &nventory..................... +)<,<<
<
Accounts !aya$le............................. +)<,<<<
$. Oork in !rocess................................... )@B,<<
<
Manufacturing Dverhead.................... )+,<<<
8aw Materials &nventory................... )C<,<<<
c. Oork in !rocess................................... C<,<<<
Manufacturing Dverhead.................... ))<,<<
<
3alaries and Oages !aya$le............. +<<,<<<
d. Manufacturing Dverhead.................... /<,<<<
Accumulated >epreciation............... /<,<<<
e. Manufacturing Dverhead.................... @<,<<<
Accounts !aya$le............................. @<,<<<
f. Oork in !rocess................................... +/<,<<
<
Manufacturing Dverhead.................. +/<,<<<
,<,<<< M; V RB per M; Y
R+/<,<<<.
g. Finished 1oods.................................... 0+<,<<
<
Oork in !rocess................................ 0+<,<<<
h. "ost of 1oods 3old.............................. /B<,<<
<
Finished 1oods................................. /B<,<<<
Accounts 8eceiva$le........................... 2<<,<<
<
3ales................................................ 2<<,<<<
R/B<,<<< V ).+0 Y R2<<,<<<.
3olutions Manual, "hapter / )0,
E%ercise 3-1$ (continued*
+.
Manufacturing Dverhead Oork in !rocess
($*
)+,<<< +/<,<<<
(f* ?al
. /+,<<< 0+<,<<<
(g*
(c* ))<,<<< ($* )@B,<<<
(d* /<,<<< (c* C<,<<<
(e* @<,<<< (f* +/<,<<<
B,<<<
?al
. ,<,<<<
(Dverapplied
overhead*
3olutions Manual, "hapter / )0/
). 3ince R)+<,<<< of studio overhead was applied to Oork in
!rocess on the $asis of R@0,<<< of direct sta# costs, the
apparent predetermined overhead rate is )2<P:
3tudio overhead applied R)+<,<<<
Y Y )2irect sta# costs incurred R@0,<<<
+. he =e.ington 1ardens !roject is the only jo$ remaining in Oork
in !rocess at the end of the month% therefore, the entire
R,0,<<< $alance in the Oork in !rocess account at that point
must apply to it. 8ecognizing that the predetermined overhead
rate is )2irect sta# costs........................................
R 2,0<<
3tudio overhead cost (R2,0<< V
)2<P*...................................................... )<,/<< )2,C<<
"osts of su$contracted work...................... R)B,)<<
Oith this information, we can now complete the jo$ cost sheet
for the =e.ington 1ardens !roject:
"osts of su$contracted work.. . R)B,)<<
>irect sta# costs..................... 2,0<<
3tudio overhead...................... )<,/<<
otal cost to 5anuary ,)........... R,0,<<<
3olutions Manual, "hapter / )00
Aote to the instructor: his e.ercise is a good vehicle for
introducing the concept of predetermined overhead rates. his
e.ercise can also $e used as a launching pad for a discussion of
the appendi. to the chapter.
). 3ince manufacturing overhead is mostly '.ed, the cost per unit
increases as the level of production decreases. his apparent
pro$lem can $e MsolvedN using predetermined overhead rates,
which should $e $ased on e.pected activity for the entire year.
Many students will use units of product in computing the
predetermined overhead rate, as follows:
!redetermined
Y
overhead rate
RC2<,<<<
Y Y R/.B< per unit.
+<<,<<< units
he predetermined overhead rate could also $e set on the
$asis of either direct la$or cost or direct materials cost. he
computations are:
!redetermined
Y
overhead rate
RC2<,<<<
,<<P of direct
Y Y
la$or cost.
R,+<,<<< direct la$or cost
!redetermined
Y
overhead rate
RC2<,<<<
)2irect materials..............
R+/<,<<
<
R)+<,<<
<
R
2<,<<<
R)B<,<<
<
>irect la$or..................... )+B,<<< 2/,<<< ,+,<<< C2,<<<
Manufacturing
overhead:
Applied at R/.B< per
unit, ,<<P of direct
la$or cost, or )2<P of
direct materials cost..... ,B/,<<< )C+,<<< C2,<<< +BB,<<<
otal cost.........................
R@0+,<<
<
R,@2,<<
<
R)BB,<<
<
R02/,<<
<
Aum$er of units
produced...................... B<,<<< /<,<<< +<,<<< 2<,<<<
Knit product cost............. RC./< RC./< RC./< RC./<
3olutions Manual, "hapter / )0@
).
!redetermined
Y
overhead rate
R)C+,<<<
Y Y R+./< per M;
B<,<<< M;s
+. he amount of overhead cost applied to Oork in !rocess for the
year would $e: @0,<<< machine7hours V R+./< per machine7
hour Y R)B<,<<<. his amount is shown in entry (a* $elow:
Manufacturing
Dverhead
(Maintenance* +),<<< )B<,<<< (a*
(&ndirect
materials*
B,<<<
(&ndirect la$or* 2<,<<<
(Ktilities* ,+,<<<
(&nsurance* @,<<<
(>epreciation* 02,<<<
?alance /,<<<
Oork in !rocess
(>irect materials* @)<,<<
<
(>irect la$or* C<,<<<
(Dverhead* (a* )B<,<<
<
,. Dverhead is underapplied $y R/,<<< for the year, as shown in
the Manufacturing Dverhead account a$ove. he entry to close
out this $alance to "ost of 1oods 3old would $e:
"ost of 1oods 3old................................ /,<<<
Manufacturing Dverhead.................. /,<<<
3olutions Manual, "hapter / )0B
/. Ohen overhead is applied using a predetermined rate $ased on
machine7hours, it is assumed that overhead cost is proportional
to machine7hours. 3o when the actual machine7hours turn out
to $e @0,<<<, the costing system assumes that the overhead
will $e @0,<<< machine7hours V R+./< per machine7hour, or
R)B<,<<<. his is a drop of R)+,<<< from the initial estimated
manufacturing overhead cost of R)C+,<<<. ;owever, the actual
manufacturing overhead did not drop $y this much. he actual
manufacturing overhead was R)B/,<<<9a drop of RB,<<< from
the estimate. he manufacturing overhead did not decline $y
the full R)+,<<< $ecause of the e.istence of '.ed costs andHor
$ecause overhead spending was not under control. hese
issues will $e covered in more detail in later chapters.
3olutions Manual, "hapter / )0C
). &tem (a*: Actual manufacturing overhead costs for the year.
&tem ($*: Dverhead cost applied to work in process for the
year.
&tem (c*: "ost of goods manufactured for the year.
&tem (d*: "ost of goods sold for the year.
+. "ost of 1oods 3old....................................
@<,<<
<
Manufacturing Dverhead......................
@<,<<
<
,. he underapplied overhead will have to $e allocated to the
other accounts on the $asis of the overhead applied during the
year in the ending $alance of each account:
Oork in !rocess........... R )C,0<< 0 P
Finished 1oods............ 0B,0<< )0
"ost of 1oods 3old...... ,)+,<<< B<
otal cost..................... R,C<,<<< )<< P
Ksing these percentages, the entry would $e as follows:
Oork in !rocess (0P V R@<,<<<*............. ,,0<<
Finished 1oods ()0P V R@<,<<<*............
)<,0<
<
"ost of 1oods 3old (B<P V R@<,<<<*......
02,<<
<
Manufacturing Dverhead....................
@<,<<
<
3olutions Manual, "hapter / )2<
). a. 8aw Materials...................................... ,+0,<<<
Accounts !aya$le............................ ,+0,<<<
$. Oork in !rocess................................... +,+,<<<
Manufacturing Dverhead..................... 0B,<<<
8aw Materials................................. +C<,<<<
c. Oork in !rocess................................... 2<,<<<
Manufacturing Dverhead..................... )+<,<<<
Oages and 3alaries !aya$le........... )B<,<<<
d. Manufacturing Dverhead..................... @0,<<<
Accumulated >epreciation.............. @0,<<<
e. Manufacturing Dverhead..................... 2+,<<<
Accounts !aya$le............................ 2+,<<<
f. Oork in !rocess................................... ,<<,<<<
Manufacturing Dverhead................ ,<<,<<<
!redetermined
Y
overhead rate
R/,B<<,<<<
Y Y R+< per M;
+/<,<<< M;s
)0,<<< M; V R+< per M; Y R,<<,<<<.
+.
Manufacturing Dverhead Oork in !rocess
($* 0B,<<< ,<<,<<< (f* ($* +,+,<<<
(c* )+<,<<< (c* 2<,<<<
(d* @0,<<< (f* ,<<,<<<
(e* 2+,<<<
3olutions Manual, "hapter / )2)
,. he cost of the completed jo$ would $e R0C+,<<< as shown in
the Oork in !rocess 7account a$ove. he entry would $e:
Finished 1oods............................. 0C+,<<<
Oork in !rocess....................... 0C+,<<<
/. he unit product cost on the jo$ cost sheet would $e:
R0C+,<<< [ )2,<<< units Y R,@ per unit.
3olutions Manual, "hapter / )2+
). he overhead applied to Mrs. ?rinksiGs account would $e
computed as follows:
5::; 5::7
Estimated overhead cost (a*.......................
R,)<,0<
<
R,)<,0<
<
Estimated professional sta# hours ($*......... /,2<< /,0<<
!redetermined overhead rate (a* [ ($*....... R2@.0< R2C.<<
!rofessional sta# hours charged to Ms.
?rinksiGs account...................................... V +.0 V +.0
Dverhead applied to Ms. ?rinksiGs account. . R)2B.@0 R)@+.0<
+. &f the actual overhead cost and the actual professional hours
charged turn out to $e e.actly as estimated there would $e no
under7 or overapplied overhead.
5::; 5::7
!redetermined overhead rate (see a$ove*. . R2@.0< R2C.<<
Actual professional sta# hours charged to
clientsG accounts ($y assumption*............. V /,2<< V /,0<<
Dverhead applied........................................
R,)<,0<
<
R,)<,0<
<
Actual overhead cost incurred ($y
assumption*.............................................. ,)<,0<< ,)<,0<<
Knder7 or overapplied overhead.................. R < R <
,. &f the predetermined overhead rate is $ased on the professional
sta# hours availa$le, the computations would $e:
Estimated overhead cost (a*.........................
R,)<,0<
<
R,)<,0<
<
!rofessional sta# hours availa$le ($*............ 2,<<< 2,<<<
!redetermined overhead rate (a* [ ($*......... R0).@0 R0).@0
!rofessional sta# hours charged to Ms.
?rinksiGs account........................................ V +.0 V +.0
Dverhead applied to Ms. ?rinksiGs account. . . R)+C.,B R)+C.,B
3olutions Manual, "hapter / )2,
/. &f the actual overhead cost and the actual professional sta#
hours charged to clientsG accounts turn out to $e e.actly as
estimated there would $e underapplied overhead as shown
$elow.
5::; 5::7
!redetermined overhead rate (see a$ove*
(a*.............................................................. R0).@0 R0).@0
Actual professional sta# hours charged to
clientsG accounts ($y assumption* ($*......... V /,2<< V /,0<<
Dverhead applied (a* V ($*...........................
R+,B,<0
<
R+,+,B@
0
Actual overhead cost incurred ($y
assumption*............................................... ,)<,0<< ,)<,0<<
Knderapplied overhead................................ R @+,/0< R @@,2+0
he underapplied overhead is $est interpreted in this situation
as the cost of idle capacity. !roponents of this method of
computing predetermined overhead rates suggest that the
underapplied overhead $e treated as a period e.pense that
would $e separately disclosed on the income statement as "ost
of Knused "apacity.
3olutions Manual, "hapter / )2/
E%ercise 3-1! (,< minutes*
). <arris Chan 9ames
>esigner7hours....................... )+< )<< C<
!redetermined overhead
rate...................................... V RC< V RC< V RC<
applied................................. R)<,B<< RC,<<< RB,)<<
+. <arris Chan
>irect materials...................... R/,0<< R ,,@<<
>irect la$or............................ C,2<< B,<<<
Dverhead applied................... )<,B<< C,<<<
otal cost................................ R+/,C<< R+<,@<<
"ompleted !rojectsZ........................ /0,2<<
Oork in !rocess........................... /0,2<<
Z R+/,C<< \ R+<,@<< Y R/0,2<<.
,. he $alance in the Oork in !rocess account will consist entirely
of the costs associated with the 5ames project:
>irect materials..................................
R
),/<<
>irect la$or........................................ @,+<<
Dverhead applied...............................
B,)<
<
otal cost in work in process...............
R)2,@<
<
/. he $alance in the Dverhead account can $e determined as
follows:
Dverhead
Actual overhead
costs
,<,<<< +@,C<< Applied overhead
costs
Knderapplied
overhead
+,)<<
As indicated a$ove, the de$it $alance in the Dverhead account
is called underapplied overhead.
&ro'lem 3-1" (/0 minutes*
). a. 8aw Materials...................................... +@0,<<<
"ash............................................... +@0,<<<
$. Oork in !rocess................................... ++<,<<<
Manufacturing Dverhead..................... 2<,<<<
8aw Materials................................. +B<,<<<
c. Oork in !rocess................................... )B<,<<<
Manufacturing Dverhead..................... @+,<<<
3ales "ommissions E.pense............... 2,,<<<
3alaries E.pense................................. C<,<<<
"ash............................................... /<0,<<<
d. Manufacturing Dverhead..................... ),,<<<
8ent E.pense...................................... 0,<<<
"ash............................................... )B,<<<
e. Manufacturing Dverhead..................... 0@,<<<
"ash............................................... 0@,<<<
f. Advertising E.pense............................ )/<,<<<
"ash............................................... )/<,<<<
g. Manufacturing Dverhead..................... BB,<<<
>epreciation E.pense......................... )+,<<<
Accumulated >epreciation............. )<<,<<<
h. Oork in !rocess................................... +C@,<<<
Manufacturing Dverhead................ +C@,<<<
!redetermined
Y
overhead rate
8m$ ,,<,<<<
)20P of
Y Y
direct la$or cost
8m$ +<<,<<< direct la$or cost
8m$ )B<,<<< actual direct la$or cost V )20P Y 8m$ +C@,<<<.
i. Finished 1oods.................................... 2@0,<<<
Oork in !rocess.............................. 2@0,<<<
j. "ash.................................................... ),+0<,<<<
3ales.............................................. ),+0<,<<<
"ost of 1oods 3old.............................. @<<,<<<
Finished 1oods............................... @<<,<<<
+.
8aw Materials Oork in !rocess
?al
. +0,<<< +B<,<<<
($* ?al
. )<,<<< 2@0,<<<
(i*
(a* +@0,<<< ($* ++<,<<<
?al
. +<,<<<
(c*
)B<,<<<
(h* +C@,<<<
?al
. ,+,<<<
Finished 1oods Manufacturing Dverhead
?al
.
/<,<<< @<<,<<< (j* ($* 2<,<<< +C@,<<< (h*
(i* 2@0,<<< (c* @+,<<<
?al
.
)0,<<< (d* ),,<<<
(e* 0@,<<<
(g* BB,<<<
@,<<< ?al
.
"ost of 1oods 3old
(j* @<<,<<<
,. Manufacturing overhead is overapplied $y 8m$ @,<<< for the
year. he entry to close this $alance to "ost of 1oods 3old
would $e:
Manufacturing Dverhead.............................. @,<<<
3olutions Manual, "hapter / )2@
"ost of 1oods 3old.................................. @,<<<
3olutions Manual, "hapter / )2B
/.
1old Aest "ompany
&ncome 3tatement
3ales..................................................
8m$
),+0<,<<<
=ess cost of goods sold
(8m$ @<<,<<< 7 8m$ @,<<<*........... 2C,,<<<
1ross margin..................................... 00@,<<<
=ess selling and administrative e.penses:
3ales commissions.......................... 8m$ 2,,<<<
Administrative salaries.................... C<,<<<
8ent e.pense................................... 0,<<<
Advertising e.pense........................ )/<,<<<
>epreciation e.pense...................... )+,<<<
,)<,<<
<
Aet operating income........................
8m$ +/@,<<
<
3olutions Manual, "hapter / )2C
&ro'lem 3-1# (2< minutes*
). and +.
"ash Accounts 8eceiva$le
?al
.
2,,<<< @B0,<<< (m* ?al
.
)<+,<<<
B0<,<<<
(l*
(l* B0<,<<< (k* C+0,<<<
?al
.
)+B,<<< ?al
.
)@@,<<<
8aw Materials !repaid &nsurance
?al
.
,<,<<< +<<,<<< ($* ?al
.
C,<<< @,<<< (g*
(a* )B0,<<< ?al
. +,<<<
?al
.
)0,<<<
Iideos in !rocess Finished 1oods
?al
.
/0,<<<
00<,<<<
(j* ?al
. B),<<< 2<<,<<<
(k*
($* )@<,<<< (j* 00<,<<<
(f* B+,<<< ?al
. ,),<<<
(i* +C<,<<<
?al
.
,@,<<<
3tudio and E4uipment Accumulated >epreciation
?al
. @,<,<<< +)<,<<<
?al
.
B/,<<< (d*
+C/,<<< ?al
.
3tudio Dverhead >epreciation E.pense
($* ,<,<<< +C<,<<< Z (i* (d* +),<<<
(c* @+,<<<
(d* 2,,<<<
3olutions Manual, "hapter / )@<
(f* ))<,<<<
(g* 0,2<< &nsurance E.pense
(n* C,/<< C,/<< ?al. (g* ),/<<
Z R+B<,<<< [ @,<<< hours Y R/< per hour%
@,+0< hours V R/< per hour Y R+C<,<<<.
Advertising E.pense Miscellaneous E.pense
(e* ),<,<<< (h* B,2<<
3olutions Manual, "hapter / )@)
&ro'lem 3-1# (continued*
Administrative 3alaries
E.pense
3ales
(f* C0,<<< C+0,<<< (k*
"ost of 1oods 3old Accounts !aya$le
(k*
2<<,<<< C,/<<
(n* (m* 0<<,<<< )2<,<<< ?al
.
)B0,<<< (a*
?al
. 0C<,2<<
@+,<<< (c*
),<,<<< (e*
B,2<< (h*
00,2<< ?al
.
3alaries J Oages !aya$le
(m* +B0,<<< +B@,<<< (f*
+,<<< ?al.
"apital 3tock 8etained Earnings
/+<,<<<
?al.
+@<,<<<
?al
.
,. Dverhead is overapplied for the year. Entry (n* a$ove records
the closing of this overapplied overhead $alance to "ost of
1oods 3old.
/.
3upreme Iideos, &nc.
&ncome 3tatement
3ales of videos........................................ RC+0,<<<
=ess cost of goods sold (R2<<,<<< X
RC,/<<*................................................. 0C<,2<<
1ross margin........................................... ,,/,/<<
=ess selling and administrative
e.penses:
3olutions Manual, "hapter / )@+
>epreciation e.pense........................... R +),<<<
Advertising e.pense.............................. ),<,<<<
Administrative salaries.......................... C0,<<<
&nsurance e.pense................................ ),/<<
Miscellaneous e.pense......................... B,2<< +02,<<<
Aet operating income.............................. R@B,/<<
3olutions Manual, "hapter / )@,
&ro'lem 3-2$ (2< minutes*
). a. 8aw Materials................................... )@<,<<<
Accounts !aya$le........................ )@<,<<<
$. Oork in !rocess................................ )//,<<<
Manufacturing Dverhead.................. ,2,<<<
8aw Materials.............................. )B<,<<<
c. Oork in !rocess................................ +<<,<<<
Manufacturing Dverhead.................. B+,<<<
3alaries E.pense.............................. C<,<<<
3alaries and Oages !aya$le........ ,@+,<<<
d. Manufacturing Dverhead.................. 20,<<<
Accounts !aya$le........................ 20,<<<
e. Advertising E.pense......................... )<<,<<<
Accounts !aya$le........................ )<<,<<<
f. Manufacturing Dverhead.................. )B,<<<
&nsurance E.pense........................... +,<<<
!repaid &nsurance........................ +<,<<<
g. Manufacturing Dverhead.................. )0,,<<<
>epreciation E.pense...................... +@,<<<
Accumulated >epreciation........... )B<,<<<
h. Oork in !rocess................................ ,0<,<<<
Manufacturing Dverhead............. ,0<,<<<
R+<<,<<< actual direct la$or cost V )@0P Y R,0<,<<< overhead
applied.
i. Finished 1oods................................. @<<,<<<
Oork in !rocess........................... @<<,<<<
j. Accounts 8eceiva$le........................ ),<<<,<<<
3ales........................................... ),<<<,<<<
"ost of 1oods 3old........................... @+<,<<<
Finished 1oods............................ @+<,<<<
3olutions Manual, "hapter / )@/
&ro'lem 3-2$ (continued*
+.
8aw Materials Finished 1oods
?al
.
,+,<<< )B<,<<< ($* ?al
.
/B,<<< @+<,<<< (j*
(a* )@<,<<< (i* @<<,<<<
?al
.
++,<<< ?al
.
+B,<<<
Oork in !rocess Manufacturing Dverhead
?al
.
+<,<<< @<<,<<< (i* ($* ,2,<<< ,0<,<<< (h*
($* )//,<<< (c* B+,<<<
(c* +<<,<<< (d* 20,<<<
(h* ,0<,<<< (f* )B,<<<
?al
.
)/,<<< (g* )0,,<<<
?al
.
/,<<<
"ost of 1oods 3old
(j* @+<,<<<
,. Dverhead is underapplied $y R/,<<< for the year. he entry to
close this $alance to "ost of 1oods 3old would $e:
"ost of 1oods 3old................................ /,<<<
Manufacturing Dverhead.................. /,<<<
/.
Almeda !roducts, &nc.
&ncome 3tatement
For the Qear Ended March ,)
3ales........................................................
R),<<<,<<
<
=ess cost of goods sold (R@+<,<<< \
R/,<<<*.................................................. @+/,<<<
1ross margin............................................ +@2,<<<
e.penses:
3alary e.pense...................................... R C<,<<<
3olutions Manual, "hapter / )@0
Advertising e.pense.............................. )<<,<<<
&nsurance e.pense................................. +,<<<
>epreciation e.pense............................ +@,<<< +)C,<<<
Aet operating income.............................. R 0@,<<<
3olutions Manual, "hapter / )@2
). and +.
"ash Accounts 8eceiva$le
?al
.
@,<<< +,/,<<< (m* ?al
.
)B,<<<
+/0,<<<
(l*
(l* +/0,<<< (k* +0<,<<<
?al
.
)B,<<< ?al
.
+,,<<<
8aw Materials !repaid &nsurance
?al
.
C,<<< ,B,<<< ($* ?al
.
/,<<< ,,<<< (g*
(a* /<,<<< ?al
. ),<<<
?al
.
)),<<<
Oork in !rocess Finished 1oods
?al
.
+<,<<<
)/<,<<<
(j* ?al
. ,+,<<< ),<,<<<
(k*
($* ,+,,<< (j* )/<,<<<
(f* /0,<<< ?al
. /+,<<<
(i* 2<,<<<
?al
.
)@,,<<
!lant and E4uipment Accumulated >epreciation
?al
. +)<,<<< 0,,<<<
?al
.
,2,<<< (d*
BC,<<< ?al
.
Manufacturing Dverhead >epreciation E.pense
($* 0,@<< 2<,<<< Z (i* (d* C,<<<
(c* )C,)<<
(d* +@,<<<
3olutions Manual, "hapter / )@@
(f* )<,<<<
(g* +,/<< &nsurance E.pense
?al
.
/,+<< /,+<< (n* (g* 2<<
Z@,0<< M; V RB per M; Y R2<,<<<.
Advertising E.pense Miscellaneous E.pense
(e* /B,<<< (h* C,0<<
3olutions Manual, "hapter / )@B
Administrative 3alaries
E.pense
3ales
(f* ,<,<<< +0<,<<< (k*
"ost of 1oods 3old Accounts !aya$le
(k*
),<,<<<
(m* )0<,<<< ,B,<<< ?al
.
(n* /,+<< /<,<<< (a*
?al
. ),/,+<<
)C,)<< (c*
/B,<<< (e*
C,0<< (h*
/,2<< ?al
.
3alaries J Oages !aya$le
(m* B/,<<< B0,<<< (f*
),<<< ?al.
"apital 3tock 8etained Earnings
)2<,<<<
?al.
/C,<<<
?al
.
,. Dverhead is underapplied. Entry (n* a$ove records the closing
of this underapplied overhead $alance to "ost of 1oods 3old.
/.
;udson "ompany
&ncome 3tatement
3ales........................................................ R+0<,<<<
=ess cost of goods sold (R),<,<<< \
R/,+<<*.................................................. ),/,+<<
1ross margin........................................... ))0,B<<
e.penses:
>epreciation e.pense............................ RC,<<<
Advertising e.pense.............................. /B,<<<
3olutions Manual, "hapter / )@C
Administrative salaries e.pense............ ,<,<<<
&nsurance e.pense................................ 2<<
Miscellaneous e.pense.......................... C,0<< C@,)<<
Aet operating income.............................. R )B,@<<
3olutions Manual, "hapter / )B<
).
?al
.
,<,<<
<
)2,B<
<
(a* ?al
.
/),<<<
Z
,B,,<
<
(e*
(a* ),,+<<
($* +<,<<<
(d* +B,<<<
?al
.
2,,C<<
Finished 1oods Manufacturing
Dverhead
?al
.
0<,<<
<
(a* ,,2<< +B,<<
<
(d*
(e* ,B,,<
<
($* @,<<<
(c* )C,/<<
3alaries J Oages
!aya$le
Accounts !aya$le
+@,<<< ($* )C,/<
<
(c*
Z
5o$ +<B materials, la$or, and overhead at
May ,)..................................................................
8K8
+B,@<<
5o$ +<C materials, la$or, and overhead at
May ,)..................................................................
)+,,<
<
otal Oork in !rocess inventory at May ,)..............
8K8
/),<<<
+. a. Oork in !rocess................................
),,+<
< Z
Manufacturing Dverhead.................. ,,2<<
8aw Materials.............................. )2,B<<
Z8K8 2,<<< \ 8K8 @,+<< Y 8K8 ),,+<<.
his entry is posted to the 7accounts as entry (a* a$ove.
$. Oork in !rocess................................ +<,<<< Z
3olutions Manual, "hapter / )B)
Manufacturing Dverhead.................. @,<<<
3alaries and Oages !aya$le........ +@,<<<
Z8K8 /,<<< \ 8K8 @,0<< \ 8K8 B,0<< Y 8K8 +<,<<<.
his entry is posted to the 7accounts as entry ($* a$ove.
3olutions Manual, "hapter / )B+
c. Manufacturing Dverhead..................
)C,/<
<
Accounts !aya$le........................ )C,/<<
his entry is posted to the 7accounts as entry (c* a$ove.
,. Apparently, the company uses a predetermined overhead rate
of )/<P of direct la$or cost. his 'gure can $e determined $y
relating the May applied overhead cost on the jo$ cost sheets
to the May direct la$or cost shown on these sheets. For
e.ample, in the case of jo$ +<B:
May overhead cost 8K8 )),+<<
)/<P of direct
Y Y
la$or cost
May direct la$or cost 8K8 B,<<<
he overhead cost applied to each jo$ during 5une would $e:
5o$ +<B: 8K8 /,<<< V )/<P...... 8K8 0,2<<
5o$ +<C: 8K8 @,0<< V )/<P...... )<,0<<
5o$ +)<: 8K8 B,0<< V )/<P...... )),C<<
otal applied overhead..............
8K8+B,<<
<
he entry to record the application of overhead cost to jo$s
would $e ]recorded as entry (d* in the 7accounts a$ove^:
Oork in !rocess............................ +B,<<<
Manufacturing Dverhead......... +B,<<<
3olutions Manual, "hapter / )B,
/. he total cost of jo$ +irect materials.....................................................
8K8
C,0<<
>irect la$or (8K8 B,<<< \ 8K8 /,<<<*................... )+,<<<
Manufacturing overhead applied (8K8 )+,<<< V
)/<P*..................................................................
)2,B<
<
otal cost...............................................................
8K8
,B,,<<
he entry to record the transfer of the completed jo$ would $e
]recorded as entry (e* in the 7accounts a$ove^:
Finished 1oods............................. ,B,,<<
Oork in !rocess....................... ,B,,<<
0. As shown in the 7accounts a$ove, the $alance at 5une ,< was
8K8 2,,C<<. he $reakdown of this amount $etween jo$s +<C
and +)< would $e:
9ob 5:= 9ob 54: ,otal
>irect materials.............
8K8
)),)<< 8K8 @,+<<
8K8
)B,,<<
>irect la$or................... )<,0<< B,0<< )C,<<<
Manufacturing
overhead applied........
)/,@<
<
)),C<
< +2,2<<
otal cost.......................
8K8
,2,,<<
8K8
+@,2<<
8K8
2,,C<<
3olutions Manual, "hapter / )B/
). Molding >epartment predetermined overhead rate:
!redetermined
Y
overhead rate
R2<+,<<<
Y Y RB.2< per machine7hour.
@<,<<< M;s
!ainting >epartment predetermined overhead rate:
!redetermined
Y
overhead rate
R@,0,<<<
)@0P of direct
Y Y
la$or cost.
R/+<,<<< direct la$or cost
+. Molding >epartment overhead applied:
))< machine7hours V RB.2< per
machine7hour............................................. R C/2
!ainting >epartment overhead applied:
R2B< direct la$or cost V )@0P................... ),)C<
otal overhead cost......................................... R+,),2
,. otal cost of 5o$ +<0:
Molding
!ept*
Paintin
g
!ept* ,otal
>irect materials..................... R /@< R ,,+ R B<+
>irect la$or............................ +C< 2B< C@<
applied................................ C/2 ),)C< +,),2
otal cost............................... R),@<2 R+,+<+ R,,C<B
Knit product cost for 5o$ +<0:
otal cost, R,,C<B
Y R@B.)2 per unit
0< units
3olutions Manual, "hapter / )B0
/. Molding
!ept*
Painting
!ept*
Manufacturing overhead incurred...... R0@<,<<< R@0<,<<<
Manufacturing overhead applied:
20,<<< M;s V RB.2< per M;............ 00C,<<<
R/,2,<<< direct la$or cost V )@0P. @2,,<<<
Knderapplied (or overapplied*
overhead......................................... R)),<<< R (),,<<<*
3olutions Manual, "hapter / )B2
). he cost of raw materials put into production would $e:
8aw materials inventory, )H)............. R)0,<<<
>e$its (purchases of materials*......... )+<,<<<
Materials availa$le for use................ ),0,<<<
8aw materials inventory, )+H,)......... +0,<<<
Materials re4uisitioned for
production...................................... R))<,<<<
+. Df the R))<,<<< in materials re4uisitioned for production,
RC<,<<< was de$ited to Oork in !rocess as direct materials.
herefore, the di#erence of R+<,<<< would have $een de$ited
to Manufacturing Dverhead as indirect materials.
,. otal factory wages accrued during the year
(credits to the Factory Oages !aya$le account*.... R)B<,<<<
=ess direct la$or cost (from Oork in !rocess*.......... )0<,<<<
&ndirect la$or cost................................................... R,<,<<<
/. he cost of goods manufactured would have $een R/@<,<<<9
the credits to the Oork in !rocess account.
0. he "ost of 1oods 3old for the year would have $een:
Finished goods inventory, )H).................................... R/<,<<<
Add: "ost of goods manufactured (from Oork in
!rocess*.................................................................. /@<,<<<
1oods availa$le for sale............................................ 0)<,<<<
Finished goods inventory, )+H,)................................ 2<,<<<
"ost of goods sold.....................................................
R/0<,<<
<
3olutions Manual, "hapter / )B@
2. he predetermined overhead rate would have $een:
!redetermined
Y
overhead rate
R+/<,<<<
)2<P of direct
Y Y
la$or cost
R)0<,<<< direct la$or cost
@. Manufacturing overhead would have $een overapplied $y
R)<,<<<, computed as follows:
Actual manufacturing overhead cost for the year
(de$its*................................................................. R+,<,<<<
Applied manufacturing overhead cost (from Oork
in !rocess9this would have $een the credits to
the
Manufacturing Dverhead account*........................ +/<,<<<
Dverapplied overhead.............................................
R()<,<<<
*
B. he ending $alance in Oork in !rocess is R,<,<<<. >irect
materials make up RC,+<< of this $alance, and manufacturing
overhead makes up R)+,B<<. he computations are:
?alance, Oork in !rocess, )+H,).............................. R,<,<<<
=ess: >irect la$or cost (given*................................. (B,<<<*
Manufacturing overhead cost (RB,<<< V
)2<P*........................................................... ()+,B<<*
>irect materials cost (remainder*............................ R C,+<<
3olutions Manual, "hapter / )BB
&ro'lem 3-25 (C< minutes*
). a. Materials and 3upplies..................... 2C<,<<<
Accounts !aya$le........................ 2C<,<<<
$. Films in !rocess................................ 02<,<<<
!roduction Dverhead....................... )/<,<<<
Materials and 3upplies................ @<<,<<<
c. !roduction Dverhead....................... C<,<<<
Accounts !aya$le........................ C<,<<<
d. Films in !rocess................................ ),,<<,<<<
!roduction Dverhead....................... +,<,<<<
3alaries E.pense.............................. 20<,<<<
3alaries and Oages !aya$le........
+,)B<,<<
<
e. Advertising E.pense........................ B<<,<<<
Accounts !aya$le........................ B<<,<<<
f. !roduction Dverhead....................... 2<,<<<
&nsurance E.pense........................... )<,<<<
!repaid &nsurance....................... @<,<<<
g. !roduction Dverhead....................... 0+<,<<<
>epreciation E.pense...................... ),<,<<<
Accumulated >epreciation.......... 20<,<<<
h. !roduction Dverhead....................... ,2<,<<<
8ent E.pense................................... /<,<<<
Accounts !aya$le........................ /<<,<<<
i. he companyGs predetermined overhead rate would $e:
!redetermined
Y
overhead rate
R),,0<,<<<
RC< per
Y Y
camera7hour.
)0,<<< camera7hours
he overhead cost applied to production would $e:
)2,0<< camera hours V RC< per camera7hour Y
R),/B0,<<<.
3olutions Manual, "hapter / )BC
he entry to record this application follows:
Films in !rocess................................ ),/B0,<<<
!roduction Dverhead...................
),/B0,<<
<
j. Finished Films.................................. ,,/<<,<<<
Films in !rocess...........................
,,/<<,<<
<
k. Accounts 8eceiva$le........................ 2,<<<,<<<
3ales 8evenue.............................
2,<<<,<<
<
"ost of Films 3old............................. /,<<<,<<<
Finished Films..............................
/,<<<,<<
<
l. "ash................................................ 0,/<<,<<<
Accounts 8eceiva$le...................
0,/<<,<<
<
m. Accounts !aya$le............................. +,0<<,<<<
3alaries and Oages !aya$le............. +,+<<,<<<
"ash............................................
/,@<<,<<
<
3olutions Manual, "hapter / )C<
+.
"ash Accumulated >epreciation
?al. 2<,<<< /,@<<,<<
<
(m* ),CC<,<<
<
?al.
(l* 0,/<<,<<
<
20<,<<< (g*
?al. @2<,<<< +,2/<,<<
<
?al.
Accounts 8eceiva$le Accounts !aya$le
?al. +)<,<<< 0,/<<,<<
<
(l* (m
*
+,0<<,<<
<
@<<,<<< ?al.
(k* 2,<<<,<<
<
2C<,<<< (a*
?al. B)<,<<< C<,<<< (c*
B<<,<<< (e*
!repaid &nsurance /<<,<<< (h*
?al. C<,<<< @<,<<< (f* )B<,<<< ?al.
?al. +<,<<< 3alaries J Oages !aya$le
(m* +,+<<,<<
<
,0,<<< ?al.
Materials and 3upplies +,)B<,<<
<
(d*
?al. ),<,<<< @<<,<<< ($* )0,<<< ?al.
(a* 2C<,<<<
?al. )+<,<<< "apital 3tock
+,0<<,<<
<
?al.
Films in !rocess
?al. @0,<<< ,,/<<,<<
<
(j* 8etained Earnings
($* 02<,<<< ),/<<,<<
<
?al.
(d* ),,<<,<<
<
(i* ),/B0,<<
<
3ales
3olutions Manual, "hapter / )C)
?al. +<,<<< 2,<<<,<<
<
(k*
Finished Films "ost of Films 3old
?al. B2<,<<< /,<<<,<<
<
(k* (k* /,<<<,<<
<
(j* ,,/<<,<<
<
?al. +2<,<<<
3tudio and E4uipment
?al.0,+<<,<<
<
3olutions Manual, "hapter / )C+
!roduction Dverhead >epreciation E.pense
($* )/<,<<< ),/B0,<<
<
(i* (g* ),<,<<<
(c* C<,<<<
(d* +,<,<<< &nsurance E.pense
(f* 2<,<<< (f* )<,<<<
(g* 0+<,<<<
(h* ,2<,<<<
B0,<<< ?al.
Advertising E.pense 8ent E.pense
(e* B<<,<<< (h* /<,<<<
3alaries E.pense
(d* 20<,<<<
,. !roduction overhead is overapplied for the year. he journal
entry would $e as follows:
!roduction Dverhead....................... B0,<<<
"ost of Films 3old........................ B0,<<<
3olutions Manual, "hapter / )C,
/. Film 3pecialties, &nc.
&ncome 3tatement
For the Qear Ended April ,<
3ales revenue.............................................. R2,<<<,<<<
=ess cost of 'lms sold (R/,<<<,<<< X
RB0,<<<*.................................................... ,,C)0,<<<
1ross margin................................................ +,<B0,<<<
3alaries e.pense........................................ R20<,<<<
Advertising e.pense.................................. B<<,<<<
&nsurance e.pense..................................... )<,<<<
>epreciation e.pense................................ ),<,<<<
8ent e.pense............................................. /<,<<< ),2,<,<<<
Aet operating income.................................. R/00,<<<
3olutions Manual, "hapter / )C/
). he predetermined overhead rate is:
!redetermined
Y
overhead rate
3fr C<<,<<<
Y Y )+ 3fr per M;.
@0,<<< M;s
+. Actual manufacturing overhead cost..............
3fr
B0<,<<<
Manufacturing overhead cost applied to
Oork in !rocess during the year: 2<,<<<
actual M;s V )+ 3fr per M;.........................
@+<,<<
<
Knderapplied overhead cost...........................
3fr
),<,<<<
,. "ost of 1oods 3old................................ ),<,<<<
Manufacturing Dverhead.................. ),<,<<<
/. he underapplied $alance would $e allocated using the
following percentages:
Dverhead applied during the year
in:
Oork in process...............................
3fr
,2,<<< 0 P
Finished goods................................ )B<,<<< +0 P
"ost of goods sold...........................
0</,<<
< @< P
otal..................................................
@+<,<<
< )<< P
he entry to record the allocation of the underapplied overhead
would $e:
Oork in !rocess (0P V 3fr ),<,<<<*.... 2,0<<
Finished 1oods (+0P V 3fr ),<,<<<*... ,+,0<<
"ost of 1oods 3old (@<P V 3fr
),<,<<<*........................................... C),<<<
Manufacturing Dverhead............. ),<,<<<
3olutions Manual, "hapter / )C0
0. "ost of goods sold if the underapplied
overhead is closed directly to cost of goods
sold
(3fr ),/<<,<<< \ 3fr ),<,<<<*........................ 3fr ),0,<,<<<
"ost of goods sold if the underapplied
overhead is allocated among the accounts
(3fr ),/<<,<<< \ 3fr C),<<<*.......................... ),/C),<<<
>i#erence in cost of goods sold........................ 3fr ,C,<<<
hus, net operating income will $e 3fr ,C,<<< greater if the
underapplied overhead is allocated rather than closed directly
to cost of goods sold.
3olutions Manual, "hapter / )C2
). a.
Estimated overhead cost RB<<,<<<
Y Y )2<P
Estimated direct materials used R0<<,<<<
$. ?efore the under7 or overapplied overhead can $e computed,
we must determine the amount of direct materials used in
production for the year.
8aw materials inventory, $eginning................ R+<,<<<
Add, !urchases of raw materials..................... 0)<,<<<
8aw materials availa$le.................................. 0,<,<<<
>educt: 8aw materials inventory, ending....... B<,<<<
8aw materials used in production...................R/0<,<<<
3ince no indirect materials are identi'ed in the pro$lem,
these would all $e direct materials. Oith this 'gure, we can
proceed as follows:
Actual manufacturing overhead costs:
&ndirect la$or................................................ R)@<,<<<
!roperty ta.es.............................................. /B,<<<
>epreciation of e4uipment........................... +2<,<<<
Maintenance................................................ C0,<<<
&nsurance..................................................... @,<<<
8ent, $uilding............................................... )B<,<<<
otal actual costs............................................ @2<,<<<
Applied manufacturing overhead costs:
R/0<,<<< V )2<P........................................ @+<,<<<
Knderapplied overhead.................................. R /<,<<<
3olutions Manual, "hapter / )C@
+. 1itano !roducts
>irect materials:
8aw materials inventory, $eginning........
R
+<,<<<
Add purchases of raw materials.............. 0)<,<<<
otal raw materials availa$le................... 0,<,<<<
>educt raw materials inventory, ending.. B<,<<<
8aw materials used in production..............
R /0<,<<
<
>irect la$or................................................ C<,<<<
Manufacturing overhead applied to work
in process................................................ @+<,<<<
otal manufacturing costs.......................... ),+2<,<<<
Add: Oork in process, $eginning................ )0<,<<<
),/)<,<<<
>educt: Oork in process, ending................ @<,<<<
"ost of goods manufactured......................
R),,/<,<<
<
,. "ost of goods sold:
Finished goods inventory, $eginning............ R +2<,<<<
Add: "ost of goods manufactured................. ),,/<,<<<
1oods availa$le for sale............................... ),2<<,<<<
>educt: Finished goods inventory, ending.... /<<,<<<
"ost of goods sold........................................
R),+<<,<<
<
he underapplied overhead can either $e closed out to "ost of
1oods 3old or allocated $etween Oork in !rocess, Finished
1oods, and "ost of 1oods 3old $ased on the overhead applied
during the year in the ending $alance in each of these
accounts.
/. >irect materials.............................................. RB,0<<
>irect la$or..................................................... +,@<<
Dverhead applied (RB,0<< V )2<P*................ ),,2<<
otal manufacturing cost................................. R+/,B<<
3olutions Manual, "hapter / )CB
R+/,B<< V )+0P Y R,),<<< price to the customer.
3olutions Manual, "hapter / )CC
0. he amount of overhead cost in Oork in !rocess would $e:
R+/,<<< direct materials cost V )2educt: >irect materials................ R+/,<<<
Manufacturing overhead.... ,B,/<< 2+,/<<
>irect la$or cost............................. R @,2<<
he completed schedule of costs in Oork in !rocess would $e:
>irect materials.............................. R+/,<<<
>irect la$or..................................... @,2<<
Manufacturing overhead................. ,B,/<<
Oork in process inventory.............. R@<,<<<
3olutions Manual, "hapter / +<<
). he overhead applied to the Ierde ?aja jo$ is computed as
follows:
5::; 5::7
Estimated studio overhead cost (a*..........
R)2<,<<
<
R)2<,<<
<
Estimated hours of studio service ($*....... B<< ),<<<
!redetermined overhead rate (a* [ ($*.... R+<< R)2<
Ierde ?aja jo$Gs studio hours .................. V /< V /<
Dverhead applied to the Ierde ?aja jo$ . . RB,<<< R2,/<<
Dverhead is underapplied for $oth years as computed $elow:
5::; 5::7
!redetermined overhead rate (see
a$ove* (a*................................................ R+<< R)2<
Actual hours of studio service provided
($*............................................................ 0<< @0<
Dverhead applied (a* V ($*........................
R)<<,<<
<
R)+<,<<
<
Actual studio cost incurred......................... )2<,<<< )2<,<<<
Knderapplied overhead.............................. R 2<,<<< R /<,<<<
+. &f the predetermined overhead rate is $ased on the hours of
studio service at capacity, the computations would $e:
5::; 5::7
Estimated studio overhead cost (a*............ R)2<,<<<
R)2<,<<
<
;ours of studio service at capacity ($*....... ),2<< ),2<<
!redetermined overhead rate (a* [ ($*...... R)<< R)<<
Ierde ?aja jo$Gs studio hours .................... V /< V /<
Dverhead applied to the Ierde ?aja jo$ .... R/,<<< R/,<<<
3olutions Manual, "hapter / +<)
Dverhead is underapplied for $oth years under this method as
well:
5::; 5::7
!redetermined overhead rate (see
a$ove* (a*............................................... R)<< R)<<
Actual hours of studio service provided
($*........................................................... 0<< @0<
Dverhead applied (a* V ($*....................... R 0<,<<< R @0,<<<
Actual studio cost incurred........................ )2<,<<< )2<,<<<
Knderapplied overhead............................. R))<,<<< R B0,<<<
,. Ohen the predetermined overhead rate is $ased on capacity,
the underapplied overhead is interpreted as the cost of idle
capacity. &ndeed, proponents of this method suggest that the
underapplied overhead should $e treated as a period e.pense
that would $e separately disclosed on the income statement as
"ost of Knused "apacity.
/. !latinum rackGs fundamental pro$lem is the competition that
is drawing customers away. he competition is a$le to o#er the
latest e4uipment, e.cellent service, and attractive prices. he
company must do something to counter this threat or it will
ultimately face failure.
Knder the conventional approach in which the predetermined
overhead rate is $ased on the estimated studio hours, the
apparent cost of the Ierde ?aja jo$ has increased $etween
+<</ and +<<0. hat happens $ecause the company is losing
$usiness to competitors and therefore the companyGs '.ed
overhead costs are $eing spread over a smaller $ase. his
results in costs that seem to increase as the volume declines.
Knder this method, !latinum rackGs managers may $e misled
into thinking that the pro$lem is rising costs and they may $e
tempted to raise prices to recover their apparently increasing
costs. his would almost surely accelerate the companyGs
decline.
3olutions Manual, "hapter / +<+
Knder the alternative approach, the overhead cost of the Ierde
?aja jo$ is sta$le at R/,<<< and lower than the costs reported
under the conventional method. Knder the conventional
method, managers may $e misled into thinking that they are
actually losing money on the Ierde ?aja jo$ and they might
refuse such jo$s in the future9another sure road to disaster.
his is much less likely to happen if the lower cost of R/,<<< is
reported. &t is true that the underapplied overhead under the
alternative approach is much larger than under the
conventional approach and is growing. ;owever, if it is properly
la$eled as the cost of idle capacity, management is much more
likely to draw the appropriate conclusion that the real pro$lem
is the loss of $usiness (and therefore more idle capacity* rather
than an increase in costs.
Ohile $asing the predetermined rate on capacity rather than on
estimated activity will not solve the companyGs $asic pro$lems,
at least this method is less likely to send managers misleading
signals.
3olutions Manual, "hapter / +<,
). 8esearch J >ocuments predetermined overhead rate:
!redetermined
Y
overhead rate
RB/<,<<<
Y Y R,0 per hour.
+/,<<< hours
=itigation predetermined overhead rate:
!redetermined
Y
overhead rate
R,2<,<<<
/ocuments overhead applied:
+2 hours V R,0 per hour.............................. R C)<
=itigation overhead applied: R0,@<< V /<P.... +,+B<
otal overhead cost......................................... R,,)C<
,. otal cost of "ase /)B7,:
!epartments
2esearch
>
!ocument
s
)itigatio
n ,otal
=egal forms and
supplies......................... R B< R /< R )+<
>irect attorney cost......... ,0< 0,@<< 2,<0<
Dverhead cost applied..... C)< +,+B< ,,)C<
otal cost......................... R),,/< RB,<+< RC,,2<
/. 2esearch
>
!ocuments
)itigatio
n
>epartmental overhead cost
incurred........................................... RB@<,<<< R,)0,<<<
>epartmental overhead cost
applied:
3olutions Manual, "hapter / +</
+2,<<< hours V R,0 per hour........... C)<,<<<
R@0<,<<< V /<P.............................. ,<<,<<<
Knderapplied (or overapplied*
overhead......................................... R (/<,<<<* R)0,<<<
3olutions Manual, "hapter / +<0
). a.
!redetermined
Y
overhead rate
RB/<,<<<
)/<P of direct
Y Y
la$or cost
R2<<,<<< direct la$or cost
$. RC,0<< V )/<P Y R),,,<<.
+. a.
Fabricatin
g
!epartme
nt
Machining
!epartme
nt
Assembl%
!epartme
nt
Estimated
manufacturing
overhead cost (a*...... R,0<,<<< R/<<,<<< R C<,<<<
Estimated direct
la$or cost ($*............. R+<<,<<< R)<<,<<< R,<<,<<<
!redetermined
overhead rate (a* [
($*............................. )@0P /<epartment:
R+,B<< V )@0P.......................... R/,C<<
Machining >epartment:
R0<< V /<<P............................. +,<<<
Assem$ly >epartment:
R2,+<< V ,<P............................ ),B2<
otal applied overhead................. RB,@2<
,. he $ulk of the la$or cost on the Uoopers jo$ is in the Assem$ly
>epartment, which incurs very little overhead cost. he
department has an overhead rate of only ,<P of direct la$or
cost as compared to much higher rates in the other two
departments. herefore, as shown a$ove, use of departmental
overhead rates results in a relatively small amount of overhead
cost $eing charged to the jo$.
Kse of a plantwide overhead rate in e#ect redistri$utes
3olutions Manual, "hapter / +<2
overhead costs proportionately $etween the three departments
(at )/<P of direct la$or cost* and results in a large amount of
overhead cost $eing charged to the Uoopers jo$, as shown in
!art ). his may e.plain why the company
3olutions Manual, "hapter / +<@
$id too high and lost the jo$. oo much overhead cost was
assigned to the jo$ for the kind of work $eing done on the jo$
in the plant.
Dn jo$s that re4uire a large amount of la$or in the Fa$ricating
or Machining >epartments the opposite will $e true, and the
company will tend to charge too little overhead cost to the jo$s
if a plantwide overhead rate is $eing used. he reason is that
the plantwide overhead rate ()/<P* is much lower than the
rates would $e if these departments were considered
separately.
/. he companyGs $id price was:
>irect materials........................................ R/,2<<
>irect la$or.............................................. C,0<<
Manufacturing overhead applied
(a$ove*.................................................. ),,,<<
otal manufacturing cost.......................... R+@,/<<
?idding rate............................................. V ).0
otal $id price........................................... R/),)<<
&f departmental overhead rates had $een used, the $id price
would have $een:
>irect materials........................................ R/,2<<
>irect la$or.............................................. C,0<<
(a$ove*.................................................. B,@2<
otal manufacturing cost.......................... R++,B2<
?idding rate............................................. V ).0
otal $id price........................................... R,/,+C<
Aote that if departmental overhead rates had $een used,
elede. "ompany would have $een the low $idder on the
Uoopers jo$ since the competitor under$id elede. $y only
R+,<<<.
0. a. Actual overhead cost................................... RB2/,<<<
Applied overhead cost (R0B<,<<< V
)/<P*....................................................... B)+,<<<
3olutions Manual, "hapter / +<B
Knderapplied overhead cost........................ R0+,<<<
3olutions Manual, "hapter / +<C
$. !epartment
Fabricatin
g
Machinin
g
Assemb
l%
,otal
Plant
Actual overhead
cost.................... R,2<,<<< R/+<,<<< RB/,<<< RB2/,<<<
Applied overhead
cost:...................
R+)<,<<< V
)@0P................ ,2@,0<<
R)<B,<<< V
/<<P................ /,+,<<<
R+2+,<<< V
,<P.................. @B,2<< B@B,)<<
Knderapplied
(overapplied*
overhead cost..... R (@,0<<* R()+,<<<* R0,/<< R()/,)<<*
3olutions Manual, "hapter / +)<
&ro'lem 3-31 ()+< minutes*
). a. 8aw Materials................................ +<<,<<<
Accounts !aya$le...................... +<<,<<<
$. Oork in !rocess.............................. )B0,<<<
8aw Materials........................... )B0,<<<
c. Manufacturing Dverhead............... 2,,<<<
Ktilities E.pense............................ @,<<<
Accounts !aya$le...................... @<,<<<
d. Oork in !rocess.............................. +,<,<<<
Manufacturing Dverhead............... C<,<<<
3alaries E.pense........................... ))<,<<<
3alaries and Oages !aya$le...... /,<,<<<
e. Manufacturing Dverhead............... 0/,<<<
Accounts !aya$le...................... 0/,<<<
f. Advertising E.pense...................... ),2,<<<
Accounts !aya$le...................... ),2,<<<
g. Manufacturing Dverhead............... @2,<<<
>epreciation E.pense.................... )C,<<<
Accumulated >epreciation........ C0,<<<
h. Manufacturing Dverhead............... )<+,<<<
8ent E.pense................................. )B,<<<
Accounts !aya$le...................... )+<,<<<
i. Oork in !rocess.............................. ,C<,<<<
Manufacturing Dverhead.................................... ,C<,<<<
!redetermined
Y
overhead rate
Akr ,2<,<<<
Y Y Akr /<< per >=;.
C<< >=;s
C@0 actual >=; V Akr /<< per >=; Y Akr ,C<,<<<.
3olutions Manual, "hapter / +))
j. Finished 1oods............................... @@<,<<<
Oork in !rocess......................... @@<,<<<
k. Accounts 8eceiva$le...................... ),+<<,<<<
3ales.........................................
),+<<,<<
<
"ost of 1oods 3old......................... B<<,<<<
Finished 1oods.......................... B<<,<<<
3olutions Manual, "hapter / +)+
+.
Accounts 8eceiva$le 3ales
(k* ),+<<,<<
<
),+<<,<<
<
(k*
8aw Materials "ost of 1oods 3old
?al
.
,<,<<< )B0,<<< ($* (k* B<<,<<<
(a* +<<,<<<
?al
.
/0,<<<
Oork in !rocess Manufacturing Dverhead
?al. +),<<< @@<,<<< (j* (c* 2,,<<< ,C<,<<
<
(i*
($* )B0,<<< (d* C<,<<<
(d* +,<,<<< (e* 0/,<<<
(i* ,C<,<<< (g* @2,<<<
?al. 02,<<< (h* )<+,<<<
0,<<< ?al
.
Finished 1oods Advertising E.pense
?al. 2<,<<< B<<,<<< (k* (f* ),2,<<<
(j* @@<,<<<
?al. ,<,<<<
Accumulated >epreciation Ktilities E.pense
C0,<<< (g* (c* @,<<<
Accounts !aya$le 3alaries E.pense
+<<,<<< (a* (d* ))<,<<<
@<,<<< (c*
0/,<<< (e* >epreciation E.pense
),2,<<< (f* (g* )C,<<<
)+<,<<< (h*
3olutions Manual, "hapter / +),
3alaries J Oages !aya$le 8ent E.pense
/,<,<<< (d* (h* )B,<<<
3olutions Manual, "hapter / +)/
,. Froya Fa$rikker AH3
>irect materials:
8aw materials inventory, $eginning.... Akr ,<,<<<
!urchases of raw materials................. +<<,<<<
Materials availa$le for use.................. +,<,<<<
8aw materials inventory, ending......... /0,<<<
Materials used in production...............
Akr
)B0,<<<
>irect la$or............................................ +,<,<<<
Manufacturing overhead applied to
work in process................................... ,C<,<<<
otal manufacturing costs...................... B<0,<<<
Add: Oork in process, $eginning............ +),<<<
B+2,<<<
>educt: Oork in process, ending........... 02,<<<
"ost of goods manufactured..................
Akr
@@<,<<<
/. Manufacturing Dverhead....................... 0,<<<
"ost of 1oods 3old............................ 0,<<<
3chedule of cost of goods sold:
Finished goods inventory, $eginning.. .
Akr
2<,<<<
Add: "ost of goods manufactured.......
@@<,<<
<
1oods availa$le for sale...................... B,<,<<<
>educt 'nished goods inventory,
ending..............................................
,<,<<
<
Knadjusted cost of goods sold............. B<<,<<<
>educt: Dverapplied overhead............ 0,<<<
Adjusted cost of goods sold.................
Akr
@C0,<<<
3olutions Manual, "hapter / +)0
0. Froya Fa$rikker AH3
&ncome 3tatement
3ales..................................................
Akr
),+<<,<<<
=ess cost of goods sold...................... @C0,<<<
1ross margin...................................... /<0,<<<
e.penses:
Advertising e.pense........................
Akr
),2,<<<
Ktilities e.pense.............................. @,<<<
3alaries e.pense.............................. ))<,<<<
>epreciation e.pense...................... )C,<<<
8ent e.pense................................... )B,<<< +C<,<<<
Aet operating income........................ Akr ))0,<<<
2. >irect materials....................................................... Akr B,<<<
>irect la$or............................................................. C,+<<
(,C hours V Akr /<< per hour*.............................. )0,2<<
otal manufacturing cost......................................... ,+,B<<
Add markup (2<P V Akr ,+,B<<*............................ )C,2B<
otal $illed price of jo$ /)+..................................... Akr 0+,/B<
Akr 0+,/B< [ / units Y Akr ),,)+< per unit.
3olutions Manual, "hapter / +)2
&ro'lem 3-32 ()+< minutes*
).
"ash Accumulated >epreciation
?al. ,0,<<< ),+@<,<<
<
(p* ))<,<<< ?al.
(o* ),,0<,<<
<
0<,<<< (k*
?al. ))0,<<< )2<,<<< ?al.
Accounts 8eceiva$le Accounts !aya$le
?al. )+@,<<< ),,0<,<<
<
(o* (p* C@<,<<< B2,<<< ?al.
(n* ),/<<,<<
<
/<<,<<< (a*
?al. )@@,<<< B),<<< (d*
/,,<<< (e*
!lant and E4uipment @<,<<< (g*
?al. /<<,<<< C,<<< (h*
+<<,<<< (i*
!repaid &nsurance )+<,<<< (j*
?al. C,<<< @,<<< (f* ,C,<<< ?al.
?al. +,<<< 3alaries J Oages !aya$le
(p* ,<<,<<< C,<<< ?al.
8aw Materials ,)2,<<< (c*
?al. )<,<<< ,@<,<<< ($* +0,<<< ?al.
(a* /<<,<<<
?al. /<,<<< "apital 3tock
,@0,<<< ?al.
Oork in !rocess
?al. //,<<< BC<,<<< (m* 8etained Earnings
($* ,+<,<<< )+<,<<< ?al.
(c* @2,<<<
(l* /B<,<<< 3ales
?al. ,<,<<< ),/<<,<<
<
(n*
Finished 1oods "ost of 1oods 3old
?al. @0,<<< C,<,<<< (n* (n* C,<,<<<
3olutions Manual, "hapter / +)@
(m* BC<,<<<
?al. ,0,<<<
3olutions Manual, "hapter / +)B
Manufacturing Dverhead ravel E.pense
($* 0<,<<< /B<,<<< Z (l* (e* /,,<<<
(c* ),<,<<<
(d* B),<<< Ktilities E.pense
(f* @,<<< (g* @,<<<
(g* 2,,<<<
(h* C,<<< Advertising E.pense
(j* )+<,<<< (i* +<<,<<<
(k* /<,<<<
?al. +<,<<< >epreciation E.pense
(k* )<,<<<
3alaries E.pense
(c* ))<,<<<
Estimated total manuf. overhead cost R0)<,<<<
Z Y
Estimated direct materials cost R,/<,<<<
Y)0irect materials:
8aw materials inventory, 5an. )............ R)<,<<<
Add: !urchases of raw materials........... /<<,<<<
Materials availa$le for use.................... /)<,<<<
>ec. ,)............................................... /<,<<<
8aw materials used in production......... ,@<,<<<
=ess indirect materials.......................... 0<,<<<
R,+<,<<
<
>irect la$or............................................. @2,<<<
Manufacturing overhead applied to
work in process..................................... /B<,<<<
otal manufacturing costs....................... B@2,<<<
Add: Oork in process, 5an. ).................... //,<<<
C+<,<<<
>educt: Oork in process, >ec. ,)............ ,<,<<<
"ost of goods manufactured...................
RBC<,<<
<
,. "ost of 1oods 3old.................................. +<,<<<
Manufacturing Dverhead...................... +<,<<<
3chedule of cost of goods sold:
Finished goods inventory, 5an. )........... R @0,<<<
Add: "ost of goods manufactured......... BC<,<<<
1oods availa$le for sale........................ C20,<<<
>ec. ,)............................................... ,0,<<<
Knadjusted cost of goods sold.............. C,<,<<<
Add underapplied overhead.................. +<,<<<
Adjusted cost of goods sold.................. RC0<,<<<
3olutions Manual, "hapter / ++<
/. "henko !roducts, &nc.
&ncome 3tatement
3ales...................................................
R),/<<,<<
<
=ess cost of goods sold........................
C0<,<<
<
1ross margin....................................... /0<,<<<
e.penses:
3alaries e.pense...............................
R))<,<<
<
ravel e.pense.................................. /,,<<<
Ktilities e.pense (R@<,<<< V )<P*.... @,<<<
Advertising e.pense......................... +<<,<<<
>epreciation e.pense (R0<,<<< V
+<P*............................................... )<,<<<
,@<,<<
<
Aet operating income..........................
R B<,<<
<
0. >irect materials.............................................. RB,<<<
>irect la$or.................................................... ),2<<
Manufacturing overhead (RB,<<< V )0<P*..... )+,<<<
otal manufacturing costs of jo$ /)+.............. +),2<<
?illing rate...................................................... V ).@0
otal amount $illed......................................... R,@,B<<
R,@,B<< [ /<< units Y RC/.0< per unit.
3olutions Manual, "hapter / ++)
Case 3-33 (/0 minutes*
). he revised predetermined overhead rate is determined as
follows:
Driginal estimated total manufacturing
overhead.....................................................
R,,/<+,<<
<
!lus: =ease cost of the new machine............. ,/B,<<<
!lus: "ost of new technicianHprogrammer..... 0<,<<<
Estimated total manufacturing overhead.......
R,,B<<,<<
<
Driginal estimated total direct la$or7hours. . . . 2,,<<<
=ess: Estimated reduction in direct la$or7
hours........................................................... 2,<<<
Estimated total direct la$or7hours.................. 0@,<<<
Estimated total manufacturing overhead
!redetetermined
Y
overhead rate
R,,B<<,<<<
Y
0@,<<< >=;s
Y R22.2@ per >=;
he revised predetermined overhead rate is higher than the
original rate $ecause the automated milling machine will
increase the overhead for the year (the numerator in the rate*
and will decrease the direct la$or7hours (the denominator in the
rate*. his dou$le7whammy e#ect increases the predetermined
overhead rate.
+. Ac4uisition of the automated milling machine will increase the
apparent costs of all jo$s9not just those that use the new
facility. his is $ecause the company uses a plantwide
overhead rate. &f there were a di#erent overhead rate for each
department, this would not happen.
,. he predetermined overhead rate is now considera$ly higher
than it was. his will penalize products that continue to use the
same amount of direct la$or7hours. 3uch products will now
appear to $e less pro'ta$le and the managers of these
products will appear to $e doing a poorer jo$. here may $e
3olutions Manual, "hapter / +++
pressure to increase the prices of these products even though
there has in fact $een no increase in their real costs.
3olutions Manual, "hapter / ++,
/. Ohile it may have $een a good idea to ac4uire the new
e4uipment $ecause of its greater capa$ilities, the calculations
of the cost savings were in error. he original calculations
implicitly assumed that overhead would decrease $ecause of
the reduction in direct la$or7hours. &n reality, the overhead
increased $ecause of the additional costs of the new
e4uipment. A di#erential cost analysis would reveal that the
automated e4uipment would increase total cost $y a$out
R,)2,<<< a year if the la$or reduction is only +,<<< hours.
"ost conse4uences of leasing the automated e4uipment:
&ncrease in manufacturing overhead cost:
=ease cost of the new machine..........................
R,/B,<<
<
"ost of new technicianHprogrammer................... 0<,<<<
,CB,<<<
=ess: la$or cost savings (+,<<< hours V R/) per
hour*.................................................................. B+,<<<
Aet increase in annual costs.................................
R,)2,<<
<
Even if the entire 2,<<<7hour reduction in direct la$or7hours had
happened, that would have added only R)2/,<<< (/,<<< hours
V R/) per hour* in cost savings. he net increase in annual
costs would have $een R)0+,<<< and the machine would still
$e an unattractive proposal. he entire 2,<<<7hour reduction
may ultimately $e realized as workers retire or 4uit. ;owever,
this is $y no means automatic.
here are two morals to this tale. First, predetermined
overhead rates should not $e misinterpreted as varia$le costs.
hey are not. 3econd, a reduction in direct la$or re?uirements
does not necessarily lead to a reduction in direct la$or hours
paid. &t is often very diEcult to actually reduce the direct la$or
force and may $e virtually impossi$le e.cept through natural
attrition in some countries.
3olutions Manual, "hapter / ++/
Case 3-34 ()+< minutes*
). -raditional approach2
Actual total manufacturing overhead cost
incurred
(assumed to e4ual the original estimate*.......... R/,<<<,<<<
()2<,<<< units V R+0 per unit*.......................... /,<<<,<<<
Dverhead under7 or overapplied.......................... R <
Iault ;ard >rives, &nc.
&ncome 3tatement: raditional Approach
8evenue ()0<,<<< units V R2< per unit*.
RC,<<<,<<
<
"ost of 1oods 3old:
Iaria$le manufacturing
()0<,<<< units V R)0 per unit*...........
R+,+0<,<<
<
()0<,<<< units V R+0 per unit*...........
,,@0<,<<
<
2,<<<,<<
<
1ross margin........................................... ,,<<<,<<<
Administrative and selling e.penses.......
+,@<<,<<
<
Aet operating income..............................
R ,<<,<<
<
4e5 approach2
&ncome 3tatement: Aew Approach
8evenue ()0<,<<< units V R2< per unit*.......
RC,<<<,<<
<
"ost of 1oods 3old:
()0<,<<< units V R)0 per unit*.................
R+,+0<,<<
<
()0<,<<< units V R+< per unit*.................
,,<<<,<<
<
0,+0<,<<
<
3olutions Manual, "hapter / ++0
1ross margin................................................ ,,@0<,<<<
"ost of Knused "apacity ](+<<,<<< units X
)2<,<<< units* V R+< per unit^................... B<<,<<<
Administrative and selling e.penses.............
+,@<<,<<
<
Aet operating income...................................
R +0<,<<
<
3olutions Manual, "hapter / ++2
+. -raditional approach2
Knder the traditional approach, the reported net operating
income can $e increased $y increasing the production level
which then results in overapplied overhead which is deducted
from "ost of 1oods 3old.
Additional net operating income re4uired to
attain target net operating income (R0<<,<<< X
R,<<,<<<* (a*........................................................ R+<<,<<<
Dverhead applied per unit of output ($*..................
R+0 per
unit
Additional output re4uired to attain target net
operating income (a* [ ($*...................................B,<<< units
Actual total manufacturing overhead cost
incurred................................................................R/,<<<,<<<
]()2<,<<< units \ B,<<< units* V R+0 per unit^..... /,+<<,<<<
Dverhead overapplied............................................. R +<<,<<<
&ncome 3tatement: raditional Approach
8evenue ()0<,<<< units V R2< per unit*.....
RC,<<<,<<
<
"ost of 1oods 3old:
()0<,<<< units V R)0 per unit*..............
R+,+0<,<<
<
()0<,<<< units V R+0 per unit*.............. ,,@0<,<<<
=ess: Manufacturing overhead
overapplied........................................... +<<,<<<
0,B<<,<<
<
1ross margin.............................................. ,,+<<,<<<
Administrative and selling e.penses..........
+,@<<,<<
<
Aet operating income.................................
R 0<<,<<
<
Aote: &f the overapplied manufacturing overhead were prorated
3olutions Manual, "hapter / ++@
$etween ending inventories and "ost of 1oods 3old, more units
would have to $e produced to attain the target net pro't of
R0<<,<<<. &n fact, it can $e shown that the total production
level would have to $e )2C,<)/ units rather than )2B,<<< units.
3olutions Manual, "hapter / ++B
4e5 approach2
Knder the new approach, the reported net operating income can
$e increased $y increasing the production level. his results in
less of a deduction on the income statement for the "ost of
Knused "apacity.
Additional net operating income re4uired to attain
target net operating income (R0<<,<<< X
R+0<,<<<* (a*......................................................... R+0<,<<<
Dverhead applied per unit of output ($*.................... R+< per unit
Additional output re4uired to attain target net
operating income (a* [ ($*..................................... )+,0<< units
Estimated num$er of units produced........................
)2<,<<<
units
Actual num$er of units to $e produced.....................
)@+,0<<
units
&ncome 3tatement: Aew Approach
8evenue ()0<,<<< units V R2< per unit*.......
RC,<<<,<<
<
"ost of 1oods 3old:
()0<,<<< units V R)0 per unit*.................
R+,+0<,<<
<
()0<,<<< units V R+< per unit*.................
,,<<<,<<
< 0,+0<,<<<
1ross margin................................................. ,,@0<,<<<
"ost of Knused "apacity ](+<<,<<< units X
)@+,0<< units* V R+< per unit^.................... 00<,<<<
Administrative and selling e.penses............. +,@<<,<<<
Aet operating income.................................... R 0<<,<<<
3olutions Manual, "hapter / ++C
,. Aet operating income is more volatile under the new method
than under the old method. he reason for this is that the
reported pro't per unit sold is higher under the new method $y
R0, the di#erence in the predetermined overhead rates. As a
conse4uence, swings in sales in either direction will have a
more dramatic impact on reported pro'ts under the new
method.
/. As the computations in part (+* a$ove show, the Mhat trickN is a
$it harder to perform under the new method. Knder the old
method, the target net operating income can $e attained $y
producing an additional B,<<< units. Knder the new method,
the production would have to $e increased $y )+,0<< units.
Again, this is a conse4uence of the di#erence in predetermined
overhead rates. he drop in sales has had a more dramatic
e#ect on net operating income under the new method as noted
a$ove in part (,*. &n addition, since the predetermined
overhead rate is lower under the new method, producing
e.cess inventories has less of an e#ect per unit on net
operating income than under the traditional method and hence
more e.cess production is re4uired.
0. Dne can argue that whether the Mhat trickN is unethical
depends on the level of sophistication of the owners of the
company and others who read the 'nancial statements. &f they
understand the e#ects of e.cess production on net operating
income and are not misled, it can $e argued that the hat trick is
ethical. ;owever, if that were the case, there does not seem to
$e any reason to use the hat trick. Ohy would the owners want
to tie up working capital in inventories just to arti'cially attain
a target net operating income for the periodF And increasing
the rate of production toward the end of the year is likely to
increase overhead costs due to overtime and other costs.
?uilding up inventories all at once is very likely to $e much
more e.pensive than increasing the rate of production
uniformly throughout the year. &n the case, we assumed that
there would not $e an increase in overhead costs due to the
additional production, $ut that is likely not to $e true.
3olutions Manual, "hapter / +,<
&n our opinion the hat trick is unethical unless there is a good
reason for increasing production other than to arti'cially $oost
the current periodGs net operating income. &t is certainly
unethical if the purpose is to fool users of 'nancial reports such
as owners and creditors or if the purpose is to meet targets so
that $onuses will $e paid to top managers.
). 3having 0P o# the estimated direct la$or7hours in the
predetermined overhead rate will result in an arti'cially high
overhead rate. he arti'cially high predetermined overhead
rate is likely to result in overapplied overhead for the year. he
cumulative e#ect of overapplying the overhead throughout the
year is all recognized in >ecem$er when the $alance in the
Manufacturing Dverhead account is closed out to "ost of 1oods
3old. &f the $alance were closed out every month or every
4uarter, this e#ect would $e dissipated over the course of the
year.
+. his 4uestion may generate lively de$ate. Ohere should erri
8onsinGs loyalties lieF &s she working for the general manager of
the division or for the corporate controllerF &s there anything
wrong with the M"hristmas $onusNF ;ow far should erri go in
$ucking her $oss on a new jo$F
Ohile individuals can certainly disagree a$out what erri should
do, some of the facts are indisputa$le. First, the practice of
understating direct la$or7hours results in arti'cially in-ating the
overhead rate. his has the e#ect of in-ating the cost of goods
sold 'gures in all months prior to >ecem$er and overstating
the costs of inventories. &n >ecem$er, the huge adjustment for
overapplied overhead provides a $ig $oost to net operating
income. herefore, the practice results in distortions in the
pattern of net operating income over the year. &n addition,
since all of the adjustment is taken to "ost of 1oods 3old,
inventories are still overstated at year7end. his means, of
course, that the net operating income for the entire year is also
overstated.
Ohile erri is in an e.tremely diEcult position, her
responsi$ilities under the &MAGs 3tandards of Ethical "onduct
3olutions Manual, "hapter / +,)
for Management Accountants seem to $e clear. he D$jectivity
3tandard states that Mmanagement accountants have a
responsi$ility to disclose fully all relevant information that
could reasona$ly $e e.pected to in-uence an intended userGs
understanding of the reports, comments, and
recommendations presented.N &n our opinion, erri should
discuss this situation with her immediate supervisor in the
controllerGs oEce at corporate head4uarters. his step may
$ring her into direct con-ict with the general manager of the
division, so it would $e a very diEcult decision for her to make.
3olutions Manual, "hapter / +,+
&n the actual situation that this case is $ased on, the corporate
controllerGs sta# were aware of the general managerGs
accounting tricks, $ut top management of the company
supported the general manager $ecause Mhe comes through
with the resultsN and could $e relied on to hit the annual pro't
targets for his division. !ersonally, we would $e very
uncomforta$le supporting a manager who will resort to
deli$erate distortions to achieve Mresults.N &f the manager will
pull tricks in this area, what else might he $e doing that is
4uestiona$le or even perhaps illegalF
3olutions Manual, "hapter / +,,
,roup E%ercise 3-3
3tudent answers will depend on who they contact. For illustration
purposes, we contacted the chief 'nancial oEcer of Avianne
;ealthcare !roducts, a manufacturer of scented soaps and lotions,
who provided us with the following information.
). According to the "FD, the company uses process costing.
+. Dverhead is assigned on the $asis of direct la$or7hours. he
overhead rate is roughly R0 per direct la$or7hour.
,. !roduct costs are used in making decisions. he costs of raw
materials a#ect how much of each product is manufactured
and each productGs selling price. According to the "FD, costs
much $e watched closely to maintain a successful $usiness.
/. !roduction volume and costs should $e carefully monitored to
avoid wasteful e.cess inventory. "hanges in sales should $e
monitored to determine the 4uantity of each product that
needs to $e produced.
0. he company has maintained the same cost system since it
was started in )C@C.
3olutions Manual, "hapter / +,/
Chapter 4
S)stems 1esign2 &rocess Costing
4-1 A process costing system should $e
used in situations where a homogeneous
product is produced on a continuous $asis.
4-2
). 5o$7order costing and process costing
have the same $asic purposes9to
assign materials, la$or, and overhead
cost to products and to provide a
mechanism for computing unit product
costs.
+. ?oth systems use the same $asic
manufacturing accounts.
,. "osts -ow through the accounts in
$asically the same way in $oth
systems.
4-3 "osts are accumulated $y
department in a process costing system.
4-4 &n a process costing system, the
activity performed in a department must
$e performed uniformly on all units
moving through it and the output of the
department must $e homogeneous.
4-5 "ost accumulation is simpler under
process costing $ecause costs only need
to $e assigned to departments9not
separate jo$s. A company usually has a
small num$er of processing departments,
whereas a jo$7order costing system often
must keep track of the costs of hundreds
or even thousands of jo$s.
4- &n a process costing system, a Oork
in !rocess account is maintained for each
separate processing department.
4-! he journal entry would $e:
Oork in !rocess, Firing................................ SSSS
Oork in !rocess, SSSS
Mi.ing................................................
4-" he costs that might $e added in
the Firing >epartment include: ()* costs
transferred in from the Mi.ing
>epartment% (+* materials costs added in
the Firing >epartment% (,* la$or costs
added in the Firing >epartment% and (/*
overhead costs added in the Firing
>epartment.
4-# Knder the weighted7average
method, e4uivalent units of production
consist of units transferred to the ne.t
department (or to 'nished goods* during
the period plus the e4uivalent units in the
departmentGs ending work in process
inventory.
4-1$ A 4uantity schedule summarizes
the physical -ow of units through a
department during a period. &t serves
several purposes. First, it provides
information a$out activity in the
department and also shows the stage of
completion of any in7process units.
3econd, it provides data for computing the
e4uivalent units and for preparing the
other parts of the production report.
4-11 &n process costing a unit of product
accumulates cost in each department that
it passes through, with the costs of one
department added to the costs of the
preceding department in a snow$alling
fashion.
4-12 he company will want to
distinguish $etween the costs of the
metals used to make the medallions, $ut
the medals are otherwise identical and go
3olutions Manual, "hapter / +,0
through the same production processes.
hus, operation costing is ideally suited for
the companyGs needs.
4-13 Any company that manufactures
products that have some common
characteristics and some individual
characteristics may want to use operation
costing. E.amples include te.tiles, shoes,
electronic parts, and clothing.
4-14 Knder the F&FD method, units
transferred out are divided into two parts.
Dne part consists of the units in the
$eginning inventory. Dnly the work needed
to complete these units is shown as part
of the e4uivalent units for the current
period. he other part of the units
transferred out consists of the units
started and completed during the current
period% these units are shown as a
separate amount in the e4uivalent units
computation under the F&FD method.
4-15 Knder the F&FD method, units
transferred out are divided into two
groups. he 'rst group consists of units
from the $eginning work in process
inventory. he second group consists of
units started and completed during the
period.
4-1 he F&FD method is superior to the
weighted7average method for cost control
$ecause current performance should $e
measured in relation to costs of the
current period only, and the weighted7
average method mi.es these costs in with
costs of the prior period. hus, under the
weighted7average method, the
departmentGs apparent performance in the
current period is in-uenced to some
e.tent $y what happened in a prior period.
3olutions Manual, "hapter / +,2
E%ercise 4-1 (+< minutes*
a. o record issuing raw materials for use in production:
Oork in !rocess9Molding >epartment. . +,,<<<
Oork in !rocess9Firing >epartment...... B,<<<
8aw Materials.................................. ,),<<<
$. o record direct la$or costs incurred:
Oork in !rocess9Molding >epartment. . )+,<<<
Oork in !rocess9Firing >epartment...... @,<<<
Oages !aya$le................................ )C,<<<
c. o record applying manufacturing overhead:
Oork in !rocess9Molding >epartment. . +0,<<<
Oork in !rocess9Firing >epartment...... ,@,<<<
Manufacturing Dverhead................. 2+,<<<
d. o record transfer of un'red, molded $ricks from the Molding
>epartment to the Firing >epartment:
Oork in !rocess9Firing >epartment...... 0@,<<<
Oork in !rocess9Molding >epartment
0@,<<<
e. o record transfer of 'nished $ricks from the Firing >epartment
to the 'nished $ricks warehouse:
Finished 1oods...................................... )<,,<<<
Oork in !rocess9Firing >epartment )<,,<<<
f. o record "ost of 1oods 3old:
"ost of 1oods 3old................................ )<),<<<
Finished 1oods................................ )<),<<<
3olutions Manual, "hapter / +,@
Oeighted7Average Method
E?uivalent Units
'EU+
Material
s
Conversio
n
Knits transferred out )C<,<<< )C<,<<<
Oork in process, ending:
)0,<<< units V B<P )+,<<<
)0,<<< units V /<P 2,<<<
E4uivalent units +<+,<<< )C2,<<<
3olutions Manual, "hapter / +,B
F&FD Method
E?uivalent Units
'EU+
Material
s
Conversio
n
Oork in process, $eginning:
,<,<<< units V ,0PZ )<,0<<
,<,<<< units V @<PZ +),<<<
3tarted and completed during
Dcto$erZZ )2<,<<< )2<,<<<
)0,<<< units V B<P )+,<<<
)0,<<< units V /<P 2,<<<
E4uivalent units )B+,0<< )B@,<<<
Z Oork needed to complete these units.
ZZ )@0,<<< units started X )0,<<< units in ending work in process
Y )2<,<<< started and completed
3olutions Manual, "hapter / +,C
,ons
). Oork in process, 5une )........................................... +<,<<<
3tarted into production during the month............... )C<,<<<
otal tons in process................................................ +)<,<<<
>educt work in process, 5une ,<............................. ,<,<<<
"ompleted and transferred out during the month... )B<,<<<
+. ons to $e accounted for:
Oork in process, 5une ) (materials C<P
complete,
la$or and overhead B<P complete*.................... +<,<<<
3tarted into production during the month............. )C<,<<<
otal tons to $e accounted for................................. +)<,<<<
ons accounted for as follows:
ransferred out during the month......................... )B<,<<<
Oork in process, 5une ,< (materials 2<P
complete,
la$or and overhead /<P complete*.................... ,<,<<<
otal tons accounted for.......................................... +)<,<<<
3olutions Manual, "hapter / +/<
F&FD Method
). he num$er of tons completed and transferred out during the
month is the same regardless of the costing method used.
hus, as in the similar e.ercise that is $ased on the weighted7
average method, )B<,<<< tons would have $een completed
and transferred out. ;owever, under the F&FD method we must
$reak this down $etween the tons that were completed from
the $eginning inventory and the tons started and completed
during the current period. his $reakdown is shown in !art +
$elow:
+. ons to $e accounted for:
Oork in process, 5une ) (materials C<P
complete% la$or and overhead B<P
complete*........................................................... +<,<<<
3tarted into production during the month.............
)C<,<<
<
otal tons to $e accounted for.................................
+)<,<<
<
ons accounted for as follows:
ransferred out during the month:
ons from the $eginning inventory..................... +<,<<<
ons started and completed during the
month..............................................................
)2<,<<
< Z
Oork in process, 5une ,< (materials 2<P
complete% la$or and overhead /<P
complete*........................................................... ,<,<<<
otal tons accounted for..........................................
+)<,<<
<
Z )C<,<<< tons started into production X ,<,<<< tons in
ending work in process Y )2<,<<< tons started and
completed.
3olutions Manual, "hapter / +/)
).
Material
s )abor
$verhea
d
Oork in process, May ) R )B,<<< R 0,0<< R +@,0<<
"ost added during May +,B,C<< B<,,<< /<),0<<
otal cost (a* R+02,C<< RB0,B<< R/+C,<<<
E4uivalent units of production
($* ,0,<<< ,,,<<< ,,,<<<
"ost per e4uivalent unit (a* [
($* R@.,/ R+.2< R),.<<
+.
"ost per EK for materials R @.,/
"ost per EK for la$or +.2<
"ost per EK for overhead ),.<<
otal cost per EK R++.C/
3olutions Manual, "hapter / +/+
). "omputation of the total cost per EK:
"ost per EK for materials R)+.0<
"ost per EK for la$or ,.+<
"ost per EK for overhead 2./<
otal cost per EK R++.)<
+. "omputation of e4uivalent units in ending inventory:
Material
s )abor
$verhea
d
Knits in ending inventory ,,<<< ,,<<< ,,<<<
!ercentage completed B<P 2<P 2<P
E4uivalent units of
production +,/<< ),B<< ),B<<
,. "ost 8econciliation
,otal
Cost
Material
s )abor
$ver/
head
"ost accounted for as
follows:
ransferred to the ne.t
department: +0,<<<
units at R++.)< per unit R00+,0<
< +0,<<< +0,<<< +0,<<<
Materials, at R)+.0< per
EK
,<,<<< +,/<<
=a$or, at R,.+< per EK 0,@2< ),B<<
Dverhead, at R2./< per
EK
)),0+< ),B<<
otal work in process /@,+B<
otal cost accounted for
R0CC,@B
<
3olutions Manual, "hapter / +/,
F&FD Method
). Material
s )abor
$verhea
d
"ost added during May (a*
R)C,,,+
< R2+,<<< R,)<,<<<
E4uivalent units of production
($* +@,<<< +0,<<< +0,<<<
($* R@.)2 R+./B R)+./<
+.
"ost per EK for
materials R @.)2
"ost per EK for la$or +./B
"ost per EK for
overhead )+./<
otal cost per EK R++.</
3olutions Manual, "hapter / +//
E%ercise 4-# (/0 minutes*
F&FD Method
). "omputation of the total cost per EK:
"ost per EK for material R+0./<
"ost per EK for conversion )B.+<
otal cost per EK R/,.2<
+. "omputation of e4uivalent units in ending inventory:
Materials Conversion
Knits in ending inventory ,<< ,<<
!ercentage completed @<P 2<P
E4uivalent units of
production +)< )B<
,. "omputation of e4uivalent units re4uired to complete the
$eginning inventory:
Materials Conversion
Knits in $eginning
inventory /<< /<<
!ercentage uncompleted +<P 2<P
E4uivalent units of
production B< +/<
/. Knits transferred to the ne.t department................ ,,)<<
Knits from the $eginning inventory......................... /<<
Knits started and completed during the
period................................................................... +,@<<
3olutions Manual, "hapter / +/0
E%ercise 4-# (continued*
0. "ost 8econciliation
E?uivalent Units
,otal
Cost
Material
s
Conversio
n
"ost accounted for as follows:
ransferred to the ne.t department:
From the $eginning inventory:
"ost in the $eginning inventory....................... R )),</<
"ost to complete these units:
Materials at R+0./< per EK........................... +,<,+ B<
"onversion at R)B.+< per EK........................ /,,2B +/<
otal cost from $eginning inventory................... )@,//<
Knits started and completed this month at
R/,.2< per unit................................................ ))@,@+< +,@<< +,@<<
otal cost transferred to the ne.t department....... ),0,)2<
Materials at R+0./< per EK................................. 0,,,/ +)<
"onversion at R)B.+< per EK.............................. ,,+@2 )B<
otal work in process, ending................................ B,2)<
otal cost accounted for........................................R)/,,@@<
3olutions Manual, "hapter / +/2
E%ercise 4-1$ ()< minutes*
Oork in !rocess9"ooking....................................... /+,<<<
8aw Materials &nventory..................................... /+,<<<
Oork in !rocess9"ooking....................................... 0<,<<<
Oork in !rocess9Molding........................................ ,2,<<<
Oages !aya$le................................................... B2,<<<
Oork in !rocess9"ooking....................................... @0,<<<
Oork in !rocess9Molding........................................ /0,<<<
Manufacturing Dverhead....................................
)+<,<<
<
Oork in !rocess9Molding........................................
)2<,<<
<
Oork in !rocess9"ooking...................................
)2<,<<
<
Finished 1oods........................................................
+/<,<<
<
Oork in !rocess9Molding...................................
+/<,<<
<
3olutions Manual, "hapter / +/@
8uantit
%
Schedul
e
!ounds to $e accounted for:
Oork in process, 5uly )
(materials )<<P complete,
conversion ,<P complete* +<,<<<
3tarted into production during
5uly ,B<,<<<
otal pounds to $e accounted for /<<,<<<
E?uivalent Units 'EU+
Materials
Conversio
n
!ounds accounted for as follows:
ransferred to ne.t
department during 5ulyZ ,@0,<<< ,@0,<<< ,@0,<<<
Oork in process, 5uly ,)
conversion 2<P complete* +0,<<< +0,<<< )0,<<<
otal pounds accounted for /<<,<<< /<<,<<< ,C<,<<<
Z +<,<<< \ ,B<,<<< X +0,<<< Y ,@0,<<<
3olutions Manual, "hapter / +/B
F&FD Method
8uantit
%
Schedul
e
Oork in process, 5uly )
conversion ,<P complete*
+<,<<<
3tarted into production
during 5uly ,B<,<<<
otal pounds to $e accounted
for /<<,<<<
Materials
Conversio
n
!ounds accounted for as
follows
ransferred to ne.t
department:
From the $eginning
inventory +<,<<< < )/,<<< Z
3tarted and completed this
monthZZ ,00,<<< ,00,<<< ,00,<<<
Oork in process, 5uly ,)
conversion 2<P complete*
+0,<<< +0,<<< )0,<<<
otal pounds accounted for
/<<,<<< ,B<,<<< ,B/,<<<
Z Oork re4uired to complete these units:
+<,<<< pounds V ()<<P X ,<P* Y )/,<<< pounds.
ZZ ,B<,<<< pounds started X +0,<<< pounds in ending work in
process inventory Y ,00,<<< pounds started and
3olutions Manual, "hapter / +/C
completed this month.

3olutions Manual, "hapter / +0<
). For the sake of $revity, only the portion of the 4uantity schedule from which the
e4uivalent units are computed is shown $elow.
8uantit%
E?uivalent Units
'EU+
Schedule
Materials Conversio
n
Knits accounted for as follows:
ransferred to the ne.t process )@0,<<< )@0,<<< )@0,<<<
Oork in process, May ,)
conversion ,<P complete* )<,<<< )<,<<< ,,<<<
otal units accounted for )B0,<<< )B0,<<< )@B,<<<
+. ,otal
Cost
Material
s
Conversio
n
0hole
Unit
"ost to $e accounted for:
Oork in process, May ).........................................
R 0,0<
< R ),0<< R /,<<<
"ost added $y the department.............................
/<2,<<
< 0/,<<< ,0+,<<<
otal cost to $e accounted for (a*............................
R/)),0<
< R00,0<< R,02,<<<
E4uivalent units ($*................................................. )B0,<<< )@B,<<<
"ost per e4uivalent unit (a* [ ($*............................R<.,< \ R+.<< Y R+.,<
3olutions Manual, "hapter / +0)
3olutions Manual, "hapter / +0+
,otal E?uivalent Units 'EU+
Cost
Material
s
Conversio
n
process ()@0,<<< units V
R+.,< per unit*
R/<+,0<
< )@0,<<< )@0,<<<
Oork in process, May ,):
Materials, at R<.,< per EK
,,<<< )<,<<<
"onversion, at R+.<< per
EK 2,<<< ,,<<<
otal work in process C,<<<
R/)),0<
<
3olutions Manual, "hapter / +0,
F&FD Method
). 6uantity schedule and e4uivalent units:
8uantit
%
Schedul
e
Knits to $e accounted for:
Oork in process, May ) (materials )<<P
complete, conversion /<P complete*................. 0,<<<
3tarted into production......................................... )B<,<<<
otal units to $e accounted for................................ )B0,<<<
E?uivalent Units
'EU+
Material
s
Conversio
n
ransferred to the ne.t process:
From the $eginning inventory............................. 0,<<< < ,,<<< Z
3tarted and completed this monthZZ.................. )@<,<<< )@<,<<< )@<,<<<
Oork in process, May ,) (materials )<<P
complete, conversion ,<P complete*................. )<,<<< )<,<<< ,,<<<
otal units accounted for......................................... )B0,<<< )B<,<<< )@2,<<<
ZOork needed to complete the units in $eginning inventory.
ZZ )B<,<<< units started into production X )<,<<< units in ending work in process Y )@<,<<<
units started and completed
3olutions Manual, "hapter / +0/
+.
,otal
Cost
Materia
ls
Conversio
n
0hole
Unit
Oork in process, May )
R 0,0<
<
"ost added $y the department (a*
/<2,<<
< R0/,<<< R,0+,<<<
otal cost to $e accounted for
R/)),0<
<
E4uivalent units ($* )B<,<<< )@2,<<<
"ost per e4uivalent unit (a* [ ($* R<.,< \ R+.<< Y R+.,<
3olutions Manual, "hapter / +00
F&FD Method
,otal
E?uivalent Units
'EU+
Cost
Material
s
Conversio
n
ransferred to the ne.t process:
"ost in the $eginning
inventory
R 0,0<
<
Materials, at R<.,< per EK
< <
"onversion, at R+.<< per
EK 2,<<< ,,<<<
otal cost from $eginning
inventory )),0<<
Knits started and completed
this month: )@<,<<< units V
R+.,< per unit
,C),<<
< )@<,<<< )@<,<<<
otal cost transferred
/<+,0<
<
Materials, at R<.,< per EK ,,<<< )<,<<<
"onversion, at R+.<< per EK
2,<<< ,,<<<
otal work in process C,<<<
R/)),0<
<
E%ercise 4-1! (+< minutes*
).
8uantit
%
Schedul
e
Oork in process,
$eginning (materials
B<P complete, la$or
and overhead 2<P
complete* 0,<<<
3tarted into production /0,<<<
otal units to $e accounted
for 0<,<<<
Knits accounted for as
follows:
Material
s
)abor $verhea
d
department /+,<<< /+,<<< /+,<<< /+,<<<
Oork in process, ending
(materials @0P
complete, la$or and
overhead 0<P
complete* B,<<< 2,<<< /,<<< /,<<<
otal units accounted for 0<,<<< /B,<<< /2,<<< /2,<<<
3olutions Manual, "hapter / +0@
E%ercise 4-1! (continued*
+. ,otal
Cost
Materia
ls )abor
$verhea
d
0hole
Unit
Oork in process, $eginning R
@,)0< R/,,+<
R
),</< R),@C<
"ost added $y the
department )<2,00< 0+,B<<
+),0<
< ,+,+0<
(a*
R)),,@<
<
R0@,)+
<
R++,0/
< R,/,</<
E4uivalent units ($* /B,<<< /2,<<< /2,<<<
($* R).)C R<./C \ R<.@/ Y R+./+
3olutions Manual, "hapter / +0B
E%ercise 4-1" (+< minutes*
F&FD Method
).
8uantit
%
Schedul
e
Oork in process, $eginning (materials B<P
complete, la$or and overhead 2<P
complete*...........................................................0,<<<
3tarted into production......................................... /0,<<<
otal units accounted for......................................... 0<,<<<
Materia
ls )abor
$verhea
d
ransferred to the ne.t department:
From the $eginning inventory.............................0,<<< ),<<< Z +,<<< Z +,<<< Z
3tarted and completed this monthZZ.................. ,@,<<< ,@,<<< ,@,<<< ,@,<<<
Oork in process, ending (materials @0P
complete, la$or and overhead 0<P
complete*...........................................................B,<<< 2,<<< /,<<< /,<<<
otal units accounted for......................................... 0<,<<< //,<<< /,,<<< /,,<<<
Z Oork re4uired to complete the $eginning inventory.
3olutions Manual, "hapter / +0C
ZZ /0,<<< units started into production X B,<<< units in ending work in process
Y ,@,<<< started and completed
3olutions Manual, "hapter / +2<
E%ercise 4-1" (continued*
+.
,otal
Cost
Material
s )abor
$verhea
d
0hole
Unit
Oork in process, $eginning R @,)0<
"ost added during the month
(a* )<2,00< R0+,B<< R+),0<< R,+,+0<
R)),,@<
<
E4uivalent units ($* //,<<< /,,<<< /,,<<<
($* R).+< \ R<.0< \ R<.@0 Y R+./0
3olutions Manual, "hapter / +2)
)., +., and ,.
8uantit% Schedule and E?uivalent Units
8uantit
%
Schedul
e
complete% la$or and overhead B<P
complete*........................................................... )<,<<<
3tarted into production......................................... )<<,<<<
otal units to $e accounted for................................ ))<,<<<
Material
s )abor
$verhea
d
ransferred out..................................................... C0,<<< C0,<<< C0,<<< C0,<<<
Oork in process, May ,) (materials 2<P
complete% la$or and overhead +<P
complete*........................................................... )0,<<< C,<<< ,,<<< ,,<<<
otal units accounted for......................................... ))<,<<< )</,<<< CB,<<< CB,<<<
3olutions Manual, "hapter / +2+
Cost per E?uivalent Unit
,otal
Cost
Material
s )abor
$verhea
d
0hole
Unit
Oork in process, May ) R B,@<< R ),0<< R),B<< R0,/<<
"ost added during the
month +/0,,<< )0/,0<< ++,@<< 2B,)<<
(a*
R+0/,<<
< R)02,<<< R+/,0<< R@,,0<<
E4uivalent units ($* )</,<<< CB,<<< CB,<<<
($* R).0< \ R<.+0 \ R<.@0 Y R+.0<
Cost 2econciliation
Cost Materials )abor $verhead
ransferred out: C0,<<< units
V R+.0< per unit R+,@,0<< C0,<<< C0,<<< C0,<<<
Materials, at R).0< per EK ),,0<< C,<<<
=a$or, at R<.+0 per EK @0< ,,<<<
Dverhead, at R<.@0 per EK +,+0< ,,<<<
otal work in process )2,0<<
otal cost accounted for R+0/,<<<
3olutions Manual, "hapter / +2,
&ro'lem 4-2$ (/0 minutes*
F&FD Method
). +., and ,.
8uantit
%
Schedul
e
Oork in process, 5uly ) (materials )<<P
complete% conversion ,<P complete*................. )<,<<<
3tarted into production......................................... )@<,<<<
otal units to $e accounted for................................ )B<,<<<
E?uivalent Units
Material
s
Conversio
n
ransferred to packaging:
From the $eginning inventory............................. )<,<<< < @,<<<Z
3tarted and completed this monthZZ.................. )0<,<<< )0<,<<< )0<,<<<
Oork in process, 5uly ,) (materials )<<P
complete% conversion /<P complete*................. +<,<<< +<,<<< B,<<<
otal units accounted for......................................... )B<,<<< )@<,<<< )20,<<<
Z)<,<<< V ()<<P X ,<P* Y @,<<<
ZZ )@<,<<< units started into production X +<,<<< units in ending work in process
3olutions Manual, "hapter / +2/
Y )0<,<<< units started and completed
,otal
Cost
Materia
ls
Conversio
n
0hol
e Unit
Oork in process, 5uly ) R ),,/<<
"ost added $y the department
(a* ,B,,2<<
R),C,/<
< R+//,+<<
R,C@,<<
<
E4uivalent units ($* )@<,<<< )20,<<<
"ost per e4uivalent unit (a* [ ($* R<.B+ \ R)./B Y R+.,<
Cost 2econciliation
,otal
E?uivalent Units
'EU+
Cost
Material
s
Conversio
n
ransferred to packaging:
inventory R ),,/<<
Materials, at R<.B+ per EK < <
"onversion, at R)./B per EK )<,,2< @,<<<
inventory +,,@2<
3tarted and completed this
month: )0<,<<< units V R+.,<
per unit ,/0,<<< )0<,<<< )0<,<<<
otal cost transferred ,2B,@2<
Oork in process, 5uly ,):
Materials, at R<.B+ per EK )2,/<< +<,<<<
"onversion, at R)./B per EK )),B/< B,<<<
otal work in process +B,+/<
otal cost accounted for R,C@,<<<
3olutions Manual, "hapter / +2@
8uantit%
Schedul
e
Oork in process, 5une ) (materials
)<<P complete, conversion @0P
complete*........................................................... +<,<<<
otal units to $e accounted for................................ +<<,<<<
E?uivalent Units
'EU+
Material
s
Conversio
n
ransferred to $ottling:......................................... )2<,<<< )2<,<<< )2<,<<<
Oork in process, 5une ,< (materials
)<<P complete, conversion +0P
complete*........................................................... /<,<<< /<,<<< )<,<<<
otal units accounted for....................................... +<<,<<< +<<,<<< )@<,<<<
3olutions Manual, "hapter / +2B
Costs per E?uivalent Unit
,otal
Cost Materials
Conversio
n
0hole
Unit
Oork in process, 5une ) R0<,<<< R+0,+<< R+/,B<<
"ost added during 5une 0@,,0<< ,,/,B<< +,B,@<<
otal cost to $e accounted for (a* R2+,,0<< R,2<,<<< R+2,,0<<
E4uivalent units ($* +<<,<<< )@<,<<<
"ost per e4uivalent unit (a* [ ($* R).B< \ R).00 Y R,.,0
Cost 2econciliation
Cost Materials
Conversio
n
ransferred to $ottling:
)2<,<<< units V R,.,0 per unit R0,2,<<< )2<,<<< )2<,<<<
Oork in process, 5une ,<:
Materials, at R).B< per EK @+,<<< /<,<<<
"onversion, at R).00 per EK )0,0<< )<,<<<
otal work in process B@,0<<
otal cost accounted for R2+,,0<<
3olutions Manual, "hapter / +2C
F&FD Method
8uantit%
Schedul
e
Oork in process, 5une ) (materials
)<<P complete, conversion @0P
complete*........................................................... +<,<<<
otal units to $e accounted for................................ +<<,<<<
E?uivalent Units
'EU+
Material
s
Conversio
n
From the $eginning inventory............................. +<,<<< < 0,<<< Z
3tarted and completed this monthZZ.................. )/<,<<< )/<,<<< )/<,<<<
Oork in process, 5une ,< (materials
)<<P complete, conversion +0P
complete*........................................................... /<,<<< /<,<<< )<,<<<
otal units accounted for......................................... +<<,<<< )B<,<<< )00,<<<
Z +<,<<< V ()<<P X @0P* Y 0,<<<
3olutions Manual, "hapter / +@<
ZZ )B<,<<< units started into production X /<,<<< units in ending work in process
Y )/<,<<< units started and completed
3olutions Manual, "hapter / +@)
,otal
Cost
Material
s
Conversio
n
0hole
Unit
Oork in process, 5une ) R 0<,<<<
"ost added during 5une (a* 0@,,0<< R,,/,B<< R+,B,@<<
R2+,,0<
<
E4uivalent units ($* )B<,<<< )00,<<<
"ost per e4uivalent unit (a* [ ($* R).B2 \ R).0/ Y R,./<
3olutions Manual, "hapter / +@+
Cost 2econciliation
,otal
E?uivalent Units
'EU+
Cost
Material
s
Conversio
n
"ost in the $eginning inventory......................
R
0<,<<<
Materials, at R).B2 per EK........................... < <
"onversion, at R).0/ per EK........................ @,@<< 0,<<<
otal cost from $eginning inventory................... 0@,@<<
Knits started and completed during
5une: )/<,<<< units V R,./< per
unit..................................................................
/@2,<<
< )/<,<<< )/<,<<<
otal cost transferred to $ottling...........................
0,,,@<
<
Oork in process, 5une ,<:
Materials, at R).B2 per EK.................................. @/,/<< /<,<<<
"onversion, at R).0/ per EK...............................
)0,/<
< )<,<<<
otal work in process.............................................
BC,B<
<
otal cost accounted for.......................................... R2+,,0<
3olutions Manual, "hapter / +@,
<
3olutions Manual, "hapter / +@/
). A completed production report follows:
8uantit%
Schedul
e
complete, la$or and overhead )H,
complete*........................................................... )B,<<<
3tarted into production......................................... )2@,<<<
otal pounds to $e accounted for............................ )B0,<<<
E?uivalent Units
'EU+
Material
s
)abor >
$verhead
!ounds accounted for as follows:
ransferred to mi.ing............................................ )@<,<<< )@<,<<< )@<,<<<
Oork in process, May ,) (materials )<<P
complete, la$or and overhead +H,
complete*........................................................... )0,<<< )0,<<< )<,<<<
otal pounds accounted for..................................... )B0,<<< )B0,<<< )B<,<<<
3olutions Manual, "hapter / +@0
,otal
Cost
Material
s
)abor >
$verhea
d
0hole
Unit
Oork in process, May ) R+),B<<
R
)/,2<< R @,+<<
"ost added during May ,2<,+<< ),,,/<< ++2,B<<
otal cost to $e accounted for (a*
R,B+,<<
<
R)/B,<<
<
R+,/,<<
<
E4uivalent units ($* )B0,<<< )B<,<<<
"ost per e4uivalent unit (a* [ ($* R<.B< \ R).,< Y R+.)<
Cost 2econciliation
,otal
Cost Materials
)abor >
$verhead
ransferred to mi.ing: )@<,<<<
units V R+.)< per unit
R,0@,<<
< )@<,<<< )@<,<<<
Materials, at R<.B< per EK )+,<<< )0,<<<
=a$or and overhead, at R).,< per
EK ),,<<< )<,<<<
otal work in process +0,<<<
otal cost accounted for R,B+,<<
3olutions Manual, "hapter / +@2
<
3olutions Manual, "hapter / +@@
+. he weighted7average method mi.es costs of the prior period
with current period costs. hus, under the weighted7average
method, unit costs are in-uenced to some e.tent $y what
happened in a prior period. his pro$lem $ecomes particularly
signi'cant when attempting to measure performance in the
current period. 1ood cost control in the current period might $e
concealed to some degree $y the unit costs that have $een
$rought forward in the $eginning inventory. he reverse could
also $e true in that poor cost control might $e concealed $y the
costs of the prior period that have $een $rought forward and
added in with current period costs.
3olutions Manual, "hapter / +@B
F&FD Method
he completed production report follows:
8uantit
%
Schedul
e
1allons to $e accounted for:
Oork in process, April ) (materials )<<P
complete, conversion B<P complete*................. )<,<<<
3tarted into production......................................... )/<,<<<
otal gallons to $e accounted for............................. )0<,<<<
E?uivalent Units
'EU+
Material
s
Conversi
on
1allons accounted for as follows:
ransferred to mi.ing:
From the $eginning inventory............................. )<,<<< < +,<<< Z
3tarted and completed this monthZZ.................. ))<,<<< ))<,<<< ))<,<<<
Oork in process, April ,< (materials )<<P
complete, conversion 2<P complete*................. ,<,<<< ,<,<<< )B,<<<
otal gallons accounted for...................................... )0<,<<< )/<,<<< ),<,<<<
Z Oork re4uired to complete units in $eginning inventory
3olutions Manual, "hapter / +@C
ZZ )/<,<<< units started X ,<,<<< units in ending work in process Y ))<,<<< started and
completed
3olutions Manual, "hapter / +B<
,otal
Cost
Material
s
Conversio
n
0hole
Unit
Oork in process, April ) R ,C,<<<
"ost added during April (a* 0@),<<<
R+0C,<<
< R,)+,<<<
R2)<,<<
<
E4uivalent units ($* )/<,<<< ),<,<<<
($* R).B0 \ R+./< Y R/.+0
3olutions Manual, "hapter / +B)
Cost 2econciliation
,otal
E?uivalent Units
'EU+
Cost
Material
s
Conversio
n
ransferred to Mi.ing:
"ost in the $eginning inventory......................
R
,C,<<<
Materials, at R).B0 per EK.......................... < <
"onversion, at R+./< per EK....................... /,B<< +,<<<
otal cost from $eginning inventory................... /,,B<<
1allons started and completed during
April: ))<,<<< V R/.+0 per unit........................ /2@,0<< ))<,<<< ))<,<<<
otal cost transferred to Mi.ing............................. 0)),,<<
Oork in process, April ,<:
Materials, at R).B0 per EK.................................. 00,0<< ,<,<<<
"onversion, at R+./< per EK............................... /,,+<< )B,<<<
otal work in process............................................. CB,@<<
otal cost accounted for..........................................
R2)<,<<
<
3olutions Manual, "hapter / +B+
). he e4uivalent units for the month would $e:
8uantit
%
E?uivalent Units
'EU+
Schedul
e
Material
s
Conversio
n
ransferred to ne.t department............................ )C<,<<< )C<,<<< )C<,<<<
Oork in process, April ,< (materials
@0P complete, conversion 2<P
complete*........................................................... /<,<<< ,<,<<< +/,<<<
otal units accounted for......................................... +,<,<<< ++<,<<< +)/,<<<
+.
,otal
Cost
Material
s
Conversio
n
0hole
Unit
Oork in process, April )...........................................
R CB,<<
<
R 2@,B<
< R ,<,+<<
"ost added during the month.................................. B+@,<<< 0@C,<<< +/B,<<<
otal cost (a*...........................................................
RC+0,<<
<
R2/2,B<
< R+@B,+<<
E4uivalent units ($*................................................. ++<,<<< +)/,<<<
"ost per e4uivalent unit (a* [ ($*............................ R+.C/ \ R).,< Y R/.+/
,.
otal units transferred............................................. )C<,<<<
3olutions Manual, "hapter / +B,
=ess units in the $eginning inventory...................... ,<,<<<
Knits started and completed during
April...................................................................... )2<,<<<
3olutions Manual, "hapter / +B/
/. Ao, the manager should not $e rewarded for good cost control.
he Mi.ing >epartmentGs low unit cost for April occurred
$ecause the costs of the prior month have $een averaged in
with AprilGs costs. his is a major criticism of the weighted7
average method in that the costs computed for product costing
purposes canGt $e used to evaluate cost control or to measure
performance for the current period.
3olutions Manual, "hapter / +B0
&ro'lem 4-2 (C< minutes*
). a. Oork in !rocess98e'ning >epartment................... /C0,<<<
Oork in !rocess9?lending >epartment.................. ))0,<<<
8aw Materials..................................................... 2)<,<<<
$. Oork in !rocess98e'ning >epartment................... @+,<<<
Oork in !rocess9?lending >epartment.................. )B,<<<
3alaries and Oages !aya$le............................... C<,<<<
c. Manufacturing Dverhead......................................... ++0,<<<
Accounts !aya$le............................................... ++0,<<<
d. Oork in !rocess98e'ning >epartment................... )B),<<<
Manufacturing Dverhead.................................... )B),<<<
d. Oork in !rocess9?lending >epartment.................. /+,<<<
Manufacturing Dverhead.................................... /+,<<<
e. Oork in !rocess9?lending >epartment.................. @/<,<<<
Oork in !rocess98e'ning
>epartment..................................................... @/<,<<<
f. Finished 1oods........................................................ C0<,<<<
Oork in !rocess9?lending
>epartment..................................................... C0<,<<<
g. Accounts 8eceiva$le...............................................
),0<<,<<
<
3ales..................................................................
),0<<,<<
<
"ost of 1oods 3old.................................................. C<<,<<<
Finished 1oods................................................... C<<,<<<
3olutions Manual, "hapter / +B2
+.
Accounts 8eceiva$le 8aw Materials
(g* ),0<<,<<
<
?al. 2)B,<<
<
2)<,<<< (a*
?al. B,<<<
Oork in !rocess
8e'ning >epartment
Oork in !rocess
?lending >epartment
?al
.
,B,<<< @/<,<<< (e* ?al
.
20,<<< C0<,<<< (f*
(a* /C0,<<< (a* ))0,<<<
($* @+,<<< ($* )B,<<<
(d* )B),<<< (d* /+,<<<
?al
.
/2,<<< (e* @/<,<<<
?al
.
,<,<<<
?al
.
+<,<<< C<<,<<< (g* (c* ++0,<<
<
++,,<<< (d*
(f* C0<,<<< ?al. +,<<<
?al
.
@<,<<<
Accounts !aya$le 3alaries and Oages !aya$le
++0,<<< (c* C<,<<< ($*
3ales "ost of 1oods 3old
),0<<,<<
<
(g* (g* C<<,<<<
3olutions Manual, "hapter / +B@
,. he production report for the re'ning department follows:
8uantit
%
Schedul
e
1allons to $e accounted for:
Oork in process, March ) (materials )<<P
complete, la$or and overhead C<P
complete*........................................................... +<,<<<
3tarted into production......................................... ,C<,<<<
otal gallons to $e accounted for............................. /)<,<<<
Material
s )abor
$verhea
d
1allons accounted for as follows:
ransferred to $lendingZ ,@<,<<< ,@<,<<< ,@<,<<< ,@<,<<<
Oork in process, March ,) (materials @0P
complete, la$or and overhead +0P
complete*........................................................... /<,<<< ,<,<<< )<,<<< )<,<<<
otal gallons accounted for...................................... /)<,<<< /<<,<<< ,B<,<<< ,B<,<<<
Z /)<,<<< gallons X /<,<<< gallons Y ,@<,<<< gallons
3olutions Manual, "hapter / +BB
,otal
Cost
Material
s )abor
$verhea
d
0hol
e
Unit
Oork in process, March )
R
,B,<<< R+0,<<<
R
/,<<< R C,<<<
"ost added during March @/B,<<< /C0,<<< @+,<<<
)B),<<
<
otal cost to $e accounted for (a*
R@B2,<<
< R0+<,<<<
R@2,<<
<
R)C<,<<
<
E4uivalent units ($* /<<,<<<
,B<,<<
< ,B<,<<<
"ost per e4uivalent unit (a* [ ($* R).,< \ R<.+< \ R<.0< Y R+.<<
Cost 2econciliation
Cost Materials )abor $verhead
ransferred to $lending:
,@<,<<< gallons V R+.<< per
gallon
R@/<,<<
< ,@<,<<< ,@<,<<< ,@<,<<<
Oork in process, March ,):
Materials, at R).,< per EK ,C,<<< ,<,<<<
=a$or, at R<.+< per EK +,<<< )<,<<<
Dverhead, at R<.0< per EK 0,<<< )<,<<<
3olutions Manual, "hapter / +BC
otal work in process /2,<<<
R@B2,<<
<
3olutions Manual, "hapter / +C<
). he e4uivalent units would $e:
Materials )abor $verhead
Knits completed during the year C<<,<<< C<<,<<< C<<,<<<
Oork in process, >ec. ,):
,<<,<<< units V )<<P ,<<,<<<
,<<,<<< units V 0<P )0<,<<< )0<,<<<
otal e4uivalent units (a* ),+<<,<<< ),<0<,<<< ),<0<,<<<
he costs per e4uivalent unit would $e:
Materials )abor $verhead
0hole
Unit
Oork in process, 5anuary )
R +<<,<<
<
R
,)0,<<< R )BC,<<< Z
"ost added during the year
),,<<,<<
<
),CC0,<<
< ),)C@,<<< ZZ
otal costs ($*
R),0<<,<<
<
R+,,)<,<<
<
R),,B2,<<
<
"ost per e4uivalent unit ($* [
(a* R).+0 \ R+.+< \ R).,+ Y R/.@@
Z 2<P V R,)0,<<< Y R)BC,<<<
ZZ 2<P V R),CC0,<<< Y R),)C@,<<<
3olutions Manual, "hapter / +C)
+. he amount of cost that should $e assigned to the ending inventories is:
0or& in
Process
Finished
@oods ,otal
Oork in process:
Materials: ,<<,<<< units V R).+0 per
unit.....................................................................
R,@0,<<
<
R ,@0,<<
<
=a$or: )0<,<<< EK V R+.+< per unit...................... ,,<,<<< ,,<,<<<
Dverhead: )0<,<<< EK V R).,+ per unit............... )CB,<<< )CB,<<<
Finished goods: +<<,<<< units V R/.@@ per
unit....................................................................... RC0/,<<< C0/,<<<
otal cost to $e assigned to inventories..................
RC<,,<<
< RC0/,<<<
R),B0@,<<
<
,. he necessary adjustments would $e:
0or& in
Process
Finished
@oods ,otal
"ost to $e assigned to inventories (a$ove*.............
RC<,,<<
< R C0/,<<<
R),B0@,<<
<
Qear7end $alances in the accounts.......................... 22<,C2< ),<<C,B<< ),2@<,@2<
>i#erence...............................................................
R+/+,</
<
R (00,B<<
* R )B2,+/<
Oork in !rocess &nventory +/+,</<
Finished 1oods &nventory 00,B<<
"ost of 1oods 3old )B2,+/<
3olutions Manual, "hapter / +C+
/. he simplest computation of the cost of goods sold would $e:
?eginning 'nished goods inventory........................ <
Knits completed during the year............................. C<<,<<<
Knits availa$le for sale............................................ C<<,<<<
=ess units in ending 'nished goods
inventory.............................................................. +<<,<<<
Knits sold during the year....................................... @<<,<<<
"ost per e4uivalent unit (from part )*..................... V R/.@@
"ost of goods sold...................................................
R,,,,C,<<
<
Alternative computation:
otal manufacturing cost incurred:
Materials (part )*..................................................
R),0<<,<<
<
=a$or (part )*........................................................ +,,)<,<<<
Dverhead (part )*................................................. ),,B2,<<<
otal manufacturing cost......................................... 0,)C2,<<<
=ess cost assigned to inventories (part +*............... ),B0@,<<<
"ost of goods sold...................................................
R,,,,C,<<
<
: he Mc1raw7;ill "ompanies, &nc., +<<2
3olutions Manual, "hapter / +C,
&ro'lem 4-2" (C< minutes*
). a.
Oork in !rocess9"ooking
>epartment.......................................................... 0@<,<<<
Oork in !rocess9?ottling
>epartment.......................................................... ),<,<<<
8aw Materials..................................................... @<<,<<<
$.
>epartment.......................................................... )<<,<<<
>epartment.......................................................... B<,<<<
3alaries and Oages !aya$le............................... )B<,<<<
c. Manufacturing Dverhead......................................... /<<,<<<
Accounts !aya$le............................................... /<<,<<<
d.
>epartment.......................................................... +,0,<<<
>epartment.......................................................... )0B,<<<
Manufacturing Dverhead.................................... ,C,,<<<
e.
>epartment.......................................................... C<<,<<<
>epartment..................................................... C<<,<<<
f. Finished 1oods........................................................
),,<<,<<
<
>epartment.....................................................
),,<<,<<
<
g. Accounts 8eceiva$le...............................................
+,<<<,<<
<
3ales..................................................................
+,<<<,<<
<
"ost of 1oods 3old.................................................. ),+0<,<<
3olutions Manual, "hapter / +C/
<
Finished 1oods...................................................
),+0<,<<
<
3olutions Manual, "hapter / +C0
+.
Accounts 8eceiva$le 8aw Materials
(g* +,<<<,<<
<
?al. @)<,<<
<
@<<,<<< (a*
?al. )<,<<<
Oork in !rocess
"ooking >epartment
Oork in !rocess
?ottling >epartment
?al
.
2),<<< C<<,<<< (e* ?al
.
B0,<<< ),,<<,<<
<
(f*
(a* 0@<,<<< (a* ),<,<<<
($* )<<,<<< ($* B<,<<<
(d* +,0,<<< (d* )0B,<<<
?al
.
22,<<< (e* C<<,<<<
?al
.
0,,<<<
?al
.
/0,<<< ),+0<,<<
<
(g* (c* /<<,<<
<
,C,,<<< (d*
(f* ),,<<,<<
<
?al. @,<<<
?al
.
C0,<<<
Accounts !aya$le 3alaries and Oages !aya$le
/<<,<<< (c* )B<,<<< ($*
3ales "ost of 1oods 3old
+,<<<,<<
<
(g* (g* ),+0<,<
<<
3olutions Manual, "hapter / +C2
,. he production report for the cooking department follows:
8uantit
%
Schedul
e
6uarts to $e accounted for:
Oork in process, May ) (materials 2<P
complete, la$or and overhead ,<P
complete*........................................................... @<,<<<
3tarted into productionZ....................................... ,B<,<<<
otal 4uarts accounted for....................................... /0<,<<<
Material
s )abor
$verhea
d
6uarts accounted for as follows:
ransferred to $ottling:......................................... /<<,<<< /<<,<<<
/<<,<<
< /<<,<<<
Oork in process, May ,) (materials @<P
complete, la$or and overhead /<P
complete*........................................................... 0<,<<< ,0,<<< +<,<<< +<,<<<
otal 4uarts accounted for....................................... /0<,<<< /,0,<<<
/+<,<<
< /+<,<<<
Z (/<<,<<< \ 0<,<<<* X @<,<<< Y ,B<,<<<
3olutions Manual, "hapter / +C@
,otal
Cost
Material
s )abor
$verhea
d
0hol
e
Unit
Oork in process, May )
R
2),<<<
R
,C,<<< R 0,<<<
R
)@,<<<
"ost added during May
C<0,<<
< 0@<,<<< )<<,<<< +,0,<<<
(a*
RC22,<<
<
R2<C,<<
<
R)<0,<<
<
R+0+,<<
<
E4uivalent units ($* /,0,<<< /+<,<<< /+<,<<<
($* R)./< \ R<.+0 \ R<.2< Y R+.+0
Cost 2econciliation
Cost
Material
s )abor
$verhea
d
ransferred to $ottling: /<<,<<<
4uarts _ R+.+0 per 4uart
RC<<,<<
< /<<,<<< /<<,<<< /<<,<<<
Materials _ R)./< per EK /C,<<< ,0,<<<
=a$or _ R<.+0 per EK 0,<<< +<,<<<
Dverhead _ R<.2< per EK )+,<<< +<,<<<
3olutions Manual, "hapter / +CB
otal work in process 22,<<<
RC22,<<
<
3olutions Manual, "hapter / +CC
Case 4-2# (C< minutes*
his case is diEcult9particularly part ,, which re4uires
analytical skills.
3ince there are no $eginning inventories, it makes no
di#erence whether the weighted7average or F&FD method is
used $y the company. Qou may choose to assign the pro$lem
specifying that the F&FD method $e used rather than the
weighted7average method.
). he computation of the cost of goods sold follows:
,ransferred
"n Conversion
Estimated completion )<<P ,<P
"omputation of e4uivalent
units:
"ompleted and transferred
out +<<,<<< +<<,<<<
ransferred in,
)<,<<< units V )<<P )<,<<<
"onversion,
)<,<<< units V ,<P ,,<<<
otal e4uivalent units +)<,<<< +<,,<<<
,ransferred
"n Conversion
0hole
Unit
Oork in process < <
"ost added during the
month
R,C,,@0,<<
<
R+<,B<@,0<
<
otal cost to $e accounted
for (a*
R,C,,@0,<<
<
R+<,B<@,0<
<
E4uivalent units (a$ove*
($* +)<,<<< +<,,<<<
"ost per e4uivalent unit,
(a* [ ($* R)B@.0<
\
R)<+.0< Y R+C<.<<
"ost of goods sold Y +<<,<<< units V R+C< per unit Y
3olutions Manual, "hapter / ,<<
R0B,<<<,<<<
3olutions Manual, "hapter / ,<)
Case 4-2# (continued*
+. he estimate of the percentage completion of ending work in
process inventories a#ects the unit costs of 'nished goods and
therefore of the cost of goods sold. 1ary 3tevens would like the
estimated percentage completion 'gures to $e increased for
the ending work in process. he higher the percentage of
completion of ending work in process, the higher the e4uivalent
units for the period and the lower the unit costs.
,. &ncreasing the percentage of completion can increase net
operating income $y reducing the cost of goods sold. o
increase net operating income $y R+<<,<<<, the cost of goods
sold would have to $e decreased $y R+<<,<<< from
R0B,<<<,<<< down to R0@,B<<,<<<.
he percentage of completion, S, a#ects the cost of goods
sold $y its e#ect on the unit cost, which can $e determined as
follows:
Knit cost Y R)B@.0< \
R+<,B<@,0<<
+<<,<<<\)<,<<<S
And the cost of goods sold can $e computed as follows:
"ost of goods sold Y +<<,<<< V Knit cost
3ince cost of goods sold must $e reduced down to
R0@,B<<,<<<, the unit cost must $e R+BC.<< (R0@,B<<,<<< [
+<<,<<< units*. hus, the re4uired percentage completion, S, to
o$tain the R+<<,<<< reduction in cost of goods sold can $e
found $y solving the following e4uation:
R+<,B<@,0<<
R)B@.0< \ Y R+BC.<<
+<<,<<< \ )<,<<<S
3olutions Manual, "hapter / ,<+
R+<,B<@,0<<
Y R+BC.<< 7 R)B@.0<
+<<,<<< \ )<,<<<S
R+<,B<@,0<<
Y R)<).0<
+<<,<<< \ )<,<<<S
+<<,<<< \ )<,<<<S )
Y
R+<,B<@,0<< R)<).0<
R+<,B<@,0<<
+<<,<<< \ )<,<<<S Y
R)<).0<
+<<,<<< \ )<,<<<S Y +<0,<<<
)<,<<<S Y +<0,<<< 7 +<<,<<<
)<,<<<S Y 0,<<<
0,<<<
S Y Y 0<P
)<,<<<
hus, changing the percentage completion to 0<P will
decrease cost of goods sold and increase net operating income
$y R+<<,<<< as veri'ed on the ne.t page.
3olutions Manual, "hapter / ,<,
,. (continued*
,ransferred "n Conversion
Estimated completion )<<P 0<P
"omputation of e4uivalent units:
"ompleted and transferred out +<<,<<< +<<,<<<
ransferred in, )<,<<< units V
)<<P )<,<<<
"onversion, )<,<<< units V 0<P 0,<<<
otal e4uivalent units +)<,<<< +<0,<<<
,ransferred "n Conversion
0hole
Unit
Oork in process < <
"ost added during the month R,C,,@0,<<<
R+<,B<@,0<
<
otal cost to $e accounted for (a* R,C,,@0,<<<
R+<,B<@,0<
<
E4uivalent units (a$ove* ($* +)<,<<< +<0,<<<
"ost per e4uivalent unit, (a* [ ($* R)B@.0<
\
R)<).0<
YR+BC.<
<
"ost of goods sold Y +<<,<<< units V R+BC per unit Y R0@,B<<,<<<
3olutions Manual, "hapter / ,</
,. (continued*
he following is an alternative approach to solving this
pro$lem:
o he additional income needed Y R+<<,<<< [ +<<,<<< units
Y R) per unit
o he cost transferred in cannot $e changed, so the conversion
cost must $e reduced from R)<+.0< to R)<).0< per EK.
o herefore, the e4uivalent units for conversion need to $e:
R+<,B<@,0<< [ R)<).0< per EK Y +<0,<<< EKs.
o +<0,<<< EKs X +<<,<<< units transferred out Y 0,<<< EK in
O&!
o 0,<<< EK [ )<,<<< units in O&! Y 0<P complete
3olutions Manual, "hapter / ,<0
/. Mary is in a very diEcult position. "olla$orating with 1ary
3tevens in su$verting the integrity of the accounting system is
unethical $y almost any standard. o put the situation in its
starkest light, 3tevens is suggesting that the production
managers lie to get their $onus. ;aving said that, the peer
pressure to go along in this situation may $e intense. &t is
diEcult on a personal level to ignore such peer pressure.
Moreover, Mary pro$a$ly prefers not to risk alienating people
she might need to rely on in the future. Dn the other hand,
Mary should $e careful not to accept at face value 1ary
3tevensG assertion that all of the other managers are Mdoing as
much as they can to pull this $onus out of the hat.N hose who
engage in unethical or illegal acts often rationalize their own
$ehavior $y e.aggerating the e.tent to which others engage in
the same kind of $ehavior. Dther managers may actually $e
very uncomforta$le Mpulling stringsN to make the target pro't
for the year.
From a $roader perspective, if the net pro'ts reported $y the
managers in a division cannot $e trusted, then the company
would $e foolish to $ase $onuses on the net pro't 'gures. A
$onus system $ased on divisional net pro'ts presupposes the
integrity of the accounting system. ;owever, the company
should perhaps reconsider how it determines the $onus. &t is
4uite common for companies to pay an Mall or nothingN $onus
contingent on making a particular target. his inevita$ly
creates powerful incentives to $end the rules when the target
has not 4uite $een attained. &t might $e $etter to have a $onus
without this Mall or nothingN feature. For e.ample, managers
could $e paid a $onus of .P of pro'ts a$ove target pro'ts
rather than a $onus that is a preset percentage of their $ase
salary. Knder such a policy, the e#ect of adding that last dollar
of pro'ts that just pushes the divisional net pro'ts over the
target pro't will add a few pennies to the managerGs
compensation rather than thousands of dollars. herefore, the
incentives to misstate the net operating income are reduced.
Ohy tempt people unnecessarilyF

3olutions Manual, "hapter / ,<2
Case 4-3$ (/0 minutes*
). he production report follows:
8uantit%
Schedul
e
Oork in process, April ) (materials
)<<P complete, conversion 2<P
complete*........................................................... /0<
8eceived from the preceding
department........................................................ ),C0<
otal units accounted for......................................... +,/<<
,ransferre
d "n
Material
s
Conversio
n
ransferred to 'nished goods................................ ),B<< ),B<< ),B<< ),B<<
Oork in process, April ,< (materials
<P complete, conversion ,0P
complete*................................................. 2<< 2<< < +)<
otal units accounted for......................................... +,/<< +,/<< ),B<< +,<)<
3olutions Manual, "hapter / ,<@
,otal
Cost
,ransferre
d "n
Material
s
Conversio
n
0hole
Unit
Oork in process, April ) RB,+<B R/,<2B R),CB< R +,)2<
"ost transferred in or added
,B,<@< )@,C/< 2,+)< ),,C+<
(a* R/2,+@B R++,<<B RB,)C< R)2,<B<
E4uivalent units ($* +,/<< ),B<< +,<)<
($* RC.)@ \ R/.00 \ RB.<< YR+).@+
3olutions Manual, "hapter / ,<B
Cost 2econciliation
,otal
Cost
,ransferre
d "n
Material
s
Conversio
n
ransferred to 'nished goods:
),B<< units V R+).@+ per unit.............................
R,C,<C
2 ),B<< ),B<< ),B<<
ransferred in cost, at RC.)@ per
EK.................................................................... 0,0<+ 2<<
Materials, at R/.00 per EK.................................. < <
"onversion, at RB.<< per EK............................... ),2B< +)<
otal work in process............................................. @,)B+
otal cost accounted for..........................................
R/2,+@
B
+. he unit cost 'gure in the report prepared $y the new assistant controller is high
$ecause none of the cost incurred during the month was assigned to the units in the
ending work in process inventory.
3olutions Manual, "hapter / ,<C
). he production report follows:
8uantit
%
Schedul
e
Oork in process, April ) (materials
)<<P complete, conversion 2<P
complete*........................................................... /0<
8eceived from the preceding dept. ),C0<
otal units to $e accounted for................................ +,/<<
,ransferre
d "n
Material
s
Conversio
n
From the $eginning inventory............................. /0< < )B<Z
8eceived and completed this monthZZ............... ),,0< ),,0< ),,0< ),,0<
Oork in process, April ,< (materials <P
complete, conversion ,0P complete*................. 2<< 2<< < +)<
otal units accounted for......................................... +,/<< ),C0< ),,0< ),@/<
Z /0< V ()<<P X 2<P* Y )B<
ZZ ),C0< units X 2<< units Y ),,0< units
3olutions Manual, "hapter / ,)<
,otal
Cost
,ransferre
d "n
Material
s
Conversio
n
0hole
Unit
Oork in process, April )
R
B,+<B
"ost transferred in or added
(a* ,B,<@< R)@,C/< R2,+)< R),,C+<
R/2,+@
B
E4uivalent units ($* ),C0< ),,0< ),@/<
($* RC.+< \ R/.2< \ RB.<< YR+).B<
3olutions Manual, "hapter / ,))
Cost 2econciliation
,otal
Cost
,ransferre
d "n
Material
s
Conversio
n
inventory RB,+<B
"onversion, at RB per EK
),//< )B<
inventory C,2/B
Knits started and completed:
),,0< units V R+).B< per unit
+C,/,< ),,0< ),,0< ),,0<
otal cost transferred to 'nished
goods ,C,<@B
ransferred in, at RC.+< per EK
0,0+< 2<<
Materials, at R/.2< per EK < <
"onversion, at RB.<< per EK
),2B< +)<
otal work in process @,+<<
3olutions Manual, "hapter / ,)+
otal cost accounted for R/2,+@B
3olutions Manual, "hapter / ,),
+. he e#ects of the cost7cutting will tend to show up more under
the F&FD method. he reason is that the F&FD method keeps the
costs of the current period separate from the costs of prior
periods. hus, under the F&FD method, management will $e
a$le to see the e#ect of price increases on unit costs without
any distorting in-uence from what has happened in the past.
Knder the weighted7average method, however, costs carried
over from the prior period are averaged in with costs of the
current period, which will tend to reduce somewhat the impact
of increased materials prices on current period unit costs.
3olutions Manual, "hapter 0 +))
,roup E%ercise 4-32
he answer to this e.ercise will depend on the industry that the
students select to study.
3olutions Manual, "hapter 0 +)+
Chapter 5
Cost Behavior2 Anal)sis and 6se
5-1
a. Iaria$le cost: A varia$le cost remains
constant on a per unit $asis, $ut
changes in total in direct relation to
changes in volume.
$. Fi.ed cost: A '.ed cost remains
constant in total amount, $ut changes,
if e.pressed on a per unit $asis,
inversely with changes in volume.
c. Mi.ed cost: A mi.ed cost contains $oth
varia$le and '.ed cost elements.
5-2
a. Knit '.ed costs decrease as volume
increases.
$. Knit varia$le costs remain constant as
volume increases.
c. otal '.ed costs remain constant as
volume increases.
d. otal varia$le costs increase as volume
increases.
5-3
a. "ost $ehavior: "ost $ehavior refers to
the way in which costs change in
response to changes in a measure of
activity such as sales volume,
production volume, or orders
processed.
$. 8elevant range: he relevant range is
the range of activity within which
assumptions a$out varia$le and '.ed
cost $ehavior are valid.
5-4 An activity $ase is a measure of
whatever causes the incurrence of a
varia$le cost. E.amples of activity $ases
include units produced, units sold, letters
typed, $eds in a hospital, meals served in
a cafe, service calls made, etc.
5-5
a. Iaria$le cost: A varia$le cost remains
increases or decreases in total in direct
relation to changes in activity.
$. Mi.ed cost: A mi.ed cost is a cost that
contains $oth varia$le and '.ed cost
elements.
c. 3tep7varia$le cost: A step7varia$le cost
is a cost that is incurred in large
chunks, and which increases or
decreases only in response to fairly
wide changes in activity.
5- he linear assumption is
reasona$ly valid providing that the cost
formula is used only within the relevant
range.
5-! A discretionary '.ed cost has a
fairly short planning horizon9usually a
year. 3uch costs arise from annual
decisions $y management to spend in
certain '.ed cost areas, such as
advertising, research, and management
development. A committed '.ed cost has
3olutions Manual, "hapter 0 +),
Cost
Activity
Mixed Cost
Variable Cost
Step-Variable Cost
a long planning horizon9generally many
years. 3uch costs relate to a companyGs
investment in facilities, e4uipment, and
$asic organization. Dnce such costs have
$een incurred, a company $ecomes
Mlocked inN for many years.
3olutions Manual, "hapter 0 +)/
5-"
a. "ommitted d. "ommitted
$. >iscretionary e. "ommitted
c. >iscretionary f. >iscretionary
5-# Qes. As the anticipated level of
activity changes, the level of '.ed costs
needed to support operations will also
change. Most '.ed costs are adjusted
upward and downward in large steps,
rather than $eing a$solutely '.ed at one
level for all ranges of activity.
5-1$ he high7low method uses only two
points to determine a cost formula. hese
two points are likely to $e less than typical
since they represent e.tremes of activity.
5-11 A mi.ed cost can $e e.pressed in
formula form as Q Y a \ $S. &n cost
analysis, the MaN term represents the '.ed
cost element, and the M$N term represents
the varia$le cost element per unit of
activity.
5-12 he term Mleast7s4uares
regressionN means that the sum of the
s4uares of the deviations from the plotted
points on a graph to the regression line is
smaller than could $e o$tained from any
other line that could $e 'tted to the data.
5-13 Drdinary single least7s4uares
regression analysis is used when a
varia$le cost is a function of only a single
factor. &f a cost is a function of more than
one factor, multiple regression analysis
should $e used to analyze the $ehavior of
the cost.
5-14 he contri$ution approach income
statement organizes costs $y $ehavior,
'rst deducting varia$le e.penses to o$tain
contri$ution margin, and then deducting
'.ed e.penses to o$tain net operating
income. he traditional approach
organizes costs $y function, such as
production, selling, and administration.
Oithin a functional area, '.ed and varia$le
costs are intermingled.
5-15 he contri$ution margin is total
sales revenue less total varia$le e.penses.
"hapter 0
"ost ?ehavior: Analysis and
Kse
3olutions to 6uestions
07)
,. Iaria$le cost: A varia$le cost is one
that remains constant on a per unit
$asis, $ut which changes in total in
direct relationship to changes in
volume.
,. Fi.ed cost: A '.ed cost is one that
remains constant in total amount,
$ut which changes, if e.pressed
on a per unit $asis, inversely with
changes in volume.
/. Mi.ed cost: A mi.ed cost is a cost
that contains $oth varia$le and
'.ed cost elements.
07+
3olutions Manual, "hapter 0 +)0
Knit '.ed costs will decrease as volume
increases.
+. Knit varia$le costs will remain
constant as volume increases.
,. otal '.ed costs will remain
constant as volume increases.
/. otal varia$le costs will increase as
volume increases.
07,
,. "ost $ehavior: "ost $ehavior can $e
de'ned as the way in which costs
change in response to changes in
some underlying activity, such as sales
volume, production volume, or orders
processed.
). 8elevant range: he relevant range
can $e de'ned as that range of activity
within which assumptions relative to
varia$le and '.ed cost $ehavior are
valid.
07/ An activity $ase is a
measure of whatever causes
the incurrence of a varia$le
cost. E.amples of activity
$ases include units produced,
units sold, letters typed, $eds
in a hospital, meals served in
a cafe, service calls made,
etc.
070 (3ee the e.hi$it $elow.*
+. Iaria$le cost: A varia$le cost remains
increases or decreases in total in direct
relationship to changes in activity.
3olutions Manual, "hapter 0 +)2
,.
,. Mi.ed cost: A mi.ed cost is a cost that
contains $oth varia$le and '.ed cost
elements.
/. 3tep7varia$le cost: A step7varia$le cost
is a cost that is incurred in large
chunks, and which increases or
decreases only in response to fairly
wide changes in activity.
072 he linear assumption is
reasona$ly valid providing the
cost formula is used only
within the relevant range.
07@ A discretionary '.ed cost
is one that has a fairly short
planning horizon9usually a
year. 3uch costs arise from
annual decisions $y
management to spend in
certain '.ed cost areas, such
as advertising, research, and
management development. A
committed '.ed cost is one
that has a long planning
horizon9generally many
years. 3uch costs relate to a
companyGs investment in
facilities, e4uipment, and
$asic organization. Dnce such
costs have $een incurred, a
company $ecomes Mlocked inN
to the decision for many
years.
07B
o "ommitted d. "ommitted
,. >iscretionary e. "ommitted
/. >iscretionary f. >iscretionary
07C Qes. As the anticipated
level of activity changes, the
level of discretionary '.ed
costs needed to support
operations will also change. &n
essence, '.ed costs should $e
viewed as going upward and
downward in $road steps,
rather than $eing a$solutely
'.ed at one level for all
ranges of activity. he same
concept is true with
committed '.ed costs,
although the steps are often
much wider than for
discretionary '.ed costs.
07)< he major disadvantage
of the high7low method is that
it uses only two points in
determining a cost formula
and these two points are likely
to $e less than typical since
they represent e.tremes of
activity.
3olutions Manual, "hapter 0 +)@
07)) he high7low method,
the scattergraph method, and
the least7s4uares regression
method are used to analyze
mi.ed costs. he least7
s4uares regression method is
generally considered to $e
most accurate, since it derives
the '.ed and varia$le
elements of a mi.ed cost $y
means of statistical analysis.
he scattergraph method
derives these elements $y
visual inspection only, and the
high7low method utilizes only
two points in doing a cost
analysis, making it the least
accurate of the three
methods.
07)+ A regression line can $e
e.pressed in formula form as
Q Y a \ $S. &n cost analysis,
the MaN term represents the
'.ed cost element, and the
M$N term represents the
varia$le cost element per unit
of activity.
07), he '.ed cost element is
represented $y the point
where the regression line
intersects the vertical a.is on
the graph. he varia$le cost
per unit is represented $y the
slope of the line.
07)/ he term Mleast7s4uares
regressionN means that the
sum of the s4uares of the
deviations from the plotted
points on a graph to the
regression line is smaller than
could $e o$tained from any
other line that could $e 'tted
to the data.
07)0 Drdinary single least7
s4uares regression analysis is
used when a varia$le cost is a
function of only a single
factor. &f a cost is a function of
more than one factor, then
multiple regression analysis
must $e used to accurately
analyze the $ehavior of the
cost.
07)2 he contri$ution approach to the
income statement organizes costs $y
$ehavior, 'rst deducting varia$le
e.penses to o$tain contri$ution margin,
and then deducting '.ed e.penses to
o$tain net income. he traditional
approach organizes costs $y function,
such as production, selling, and
administration. Oithin a functional area,
'.ed and varia$le costs are intermingled.
07)@ he contri$ution margin
is total sales revenue less
total varia$le e.penses.
3olutions Manual, "hapter 0 +)B
)
.
Cups of Co#ee Served
in a 0ee&
5A::: 5A4:: 5A5::
Fi.ed cost................................. R),+<< R),+<< R),+<
<
Iaria$le cost............................ //< /2+ /B/
otal cost.................................. R),2/< R),22+ R),2B
/
"ost per cup of co#ee
served Z.................................
R<.B+< R<.@C) R<.@2
0
Z otal cost [ cups of co#ee served in a week
+. he average cost of a cup of co#ee declines as the num$er of
cups of co#ee served increases $ecause the '.ed cost is
spread over more cups of co#ee.
3olutions Manual, "hapter 2 C
E%ercise 5-2 (/0 minutes*
).
Units
Shipped
Shipping
Expense
;igh activity level (5une*... B R+,@<<
=ow activity level (5uly*..... + ),+<<
"hange............................. 2 R),0<<
Iaria$le cost element:
"hange in e.pense R),0<<
Y YR+0< per unit.
"hange in activity 2 units
Fi.ed cost element:
3hipping e.pense at high activity level............... R+,@<<
=ess varia$le cost element (R+0< per unit V B
units*................................................................ +,<<<
otal '.ed cost.................................................... R@<<
he cost formula is R@<< per month plus R+0< per unit shipped
or
Q Y R@<< \ R+0<S,
where S is the num$er of units shipped.
+. a. 3ee the scattergraph on the following page.
$. (Aote: 3tudentsG answers will vary due to the imprecision of
this method of estimating varia$le and '.ed costs.*
otal cost at 0 units shipped per month ]a
point falling on the regression line in (a*^........ R+,<<<
=ess '.ed cost element (intersection of the Q
a.is*................................................................ ),<<<
Iaria$le cost element........................................ R),<<<
R),<<< [ 0 units Y R+<< per unit.
he cost formula is R),<<< per month plus R+<< per unit
shipped or
Q Y R),<<< \ R+<<S.
where S is the num$er of units shipped.
3olutions Manual, "hapter 2 )<
+. a. he scattergraph would $e:
,. he cost of shipping units is likely to depend on the weight and
volume of the units and the distance traveled as well as on the
num$er of units shipped. &n addition, higher cost shipping
might $e necessary in some situations to meet a deadline.
3olutions Manual, "hapter 2 ))
R<
R0<<
R),<<<
R),0<<
R+,<<<
R+,0<<
R,,<<<
< + / 2 B )<
6nits Shipped
S
h
i
p
p
i
n
g

E
%
p
e
n
s
e
Q
S
).
Month
Units
Shipped
'B+
Shipping
Expense '-+
5anuary , R),B<<
Fe$ruary 2 R+,,<<
March / R),@<<
April 0 R+,<<<
May @ R+,,<<
5une B R+,@<<
5uly + R),+<<
3tatistical software or a spreadsheet application such as E.cel
can $e used to compute the slope and intercept of the least7
s4uares regression line for the a$ove data. he results are:
&ntercept ('.ed cost*.............. RC))
3lope (varia$le cost per
unit*.....................................
R+)B
8
+
........................................... <.C)
herefore, the cost formula is RC)) per month plus R+)B per
unit shipped or
Q Y RC)) \ R+)BS.
Aote that the 8
+
is <.C), which means that C)P of the variation
in shipping costs is e.plained $y the num$er of units shipped.
his is a very high 8
+
and indicates a good 't.
+. Variable
Cost per
Unit
Fixed
Cost per
Month
6uick7and7dirty scattergraph
method........................................... R+<< R),<<<
;igh7low method............................... R+0< R@<<
=east7s4uares regression method..... R+)B RC))
Aote that the high7low method gives estimates that are 4uite
di#erent from the estimates provided $y least7s4uares
regression.
3olutions Manual, "hapter 2 )+
). $ccupanc
%/!a%s
Electrical
Costs
;igh activity level
(August*......................... +,/<2 R0,)/B
=ow activity level
(Dcto$er*....................... )+/ ),0BB
"hange............................ +,+B+ R,,02<
Iaria$le cost Y "hange in cost [ "hange in activity
Y R,,02< [ +,+B+ occupancy7days
Y R).02 per occupancy7day
otal cost (August*................................................ R0,)/B
Iaria$le cost element
(R).02 per occupancy7day V +,/<2 occupancy7
days*.................................................................. ,,@0,
Fi.ed cost element................................................ R),,C0
+. Electrical costs may re-ect seasonal factors other than the just
the variation in occupancy days. For e.ample, common areas
such as the reception area must $e lighted for longer periods
during the winter than in the summer. his will result in
seasonal -uctuations in the '.ed electrical costs. Additionally,
the '.ed costs will $e a#ected $y the num$er of days in a
month. &n other words, costs like the costs of lighting common
areas are varia$le with respect to the num$er of days in the
month, $ut are '.ed with respect to how many rooms are
occupied during the month. Dther, less systematic, factors may
also a#ect electrical costs such as the frugality of individual
guests. 3ome guests will turn o# lights when they leave a
room. Dthers will not.
3olutions Manual, "hapter 2 ),
).
;E A=!&AE ;DK3E, &A".
&ncome 3tatement93ki >epartment
3ales.................................................................
R)0<,<<
<
=ess varia$le e.penses:
"ost of goods sold (+<< pairsZ V R/0< per
pair*............................................................. RC<,<<<
3elling e.penses (+<< pairs V R0< per pair*. . . )<,<<<
Administrative e.penses (+<P V R)<,<<<*..... +,<<< )<+,<<<
"ontri$ution margin.......................................... /B,<<<
=ess '.ed e.penses:
3elling e.penses
]R,<,<<< X (+<< pairs V R0< per pair*^......... +<,<<<
Administrative e.penses (B<P V R)<,<<<*..... B,<<< +B,<<<
Aet operating income........................................ R +<,<<<
ZR)0<,<<< [ R@0< per pair Y +<< pairs.
+. 3ince +<< pairs of skis were sold and the contri$ution margin
totaled R/B,<<< for the 4uarter, the contri$ution of each pair of
skis toward covering '.ed costs and toward earning of pro'ts
was R+/< (R/B,<<< [ +<< pairs Y R+/< per pair*. Another way
to compute the R+/< is:
3elling price per pair...................... R@0<
"ost per pair................................ R/0<
3elling e.penses.......................... 0<
Administrative e.penses
(R+,<<< [ +<< pairs*................. )< 0)<
"ontri$ution margin per pair.......... R+/<
3olutions Manual, "hapter 2 )/
E%ercise 5- (+< minutes*
). he companyGs varia$le cost per unit would $e:
R)B<,<<<
YR2 per unit.
,<,<<< units
&n accordance with the $ehavior of varia$le and '.ed costs, the
completed schedule would $e:
Units produced and sold
6:A::: 7:A::: ;:A:::
otal costs:
Iaria$le costs..........
R)B<,<<
< R+/<,<<<
R,<<,<<
<
Fi.ed costs............... ,<<,<<< ,<<,<<< ,<<,<<<
otal costs................
R/B<,<<
< R0/<,<<<
R2<<,<<
<
"ost per unit:
Iaria$le cost............ R 2.<< R 2.<< R 2.<<
Fi.ed cost................. )<.<< @.0< 2.<<
otal cost per unit.... R)2.<< R),.0< R)+.<<
+. he companyGs income statement in the contri$ution format
would $e:
3ales (/0,<<< units V R)2 per unit*.................. R@+<,<<<
=ess varia$le e.penses (/0,<<< units V R2
per unit*......................................................... +@<,<<<
"ontri$ution margin.......................................... /0<,<<<
=ess '.ed e.pense............................................ ,<<,<<<
Aet operating income....................................... R)0<,<<<
3olutions Manual, "hapter 2 )0
). a. >i#erence in cost:
Monthly operating costs at B<P occupancy:
/0< $eds V Bi#erence in cost................................................. R)B,C<<
>i#erence in activity:
Bi#erence in activity............................................. +,@<<
"hange in cost R)B,C<<
Y YR@ per $ed7day.
"hange in activity +,@<< $ed7days
$. Monthly operating costs at B<P occupancy
(a$ove*.................................................................
R,/0,2<
<
=ess varia$le costs:
,2< $eds V ,< days V R@ per $ed7day................. @0,2<<
Fi.ed operating costs per month.............................
R+@<,<<
<
+. /0< $eds V @<P Y ,)0 $eds occupied.
Fi.ed costs.......................................................... R+@<,<<<
Iaria$le costs: ,)0 $eds V ,< days V R@ per
$ed7day............................................................ 22,)0<
otal e.pected costs............................................ R,,2,)0<
E%ercise 5-" (+< minutes*
).
@uest
/
!a%s
Custodia
l
Supplies
Expense
;igh activity level (5uly*............ )+,<<< R),,0<<
=ow activity level (March*.......... /,<<< @,0<<
"hange...................................... B,<<< R 2,<<<
"hange in e.pense R2,<<<
Y YR<.@0 per guest7day
"hange in activity B,<<< guest7days
Fi.ed cost element:
"ustodial supplies e.pense at high activity
level.............................................................. R),,0<<
=ess varia$le cost element:
)+,<<< guest7days V R<.@0 per guest7day.... C,<<<
otal '.ed cost................................................ R/,0<<
he cost formula is R/,0<< per month plus R<.@0 per guest7day
or
Q Y R/,0<< \ R<.@0 S.
+. "ustodial supplies e.pense for )),<<< guest7days:
Iaria$le cost:
)),<<< guest7days V R<.@0 per
guest7day............................................. R B,+0<
Fi.ed cost................................................ /,0<<
otal cost.................................................R)+,@0<
3olutions Manual, "hapter 2 )@
E%ercise 5-# (,< minutes*
). he scattergraph appears $elow:
3olutions Manual, "hapter 2 )B
R<
R+,<<<
R/,<<<
R2,<<<
RB,<<<
R)<,<<<
R)+,<<<
R)/,<<<
R)2,<<<
< +,<<< /,<<< 2,<<< B,<<< )<,<<< )+,<<< )/,<<<
1uest7>ays
"
u
s
t
o
d
i
a
l

3
u
p
p
l
i
e
s

"
o
s
t
Q
S
+. (Aote: 3tudentsG answers will vary considera$ly due to the
inherent lack of precision and su$jectivity of the 4uick7and7dirty
method.*
otal costs at @,0<< guest7days per month ]a
point falling on the line in ()*^............................ RC,@0<
=ess '.ed cost element (intersection of the Q
a.is*................................................................... ,,@0<
Iaria$le cost element........................................... R2,<<<
R2,<<< [ @,0<< guest7days Y R<.B< per guest7day.
he cost formula is therefore R,,@0< per month, plus R<.B< per
guest7day or
Q Y R,,@0< \ R<.B<S,
where S is the num$er of guest7days.
,. he high7low method would not provide an accurate cost
formula in this situation since a line drawn through the high
and low points would have a slope that is too -at and would $e
placed too high, cutting the cost a.is at a$out R/,0<< per
month. he high and low points are not representative of all of
the data in this situation.
3olutions Manual, "hapter 2 )C
). he scattergraph appears $elow:
3olutions Manual, "hapter 2 +<
R<
R)<,<<<
R+<,<<<
R,<,<<<
R/<,<<<
R0<,<<<
R2<,<<<
< +,<<< /,<<< 2,<<< B,<<< )<,<<< )+,<<< )/,<<<
Knits !roduced
!
r
o
c
e
s
s
i
n
g

"
o
s
t
Q
S
E%ercise 5-1$ (continued*
+. (3tudentsG answers will vary considera$ly due to the inherent
imprecision of the 4uick7and7dirty method.*
he appro.imate monthly '.ed cost is R,<,<<<9the point
where the line intersects the cost a.is. he varia$le cost per
unit processed can $e estimated using the B,<<<7unit level of
activity, which falls on the line:
otal cost at an B,<<<7unit level of activity...... R/2,<<<
=ess '.ed costs............................................... ,<,<<<
Iaria$le costs at an B,<<<7unit level of
activity.......................................................... R)2,<<<
R)2,<<< [ B,<<< units Y R+ per unit.
herefore, the cost formula is R,<,<<< per month plus R+ per
unit processed.
D$serve from the scattergraph that if the company used the
high7low method to determine the slope of the regression line,
the line would $e too steep. his would result in
underestimating '.ed costs and overestimating the varia$le
cost per unit.
3olutions Manual, "hapter 2 +)
).
Cilometer
s !riven
,otal
Annual
Cost3
;igh level of activity...................... )<0,<<< R)),C@<
=ow level of activity....................... @<,<<< C,,B<
"hange.......................................... ,0,<<< R+,0C<
)<0,<<< kilometers V R<.))/ per kilometer Y
R)),C@<
@<,<<< kilometers V R<.),/ per kilometer Y
RC,,B<
Iaria$le cost per kilometer:
"hange in cost R+,0C<
Y YR<.<@/ per kilometer.
"hange in activity ,0,<<< kilometers
Fi.ed cost per year:
otal cost at )<0,<<< kilometers................ R)),C@<
=ess varia$le portion:
)<0,<<< kilometers V R<.<@/ per
kilometer................................................ @,@@<
Fi.ed cost per year.................................... R/,+<<
+. Q Y R/,+<< \ R<.<@/S
,. Fi.ed cost...................................................... R/,+<<
Iaria$le cost:
B<,<<< kilometers V R<.<@/ per
kilometer.................................................... 0,C+<
otal annual cost........................................... R)<,)+<
3olutions Manual, "hapter 2 ++
).
0ee&
Units
'B+
,otal Etching Cost
'-+
) / )B
+ , )@
, B +0
/ 2 +<
0 @ +/
2 + )2
&ntercept ('.ed cost*.............. 3Fr )+.,+
unit*.....................................
3Fr ).0/
8
+
........................................... <.C,
herefore, the cost formula is 3Fr )+.,+ per month plus 3Fr
).0/ per unit etched or
Q Y 3Fr )+.,+ \ 3Fr ).0/.
Aote that the 8
+
is <.C,, which means that C,P of the variation
in etching costs is e.plained $y the num$er of units etched.
his is a very high 8
+
and indicates a good 't.
+. Q Y 3Fr )+.,+ \ 3Fr ).0/S
,. otal e.pected etching cost if 0 units are processed:
Iaria$le cost: 0 units V 3Fr ).0/ per
unit................................................... 3Fr @.@<
Fi.ed cost............................................ )+.,+
otal e.pected cost.............................. 3Fr +<.<+
3olutions Manual, "hapter 2 +,
). "ost of goods sold...............Iaria$le
Advertising e.pense............Fi.ed
3hipping e.pense................Mi.ed
3alaries and commissions....Mi.ed
&nsurance e.pense...............Fi.ed
>epreciation e.pense..........Fi.ed
+. Analysis of the mi.ed e.penses:
Units
Shipping
Expense
Salaries and
Commission
Expense
;igh level of activity.... 0,<<< AR,B,<<< ARC<,<<<
=ow level of activity..... /,<<< ,/,<<< @B,<<<
"hange........................ ),<<< AR /,<<< AR)+,<<<
"hange in cost
Iaria$le rateY
"hange in activity
AR/,<<<
3hipping e.pense: YAR/ per unit.
),<<< units
AR)+,<<<
3alaries and "ommission E.pense: YAR)+ per unit.
),<<< units
Fi.ed cost element:
Shipping
Expense
Salaries and
Commission
Expense
"ost at high level of
activity............................. AR,B,<<< ARC<,<<<
=ess varia$le cost
element:
0,<<< units V AR/ per
unit................................ +<,<<<
0,<<< units V AR)+ per
unit................................ 2<,<<<
Fi.ed cost element.............. AR)B,<<< AR,<,<<<
3olutions Manual, "hapter 2 +/
he cost formulas are:
3hipping e.pense:
AR)B,<<< per month plus AR/ per unit
or
Q Y AR)B,<<< \ AR/ S.
3alaries and "omm. e.pense:
AR,<,<<< per month plus AR)+ per unit
or
Q Y AR,<,<<< \ AR)+ S.
,.
Morrise% > Bro1nA )td*
"ncome Statement
For the Month Ended September 6:
3ales revenue
(0,<<< units V AR)<< per unit*............
AR0<<,<<
<
"ost of goods sold
(0,<<< units V AR2< per unit*..........
AR,<<,<<
<
3hipping e.pense
(0,<<< units V AR/ per unit*............. +<,<<<
3alaries and commissions e.pense
(0,<<< units V AR)+ per unit*........... 2<,<<< ,B<,<<<
"ontri$ution margin.............................. )+<,<<<
=ess '.ed e.penses:
Advertising e.pense............................ +),<<<
3hipping e.pense................................ )B,<<<
3alaries and commissions e.pense..... ,<,<<<
&nsurance e.pense.............................. 2,<<<
>epreciation e.pense......................... )0,<<< C<,<<<
Aet operating income............................
AR
,<,<<<
3olutions Manual, "hapter 2 +0
). MA8O&"UG3 !&AAD3, &A".
&ncome 3tatement
For the Month of August
3ales (/< pianos V R,,)+0 per piano*........
R)+0,<<
<
=ess cost of goods sold
(/< pianos V R+,/0< per piano*...............
CB,<<
<
1ross margin............................................. +@,<<<
3elling e.penses:
Advertising............................................ R @<<
3ales salaries and commissions
]RC0< \ (BP V R)+0,<<<*^................. )<,C0<
>elivery of pianos
(/< pianos V R,< per piano*............... ),+<<
Ktilities................................................. ,0<
>epreciation of sales facilities.............. B<<
otal selling e.penses.............................. )/,<<<
Administrative e.penses:
E.ecutive salaries................................. +,0<<
&nsurance.............................................. /<<
"lerical
]R),<<< \ (/< pianos V R+< per
piano*^................................................ ),B<<
>epreciation of oEce e4uipment.......... ,<<
otal administrative e.penses................. 0,<<<
otal operating e.penses...........................
)C,<<
<
Aet operating income................................
R
B,<<<
3olutions Manual, "hapter 2 +2
+. MA8O&"UG3 !&AAD3, &A".
&ncome 3tatement
For the Month of August
,otal
Per
Piano
3ales (/< pianos V R,,)+0 per piano*........... R)+0,<<< R,,)+0
"ost of goods sold
(/< pianos V R+,/0< per piano*................ CB,<<< +,/0<
3ales commissions (BP V R)+0,<<<*.......... )<,<<< +0<
>elivery of pianos (/< pianos V R,< per
piano*....................................................... ),+<< ,<
"lerical (/< pianos V R+< per piano*.......... B<< +<
otal varia$le e.penses................................. ))<,<<< +,@0<
"ontri$ution margin...................................... )0,<<< R ,@0
=ess '.ed e.penses:
Advertising................................................. @<<
3ales salaries.............................................. C0<
Ktilities....................................................... ,0<
>epreciation of sales facilities.................... B<<
E.ecutive salaries....................................... +,0<<
&nsurance.................................................... /<<
"lerical....................................................... ),<<<
>epreciation of oEce e4uipment................ ,<<
otal '.ed e.penses...................................... @,<<<
Aet operating income................................... R B,<<<
,. Fi.ed costs remain constant in total $ut vary on a per unit $asis
inversely with changes in the activity level. As the activity level
increases, for e.ample, the '.ed costs will decrease on a per
unit $asis. 3howing '.ed costs on a per unit $asis on the
income statement might mislead management into thinking
that the '.ed costs $ehave in the same way as the varia$le
costs. hat is, management might $e misled into thinking that
the per unit '.ed costs would $e the same regardless of how
many pianos were sold during the month. For this reason, '.ed
costs generally are shown only in totals on a contri$ution
format income statement.
3olutions Manual, "hapter 2 +@
).
,erm
(umber of
Sections
$#ered 'B+ ,otal Cost '-+
Fall, last year......... / R)<,<<<
Ointer, last year. . . 2 R)/,<<<
3ummer, last
year.................... + R@,<<<
Fall, this year......... 0 R),,<<<
Ointer, this year. . . , RC,0<<
A spreadsheet application such as E.cel or a statistical software
package can $e used to compute the slope and intercept of the
least7s4uares regression line for the a$ove data. he results
are:
&ntercept ('.ed cost*.............. R,,@<<
unit*.....................................
R),@0<
8
+
........................................... <.C0
herefore, the varia$le cost is R),@0< per section and the '.ed
cost is R,,@<< per term.
Aote that the 8
+
is <.C0, which means that C0P of the variation
in cost is e.plained $y the num$er of sections. his is a very
high 8
+
and indicates a very good 't.
+. Q Y R,,@<< \ R),@0<S
,. E.pected total cost would $e:
Fi.ed cost................................................... R,,@<<
Iaria$le cost (B sections V R),@0< per
section*.................................................... )/,<<<
otal cost.................................................... R)@,@<<
he pro$lem with using the cost formula from (+* to derive total
cost is that an activity level of B sections may lie outside the
relevant range9the range of activity within which the '.ed
cost is appro.imately R,,@<< per term and the varia$le cost is
3olutions Manual, "hapter 2 +B
appro.imately R),@0< per section o#ered. hese
appro.imations appear to $e reasona$ly accurate within the
range of + to 2 sections, $ut they may $e invalid outside this
range.
3olutions Manual, "hapter 2 +C
/.
3olutions Manual, "hapter 2 ,<
R<
R+,<<<
R/,<<<
R2,<<<
RB,<<<
R)<,<<<
R)+,<<<
R)/,<<<
R)2,<<<
< ) + , / 0 2 @
4um'er o7 Sections
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C
o
s
t
Q
S
)
.
a
.
, c
.
)) e
.
/ g
.
+ i
.
C
$
.
2 d
.
) f. )< h
.
@
+. Oithout a knowledge of the underlying cost $ehavior patterns,
it would $e diEcult if not impossi$le for a manager to properly
analyze the 'rmGs cost structure. he reason is that all costs
donGt $ehave in the same way. Dne cost might move in one
direction as a result of a particular action, and another cost
might move in an opposite direction. Knless the $ehavior
pattern of each cost is clearly understood, the impact of a
'rmGs activities on its costs will not $e known until after the
activity has occurred.
3olutions Manual, "hapter 2 ,)
&ro'lem 5-1! (/0 minutes*
). ;igh7low method:
(umber
of
Scans
Utilities
Cost
;igh level of
activity.................. )0< R/,<<<
=ow level of
activity.................. 2< +,+<<
"hange.................... C< R),B<<
"hange in cost R),B<<
Iaria$le rate: Y YR+< per scan
"hange in activity C< scans
Fi.ed cost: otal cost at high level of activity...... R/,<<<
=ess varia$le element:
)0< scans V R+< per scan.............. ,,<<<
Fi.ed cost element............................ R),<<<
herefore, the cost formula is: Q Y R),<<< \ R+<S.
+. 3cattergraph method (see the scattergraph on the following
page*:
(Aote: 3tudentsG answers will vary due to the inherent
he line intersects the cost a.is at a$out R),+<<. he varia$le
cost can $e estimated as follows:
otal cost at )<< scans (a point that falls on the
line*................................................................... R,,<<<
=ess the '.ed cost element................................. ),+<<
Iaria$le cost element (total*................................ R),B<<
R),B<< [ )<< scans Y R)B per scan.
herefore, the cost formula is: Q Y R),+<< \ R)BS.
3olutions Manual, "hapter 2 ,+
he completed scattergraph:
3olutions Manual, "hapter 2 ,,
R<
R0<<
R),<<<
R),0<<
R+,<<<
R+,0<<
R,,<<<
R,,0<<
R/,<<<
R/,0<<
< +< /< 2< B< )<< )+< )/< )2<
4um'er o7 Scans
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Q
&ro'lem 5-1" (,< minutes*
). he least7s4uares regression method:
Month
(umber of Scans
'B+
Utilities Cost
'-+
5anuary 2< R+,+<<
Fe$ruary @< R+,2<<
March C< R+,C<<
April )+< R,,,<<
May )<< R,,<<<
5une ),< R,,2<<
5uly )0< R/,<<<
August )/< R,,2<<
3eptem$e
r ))< R,,)<<
Dcto$er B< R+,0<<
or can $e used to compute the slope and intercept of the least7
&ntercept ('.ed cost*.............. $1,1!1
unit*.................................... $18"18
8
+
........................................... 0"#!
herefore, the varia$le cost of power per scan is R)B.)B and
the '.ed cost of power is R),)@) per month and the cost
formula is:
Q Y R),)@) \ R)B.)BS.
Aote that the 8
+
is <.C@, which means that C@P of the variation
in utilities cost is e.plained $y the num$er of scans. his is a
very high 8
+
and indicates a very good 't.
+. As shown in the graph in part (+* of pro$lem 07)@, the high and
low points in this case fall in such a way they are not
representative of all points of cost data. A regression line drawn
through these two points would $e too steep and thus result in
an inaccurate cost formula. his is the major defect in the high7
low method% although it is simple to apply, the manager must
$e careful in its use or misleading information may result.
3olutions Manual, "hapter 2 ,/
). he scattergraph is presented $elow.
3olutions Manual, "hapter 2 ,0
R<
R0<<
R),<<<
R),0<<
R+,<<<
R+,0<<
R,,<<<
R,,0<<
R/,<<<
R/,0<<
R0,<<<
< ) + , / 0 2 @ B C )< )) )+ ), )/ )0 )2
-otal Mileage 8$$$9
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S
Q
+. (Aote: 3tudentsG answers will vary due to the inherent
he '.ed cost element can $e o$tained $y noting the point
where the line intersects the vertical (cost* a.is. As shown on
the scattergraph, this point is at appro.imately R+,0<< per
month. 1iven this 'gure, the varia$le cost element can $e
o$tained $y the following computation:
otal cost at )+,<<< miles driven per monthZ. . R/,<<<
=ess '.ed cost element................................... +,0<<
Iaria$le cost element...................................... R),0<<
ZAote that total costs at this point fall on the line.
Iaria$le cost R),0<<
Y YR<.)+0 per mile.
Aum$er of miles driven )+,<<< miles
herefore, the cost of operating the autos can $e e.pressed as
R+,0<< per month plus R<.)+0 per mile driven or
Q Y R+,0<< \ R<.)+0S.
3olutions Manual, "hapter 2 ,2
&ro'lem 5-2$ (,< minutes*
). =east7s4uares regression analysis:
Month
Miles
!riven
':::+ 'B+
,otal Cost
'-+
5anuary / R,,<<<
Fe$ruary B R,,@<<
March @ R,,,<<
April )+ R/,<<<
May 2 R,,,<<
5une )) R,,C<<
5uly )/ R/,+<<
August )< R,,2<<
3eptem$
er ), R/,)<<
Dcto$er )0 R/,/<<
&ntercept ('.ed cost per month*........... $2,$42
3lope (varia$le cost per thousand
miles*................................................ $120"8%
8
+
......................................................... 0"#6
herefore, the varia$le cost of operating the -eet of autos is
R)+<.B, per thousand miles driven or R<.)+) per mile
(rounded* and the '.ed cost is R+,0/+ per month.
Aote that the 8
+
is <.C2, which means that C2P of the variation
in the cost of operating the -eet of autos is e.plained $y the
num$er of miles driven. his is a very high 8
+
and indicates a
very good 't.
+. Q Y R+,0/+ \ R)+<.B,S (where S Y thousands of miles driven*.
3olutions Manual, "hapter 2 ,@
).
8uarter
Units
Sold
':::+ 'B+
Shipping
Expense '-+
Qear )7)
st
)< R))C,<<<
+
nd
)2 R)@0,<<<
,
rd
)B R)C<,<<<
/
th
)0 R)2/,<<<
Qear +7)
st
)) R),<,<<<
+
nd
)@ R)B0,<<<
,
rd
+< R+)<,<<<
/
th
), R)/@,<<<
&ntercept ('.ed cost per 4uarter*......... $%0,000
3lope (varia$le cost per thousand
units*................................................. $#,000
8
+
......................................................... 0"##8
herefore the cost formula for shipping e.pense is R,<,<<< per
4uarter plus RC,<<< per thousand units sold (RC.<< per unit* or
Q Y R,<,<<< \ RC.<<S.
where S is the num$er of units sold.
Aote that the 8
+
is <.CCB, which means that CC.BP of the
variation in shipping e.pense is e.plained $y the num$er of
units sold. his is an e.tremely high 8
+
and indicates an
e.cellent 't.
3olutions Manual, "hapter 2 ,B
+. M&=>EA "DM!AAQ
?udgeted &ncome 3tatement
For the First 6uarter, Qear ,
3ales ()+,<<< units V R)<< per unit*.....
R),+<<,<<
<
"ost of goods sold
()+,<<< units V R,0 unit*..................
R/+<,<<
<
3ales commission (2P V
R),+<<,<<<*...................................... @+,<<<
3hipping e.pense
()+,<<< units V RC per unit*............. )<B,<<<
otal varia$le e.penses.........................
2<<,<<
<
"ontri$ution margin............................... 2<<,<<<
=ess '.ed e.penses:
Advertising e.pense............................ +)<,<<<
3hipping e.pense................................ ,<,<<<
Administrative salaries........................ )/0,<<<
&nsurance e.pense.............................. C,<<<
>epreciation e.pense.......................... @2,<<<
otal '.ed e.penses..............................
/@<,<<
<
R
),<,<<<
3olutions Manual, "hapter 2 ,C
). MarchD)o1 9uneD<igh
EA::: Units =A::: Units
>irect materials cost _ R2 per
unit........................................... R ,2,<<< R 0/,<<<
>irect la$or cost _ R)< per unit. 2<,<<< C<,<<<
Manufacturing overhead costZ.... @B,<<< )<+,<<<
otal manufacturing costs........... )@/,<<< +/2,<<<
Add: Oork in process,
$eginning................................. C,<<< ,+,<<<
)B,,<<< +@B,<<<
>educt: Oork in process,
ending...................................... )0,<<< +),<<<
"ost of goods manufactured....... R)2B,<<< R+0@,<<<
Z"omputed $y working upwards through the statements.
+. Units
Produce
d
Cost
$bserved
5une9;igh level of activity...... C,<<< R)<+,<<<
March9=ow level of activity..... 2,<<< @B,<<<
"hange.................................... ,,<<< R+/,<<<
"hange in cost R+/,<<<
Y YRB.<< per unit
"hange in activity ,,<<< units
otal cost at the high level of activity....... R)<+,<<<
=ess varia$le cost element
(RB.<< per unit V C,<<< units*............... @+,<<<
Fi.ed cost element................................... R ,<,<<<
herefore, the cost formula is: R,<,<<< per month, plus RB.<<
per unit produced or
Q Y R,<,<<< \ RB.<<S.
3olutions Manual, "hapter 2 /<
,. he cost of goods manufactured if @,<<< units are produced:
>irect materials cost (@,<<< units V R2.<< per
unit*.............................................................. R /+,<<<
>irect la$or cost (@,<<< units V R)<.<< per
unit*.............................................................. @<,<<<
Manufacturing overhead cost:
Fi.ed portion.................................................
R,<,<<
<
Iaria$le portion (@,<<< units V RB.<< per
unit*........................................................... 02,<<< B2,<<<
otal manufacturing costs............................... )CB,<<<
Add: Oork in process, $eginning..................... <
)CB,<<<
>educt: Oork in process, ending..................... <
"ost of goods manufactured...........................
R)CB,<<
<
3olutions Manual, "hapter 2 /)
). Maintenance cost at the @0,<<< direct la$or7hour level of
activity can $e isolated as follows:
)evel of Activit%
;:A::: !)< F;A::: !)<
otal factory overhead cost.............
`)/,+0<,<<
< `)@,2+0,<<<
>educt:
&ndirect materials _ `)<< per
>=;Z........................................... 0,<<<,<<< @,0<<,<<<
8ent.............................................. 2,<<<,<<< 2,<<<,<<<
Maintenance cost............................ ` ,,+0<,<<< ` /,)+0,<<<
Z `0,<<<,<<< [ 0<,<<< >=; Y `)<< per >=;
+. ;igh7low analysis of maintenance cost:
!irect
)abor/
<ours
Maintenance
Cost
;igh level of activity..... @0,<<< `/,)+0,<<<
=ow level of activity...... 0<,<<< ,,+0<,<<<
"hange......................... +0,<<< ` B@0,<<<
"hange in cost `B@0,<<<
Y Y`,0 per >=;
"hange in activity +0,<<< >=;
Fi.ed cost element:
otal cost at the high level of activity........... `/,)+0,<<<
(@0,<<< >=; V `,0 per >=;*..................... +,2+0,<<<
Fi.ed cost element....................................... `),0<<,<<<
herefore, the cost formula for maintenance is `),0<<,<<< per
year plus `,0 per direct la$or7hour or
Q Y `),0<<,<<< \ `,0S
3olutions Manual, "hapter 2 /+
,. otal factory overhead cost at @<,<<< direct la$or7hours would
$e:
&ndirect materials
(@<,<<< >=; V `)<< per >=;*..........
` @,<<<,<<
<
8ent.................................................... 2,<<<,<<<
Maintenance:
Iaria$le cost element
(@<,<<< >=; V `,0 per >=;*..........
`+,/0<,<<
<
Fi.ed cost element............................ ),0<<,<<<
,,C0<,<<
<
otal factory overhead cost.................
`)2,C0<,<<
<
3olutions Manual, "hapter 2 /,
). Maintenance cost at the C<,<<< machine7hour level of activity
can $e isolated as follows:
)evel of Activit%
E:A::: M<s
=:A:::
M<s
otal factory overhead cost..... R)@/,<<< R+/2,<<<
>educt:
Ktilities cost _ R<.B< per
M;Z.................................... /B,<<< @+,<<<
3upervisory salaries.............. +),<<< +),<<<
Maintenance cost.................... R)<0,<<< R)0,,<<<
ZR/B,<<< [ 2<,<<< M;s Y R<.B< per M;
+. ;igh7low analysis of maintenance cost:
Machine
/<ours
Maintenanc
e Cost
;igh activity level................. C<,<<< R)0,,<<<
=ow activity level.................. 2<,<<< )<0,<<<
"hange................................. ,<,<<< R /B,<<<
Iaria$le rate:
"hange in cost R/B,<<<
Y YR).2< per M;.
"hange in activity ,<,<<< M;s
otal '.ed cost:
otal maintenance cost at the high activity
level............................................................
R)0,,<<
<
(C<,<<< M;s V R).2< per M;*..................... )//,<<<
Fi.ed cost element........................................ R C,<<<
herefore, the cost formula for maintenance is: RC,<<< per
month plus R).2< per machine7hour or
Q Y RC,<<< \ R).2<S.
3olutions Manual, "hapter 2 //
,. Variable Cost per
Machine/<our
Fixed
Cost
Maintenance cost R).2< R C,<<<
Ktilities cost <.B<
3upervisory salaries
cost +),<<<
otals R+./< R,<,<<<
hus, the cost formula would $e: Q Y R,<,<<< \ R+./<S.
/. otal overhead cost at an activity level of @0,<<< machine7
hours:
Fi.ed costs............................................. R,<,<<<
Iaria$le costs: @0,<<< M;s V R+./<
per M;................................................. )B<,<<<
otal overhead costs.............................. R+)<,<<<
3olutions Manual, "hapter 2 /0
Case 5-25 (C< minutes*
). >irect la$or7hour allocation $ase:
Electrical costs (a*............................
`,,B@C,<<
<
>irect la$or7hours ($*....................... /+B,</< >=;s
!redetermined overhead rate (a* [
($*.................................................. `C.<2 per >=;
Machine7hour allocation $ase:
Electrical costs (a*.............................
`,,B@C,<<
<
Machine7hours ($*............................. ,2C,2<< M;s
($*................................................... `)<.0< per M;
+. Electrical cost for the shipyard jo$ under the old costing
system:
!redetermined overhead rate (a*........... `C.<2 per >=;
>irect la$or7hours for the jo$ ($*............ ,0< >=;s
Electrical cost applied to the jo$ (a* V
($*....................................................... `,,)@)
Electrical cost for the shipyard jo$ under the new A?" system:
!redetermined overhead rate (a*........... `)<.0< per M;
Machine7hours for the jo$ ($*................. +@< M;s
Electrical cost applied to the jo$ (a* V
($*....................................................... `+,B,0
3olutions Manual, "hapter 2 /2
,. 3cattergraph for electrical costs and machine7hours:
3olutions Manual, "hapter 2 /@
<
)<,<<<
+<,<<<
,<,<<<
/<,<<<
0<,<<<
2<,<<<
@<,<<<
B<,<<<
C<,<<<
< +,<<< /,<<< 2,<<< B,<<< )<,<<<
Machine-:ours
E
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e
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i
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s

8
)
e
n
9
3cattergraph for electrical costs and direct la$or7hours:
&n general, the allocation $ase should actually cause the cost
$eing allocated. &f it doesnGt, costs will $e incorrectly assigned
to jo$s. &ncorrectly assigned costs are worse than useless for
decision7making.
=ooking at the a$ove scattergraph, electrical costs do not
appear to $e related to direct la$or7hours. Electrical costs do
vary, $ut apparently not in response to changes in direct la$or7
hours. Dn the other hand, looking at the scattergraph for
machine7hours, there is some tendency for electrical costs to
increase as the machine7hours increase. 3o if one must
3olutions Manual, "hapter 2 /B
<
)<,<<<
+<,<<<
,<,<<<
/<,<<<
0<,<<<
2<,<<<
@<,<<<
B<,<<<
C<,<<<
< +,<<< /,<<< 2,<<< B,<<< )<,<<<
1irect ;a'or-:ours
E
l
e
c
t
r
i
c
a
l

C
o
s
t
s

8
)
e
n
9
choose $etween machine7hours and direct la$or7hours as an
allocation $ase, machine7hours seems to $e the $etter choice.
Even so, it looks like little of the overhead cost is really
e.plained even $y machine7hours. Electrical cost has a large
'.ed component and much of the variation in the cost is
unrelated to machine hours.
/.
Machine <ours
Electrical
Costs
Oeek
) @,+<< `@@,)<<
Oeek
+ B,+<< `B/,/<<
Oeek
, B,@<< `B<,/<<
Oeek
/ @,+<< `@0,0<<
Oeek
0 @,/<< `B),)<<
Oeek
2 B,B<< `B,,,<<
Oeek
@ 2,/<< `@C,+<<
Oeek
B @,@<< `B0,0<<
Ksing statistical software or a spreadsheet application such as
E.cel to compute estimates of the intercept and the slope for
the a$ove data, the results are:
&ntercept ('.ed cost per week*............ `2,,0+B
3lope (varia$le cost per machine7
hour*.................................................. `+.+/
8
+
......................................................... 0"28
herefore the cost formula for electrical costs is `2,,0+B per
week plus `+.+/ per machine7hour, or
Q Y `2,,0+B \ `+.+/ S,
3olutions Manual, "hapter 2 /C
where S is machine7hours.
Aote that the 8
+
is <.+B, which means that only +BP of the
variation in electrical cost is e.plained $y machine7hours. Dther
factors, discussed in part (2* $elow, are responsi$le for most of
the variation in electrical costs from week to week.
3olutions Manual, "hapter 2 0<
0. he shipyard jo$ re4uires +@< machine7hours. At `+.+/ per
machine7hour, the electrical cost actually caused $y the jo$
would $e only `2</.B<. his contrasts with the electrical cost of
`,,)@) under the old cost system and `+,B,0 under the new
A?" system. ?oth the old cost system and the new A?" system
grossly overstate the electrical costs of the jo$. his is $ecause
under $oth cost systems, the large '.ed electrical costs of
`2,,0+B per week are allocated to jo$s along with the electrical
costs that actually vary with the amount of work $eing done. &n
practice, almost all categories of overhead costs pose similar
pro$lems. As a conse4uence, the costs of individual jo$s are
likely to $e seriously overstated for decision7making purposes
under $oth traditional and A?" systems. ?oth systems provide
accepta$le cost data for e.ternal reporting, $ut $oth provide
potentially misleading data for internal decision7making unless
suita$le adjustments are made.
2. Electricity is used for heating, cooling, and lighting the $uilding
as well as to run e4uipment. herefore, consumption of
electrical power is likely to $e a#ected at least $y the weather
and $y the time of the year as well as $y how many hours the
e4uipment is run. (Fewer daylight hours mean the lights have
to $e on longer.*
3olutions Manual, "hapter 2 0)
). he scattergraph of direct la$or cost versus the num$er of
units produced is presented $elow:
3olutions Manual, "hapter 2 0+
+. he scattergraph of the direct la$or cost versus the num$er of
paid days is presented $elow:
3olutions Manual, "hapter 2 0,
4um'er o7 &aid 1a)s
,. he num$er of paid days should $e used as the activity $ase
rather than the num$er of units produced. he scattergraphs
reveal a much stronger relation (i.e., higher correlation*
$etween direct la$or costs and num$er of paid days than
$etween direct la$or costs and num$er of units produced.
Iariations in the direct la$or costs apparently occur $ecause of
the num$er of paid days in the month and have little to do with
the num$er of units that are produced. &t appears that the
direct la$or costs are $asically '.ed with respect to how many
units are produced in a month. his would happen if the direct
la$or workers are treated as full7time employees who are paid
even if there is insuEcient work to keep them $usy. Moreover,
for planning purposes, the company is likely to $e a$le to
predict the num$er of paid days in the month with much
greater accuracy than the num$er of units that will $e
produced.
3olutions Manual, "hapter 2 0/
Case 5-2! (C< minutes*
Aote to the instructor: his case re4uires the a$ility to $uild on
concepts that are introduced only $rie-y in the te.t. o some
degree, this case anticipates issues that will $e covered in more
depth in later chapters.
). &n order to estimate the contri$ution to pro't of the charity
event, it is 'rst necessary to estimate the varia$le costs of
catering the event. he costs of food and $everages and la$or
are all apparently varia$le with respect to the num$er of
guests. ;owever, the situation with respect overhead e.penses
is less clear. A good 'rst step is to plot the la$or hour and
overhead e.pense data in a scattergraph as shown $elow.
3olutions Manual, "hapter 2 00
R<
R)<,<<<
R+<,<<<
R,<,<<<
R/<,<<<
R0<,<<<
R2<,<<<
R@<,<<<
RB<,<<<
RC<,<<<
< +,<<< /,<<< 2,<<< B,<<<
=a$or ;ours
D
v
e
r
h
e
a
d

E
.
p
e
n
s
e
s
S
Q
Case 5-2! (continued*
his scattergraph reveals several interesting points a$out the
$ehavior of overhead costs:
L he relation $etween overhead e.pense and la$or hours is
appro.imated reasona$ly well $y a straight line. (;owever,
there appears to $e a slight downward $end in the plot as the
la$or hours increase. 3uch increasing returns to scale is a
common occurrence. 3ee Aoreen J 3oderstrom, MAre overhead
costs strictly proportional to activityFN 9ournal of Accounting
and Economics, vol. )@, )CC/, pp. +007+@B.*
L he data points are all fairly close to the straight line. his
indicates that most of the variation in overhead e.penses is
e.plained $y la$or hours. As a conse4uence, there pro$a$ly
wouldnGt $e much $ene't to investigating other possi$le cost
drivers for the overhead e.penses.
L Most of the overhead e.pense appears to $e '.ed. Maria
should ask herself if this is reasona$le. Are there in fact large
'.ed e.penses such as rent, depreciation, and her own salaryF
he overhead e.penses could $e decomposed into '.ed and
varia$le elements using the high7low method, least7s4uares
regression method, or even the 4uick7and7dirty method $ased on
the scattergraph.
L he high7low method throws away most of the data and $ases
the estimates of varia$le and '.ed costs on data for only two
months. For that reason, it is a decidedly inferior method in this
situation. Aevertheless, if the high7low method were used, the
estimates would $e computed as follows:
)abor
$verhea
d
<ours Expense
;igh level of activity.... @,0<< R@@,<<<
=ow level of activity..... +,0<< 00,<<<
"hange........................ 0,<<< R++,<<<
Iaria$le cost Y
"hange in cost R++,<<<
"hange in activity 0,<<< la$or hours
Y

Y R/./< per la$or hour
3olutions Manual, "hapter 2 0@
Fi.ed cost element Y otal cost X Iaria$le cost element
Y R@@,<<< X R/./< per la$or7hour V
@,0<< la$or7hours
Y R//,<<<
L he 4uick7and7dirty method $ased on the scattergraph is
pro$a$ly $etter than the high7low method in this situation and
should give accepta$le estimates of the '.ed and varia$le
components of overhead e.penses. he estimates should $e
fairly close (within the inherent imprecision of the method* to
the estimates that would result from using least7s4uares
regression.
L Ksing statistical software, the least7s4uares regression method
yields estimates of R,.C0 per la$or hour for the varia$le cost
and R/B,)+2 per month for the '.ed cost. he adjusted 8
+
is
C2P.
he total varia$le cost per guest is computed as follows:
Food and $everages................................. R)0.<<
=a$or (<.0 hour V R)<.<< per hour*.......... 0.<<
Dverhead (<.0 hour V R,.C0 per hour*...... ).CB
otal varia$le cost per guest..................... R+).CB
And the total contri$ution from )B< guests paying R,) each is
8evenue ()B< guests V R,).<< per
guest*..................................................... R0,0B<.<<
Iaria$le cost ()B< guests V R+).CB per
guest*..................................................... ,,C02./<
"ontri$ution to pro't................................ R),2+,.2<
Fi.ed costs are not included in the a$ove computation $ecause
there is no indication that there would $e any additional '.ed
costs incurred as a conse4uence of catering the cocktail party.
&f additional '.ed costs were incurred, they should $e
su$tracted from revenues as well to determine the pro't of the
party.
3olutions Manual, "hapter 2 0B
+. Assuming that no additional '.ed costs are incurred as a result
of catering the charity event, any price greater than the
varia$le cost per guest of roughly R++ would contri$ute to
pro'ts.
3olutions Manual, "hapter 2 0C
,. Oe would favor $idding slightly less than R,< to get the
contract. Any $id a$ove R++ would contri$ute to pro'ts and a
$id at the normal price of R,) is unlikely to land the contract.
And apart from the contri$ution to pro't, catering the event
would show o# the companyGs capa$ilities to potential clients.
he danger is that a price lower than the normal $id of R,)
might set a precedent for the future or it might em$roil the
company in a price war among caterers. ;owever, the price
need not $e pu$licized and the lower price could $e justi'ed to
future clients $ecause this is a charity event. Another
possi$ility would $e for Maria to maintain her normal price $ut
throw in additional services at no cost to the customer.
Ohether to compete $ased on price or service is a delicate
issue that Maria will have to decide after getting to know the
personality and preferences of her customers.
3olutions Manual, "hapter 2 2<
Case 5-2" (C< minutes*
). ;igh7low method:
<ours Cost
;igh level of activity. . . +0,<<< RCC,<<<
=ow level of activity. . . . )<,<<< 2/,0<<
"hange....................... )0,<<< R,/,0<<
Iaria$le element: R,/,0<< [ )0,<<< >=; Y R+.,< per >=;
Fi.ed element:
otal cost9+0,<<< >=;................... RCC,<<<
=ess varia$le element:
+0,<<< >=; V R+.,< per >=;........ 0@,0<<
Fi.ed element.................................. R/),0<<
herefore, the cost formula is: Q Y R/),0<< \ R+.,<S.
+. Ksing statistical software, the least7s4uares regression method
yields estimates of R,C,B0C per month for the '.ed cost and
R+.)0 per direct la$or7hour for the varia$le cost. he 8
+
is <.C).
herefore, the cost formula is Q Y R,C,B0C \ R+.)0S.
3olutions Manual, "hapter 2 2)
Case 5-2" (continued*
,. he scattergraph is shown $elow. he change in e4uipment
lease cost from a '.ed fee to an hourly rate causes the slope of
the regression line to $e steeper a$ove )C,0<< >=;, and to $e
discontinuous $etween the '.ed fee and hourly rate points.
here are in essence two relevant ranges9one $elow )C,0<<
>=; and one a$ove )C,0<< >=;. Oithin each relevant range, a
single straight line provides a reasona$le appro.imation to cost
$ehavior.
3olutions Manual, "hapter 2 2+
/. a. ;igh7low method:
Iaria$le (++,0<< >=; V R+.,< per
>=;*.............................................. R0),@0<
Fi.ed................................................ /),0<<
otal cost......................................... RC,,+0<
$. =east7s4uares regression method:
Iaria$le (++,0<< >=; V R+.)0 per
>=;*............................................... R/B,,@0
Fi.ed................................................. ,C,B0C
otal cost.......................................... RBB,+,/
c. 3cattergraph method:
8eading directly o# the graph, total overhead cost at ++,0<<
>=; would $e appro.imately RC<,<<<.
0. his pro$lem clearly illustrates the point that a scattergraph
should $e the starting point in all cost analysis work. &n this
case, it should $e preferred over the other two methods as a
cost estimating tool. he change in the $asis for the lease
payments a$ove )C,0<< direct la$or7hours causes a
discontinuity in the regression line. &n fact, two lines rather
than one provide the $est 't. he cost formulas computed with
the high7low and regression methods are faulty since they are
$ased on the assumption that a single straight line provides the
$est 't to the data. he high7low method, of course, is always
suspect since it relies on only two points (which in this case
gives the regression line too steep of a slope*. he least7
s4uares regression method should $e used in the Franklin plant
only if two separate regression formulas are computed9one for
the activity level over which a '.ed fee on rented e4uipment is
in e#ect, and one for the activity level over which hourly rates
are in e#ect.
3olutions Manual, "hapter 2 2,
,roup E%ercise 5-2#
3tudent answers will depend on who they contact. !erhaps
surprisingly, many organizations make no attempt to formally
distinguish $etween varia$le and '.ed costs in their planning and
in controlling operations.
3olutions Manual, "hapter 2 2/
Chapter
Cost-<olume-&ro/t =elationships
-1 he contri$ution margin ("M* ratio
is the ratio of the total contri$ution margin
to total sales revenue. &t can $e used in a
variety of ways. For e.ample, the change
in total contri$ution margin from a given
change in total sales revenue can $e
estimated $y multiplying the change in
total sales revenue $y the "M ratio. &f '.ed
costs do not change, then a dollar
increase in contri$ution margin will result
in a dollar increase in net operating
income. he "M ratio can also $e used in
$reak7even analysis. herefore, for
planning purposes, knowledge of a
productGs "M ratio is e.tremely helpful in
forecasting contri$ution margin and net
operating income.
-2 &ncremental analysis focuses on the
changes in revenues and costs that will
result from a particular action.
-3 All other things e4ual, "ompany ?,
with its higher '.ed costs and lower
varia$le costs, will have a higher
contri$ution margin ratio. herefore, it will
tend to realize the most rapid increase in
contri$ution margin and in pro'ts when
sales increase.
-4 Dperating leverage measures the
impact on net operating income of a given
percentage change in sales. he degree of
operating leverage at a given level of
sales is computed $y dividing the
contri$ution margin at that level of sales
$y the net operating income.
-5 Ao. A )<P decrease in the selling
price will have a greater impact on pro'ts
than a )<P increase in varia$le e.penses,
since the selling price is a larger 'gure
than the varia$le e.penses.
Mathematically, the same percentage
applied to a larger $ase will yield a larger
result. &n addition, the selling price a#ects
how much of the product will $e sold.
- he $reak7even point is the level of
sales at which pro'ts are zero. &t can also
$e de'ned as the point where total
revenue e4uals total cost, and as the point
where total contri$ution margin e4uals
total '.ed cost.
-! hree approaches to $reak7even
analysis are (a* the graphical method, ($*
the e4uation method, and (c* the
contri$ution margin method.
&n the graphical method, total cost
and total revenue data are plotted on a
graph. he intersection of the total cost
and the total revenue lines indicates the
$reak7even point. he graph shows the
$reak7even point in $oth units and dollars
of sales.
he e4uation method uses some
variation of the e4uation 3ales Y Iaria$le
e.penses \ Fi.ed e.penses \ !ro'ts,
where pro'ts are zero at the $reak7even
point. he e4uation is solved to determine
the $reak7even point in units or dollar
sales.
&n the contri$ution margin method,
total '.ed cost is divided $y the
contri$ution margin per unit to o$tain the
$reak7even point in units. Alternatively,
total '.ed cost can $e divided $y the
contri$ution margin ratio to o$tain the
$reak7even point in sales dollars.
-" (a* &f the selling price decreased,
then the total revenue line would rise less
steeply, and the $reak7even point would
occur at a higher unit volume. ($* &f '.ed
costs increased, then $oth the '.ed cost
line and the total cost line would shift
upward and the $reak7even point would
occur at a higher unit volume. (c* &f the
varia$le costs increased, then the total
cost line would rise more steeply and the
$reak7even point would occur at a higher
unit volume.
-#
3ales revenue per car washed.................... R/.<
<
Iaria$le cost per car................................... <.2<
"ontri$ution margin per car....................... R,./
<
otal '.ed e.penses R),@<<
0<<
Y Y
cars
"ontri$ution margin per car R,./<
-1$ he margin of safety is the e.cess
of $udgeted (or actual* sales over the
$reak7even volume of sales. &t states the
amount $y which sales can drop $efore
losses $egin to $e incurred.
-11 "ompany S, with its higher '.ed
costs and lower varia$le costs, would have
a higher $reak7even point than "ompany
Q. ;ence, "ompany S would also have the
lower margin of safety.
-12 he sales mi. is the relative
proportions in which a companyGs products
are sold. he usual assumption in cost7
volume7pro't analysis is that the sales mi.
will not change.
-13 A higher $reak7even point and a
lower net operating income could result if
the sales mi. shifted from high
contri$ution margin products to low
contri$ution margin products. 3uch a shift
would cause the average contri$ution
margin ratio in the company to decline,
resulting in less total contri$ution margin
for a given amount of sales. hus, net
operating income would decline. Oith a
lower contri$ution margin ratio, the $reak7
even point would $e higher since it would
re4uire more sales to cover the same
amount of '.ed costs.
E%ercise -1 (+< minutes*
). he new income statement would $e:
,otal Per Unit
3ales ()<,)<< units* R,0,,0<< R,0.<<
=ess varia$le
e.penses +<+,<<< +<.<<
"ontri$ution margin )0),0<< R)0.<<
=ess '.ed e.penses ),0,<<<
Aet operating income R )2,0<<
Qou can get the same net operating income using the following
approach.
Driginal net operating
income
R)0,<<
<
"hange in contri$ution
margin
()<< units V R)0.<< per
unit* ),0<<
Aew net operating income
R)2,0<
<
+. he new income statement would $e:
,otal
Per
Unit
3ales (C,C<< units*
R,/2,0<
< R,0.<<
=ess varia$le e.penses )CB,<<< +<.<<
"ontri$ution margin )/B,0<< R)0.<<
Aet operating income R ),,0<<
Qou can get the same net operating income using the following
approach.
Driginal net operating income R)0,<<<
"hange in contri$ution margin
(7)<< units V R)0.<< per unit*
(),0<<*
Aew net operating income R),,0<<
3olutions Manual, "hapter 2 2@
E%ercise -1 (continued*
,. he new income statement would $e:
,otal Per Unit
3ales (C,<<< units* R,)0,<<< R,0.<<
=ess varia$le
e.penses )B<,<<< +<.<<
"ontri$ution margin ),0,<<< R)0.<<
Aet operating
income R <
Aote: his is the companyGs $reak7even point.
3olutions Manual, "hapter 2 2B
E%ercise -2 (,< minutes*
). he "I! graph can $e plotted using the three steps outlined in
the te.t. he graph appears on the ne.t page.
3tep ). >raw a line parallel to the volume a.is to represent the
total '.ed e.pense. For this company, the total '.ed e.pense is
R+/,<<<.
3tep +. "hoose some volume of sales and plot the point
representing total e.penses ('.ed and varia$le* at the activity
level you have selected. OeGll use the sales level of B,<<< units.
Fi.ed e.pense......................................................... R +/,<<<
Iaria$le e.pense (B,<<< units V R)B per
unit*...................................................................... )//,<<<
otal e.pense..........................................................
R)2B,<<
<
3tep ,. "hoose some volume of sales and plot the point
representing total sales dollars at the activity level you have
selected. OeGll use the sales level of B,<<< units again.
otal sales revenue (B,<<< units V R+/ per
unit*......................................................................
R)C+,<<
<
+. he $reak7even point is the point where the total sales revenue
and the total e.pense lines intersect. his occurs at sales of
/,<<< units. his can $e veri'ed $y solving for the $reak7even
point in unit sales, 6, using the e4uation method as follows:
3ales
Y Iaria$le e.penses \ Fi.ed e.penses \
!ro'ts
R+/6 Y R)B6 \ R+/,<<< \ R<
R26 Y R+/,<<<
6 Y R+/,<<< [ R2 per unit
6 Y /,<<< units
3olutions Manual, "hapter 2 2C
3olutions Manual, "hapter 2 @<
"I! 1raph
R<
R0<,<<<
R)<<,<<<
R)0<,<<<
R+<<,<<<
< +,<<< /,<<< 2,<<< B,<<<
Iolume in Knits
>
o
l
l
a
r
s
Fi.ed E.pense otal E.pense
otal 3ales 8evenue
E%ercise -3 ()< minutes*
). he companyGs contri$ution margin ("M* ratio is:
otal sales R+<<,<<<
otal varia$le e.penses )+<,<<<
Y otal contri$ution
margin B<,<<<
[ otal sales R+<<,<<<
Y "M ratio /<P
+. he change in net operating income from an increase in total
sales of R),<<< can $e estimated $y using the "M ratio as
follows:
"hange in total sales R),<<<
V "M ratio /< P
Y Estimated change in net
operating income R /<<
his computation can $e veri'ed as follows:
otal sales
R+<<,<<
<
[ otal units sold 0<,<<< units
Y 3elling price per
unit R/.<<
per
unit
&ncrease in total sales R),<<<
[ 3elling price per
unit R/.<<
per
unit
Y &ncrease in unit
sales +0< units
Driginal total unit
sales 0<,<<< units
Aew total unit sales 0<,+0< units
$riginal (e1
otal unit sales 0<,<<< 0<,+0<
3ales
R+<<,<<
<
R+<),<<
<
=ess varia$le )+<,<<< )+<,2<<
3olutions Manual, "hapter 2 @)
e.penses
"ontri$ution margin B<,<<< B<,/<<
=ess '.ed e.penses 20,<<< 20,<<<
Aet operating income R )0,<<< R )0,/<<
3olutions Manual, "hapter 2 @+
). he following ta$le shows the e#ect of the proposed change in
monthly advertising $udget:
Sales
0ith
Additional
Current
Advertisin
g
Sales Budget
!i#erenc
e
3ales...........................
R)B<,<<
< R)BC,<<< R C,<<<
=ess varia$le
e.penses..................
)+2,<<
< ),+,,<< 2,,<<
"ontri$ution margin.... 0/,<<< 02,@<< +,@<<
=ess '.ed e.penses.... ,<,<<< ,0,<<< 0,<<<
Aet operating income.
R +/,<<
< R +),@<< R(+,,<<*
Assuming no other important factors need to $e considered,
the increase in the advertising $udget should not $e approved
since it would lead to a decrease in net operating income of
R+,,<<.
Alternative 3olution )
E.pected total contri$ution margin:
R)BC,<<< V ,<P "M ratio R02,@<<
!resent total contri$ution margin:
R)B<,<<< V ,<P "M ratio 0/,<<<
&ncremental contri$ution margin +,@<<
"hange in '.ed e.penses:
=ess incremental advertising
e.pense 0,<<<
"hange in net operating income R(+,,<<*
Alternative 3olution +
&ncremental contri$ution margin:
RC,<<< V ,<P "M ratio R +,@<<
=ess incremental advertising 0,<<<
3olutions Manual, "hapter 2 @,
e.pense
"hange in net operating income R(+,,<<*
3olutions Manual, "hapter 2 @/
+. he R+ increase in varia$le costs will cause the unit
contri$ution margin to decrease from R+@ to R+0 with the
following impact on net operating income:
E.pected total contri$ution margin with the
higher74uality components:
+,+<< units V R+0 per unit.................................... R00,<<<
+,<<< units V R+@ per unit.................................... 0/,<<<
"hange in total contri$ution margin........................ R ),<<<
Assuming no change in '.ed costs and all other factors remain
the same, the higher74uality components should $e used.
3olutions Manual, "hapter 2 @0
). he e4uation method yields the $reak7even point in unit sales,
6, as follows:
3ales
!ro'ts
R)06 Y R)+6 \ R/,+<< \ R<
R,6 Y R/,+<<
6 Y R/,+<< [ R, per $asket
6 Y ),/<< $askets
+. he e4uation method can $e used to compute the $reak7even
point in sales dollars, S, as follows:
Per
Unit
Percent of
Sales
3ales price R)0 )<<P
=ess varia$le
e.penses )+ B<P
"ontri$ution margin R , +<P
3ales Y Iaria$le e.penses \ Fi.ed e.penses \
!ro'ts
S Y <.B<S \ R/,+<< \ R<
<.+<S Y R/,+<<
S Y R/,+<< [ <.+<
S Y R+),<<<
,. he contri$ution margin method gives an answer that is
identical to the e4uation method for the $reak7even point in
unit sales:
?reak7even point in units
sold
Y Fi.ed e.penses [ Knit
"M
Y R/,+<< [ R, per
$asket
Y ),/<< $askets
/. he contri$ution margin method also gives an answer that is
identical to the e4uation method for the $reak7even point in
dollar sales:
3olutions Manual, "hapter 2 @2
?reak7even point in sales
dollars
Y Fi.ed e.penses [ "M
ratio
Y R/,+<< [ <.+<
Y R+),<<<
3olutions Manual, "hapter 2 @@
E%ercise - ()< minutes*
). he e4uation method yields the re4uired unit sales, 6, as
follows:
3ales
!ro'ts
R)+<
6 Y RB<6 \R0<,<<<\ R)<,<<<
R/<6 Y R2<,<<<
6 Y R2<,<<< [ R/< per unit
6 Y ),0<< units
+. he contri$ution margin yields the re4uired unit sales as
follows:
Fi.ed e.penses \ arget pro't
Knits sold to attain
Y
target pro't
Knit contri$ution margin
R0<,<<< \ R)0,<<<
Y
R/< per unit
R20,<<<
Y Y ),2+0 units
R/< per unit
3olutions Manual, "hapter 2 @B
E%ercise -! ()< minutes*
). o compute the margin of safety, we must 'rst compute the
$reak7even unit sales.
3ale
s
!ro'ts
R,<
6 Y R+<6 \ R@,0<< \ R<
R)<
6 Y R@,0<<
6 Y R@,0<< [ R)< per unit
6 Y @0< units
3ales (at the $udgeted volume of ),<<<
units*....................................................................
R,<,<<
<
?reak7even sales (at @0< units*............................... ++,0<<
Margin of safety (in dollars*..................................... R @,0<<
+. he margin of safety as a percentage of sales is as follows:
Margin of safety (in dollars*..................................... R@,0<<
[ 3ales....................................................................
R,<,<<
<
Margin of safety as a percentage of
sales..................................................................... +0.egree of operating
leverage.......................... /.B
+. A 0P increase in sales should result in a +/P increase in net
operating income, computed as follows:
>egree of operating leverage............................... /.B
V !ercent increase in sales................................... 0P
Estimated percent increase in net operating
income............................................................... +/P
,. he new income statement re-ecting the change in sales would
$e:
Amount
Percent
of Sales
3ales RB/,<<< )<<P
=ess varia$le
e.penses ,,,2<< /<P
"ontri$ution margin 0<,/<< 2<P
=ess '.ed e.penses ,B,<<<
Aet operating
income R)+,/<<
Aet operating income re-ecting change in
sales...............................................................
R)+,/<
<
Driginal net operating income...........................
R)<,<<
<
!ercent change in net operating income........... +/P
3olutions Manual, "hapter 2 B<
E%ercise -# (+< minutes*
). he overall contri$ution margin ratio can $e computed as
follows:
otal contri$ution margin
Dverall "M ratio Y
otal sales
R,<,<<<
Y Y,<P
R)<<,<<<
+. he overall $reak7even point in sales dollars can $e computed
as follows:
Dverall $reak7even
otal '.ed e.penses
Y
Dverall "M ratio

R+/,<<<
Y
,<P
Y RB<,<<<
,. o construct the re4uired income statement, we must 'rst
determine the relative sales mi. for the two products:
Claimump
er
Ma&eove
r ,otal
Driginal dollar sales R,<,<<< R@<,<<<
R)<<,<<
<
!ercent of total ,<P @<P )<<P
3ales at $reak7even R+/,<<< R02,<<< RB<,<<<
Claimump
er
Ma&eove
r ,otal
3ales R+/,<<< R02,<<< RB<,<<<
=ess varia$le
e.pensesZ )2,<<< /<,<<< 02,<<<
"ontri$ution margin R B,<<< R)2,<<< +/,<<<
=ess '.ed e.penses +/,<<<
Aet operating income R <
Z"laimjumper varia$le e.penses: (R+/,<<<HR,<,<<<* V R+<,<<< Y
R)2,<<<
Makeover varia$le e.penses: (R02,<<<HR@<,<<<* V R0<,<<< Y
R/<,<<<
3olutions Manual, "hapter 2 B)
E%ercise -1$ (+< minutes*
,otal
Per
Unit
).
3ales (+<,<<< units V ).)0 Y +,,<<<
units*.................................................................... R,/0,<<< R )0.<<
=ess varia$le e.penses........................................... +<@,<<< C.<<
"ontri$ution margin................................................ ),B,<<< R 2.<<
=ess '.ed e.penses................................................ @<,<<<
Aet operating income.............................................. R2B,<<<
+.
3ales (+<,<<< units V ).+0 Y +0,<<<
units*.................................................................... R,,@,0<< R),.0<
=ess varia$le e.penses........................................... ++0,<<< C.<<
"ontri$ution margin................................................ ))+,0<< R /.0<
=ess '.ed e.penses................................................ @<,<<<
Aet operating income.............................................. R/+,0<<
,.
3ales (+<,<<< units V <.C0 Y )C,<<<
units*.................................................................... R,),,0<< R)2.0<
=ess varia$le e.penses........................................... )@),<<< C.<<
"ontri$ution margin................................................ )/+,0<< R @.0<
=ess '.ed e.penses................................................ C<,<<<
Aet operating income.............................................. R0+,0<<
/.
3ales (+<,<<< units V <.C< Y )B,<<<
units*.................................................................... R,<+,/<< R)2.B<
=ess varia$le e.penses........................................... )@+,B<< C.2<
"ontri$ution margin................................................ )+C,2<< R @.+<
=ess '.ed e.penses................................................ @<,<<<
Aet operating income.............................................. R0C,2<<
3olutions Manual, "hapter 2 B+
). he contri$ution margin per person would $e:
!rice per ticket................................................ R,0
>inner.......................................................... R)B
Favors and program...................................... + +<
"ontri$ution margin per person...................... R)0
he '.ed e.penses of the dinner7dance total R2,<<<. he
$reak7even point would $e:
3ales Y
Iaria$le e.penses \ Fi.ed e.penses \
!ro'ts
R,06 Y R+<6 \ R2,<<< \ R<
R)06 Y R2,<<<
6 Y R2,<<< [ R)0 per person
6 Y
/<< persons% or, at R,0 per person,
R)/,<<<
Alternative solution:
Fi.ed e.penses
?reak7even point
Y
in unit sales
R2,<<<
Y Y /<< persons
R)0 per person
or, at R,0 per person, R)/,<<<.
+. Iaria$le cost per person (R)B \ R+*............ R+<
Fi.ed cost per person (R2,<<< [ ,<<
persons*................................................... +<
icket price per person to $reak even......... R/<
3olutions Manual, "hapter 2 B,
,. "ost7volume7pro't graph:
3olutions Manual, "hapter 2 B/
R<
R+,<<<
R/,<<<
R2,<<<
RB,<<<
R)<,<<<
R)+,<<<
R)/,<<<
R)2,<<<
R)B,<<<
R+<,<<<
< )<< +<< ,<< /<< 0<< 2<< @<<
Aum$er of !ersons
o
t
a
l

3
a
l
e
s
otal
E.penses
otal
Fi.ed
E.penses
otal 3ales
?reak7even point:
/<< persons or
R)/,<<< total sales
). Iaria$le e.penses: R/< V ()<<P X ,<P* Y R+B.
+. a. 3elling price............................................................ R/< )<<P
=ess varia$le e.penses........................................... +B @<
"ontri$ution margin................................................ R)+ ,<P
=et 6 Y ?reak7even point in units.
3ales Y
!ro'ts
R/<6 Y R+B6 \ R)B<,<<< \ R<
R)+6 Y R)B<,<<<
6 Y R)B<,<<< [ R)+ per unit
6 Y )0,<<< units
&n sales dollars: )0,<<< units V R/< per unit Y R2<<,<<<
=et S Y
?reak7even point in sales
dollars.
S Y <.@<S \ R)B<,<<< \ R<
<.,<S
Y R)B<,<<<
S Y R)B<,<<< [ <.,<
S Y R2<<,<<<
&n units: R2<<,<<< [ R/< per unit Y )0,<<< units
$. R/<6 Y R+B6 \ R)B<,<<< \ R2<,<<<
R)+6 Y R+/<,<<<
6 Y R+/<,<<< [ R)+ per unit
6 Y +<,<<< units
&n sales dollars: +<,<<< units V R/< per unit Y RB<<,<<<
S Y <.@<S \ R)B<,<<< \ R2<,<<<
<.,<S Y R+/<,<<<
S Y R+/<,<<< [ <.,<
S Y RB<<,<<<
3olutions Manual, "hapter 2 B0
&n units: RB<<,<<< [ R/< per unit Y +<,<<< units
3olutions Manual, "hapter 2 B2
c. he companyGs new costHrevenue relationships will $e:
3elling price............................................................ R/< )<<P
=ess varia$le e.penses (R+B X
R/*........................................................................ +/ 2<
"ontri$ution margin................................................ R)2 /<P
R/<6 Y R+/6 \ R)B<,<<< \ R<
R)26 Y R)B<,<<<
6 Y
R)B<,<<< [ R)2 per
unit
6 Y )),+0< units
&n sales dollars: )),+0< units V R/< per unit Y R/0<,<<<
S Y <.2<S \ R)B<,<<< \ R<
<./<S
Y R)B<,<<<
S Y R)B<,<<< [ <./<
S Y R/0<,<<<
&n units: R/0<,<<< [ R/< per unit Y )),+0< units
,. a.
Fi.ed e.penses
?reak7even point
Y
in unit sales
R)B<,<<<
Y Y )0,<<< units
R)+ per unit
&n sales dollars: )0,<<< units V R/< per unit Y R2<<,<<<
3olutions Manual, "hapter 2 B@
Fi.ed e.penses
?reak7even point
Y
in sales dollars
"M ratio
R)B<,<<<
Y Y R2<<,<<<
<.,<
&n units: R2<<,<<< [ R/< per unit Y )0,<<< units.
3olutions Manual, "hapter 2 BB
$.
Knit sales to attain
Y
target pro't
R)B<,<<< \ R2<,<<<
Y Y+<,<<< units
R)+ per unit
&n sales dollars: +<,<<< units V R/< per unit YRB<<,<<<
>ollar sales to attain
Y
target pro't
"M ratio
R)B<,<<< \ R2<,<<<
Y YRB<<,<<<
<.,<
&n units: RB<<,<<< [ R/< per unit Y+<,<<< units
c.
Fi.ed e.penses
?reak7even point
Y
in unit sales
R)B<,<<<
Y Y)),+0< units
R)2 per unit
&n sales dollars: )),+0< units V R/< per unit Y R/0<,<<<
Fi.ed e.penses
?reak7even point
Y
in sales dollars
"M ratio
R)B<,<<<
Y YR/0<,<<<
<./<
&n units: R/0<,<<< [ R/< per unit Y)),+0< units
3olutions Manual, "hapter 2 BC
). 3ales Y Iaria$le e.penses \ Fi.ed e.penses \ !ro'ts
R0<6 Y R,+6 \ R)<B,<<< \ R<
R)B6 Y R)<B,<<<
6 Y R)<B,<<< [ R)B per stove
6 Y
2,<<< stoves, or at R0< per stove, R,<<,<<< in
sales.
Fi.ed e.penses
?reak7even point
Y
in unit sales
R)<B,<<<
Y Y2,<<< stoves
R)B.<< per stove
or at R0< per stove, R,<<,<<< in sales.
+. An increase in the varia$le e.penses as a percentage of the
selling price would result in a higher $reak7even point. he
reason is that if varia$le e.penses increase as a percentage of
sales, then the contri$ution margin will decrease as a
percentage of sales. A lower "M ratio would mean that more
stoves would have to $e sold in order to generate enough
contri$ution margin to cover the '.ed costs.
,. PresentG
HA::: Stoves
ProposedG
4:A::: Stoves3
,otal
Per
Unit ,otal
Per
Uni
t
3ales
R/<<,<<
< R0<
R/0<,<<
< R/0
ZZ
=ess varia$le
e.penses
+02,<<
< ,+ ,+<,<<< ,+
"ontri$ution margin )//,<<< R)B ),<,<<< R),
=ess '.ed e.penses
)<B,<<
< )<B,<<<
Aet operating
income
R
,2,<<< R ++ ,<<<
3olutions Manual, "hapter 2 C<
ZB,<<< stoves V ).+0 Y )<,<<< stoves
ZZR0< V <.C Y R/0
As shown a$ove, a +0P increase in volume is not enough to
o#set a )<P reduction in the selling price% thus, net operating
income decreases.
3olutions Manual, "hapter 2 C)
/. 3ales Y Iaria$le e.penses \ Fi.ed e.penses \ !ro'ts
R/06 Y R,+6 \ R)<B,<<< \ R,0,<<<
R),6 Y R)/,,<<<
6 Y R)/,,<<< [ R), per stove
6 Y )),<<< stoves
Y
target pro't
R)<B,<<< \ R,0,<<<
Y Y )),<<< stoves
R), per stove
3olutions Manual, "hapter 2 C+
a. Case I4 Case I5
Aum$er of units
sold )0,<<< Z /,<<<
3ales
R)B<,<<
< Z R)+ R)<<,<<< Z R+0
=ess varia$le
e.penses )+<,<<< Z B 2<,<<< )0
"ontri$ution margin 2<,<<< R / /<,<<< R)< Z
=ess '.ed e.penses 0<,<<< Z ,+,<<< Z
Aet operating
income
R
)<,<<< R B,<<< Z
Case I6 Case I7
Aum$er of units
sold )<,<<< Z 2,<<< Z
3ales
R+<<,<<
< R+< R,<<,<<< Z R0<
=ess varia$le
e.penses @<,<<< Z @ +)<,<<< ,0
"ontri$ution margin ),<,<<< R), Z C<,<<< R)0
=ess '.ed e.penses ))B,<<< )<<,<<< Z
Aet operating
income R )+,<<< Z R()<,<<<*Z
$. Case I4 Case I5
3ales R0<<,<<< Z )<<P R/<<,<<< Z )<<P
=ess varia$le
e.penses /<<,<<< B< +2<,<<< Z 20
"ontri$ution margin )<<,<<< +<PZ )/<,<<< ,0P
=ess '.ed e.penses C,,<<< )<<,<<< Z
Aet operating
income R @,<<< Z R/<,<<<
Case I6 Case I7
3ales R+0<,<<< )<<P R2<<,<<< Z )<<P
=ess varia$le
e.penses )<<,<<< /< /+<,<<< Z @<
"ontri$ution margin )0<,<<< 2<P Z )B<,<<< ,<P
3olutions Manual, "hapter 2 C,
=ess '.ed e.penses ),<,<<< Z )B0,<<<
Aet operating
income R+<,<<< Z R (0,<<<* Z
Z1iven
3olutions Manual, "hapter 2 C/
). 3ales Y
!ro'ts
R,<6 Y R)+6 \ R+)2,<<< \ R<
R)B6 Y R+)2,<<<
6 Y R+)2,<<< [ R)B per unit
6 Y )+,<<< units, or at R,< per unit, R,2<,<<<
Fi.ed e.penses
?reak7even point
Y
in unit sales
R+)2,<<<
Y Y )+,<<< units
R)B per unit
or at R,< per unit, R,2<,<<<
+. he contri$ution margin is R+)2,<<< since the contri$ution
margin is e4ual to the '.ed e.penses at the $reak7even point.
,. Fi.ed e.penses \ arget pro't
Knits sold to attain
Y
target pro't
R+)2,<<< \ RC<,<<<
Y Y )@,<<< units
R)B per unit
,otal Unit
3ales ()@,<<< units V R,< per unit*. .
R0)<,<<
< R,<
=ess varia$le e.penses
()@,<<< units V R)+ per unit*......... +</,<<< )+
"ontri$ution margin.......................... ,<2,<<< R)B
=ess '.ed e.penses.......................... +)2,<<<
Aet operating income.......................
R
C<,<<<
3olutions Manual, "hapter 2 C0
/. Margin of safety in dollar terms:
Margin of safety
Y otal sales 7 ?reak7even sales
in dollars
Y R/0<,<<< 7 R,2<,<<< Y RC<,<<<
Margin of safety in percentage terms:
Margin of safety in dollars
Margin of safety
Y
percentage
otal sales
RC<,<<<
Y Y +<P
R/0<,<<<
0. he "M ratio is 2<P.
E.pected total contri$ution margin: (R0<<,<<< V
2<P*.....................................................................
R,<<,<<
<
!resent total contri$ution margin: (R/0<,<<< V
2<P*..................................................................... +@<,<<<
&ncreased contri$ution margin................................. R ,<,<<<
R0<,<<< incremental sales V 2<P "M ratio Y R,<,<<<.
3ince in this case the companyGs '.ed e.penses will not
change, 4uarterly net operating income will also increase $y
R,<,<<<.
3olutions Manual, "hapter 2 C2
E%ercise -1 ()0 minutes*
).
,otal
Per
Unit
3ales ()0,<<< games*............................................. R,<<,<<< R+<
=ess varia$le e.penses........................................... C<,<<< 2
"ontri$ution margin................................................ +)<,<<< R)/
=ess '.ed e.penses................................................ )B+,<<<
Aet operating income.............................................. R +B,<<<
he degree of operating leverage would $e:
"ontri$ution margin
>egree of operating
Y
leverage
Aet operating income
R+)<,<<<
Y Y @.0
R+B,<<<
+. a. 3ales of )B,<<< games would represent a +<P increase over
last yearGs sales. 3ince the degree of operating leverage is
@.0, net operating income should increase $y @.0 times as
much, or $y )0<P (@.0 V +<P*.
$. he e.pected total dollar amount of net operating income for
ne.t year would $e:
=ast yearGs net operating income............................ R+B,<<<
E.pected increase in net operating
income ne.t year ()0<P V R+B,<<<*.................... /+,<<<
otal e.pected net operating income...................... R@<,<<<
3olutions Manual, "hapter 2 C@
E%ercise -1! (,< minutes*
).
Flight
!%namic Sure Shot ,otal Compan%
Amount J Amount J Amount J
3ales
!)0<,<<
< )<<
!+0<,<<
< )<<
!/<<,<<
< )<<.<
=ess varia$le
e.penses ,<,<<
< +< )2<,<<< 2/ )C<,<<< /@.0
"ontri$ution
margin
!)+<,<<
< B< ! C<,<<< ,2 +)<,<<< 0+.0Z
=ess '.ed
e.penses
)B,,@0<
Aet operating
income ! +2,+0<
Z!+)<,<<< [ !/<<,<<< Y 0+.0P.
+. he $reak7even point for the company as a whole would $e:
Fi.ed e.penses
?reak7even point in
Y
total dollar sales
Dverall "M ratio
!)B,,@0<
Y Y!,0<,<<<
<.0+0
,. he additional contri$ution margin from the additional sales
would $e computed as follows:
!)<<,<<< V 0+.0P "M ratio Y !0+,0<<
Assuming no change in '.ed e.penses, all of this additional
contri$ution margin of !0+,0<< should drop to the $ottom line
as increased net operating income.
his answer assumes no change in selling prices, varia$le
costs per unit, '.ed e.pense, or sales mi..
3olutions Manual, "hapter 2 CB
&ro'lem -1" (2< minutes*
). 3ales Y Iaria$le e.penses \ Fi.ed e.penses \ !ro'ts
R,<.<<6 Y R)B.<<6 \ R)0<,<<< \ R<
R)+.<<6 Y R)0<,<<<
6 Y R)0<,<<< [ R)+.<< per pair
6 Y )+,0<< pairs
)+,0<< pairs V R,< per pair Y R,@0,<<< in sales.
Fi.ed e.penses
?reak7even point
Y
in unit sales
R)0<,<<<
Y Y )+,0<< pairs
R)+.<< per pair
Fi.ed e.penses
?reak7even point
Y
in sales dollars
"M ratio
R)0<,<<<
Y Y R,@0,<<< in sales
<./<
+. 3ee the graph on the following page.
,. he simplest approach is:
?reak7even sales )+,0<< pairs
Actual sales )+,<<< pairs
3ales short of $reak7even 0<< pairs
0<< pairs V R)+ contri$ution margin per pair Y R2,<<< loss
3ales ()+,<<< pairs V R,<.<< per pair*.................... R,2<,<<<
()+,<<< pairs V R)B.<< per pair*........................... +)2,<<<
"ontri$ution margin................................................ )//,<<<
=ess '.ed e.penses................................................ )0<,<<<
Aet operating loss................................................... R (2,<<<*
3olutions Manual, "hapter 2 CC
&ro'lem -1" (continued*
+. "ost7volume7pro't graph:
3olutions Manual, "hapter 2 )<<
R<
R0<
R)<<
R)0<
R+<<
R+0<
R,<<
R,0<
R/<<
R/0<
R0<<
< +,0<< 0,<<< @,0<< )<,<<< )+,0<< )0,<<< )@,0<< +<,<<<
Aum$er of !airs of 3hoes 3old
o
t
a
l

3
a
l
e
s

(
<
<
<
s
*
?reak7even point:
)+,0<< pairs of shoes or
R,@0,<<< total sales
otal 3ales
otal
E.pense
s
otal
Fi.ed
E.pense
s
/. he varia$le e.penses will now $e R)B.@0 (R)B.<< \ R<.@0* per
pair, and the contri$ution margin will $e R)).+0 (R,<.<< X
R)B.@0* per pair.
3ales Y
!ro'ts
R,<.<<6
Y R)B.@06 \ R)0<,<<< \ R<
R)).+06
Y R)0<,<<<
6 Y R)0<,<<< [ R)).+0 per pair
6 Y ),,,,, pairs (rounded*
),,,,, pairs V R,<.<< per pair Y R/<<,<<< in sales
Fi.ed e.penses
?reak7even point
Y
in unit sales
"M per unit
R)0<,<<<
Y Y ),,,,, pairs
R)).+0 per pair
Fi.ed e.penses
?reak7even point
Y
in sales dollars
"M ratio
R)0<,<<<
Y Y R/<<,<<< in sales
<.,@0
0. he simplest approach is:
Actual sales )0,<<< pairs
?reak7even sales )+,0<< pairs
E.cess over $reak7even sales
+,0<< pairs
+,0<< pairs V R)).0< per pairZ Y R+B,@0< pro't
ZR)+.<< present contri$ution margin X R<.0< commission Y
R)).0<
3ales ()0,<<< pairs V R,<.<< per pair*.................... R/0<,<<<
3olutions Manual, "hapter 2 )<)
=ess varia$le e.penses ()+,0<< pairs V
R)B.<< per pair% +,0<< pairs V R)B.0<
per pair*................................................................ +@),+0<
"ontri$ution margin................................................ )@B,@0<
=ess '.ed e.penses................................................ )0<,<<<
Aet operating income.............................................. R +B,@0<
3olutions Manual, "hapter 2 )<+
2. he new varia$le e.penses will $e R),.0< per pair.
3ales Y Iaria$le e.penses \ Fi.ed e.penses \ !ro'ts
R,<.<<6 Y R),.0<6 \ R)B),0<< \ R<
R)2.0<6 Y R)B),0<<
6 Y R)B),0<< [ R)2.0< per pair
6 Y )),<<< pairs
)),<<< pairs V R,<.<< per pair Y R,,<,<<< in sales.
Although the change will lower the $reak7even point from
)+,0<< pairs to )),<<< pairs, the company must consider
whether this reduction in the $reak7even point is more than
o#set $y the possi$le loss in sales arising from having the sales
sta# on a salaried $asis. Knder a salary arrangement, the sales
sta# has less incentive to sell than under the present
commission arrangement, resulting in a potential loss of sales
and a reduction of pro'ts. Although it is generally desira$le to
lower the $reak7even point, management must consider the
other e#ects of a change in the cost structure. he $reak7even
point could $e reduced dramatically $y dou$ling the selling
price $ut it does not necessarily follow that this would improve
the companyGs pro't.
3olutions Manual, "hapter 2 )<,
&ro'lem -1# (2< minutes*
). he "M ratio is ,<P.
,otal
Per
Unit
Percent of
Sales
3ales ()C,0<< units*
R0B0,<<
< R,<.<< )<<P
=ess varia$le
e.penses
/<C,0<
< +).<< @<
"ontri$ution margin
R)@0,0<
< RC.<< ,<P
he $reak7even point is:
3ales Y
!ro'ts
R,<.<<6
Y R+).<<6 \ R)B<,<<< \ R<
RC.<<6 Y R)B<,<<<
6 Y R)B<,<<< [ RC.<< per unit
6 Y +<,<<< units
+<,<<< units V R,<.<< per unit Y R2<<,<<< in sales.
Fi.ed e.penses
?reak7even point
Y
in unit sales
R)B<,<<<
Y Y+<,<<< units
RC.<< per unit
Fi.ed e.penses
?reak7even point
Y
in sales dollars
"M ratio
R)B<,<<<
Y Y R2<<,<<< in sales
<.,<
+. &ncremental contri$ution margin:
RB<,<<< increased sales V <.,< "M ratio.............. R+/,<<<
=ess increased advertising cost............................... )2,<<<
3olutions Manual, "hapter 2 )</
&ncrease in monthly net operating income.............. R B,<<<
3ince the company is now showing a loss of R/,0<< per month,
if the changes are adopted, the loss will turn into a pro't of
R,,0<< each month (RB,<<< less R/,0<< Y R,,0<<*.
3olutions Manual, "hapter 2 )<0
&ro'lem -1# (continued*
,. 3ales (,C,<<< units _ R+@.<< per unitZ*.................. R),<0,,<<<
(,C,<<< units _ R+).<< per unit*.......................... B)C,<<<
"ontri$ution margin................................................ +,/,<<<
=ess '.ed e.penses (R)B<,<<< \
R2<,<<<*............................................................... +/<,<<<
Aet operating loss................................................... R (2,<<<*
ZR,<.<< X (R,<.<< V <.)<* Y R+@.<<
/. 3ales Y
!ro'ts
R,<.<<6
Y R+).@06Z \ R)B<,<<< \ RC,@0<
RB.+06 Y R)BC,@0<
6 Y R)BC,@0< [ RB.+0 per unit
6 Y +,,<<< units
ZR+).<< \ R<.@0 Y R+).@0
Y
target pro't
"M per unit
R)B<,<<< \ RC,@0<
Y Y+,,<<< units
RB.+0 per unitZZ
ZZR,<.<< X R+).@0 Y RB.+0
0. a. he new "M ratio would $e:
Per Unit
Percent of
Sales
3ales R,<.<< )<<P
=ess varia$le
e.penses )B.<< 2<
"ontri$ution margin R)+.<< /<P
3olutions Manual, "hapter 2 )<2
he new $reak7even point would $e:
Fi.ed e.penses
?reak7even point
Y
in unit sales
R)B<,<<< \ R@+,<<<
Y Y+),<<< units
R)+.<< per unit
Fi.ed e.penses
?reak7even point
Y
in sales dollars
"M ratio
R)B<,<<< \ R@+,<<<
Y YR2,<,<
<./<
<<
$. "omparative income statements follow:
(ot Automated Automated
,otal
Per
Unit J ,otal
Per
Unit J
3ales
(+2,<<<
units*
R@B<,<<
<
R,<.<
< )<<P
R@B<,<<
<
R,<.<
< )<<P
=ess
varia$le
e.penses 0/2,<<
< +).<< @< /2B,<<< )B.<< 2<
"ontri$ution
margin +,/,<<< R C.<< ,<P ,)+,<<<
R)+.<
< /<P
=ess '.ed
e.penses )B<,<<
< +0+,<<<
Aet
operating
income
R 0/,<<
<
R
2<,<<<
c. Ohether or not the company should automate its operations
depends on how much risk the company is willing to take
and on prospects for future sales. he proposed changes
would increase the companyGs '.ed costs and its $reak7even
point. ;owever, the changes would also increase the
3olutions Manual, "hapter 2 )<@
companyGs "M ratio (from <.,< to <./<*. he higher "M ratio
means that once the $reak7even point is reached, pro'ts will
increase more rapidly than at present. &f +2,<<< units are
sold ne.t month, for e.ample, the higher "M ratio will
generate R2,<<< more in pro'ts than if no changes are
made.
3olutions Manual, "hapter 2 )<B
he greatest risk of automating is that future sales may drop
$ack down to present levels (only )C,0<< units per month*,
and as a result, losses will $e even larger than at present due
to the companyGs greater '.ed costs. (Aote the pro$lem
states that sales are erratic from month to month.* &n sum,
the proposed changes will help the company if sales continue
to trend upward in future months% the changes will hurt the
company if sales drop $ack down to or near present levels.
4ote to the (nstructor2 Although it is not asked for in the
pro$lem, if time permits you may want to compute the point
of indi#erence $etween the two alternatives in terms of units
sold% i.e., the point where pro'ts will $e the same under
either alternative. At this point, total revenue will $e the
same% hence, we include only costs in our e4uation:
=et 6 Y
!oint of indi#erence in units
sold
R+).<<6 \ R)B<,<<<
Y R)B.<<6 \ R+0+,<<<
R,.<<6 Y R@+,<<<
6 Y R@+,<<< [ R,.<< per unit
6 Y +/,<<< units
&f more than +/,<<< units are sold in a month, the proposed
plan will yield the greater pro'ts% if less than +/,<<< units are
sold in a month, the present plan will yield the greater pro'ts
(or the least loss*.
3olutions Manual, "hapter 2 )<C
&ro'lem -2$ (2< minutes*
). 3ales price R+<.<< )<<P
B.<< /<
"ontri$ution margin R)+.<< 2<P
+
.
Fi.ed e.penses
?reak7even point in
Y
total sales dollars
"M ratio
R)B<,<<<
Y YR,<<,<<<
<.2<
,. R@0,<<< increased sales V <.2< "M ratio Y R/0,<<< increased
contri$ution margin. 3ince the '.ed costs will not change, net
operating income should also increase $y R/0,<<<.
/. a. "ontri$ution margin
>egree of
Y
operating leverage
R+/<,<<<
Y Y /
R2<,<<<
$. / V +<P Y B<P increase in net operating income.
0. )ast -earG
4HA::: units
ProposedG
57A::: units3
Amount
Per
Unit Amount
Per
Unit
3ales
R,2<,<<
< R+<.<<
R/,+,<<
< R)B.<<
ZZ
=ess varia$le
e.penses )//,<<< B.<< )C+,<<< B.<<
"ontri$ution margin +)2,<<< R)+.<< +/<,<<< R)<.<<
=ess '.ed e.penses )B<,<<< +)<,<<<
Aet operating
income R ,2,<<< R ,<,<<<
Z)B,<<< units \ 2,<<< units Y +/,<<< units
ZZR+<.<< V <.C Y R)B.<<
3olutions Manual, "hapter 2 ))<
Ao, the changes should not $e made.
3olutions Manual, "hapter 2 )))
&ro'lem -2$ (continued*
2. E.pected total contri$ution margin:
)B,<<< units V ).+0 V R)).<< per unitZ................
R+/@,0<
<
)B,<<< units V R)+.<< per unit............................. +)2,<<<
&ncremental contri$ution margin, and the amount
$y which advertising can $e increased with net
operating income remaining unchanged............... R ,),0<<
ZR+<.<< X (RB.<< \ R).<<* Y R)).<<
3olutions Manual, "hapter 2 ))+
&ro'lem -21 (,< minutes*
). Product
0hite Fragrant )oonKain ,otal
!ercentage of
total sales /<P +/P ,2P )<<P
3ales
?,<<,<<
<
)<<
P
?)B<,<<
< )<<P
?+@<,<<
< )<<P
?
@0<,<<<
)<<
P
=ess varia$le
e.penses +)2,<<< @+ ,2,<<< +<
)<B,<<
< /<
,2<,<<
< /B
"ontri$ution
margin ? B/,<<< +BP
?)//,<<
< B<P
?)2+,<<
< 2<P ,C<,<<< 0+P
Z
=ess '.ed
e.penses
//C,+B
<
Aet operating
income (loss*
?
(0C,+B<*
Z?,C<,<<< [ ?@0<,<<< Y 0+P.
+. ?reak7even sales would $e:
Fi.ed e.penses
?reak7even point
Y
in total dollar sales
"M ratio
?//C,+B<
Y Y?B2/,<<<
<.0+<
3olutions Manual, "hapter 2 )),
&ro'lem -21 (continued*
,. Memo to the president:
Although the company met its sales $udget of ?@0<,<<< for the
month, the mi. of products changed su$stantially from that
$udgeted. his is the reason the $udgeted net operating
income was not met, and the reason the $reak7even sales were
greater than $udgeted. he companyGs sales mi. was planned
at +<P Ohite, 0+P Fragrant, and +BP =oonzain. he actual
sales mi. was /<P Ohite, +/P Fragrant, and ,2P =oonzain.
As shown $y these data, sales shifted away from Fragrant 8ice,
which provides our greatest contri$ution per dollar of sales, and
shifted toward Ohite 8ice, which provides our least contri$ution
per dollar of sales. Although the company met its $udgeted
level of sales, these sales provided considera$ly less
contri$ution margin than we had planned, with a resulting
decrease in net operating income. Aotice from the attached
statements that the companyGs overall "M ratio was only 0+P,
as compared to a planned "M ratio of 2/P. his also e.plains
why the $reak7even point was higher than planned. Oith less
average contri$ution margin per dollar of sales, a greater level
of sales had to $e achieved to provide suEcient contri$ution
margin to cover '.ed costs.
3olutions Manual, "hapter 2 ))/
&ro'lem -22 (/0 minutes*
). 3ales ()0,<<< units V R@< per unit*......................... R),<0<,<<<
=ess varia$le e.penses ()0,<<< units V R/< per
unit*...................................................................... 2<<,<<<
"ontri$ution margin................................................ /0<,<<<
=ess '.ed e.penses................................................ 0/<,<<<
Aet operating loss................................................... R (C<,<<<*
+
.
Fi.ed e.penses
?reak7even point
Y
in unit sales
R0/<,<<<
Y Y)B,<<< units
R,< per unit
)B,<<< units V R@< per unit Y R),+2<,<<< to $reak even.
3olutions Manual, "hapter 2 ))0
,.
Unit
Sale
s
Pric
e
Unit
Variabl
e
Expens
e
Unit
Contributio
n Margin
Volume
'Units+
,otal
Contributio
n Margin
Fixed
Expenses
(et
operating
income
R@< R/< R,< )0,<<< R/0<,<<< R0/<,<<< R (C<,<<<*
2B /< +B +<,<<< 02<,<<< 0/<,<<< +<,<<<
22 /< +2 +0,<<< 20<,<<< 0/<,<<< ))<,<<<
2/ /< +/ ,<,<<< @+<,<<< 0/<,<<< )B<,<<<
2+ /< ++ ,0,<<< @@<,<<< 0/<,<<< +,<,<<<
2< /< +< /<,<<< B<<,<<< 0/<,<<< +2<,<<<
0B /< )B /0,<<< B)<,<<< 0/<,<<< +@<,<<<
02 /< )2 0<,<<< B<<,<<< 0/<,<<< +2<,<<<
hus, the ma.imum pro't is R+@<,<<<. his level of pro't can $e earned $y selling
/0,<<< units at a price of R0B each.
3olutions Manual, "hapter 2 ))2
/. At a selling price of R0B per unit, the contri$ution margin is R)B
per unit. herefore:
Fi.ed e.penses
?reak7even point
Y
in unit sales
R0/<,<<<
Y Y,<,<<< units
R)B per unit
,<,<<< units VR0B per unit Y R),@/<,<<< to $reak even.
his $reak7even point is di#erent from the $reak7even point in
part (+* $ecause of the change in selling price. Oith the change
in selling price the unit contri$ution margin drops from R,< to
R)B, resulting in an increase in the $reak7even point.
3olutions Manual, "hapter 2 ))@
). ()* >ollars
(+* Iolume of output, e.pressed in units, P of capacity,
sales, or some other measure
(,* otal e.pense line
(/* Iaria$le e.pense area
(0* Fi.ed e.pense area
(2* ?reak7even point
(@* =oss area
(B* !ro't area
(C* 8evenue line
3olutions Manual, "hapter 2 ))B
+. a. =ine ,: 8emain unchanged.
=ine C: ;ave a steeper slope.
?reak7even
point:
>ecrease.
$. =ine ,: ;ave a -atter slope.
=ine C: 8emain unchanged.
?reak7even
point:
>ecrease.
c. =ine ,: 3hift upward.
?reak7even
point:
&ncrease.
d. =ine ,: 8emain unchanged.
?reak7even
point:
8emain unchanged.
e. =ine ,: 3hift downward and have a steeper slope.
?reak7even
point:
!ro$a$ly change, $ut the direction is
uncertain.
f. =ine ,: ;ave a steeper slope.
=ine C: ;ave a steeper slope.
?reak7even
point:
8emain unchanged in terms of units%
increase in terms of total dollars of
sales.
g. =ine ,: 3hift upward.
?reak7even
point:
&ncrease.
h. =ine ,: 3hift upward and have a -atter slope.
?reak7even
point:
!ro$a$ly change, $ut the direction is
uncertain.
3olutions Manual, "hapter 2 ))C
&ro'lem -24 (@0 minutes*
). a. 3elling price.................. R+0 )<<P
=ess varia$le e.penses. )0 2<
"ontri$ution margin...... R)< /<P
3ales
Y Iaria$le e.penses \ Fi.ed e.penses \ !ro'ts
R+06
Y R)06 \ R+)<,<<< \ R<
R)<6
Y R+)<,<<<
6 Y R+)<,<<< [ R)< per $all
6 Y +),<<< $alls
Fi.ed e.penses
?reak7even point
Y
in unit sales
R+)<,<<<
Y Y+),<<< $alls
R)< per $all
$. he degree of operating leverage would $e:
"ontri$ution margin
>egree of
Y
operating leverage
R,<<,<<<
Y Y,.,, (rounded*
RC<,<<<
+. he new "M ratio will $e:
3elling price................... R+0 )<<P
=ess varia$le e.penses.. )B @+
"ontri$ution margin...... R @ +BP
he new $reak7even point will $e:
R+06 Y R)B6 \ R+)<,<<< \ R<
R@6 Y R+)<,<<<
6 Y R+)<,<<< [ R@ per $all
3olutions Manual, "hapter 2 )+<
6 Y ,<,<<< $alls
3olutions Manual, "hapter 2 )+)
Fi.ed e.penses
?reak7even point
Y
in unit sales
R+)<,<<<
Y Y,<,<<< $alls
R@ per $all
,. 3ales Y
!ro'ts
R+06 Y R)B6 \ R+)<,<<< \ RC<,<<<
R@6 Y R,<<,<<<
6 Y R,<<,<<< [ R@ per $all
6 Y /+,B0@ $alls (rounded*
Fi.ed e.penses \arget pro't
Y
target pro't
R+)<,<<<\RC<,<<<
Y Y/+,B0@ $alls
R@ per $all
hus, sales will have to increase $y )+,B0@ $alls (/+,B0@ $alls,
less ,<,<<< $alls currently $eing sold* to earn the same amount
of net operating income as last year. he computations a$ove
and in part (+* show 4uite clearly the dramatic e#ect that
increases in varia$le costs can have on an organization. he
e#ects on Aorthwood "ompany are summarized $elow:
Present
Expecte
d
"om$ination margin ratio.............................. /<P +BP
?reak7even point (in $alls*............................ +),<<< ,<,<<<
3ales (in $alls* needed to earn a RC<,<<<
pro't........................................................... ,<,<<< /+,B0@
Aote particularly that if varia$le costs do increase ne.t year,
then the company will just $reak even if it sells the same
num$er of $alls (,<,<<<* as it did last year.
3olutions Manual, "hapter 2 )++
/. he contri$ution margin ratio last year was /<P. &f we let !
e4ual the new selling price, then:
! Y R)B \ <./<!
<.2<!
Y R)B
! Y R)B [ <.2<
! Y R,<
o verify:
3elling price.................. R,< )<<P
)B 2<
"ontri$ution margin...... R)+ /<P
herefore, to maintain a /<P "M ratio, a R, increase in varia$le
costs would re4uire a R0 increase in the selling price.
0. he new "M ratio would $e:
3elling price...................... R+0 )<<P
=ess varia$le e.penses..... CZ ,2
"ontri$ution margin.......... R)2 2/P
ZR)0 X (R)0 V /<P* Y RC
he new $reak7even point would $e:
3ales Y
!ro'ts
R+06 Y RC6 \ R/+<,<<< \ R<
R)26 Y R/+<,<<<
6 Y R/+<,<<< [ R)2 per $all
6 Y +2,+0< $alls
Fi.ed e.penses
?reak7even point
Y
in unit sales
R/+<,<<<
Y Y+2,+0< $alls
R)2 per $all
Although this new $reak7even is greater than the companyGs
3olutions Manual, "hapter 2 )+,
present $reak7even of +),<<< $alls ]see !art ()* a$ove^, it is
less than the $reak7even point will $e if the company does not
automate and varia$le la$or costs rise ne.t year ]see !art (+*
a$ove^.
3olutions Manual, "hapter 2 )+/
2. a. 3ales Y
!ro'ts
R+06 Y RC6 \ R/+<,<<< \ RC<,<<<
R)26 Y R0)<,<<<
6 Y R0)<,<<< [ R)2 per $all
6 Y ,),B@0 $alls
Knit sales to attain Fi.ed e.penses \ arget pro't
Y
target pro't Knit contri$ution margin
R/+<,<<< \ RC<,<<<
Y Y,),B@0 $alls
R)2 per $all
hus, the company will have to sell ),B@0 more $alls (,),B@0
X ,<,<<< Y ),B@0* than now $eing sold to earn a pro't of
RC<,<<< per year. ;owever, this is still far less than the
/+,B0@ $alls that would have to $e sold to earn a RC<,<<<
pro't if the plant is not automated and varia$le la$or costs
rise ne.t year ]see !art (,* a$ove^.
$. he contri$ution income statement would $e:
3ales (,<,<<< $alls V R+0 per $all*................... R@0<,<<<
=ess varia$le e.penses (,<,<<< $alls V RC
per $all*.......................................................... +@<,<<<
"ontri$ution margin.......................................... /B<,<<<
=ess '.ed e.penses.......................................... /+<,<<<
Aet operating income....................................... R2<,<<<
"ontri$ution margin
>egree of
Y
operating leverage
R/B<,<<<
Y YB
R2<,<<<
3olutions Manual, "hapter 2 )+0
c. his pro$lem illustrates the diEculty faced $y many
companies today. Iaria$le costs for la$or are rising, yet
$ecause of competitive pressures it is often diEcult to pass
these cost increases along in the form of a higher price for
products. hus, companies are forced to automate (to some
degree* resulting in higher operating leverage, often a higher
$reak7even point, and greater risk for the company.
here is no clear answer as to whether one should have $een
in favor of constructing the new plant. ;owever, this
4uestion provides an opportunity to $ring out points such as
in the preceding paragraph and it forces students to think
a$out the issues.
3olutions Manual, "hapter 2 )+2
&ro'lem -25 (2< minutes*
). 3ales Y
!ro'ts
R/<.<<6
Y R)2.<<6 \ R2<,<<< \ R<
R+/.<<6
Y R2<,<<<
6 Y R2<,<<< [ R+/.<< per pair
6 Y +,0<< pairs
+,0<< pairs V R/<.<< per pair Y R)<<,<<< in sales
Fi.ed e.penses R2<,<<<
?reak7even point
Y Y Y+,0<< pairs
in unit sales
"M per unit R+/.<< per pair
Fi.ed e.penses R2<,<<<
?reak7even point
Y Y YR)<<,<<<
in dollar sales
"M ratio <.2<<
+. 3ee the graph at the end of this solution.
,. 3ales Y Iaria$le e.penses \ Fi.ed e.penses \ !ro'ts
R/<.<<6
Y R)2.<<6 \ R2<,<<< \ R)B,<<<
R+/.<<6
Y R@B,<<<
6 Y R@B,<<< [ R+/.<< per pair
6 Y ,,+0< pairs
Y
target pro't
R2<,<<< \ R)B,<<<
Y Y,,+0< pairs
R+/.<< per pair
/. &ncremental contri$ution margin:
R+0,<<< increased sales V 2<P "M ratio.............. R)0,<<<
&ncremental '.ed salary cost.................................. B,<<<
&ncreased net income.............................................. R @,<<<
3olutions Manual, "hapter 2 )+@
Qes, the position should $e converted to a full7time $asis.
3olutions Manual, "hapter 2 )+B
0
.
a
.
"ontri$ution margin R@+,<<<
>egree of
Y Y Y2
operating leverage
Aet operating income R)+,<<<
$. 2.<< V 0<P sales increase Y ,<<P increase in net operating
income. hus, net operating income ne.t year would $e:
R)+,<<< \ (R)+,<<< V ,<<P* Y R/B,<<<.
+. "ost7volume7pro't graph:
3olutions Manual, "hapter 2 )+C
R<
R+<
R/<
R2<
RB<
R)<<
R)+<
R)/<
R)2<
R)B<
R+<<
< 0<< ),<<< ),0<< +,<<< +,0<< ,,<<< ,,0<< /,<<< /,0<< 0,<<<
Aum$er of !airs of 3andals 3old
o
t
a
l

3
a
l
e
s

(
<
<
<
s
*
?reak7even point:
+,0<< pairs of sandals or
R)<<,<<< total sales
otal 3ales
otal
E.pense
s
otal
Fi.ed
E.pense
s
). he contri$ution margin per unit on the 'rst )2,<<< units is:
Per Unit
3ales price R,.<<
=ess varia$le e.penses ).+0
"ontri$ution margin R).@0
he contri$ution margin per unit on anything over )2,<<< units
is:
Per Unit
3ales price R,.<<
=ess varia$le e.penses )./<
"ontri$ution margin R).2<
hus, for the 'rst )2,<<< units sold, the total amount of
contri$ution margin generated would $e:
)2,<<< units V R).@0 per unit Y R+B,<<<
3ince the '.ed costs on the 'rst )2,<<< units total R,0,<<<, the
R+B,<<< contri$ution margin a$ove is not enough to permit the
company to $reak even. herefore, in order to $reak even,
more than )2,<<< units will have to $e sold. he '.ed costs
that will have to $e covered $y the additional sales are:
Fi.ed costs on the 'rst )2,<<< units........................ R,0,<<<
=ess contri$ution margin from the 'rst )2,<<<
units..................................................................... +B,<<<
8emaining unrecovered '.ed costs.........................@,<<<
Add monthly rental cost of the additional
space needed to produce more than )2,<<<
units..................................................................... ),<<<
otal '.ed costs to $e covered $y remaining
sales..................................................................... R B,<<<
3olutions Manual, "hapter 2 ),<
he additional sales of units re4uired to cover these '.ed costs
would $e:
otal remaining '.ed costs RB,<<<
Y Y0,<<< units
Knit contri$ution margin on added units R).2< per unit
herefore, a total of +),<<< units ()2,<<< \ 0,<<<* must $e
sold in order for the company to $reak even. his num$er of
units would e4ual total sales of:
+),<<< units V R,.<< per unit Y R2,,<<< in total sales.
+
.
arget pro't R)+,<<<
Y Y@,0<< units
Knit contri$ution margin R).2< per unit
hus, the company must sell @,0<< units a$ove the $reak7even
point to earn a pro't of R)+,<<< each month. hese units,
added to the +),<<< units re4uired to $reak even, would e4ual
total sales of +B,0<< units each month to reach the target pro't
'gure.
,. &f a $onus of R<.)< per unit is paid for each unit sold in e.cess
of the $reak7even point, then the contri$ution margin on these
units would drop from R).2< to R).0< per unit.
he desired monthly pro't would $e:
+0P V (R,0,<<< \ R),<<<* Y RC,<<<
hus,
arget pro't RC,<<<
Y Y2,<<< units
Knit contri$ution margin R).0< per unit
herefore, the company must sell 2,<<< units a$ove the $reak7
even point to earn a pro't of RC,<<< each month. hese units,
added to the +),<<< units re4uired to $reak even, would e4ual
total sales of +@,<<< units each month.
3olutions Manual, "hapter 2 ),)
&ro'lem -2! (,< minutes*
). he contri$ution margin per sweatshirt would $e:
3elling price............................................................ R),.0<
!urchase cost of the sweatshirts........................... RB.<<
"ommission to the student
salespersons...................................................... ).0< C.0<
"ontri$ution margin................................................ R/.<<
3ince there are no '.ed costs, the num$er of unit sales needed
to yield the desired R),+<< in pro'ts can $e o$tained $y
dividing the target R),+<< pro't $y the unit contri$ution
margin:
arget pro't R),+<<
Y Y,<< sweatshirts
Knit contri$ution margin R/.<< per sweatshirt
,<< sweatshirts VR),.0< per sweatshirt Y R/,<0< in total sales.
+. 3ince an order has $een placed, there is now a M'.edN cost
associated with the purchase price of the sweatshirts (i.e., the
sweatshirts canGt $e returned*. For e.ample, an order of @0
sweatshirts re4uires a M'.edN cost (investment* of R2<< (@0
sweatshirts V RB.<< per sweatshirt Y R2<<*. he varia$le cost
drops to only R).0< per sweatshirt, and the new contri$ution
margin per sweatshirt $ecomes:
3elling price............................................................ R),.0<
=ess varia$le e.penses (commissions
only*..................................................................... ).0<
"ontri$ution margin................................................ R)+.<<
3ince the M'.edN cost of R2<< must $e recovered $efore Mr.
;ooper shows any pro't, the $reak7even computation would
$e:
Fi.ed e.penses
?reak7even point
Y
in unit sales
R2<<
Y Y0< sweatshirts
R)+.<< per sweatshirt
3olutions Manual, "hapter 2 ),+
0< sweatshirts VR),.0< per sweatshirt Y R2@0 in total sales
&f a 4uantity other than @0 sweatshirts were ordered, the
answer would change accordingly.
3olutions Manual, "hapter 2 ),,
&ro'lem -2" (2< minutes*
). he income statements would $e:
Present Proposed
Amount
Per
Uni
t J Amount
Per
Unit J
3ales
R/0<,<<
< R,< )<<P R/0<,<<< R,< )<<P
=ess varia$le
e.penses
,)0,<<
< +) @< )B<,<<< )+Z /<
"ontri$ution
margin ),0,<<< R C ,egree of operating
leverage
R),0,<<<
Y,
R/0,<<<
R+@<,<<<
Y2
R/0,<<<
$. ?reak7even point in
dollars
RC<,<<<
Y
<.,<
R,<<,<<<
R++0,<<<
Y
<.2<
R,@0,<<<
c. Margin of safety Y
otal sales X ?reak7
even sales:
R/0<,<<< X
R,<<,<<<
R)0<,<<<
R/0<,<<< X
R,@0,<<<
R@0,<<<
Margin of safety
percentage Y Margin
of safety [ otal
sales:
R)0<,<<< [ ,, )H,P
3olutions Manual, "hapter 2 ),/
R/0<,<<<
R@0,<<< [
R/0<,<<<
)2 +H,P
3olutions Manual, "hapter 2 ),0
,. he major factor would $e the sensitivity of the companyGs
operations to cyclical movements in the economy. &n years of
strong economic activity, the company will $e $etter o# with
the new e4uipment. he reason is that the new e4uipment will
increase the "M ratio, permitting pro'ts to rise more rapidly in
years that sales are strong. ;owever, in periods of economic
recession, the company will $e worse o# with the new
e4uipment. he greater '.ed costs created $y the new
e4uipment will cause losses to $e deeper and sustained more
4uickly than at present. hus, management must decide
whether the potential for greater pro'ts in good years is worth
the risk of deeper losses in $ad years.
/. Ao information is given in the pro$lem concerning the new
varia$le e.penses or the new contri$ution margin ratio. ?oth of
these items must $e determined $efore the new $reak7even
point can $e computed. he computations are:
Aew varia$le e.penses:
R0B0,<<<ZY Iaria$le e.penses \ R)B<,<<< \ R0/,<<<ZZ
R,0),<<< Y Iaria$le e.penses
ZAew level of sales: R/0<,<<< V ).,< Y R0B0,<<<
ZZAew level of net operating income: R/0,<<< V ).+ Y
R0/,<<<
Aew "M ratio:
3ales
R0B0,<<
< )<<P
,0),<<
< 2<
"ontri$ution margin
R+,/,<<
< /<P
Oith the a$ove data, the new $reak7even point can $e
computed:
Fi.ed e.penses R)B<,<<<
?reak7even point
Y Y YR/0<,<<<
in dollar sales
"M ratio <./
3olutions Manual, "hapter 2 ),2
he greatest risk is that the marketing managerGs estimates of
increases in sales and net operating income will not materialize
and that sales will remain at their present level. Aote that the
present level of sales is R/0<,<<<, which is just e4ual to the
$reak7even level of sales under the new marketing method.
hus, if the new marketing strategy is adopted and sales
remain unchanged, pro'ts will drop from the current level of
R/0,<<< per month to zero.
&t would $e a good idea to compare the new marketing strategy
to the current situation more directly. Ohat level of sales would
$e needed under the new method to generate at least the
R/0,<<< in pro'ts the company is currently earning each
monthF he computations are:
>ollar sales to attain
Y
target pro't
"M ratio
R)B<,<<<\R/0,<<<
Y
<./<
Y R02+,0<< in sales each month
hus, sales would have to increase $y at least +0P (R02+,0<<
is +0P higher than R/0<,<<<* in order to make the company
$etter o# with the new marketing strategy than with the
current situation. his appears to $e e.tremely risky.
3olutions Manual, "hapter 2 ),@
&ro'lem -2# (/0 minutes*
). a. <a1aiian
Fantas%
,ahitian
9o% ,otal
Amount J Amount J
Amoun
t J
3ales..........................
R,<<,<<
<
)<<.
<
R0<<,<<
<
)<<.
<
RB<<,<<
< )<<.<
=ess varia$le
e.penses................. )B<,<<< 2<.< )<<,<<< +<.<
+B<,<<
< ,0.<
"ontri$ution margin...
R)+<,<<
< /<.<
R/<<,<<
< B<.< 0+<,<<< 20.<
=ess '.ed e.penses. . .
/@0,B<
<
Aet operating
income.....................
R //,+<
<
$. Fi.ed e.penses R/@0,B<<
?reak7even point
Y Y YR@,+,<<<
in dollar sales
"M ratio <.20<
Margin of safetyYActual sales 7 ?reak7even sales
YRB<<,<<< 7 R@,+,<<<YR2B,<<<
Margin of safety Margin of safety in dollars
Y
percentage Actual sales
R2B,<<<
Y YB.0P
RB<<,<<<
3olutions Manual, "hapter 2 ),B
3olutions Manual, "hapter 2 ),C
+. a.
<a1aiian
Fantas%
,ahitian
9o%
Samoan
!elight ,otal
Amoun
t J Amount J Amount J Amount J
3ales.................
R,<<,<<
< )<<.<
R0<<,<<
< )<<
R/0<,<<
< )<<.<
R),+0<,<<
< )<<.<
=ess varia$le
e.penses........
)B<,<<
< 2<.< )<<,<<< +< ,2<,<<< B<.< 2/<,<<< 0).+
"ontri$ution
margin............
R)+<,<<
< /<.<
R/<<,<<
< B< R C<,<<< +<.< 2)<,<<< /B.B
=ess '.ed
e.penses........ /@0,B<<
Aet operating
income............
R ),/,+<
<
3olutions Manual, "hapter 2 )/<
$. Fi.ed e.penses R/@0,B<<
?reak7even point
Y Y Y RC@0,<<<
in dollar sales
"M ratio <./BB
Margin of safetyYActual sales 7 ?reak7even sales
YR),+0<,<<< 7 RC@0,<<<YR+@0,<<<
Margin of safety Margin of safety in dollars
Y
percentage Actual sales
R+@0,<<<
Y Y++P
R),+0<,<<<
,. he reason for the increase in the $reak7even point can $e
traced to the decrease in the companyGs overall contri$ution
margin ratio when the third product is added. Aote from the
income statements a$ove that this ratio drops from 20P to
/B.BP with the addition of the third product. his product (the
3amoan >elight* has a "M ratio of only +<P, which causes the
average contri$ution margin per dollar of sales to shift
downward.
his pro$lem shows the somewhat tenuous nature of $reak7
even analysis when the company has more than one product.
he analyst must $e very careful of his or her assumptions
regarding sales mi., including the addition (or deletion* of new
products.
&t should $e pointed out to the president that even though the
$reak7even point is higher with the addition of the third
product, the companyGs margin of safety is also greater. Aotice
that the margin of safety increases from R2B,<<< to R+@0,<<<
or from B.0P to ++P. hus, the addition of the new product
shifts the company much further from its $reak7even point,
even though the $reak7even point is higher.
3olutions Manual, "hapter 2 )/)
&ro'lem -3$ (2< minutes*
).
"A8?ES, &A".
&ncome 3tatement For April
Standard !eluxe ,otal
3ales..........................
R+/<,<<
< )<<
R)0<,<<
< )<<
R,C<,<<
< )<<.<
=ess varia$le
e.penses:
!roduction................ 2<,<<< +0 2<,<<< /< )+<,<<< ,<.B
3ales commission.... ,2,<<< )0
++,0<
< )0
0B,0<
< )0.<
otal varia$le
e.penses................. C2,<<< /<
B+,0<
< 00
)@B,0<
< /0.B
"ontri$ution margin. . .
R)//,<<
< 2<
R
2@,0<< /0
R+)),0<
< 0/.+
=ess '.ed e.penses:
Advertising.............. )<0,<<<
>epreciation............ +),@<<
Administrative.........
2,,<<
<
otal '.ed e.penses...
)BC,@<
<
Aet operating
income.....................
R
+),B<<
"A8?ES, &A".
&ncome 3tatement For May
Standard !eluxe ,otal
Amoun
t J Amount J Amount J
3ales.........................
R2<,<<
< )<<
R,@0,<<
< )<<
R/,0,<<
< )<<.<
=ess varia$le
e.penses:
!roduction............... )0,<<< +0 )0<,<<< /< )20,<<< ,@.C
3olutions Manual, "hapter 2 )/+
3ales commission. . . C,<<< )0 02,+0< )0 20,+0< )0.<
otal varia$le
e.penses................ +/,<<< /< +<2,+0< 00 +,<,+0< 0+.C
"ontri$ution margin. .
R,2,<<
< 2<
R)2B,@0
< /0 +</,@0< /@.)
=ess '.ed e.penses:
Advertising.............. )<0,<<<
>epreciation........... +),@<<
Administrative........ 2,,<<<
otal '.ed e.penses. . )BC,@<<
Aet operating
income.................... R)0,<0<
3olutions Manual, "hapter 2 )/,
&ro'lem -3$ (continued*
+. he sales mi. has shifted over the last year from 3tandard sets
to >elu.e sets. his shift has caused a decrease in the
companyGs overall "M ratio from 0/.+P in April to /@.)P in
May. For this reason, even though total sales (in dollars* are
greater, net operating income is lower.
,. 3ales commissions could $e $ased on contri$ution margin,
rather than on sales price. A -at rate on total contri$ution
margin, as the te.t suggests, might encourage the
salespersons to emphasize the product with the greatest
contri$ution to the pro'ts of the 'rm.
/. a. he $reak7even in dollar sales can $e computed as follows:
Fi.ed e.penses
R)BC,@<<
Y Y R,0<,<<<
<.0/+
"M ratio
$. MayGs $reak7even point is higher than AprilGs. his is $ecause
the companyGs overall "M ratio has gone down, i.e., the sales
mi. has shifted from the more pro'ta$le to the less pro'ta$le
units.
3olutions Manual, "hapter 2 )//
Case -31 (2< minutes*
). and +. Part 4 Part 5a Part 5b
,otal
Per
Unit ,otal
Per
Unit ,otal
Per
Unit
3ales....................................... R/0<,<<< R)<.<< R2<<,<<<
,
RB.<< R@+<,<<<
/
R)+.<<
>irect materials.................... C<,<<< +.<< )0<,<<< +.<< )+<,<<< +.<<
>irect la$or........................... @B,,<< ).@/ ),<,0<< ).@/ )</,/<< ).@/
Iaria$le overhead................. ),,0<< <.,< ++,0<< <.,< )B,<<< <.,<
Iaria$le selling:
"ommissions...................... +@,<<< <.2<
)
,2,<<< <./B
)
2/,B<< ).<B
)
3hipping............................. 0,/<< <.)+ C,<<< <.)+ @,+<< <.)+
Iaria$le administrative......... ),B<< <.</ ,,<<< <.</ +,/<< <.</
otal varia$le e.penses........... +)2,<<< /.B< ,0),<<< /.2B ,)2,B<< 0.+B
"ontri$ution margin +,/,<<< R0.+< +/C,<<< R,.,+ /<,,+<< R2.@+
=ess '.ed e.penses:
Manufacturing overhead....... B0,<<<
+
B0,<<< B0,<<<
3elling (advertising, etc.*...... )+<,<<< )+<,<<< ++<,<<<
0
Administrative (salaries,
etc.*.................................... /B,<<< /B,<<< /B,<<<
otal '.ed e.penses................ +0,,<<< +0,,<<< ,0,,<<<
Aet operating income (loss*....
R()C,<<<
* R (/,<<<* R 0<,+<<
)
2P of sales dollars for parts ) and +a% CP for part
+$.
/
/0,<<< units V ) )H, Y 2<,<<<
units%
+
RCB,0<< X (/0,<<< units V R<.,<* Y RB0,<<<. R)<.<< \ (R)<.<< V +<P* Y
R)+.<<%
,
R)<.<< X (R)<.<< V +<P* Y RB.<<% RB.<< V @0,<<< 2<,<<< units V R)+.<< Y
3olutions Manual, "hapter 2 )/0
units R@+<,<<<.
Y R2<<,<<<.
0
R)+<,<<< \ R)<<,<<< Y
R++<,<<<.
3olutions Manual, "hapter 2 )/2
Case -31 (continued*
,. 3elling price per unit................................. R)<.<<
Driginal unit varia$le e.pense (from part
)*............................................................ R/.B<
=ess reduction in materials cost................ <.@< /.)<
Aew contri$ution margin per unit............. R0.C<
Fi.ed e.penses\arget pro't
Y
target pro't
R+0,,<<<\R,<,+<<
Y Y/B,<<< units
R0.C< per unit
/. "ontri$ution margin generated
(2<,<<< units V R0.+< per unit*................. R,)+,<<<
=ess:
Fi.ed costs to $e covered (from part )*.....
R+0,,<<
<
arget pro't (2<,<<< units V R)< per unit
Y R2<<,<<<% R2<<,<<< V /.0P Y
R+@,<<<*................................................. +@,<<< +B<,<<<
"ontri$ution margin availa$le for
increased advertising................................ R,+,<<<
0. he 4uoted price per unit would $e:
Iaria$le production e.pense (R+.<< \ R).@/ \
R<.,<*................................................................ R/.</
3hipping e.pense (R<.)+ V ).0*........................... <.)B
Iaria$le administrative e.pense (R<.</ V <.@0*... <.<,
3pecial insurance fee (R0,@<< [ C,0<< units*....... <.2<
!resent net operating loss (R)C,<<< [ C,0<<
units*................................................................. +.<<
>esired pro't (R)/,+0< [ C,0<< units*................. ).0<
6uoted price per unit........................................... RB.,0
&t should $e pointed out, however, that the price charged to the
overseas distri$utor should $e determined $y how much the
overseas distri$utor is willing to pay and competitive conditions
rather than $y Ohitney "ompanyGs desired pro't. Any price
greater than the cost of R/.B0 per unit (Y RB.,0 X R).0< X
3olutions Manual, "hapter 2 )/@
R+.<<* would reduce OhitneyGs net operating loss. Dn the other
hand, if the distri$utor is willing to pay more than RB.,0 per
unit, it would $e foolish to leave the additional pro't on the
ta$le.
3olutions Manual, "hapter 2 )/B
Case -32 (C< minutes*
). a. ?efore the income statement can $e completed, we need to
estimate the companyGs revenues and e.penses for the
month.
he 'rst step is to compute the sales for the month in $oth
units and dollars. 3ales in units would $e:
,,,<<< units (5uly sales* [ ).)< Y ,<,<<< units sold in 5une.
o determine the sales in dollars, we must integrate the
$reak7even point, the margin of safety in dollars, and the
margin of safety percentage. he computations are:
Margin of safety in dollarsYotal sales 7 ?reak7even sales
Yotal sales 7 R)B<,<<<
Margin of safety
Y
percentage (+<P*
otal sales
&f the margin of safety in dollars is +<P of total sales, then
the $reak7even point in dollars must $e B<P of total sales.
herefore, total sales would $e:
R)B<,<<<
YB<P
otal sales
otal sales Y R)B<,<<<[B<P
Y R++0,<<<
he selling price per unit would $e:
R++0,<<< total sales [ ,<,<<< units Y R@.0< per unit.
he second step is to determine the total contri$ution margin
for the month of 5une. his can $e done $y using the
operating leverage concept. Aote that a )<P increase in
sales has resulted in a 0<P increase in net operating income
$etween 5une and 5uly:
5 uly increased net income R/<,0<< 7 R+@,<<< R),,0<<
Y Y Y0<P
5 une net income R+@,<<< R+@,<<<
3olutions Manual, "hapter 2 )/C
3ince the net operating income for 5uly increased $y 0<P
when sales increased $y )<P, the degree of operating
leverage for 5une must $e 0. herefore, total contri$ution
margin for 5une must have $een:
0 V R+@,<<< Y R),0,<<<.
5uneGs income statement can now $e completed $y simply
inserting known data and computing unknown data:
!Q88;&" "DM!AAQ
Actual &ncome 3tatement
For the Month Ended 5une ,<
,otal
Per
Unit
Percen
t
3ales (,<,<<< units*....
R++0,<<
< R@.0< )<<
=ess varia$le
e.penses.................. C<,<<< Z ,.<< Z /<
Z
"ontri$ution margin.... ),0,<<< R/.0< 2< Z
=ess '.ed e.penses.... )<B,<<< Z
Aet operating
income.....................
R
+@,<<<
Z"omputed $y working from known data.
$. he $reak7even point:
Fi.ed e.penses
?reak7even point
Y
in unit sales
R)<B,<<<
Y Y +/,<<<
R/.0< per unit
&n dollars: +/,<<< units V R@.0< per unit Y R)B<,<<<
3olutions Manual, "hapter 2 )0<
c. Margin of safety in dollarsYotal sales 7 ?reak7even sales
YR++0,<<< 7 R)B<,<<< Y R/0,<<<
Margin of safety
Y
percentage
otal sales
R/0,<<<
Y Y +<P
R++0,<<<
3olutions Manual, "hapter 2 )0)
d. he degree of operating leverage:
"ontri$ution margin R),0,<<<
Y Y 0
Aet income R+@,<<<
+. a. 5ulyGs income statement can $e completed using data given
in the pro$lem and data derived for 5uneGs income statement
a$ove:
!Q88;&" "DM!AAQ
!rojected &ncome 3tatement
For the Month Ended 5uly ,)
,otal
Per
Unit
Percen
t
3ales (,,,<<< units* R+/@,0<< R@.0< )<<
=ess varia$le e.penses CC,<<< ,.<< /<
"ontri$ution margin )/B,0<< R/.0< 2<
=ess '.ed e.penses )<B,<<<
R
/<,0<<
$. Margin of safety in dollars Yotal sales 7 ?reak7even sales
YR+/@,0<< 7 R)B<,<<<YR2@,0<<
Margin of safety
Y
percentage
otal sales
R2@,0<<
Y Y+@.,P (rounded*
R+/@,0<<
"ontri$ution margin
>egree of operating
Y
leverage
R)/B,0<<
Y Y,.@ (rounded*
R/<,0<<
he margin of safety has gone up since the companyGs sales
3olutions Manual, "hapter 2 )0+
will $e greater in 5uly than they were in 5une, thus moving
the company farther away from its $reak7even point.
3olutions Manual, "hapter 2 )0,
he degree of operating leverage operates in the opposite
manner from the margin of safety. As a company moves
farther away from its $reak7even point, the degree of
operating leverage decreases. he reason it decreases is that
$oth contri$ution margin and net operating income are
increasing at the same dollar rate as additional units are
sold, and, mathematically, dividing one $y the other will yield
a progressively smaller num$er.
,. he increased la$or cost will $e R<.2< per unit, )H, of R).B< per
unit. he new varia$le e.pense will therefore total R,.2< per
unit, and the new contri$ution margin ratio will $e:
3ales R@.0< )<<P
=ess varia$le e.penses ,.2< /B
"ontri$ution margin R,.C< 0+P
he target pro't per unit will $e:
+<P V R@.0< Y R).0<.
herefore,
3ales Y
!ro'ts
R@.0<6 Y R,.2<6 \ R)<B,<<< \ R).0<6
R+./<6 Y R)<B,<<<
6 Y R)<B,<<< [ R+./< per unit
6 Y /0,<<< units
3ales Y
!ro'ts
S Y <./BS \ R)<B,<<< \ <.+<S
<.,+S Y R)<B,<<<
S Y R)<B,<<< [ <.,+
S Y
R,,@,0<<% or, at R@.0< per unit, /0,<<<
units
3olutions Manual, "hapter 2 )0/
Case -33 (@0 minutes*
?efore proceeding with the solution, it is helpful 'rst to restructure the data into
contri$ution format for each of the three alternatives. (he data in the statements $elow
are in thousands.*
4;J
Commission
5:J
Commission $1n Sales Force
3ales R)2,<<< )<<P R)2,<<< )<<P
R)2,<<<.
< )<<.<P
Manufacturing @,+<< @,+<< @,+<<.<
"ommissions ()0P, +<P
@.0P* +,/<< ,,+<<
),+<<.
<
otal varia$le e.penses C,2<< 2< )<,/<< 20
B,/<<.
< 0+.0
"ontri$ution margin 2,/<< /<P 0,2<< ,0P
@,2<<.
< /@.0P
=ess '.ed e.penses:
Manufacturing overhead +,,/< +,,/< +,,/<.<
Marketing )+< )+< +,0+<.< Z
Administrative ),B<< ),B<< ),@+0.< ZZ
&nterest 0/< 0/<

0/<.<
otal '.ed e.penses /,B<< /,B<<
@,)+0.
<
&ncome $efore income ta.es ),2<< B<< /@0.<
=ess income ta.es (,<P* /B< +/< )/+.0
Aet income R ),)+< R 02< R ,,+.0
ZR)+<,<<< \ R+,/<<,<<< Y R+,0+<,<<<.
ZZR),B<<,<<< X R@0,<<< Y R),@+0,<<<.
). Ohen the income $efore ta.es is zero, income ta.es will also
$e zero and net income will $e zero. herefore, the $reak7even
calculations can $e $ased on the income $efore ta.es.
a. ?reak7even point in dollar sales if the commission remains
)0P.
Fi.ed costs R/,B<<,<<<
Y YR)+,<<<,<<<
"M ratio <./<
$. ?reak7even point in dollar sales if the commission increases
to +<P.
Fi.ed costs R/,B<<,<<<
Y YR),,@)/,+B2
"M ratio <.,0
c. ?reak7even point in dollar sales if the company employs its
own sales force.
Fi.ed costs R@,)+0,<<<
Y YR)0,<<<,<<<
"M ratio <./@0
+. &n order to generate a R),)+<,<<< net income, the company
must generate R),2<<,<<< in income $efore ta.es. herefore,
Fi.ed e.penses \ arget income $efore ta.es
>ollar sales to
Y
attain target
"M ratio
R/,B<<,<<< \ R),2<<,<<< R2,/<<,<<<
Y Y Y R)B,+B0,@)/
<.,0 <.,0
,. o determine the volume of sales at which net income would $e
e4ual under either the +<P commission plan or the company
sales force plan, we 'nd the volume of sales where costs $efore
income ta.es under the two plans are e4ual.
S Y otal sales revenue
<.20S \
R/,B<<,<<< Y <.0+0S \ R@,)+0,<<<
<.)+0S Y R+,,+0,<<<
S Y R+,,+0,<<< [ <.)+0
3olutions Manual, "hapter 2 )0@
S Y R)B,2<<,<<<
3olutions Manual, "hapter 2 )0B
hus, at a sales level of R)B,2<<,<<< either plan would yield
the same income $efore ta.es and net income. ?elow this sales
level, the commission plan would yield the largest net income%
a$ove this sales level, the sales force plan would yield the
largest net income.
/. a., $., and c.
4;J
Commissio
n
5:J
Commissi
on
$1n
Sales
Force
"ontri$ution margin (!art )*
(.* R2,/<<,<<< R0,2<<,<<< R@,2<<,<<<
&ncome $efore ta.es (!art )*
(y* R),2<<,<<< R B<<,<<< R /@0,<<<
>egree of operating
leverage:
(.* [ (y* / @ )2
0. Oe would continue to use the sales agents for at least one
more year, and possi$ly for two more years. he reasons are as
follows:
>irst. use of the sales agents would have a less dramatic
e#ect on net income.
Second, use of the sales agents for at least one more year
would give the company more time to hire competent people
and get the sales group organized.
-hird. the sales force plan doesnGt $ecome more desira$le
than the use of sales agents until the company reaches sales
of R)B,2<<,<<< a year. his level pro$a$ly wonGt $e reached
for at least one more year, and possi$ly two years.
>ourth. the sales force plan will $e highly leveraged since it
will greatly increase '.ed costs (and decrease varia$le
costs*. Dne or two years from now, when sales have reached
the R)B,2<<,<<< level, the company can $ene't greatly from
this leverage. For the moment, pro'ts will $e greater and
risks will $e less $y staying with the agents, even at the
higher +epartment can $e computed as follows:
Annual
Patient/!a%s Aides (urses
Supervisi
ng (urses
,otal
Personne
l
$ther
Fixed Cost
,otal
Fixed
Cost
L
M4HA:::
L
M5EA:::
L
M6EA:::
)<,<<<7
)/,<<< R,@B,<<< R+B2,<<< R)//,<<< RB<B,<<< R/0/,<<<
R),+2+,<<
<
)/,<<)7
)@,<<< ,C2,<<< ,)+,<<< )//,<<< B0+,<<< /0/,<<< ),,<2,<<<
)@,<<)7
+,,@+0 ,C2,<<< ,,B,<<< )//,<<< B@B,<<< /0/,<<< ),,,+,<<<
+,,@+27
+0,00< /0<,<<< ,2/,<<< )B<,<<< CC/,<<< /0/,<<< ),//B,<<<
+0,00)7
+@,,@0 /2B,<<< ,2/,<<< )B<,<<< ),<)+,<<< /0/,<<< ),/22,<<<
+@,,@27
+C,+<< 0++,<<< /)2,<<< +)2,<<< ),)0/,<<< /0/,<<< ),2<B,<<<
+. he M$reak7evenN can $e computed for each range of activity $y dividing the total '.ed
cost for that range of activity $y the contri$ution margin per patient7day, which is RB<
(YR),< revenue 7 R0< varia$le cost*.
Annual
Patient/!a%s
'a+
,otal
Fixed
Cost
'b+
Contributio
n Margin
NBrea&/
EvenO
'a+ P 'b+
0ithin
2elevant
2angeQ
3olutions Manual, "hapter 2 )2)
)<,<<<7
)/,<<<
R),+2+,<<
< RB< )0,@@0 Ao
)/,<<)7
)@,<<< ),,<2,<<< B< )2,,+0 Qes
)@,<<)7
+,,@+0 ),,,+,<<< B< )2,20< Ao
+,,@+27
+0,00< ),//B,<<< B< )B,)<< Ao
+0,00)7
+@,,@0 ),/22,<<< B< )B,,+0 Ao
+@,,@27
+C,+<< ),2<B,<<< B< +<,)<< Ao
3olutions Manual, "hapter 2 )2+
Ohile a M$reak7evenN can $e computed for each range of activity (i.e., relevant range*,
all $ut one of these $reak7evens is $ogus. For e.ample, within the range of )<,<<< to
)/,<<< patient7days, the computed $reak7even is )0,@00 patient7days. ;owever, this
level of activity is outside this relevant range. o serve )0,@00 patient7days, the '.ed
costs would have to $e increased from R),+2+,<<< to R),,<2,<<< $y adding one more
aide and one more nurse. he only M$reak7evenN that occurs within its own relevant
range is )2,,+0. his is the only legitimate $reak7even.
,. he level of activity re4uired to earn a pro't of R+<<,<<< can $e computed as follows:
Annual
Patient/!a%s
,otal
Fixed
Cost
,arget
Pro.t
'a+
,otal Fixed
Cost R ,arget
Pro.t
'b+
Contributio
n Margin
Activit%
to Attain
,arget
Pro.t
'a+ P 'b+
0ithin
2elevant
2angeQ
)<,<<<7
)/,<<<
R),+2+,<<
<
R+<<,<<
< R),/2+,<<< RB< )B,+@0 Ao
)/,<<)7
)@,<<< ),,<2,<<<
+<<,<<<
),0<2,<<< B< )B,B+0 Ao
)@,<<)7
+,,@+0 ),,,+,<<<
+<<,<<<
),0,+,<<< B< )C,)0< Qes
+,,@+27
+0,00< ),//B,<<<
+<<,<<<
),2/B,<<< B< +<,2<< Ao
+0,00)7
+@,,@0 ),/22,<<<
+<<,<<<
),222,<<< B< +<,B+0 Ao
+@,,@27
+C,+<< ),2<B,<<<
+<<,<<<
),B<B,<<< B< ++,2<< Ao
3olutions Manual, "hapter 2 )2,
&n this case, the only solution that is within the appropriate relevant range is )C,)0<
patient7days.
3olutions Manual, "hapter 2 )2/
Case -35 (2< minutes*
Aote: his is a pro$lem that will challenge the very $est studentsG
conceptual and analytical skills.
). he overall $reak7even sales can $e determined using the "M
ratio.
Velcro Metal (%lon ,otal
3ales
R)20,<<
< R,<<,<<<
R,/<,<<
< RB<0,<<<
Iaria$le e.penses )+0,<<< )/<,<<< )<<,<<< ,20,<<<
"ontri$ution margin R /<,<<< R)2<,<<<
R+/<,<<
< //<,<<<
Fi.ed e.penses /<<,<<<
R /<,<<<
"ontri$ution margin R//<,<<<
"M ratioY <.0/22
3ales RB<0,<<<
Y Y
Fi.ed e.penses R/<<,<<<
?reak7even point in
Y R@,+,<<< (rounded*
total sales dollars
"M ratio <.0/22
Y Y
+. he issue is what to do with the common '.ed cost when
computing the $reak7evens for the individual products. he
correct approach is to ignore the common '.ed costs. &f the
common '.ed costs are included in the computations, the
$reak7even points will $e overstated for individual products and
managers may drop products that in fact are pro'ta$le.
a. he $reak7even points for each product can $e computed
using the contri$ution margin approach as follows:
Velcro Metal (%lon
Knit selling price .................................................... R).20 R).0< R<.B0
Iaria$le cost per unit ............................................. ).+0 <.@< <.+0
Knit contri$ution margin (a* ................................... R<./< R<.B< R<.2<
!roduct '.ed e.penses ($* .....................................
R+<,<<
<
RB<,<<
<
R2<,<<
<
?reak7even point in units sold ($* 0<,<<< )<<,<< )<<,<<
3olutions Manual, "hapter @ C)
[ (a* ....................................................................< <
3olutions Manual, "hapter @ C+
$. &f the company were to sell e.actly the $reak7even 4uantities
computed a$ove, the company would lose R+/<,<<<9the
amount of the common '.ed cost. his can $e veri'ed as
follows:
Knit sales 0<,<<< )<<,<<< )<<,<<<
3ales RB+,0<<
R)0<,<<
< RB0,<<< R ,)@,0<<
Iaria$le e.penses
2+,0<< @<,<<< +0,<<< )0@,0<<
"ontri$ution
margin R+<,<<< R B<,<<< R2<,<<< )2<,<<<
Fi.ed e.penses /<<,<<<
Aet operating
income
R(+/<,<<<
*
At this point, many students conclude that something is wrong
with their answer to part (a* since a result in which the
company loses money operating at the $reak7evens for the
individual products does not seem to make sense. hey also
worry that managers may $e lulled into a false sense of
security if they are given the $reak7evens computed in part (a*.
otal sales at the individual product $reak7evens is only
R,)@,0<< whereas the total sales at the overall $reak7even
computed in part ()* is R@,+,<<<.
Many students (and managers, for that matter* attempt to
resolve this apparent parado. $y allocating the common '.ed
costs among the products prior to computing the $reak7evens
for individual products. Any of a num$er of allocation $ases
could $e used for this purpose9sales, varia$le e.penses,
product7speci'c '.ed e.penses, contri$ution margins, etc. (Oe
usually take a tally of how many students allocated the
common '.ed costs using each possi$le allocation $ase $efore
proceeding.* For e.ample, the common '.ed costs are
allocated on the ne.t page $ased on sales.
3olutions Manual, "hapter @ C,
Allocation of common '.ed e.penses on the $asis of sales
revenue:
3ales
R)20,<<
< R,<<,<<<
R,/<,<<
<
RB<0,<<
<
!ercentage of total sales +<./C@P ,@.+2@P /+.+,2P )<<.<P
Allocated common '.ed
e.penseZ R/C,)C, R BC,//)
R)<),,2
2
R+/<,<<
<
!roduct '.ed e.penses +<,<<< B<,<<< 2<,<<< )2<,<<<
Allocated common and
product '.ed e.penses
(a* R2C,)C, R)2C,//)
R)2),,2
2
R/<<,<<
<
($* R<./< R<.B< R<.2<
M?reak7evenN point in
units sold (a* [ ($* )@+,CB, +)),B<) +2B,C/,
Zotal common '.ed e.pense V percentage of total sales
&f the company sells )@+,CB, units of the Ielcro product, +)),B<)
units of the Metal product, and +2B,C/, units of the Aylon
product, the company will indeed $reak even overall. ;owever,
the apparent $reak7evens for two of the products are higher than
their normal annual sales.
Velcro Metal (%lon
Aormal annual sales
volume
)<<,<<< +<<,<<< /<<,<<<
M?reak7evenN annual sales )@+,CB, +)),B<) +2B,C/,
M3trategicN decision drop drop retain
&t would $e natural for managers to interpret a $reak7even for a
product as the level of sales $elow which the company would $e
'nancially $etter o# dropping the product. herefore, we should
not $e surprised if managers, $ased on the a$ove erroneous
$reak7even calculation, would decide to drop the Ielcro and Metal
products and concentrate on the companyGs Mcore competency,N
which appears to $e the Aylon product.
3olutions Manual, "hapter @ C/
&f the managers drop the Ielcro and Metal products, the company
would face a loss of R2<,<<< computed as follows:
3ales dropped dropped
R,/<,<<
< R,/<,<<<
Iaria$le e.penses )<<,<<< )<<,<<<
"ontri$ution margin
R+/<,<<
< +/<,<<<
Fi.ed e.pensesZ ,<<,<<<
R(2<,<<<*
Z ?y dropping the two products, the company reduces its '.ed
e.penses $y only R)<<,<<< (YR+<,<<< \ RB<,<<<*. herefore,
the total '.ed e.penses are R,<<,<<< rather than R/<<,<<<.
?y dropping the two products, the company would go from
making a pro't of R/<,<<< to su#ering a loss of R2<,<<<. he
reason is that the two dropped products were contri$uting
R)<<,<<< toward covering common '.ed e.penses and toward
pro'ts. his can $e veri'ed $y looking at a segmented income
statement like the one that will $e introduced in a later chapter.
3ales
R)20,<<
<
R,<<,<<
<
R,/<,<<
< RB<0,<<<
Iaria$le e.penses )+0,<<< )/<,<<< )<<,<<< ,20,<<<
"ontri$ution margin /<,<<< )2<,<<< +/<,<<< //<,<<<
!roduct '.ed e.penses
+<,<<< B<,<<< 2<,<<< )2<,<<<
!roduct segment margin
R +<,<<< R B<,<<<
R)B<,<<
< +B<,<<<
"ommon '.ed e.penses
+/<,<<<
R /<,<<<
R)<<,<<<
3olutions Manual, "hapter @ C0
,roup E%ercise -3
). he answer to this 4uestion will vary from school to school.
+. Managers will hire more support sta#, such as security and
vending personnel, for $ig games that predicta$ly draw more
people. hese costs are varia$le with respect to the num$er of
expected attendees, $ut are '.ed with respect to the num$er
of people who actually $uy tickets. Most other costs are '.ed
with respect to $oth the num$er of e.pected and actual tickets
sold9including the costs of the coaching sta#, athletic
scholarships, uniforms and e4uipment, facilities, and so on.
,. he answer to this 4uestion will vary from school to school, $ut
a clear distinction should $e drawn $etween the costs that are
varia$le with respect to the num$er of tickets sold (i.e., actual
attendees* versus the costs that are varia$le with respect to
the num$er of tickets that are e.pected to $e sold. he costs
that are varia$le with respect to the num$er of tickets actually
sold, given the num$er of e.pected tickets sold, are pro$a$ly
inconse4uential since, as discussed a$ove, staEng is largely
decided $ased on e.pectations.
/. he answer to this 4uestion will vary from school to school. he
lost pro't is the di#erence $etween the ticket price and the
varia$le cost of 'lling a seat multiplied $y the num$er of unsold
seats.
0. he answer to this 4uestion will vary from school to school.
2. he answer to this 4uestion will vary from school to school, $ut
should $e $ased on the answers to parts (/* and (0* a$ove.
3olutions Manual, "hapter @ C2
,roup E%ercise -3!
). &f CP increases continue for ten years, then the cost of tuition
and room and $oard at a private college will cost +.,@ times as
much as today ().<C
)<
Y+.,@*. hus, a college education that
costs R)<<,<<< today would cost R+,@,<<< in ten years. his
appears to $e 4uite una#orda$le9particularly if family incomes
increase at much less than the CP rate.
+. he cost of adding an additional student to a class is virtually
zero. ?asically, all of a collegeGs costs are '.ed with respect to
how many students are enrolled in a particular scheduled class.
,. &ncreasing enrollment will lead to more eEcient use of the
currently underutilized capacity of higher education. &f more
students are enrolled in a college whose enrollments are $elow
capacity, then the cost per student should decrease.
"onse4uently, tuition should decrease as well, unless capacity
is e.panded to accommodate the additional students.
/. !rivate colleges should $ene't more than pu$lic colleges from
increasing enrollments $ecause tuition is generally higher at
private institutions% therefore, more revenue will $e received
from additional students. he revenue stream tends to $e much
more constant at pu$lic colleges, which rely on funds provided
$y the state. his shields pu$lic colleges somewhat during
periods of decreasing enrollments, $ut prevents them from
realizing the full $ene'ts of increasing enrollments.
3olutions Manual, "hapter @ C@
,roup E%ercise -3"
!arts ), +, and ,
A#ected
b% adding
service to
an
airportQ
A#ected
b% adding
a SightQ
Variable
1ith
respect to
seats
.lledQ
Fuel and oil.............................. Qes Qes 3omewhat
Flying operations la$or (-ight
crews9pilots, copilots,
navigators, and -ight
engineers*............................. Qes Qes Ao
!assenger service la$or (-ight
attendants*............................ Qes Qes 3omewhat
Aircraft traEc and servicing
la$or (personnel servicing
aircraft and handling
passengers at gates,
$aggage, and cargo*.............. Qes Qes 3omewhat
!romotions and sales la$or
(reservations and sales
agents, advertising and
pu$licity*............................... 3omewhat Ao Ao
Maintenance la$or
(maintenance of -ight
e4uipment and ground
property and e4uipment*....... Qes 3omewhat Ao
Maintenance materials and
overhead............................... Qes Qes Ao
1round property and
e4uipment (landing fees,
and rental e.penses and
depreciation for ground
property and e4uipment*....... Qes 3omewhat Ao
Flight e4uipment (rental
e.penses and depreciation
on aircraft frames and
engines*................................ Qes Qes Ao
1eneral overhead 3omewhat Ao Ao
3olutions Manual, "hapter @ CB
(administrative personnel,
utilities, insurance,
communications, etc.*...........
3olutions Manual, "hapter @ CC
,roup E%ercise -3" (continued*
/. he varia$le cost of 'lling a seat on an already7scheduled -ight
is very small. he num$er of -ight attendants on a -ight might
have to $e augmented and the num$er of meals served would
have to $e increased, $ut $eyond that there would $e very little
varia$le cost. Fuel costs would increase $ecause of the added
weight, $ut not $y very much. "onse4uently, almost all of the
ticket price falls directly to the $ottom line as increased net
operating income. his makes airline pro'ts very sensitive to
the load factor. As the percentage of seats 'lled $y paying
passengers increases, pro'ts increase dramatically. he
downside of this is that if the load factor declines, losses can
happen very 4uickly.
Airlines have very high '.ed costs and very low varia$le costs,
which gives them a lot of operating leverage. Ohen operating
leverage is high, pro'ts are sensitive $ecause each item sold
contri$utes more to revenue, a$ove '.ed costs. hus, $eyond
the $reak7even point, pro'ts grow more rapidly than they
would if operating leverage was low. ;owever, if the $reak7
even point is not reached, then losses are greater, $ecause a
higher proportion of costs is '.ed.
3olutions Manual, "hapter @ )<<
Chapter !
<aria'le Costing2 A -ool 7or
Management
!-1 he $asic di#erence $etween
a$sorption and varia$le costing is due to
the handling of '.ed manufacturing
overhead. Knder a$sorption costing, '.ed
manufacturing overhead is treated as a
product cost and hence is an asset until
products are sold. Knder varia$le costing,
'.ed manufacturing overhead is treated
as a period cost and is charged in full
against the current periodGs income.
!-2 3elling and administrative
e.penses are treated as period costs
under $oth varia$le costing and
a$sorption costing.
!-3 Knder a$sorption costing, '.ed
manufacturing overhead costs are
included in product costs, along with direct
materials, direct la$or, and varia$le
manufacturing overhead. &f some of the
units are not sold $y the end of the period,
then they are carried into the ne.t period
as inventory. he '.ed manufacturing
overhead cost attached to the units in
ending inventory follow the units into the
ne.t period as part of their inventory cost.
Ohen the units carried over as inventory
are 'nally sold, the '.ed manufacturing
overhead cost that has $een carried over
with the units is included as part of that
periodGs cost of goods sold.
!-4 A$sorption costing advocates
$elieve that a$sorption costing does a
$etter jo$ of matching costs with revenues
than varia$le costing. hey argue that all
manufacturing costs must $e assigned to
products to properly match the costs of
producing units of product with the
revenues from the units when they are
sold. hey $elieve that no distinction
should $e made $etween varia$le and
'.ed manufacturing costs for the purposes
of matching costs and revenues.
!-5 Advocates of varia$le costing argue
that '.ed manufacturing costs are not
really the cost of any particular unit of
product. &f a unit is made or not, the total
'.ed manufacturing costs will $e e.actly
the same. herefore, how can one say that
these costs are part of the costs of the
productsF hese costs are incurred to have
the capacity to make products during a
particular period and should $e charged
against that period as period costs
according to the matching principle.
!- &f production and sales are e4ual,
net operating income should $e the same
under a$sorption and varia$le costing.
Ohen production e4uals sales, inventories
do not increase or decrease and therefore
under a$sorption costing '.ed
manufacturing overhead cost cannot $e
deferred in inventory or released from
inventory.
!-! &f production e.ceeds sales,
a$sorption costing will usually show higher
net operating income than varia$le
costing. Ohen production e.ceeds sales,
inventories increase and therefore under
a$sorption costing part of the '.ed
manufacturing overhead cost of the
current period will $e deferred in inventory
to the ne.t period. &n contrast, all of the
'.ed manufacturing overhead cost of the
current period will $e charged immediately
3olutions Manual, "hapter @ )<)
against income as a period cost under
varia$le costing.
!-" &f '.ed manufacturing overhead
cost is released from inventory, then
inventory levels must have decreased and
therefore production must have $een less
than sales.
!-# &nventory decreased. he decrease
resulted in '.ed manufacturing overhead
cost $eing released from inventory and
charged against income as part of cost of
goods sold. his added '.ed
manufacturing overhead cost resulted in a
loss even though the company operated
at its $reakeven.
!-1$ Knder a$sorption costing it is
possi$le to increase net operating income
simply $y increasing the level of
production without any increase in sales. &f
production e.ceeds sales, units of product
are added to inventory. hese units carry a
portion of the current periodGs '.ed
manufacturing overhead costs into the
inventory account, there$y reducing the
current periodGs reported e.penses and
causing net operating income to increase.
!-11 1enerally speaking, varia$le
costing cannot $e used e.ternally for
'nancial reporting purposes nor can it $e
used for ta. purposes. &t can, however, $e
used in internal reports.
!-12 >i#erences in reported net
operating income $etween a$sorption and
varia$le costing arise $ecause of changing
levels of inventory. Knder 5&, goods are
produced strictly to customersG orders.
Oith production geared to sales,
inventories are largely (or entirely*
eliminated. &f inventories are completely
eliminated, they cannot change from one
period to another and a$sorption costing
and varia$le costing will report the same
net operating income.
3olutions Manual, "hapter @ )<+
E%ercise !-1 ()0 minutes*
(Aote: All currency values are in thousands of rupiah.*
). Knder a$sorption costing, all manufacturing costs (varia$le and
'.ed* are included in product costs.
>irect materials.......................................................
8p)<
<
>irect la$or............................................................. ,+<
Iaria$le manufacturing overhead........................... /<
Fi.ed manufacturing overhead (8p2<,<<< [ +0<
units*....................................................................
+/
<
Knit product cost.....................................................
8p@<
<
+. Knder varia$le costing, only the varia$le manufacturing costs
are included in product costs.
>irect materials.......................................................
8p)<
<
>irect la$or............................................................. ,+<
Iaria$le manufacturing overhead........................... /<
Knit product cost.....................................................
8p/2
<
Aote that selling and administrative e.penses are not treated
as product costs under either a$sorption or varia$le costing%
that is, they are not included in the costs that are inventoried.
hese e.penses are always treated as period costs and are
charged against the current periodGs revenue.
3olutions Manual, "hapter @ )<,
E%ercise !-2 (,< minutes*
(Aote: All currency values are in thousands of rupiah.*
). +0 units V 8p+/< per unit '.ed manufacturing overhead per
unit Y 8p2,<<<
+. he varia$le costing income statement appears $elow:
3ales......................................................... 8p)C),+0<
Iaria$le cost of goods sold:
?eginning inventory............................. 8p<
Add varia$le manufacturing costs
(+0< units V 8p/2< per unit*.............
))0,<<
<
1oods availa$le for sale....................... ))0,<<<
=ess ending inventory
(+0 units V 8p/2< per unit*...............
)),0<
<
Iaria$le cost of goods soldZ.................... )<,,0<<
Iaria$le selling and administrative
e.penses (++0 units V 8p+< per unit*. . /,0<< )<B,<<<
"ontri$ution margin.................................. B,,+0<
=ess '.ed e.penses:
Fi.ed manufacturing overhead............... 2<,<<<
Fi.ed selling and administrative
e.penses.............................................. +<,<<< B<,<<<
Aet operating income............................... 8p ,,+0<
Z he varia$le cost of goods sold could $e computed more
simply as: ++0 units sold V 8p/2< per unit Y 8p)<,,0<<.
he di#erence in net operating income $etween varia$le and
a$sorption costing can $e e.plained $y the deferral of '.ed
manufacturing overhead cost in inventory that has taken place
under the a$sorption costing approach. Aote from part ()* that
8p2,<<< of '.ed manufacturing overhead cost has $een
deferred in inventory to the ne.t period. hus, net operating
income under the a$sorption costing approach is 8p2,<<<
higher than it is under varia$le costing.
3olutions Manual, "hapter @ )</
E%ercise !-3 (+< minutes*
). -ear 4 -ear 5 -ear 6
?eginning inventories
(units*............................ +<< )@< )B<
Ending inventories
(units*............................ )@< )B< ++<
"hange in inventories
(units*............................ (,<* )< /<
Iaria$le costing net
operating income...........
R),<B<,/<
<
R),<,+,/<
< RCC2,/<<
Add: Fi.ed
manufacturing
overhead cost deferred
in inventory under
a$sorption costing ()<
units V R02< per unit%
/< units V R02< per
unit*............................... 0,2<< ++,/<<
>educt: Fi.ed
manufacturing
overhead cost released
from inventory under
a$sorption costing (,<
units V R02< per unit*.... ()2,B<<*
A$sorption costing net
operating income...........
R),<2,,2<
<
R),<,B,<<
<
R),<)B,B
<<
+. 3ince a$sorption costing net operating income was greater
than varia$le costing net operating income in Qear /,
inventories must have increased during the year and hence
'.ed manufacturing overhead was deferred in inventories. he
amount of the deferral is just the di#erence $etween the two
net operating incomes or R+B,<<< Y R),<)+,/<< X RCB/,/<<.
3olutions Manual, "hapter @ )<0
). a. ?y assumption, the unit selling price, unit varia$le costs, and
total '.ed costs are constant from year to year.
"onse4uently, varia$le costing net operating income will
vary with sales. &f sales increase, varia$le costing net
operating income will increase. &f sales decrease, varia$le
costing net operating income will decrease. &f sales are
constant, varia$le costing net operating income will $e
constant. 3ince varia$le costing net operating income was
R0)<,2<< each year, unit sales must have $een the same in
each year.
he same is not true of a$sorption costing net operating
income. 3ales and a$sorption costing net operating income
do not necessarily move in the same direction since changes
in inventories also a#ect a$sorption costing net operating
income.
$. Ohen varia$le costing net operating income e.ceeds
a$sorption costing net operating income, sales e.ceed
production. &nventories shrink and '.ed manufacturing
overhead costs are released from inventories. &n contrast,
when varia$le costing net operating income is less than
a$sorption costing net operating income, production e.ceeds
sales. &nventories grow and '.ed manufacturing overhead
costs are deferred in inventories. he year7$y7year e#ects
are shown $elow.
-ear 4 -ear 5 -ear 6 -ear 7
Iaria$le
costing AD&
a
A$sorption
costing AD&
Iaria$le
costing AD&
a
A$sorption
costing AD&
Iaria$le
costing AD&
b
A$sorption
costing AD&
Iaria$le
costing AD&
b
A$sorption
costing AD&
!roduction
b 3ales
!roduction
b 3ales
!roduction
a 3ales
!roduction
a 3ales
&nventories
grow
&nventories
grow
&nventories
shrink
&nventories
shrink
3olutions Manual, "hapter @ )<2
E%ercise !-4 (continued*
+. a. As discussed in part () a* a$ove, unit sales and varia$le
costing net operating income move in the same direction
when unit selling prices and the cost structure are constant.
3ince varia$le costing net operating income varied from year
to year, unit sales must have also varied from year to year.
his is true even though the a$sorption costing net operating
income was the same for all four years. ;ow can that $eF ?y
manipulating production (and inventories* it may $e possi$le
for some time to keep a$sorption costing net operating
income rock steady or on an upward path even though unit
sales -uctuate from year to year. ;owever, if this is done in
the face of falling sales, eventually inventories will grow to
$e so large that they cannot $e ignored.
$. As stated in part () $* a$ove, when varia$le costing net
operating income e.ceeds a$sorption costing net operating
income, sales e.ceed production. &nventories shrink and
'.ed manufacturing overhead costs are released from
inventories. &n contrast, when varia$le costing net operating
income is less than a$sorption costing net operating income,
production e.ceeds sales. &nventories grow and '.ed
manufacturing overhead costs are deferred in inventories.
he year7$y7year e#ects are shown $elow.
Iaria$le
costing AD&
b
A$sorption
costing AD&
Iaria$le
costing AD&
b
A$sorption
costing AD&
Iaria$le
costing AD&
a
A$sorption
costing AD&
Iaria$le
costing AD&
a
A$sorption
costing AD&
!roduction
a 3ales
!roduction
a 3ales
!roduction
b 3ales
!roduction
b 3ales
&nventories
shrink
&nventories
shrink
&nventories
grow
&nventories
grow
3olutions Manual, "hapter @ )<@
,. Iaria$le costing appears to provide a much $etter picture of
economic reality than a$sorption costing in the e.amples
a$ove. &n the 'rst case, a$sorption costing net operating
income -uctuates wildly even though unit sales are the same
each year and there are no changes in unit selling prices, unit
varia$le costs, or total '.ed costs. &n the second case,
a$sorption costing net operating income is rock steady from
year to year even though unit sales -uctuate signi'cantly.
A$sorption costing is much more su$ject to manipulation than
varia$le costing. 3imply $y changing production levels (and
there$y deferring or releasing costs from inventory* a$sorption
costing net operating income can $e manipulated upward or
downward.
Aote: his e.ercise is $ased on the following data:
"ommon data:
Annual '.ed manufacturing costs R),/,2,/
<<
"ontri$ution margin per unit........ R),<
Annual '.ed 31A costs................ R20,,<<<
!art ):
?eginning
inventory............ 0<< ),0<< ,,0<< +,0<<
!roduction.............. +),<<< ++,<<< )C,<<< )B,<<<
3ales...................... +<,<<< +<,<<< +<,<<< +<,<<<
Ending.................... ),0<< ,,0<< +,0<< 0<<
operating
income...............
R0)<,2
<<
R0)<,2
<<
R0)<,2
<<
R0)<,2
<<
Fi.ed
manufacturing
overhead in
$eginning
inventoryZ..........
R,0,C)
<
R)<+,2
<<
R++B,0
)B
R)BC,<
<<
3olutions Manual, "hapter @ )<B
Fi.ed
manufacturing
overhead in
ending inventory
R)<+,2
<<
R++B,0
)B
R)BC,<
<<
R,C,C<
<
A$sorption costing
net operating
income...............
R0@@,+
C<
R2,2,0
)B
R/@),<
B+
R,2),0
<<
3olutions Manual, "hapter @ )<C
!art +:
?eginning
inventory............ 2,<<< +,<<< ),@@0 0,/2,
!roduction.............. )B,<<< +<,@@0 ++,2BB +<,C,2
3ales...................... ++,<<< +),<<< )C,<<< +<,<<<
Ending.................... +,<<< ),@@0 0,/2, 2,,CC
operating
income...............
R@@<,2
<<
R2/<,2
<<
R,B<,2
<<
R0)<,2
<<
Fi.ed
manufacturing
overhead in
$eginning
inventoryZ..........
R,+2,/
00
R)0C,2
<<
R)++,@
/0
R,/0,B
C<
Fi.ed
manufacturing
overhead in
ending inventory
R)0C,2
<<
R)++,@
/0
R,/0,B
C<
R/,C,<
,0
A$sorption costing
net operating
income...............
R2<,,@
/0
R2<,,@
/0
R2<,,@
/0
R2<,,@
/0
Z Fi.ed manufacturing overhead in $eginning inventory is
assumed in $oth parts ) and + for Qear ). A F&FD inventory -ow
assumption is used.
3olutions Manual, "hapter @ ))<
). a. he unit product cost under a$sorption costing would $e:
>irect materials........................................................ R 2
>irect la$or............................................................... C
Iaria$le manufacturing overhead............................. ,
otal varia$le costs................................................... )B
Fi.ed manufacturing overhead (R,<<,<<< [ +0,<<<
units*...................................................................... )+
Knit product cost....................................................... R,<
$. he a$sorption costing income statement:
3ales (+<,<<< units V R0< per unit*........
R),<<<,<<
<
?eginning inventory.............................
R <
Add cost of goods manufactured

(+0,<<< units V R,< per unit*.............
@0<,<<
<
1oods availa$le for sale....................... @0<,<<<
(0,<<< units V R,< per unit*...............
)0<,<<
< 2<<,<<<
1ross margin........................................... /<<,<<<
e.penses
](+<,<<< units V R/ per unit* \
R)C<,<<<^............................................. +@<,<<<
Aet operating income.............................
R ),<,<<
<
3olutions Manual, "hapter @ )))
+. a. he unit product cost under varia$le costing would $e:
>irect materials...................... R 2
>irect la$or............................. C
overhead.............................. ,
Knit product cost..................... R)B
$. he varia$le costing income statement:
3ales (+<,<<< units V R0< per unit*......
R),<<<,<<
<
?eginning inventory......................... R <
(+0,<<< units V R)B per unit*........
/0<,<<
<
1oods availa$le for sale................... /0<,<<<
(0,<<< units V R)B per unit*..........
C<,<<
<
Iaria$le cost of goods sold................. ,2<,<<< Z
Iaria$le selling e.pense
(+<,<<< units V R/ per unit*.............
B<,<<
< //<,<<<
"ontri$ution margin.............................. 02<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead........... ,<<,<<<
e.pense...........................................
)C<,<<
< /C<,<<<
Aet operating income........................... R @<,<<<
Zhe varia$le cost of goods sold could $e computed more
simply as: +<,<<< units V R)B per unit Y R,2<,<<<.
3olutions Manual, "hapter @ ))+
E%ercise !- (+< minutes*
). 3ales (,0,<<< units V R+0 per unit*......... RB@0,<<<
Iaria$le cost of goods sold
(,0,<<< units V R)+ per unitZ*............ R/+<,<<<
e.penses
(,0,<<< units V R+ per unit*................ @<,<<< /C<,<<<
"ontri$ution margin................................. ,B0,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead.............. )2<,<<<
e.penses............................................. +)<,<<< ,@<,<<<
Aet operating income.............................. R )0,<<<
Z >irect materials.......................... R 0
>irect la$or................................. 2
overhead.................................. )
otal varia$le manufacturing
cost.......................................... R)+
+. he di#erence in net operating income can $e e.plained $y the
R+<,<<< in '.ed manufacturing overhead deferred in inventory
under the a$sorption costing method:
Iaria$le costing net operating income................
R)0,<<
<
Add: Fi.ed manufacturing overhead cost
deferred in inventory under a$sorption
costing: 0,<<< units V R/ per unit in '.ed
manufacturing cost........................................... +<,<<<
A$sorption costing net operating income............
R,0,<<
<
3olutions Manual, "hapter @ )),
E%ercise !-! (+< minutes*
). he company is using varia$le costing. he computations are:
Variable
Costing
Absorption
Costing
>irect materials........................ R C R C
>irect la$or............................... )< )<
overhead................................ 0 0
Fi.ed manufacturing overhead
(R)0<,<<< [ +0,<<< units*...... 9 2
Knit product cost....................... R+/ R,<
otal cost, ,,<<< units............... R@+,<<< RC<,<<<
+. a. Ao, R@+,<<< is not the correct 'gure to use, since varia$le
costing is not generally accepted for e.ternal reporting
purposes or for ta. purposes.
$. he Finished 1oods inventory account should $e stated at
RC<,<<<, which represents the a$sorption cost of the ,,<<<
unsold units. hus, the account should $e increased $y
R)B,<<< for e.ternal reporting purposes. his R)B,<<<
consists of the amount of '.ed manufacturing overhead cost
that is allocated to the ,,<<< unsold units under a$sorption
costing:
,,<<< units V R2 per unit '.ed manufacturing overhead cost
Y R)B,<<<
3olutions Manual, "hapter @ ))/
E%ercise !-" (,< minutes*
). Knder varia$le costing, only the varia$le manufacturing costs
are included in product costs.
>irect materials....................... R0<
>irect la$or.............................. B<
overhead............................... +<
Knit product cost...................... R)0<
Aote that selling and administrative e.penses are not treated
as product costs% that is, they are not included in the costs that
are inventoried. hese e.penses are always treated as period
costs and are charged against the current periodGs revenue.
+. he varia$le costing income statement appears $elow:
3ales........................................................ R,,CC<,<<<
?eginning inventory............................ R <
(+<,<<< units V R)0< per unit*..........
,,<<<,<<
<
1oods availa$le for sale...................... ,,<<<,<<<
(),<<< units V R)0< per unit*........... )0<,<<<
Iaria$le cost of goods soldZ................... +,B0<,<<<
e.penses ()C,<<< units V R)< per
unit*.................................................... )C<,<<< ,,</<,<<<
"ontri$ution margin................................. C0<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead.............. @<<,<<<
e.penses............................................. +B0,<<< CB0,<<<
Aet operating loss.................................... R (,0,<<<*
Z he varia$le cost of goods sold could $e computed more
simply as: )C,<<< units sold V R)0< per unit Y R+,B0<,<<<.
3olutions Manual, "hapter @ ))0
E%ercise !-" (continued*
,. he $reak7even point in units sold can $e computed using the
contri$ution margin per unit as follows:
3elling price per unit........... R+)<
Iaria$le cost per unit.......... )2<
"ontri$ution margin per
unit................................... R0<
Fi.ed e.penses
?reak7even unit sales Y
RCB0,<<<
Y Y )C,@<< units
R0< per unit
3olutions Manual, "hapter @ ))2
E%ercise !-# (+< minutes*
). Knder a$sorption costing, all manufacturing costs (varia$le and
'.ed* are included in product costs.
>irect materials........................................................ R0<
>irect la$or............................................................... B<
Iaria$le manufacturing overhead............................. +<
Fi.ed manufacturing overhead (R@<<,<<< [ +<,<<<
units*........................................................................ ,0
Knit product cost....................................................... R)B0
+. he a$sorption costing income statement appears $elow:
3ales ()C,<<< units V R+)< per unit*........
R,,CC<,<<
<
"ost of goods sold:
?eginning inventory............................... R <
(+<,<<< units V R)B0 per unit*............. ,,@<<,<<<
1oods availa$le for sale......................... ,,@<<,<<<
(),<<< units V R)B0 per unit*............... )B0,<<<
,,0)0,<<
<
1ross margin............................................. /@0,<<<
=ess selling and administrative e.penses:
e.penses
()C,<<< units V R)< per unit*............... )C<,<<<
e.penses.............................................. +B0,<<< /@0,<<<
Aet operating income............................... R <
Aote: he company apparently has e.actly zero net operating
income even though its sales are $elow the $reak7even point
computed in E.ercise @7B. his occurs $ecause R,0,<<< of '.ed
manufacturing overhead has $een deferred in inventory and
does not appear on the income statement prepared using
a$sorption costing.
3olutions Manual, "hapter @ ))@
&ro'lem !-1$ (/0 minutes*
). a. he unit product cost under a$sorption costing is:
>irect materials.......................................................... R+<
>irect la$or................................................................. B
Iaria$le manufacturing overhead............................... +
Fi.ed manufacturing overhead (R)<<,<<< [ )<,<<<
units*........................................................................ )<
Knit product cost........................................................ R/<
$. he a$sorption costing income statement is:
3ales (B,<<< units V R@0 per unit*............
R2<<,<<
<
?eginning inventory............................... R <
()<,<<< units V R/< per unit*...............
/<<,<<
<
1oods availa$le for sale.......................... /<<,<<<
(+,<<< units V R/< per unit*................. B<,<<<
,+<,<<
<
1ross margin............................................. +B<,<<<
=ess selling and administrative e.penses
](B,<<< units V R2 per unit* \
R+<<,<<<^...............................................
+/B,<<
<
Aet operating income...............................
R
,+,<<<
+. a. he unit product cost under a$sorption costing is:
>irect materials........................
R+
<
>irect la$or............................... B
overhead................................ +
Knit product cost.......................
R,
<
3olutions Manual, "hapter @ ))B
&ro'lem !-1$ (continued*
$. he varia$le costing income statement is:
3ales (B,<<< units V R@0 per unit*.............
R2<<,<<
<
?eginning inventory.............................. R <
()<,<<< units V R,< per unit*.............
,<<,<<
<
1oods availa$le for sale........................ ,<<,<<<
(+,<<< units V R,< per unit*...............
2<,<<
<
Iaria$le cost of goods sold...................... +/<,<<<
Iaria$le selling e.penses
(B,<<< units V R2 per unit*....................
/B,<<
< +BB,<<<
"ontri$ution margin................................... ,)+,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead................ )<<,<<<
e.penses...............................................
+<<,<<
< ,<<,<<<
Aet operating income................................ R )+,<<<
,. he di#erence in the ending inventory relates to a di#erence in
the handling of '.ed manufacturing overhead costs. Knder
varia$le costing, these costs have $een e.pensed in full as
period costs. Knder a$sorption costing, these costs have $een
added to units of product at the rate of R)< per unit (R)<<,<<<
[ )<,<<< units produced Y R)< per unit*. hus, under
a$sorption costing a portion of the R)<<,<<< '.ed
manufacturing overhead cost for the month has $een added to
the inventory account rather than e.pensed on the income
statement:
Added to the ending inventory
(+,<<< units V R)< per unit*................................ R+<,<<<
E.pensed as part of cost of goods sold
(B,<<< units V R)< per unit*................................ B<,<<<
otal '.ed manufacturing overhead cost for the
month.................................................................. R)<<,<<<
3olutions Manual, "hapter @ ))C
&ro'lem !-1$ (continued*
3ince R+<,<<< of '.ed manufacturing overhead cost has $een
deferred in inventory under a$sorption costing, the net operating
income reported under that costing method is R+<,<<< higher
than the net operating income under varia$le costing, as shown in
parts ()* and (+* a$ove.
3olutions Manual, "hapter @ )+<
!ro'lem !-11 (,< minutes*
). he unit product cost under the varia$le costing method is
>irect materials....................... R/
>irect la$or.............................. @
overhead............................... )
Knit product cost...................... R)+
Oith this 'gure, the varia$le costing income statements can $e
prepared:
-ear 4 -ear 5
3ales.......................................................
R),<<<,<<
<
R),+0<,<<
<
(_ R)+ per unit*................................. /B<,<<< 2<<,<<<
e.penses (_ R+ per unit*................... B<,<<< )<<,<<<
otal varia$le e.penses........................... 02<,<<< @<<,<<<
"ontri$ution margin................................ //<,<<< 00<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead............. +@<,<<< +@<,<<<
e.penses............................................ ),<,<<< ),<,<<<
otal '.ed e.penses................................ /<<,<<< /<<,<<<
Aet operating income.............................. R /<,<<<
R )0<,<<
<
+. he reconciliation of a$sorption and varia$le costing follows:
-ear 4 -ear 5
Iaria$le costing net operating income... R/<,<<< R)0<,<<<
Add: Fi.ed manufacturing overhead
deferred in inventory under
a$sorption costing (0,<<< units V R2
per unit*............................................... ,<,<<<
>educt: Fi.ed manufacturing overhead
released from inventory under
a$sorption costing (0,<<< units V R2
(,<,<<<*
3olutions Manual, "hapter @ )+)
per unit*...............................................
A$sorption costing net operating
income................................................. R@<,<<< R)+<,<<<
3olutions Manual, "hapter @ )++
&ro'lem !-12 (2< minutes*
). a. >irect materials.................................... R ,.0<
>irect la$or........................................... )+.<<
Iaria$le manufacturing overhead......... ).<<
(R,<<,<<< [ ,<,<<< units*.................. )<.<<
Knit product cost................................... R+2.0<
$. 3ales (+B,<<< units*..............................
R),)+<,<<
<
?eginning inventory............................ R <
(,<,<<< units V R+2.0< per unit*...... @C0,<<<
1oods availa$le for sale...................... @C0,<<<
(+,<<< units V R+2.0< per unit*........ 0,,<<< @/+,<<<
1ross margin......................................... ,@B,<<<
e.pensesZ........................................... ,2B,<<<
R
)<,<<<
ZR)2B,<<< varia$le \ R+<<,<<< '.ed Y R,2B,<<<.
c. Iaria$le costing net loss.................................... R()<,<<<*
costing
(+,<<< units V R)< per unit*........................... +<,<<<
A$sorption costing net operating income.......... R )<,<<<
3olutions Manual, "hapter @ )+,
&ro'lem !-12 (continued*
+. Knder a$sorption costing, the company did earn a pro't for the
4uarter. ;owever, $efore the 4uestion can really $e answered,
one must 'rst de'ne what is meant $y a Mpro't.N he central
issue here relates to timing of release of '.ed manufacturing
overhead costs to e.pense. Advocates of varia$le costing
would argue that all such costs should $e e.pensed
immediately, and that no pro't is earned unless the revenues
of a period are suEcient to cover the '.ed manufacturing
overhead costs in full. From this point of view, then, no pro't
was earned during the 4uarter, since the '.ed costs were not
fully covered.
Advocates of a$sorption costing would argue, however, that
'.ed manufacturing overhead costs attach to units of product
as they are produced, and that such costs do not $ecome an
e.pense until the units are sold. herefore, if the selling price of
a unit is greater than the unit product cost (including a
proportionate amount of '.ed manufacturing overhead*, then a
pro't is earned even if some units produced are unsold and
carry some '.ed manufacturing overhead with them to the
following period. A diEculty with this argument is that Mpro'tsN
will vary under a$sorption costing depending on how many
units are added to or taken out of inventory. hat is, pro'ts will
depend not only on sales, $ut on what happens to inventories.
&n particular, pro'ts can $e consciously manipulated $y
increasing or decreasing a companyGs inventories.
3olutions Manual, "hapter @ )+/
,. a. 3ales (,+,<<< units V R/< per unit*......
R),+B<,<<
<
(,+,<<< units V R)2.0< per unit*......
R0+B,<<
<
e.penses (,+,<<< units V R2 per
unit*................................................. )C+,<<< @+<,<<<
"ontri$ution margin.............................. 02<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead........... ,<<,<<<
e.pense........................................... +<<,<<<
0<<,<<
<
R
2<,<<<
$. he a$sorption costing unit product cost will remain at
R+2.0<, the same as in part ()*.
3ales (,+,<<< units V R/< per unit*......
R),+B<,<<
<
?eginning inventory
(+,<<< units V R+2.0< per unit*........ R 0,,<<<
(,<,<<< units V R+2.0< per unit*...... @C0,<<<
1oods availa$le for sale...................... B/B,<<<
=ess ending inventory......................... <
B/B,<<
<
1ross margin......................................... /,+,<<<
e.pensesZ...........................................
,C+,<<
<
R /<,<<
<
ZR)C+,<<< varia$le \ R+<<,<<< '.ed Y R,C+,<<<.
c. Iaria$le costing net operating income. .
R
2<,<<<
3olutions Manual, "hapter @ )+0
>educt: '.ed manufacturing
overhead cost released from
inventory under a$sorption costing
(+,<<< units V R)< per unit*............... (+<,<<<*
A$sorption costing net operating
income................................................ R /<,<<<
3olutions Manual, "hapter @ )+2
&ro'lem !-13 (/0 minutes*
). a. and $. Absorptio
n Costing
Variable
Costing
>irect materials...................................... R/B R/B
Iaria$le manufacturing overhead........... + +
(R,2<,<<< [ )+,<<< units*................... ,< 9
Knit product cost..................................... RB< R0<
+. A$sorption costing income statement:
3ales ()<,<<< units V R)0< per unit*. .
R),0<<,<<
<
?eginning inventory......................... R <
()+,<<< units V RB< per unit*......... C2<,<<<
1ood availa$le for sale..................... C2<,<<<
(+,<<< units V RB< per unit*........... )2<,<<<
B<<,<<
<
1ross margin...................................... @<<,<<<
e.penses
]()+P V R),0<<,<<<* \ R/@<,<<<^. . .
20<,<<
<
Aet operating income.........................
R
0<,<<<
3olutions Manual, "hapter @ )+@
,. Iaria$le costing income statement:
3ales ()<,<<< units V R)0< per unit*......
R),0<<,<<
<
?eginning inventory.......................... R <
()+,<<< units V R0< per unit*.........
2<<,<<
<
1oods availa$le for sale.................... 2<<,<<<
(+,<<< units V R0< per unit*...........
)<<,<<
<
Iaria$le cost of goods soldZ................. 0<<,<<<
e.penses...........................................
)B<,<<
<
2B<,<<
<
"ontri$ution margin............................... B+<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead............. ,2<,<<<
e.penses...........................................
/@<,<<
< B,<,<<<
Aet operating loss.................................. R ()<,<<<*
Z his could $e computed more simply as )<,<<< units V R0<
per unit Y R0<<,<<<
/. A manager may prefer to take the statement prepared under
the a$sorption approach in part (+*, since it shows a pro't for
the month. As long as inventory levels are rising, a$sorption
costing will report higher pro'ts than varia$le costing. Aotice in
the situation a$ove that the company is operating $elow its
theoretical $reak7even point, $ut yet reports a pro't under the
a$sorption approach. he ethics of this approach are
de$ata$le.
0. Iaria$le costing net operating loss.................
R ()<,<<<
*
costing
2<,<<<
3olutions Manual, "hapter @ )+B
(+,<<< units V R,< per unit*.........................
A$sorption costing net operating income........
R 0<,<<
<
3olutions Manual, "hapter @ )+C
). a. and $. Absorptio
n Costing
Variable
Costing
>irect materials............................... R @ R @
>irect la$or...................................... )< )<
Iaria$le manufacturing overhead.... 0 0
(R,)0,<<< [ )@,0<< units*............ )B 9
Knit product cost............................. R/< R++
+. 9ul% August
3ales....................................................... RC<<,<<<
R),+<<,<<
<
Iaria$le cost of goods sold _ R++ per
unit.................................................... ,,<,<<< //<,<<<
e.penses _ R, per unit..................... /0,<<< 2<,<<<
otal varia$le e.penses........................... ,@0,<<< 0<<,<<<
"ontri$ution margin................................ 0+0,<<< @<<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead............. ,)0,<<< ,)0,<<<
e.penses............................................ +/0,<<< +/0,<<<
otal '.ed e.penses................................ 02<,<<< 02<,<<<
Aet operating income (loss*.................................... R (,0,<<<* R)/<,<<<
,. 9ul% August
Iaria$le costing net operating income
(loss*................................................. R (,0,<<<* R )/<,<<<
Add: Fi.ed manufacturing overhead
cost deferred in inventory under
a$sorption costing (+,0<< units V
R)B per unit*..................................... /0,<<<
>educt: Fi.ed manufacturing
inventory under a$sorption costing
(+,0<< units V R)B per unit*.............. (/0,<<<*
A$sorption costing net operating R )<,<< R C0,<<<
3olutions Manual, "hapter @ ),<
income.............................................. <
3olutions Manual, "hapter @ ),)
/. As shown in the reconciliation in part (,* a$ove, R/0,<<< of
'.ed manufacturing overhead cost was deferred in inventory
under a$sorption costing at the end of 5uly, since R)B of '.ed
manufacturing overhead cost MattachedN to each of the +,0<<
unsold units that went into inventory at the end of that month.
his R/0,<<< was part of the R02<,<<< total '.ed cost that has
to $e covered each month in order for the company to $reak
even. 3ince the R/0,<<< was added to the inventory account,
and thus did not appear on the income statement for 5uly as an
e.pense, the company was a$le to report a small pro't for the
month even though it sold less than the $reak7even volume of
sales. &n short, only R0)0,<<< of '.ed cost (R02<,<<< X
R/0,<<<* was e.pensed for 5uly, rather than the full R02<,<<<
as contemplated in the $reak7even analysis. As stated in the
te.t, this is a major pro$lem with the use of a$sorption costing
internally for management purposes. he method does not
harmonize well with the principles of cost7volume7pro't
analysis, and can result in data that are unclear or confusing to
management.
3olutions Manual, "hapter @ ),+
). a. and $.
Absorption
Costing Variable Costing
Iaria$le production costs................ R B R B RB RB
costs:
R,<<,<<< [ +<,<<< units.............. )0
R,<<,<<< [ +0,<<< units.............. )+
Knit product cost............................. R+, R+< RB RB
+. -ear 4 -ear 5
3ales.......................................................... R@<<,<<< R@<<,<<<
?eginning inventory.............................. R < R <
Add varia$le manufacturing costs......... )2<,<<<
+<<,<<
<
1oods availa$le for sale........................ )2<,<<< +<<,<<<
=ess ending inventory........................... <
/<,<<
<
Iaria$le cost of goods soldZ..................... )2<,<<< )2<,<<<
Iaria$le selling e.pense and
administrative e.penses (+<,<<< units
V R) per unit*........................................ +<,<<< )B<,<<<
+<,<<
< )B<,<<<
"ontri$ution margin................................... 0+<,<<< 0+<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead................ ,<<,<<< ,<<,<<<
3olutions Manual, "hapter @ ),,
e.penses............................................... )B<,<<< /B<,<<<
)B<,<<
< /B<,<<<
Aet operating income................................ R /<,<<< R /<,<<<
Zhis could $e computed more simply as +<,<<< units V RB per unit Y
R)2<,<<<.
3olutions Manual, "hapter @ ),/
,. -ear 4 -ear 5
Iaria$le costing net operating income......... R /<,<<< R /<,<<<
costing (0,<<< units V R)+ per unit*.......... 2<,<<<
A$sorption costing net operating income..... R /<,<<< R)<<,<<<
/. he increase in production in Qear +, in the face of level sales,
caused a $uildup of inventory and a deferral of a portion of Qear
+Gs '.ed manufacturing overhead costs to the ne.t year. his
deferral of cost relieved Qear + of R2<,<<< (0,<<< units V R)+
per unit* of '.ed manufacturing overhead cost that it otherwise
would have $orne. hus, net operating income was R2<,<<<
higher in Qear + than in Qear ), even though the same num$er
of units was sold each year. &n sum, $y increasing production
and $uilding up inventory, pro'ts increased without any
increase in sales or reduction in costs. his is a major criticism
of the a$sorption costing approach.
0. a. Knder 5&, production would have $een geared to sales.
;ence inventories would not have $een $uilt up in Qear +.
$. Knder 5&, the net operating income for Qear + using
a$sorption costing would have $een R/<,<<<9the same as
in Qear ). Oith production geared to sales, there would have
$een no inventory $uildup at the end of Qear + and therefore
there would have $een no '.ed manufacturing overhead
costs deferred in inventory. he entire R,<<,<<< in '.ed
manufacturing overhead costs would have $een charged
against Qear + operations, rather than having R2<,<<< of it
deferred to future periods through the inventory account.
hus, net operating income would have $een a$out the same
in each year under both varia$le and a$sorption costing.
3olutions Manual, "hapter B )/,
&ro'lem !-1 (,< minutes*
). ?ecause of soft demand for the ?razilian >ivisionGs product, the
inventory should $e drawn down to the minimum level of 0<
units. >rawing inventory down to the minimum level would
re4uire production as follows during the last 4uarter:
>esired inventory, >ecem$er ,)............. 0< units
E.pected sales, last 4uarter.................... 2<< units
otal needs.............................................. 20< units
=ess inventory, 3eptem$er ,<................. /<< units
8e4uired production................................ +0< units
>rawing inventory down to the minimum level would save
inventory carrying costs such as storage (rent, insurance*,
interest, and o$solescence.
he num$er of units scheduled for production will not a#ect the
reported net operating income or loss for the year if varia$le
costing is in use. All '.ed manufacturing overhead cost will $e
treated as an e.pense of the period regardless of the num$er
of units produced. hus, no '.ed manufacturing overhead cost
will $e shifted $etween periods through the inventory account
and income will $e a function of the num$er of units sold,
rather than a function of the num$er of units produced.
+. o ma.imize the ?razilian >ivisionGs operating income, Mr.
"avalas could produce as many units as storage facilities will
allow. ?y $uilding inventory to the ma.imum level, Mr. "avalas
will $e a$le to defer a portion of the yearGs '.ed manufacturing
overhead costs to future years through the inventory account,
rather than having all of these costs appear as charges on the
current yearGs income statement. ?uilding inventory to the
ma.imum level of ),<<< units would re4uire production as
follows during the last 4uarter:
>esired inventory, >ecem$er
,)........................................... ),<<< units
E.pected sales, last 4uarter...... 2<< units
otal needs................................ ),2<< units
=ess inventory, 3eptem$er ,<... /<< units
8e4uired production.................. ),+<< units
3olutions Manual, "hapter B )//
hus, $y producing enough units to $uild inventory to the
ma.imum level that storage facilities will allow, Mr. "avalas
could relieve the current year of '.ed manufacturing overhead
cost and there$y ma.imize the current yearGs operating
income.
,. ?y setting a production schedule that will ma.imize his
divisionGs net operating income9and ma.imize his own $onus
9Mr. "avalas will $e acting against the $est interests of the
company as a whole. he e.tra units arenGt needed and will $e
e.pensive to carry in inventory. Moreover, there is no indication
that demand will $e any $etter ne.t year than it has $een in
the current year, so the company may $e re4uired to carry the
e.tra units in inventory a long time $efore they are ultimately
sold.
he companyGs $onus plan undou$tedly is intended to increase
the companyGs pro'ts $y increasing sales and controlling
e.penses. &f Mr. "avalas sets a production schedule as shown in
part (+* a$ove, he will o$tain his $onus as a result of producing
rather than as a result of selling. Moreover, he will o$tain it $y
creating greater e.penses9rather than fewer e.penses9for
the company as a whole.
&n sum, producing as much as possi$le so as to ma.imize the
divisionGs net operating income and the managerGs $onus
would $e unethical $ecause it su$verts the goals of the overall
organization.
3olutions Manual, "hapter B )/0
&ro'lem !-1! (@0 minutes*
). -ear 4 -ear 5 -ear 6
3ales......................................... RB<<,<<< R 2/<,<<< RB<<,<<<
_ R+ per unit....................... )<<,<<< B<,<<< )<<,<<<
Iaria$le selling and
administrative e.penses _
R) per unit........................... 0<,<<< /<,<<< 0<,<<<
otal varia$le e.penses............. )0<,<<< )+<,<<< )0<,<<<
"ontri$ution margin.................. 20<,<<< 0+<,<<< 20<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing
overhead.............................. /B<,<<< /B<,<<< /B<,<<<
Fi.ed selling and
administrative e.penses...... )/<,<<< )/<,<<< )/<,<<<
otal '.ed e.penses.................. 2+<,<<< 2+<,<<< 2+<,<<<
Aet operating income (loss*...... R ,<,<<< R()<<,<<<*R ,<,<<<
3olutions Manual, "hapter B )/2
&ro'lem !-1! (continued*
+. a. -ear 4 -ear 5 -ear 6
Iaria$le manufacturing cost..... R+.<< R+.<< R+.<<
Fi.ed manufacturing cost:
R/B<,<<< [ 0<,<<< units....... C.2<
R/B<,<<< [ 2<,<<< units....... B.<<
R/B<,<<< [ /<,<<< units....... )+.<<
Knit product cost...................... R)).2< R)<.<< R)/.<<
$. Iaria$le costing net operating
income (loss*......................... R,<,<<<
R()<<,<<<
*
R
,<,<<<
Add (>educt*: Fi.ed
manufacturing overhead
cost deferred in inventory
from Qear + to Qear , under
a$sorption costing (+<,<<<
units V RB.<< per unit*........... )2<,<<< ()2<,<<<*
Add: Fi.ed manufacturing
overhead cost deferred in
inventory from Qear , to the
future under a$sorption
costing ()<,<<< units V
R)+.<< per unit*.....................
)+<,<<
<
operating income (loss*......... R,<,<<< R 2<,<<<
R ()<,<<<
*
,. !roduction went up sharply in Qear + there$y reducing the unit
product cost, as shown in (+a* a$ove. his reduction in cost per
unit, com$ined with the large amount of '.ed manufacturing
overhead cost deferred in inventory for the year, more than
o#set the loss of revenue. he net result is that the companyGs
net operating income increased.
/. he '.ed manufacturing overhead cost deferred in inventory
from Qear + was charged against Qear , operations, as shown in
the reconciliation in (+$*. his added charge against Qear ,
operations was o#set somewhat $y the fact that part of Qear
,Gs '.ed manufacturing overhead costs were deferred in
inventory to future years ]again see (+$*^. Dverall, the added
3olutions Manual, "hapter B )/@
costs charged against Qear , were greater than the costs
deferred to future years, so the company reported less income
for the year even though the same num$er of units was sold as
in Qear ).
3olutions Manual, "hapter B )/B
&ro'lem !-1! (continued*
0. a. Oith 5&, production would have $een geared to sales in each
year so that little or no inventory of 'nished goods would
have $een $uilt up in either Qear + or Qear ,.
$. &f 5& had $een in use, the net operating income under
a$sorption costing would have $een the same as under
varia$le costing in all three years. Oith production geared to
sales, there would have $een no ending inventory, and
therefore there would have $een no '.ed manufacturing
overhead costs deferred in inventory to other years.
Assuming that the company expected to sell 0<,<<< units in
each year and that unit product costs were set on the $asis
of that level of e.pected activity, the income statements
under a$sorption costing would have appeared as follows:
-ear 4 -ear 5 -ear 6
3ales.................................. R B<<,<<< R 2/<,<<<
R B<<,<<
<
"ost of goods
manufactured _
R)).2< per unit............. 0B<,<<< /2/,<<< Z 0B<,<<<
Add underapplied
overhead....................... C2,<<< ZZ
"ost of goods sold.............. 0B<,<<< 02<,<<< 0B<,<<<
1ross margin...................... ++<,<<< B<,<<< ++<,<<<
=ess selling and
administrative e.penses.. )C<,<<<
)B<,<<
< )C<,<<<
(loss*................................ R ,<,<<<
R()<<,<<<
* R ,<,<<<
Z /<,<<< units V R)).2< per unit Y R/2/,<<<.
ZZ )<,<<< units not produced V RC.2< per unit '.ed
manufacturing overhead cost per unit Y RC2,<<< '.ed
manufacturing overhead cost not applied to products.
3olutions Manual, "hapter B )/C
Case !-1" (C< minutes*
). 9ul% August
Septembe
r
3ales.....................................
R),@0<,<<
<
R),B@0,<<
<
R+,<<<,<<
<
costs _ RC per unit.......... 2,<,<<< 2@0,<<< @+<,<<<
administrative e.penses
_ R2 per unit................... /+<,<<< /0<,<<< /B<,<<<
otal varia$le e.penses ),<0<,<<< ),)+0,<<< ),+<<,<<<
"ontri$ution margin.............. @<<,<<< @0<,<<< B<<,<<<
=ess '.ed e.penses:
Fi.ed manufacturing
overhead
)
......................... 02<,<<< 02<,<<< 02<,<<<
Fi.ed selling and
administrative
e.penses
+
......................... +<<,<<< +<<,<<< +<<,<<<
otal '.ed e.penses.............. @2<,<<< @2<,<<< @2<,<<<
Aet operating income (loss*. .R (2<,<<<*R ()<,<<<*R /<,<<<
)
R),2B<,<<< [ , Y R02<,<<< per month.
+
Fi.ed selling and administrative e.penses (from 5ulyGs
'gures*: R2+<,<<< X (@<,<<< units V R2 per unit Y R/+<,<<<*
Y R+<<,<<<.
Aote how clear and easy to follow the varia$le costing
statements are as compared to the a$sorption costing
statements.
he R02<,<<< monthly '.ed manufacturing overhead cost can
also $e o$tained $y the following computation:
9ul% August
Septembe
r
cost applied............................. R0C0,<<<
R02<,<<
< R/+<,<<<
Knderapplied or (overapplied*
overhead................................. (,0,<<<* )/<,<<<
cost.......................................... R02<,<<<
R02<,<<
< R02<,<<<
3olutions Manual, "hapter B )0<
Case !-1" (continued*
+. he $reak7even point under varia$le costing would $e:
Fi.ed costs
?reak7even point Y
R@2<,<<< R@2<,<<<
Y Y Y @2,<<< units
R+07(RC\R2* R)< per unit
Dn the surface this answer appears to $e incorrect, since the
company sold less than @2,<<< units in $oth 5uly and August
and yet showed a pro't in $oth months on the a$sorption
costing statements. &n fact, when a student gives an answer of
@2,<<< units as the $reak7even point, you should ask, M;ow can
@2,<<< units $e the $reak7even point when the company sold
only @<,<<< units in 5uly and @0,<<< units in August and
reported a pro't in $oth monthsFN
he answer to this apparent inconsistency is that production
e.ceeded sales in $oth 5uly and August. his resulted in
deferring a portion of the '.ed manufacturing overhead costs
of these months to the future rather than showing the cost as
an e.pense on the income statement. &n each month, this
deferral of '.ed manufacturing overhead cost was large
enough to permit the company to report a pro't, even though
less than the $reak7even volume of units was sold.
,. Knder a$sorption costing, pro'ts are a#ected $y $oth sales and
production. &f production e.ceeds sales, then a portion of the
'.ed manufacturing overhead cost of the period will $e
deferred to the future. &n periods where these deferrals of '.ed
manufacturing overhead cost take place, pro'ts will $e in-ated,
as in 5uly for Oarner "ompany. &f production is less than sales,
then '.ed manufacturing overhead costs that were deferred in
inventory and carried over from prior periods will $e released
from inventory and charged as an e.pense on the income
statement. &n addition, if production in these months is less
than planned, then underapplied overhead will result, which,
when added to the costs $eing released from inventory through
inventory reduction, will depress earnings. Oe can see this
happening in 3eptem$er in Oarner "ompany, where planned
3olutions Manual, "hapter B )0)
production was B<,<<< units, $ut only 2<,<<< units were
produced.
3olutions Manual, "hapter B )0+
&n sum, with pro'ts dependent on $oth sales and production
under a$sorption costing, pro'ts can move erratically,
depending on the relation $etween sales and production in a
given period.
/. &t is helpful to prepare a schedule showing inventories,
production, and sales as a guide in preparing a reconciliation:
Beginnin
g
"nventor
%
Units
Produce
d
Units
Sold
Ending
"nventor%
5uly................. 0,<<< B0,<<< @<,<<< +<,<<<
August............ +<,<<< B<,<<< @0,<<< +0,<<<
3eptem$er...... +0,<<< 2<,<<< B<,<<< 0,<<<
?efore preparing a reconciliation, we must also determine the
'.ed manufacturing overhead rate per unit of product. his
rate would $e:
Monthly '.ed manufacturing overhead cost
Fi.ed manufacturing
Y
overhead rate
!lanned monthly production
R02<,<<<
Y Y R@ per unit
B<,<<< units
3olutions Manual, "hapter B )0,
1iven these data, the reconciliation would $e:
9ul% August
Septembe
r
Iaria$le costing net operating
income (loss*.........................
R (2<,<<<
* R ()<,<<<* R/<,<<<
inventory in 5uly (0,<<<
units V R@ per unit*................ (,0,<<<*
inventory in 5uly (+<,<<<
units V R@ per unit*................ )/<,<<<
inventory in August (+<,<<<
units V R@ per unit*................ ()/<,<<<*
inventory in August (+0,<<<
units V R@ per unit*................ )@0,<<<
inventory in 3eptem$er
(+0,<<< units V R@ per unit*. . ()@0,<<<*
inventory in 3eptem$er
(0,<<< units V R@ per unit*.. . . ,0,<<<
operating income (loss*......... R/0,<<< R+0,<<< R()<<,<<<*
3olutions Manual, "hapter B )0/
An alternate approach to the reconciliation would $e as follows:
9ul% August
Septembe
r
Iaria$le costing net operating
income (loss*......................... R(2<,<<<* R()<,<<<* R /<,<<<
inventory at the end of 5uly
()0,<<< unit increase V R@
per unit*................................. )<0,<<<
inventory at the end of
August (0,<<< unit increase
V R@ per unit*........................ ,0,<<<
inventory during 3eptem$er
(+<,<<< unit decrease V R@
per unit*................................. ()/<,<<<*
operating income (loss*......... R /0,<<< R +0,<<< R()<<,<<<*
0. a. Knder 5&, production is geared strictly to sales. herefore,
the company would have produced only enough units during
3eptem$er to meet sales needs. he computation is as
follows:
Knits sold during 3eptem$er................................... B<,<<<
=ess units in inventory at the $eginning of the
month................................................................... +0,<<<
Knits produced during 3eptem$er under 5&............ 00,<<<
Although not asked for in the 4uestion, a move to 5& during
3eptem$er would have resulted in an even deeper loss for
the month. he reason is that producing only 00,<<< units
(rather than 2<,<<< units, as in the pro$lem* would have
resulted in R,0,<<< more in underapplied overhead (see the
computation $elow*, or a loss of R),0,<<< instead of a loss of
3olutions Manual, "hapter B )00
R)<<,<<< for the month.
Knits produced during 3eptem$er.................. 2<,<<<
Knits that would have $een produced under
5&................................................................. 00,<<<
>ecrease in production................................... 0,<<<
Fi.ed manufacturing overhead rate per unit... V R@
&ncreased loss for the month........................... R,0,<<<
$. 3tarting with the ne.t 4uarter, there will $e little or no
di#erence $etween the income reported under varia$le
costing and the income reported under a$sorption costing.
Oith no inventories on hand, '.ed manufacturing overhead
cost is not shifted $etween periods under a$sorption costing.
c. Oith no inventories availa$le for deferral of '.ed
manufacturing overhead costs to other periods, it would not
$e possi$le to show a pro't under a$sorption costing if sales
were less than the $reak7even level. As stated in part (0$*
a$ove, pro'ts (and losses* will $e the same under $oth
costing methods.
3olutions Manual, "hapter B )0@
Case !-1# ()+< minutes*
). he "I! analysis developed in the previous chapter works with
varia$le costing $ut generally not with a$sorption costing.
;owever, when production e4uals sales, a$sorption costing net
operating income e4uals varia$le costing net operating income
and we can use "I! analysis without any modi'cation.
3elling price............................. R)+<.<<
=ess varia$le cost per unit........ B@.+<
Knit contri$ution margin.......... R ,+.B<
Fi.ed e.penses\ arget net pro't
Knit sales to achieve
Y
target pro't
R)),//B,<<<\ R+,<<<,<<<
Y
R,+.B< per unit
Y /)<,<<< units
+. he unit product cost at a production level of /)<,<<< units
would $e calculated as follows:
>irect materials................................... R0@.+<
>irect la$or......................................... )0.<<
Iaria$le manufacturing overhead....... 0.<<
(R2,BBB,<<< [ /)<,<<< units*........... )2.B<
Knit product cost................................. RC/.<<
3olutions Manual, "hapter B )0B
Case !-1# (continued*
3ales (/)<,<<< units V R)+< per unit*.
R/C,+<<,<<
<
"ost of goods sold:
?eginning inventory........................... R <
(/)<,<<< units V RC/ per unit*........ ,B,0/<,<<<
1oods availa$le for sale..................... ,B,0/<,<<<
=ess ending inventory........................ <
,B,0/<,<<
<
1ross margin........................................ )<,22<,<<<
e.penses:
(/)<,<<< units V R)< per unit*........ /,)<<,<<<
Fi.ed selling and administrative......... /,02<,<<<
B,22<,<<
<
Aet operating income..........................
R +,<<<,<<
<
,. ?y increasing production so that it e.ceeds sales, inventories
will $e $uilt up. his will have the e#ect of deferring '.ed
manufacturing overhead in the ending inventory. ;ow much
'.ed manufacturing overhead must $e deferred in this
mannerF he managers are suggesting an arti'cial $oost to
earnings of R,+B,<<< since at the current rate of sales, pro't
will only $e R),2@+,<<< and they want to hit the target pro't of
R+,<<<,<<<.
he amount of production, 6, re4uired to defer R,+B,<<< can
$e determined as follows:
Knits in $eginning
inventory........................ <
!lus units produced........... 6
Knits availa$le for sale...... 6
=ess units sold.................. /<<,<<<
Knits in ending inventory. . 6 X /<<,<<<
3olutions Manual, "hapter B )0C
Fi.ed manufacturing
Y
overhead per unit
$6,888,000
&
3olutions Manual, "hapter B )2<
Fi.ed manufacturing Fi.ed manufacturing Aum$er of
overhead deferred Y overhead rate V units added
in inventory per unit to inventory
R2,BBB,<<<
R,+B,<<< Y V (6 7 /<<,<<<*
6
R,+B,<<< V 6 Y R2,BBB,<<< V (6 7 /<<,<<<*
R,+B,<<< V 6 Y R2,BBB,<<< V 6 7 R2,BBB,<<< V /<<,<<<
R2,02<,<<< V 6 Y R2,BBB,<<< V /<<,<<<
6 Y /+<,<<< units
/. he unit product cost at a production level of /+<,<<< units
would $e calculated as follows:
>irect materials............................................................. R0@.+<
>irect la$or.................................................................... )0.<<
Iaria$le manufacturing overhead.................................. 0.<<
Fi.ed manufacturing overhead (R2,BBB,<<< [
/+<,<<< units*............................................................. )2./<
Knit product cost........................................................... RC,.2<
he a$sorption costing income statement would $e:
3ales (/<<,<<< units V R)+< per unit*. .
R/B,<<<,<<
<
"ost of goods sold:
?eginning inventory........................... R <
(/+<,<<< units V RC,.2< per unit*....
,C,,)+,<<
<
1oods availa$le for sale..................... ,C,,)+,<<<
(+<,<<< units V RC,.2< per unit*......
........................................................ ),B@+,<<<
,@,//<,<<
<
1ross margin.........................................
)<,02<,<<
<
e.penses:
(/<<,<<< units V R)< per unit*......... /,<<<,<<<
3olutions Manual, "hapter B )2)
Fi.ed selling and administrative......... /,02<,<<< B,02<,<<<
Aet operating income........................... R +,<<<,<<<
3olutions Manual, "hapter B )2+
0. As a practical matter, the scheme of $uilding inventories in
order to increase pro'ts would work. ;owever, the R,+B,<<< in
'.ed manufacturing overhead is only deferred in inventory. &t is
an a. hanging over the head of the managers. &f the
inventories are allowed to fall $ack to normal levels in the ne.t
year, all of that deferred cost will $e released to the income
statement. &n order to keep using inventory $uildups as a way
of meeting pro't goals, inventories must keep gro1ing year
after year. Eventually, someone on the ?oard of >irectors is
likely to 4uestion the wisdom of such large inventories.
&nventories tie up capital, take space, result in operating
pro$lems, and e.pose the company to the risk of o$solescence.
Ohen inventories are eventually cut due to these pro$lems, all
of the deferred costs will -ow through to the income statement
9with a potentially devastating e#ect on net operating income.
Apart from this practical consideration, $ehavioral and ethical
issues should $e addressed. aking the ethical issue 'rst, it is
unlikely that $uilding up inventories is the kind of action the
?oard of >irectors had in mind when they set the pro't goal.
"hances are that the ?oard of >irectors would o$ject to this
kind of manipulation if they were informed of the reason for the
$uildup of inventories. he company must incur costs in order
to $uild inventories at the end of the year. >oes this make any
sense when there is no indication that the e.cess inventories
will $e needed to meet sales demandF OouldnGt it $e $etter to
wait and meet demand out of normal production as neededF
Essentially, the managers who approached 1uochang are
asking him to waste the ownersG money so as to arti'cially
in-ate the reported net operating income so that they can get
a $onus.
?ehaviorally, this is trou$ling $ecause it suggests that the
former "ED left $ehind an unfortunate legacy in the form of
managers who encourage 4uestiona$le $usiness practices.
1uochang needs to set a new moral climate in the company or
there will likely $e even $igger pro$lems down the road.
1uochang should 'rmly turn down the managersG re4uest and
let them know why.
3olutions Manual, "hapter B )2,
;aving said all of that, it would not $e easy for 1uochang to
turn down a $onus that could $e potentially as large as
R+0,<<<9which is precisely what 1uochang would $e doing if
he were to pass up the opportunity to in-ate the companyGs
earnings. And, his refusal to cooperate with the other managers
may create a great deal of resentment and $itterness. his is a
very diEcult position for any manager to $e in and many would
pro$a$ly succum$ to the temptation.
2. he ?oard of >irectors, with their $onus plan, has
unintentionally created a situation that is very diEcult for the
new "ED. Ohenever such a $onus plan is $ased on a$sorption
costing net operating income, the temptation e.ists to
manipulate net operating income $y changing the amount that
is produced. his temptation is magni'ed when an all7or7
nothing $onus is awarded $ased on meeting target pro'ts.
Ohen actual pro'ts appear to $e within spitting distance of the
target pro'ts, the temptation to manipulate net operating
income to get the all7or7nothing $onus $ecomes almost
overpowering. &deally, managers should resist such
temptations, $ut this particular temptation can $e easily
avoided. ?onuses should $e $ased on varia$le costing net
operating income, which is less su$ject to manipulation. And,
all7or7nothing $onuses should $e replaced with $onuses that
start out small and slowly grow with net operating income.
3olutions Manual, "hapter B )2/
Case !-2$ (C< minutes*
). Knder a$sorption costing, the net operating income of a
particular period is dependent on $oth production and sales.
For this reason, the controllerGs e.planation was accurate. ;e
should have pointed out, however, that the reduction in
production resulted in a large amount of underapplied
overhead, which was added to cost of goods sold in the second
4uarter. ?y producing fewer units than planned, the company
was not a$le to a$sor$ all the '.ed manufacturing overhead
incurred during the 4uarter into units of product. he result was
that this una$sor$ed overhead ended up on the income
statement as a charge against the period, there$y sharply
slashing income.
+. First
8uarter
Second
8uarter
3ales....................................................................... R/B<,<<< R2<<,<<<
Iaria$le manufacturing _ RB per unit.................. C2,<<< )+<,<<<
e.penses _R0 per unit....................................... 2<,<<< @0,<<<
otal varia$le e.penses........................................... )02,<<< )C0,<<<
"ontri$ution margin................................................ ,+/,<<< /<0,<<<
=ess '.ed e.penses:
Fi.ed manufacturing overhead.............................. )B<,<<< )B<,<<<
e.pensesZ.......................................................... )/<,<<< )/<,<<<
otal '.ed e.penses................................................ ,+<,<<< ,+<,<<<
Aet operating income.............................................. R/,<<< RB0,<<<
Z3elling and administrative e.penses,
'rst 4uarter........................................................ R+<<,<<<
=ess varia$le portion
()+,<<< units V R0 per unit*................................ 2<,<<<
e.penses............................................................ R)/<,<<<
Case !-2$ (continued*
,. o answer this part, it is helpful to prepare a schedule of
inventories, production, and sales in units:
Beginnin
g
"nventor
%
Units
Produce
d
Units
Sold
Ending
"nventor
%
First 4uarter /,<<< )0,<<< )+,<<< @,<<<
3econd 4uarter @,<<< C,<<< )0,<<< ),<<<
Ksing these inventory data, the reconciliation would $e as
follows:
First
8uarter
Second
8uarter
Iaria$le costing net operating income.................... R /,<<< R B0,<<<
cost released from inventory during the
First 6uarter (/,<<< units V R)+ per
unit*...................................................................... (/B,<<<*
Add (deduct*: Fi.ed manufacturing
overhead cost deferred in inventory
from the First 6uarter to the 3econd
6uarter (@,<<< units V R)+ per unit*.................... B/,<<< (B/,<<<*
deferred in inventory from the 3econd
6uarter to the future (),<<< units V
R)+ per unit*......................................................... )+,<<<
A$sorption costing net operating income................ R /<,<<< R ),,<<<
Iaria$le costing net operating income.................... R/,<<< RB0,<<<
deferred in inventory to the 3econd
6uarter (,,<<< unit increase V R)+ per
unit*...................................................................... ,2,<<<
cost released from inventory due to a
decrease in inventory during the
3econd 6uarter (2,<<< unit decrease V
(@+,<<<*
R)+ per unit*.........................................................
A$sorption costing net operating income................ R/<,<<< R),,<<<
3olutions Manual, "hapter B )2@
/. he advantages of using the varia$le costing method for
internal reporting purposes include the following:
c Iaria$le costing aids in forecasting and reporting income for
decision7making purposes.
c Fi.ed costs are reported in total amount, there$y increasing
the opportunity for more e#ective control of these costs.
c !ro'ts vary directly with sales volume and are not a#ected
$y changes in inventory levels.
c Analysis of cost7volume7pro't relationships is facilitated and
management is a$le to determine the $reak7even point and
total pro't for a given volume of production and sales.
he disadvantages of using the varia$le costing method for
internal reporting purposes include the following:
c Iaria$le costing lacks accepta$ility for e.ternal 'nancial
reporting and cannot $e used for income ta.es in the Knited
3tates. As a result, additional record keeping costs may $e
re4uired.
c &t may $e diEcult to determine what costs are '.ed and what
costs are varia$le.
0. a. Knder 5&, production is geared strictly to sales. herefore,
the company would have produced only enough units during
the 4uarter to meet sales needs. he computations are:
Knits sold................................................................)0,<<<
=ess units in inventory at the $eginning of the
4uarter.................................................................. @,<<<
Knits produced during the 4uarter under 5&........... B,<<<
3olutions Manual, "hapter B )2B
Although not asked for in the pro$lem, a move to 5& during the
3econd 6uarter would have reduced the companyGs reported
net operating income even further. he net operating income
for the 4uarter would have $een:
3ales....................................................................... R2<<,<<<
?eginning inventory.............................................. R)/<,<<<
(B,<<< units V R+< per unit*............................... )2<,<<<
1oods availa$le for sale........................................ ,<<,<<<
Ending inventory................................................... <
"ost of goods sold................................................ ,<<,<<<
Add underapplied overheadZ................................ B/,<<< ,B/,<<<
1ross margin...........................................................+)2,<<<
e.penses..............................................................+)0,<<<
Aet operating income.............................................. R ),<<<
Z Dverhead rates are $ased on )0,<<< units produced each
4uarter. &f only B,<<< units are produced, then the
underapplied '.ed manufacturing overhead will $e @,<<<
units V R)+ per unit Y RB/,<<<.
$. 3tarting with the hird 6uarter, there will $e little or no
di#erence $etween the incomes reported under varia$le
costing and under a$sorption costing. he reason is that
there will $e little or no inventories on hand and therefore no
way to shift '.ed manufacturing overhead cost $etween
periods under a$sorption costing.
3olutions Manual, "hapter B )2C
,roup E%ercise !-21
). A$sorption costing, which includes $oth '.ed and varia$le
manufacturing costs in the product cost, is widely considered to
$e re4uired on e.ternal 'nancial reports in the Knited 3tates.
+ A company with sales $elow the $reak7even point may $e a$le
to report a pro't if its inventories increase. ?reak7even points
are computed assuming that '.ed costs are e.pensed in the
year in which they are incurred. ;owever, if production e.ceeds
sales and the company uses a$sorption costing, then a portion
of the '.ed manufacturing costs will $e included as part of
ending inventories on the $alance sheet rather than $eing
e.pensed on the income statement.
,. Knder a$sorption costing, whenever inventories increase,
pro'ts will increase. &nventories could increase $ecause
management intentionally manipulates pro'ts, $ut they could
also increase for other reasons. For e.ample, inventories may
increase if the company is e.pecting an increase in demand for
the companyGs products early in the ne.t accounting period.
/. Knder a$sorption costing, accounting pro'ts are reduced when
inventories decrease. Fi.ed manufacturing overhead costs that
are deferred in inventories are released to the income
statement whenever inventories are reduced. &nventories may
$e reduced for a num$er of good reasons including a switch to
5& operations or an anticipated fall in demand early in the ne.t
accounting period.
3olutions Manual, "hapter B )@<
,roup E%ercise !-22
). A higher proportion of '.ed costs will increase the disparity
$etween a$sorption unit product costs and the costs reported
under varia$le costing. his will also have the e#ect of
magnifying -uctuations in net operating income that occur
under a$sorption costing as a conse4uence of changes in
inventories. (3ee the discussion in part + $elow.*
!roponents of a$sorption costing will make the same
arguments as $efore, as will the proponents of varia$le costing.
;owever, the higher proportion of '.ed costs will increase the
di#erences $etween reports $ased on varia$le costing and
those $ased on a$sorption costing. "onse4uently, this issue
$ecomes more important as the proportion of '.ed costs in the
cost structure increases.
+. As long as a$sorption costing is used for e.ternal reporting
purposes, inventory $uildups will result in higher reported
pro'ts, while inventory reductions will cause lower reported
pro'ts. hese e#ects are magni'ed as a higher proportion of
cost $ecomes '.ed.
,. 3ome managers may prefer a$sorption costing and others may
prefer varia$le costing. Managers may prefer a$sorption
costing $ecause a$sorption costing is used on e.ternal 'nancial
reports, $ecause they prefer a$sorption costing on theoretical
grounds, or $ecause a$sorption costing pro'ts are easier to
manipulate than varia$le costing pro'ts9just increase or
decrease inventories. Dther managers may prefer varia$le
costing $ecause it is easier to understand, $ecause it is easier
and more appropriate to use in decisions, $ecause they prefer
varia$le costing on theoretical grounds, or $ecause it isnGt
su$ject to -uctuations due to changes in inventories.
3olutions Manual, "hapter B )@)
Chapter "
Activit)-Based Costing2 A -ool to Aid
1ecision Ma?ing
"-1 Activity7$ased costing di#ers from
traditional costing systems in a num$er of
ways. &n activity7$ased costing,
nonmanufacturing as well as manufacturing
costs may $e assigned to products. And,
some manufacturing costs may $e e.cluded
from product costs. An activity7$ased
costing system typically includes a num$er
of activity cost pools, each of which has its
uni4ue measure of activity. hese measures
of activity often di#er from the allocation
$ases used in traditional costing systems.
Finally, the activity rates di#er from typical
predetermined overhead rates in that they
should $e $ased on activity at capacity
rather than on the $udgeted level of
activity.
"-2 Ohen direct la$or is used as an
allocation $ase for overhead, it is implicitly
assumed that overhead cost is directly
proportional to direct la$or. Ohen cost
systems were originally developed in the
)B<<s, this assumption may have $een
reasona$ly accurate. ;owever, direct la$or
has declined in importance over the last
hundred years while overhead has $een
increasing. his suggests that there is no
longer a direct link $etween the level of
direct la$or and overhead. &ndeed, when a
company automates, direct la$or is
replaced $y machines% a decrease in direct
la$or is accompanied $y an increase in
overhead. his violates the assumption that
overhead cost is directly proportional to
direct la$or. Dverhead cost appears to $e
driven $y factors such as product diversity
and comple.ity as well as $y volume, for
which direct la$or has served as a
convenient measure.
"-3 Ohen an overhead rate is $ased on
the $udgeted level of activity, products are
implicitly charged for the costs of the
capacity they donGt use as well as for the
costs of capacity that they do use. his is
$ecause all of the costs of capacity9
whether utilized or not9are spread across
the $udgeted production. 3ince the costs of
capacity are largely '.ed, this results in
higher unit product costs when the level of
activity declines.
&f an overhead rate is $ased on the
level of activity at capacity, a product is
charged only for the costs of capacity that
it actually uses. he costs of unused
capacity are not charged to products and
are instead charged to the current period as
e.penses of the period (see Appendi. ,A*.
As a result, unit product costs are more
sta$le and costs do not appear to increase
as the level of $udgeted activity decreases.
"-4 Activity7$ased costing may $e
resisted $ecause it changes the Mrules of
the game.N &t changes some of the key
measures such as product costs used in
making decisions and may a#ect how
individuals are evaluated. Oithout top
management support, there may $e little
interest in making these changes. &n
addition, if top managers continue to make
decisions $ased on the num$ers generated
$y the traditional costing system,
su$ordinates will 4uickly conclude that the
activity7$ased costing system can $e
ignored.
"-5 Knit7level activities are performed
for each unit that is produced. ?atch7level
activities are performed for each $atch
3olutions Manual, "hapter B )@+
regardless of how many units are in the
$atch. !roduct7level activities must $e
carried out to support a product regardless
of how many $atches are run or units
produced. "ustomer7level activities must $e
carried out to support customers regardless
of what products or services they $uy.
Drganization7sustaining activities are
carried out regardless of the companyGs
precise product mi. or mi. of customers.
"- Drganization7sustaining costs and
the costs of idle capacity should not $e
assigned to products. hese costs represent
resources that are not consumed $y the
products.
"-! &n activity7$ased costing, costs must
'rst $e allocated to activity cost pools and
then are allocated from the activity cost
pools to products, customers, and other
cost o$jects.
"-" 3ince people are often involved in
more than one activity, some way must $e
found to estimate how much time they
spend on each. he most practical
approach is often to ask employees what
percentage of time they spend on each
activity. &t is also possi$le to ask people to
keep records of how they spend their time
or o$serve them as they perform their
tasks, $ut $oth of these alternatives are
costly and it is not o$vious that the data
would $e any $etter. !eople who know they
are $eing o$served may change how they
$ehave.
"-# &n traditional cost systems, product7
level costs are indiscriminately spread
across all products using direct la$or7hours
or some other allocation $ase that is tied to
volume. As a conse4uence, high7volume
products are assigned the $ulk of such
costs. &f a product is responsi$le for /<P of
the direct la$or in a factory, it will $e
assigned /<P of the manufacturing
overhead cost in the factory9including
/<P of the product7level costs of low7
volume products. &n an activity7$ased
costing system, $atch7level and product7
level costs are assigned more appropriately.
his results in shifting product7level costs
$ack to the products that cause them and
away from the high7volume products. (A
similar e#ect will $e o$served with $atch7
level costs if high7volume products are
produced in larger $atches than low7volume
products.*
"-1$ Activity rates tell managers the
average cost of resources consumed in
carrying out a particular activity such as
processing purchase orders. An activity
whose average cost is high may $e a good
candidate for process improvements.
?enchmarking can $e used to identify
which activities have unusually large costs.
&f some other organization is a$le to carry
out the activity at a signi'cantly lower cost,
it is reasona$le to suppose that
improvement may $e possi$le.
"-11 he activity7$ased costing approach
descri$ed in the chapter is pro$a$ly
unaccepta$le for e.ternal 'nancial reports
for two reasons. First, activity7$ased
product costs, as descri$ed in this chapter,
e.clude some manufacturing costs and
include some nonmanufacturing costs.
3econd, the 'rst7stage allocations are
$ased on interviews rather than veri'a$le,
o$jective data.
"-12 Ohile an activity analysis such as in
E.hi$it B7C can yield insights, it should not
$e used for decision making. he
conventional activity analysis contains no
indication of what costs can actually $e
adjusted nor is there any indication of who
would $e responsi$le for adjusting the costs
after a decision has $een made. &t would $e
dangerous, for e.ample, to drop a product
$ased solely on the activity analysis. Most
of the costs do not automatically disappear
if a product is dropped% managers must
take e.plicit actions to eliminate resources
or to transfer resources to other uses.
Managers may $e reluctant to take these
actions9particularly if it involves 'ring or
transferring people. he action analysis has
the advantage of making it clearer where
savings have to come from and hence
which managers will have to take action.
3olutions Manual, "hapter B )@,
3olutions Manual, "hapter B )@/
E%ercise "-1 ()< minutes*
a. 8eceive raw materials from suppliers: ?atch7level
$. Manage parts inventories: !roduct7level
c. >o rough milling work on products: Knit7level
d. &nterview and process new employees in the personnel
department: Drganization7sustaining
e. >esign new products: !roduct7level
f. !erform periodic preventative maintenance on general7use
e4uipment: Drganization7sustaining
g. Kse the general factory $uilding: Drganization7sustaining
h. &ssue purchase orders for a jo$: ?atch7level
3ome of these classi'cations are de$ata$le and depend on the
speci'c circumstances found in particular companies.
3olutions Manual, "hapter B )@0
E%ercise "-2 ()0 minutes*
,ravel
Pic&up
and
!eliver%
Custom
er
Service $ther ,otals
>river and guard wages................. R,2<,<
<<
R+0+,<
<<
R @+,<<
<
R ,2,<<
<
R @+<,<<
<
Iehicle operating e.pense............. )C2,<<
< )/,<<< < @<,<<< +B<,<<<
Iehicle depreciation....................... @+,<<< )B,<<< < ,<,<<< )+<,<<<
"ustomer representative salaries
and e.penses.............................. < <
)//,<<
< )2,<<< )2<,<<<
DEce e.penses.............................. < 2,<<< C,<<< )0,<<< ,<,<<<
Administrative e.penses................
<
)2,<<
<
)C+,<<
<
))+,<<
<
,+<,<<
<
otal cost........................................ R2+B,<
<<
R,<2,<
<<
R/)@,<
<<
R+@C,<
<<
R),2,<,<
<<
Each entry in the ta$le is derived $y multiplying the total cost for the cost category $y the
percentage taken from the ta$le $elow that shows the distri$ution of resource
consumption:
,ravel
Pic&up
and
!eliver
%
Custom
er
>river and guard wages................... 0<P ,0P )<P 0P )<<P
Iehicle operating e.pense............... @<P 0P <P +0P )<<P
Iehicle depreciation......................... 2<P )0P <P +0P )<<P
3olutions Manual, "hapter B )@2
"ustomer representative salaries
and e.penses................................ <P <P C<P )<P )<<P
DEce e.penses................................ <P +<P ,<P 0<P )<<P
Administrative e.penses.................. <P 0P 2<P ,0P )<<P
3olutions Manual, "hapter B )@@
Activit% Cost Pool
Estimat
ed
$verhe
ad Cost Expected Activit% Activit% 2ate
"aring for lawn
R@+,<<
<
)0<,<<
<
s4uare feet of
lawn
R<./
B
per s4uare foot of
lawn
"aring for garden $edsX
low maintenance
R+2,/<
<
+<,<<< s4uare feet of
low maintenance
$eds
R).,
+
per s4uare foot of
low maintenance
$eds
"aring for garden $edsX
high maintenance
R/),/<
<
)0,<<< s4uare feet of
high
maintenance
$eds
R+.@
2 per s4uare foot of
high maintenance
$eds
ravel to jo$s
R,,+0< )+,0<<
miles
R<.+
2 per mile
"ustomer $illing and
service
RB,@0< +0
customers
R,0<
per customer
he activity rate for each activity cost pool is computed $y dividing its estimated overhead
cost $y its e.pected activity.
3olutions Manual, "hapter B )@B
C75;
Activit% Cost Pool Activit% 2ate Activit% ABC
Cost
=a$or related.................... R2 per direct la$or7
hour
B< direct la$or7
hours
R /B<
Machine related............... R/ per machine7hour )<< machine7hours /<<
Machine setups................ R0< per setup ) setups 0<
!roduction orders............. RC< per order ) order C<
3hipments........................ R)/ per shipment ) shipment )/
!roduct sustaining............ RB/
<
per product ) product B/<
otal................................. R),B@/
MEF
Cost
=a$or related.................... R2 per direct la$or7
hour
0<< direct la$or7
hours
R ,,<<
<
Machine related............... R/ per machine7hour ),0<
<
machine7hours 2,<<<
Machine setups................ R0< per setup / setups +<<
!roduction orders............. RC< per order / orders ,2<
3hipments........................ R)/ per shipment )< shipments )/<
!roduct sustaining............ RB/
<
per product ) product B/
<
otal................................. R)<,0/
<
3olutions Manual, "hapter B )@C
C75; MEF
otal cost (a*............................. R),B@
/
R)<,0/
<
Aum$er of units produced ($*. . . +<< +,<<<
Average cost per unit (a* [ ($*.. RC.,@ R0.+@
3olutions Manual, "hapter B )B<
E%ercise "-5 (,< minutes*
he 'rst step is to compute the overhead cost for each of the products ordered $y the
customer:
Standard Model
Cost
Manufacturing volume..... R+2 per direct la$or7
hour
0+
@
direct la$or7
hours
R),,@<
+
Drder processing.............. R+B
/
per order ) order R+B/
"ustom design
processing.....................
R)B
2
per custom
design
< custom
designs
R<
"ustomer service............. R,@
C
per customer Aot applica$le
Custom !esign
Cost
Manufacturing volume..... R+2 per direct la$or7
hour
B/ direct la$or7
hours
R+,)B/
Drder processing.............. R+B
/
per order , order RB0+
"ustom design
processing.....................
R)B
2
per custom
design
, custom
designs
R00B
"ustomer service............. R,@
C
per customer Aot applica$le
3olutions Manual, "hapter B )B)
E%ercise "-5 (continued*
he second step is to compute the product margins for the two
products:
Product Pro.tabilit%
Anal%sis
Standard Model Custom
!esign
3ales............................... R,@,<<
<
R@,+<
<
"osts:
>irect materials............ R)),+B
<
R),C<
+
>irect la$or................... )<,+@@ ),2,B
Manufacturing volume. . ),,@<+ +,)B/
Drder processing........... +B/ B0+
"ustom design
processing..................
< ,0,0/
,
00
B
@,),
/
!roduct margin................ R ),/0
@
R 2
2
he 'nal step is to compute the pro'ta$ility of the customer:
Customer Pro.tabilit% Anal%sis
!roduct margin of orders placed $y
customer:
3tandard model..................................... R),/0
@
"ustom design....................................... 2
2
otal product margins............................... ),0+,
"ustomer service overhead...................... ,@
C
"ustomer margin..................................... R),)/
/
)B+ Managerial Accounting, ))th Edition
E%ercise "- (,< minutes*
). Knder the traditional direct la$or7hour $ased costing system,
manufacturing overhead is applied to products using the
predetermined overhead rate computed as follows:
Estimated total manufacturing overhead cost !redetermined
Y
overhead rate Estimated total direct la$or7 hours
R),C+<,<<<
Y Y R)2< per >=;
)+,<<< >=;sZ
Z0<,<<< units of Model S)<< _ <.+ >=; per unit \ 0,<<< units
of Model S+<< _ <./ >=; per unit Y )<,<<< >=;s \ +,<<<
>=;s Y )+,<<< >=;s
"onse4uently, manufacturing overhead would $e applied to the
products as follows:
Model
B4::
Model
B5:: ,otal
Knit sales......................... 0<,<<< 0,<<<
>irect la$or7hours per
unit................................
<.+ <./
otal direct la$or7hours..... )<,<<< +,<<< )+,<<<
otal manufacturing
overhead applied _
R)2< per direct la$or7
hour...............................
R),2<<,<
<< R,+<,<<<
R),C+<,<
<<
per unit.......................... R,+ R2/
Aote that all of the manufacturing overhead cost is applied to
the products under the companyGs traditional costing system.
)B, Managerial Accounting, ))th Edition
E%ercise "- (continued*
+. Knder the activity7$ased costing system, overhead costs ($oth
nonmanufacturing and manufacturing* would $e applied to
Model
B4::
Model
B5:: ,otal
Knit sales...................... 0<,<<< 0,<<<
Manufacturing
overhead
applied.......................
R),,/<,<
<< R,C<,<<<
R),@,<,<
<<
Aonmanufacturing
overhead applied........
)2<,<<
< ))<,<<<
+@<,<<
<
otal overhead applied.. R),0<<,<
<< R0<<,<<<
R+,<<<,<
<<
Manufacturing
overhead per unit....... R,< R)<<
,. Knder activity7$ased costing, a total of R),0<<,<<< is assigned
to Model S)<< and a total of R0<<,<<< is assigned to Model
S+<<. his is in contrast to R),2<<,<<< for Model S)<< and
R,+<,<<< for Model S+<< under the traditional costing method.
Also note that the total amount of overhead applied to $oth
products is R+,<<<,<<< under activity7$ased costing and
R),C+<,<<< under the traditional costing method. A num$er of
reasons e.ist for these di#erences. First, not all manufacturing
overhead costs are assigned to products under activity7$ased
costing. Apparently R)C<,<<< (Y R),C+<,<<< X R),@,<,<<<* of
manufacturing overhead consists of the costs of idle capacity
and organization7sustaining costs that are not assigned to
products under activity7$ased costing. "ounter$alancing this, a
total of R+@<,<<< in nonmanufacturing costs are assigned to
products under activity7$ased costing, $ut not under the
traditional method. Additionally, manufacturing overhead costs
have $een shifted from Model S)<<, the high7volume product,
to Model S+<<, the low7volume product under activity7$ased
costing. his is pro$a$ly due to the e.istence of $atch7level or
product7level costs that are more appropriately assigned under
activity7$ased costing.
!er unit costs have changed under activity7$ased costing.
)B/ Managerial Accounting, ))th Edition
his is partly due to the e.clusion of some manufacturing
overhead from product costs and the inclusion of
nonmanufacturing overhead costs. ?ut it is also due to shifting
costs from the high7volume to the low7volume product. his has
the predicta$le e#ect of increasing the per unit cost of the low7
volume product more than the per unit cost of the high7volume
product is decreased.
)B0 Managerial Accounting, ))th Edition
E%ercise "-! (+< minutes*
3ales ()+< clu$s V R/C per clu$*.....................
R0,BB<.<
<
1reen costs:
>irect materials ()+< clu$s V R+@.20 per
clu$*.............................................................
R,,,)B.<
< ,,,)B.<<
1reen margin.................................................. +,02+.<<
Qellow costs:
>irect la$or ()+< clu$s V <./ hour per clu$
V R++ per hour*............................................),<02.<<
&ndirect la$or................................................... )),./<
Marketing e.penses........................................ @<C.B< ),B@C.+<
Qellow margin.................................................. 2B+.B<
8ed costs:
Factory e4uipment depreciation...................... +)2.2<
Factory administration..................................... +C).@<
3elling and administrative wages and
salaries......................................................... ,B@.2<
3elling and administrative depreciation.......... +B.<< C+,.C<
8ed margin......................................................
(R +/).)<
*
Ohile not re4uired in the pro$lem, the conventional A?" analysis
would $e presented as follows:
3ales ()+< clu$s V R/C per clu$*.....................
R0,BB<.<
<
!roduct costs:
>irect materials............................................
R,,,)B.<
<
>irect la$or................................................... ),<02.<<
Iolume related overhead.............................. 0C0.+<
?atch processing overhead........................... 0,.0<
Drder processing overhead........................... ),+./< 0,)00.)<
!roduct margin................................................ @+/.C<
"ustomer service overhead............................. C22.<<
"ustomer margin............................................
(R +/).)<
*
)B2 Managerial Accounting, ))th Edition
E%ercise "-" ()< minutes*
Activit% Activit% )evel
a. 3ales representativesG periodic visits
to customers to keep them
informed a$out the services
provided $y "> E.press........................................ "ustomer7level
$. Drdering la$els from the printer for a
particular ">Z....................................................... !roduct7level
c. 3etting up the "> duplicating
machine to make copies from a
particular master ">............................................. ?atch7level
d. =oading the automatic la$eling
machine with la$els for a particular
">Z....................................................................... ?atch7level
e. Iisually inspecting ">s and placing
them $y hand into protective plastic
cases prior to shipping.......................................... Knit7level
!reparation of the shipping
documents for the order....................................... !roduct7level
g.
!eriodic maintenance of e4uipment........................
Drganization7
sustaining
h. =ighting and heating the companyGs
production facility.................................................
Drganization7
sustaining
!reparation of 4uarterly 'nancial
reports..................................................................
Drganization7
sustaining
Zhe cost of the la$els themselves would $e part of direct
materials.
)B@ Managerial Accounting, ))th Edition
E%ercise "-# ()< minutes*
eller wages R)2<,<<<
Assistant $ranch manager
salary
R@0,<<<
?ranch manager salary RB<,<<<
!istribution of 2esource Consumption Across Activities
$pening
Account
s
Processing
!eposits
and
0ithdra1al
s
Processing
$ther
Customer
,ransaction
s
$ther
Activities ,otals
eller wages 0P 20P +<P )<P )<<P
salary
)0P 0P ,<P 0<P )<<P
?ranch manager salary 0P <P )<P B0P )<<P
$pening
Account
s
Processing
!eposits
and
0ithdra1al
s
Processing
$ther
Customer
,ransaction
s
$ther
Activities ,otals
eller wages R B,<<< R)</,<<< R,+,<<< R )2,<<<
R)2<,<<
<
salary )),+0< ,,@0< ++,0<< ,@,0<< @0,<<<
?ranch manager salary /,<<< < B,<<< 2B,<<<
B<,<<
<
3olutions Manual, "hapter B )BB
otal cost R+,,+0< R)<@,@0< R2+,0<<
R)+),0<
<
R,)0,<<
<
eller wages are R)2<,<<< and 20P of the tellersG time is spent processing deposits and
withdrawals:
R)2<,<<< V 20P Y R)</,<<<
Dther entries in the ta$le are determined similarly.
3olutions Manual, "hapter B )BC
E%ercise "-1$ (+< minutes*
). "omputation of activity rates:
Activit% Cost Pools
'a+
,otal
Cost
'b+
,otal Activit%
'a+ P 'b+
Activit% 2ate
Dpening accounts R+,,+0< 0<< new accounts
opened
R/2.0
<
per new account
opened
!rocessing deposits and
withdrawals
R)<@,@0
<
)<<,<<< deposits and
withdrawals
processed
R).<B per deposit or
withdrawal
processed
!rocessing other customer
transactions
R2+,0<< 0,<<< other
customer
transactions
processed
R)+.0
<
per other
customer
transaction
processed
3olutions Manual, "hapter B )C<
E%ercise "-1$ (continued*
+. he cost of opening an account at the Oest'eld $ranch is
apparently much higher than at the lowest cost $ranch (R/2.0<
versus R+2.@0*. Dn the other hand, the cost of processing
deposits and withdrawals is lower than at the lowest cost
$ranch (R).<B versus R).+/*. And the cost of processing other
customer transactions is somewhat higher at the Oest'eld
$ranch (R)+.0< versus R)).B2*. his suggests that the other
$ranches may have something to learn from Oest'eld
concerning processing deposits and withdrawals and Oest'eld
may $ene't from learning a$out how some of the other
$ranches open accounts and process other transactions. &t may
$e particularly instructive to compare the details of the activity
rates. For e.ample, is the cost of opening accounts at Oest'eld
apparently high $ecause of the involvement of the assistant
$ranch manager in this activityF
&t should $e mentioned that the apparent di#erences in the
costs of the activities at the various $ranches could $e due to
inaccuracies in employeesG reports of the amount of time they
devote to the activities. he di#erences in costs may also
re-ect di#erent strategies. For e.ample, the Oest'eld $ranch
may purposely spend more time with new customers in order
to win their loyalty. he higher cost of opening new accounts at
the Oest'eld $ranch may $e justi'ed $y future $ene'ts of
having more satis'ed customers. Aevertheless, comparative
studies of the costs of activities may provide a useful starting
point for identifying $est practices within a company and where
improvements can $e made.
3olutions Manual, "hapter B )C)
Activit% Cost
Pool
'a+
Activit% 2ate
'b+
Activit%
'a+ T 'b+
ABC
Cost
Drder size 8 )2.B0 per direct la$or7hour +<< direct la$or7hours 8 ,,,@<
"ustomer
orders 8 ,+<.<< per customer order ) customer order 8 ,+<
!roduct testing
8 BC.<<
per product testing
hour /
product testing
hours 8 ,02
3elling
8
),<C<.<< per sales call + sales calls 8 +,)B<
otal 8 2,++2
According to these calculations, the total overhead cost of the order was 8 2,++2.
3olutions Manual, "hapter B )C+
). $rder
SiKe
Customer
$rders
Product
,esting Selling ,otal
Activity level +<< ) / +
direct
la$or7
hours
customer
order
product
testing
hours
sales
calls
Manufacturing:
&ndirect la$or 8),20< 8)B< 8)+< 8 < 8),C0<
Factory depreciation
),2<< < )2< < ),@2<
Factory utilities +< < / < +/
Factory administration
epreciation < )+ < B< C+
a.es and insurance
< < < /< /<
3elling e.penses < < < /<< /<<
otal overhead cost 8,,,@< 8,+< 8,02 8+,)B< 82,++2
E.ample: 8B.+0 per direct la$or7hour from the pro$lem statement V +<< direct la$or7hours
Y 8),20<
According to these calculations, the overhead cost of the order was 82,++2.
3olutions Manual, "hapter B )C,
+. he ta$le prepared in part ()* a$ove allows two di#erent
perspectives on the overhead cost of the order. he column
totals that appear in the last row of the ta$le tell us the cost of
the order in terms of the activities it re4uired. he row totals
that appear in the last column of the ta$le tell us how much the
order cost in terms of the overhead accounts in the underlying
accounting system. Another way of saying this is that the
column totals tell us what the costs were incurred for. he row
totals tell us what the costs were incurred on. For e.ample, you
may spend money on a chocolate $ar in order to satisfy your
craving for chocolate. ?oth perspectives are important. o
control costs, it is necessary to know $oth what the costs were
incurred for and what actual costs would have to $e adjusted
(i.e., what the costs were incurred on*.
he two di#erent perspectives can $e e.plicitly shown as
follows:
Ohat the overhead costs were incurred on:
Manufacturing:
&ndirect la$or 8),C0<
Factory depreciation ),@2<
Factory utilities +/
Factory administration )B<
1eneral selling J
administrative:
Oages and salaries ),@B<
>epreciation C+
a.es and insurance /<
3elling e.penses /<<
otal overhead cost 82,++2
Ohat the overhead costs were incurred for:
Drder size 8,,,@<
"ustomer orders ,+<
!roduct testing ,02
3elling +,)B<
otal overhead cost 82,++2
3olutions Manual, "hapter B )C/
Activit% )evel of Activit%
Examples of Activit%
Measures
a. >irect la$or workers assem$le
a product.
Knit >irect la$or7hours
$. !roducts are designed $y
engineers.
!roduct ;ours of design time% Aum$er
of new products designed
c. E4uipment is set up. ?atch ;ours of setup time% Aum$er
of setups
d. Machines are used to shape
and cut materials.
Knit Machine7hours% Aum$er of
units processed
e. Monthly $ills are sent out to
regular customers.
"ustomer Aum$er of $ills sent
Materials are moved from the
receiving dock to production
lines.
?atch Aum$er of loads transferred
g. All completed units are
inspected for defects.
Knit ;ours of inspection time%
Aum$er of units inspected
Aote: 3ome of these activity measures are de$ata$le.
3olutions Manual, "hapter B )C0
E%ercise "-14 (+< minutes*
). Activity rates are computed as follows:
Activit% Cost Pool
'a+
Estimate
d
$verhea
d
Cost
'b+
Expected
Activit%
'a+ P 'b+
Activit%
2ate
Machine setups R@+,<<< /<<
setup
s R)B< per setup
3pecial
processing R+<<,<<< 0,<<< M;s R/< per M;
1eneral factory RB)2,<<<
+/,<<
< >=;s R,/ per >=;
+. he unit costs can $e computed as follows, starting with the
computation of the manufacturing overhead:
<ubs
Sproc&et
s
Machine setups:
)<< setups V R)B< per setup
R )B,<<<
,<< setups V R)B< per setup
R 0/,<<<
3pecial processing:
0,<<< M;s V R/< per M; +<<,<<<
< M; V R/< per M; 7
1eneral factory:
B,<<< >=;s V R,/ per >=; +@+,<<<
)2,<<< >=;s V R,/ per >=; 0//,<<<
otal overhead cost (a*
R/C<,<<
< R0CB,<<<
Aum$er of units produced ($* )<,<<< /<,<<<
Dverhead cost per unit (a* [ ($* R/C.<< R)/.C0
<ubs
Sproc&et
s
>irect materials R,+.<< R)B.<<
3olutions Manual, "hapter B )C2
>irect la$or:
<.B< >=;s V R)0 per >=; )+.<<
<./< >=;s V R)0 per >=; 2.<<
Manufacturing overhead (see
a$ove* /C.<< )/.C0
Knit cost RC,.<< R,B.C0
3olutions Manual, "hapter B )C@
E%ercise "-15 ()0 minutes*
). and +.
Activit% Activit% )evel Possible Activit% Measures
a. Machine settings are changed
$etween $atches of di#erent
products.
?atch7level Aum$er of $atches% time to
change settings
$. !arts inventories are maintained in
the storeroom.
!roduct7level Aum$er of part types
maintained in stock
c. !roducts are milled on a milling
machine
Knit7level Machine7hours% la$or7hours
d. Aew employees are hired $y the
personnel oEce.
Drganization7
sustaining
Aot applica$leZ
e. Aew products are designed. !roduct7level ;ours of design time
!eriodic maintenance is performed
on general7purpose production
e4uipment.
Drganization7
sustaining
Aot applica$leZ
g. A $ill is sent to a customer who is
late in making payments.
"ustomer7level Aum$er of $ills
h. Qearly ta.es are paid on the
companyGs facilities.
Drganization7
sustaining
Aot applica$leZ
!urchase orders are issued for
materials to $e used in
production.
?atch7level Aum$er of purchase orders
Z Drganization7sustaining costs should not $e allocated to products or customers.
Aote: 3ome of these classi'cations and activity measures are de$ata$le.
3olutions Manual, "hapter B )CB
). he 'rst step is to determine the activity rates:
Activit% Cost
Pools
'a+
,otal
Cost
'b+
,otal Activit%
'a+ P 'b+
Activit% 2ate
3erving parties R,,,<<< 2,<<< parties R0.0< per party
3erving diners R),B,<<< )0,<<
<
diners RC.+< per diner
3erving drinks R+/,<<< )<,<<
<
drinks R+./< per drink
According to the activity7$ased costing system, the cost of
serving each of the parties can $e computed as follows:
a. !arty of / persons who order a total of , drinks:
Activit% Cost
Pool
'a+
Activit% 2ate
'b+
Activit%
'a+ T 'b+
ABC Cost
3erving parties R0.0
<
per party
) party R 0.0<
3erving diners RC.+
<
per diner
/ diners ,2.B<
3erving drinks R+./
<
per drink
, drinks @.+<
otal R/C.0<
$. !arty of + persons who order no drinks:
Activit% Cost
Pool
'a+
Activit% 2ate
'b+
Activit%
'a+ T 'b+
ABC Cost
<
per party
) party R 0.0<
3erving diners RC.+
<
per diner
+ diners )B./<
3erving drinks R+./
<
per drink
< drinks <
otal R+,.C<
c. !arty of ) person who orders + drinks:
Activit% Cost
Pool
'a+
Activit% 2ate
'b+
Activit%
'a+ T 'b+
ABC Cost
3olutions Manual, "hapter B )CC
<
per party
) party R 0.0<
3erving diners RC.+
<
per diner
) diner C.+<
3erving drinks R+./
<
per drink
+ drinks /.B<
otal R)C.0<
3olutions Manual, "hapter B +<<
+. he average cost per diner for each party can $e computed $y
dividing the total cost of the party $y the num$er of diners in
the party as follows:
a. R/C.0< [ / diners Y R)+.,@0 per diner
$. R+,.C< [ + diners Y R)).C0 per diner
c. R)C.0< [ ) diner Y R)C.0< per diner
,. he average cost per diner di#ers from party to party under the
activity7$ased costing system for two reasons. First, the cost of
serving a party (R0.0<* does not depend on the num$er of
diners in the party. herefore, the average cost per diner of this
activity decreases as the num$er of diners in the party
increases. Oith only one diner, the cost is R0.0<. Oith two
diners, the average cost per diner is cut in half to R+.@0. Oith
've diners, the average cost per diner would $e only R).)<.
And so on. 3econd, the average cost per diner di#ers also
$ecause of the di#erences in the num$er of drinks ordered $y
the diners. &f a party does not order any drinks, as was the case
with the party of two, no costs of serving drinks are assigned to
the party.
he average cost per diner di#ers from the overall average cost
of R)2 per diner for several reasons. First, the average cost of
R)2 per diner includes organization7sustaining costs that are
e.cluded from the computations in the activity7$ased costing
system. 3econd, the R)2 per diner 'gure does not recognize
di#erences in the dinersG demands on resources. &t does not
recognize that some diners order more drinks than others nor
does it recognize the economies of scale in serving larger
parties. (he $atch7level costs of serving a party can $e spread
over more diners if the party is larger.*
Oe should note that the activity7$ased costing system itself
does not recognize all of the di#erences in dinersG demands on
resources. For e.ample, there are undou$tedly di#erences in
the costs of preparing the various meals on the menu. &t may or
may not $e worth the e#ort to $uild a more detailed activity7
$ased costing system that would take such nuances into
account.
3olutions Manual, "hapter B +<)
E%ercise "-1! (/0 minutes*
). he unit product costs under the companyTs conventional
costing system would $e computed as follows:
2asco
n Parcel ,otal
Aum$er of units produced (a*................ +<,<<< B<,<<<
>irect la$or7hours per unit ($*............... <./< <.+<
otal direct la$or7hours (a* V ($*............ B,<<< )2,<<< +/,<<<
otal manufacturing overhead (a*......... R0@2,<<<
otal direct la$or7hours ($*.................... +/,<<< >=;s
!redetermined overhead rate (a* [ ($*. R +/.<< per >=;
2asco
n Parcel
>irect materials..................................... R),.<< R++.<<
>irect la$or........................................... 2.<< ,.<<
<./< >=; per unit V R+/.<< per >=;. . C.2<
<.+< >=; per unit V R+/.<< per >=;. . /.B<
Knit product cost................................... R+B.2< R+C.B<
3olutions Manual, "hapter B +<+
E%ercise "-1! (continued*
+. he unit product costs with the proposed A?" system can $e computed as follows:
Activit% Cost Pool
Estimat
ed
$verhea
d
Cost3
'b+
Expected Activit%
'a+ P 'b+
Activit% 2ate
=a$or related........
R+BB,<<
< +/,<<<
direct la$or7
hours R)+.<<
per direct la$or7
hour
Engineering
design................
R+BB,<<
< 2,<<<
engineering7
hours R/B.<<
per engineering7
hour
Zhe total overhead cost is split evenly $etween the two activity cost pools.
2ascon Parcel
Expecte
d
Expecte
d
Activit% Amount Activit% Amount
=a$or related at R)+.<< per direct la$or7hour.......... B,<<< R C2,<<< )2,<<< R)C+,<<<
Engineering design at R/B.<< per engineering7
hour...................................................................... ,,<<< )//,<<< ,,<<< )//,<<<
otal overhead cost assigned (a*............................. R+/<,<<< R,,2,<<<
Aum$er of units produced ($*................................. +<,<<< B<,<<<
Dverhead cost per unit (a* [ ($............................... R)+.<< R/.+<
he unit product costs com$ine direct materials, direct la$or, and overhead costs:
2asco
n Parcel
>irect materials R),.<< R++.<<
3olutions Manual, "hapter B +<,
>irect la$or 2.<< ,.<<
Manufacturing overhead (see
a$ove* )+.<< /.+<
Knit product cost R,).<< R+C.+<
3olutions Manual, "hapter B +</
E%ercise "-1! (continued*
,. he unit product cost of the high7volume product, !arcel,
declines under the activity7$ased costing system, whereas the
unit product cost of the low7volume product, 8ascon, increases.
his occurs $ecause half of the overhead is applied on the $asis
of engineering design hours instead of direct la$or7hours. Ohen
the overhead was applied on the $asis of direct la$or7hours,
most of the overhead was applied to the high7volume product.
;owever, when the overhead is applied on the $asis of
engineering7hours, more of the overhead cost is shifted over to
the low7volume product. Engineering7hours is a product7level
activity, so the higher the volume, the lower the unit cost and
the lower the volume, the higher the unit cost.
3olutions Manual, "hapter B +<0
E%ercise "-1" ()0 minutes*
). he order re4uires +0< direct la$or7hours (),<<< units _ <.+0 >=; per unit* and is run in
two $atches. herefore, the overhead cost of the order according to the activity7$ased
costing system would $e computed as follows:
Activit% Cost
Pool
'a+
Activit% 2ate
'b+
Activit%
'a+ T 'b+
ABC Cost
Iolume.............. R0.00
per direct la$or7
hour +0< direct la$or7hours R),,B@.0<
?atch
processing...... R)<@.<< per $atch + $atches R+)/.<<
Drder
processing...... R+@0.<< per order ) order R+@0.<<
otal.................. R),B@2.0<
he product margin on the order can $e computed as follows:
3ales (),<<< units V R+< per unit*........................... R+<,<<<.<<
"osts:
>irect materials (),<<< units V RB.0< per
unit*...................................................................
RB,0<<.<
<
>irect la$or (),<<< units V R2.<< per
unit*................................................................... 2,<<<.<<
Iolume.................................................................. ),,B@.0<
?atch processing.................................................. +)/.<<
Drder processing...................................................
+@0.<
< )2,,@2.0<
!roduct margin........................................................ R ,,2+,.0<
+. he customer margin for sales to &nterstate rucking is computed as follows:
3olutions Manual, "hapter B +<2
!roduct margin (a$ove*...........................................
R,,2+,.0
<
=ess: "ustomer service overhead
() customer V R+,/2, per customer*.................... +,/2,.<<
"ustomer margin....................................................
R),)2<.0
<
3olutions Manual, "hapter B +<@
E%ercise "-1# (/0 minutes*
). he order from &nterstate rucking re4uires +0< direct la$or7hours (),<<< units _ <.+0
>=; per unit* and is run in two $atches. herefore, the overhead cost of the order
according to the activity7$ased costing system would $e computed as follows:
Volume
Batch
Processin
g
$rder
Processin
g ,otal
Activity +0< >=;s + $atches ) order
!roduction overhead:
&ndirect la$or R )0<.<< R)+<.<< R +<.<< R +C<.<<
Factory e4uipment depreciation
),<<<.<< ,/.<< <.<< ),<,/.<<
Factory administration +0.<< )/.<< +0.<< 2/.<<
1eneral selling and administrative
overhead:
Oages and salaries )<<.<< /<.<< )2<.<< ,<<.<<
>epreciation <.<< 2.<< )<.<< )2.<<
Marketing e.penses ))+.0< <.<< 2<.<< )@+.0<
otal cost R),,B@.0< R+)/.<< R+@0.<< R),B@2.0<
E.ample: +0< >=;s V R<.2< per >=; from the pro$lem statement Y R)0<.<<
3olutions Manual, "hapter B +<B
E%ercise "-1# (continued*
he action analysis report for the order can $e constructed using
the row totals from the activity rate ta$le, organized according to
the ease of adjustment codes:
1reen costs:
unit*...................................................................
RB,0<<.<
< B,0<<.<<
1reen margin.......................................................... )),0<<.<<
Qellow costs:
unit*................................................................... 2,<<<.<<
&ndirect la$or........................................................ +C<.<<
Marketing e.penses.............................................. )@+.0< 2,/2+.0<
Qellow margin.......................................................... 0,<,@.0<
8ed costs:
Factory e4uipment depreciation........................... ),<,/.<<
Factory administration.......................................... 2/.<<
salaries............................................................... ,<<.<<
3elling and administrative depreciation................ )2.<< ),/)/.<<
8ed margin.............................................................. R ,,2+,.0<
3olutions Manual, "hapter B +<C
+. An action analysis report for the customer can $e prepared $y including the customer
service costs in the overhead analysis.
Volume
Batch
Processin
g
$rder
Processin
g
Custome
r Service ,otal
Activity +0< >=;s + $atches ) order
)
customer
!roduction overhead:
&ndirect la$or R )0<.<< R)+<.<< R +<.<< R <.<<
R +C<.<
<
Factory e4uipment
depreciation ),<<<.<< ,/.<< <.<< <.<< ),<,/.<<
Factory administration +0.<< )/.<< +0.<< )0<.<< +)/.<<
1eneral selling and
administrative overhead:
Oages and salaries )<<.<< /<.<< )2<.<< ),2<<.<< ),C<<.<<
>epreciation <.<< 2.<< )<.<< ,B.<< 0/.<<
Marketing e.penses ))+.0< <.<< 2<.<< 2@0.<<
B/@.0
<
otal cost
R),,B@.0
< R+)/.<< R+@0.<<
R+,/2,.<
<
R/,,,C.0
<
E.ample: +0< >=;s V R<.2< per >=; from the pro$lem statement Y R)0<.<<
3olutions Manual, "hapter B +)<
he action analysis report for the customer can $e constructed
using the row totals from the activity rate ta$le, organized
according to the ease of adjustment codes:
1reen costs:
unit*...................................................................
RB,0<<.<
< B,0<<.<<
1reen margin.......................................................... )),0<<.<<
Qellow costs:
unit*................................................................... 2,<<<.<<
&ndirect la$or........................................................ +C<.<<
Marketing e.penses..............................................
B/@.0
< @,),@.0<
Qellow margin.......................................................... /,,2+.0<
8ed costs:
Factory e4uipment depreciation........................... ),<,/.<<
Factory administration.......................................... +)/.<<
salaries............................................................... ),C<<.<<
3elling and administrative depreciation................ 0/.<<
,,+<+.<
<
8ed margin..............................................................
R ),)2<.0
<
3olutions Manual, "hapter B +))
E%ercise "-2$ (,< minutes*
). he 'rst7stage allocation is shown $elow:
Volume
2elated
$rder
2elated
Customer
Support $ther ,otals
Oages and
salaries R)+<,<<< R C<,<<< R2<,<<< R,<,<<<
R,<<,<<
<
Dther overhead
costs ,<,<<< )<,<<< +<,<<< /<,<<< )<<,<<<
otal overhead
cost R)0<,<<< R)<<,<<< RB<,<<< R@<,<<<
R/<<,<<
<
E.ample: According to the distri$ution of resources across activities, /<P of the
R,<<,<<< wages and salaries cost is attri$uta$le to volume related activities.
R,<<,<<< V /<P Y R)+<,<<<
Dther entries in the ta$le are determined in a similar manner.
+. "omputation of activity rates:
Activit% Cost
Pools
'a+
,otal
Cost
'b+
,otal Activit%
'a+ P 'b+
Activit% 2ate
Iolume R)0<,<<< +<,<<
<
>=;s R@.0< per >=;
Drder related R)<<,<<< /<< orders R+0< per order
"ustomer support RB<,<<< +<< customer
s
R/<< per customer
3olutions Manual, "hapter B +)+
E%ercise "-2$ (continued*
,. "omputation of the overhead costs for the 3henzhen
Enterprises order:
Activit% Cost
Pool
'a+
Activit% 2ate
'b+
Activit%
'a+ T 'b+
ABC Cost
Iolume.............. R@.0< per >=; +< >=;sZ R)0<
Drder related..... R+0< per order ) order +0<
otal.................. R/<<
Z+ >=;s per unit V )< units Y +< >=;s
/. he margins for the order and for the customer follow:
Product Pro.tabilit% Anal%sis
3ales ()< units V R,<< per unit*..............
R,,<<
<
"osts:
>irect materials ()< units V R)B< per
unit*.................................................... R),B<<
>irect la$or ()< units V R0< per unit*.... 0<<
Iolume overhead................................... )0<
Drder related overhead......................... +0<
+,@<
<
!roduct margin.........................................
R ,<
<
!roduct margin (a$ove*....................................... R ,<<
=ess: "ustomer support overhead
() customer _ R/<< per customer*.................. /<<
"ustomer margin................................................ R ()<<*
3olutions Manual, "hapter B +),
E%ercise "-21 (2< minutes*
). he 'rst7stage allocation is shown $elow:
!istribution of 2esource Consumption
Across Activit% Cost Pools
Volume
$rder
2elated
Custome
r Support $ther ,otals
Oages and salaries /<P ,<P +<P )<P )<<P
Dther overhead costs ,<P )<P +<P /<P )<<P
Volume
related
$rder
2elated
Customer
Support $ther ,otals
Oages and
salaries R)+<,<<< R C<,<<< R2<,<<< R,<,<<<
R,<<,<<
<
Dther overhead
costs ,<,<<< )<,<<< +<,<<< /<,<<< )<<,<<<
otal overhead
cost R)0<,<<< R)<<,<<< RB<,<<< R@<,<<<
R/<<,<<
<
E.ample: /<P V R,<<,<<< Y R)+<,<<<
3olutions Manual, "hapter B +)/
+. he activity rates are computed $y dividing the costs in the
cells of the 'rst7stage allocation a$ove $y the total activity
from the top of the column.
Volume
2elated
$rder
2elated
Customer
Support
otal activity..................
+<,<<<
>=;s /<< orders
+<<
customers
Oages and salaries....... R2.<< R++0.<< R,<<.<<
Dther overhead costs. . . ).0< +0.<< )<<.<<
otal cost...................... R@.0< R+0<.<< R/<<.<<
E.ample: R)+<,<<< [ +<,<<< >=;s Y R2.<< per >=;
Iolume related wages and salaries from the 'rst7stage
allocation a$ove.
,. he overhead cost for the order is computed as follows:
Volume
2elated
$rder
2elate
d ,otal
Activity........................... +< >=;s ) order
Oages and salaries........R)+<.<<
R++0.<
<
R,/0.<
<
Dther overhead costs..... ,<.<< +0.<< 00.<<
otal cost........................ R)0<.<<
R+0<.<
<
R/<<.<
<
E.ample: +< >=;s V R2.<< per >=; Y R)+<.<<
Activity rate for volume related wages and salaries from part
(+* a$ove.
3olutions Manual, "hapter B +)0
/. he activity view report can $e constructed using the column
totals at the $ottom of the overhead cost analysis in part (,*
a$ove.
3ales ()< units V R,<< per unit*.............. R,,<<<
"osts:
unit*.................................................... R),B<<
Iolume related overhead....................... )0<
Drder related overhead......................... +0< +,@<<
!roduct Margin......................................... R ,<<
!roduct margin of order (a$ove*.............. R ,<<
=ess: "ustomer support overhead
() customer V R/<< per customer*....... /<<
"ustomer margin..................................... R ()<<*
0. he action analysis report can $e constructed using the row
totals from the activity rate ta$le, organized according to the
ease of adjustment codes:
3ales ()< units V R,<< per unit*.............
R,,<<
<
1reen costs:
unit*................................................... R),B<< ),B<<
1reen margin.......................................... ),+<<
Qellow costs:
>irect la$or ()< units V R0< per unit*... 0<<
Oages and salaries (see part (,*
a$ove*................................................ ,/0 B/0
Qellow margin.......................................... ,00
8ed costs:
Dther overhead costs (see part (,*
a$ove*................................................
.......................................................... 00 00
8ed margin............................................. R ,<<
3olutions Manual, "hapter B +)2
3olutions Manual, "hapter B +)@
2. he 'rst step is to include the customer support costs in the
overhead cost analysis as follows:
Volum
e
2elate
d
$rder
2elated
Customer
Support ,otal
Activity........................ +< >=;s ) order
)
customer
Oages and salaries.....
R)+<.<
< R++0.<< R,<<.<<
R2/0.<
<
Dther overhead costs. . ,<.<< +0.<< )<<.<< )00.<<
otal cost.....................
R)0<.<
< R+0<.<< R/<<.<<
RB<<.<
<
he action analysis report can then $e easily constructed as
follows:
3ales ()< units V R,<< per unit*.............. R,,<<<
1reen costs:
unit*....................................................
R),B<
< ),B<<
1reen margin........................................... ),+<<
Qellow costs:
Oages and salaries (see a$ove*............ 2/0 ),)/0
Qellow margin........................................... 00
8ed costs:
Dther overhead costs (see a$ove*......... )00 )00
8ed margin.............................................. R ()<<*
3olutions Manual, "hapter B +)B
@. Ohile the company apparently incurred a loss on its $usiness
with 3henzen Enterprises, caution must $e e.ercised. he
green margin on the $usiness was R),+<<. Advanced !roducts
"orporation really incurred a loss on this $usiness only if at
least R),+<< of the yellow and red costs would have $een
avoided if the 3henzen Enterprises order had $een rejected. For
e.ample, we donGt know what speci'c costs are included in the
MDther overheadN category. &f these costs are committed '.ed
costs that cannot $e avoided in the short run, then the
company would $een worse o# if the 3henzen Enterprises order
had not $een accepted.
3uppose that 3henzen Enterprises will $e su$mitting a
similar order every year. As a general policy, the company
might consider turning down this $usiness in the future. "osts
that cannot $e avoided in the short run, may $e avoided in the
long run through the $udgeting process or in some other
manner. ;owever, if the 3henzen Enterprises $usiness is turned
down, management must make sure that at least R),+<< of the
yellow and red costs are really eliminated or the resources
represented $y those costs are really redeployed to the
constraint. &f these costs remain unchanged, then the company
would $e $etter o# accepting the 3henzen Enterprises $usiness
in the future.
3olutions Manual, "hapter B +)C
&ro'lem "-22 (2< minutes*
). he companyGs estimated direct la$or7hours can $e computed
as follows:
>elu.e model: 0,<<< units V + >=;s per
unit.......................................................... )<,<<< >=;s
8egular model: /<,<<< units V ) >=; per
unit.......................................................... /<,<<< >=;s
otal........................................................... 0<,<<< >=;s
Ksing just direct la$or7hours as the $ase, the predetermined
overhead rate would $e:
Estimated manufacturing overhead cost
!redetermined
Y
overhead rate
Estimated direct la$or7hours
RC<<,<<<
Y YR)B per >=;
0<,<<<>=;s
Ksing this predetermined manufacturing overhead rate, the
unit product cost of each model can $e computed as follows:
!eluxe 2egular
>irect materials................... R/< R+0
>irect la$or.......................... )/ @
R)B per >=; V + >=;s....... ,2
R)B per >=; V ) >=;........ )B
otal unit product cost.......... RC< R0<
3olutions Manual, "hapter B ++<
&ro'lem "-22 (continued*
+. Dverhead rates $y activity are computed $elow:
Activit% Cost
Pool
'a+
Estimate
d
$verhea
d Cost
'b+
Expected Activit%
'a+ P 'b+
Predetermined
$verhead 2ate
!urchasing.......... R+</,<<
<
2<< purchase
orders
R,/< per purchase
order
!rocessing.......... R)B+,<<
<
,0,<<
<
machine7
hours
R0.+< per machine7hour
3crapHrework...... R,@C,<<
<
+,<<< orders R)BC.0
<
per order
3hipping............. R),0,<<
<
C<< shipments R)0< per shipment
3olutions Manual, "hapter B ++)
,. a. he overhead applied to each product can $e determined as follows:
,he !eluxe Model
Activit% Cost Pool
'a+
Predetermined
$verhead 2ate
'b+
Activit%
'a+ T 'b+
$verhea
d Applied
!urchasing.............................. R,/< per purchase
order +<<
purchase
orders R 2B,<<<
!rocessing............................... R0.+< per machine7hour +<,<<
<
machine7hours
)</,<<<
3crapHrework........................... R)BC.0
<
per order
),<<<
orders
)BC,0<<
3hipping.................................. R)0< per shipment +0< shipments ,@,0<<
otal overhead cost................. R,CC,<<<
Manufacturing overhead cost per unit Y R,CC,<<< [ 0,<<< units Y R@C.B< per unit
,he 2egular Model
Activit% Cost Pool
'a+
Predetermined
$verhead 2ate
'b+
Activit%
'a+ T 'b+
$verhea
d Applied
!urchasing.............................. R,/< per purchase
order /<<
purchase
orders R),2,<<<
!rocessing............................... R0.+< per machine7hour )0,<<
<
machine7hours
@B,<<<
3crapHrework........................... R)BC.0
<
per order
),<<<
orders
)BC,0<<
3hipping.................................. R)0< per shipment 20< shipments C@,0<<
3olutions Manual, "hapter B +++
otal overhead cost................. R0<),<<<
Manufacturing overhead cost per unit Y R0<),<<< [ /<,<<< units Y R)+.0, per unit
3olutions Manual, "hapter B ++,
$. he unit product cost of each model under an activity costing
approach would $e:
!eluxe 2egular
>irect materials....................... R /<.<< R+0.<<
>irect la$or............................. )/.<< @.<<
(a$ove*................................. @C.B< )+.0,
otal unit product cost............. R),,.B< R//.0,
/. &t is risky to draw any de'nite conclusions $ased on the a$ove
analysis. he activity7$ased costing system used in this
company is not completely suita$le for making decisions.
!roduct costs pro$a$ly include costs of idle capacity and
organization7sustaining costs. hey also e.clude
nonmanufacturing costs that may $e caused $y the products.
Aevertheless, the a$ove analysis is suggestive.
Knit costs appear to $e distorted as a result of using direct
la$or7hours as the $ase for assigning overhead cost to
products. Although the delu.e model re4uires twice as much
la$or time as the regular model, it still is not $eing assigned
enough overhead cost, as shown in the analysis in part ,(a*.
Ohen the companyGs overhead costs are analyzed on an
activities $asis, it appears that the delu.e model is more
e.pensive to manufacture than the company realizes. Aote that
the delu.e model accounts for a majority of the machine7hours
worked, even though it accounts for only +<P of the companyGs
direct la$or7hours. Also, it re4uires just as many scrapHrework
orders as the regular model, and scrapHrework orders are very
costly to the company.
Ohen activity7$ased costing is used and the companyGs
transactions are analyzed $y product, the overhead cost jumps
for the delu.e model from R,2.<< per unit to R@C.B< per unit.
his suggests that less than half the overhead cost is $eing
assigned to the delu.e model that ought to $e assigned, and
unit costs for the delu.e model are $adly understated. &f these
costs are $eing used as a $asis for pricing, then the selling
price for the delu.e model may $e too low. his may $e the
3olutions Manual, "hapter B ++/
reason why pro'ts have $een steadily declining over the last
several years. &t may also $e the reason why sales of the
delu.e model have $een increasing rapidly.
3olutions Manual, "hapter B ++0
&ro'lem "-23 (/0 minutes*
). he 'rst7stage allocation of costs to activity cost pools for the ">1 operation appears
$elow. All 'gures $elow are in euros.
Meal
Preparatio
n
Flight/
2elated
Custom
er
"ooks and delivery personnel
wages......................................... ),B<<,<<<
/B<,<<
< < )+<,<<<
+,/<<,<<
<
Uitchen supplies............................ ,<,<<< < < < ,<,<<<
"hef salaries................................. 0/,<<< ,2,<<< @+,<<< )B,<<< )B<,<<<
E4uipment depreciation................ ,2,<<< < < +/,<<< 2<,<<<
Administrative wages and
salaries....................................... < ,<,<<< C<,<<< ,<,<<< )0<,<<<
?uilding costs................................ < < < )+<,<<<
)+<,<<
<
otal cost....................................... ),C+<,<<<
0/2,<<
<
)2+,<<
< ,)+,<<<
+,C/<,<<
<
According to the data in the pro$lem, @0P of the cooks and delivery personnel wages
are attri$uta$le to meal preparation activities.
@0P of d+,/<<,<<< Y d),B<<,<<<
3olutions Manual, "hapter B ++2
+. he activity rates at the ">1 operation are:
Meal
Preparation
Flight/
2elated
Customer
Service
Activity at ">1 ),<<<,<<< meals
0,<<<
-ights )< airlines
"ooks and delivery personnel
wages........................................... d).B<< d C2.<<
Uitchen supplies.............................. <.<,<
"hef salaries................................... <.<0/ @.+< d@,+<<
E4uipment depreciation.................. <.<,2
Administrative wages and salaries. . 2.<< C,<<<
?uilding costs..................................
otal cost......................................... d ).C+< d )<C.+< d )2,+<<
E.ample: d),B<<,<<< [ ),<<<,<<< meals Y d).B< per meal
"ooks and delivery personnel wages attri$uta$le to meal preparation from the 'rst7stage
allocation.
3olutions Manual, "hapter B ++@
,. Managers should $e cautious when comparing operations using activity7$ased costing
data9particularly when the activity7$ased costing data rely on interviews. Aevertheless,
comparisons of the data can provide insights and may suggest where it would $e fruitful
to investigate further. &n this case, side7$y7side comparison of the Drly and ">1 activity
rates reveals that the cost per meal and cost per -ight is less at ">1 than at Drly, $ut
the cost per airline for customer service activities is higher at ">1 than at Drly. his
suggests that Drly might have something to learn from ">1 concerning meal
preparation and -ight7related activities, $ut ">1 may $e a$le to learn from Drly
concerning customer service activities.
Dverall, ">1 seems to $e more eEcient than Drly $y a$out d+2,<<< as shown in the
ta$le $elow.
C!@ $rl%
!i#eren
ce
Activit% at
C!@
!i#eren
ce T
Activit%
at C!@
Meal preparation (per meal*. . . . d).C+ d).CB d<.<2
),<<<,<<<
meals
d2<,<<<
Flight7related (per -ight*.......... d)<C.+< d))0.2< d2./< 0,<<< -ights d,+,<<<
"ustomer service (per airline*.. d)2,+<< dC,2<< (d2,2<<* )< airlines (d 22,<<<*
otal......................................... d +2,<<<
3olutions Manual, "hapter B ++B
&ro'lem "-24 (/0 minutes*
). he 'rst7stage allocation of costs to activity cost pools appears $elow:
!istribution of 2esource
Consumption Across Activit% Cost
Pools
Cleanin
g
Carpet
s
,ravel
to 9obs
9ob
Suppor
t $ther ,otal
Oages @<P +<P <P )<P )<<P
"leaning supplies )<<P <P <P <P )<<P
"leaning e4uipment
depreciation
B<P <P <P +<P )<<P
Iehicle e.penses <P 2<P <P /<P )<<P
DEce e.penses <P <P /0P 00P )<<P
!residentGs compensation <P <P /<P 2<P )<<P
Cleaning
Carpets
,ravel
to 9obs
9ob
Support $ther ,otal
Oages
R)<0,<<
< R,<,<<< R < R )0,<<< R)0<,<<<
"leaning supplies /<,<<< < < < /<,<<<
"leaning e4uipment
depreciation )2,<<< < < /,<<< +<,<<<
Iehicle e.penses < /B,<<< < ,+,<<< B<,<<<
DEce e.penses < < +@,<<< ,,,<<< 2<,<<<
!residentGs compensation < < ,+,<<< /B,<<< B<,<<<
3olutions Manual, "hapter B ++C
otal cost
R)2),<<
< R@B,<<< R0C,<<<
R),+,<<
< R/,<,<<<
E.ample: @<P of R)0<,<<< Y R)<0,<<<
3olutions Manual, "hapter B +,<
+. he activity rates are computed as follows:
Activit% Cost
Pool
'a+
,otal
Cost
'b+
,otal Activit%
'a+ P 'b+
Activit% 2ate
"leaning
carpets...........
R)2),<<< +<,<<
<
hundred
s4uare
feet
RB.<0 per
hundred
s4uare feet
ravel to jo$s..... R@B,<<< 2<,<<
<
miles R).,< per mile
5o$ support........ R0C,<<< +,<<< jo$s R+C.0< per jo$
,. he cost for the Flying A 8anch jo$ is computed as follows:
Activit% Cost
Pool
'a+
Activit% 2ate
'b+
Activit%
'a+ T 'b+
ABC Cost
"leaning
carpets
RB.<0 per
hundred
s4uare feet
0 hundred
s4uare feet
R /<.+0
ravel to jo$s..... R).,< per mile @0 miles C@.0<
5o$ support........ R+C.0
<
per jo$ ) jo$ +C.0<
otal.................. R)2@.+0
/. he product margin can $e easily computed $y using the costs
calculated in part (,* a$ove.
3ales...................... R)/<.<<
"osts:
"leaning carpets. R/<.+0
ravel to jo$s....... C@.0<
5o$ support.......... +C.0< )2@.+0
!roduct margin......
(R +@.+0
*
3olutions Manual, "hapter B +,)
0. 1allatin "arpet "leaning appears to $e losing money on the
Flying A 8anch jo$. ;owever, caution is advised. 3ome of the
costs may not $e avoida$le and hence would have $een
incurred even if the Flying A 8anch jo$ had not $een accepted.
An action analysis (discussed in Appendi. BA* is a more
appropriate starting point for analysis than the simple report in
part (/* a$ove.
Aevertheless, there is a point at which travel costs eat up all of
the pro't from a jo$. Oith the companyGs current policy of
charging a -at fee for carpet cleaning irrespective of how far
away the client is from the oEce, there clearly is some point at
which jo$s should $e turned down. (Ohat if a potential
customer is located in FloridaF*
2. he company should consider charging a fee for travel to
outlying customers $ased on the distance traveled and a -at
fee per jo$. At present, close7in customers are in essence
su$sidizing service to outlying customers and large7volume
customers are su$sidizing service to low7volume customers.
Oith fees for travel and for jo$ support, the fee per hundred
s4uare feet can $e dropped su$stantially. his may result in
losing some low7volume jo$s in outlying areas, $ut the lower
fee per hundred s4uare feet may result in su$stantially more
$usiness close to ?ozeman. (&f the fee is low enough, the added
$usiness may not even have to come at the e.pense of
competitors. 3ome customers may choose to clean their
carpets more fre4uently if the price were more attractive.*
3olutions Manual, "hapter B +,+
&ro'lem "-25 (@0 minutes*
). he 'rst7stage allocation of costs to activity cost pools appears $elow:
!istribution of 2esource
Consumption Across Activit% Cost
Pools
Cleanin
g
Carpet
s
,ravel
to 9obs
9ob
Suppor
t $ther ,otal
Oages @<P +<P <P )<P )<<P
"leaning supplies )<<P <P <P <P )<<P
"leaning e4uipment
depreciation
B<P <P <P +<P )<<P
Iehicle e.penses <P 2<P <P /<P )<<P
DEce e.penses <P <P /0P 00P )<<P
!residentGs compensation <P <P /<P 2<P )<<P
Cleaning
Carpets
,ravel
to 9obs
9ob
Support $ther ,otal
Oages
R)<0,<<
< R,<,<<< R < R )0,<<< R)0<,<<<
"leaning supplies /<,<<< < < < /<,<<<
"leaning e4uipment
depreciation )2,<<< < < /,<<< +<,<<<
Iehicle e.penses < /B,<<< < ,+,<<< B<,<<<
DEce e.penses < < +@,<<< ,,,<<< 2<,<<<
!residentGs compensation < < ,+,<<< /B,<<< B<,<<<
3olutions Manual, "hapter B +,,
otal cost
R)2),<<
< R@B,<<< R0C,<<<
R),+,<<
< R/,<,<<<
E.ample: @<P of R)0<,<<< Y R)<0,<<<
3olutions Manual, "hapter B +,/
+. he activity rates are computed as follows:
Cleaning
Carpets ,ravel to 9obs 9ob Support
otal activity
+<,<<< hundred
s4uare feet
2<,<<< miles
driven +,<<< jo$s
Oages R0.+0 R<.0<
"leaning supplies +.<<
"leaning e4uipment
depreciation <.B<
Iehicle e.penses <.B<
DEce e.penses R),.0<
!residentGs compensation <.<< <.<< )2.<<
otal cost RB.<0 R).,< R+C.0<
E.ample: R)<0,<<< [ +<,<<< hundred s4uare feet Y R0.+0 per hundred s4uare feet
Oages attri$uta$le to cleaning carpets from the 'rst7stage allocation a$ove.
3olutions Manual, "hapter B +,0
,. he cost for the Flying A 8anch jo$ is computed as follows:
Cleaning
Carpets
,ravel to
9obs
9ob
Support ,otal
Activity for the Flying A jo$
0 hundred
s4uare
feet
@0 miles
driven ) jo$
Oages R+2.+0 R,@.0< R2,.@0
"leaning supplies )<.<< )<.<<
"leaning e4uipment
depreciation /.<< /.<<
Iehicle e.penses 2<.<< 2<.<<
DEce e.penses R),.0< ),.0<
!residentGs compensation <.<< <.<< )2.<< )2.<<
otal cost R/<.+0 RC@.0< R+C.0< R)2@.+0
E.ample: R0.+0 per hundred s4uare feet V 0 hundred s4uare feet Y R+2.+0
Activity rate for wages and cleaning carpets.
3olutions Manual, "hapter B +,2
/. he product margin can $e easily computed using the costs
along the right7most column of the cost ta$le prepared in part
(,*.
3ales......................................... R)/<.<<
1reen costs:
Oages..................................... R2,.@0
"leaning supplies.................... )<.<<
"leaning e4uipment
depreciation......................... /.<<
Iehicle e.penses.................... 2<.<< ),@.@0
1reen margin............................ +.+0
Qellow costs:
DEce e.penses...................... ),.0< ),.0<
Qellow margin............................ ()).+0*
8ed costs:
!residentTs compensation....... )2.<< )2.<<
8ed margin...............................
(R +@.+0
*
0. At most, 1allatin "arpet "leaning is making only R+.+0 on the
Flying A 8anch jo$. &f more than R+.+0 of the R),.0< in DEce
E.penses are actually avoida$le if the jo$ were not accepted,
then the jo$ is actually losing money.
here is a point at which travel costs eat up all of the pro't
from a jo$. Oith the companyGs current policy of charging a -at
fee for carpet cleaning irrespective of how far away the client is
from the oEce, there clearly is some point at which jo$s should
$e turned down. (Ohat if a potential customer is located in
FloridaF*
3olutions Manual, "hapter B +,@
2. he company should consider charging a fee for travel to
outlying customers $ased on the distance traveled and a -at
fee per jo$. At present, close7in customers are in essence
su$sidizing service to outlying customers and large7volume
customers are su$sidizing service to low7volume customers.
Oith fees for travel and for jo$ support, the fee per hundred
s4uare feet can $e dropped su$stantially. his may result in
losing some low7volume jo$s in outlying areas, $ut the lower
fees per hundred s4uare feet may result in su$stantially more
$usiness close to ?ozeman. (&f the fees are low enough, the
added $usiness may not even have to come at the e.pense of
competitors. 3ome customers may choose to clean their
carpets more fre4uently if the price were more attractive.*
?efore making such a radical change, the data should $e
carefully reviewed. For e.ample, the wage cost of R,@.0< for a
@07mile trip seems rather high. Are two people sent out on
jo$sF "an the remote jo$s $e done with one personF
3olutions Manual, "hapter B +,B
&ro'lem "-2 (2< minutes*
). a. Ohen direct la$or7hours are used to apply overhead cost to
products, the companyGs predetermined overhead rate would
$e:
!redetermined
Y
overhead rate
>irect la$or7hours
R),B<<,<<<
Y YR0< per >=;
,2,<<<>=;s
$. Model
B5:: B==
>irect materials.................................... R @+ R 0<
>irect la$or:
R)< per hour V ).B hours and <.C
hours.................................................. )B C
R0< per hour V ).B hours and <.C
hours.................................................. C< /0
otal unit product cost.......................... R)B< R)</
+. a. !redetermined overhead rates for the activity cost pools:
Activit% Cost
Pool
'4+
,otal Cost
'5+
,otal Activit%
'4+ P '5+
Activit% 2ate
Machine setups R ,2<,<<
<
)0< setups R+,/<<per
setup
3pecial
processing
)B<,<<< )+,<<< M;s R)0 per M;
1eneral factory ),+2<,<<< ,2,<<< >=;s R,0 per
>=;
he manufacturing overhead cost that would $e applied to
each model:
Model
B5:: B==
Machine setups:
R+,/<< per setup V 0< setups, )<<
setups...................................................................
R)+<,<<
<
R
+/<,<<<
3pecial processing: )B<,<<< 9
3olutions Manual, "hapter B +,C
R)0 per M; V )+,<<< M;s....................................
1eneral factory:
R,0 per >=; V C,<<< >=;, +@,<<<
>=;....................................................................... ,)0,<<<
C/0,<<
<
otal manufacturing overhead cost
applied..................................................................
R2)0,<<
<
R),)B0,<<
<
3olutions Manual, "hapter B +/<
$. ?efore we can determine the unit product cost under
activity7$ased costing, we must 'rst take the overhead costs
applied to each model in part +(a* a$ove and e.press them
on a per7unit $asis:
Model
B5:: B==
otal overhead cost applied (a*...................
R2)0,<<
<
R),)B0,<<
<
Aum$er of units produced ($*..................... 0,<<< ,<,<<<
Manufacturing overhead cost per unit (a*
[ ($*......................................................... R)+, R,C.0<
Oith this information, the unit product cost of each model
under activity7$ased costing would $e computed as follows:
Model
B5:: B==
>irect materials........................................... R@+.<<
R0<.<
<
>irect la$or:
R)< per >=; V ).B >=;s, <.C >=;s............ )B.<< C.<<
Manufacturing overhead (a$ove*................. )+,.<< ,C.0<
otal unit product cost.................................. R+),.<<
RCB.0
<
"omparing these unit cost 'gures with the unit costs in !art
)($*, we 'nd that the unit product cost for Model S+<< has
increased from R)B< to R+),, and the unit product cost for
Model SCC has decreased from R)</ to RCB.0<.
,. &t is especially important to note that, even under activity7
$ased costing, @<P of the companyGs overhead costs continue
to $e applied to products on the $asis of direct la$or7hours:
Machine setups (num$er of
setups*.......................................
R ,2<,<<
< +<P
3pecial processing (machine7
hours*........................................ )B<,<<< )<
1eneral factory (direct la$or7
hours*........................................ ),+2<,<<< @<
otal overhead cost...................... R),B<<,<< )<<P
3olutions Manual, "hapter B +/)
<
hus, the shift in overhead cost from the high7volume product
(Model SCC* to the low7volume product (Model S+<<* occurred
as a result of reassigning only ,<P of the companyGs overhead
costs.
3olutions Manual, "hapter B +/+
he increase in unit product cost for Model S+<< can $e
e.plained as follows: First, where possi$le, overhead costs have
$een traced to the products rather than $eing lumped together
and spread uniformly over production. herefore, the special
processing costs, which are tracea$le to Model S+<<, have all
$een assigned to Model S+<< and none assigned to Model SCC
under the activity7$ased costing approach. &t is common in
industry to have some products that re4uire special handling or
special processing of some type. his is especially true in
modern factories that produce a variety of products. Activity7
$ased costing provides a vehicle for assigning these costs to
the appropriate products.
3econd, the costs associated with the $atch7level activity
(machine setups* have also $een assigned to the speci'c
products to which they relate. hese costs have $een assigned
according to the num$er of setups completed for each product.
;owever, since a $atch7level activity is involved, another factor
a#ecting unit costs comes into play. hat factor is $atch size.
3ome products are produced in large $atches and some are
produced in small $atches. ,he smaller the batchA the higher
the per unit cost of the batch activit%* &n the case at hand, the
data can $e analyzed as follows:
Model S+<<:
"ost to complete one setup ]see +(a*^.................. R+,/<< (a*
Aum$er of units processed per setup
(0,<<< units per setup [ 0< setups Y )<<
units*..................................................................)<< units ($*
3etup cost per unit (a* [ ($*................................. R+/
Model SCC:
"ost to complete one setup (a$ove*..................... R+,/<< (a*
Aum$er of units processed per setup
(,<,<<< units per setup [ )<< setups Y ,<<
units*..................................................................,<< units ($*
3etup cost per unit (a* [ ($*................................. RB
3olutions Manual, "hapter B +/,
hus, the cost per unit for setups is three times as great for
Model S+<<, the low7volume product, as it is for Model SCC, the
high7volume product. 3uch di#erences in cost are o$scured
when direct la$or7hours (or any other volume measure* is used
as a $asis for applying overhead cost to products.
&n sum, overhead cost has shifted from the high7volume
product to the low7volume product as a result of more
appropriately assigning some costs to the products on the $asis
of the activities involved, rather than on the $asis of direct
la$or7hours.
3olutions Manual, "hapter B +//
&ro'lem "-2! (/0 minutes*
). he results of the 'rst7stage allocation appear $elow:
9ob SiKe
Estimatin
g and 9ob
Setup
0or&ing
on
(onroutin
e 9obs $ther ,otals
Oages and salaries
R)0<,<<
< R ,<,<<< R C<,<<< R ,<,<<<
R ,<<,<<
<
>isposal fees /+<,<<< < +B<,<<< < @<<,<<<
E4uipment
depreciation ,2,<<< /,0<< )B,<<< ,),0<< C<,<<<
Dn7site supplies ,<,<<< )0,<<< 0,<<< < 0<,<<<
DEce e.penses +<,<<< @<,<<< 0<,<<< 2<,<<< +<<,<<<
=icensing and
insurance
)+<,<<
< < +<<,<<< B<,<<< /<<,<<<
otal cost
R@@2,<<
< R))C,0<< R2/,,<<<
R+<),0<
<
R),@/<,<<
<
According to the data in the pro$lem, 0<P of the wages and salaries cost of R,<<,<<< is
attri$uta$le to activities related to jo$ size.
R,<<,<<< V 0<P Y R)0<,<<<
+. Activit% Cost
Pool
'a+
,otal Cost
'b+
,otal Activit%
'a+ P 'b+
Activit% 2ate
5o$ size
R@@2,<<< B<<
thousand s4uare
feet RC@<
per thousand s4uare
feet
3olutions Manual, "hapter B +/0
Estimating and
jo$ setup R))C,0<< 0<< jo$s R+,C per jo$
Oorking on
nonroutine
jo$s R2/,,<<< )<< nonroutine jo$s R2,/,< per nonroutine jo$
3olutions Manual, "hapter B +/2
&ro'lem "-2! (continued*
,. he costs of each of the jo$s can $e computed as follows using the activity rates
computed a$ove:
a. 2outine one thousand s?uare feet obG
5o$ size () thousand s4uare feet _ RC@< per thousand s4uare
feet*.......................................................................................... R C@<.<<
Estimating and jo$ setup () jo$ _ R+,C per jo$*......................... +,C.<<
Aonroutine jo$ (not applica$le*................................................... <
otal cost of the jo$..................................................................... R),+<C.<<
"ost per thousand s4uare feet (R),+<C [ ) thousand s4uare
feet*.......................................................................................... R),+<C.<<
$. 2outine t1o thousand s?uare feet obG
5o$ size (+ thousand s4uare feet _ RC@< per thousand s4uare
feet*.......................................................................................... R),C/<.<<
Estimating and jo$ setup () jo$ _ R+,C per jo$*........................ +,C.<<
Aonroutine jo$ (not applica$le*................................................... <
otal cost of the jo$..................................................................... R+,)@C.<<
"ost per thousand s4uare feet (R+,)@C [ + thousand s4uare
feet*.......................................................................................... R),<BC.0<
c. (onroutine t1o thousand s?uare feet obG
5o$ size (+ thousand s4uare feet _ RC@< per thousand s4uare
feet*.......................................................................................... R),C/<.<<
Estimating and jo$ setup () jo$ _ R+,C per jo$*........................ +,C.<<
Aonroutine jo$............................................................................ 2,/,<.<<
otal cost of the jo$..................................................................... RB,2<C.<<
3olutions Manual, "hapter B +/@
"ost per thousand s4uare feet (RB,2<C [ + thousand s4uare
feet*.......................................................................................... R/,,</.0<
3olutions Manual, "hapter B +/B
&ro'lem "-2! (continued*
/. he o$jectivity of the interview data can $e 4uestioned since
the on7site work supervisors were undou$tedly trying to prove
their case a$out the cost of nonroutine jo$s. Aevertheless, the
activity7$ased costing data certainly suggest that dramatic
di#erences e.ist in the costs of jo$s. Ohile some of the costs
may $e diEcult to adjust in response to changes in activity, it
does appear that the standard $id of R+,0<< per thousand
s4uare feet may $e su$stantially under the companyGs cost for
nonroutine jo$s. Even though it may $e diEcult to detect
nonroutine situations $efore work $egins, the average
additional cost of R2,/,< for nonroutine work suggests that the
estimator should try. And if a nonroutine situation is spotted,
this should $e re-ected in the $id price.
3avvy competitors are likely to $id less than R+,0<< per
thousand s4uare feet on routine work and su$stantially more
than R+,0<< per thousand s4uare feet on nonroutine work.
"onse4uently, Mercer As$estos 8emoval may 'nd that its
product mi. shifts toward nonroutine work and away from
routine work as customers accept $ids on nonroutine work from
the company and go to competitors for routine work. his may
have a disastrous e#ect on the companyGs pro'ts.
3olutions Manual, "hapter B +/C
&ro'lem "-2" (+< minutes*
). he cost of serving the local commercial market according to the A?" model can $e
determined as follows:
Activit% Cost Pool
'a+
Activit% 2ate
'b+
Activit%
'a+ T 'b+
ABC Cost
Animation concept
R2,</
<
per proposal
+0 proposals R)0),<<<
Animation production
R@,@+
0
per minute of
animation 0 minutes ,B,2+0
"ontract
administration
R2,B<
<
per contract
)< contracts 2B,<<<
R+0@,2+0
+. he product margin of the local commercial market is negative, as shown $elow:
3ales
R)B<,<<
<
"osts:
Animation concept
R)0),<<
<
Animation production ,B,2+0
"ontract administration
2B,<<
<
+0@,2+0
!roduct margin (R@@,2+0*
,. &t appears that the local commercial market is losing money and the company would $e
$etter o# dropping this market segment. ;owever, as discussed in !ro$lem B7+C, not all
3olutions Manual, "hapter B +0<
of the costs included a$ove may $e avoida$le. &f more than R@@,2+0 of the total costs of
R+0@,2+0 is not avoida$le, then the company really isnGt losing money on the local
commercial market and the segment should not $e dropped. hese issues will $e
discussed in more depth in "hapters )+ and ),.
3olutions Manual, "hapter B +0)
&ro'lem "-2# (,< minutes*
). he detailed cost analysis of local commercials appears $elow:
Activit% 2ates
Animatio
n
Concept
Animatio
n
Productio
n
Contract
Administrati
on
echnical sta# salaries R/,<<< R2,<<< R),2<<
Animation e4uipment
depreciation ,2< ),)+0 <
salaries ),//< )0< /,B<<
3upplies costs )+< ,<< )2<
Facility costs )+< )0< +/<
otal R2,</< R@,@+0 R2,B<<
Animation
Concept
Animation
Production
Contract
Administratio
n ,otal
Activity level +0 proposals 0 minutes )< contracts
echnical sta# salaries R)<<,<<< R,<,<<< R)2,<<<
R)/2,<<
<
Animation e4uipment
depreciation C,<<< 0,2+0 < )/,2+0
Administrative wages and ,2,<<< @0< /B,<<< B/,@0<
3olutions Manual, "hapter B +0+
salaries
3upplies costs ,,<<< ),0<< ),2<< 2,)<<
Facility costs ,,<<< @0< +,/<< 2,)0<
otal cost R)0),<<< R,B,2+0 R2B,<<<
R+0@,2+
0
E.ample: R/,<<< per proposal V +0 proposals Y R)<<,<<<
3olutions Manual, "hapter B +0,
&ro'lem "-2# (continued*
+. he action analysis report is constructed $y using the row
totals from the cost report in part ()* a$ove:
3ales R)B<,<<<
1reen costs:
3upplies costs R 2,)<< 2,)<<
1reen margin )@,,C<<
Qellow costs:
salaries B/,@0< B/,@0<
Qellow margin BC,)0<
8ed costs:
echnical sta# salaries )/2,<<<
Animation e4uipment
depreciation )/,2+0
Facility costs 2,)0< )22,@@0
8ed margin (R@@,2+0*
3olutions Manual, "hapter B +0/
&ro'lem "-2# (continued*
,. At 'rst glance, it appears that the company is losing money on
local commercials. ;owever, the action analysis report
indicates that if this market segment were dropped, most of the
costs are likely to continue $eing incurred. he nature of the
technical sta# salaries is clearly critical since it makes up the
$ulk of the costs. Management has suggested that the
technical sta# are the companyGs most valua$le asset and that
they would $e the last to go in case of 'nancial diEculties.
Aevertheless, there are at least two situations in which these
costs would $e relevant. First, dropping the local commercial
market segment may reduce future hiring of new technical
sta#. his would have the e#ect of reducing future spending
and therefore would reduce the companyGs costs. 3econd, if
technical sta# time is a constraint, dropping the local
commercial market segment would allow managers to shift
technical sta# time to other, presuma$ly more pro'ta$le, work.
;owever, if this is the case, there are $etter ways to determine
which projects should get technical sta# attention. his su$ject
will $e covered in "hapter ), in the section on utilization of
scarce resources.
Finally, the cost of the animation concept at the proposal stage
is a major drag on the pro'ta$ility of the local commercial
market. he activity7$ased costing system, as currently
designed, assumes that all project proposals re4uire the same
e#ort. his may not $e the case. !roposals for local
commercials may $e far less ela$orate than proposals for major
special e#ects animation se4uences for motion pictures. &f
management has $een putting a$out the same amount of
e#ort into every proposal, the a$ove activity7$ased costing
analysis suggests that this may $e a mistake. Management
may want to consider cutting $ack on the e#ort going into
animation concepts for local commercials at the project
proposal stage. Df course, this may lead to an even lower
success rate on $ids for local commercials.
3olutions Manual, "hapter B +00
&ro'lem "-3$ (/0 minutes*
). he company e.pects to work /<,<<< direct la$or7hours,
Mono7relay: /<,<<< units V <.@0 >=; per
unit............................................................ ,<,<<< >=;s
?i7relay: )<,<<< units V ).< >=; per unit..... )<,<<< >=;s
otal............................................................. /<,<<< >=;s
Ksing direct la$or7hours as the $ase, the predetermined
manufacturing overhead rate would $e:
!redetermined
Y
overhead rate
R),<<<,<<<
Y Y R+0 per >=;
/<,<<< >=;s
he unit product cost of each product would $e:
Mono/
rela% Bi/rela%
>irect materials (given*................ R,0.<< R/B.<<
>irect la$or (given*....................... C.<< )+.<<
R+0 per >=; V <.@0 >=;, ).<
>=;............................................ )B.@0 +0.<<
otal unit product cost................... R2+.@0 RB0.<<
+. he predetermined overhead rates would $e computed as
follows:
Activit%
'a+
Estimate
d
$verhea
d Costs
'b+
Expected
Activit%
'a+ P 'b+
Predetermined
$verhead 2ate
Maintaining
parts inventory.. R)B<,<<< ++0
part
types RB<<
per part
type
!rocessing
purchase
orders................ RC<,<<< ),<<< orders RC< per order
6uality control..... R+,<,<<< 0,@0< tests R/< per test
Machine related... R0<<,<<<
)<,<<
< M;s R0< per M;
3olutions Manual, "hapter B +0@
&ro'lem "-3$ (continued*
,. a. Mono/rela% Bi/rela%
Activit
% Amount
Activit
% Amount
Maintaining parts
inventory, at RB<<
per part type )< per
order @0 R 2<,<<< )0<
R)+<,<<
<
!rocessing purchase
orders, at RC< per
order B<< @+,<<< +<< )B,<<<
6uality control, at R/<
per test +,0<< )<<,<<< ,,+0< ),<,<<<
Machine related, at R0<
per machine7hour /,<<< +<<,<<< 2,<<< ,<<,<<<
otal manufacturing
overhead cost
R/,+,<<
<
R02B,<<
<
Manufacturing overhead cost per unit of each
product:
Mono7
relay:
R/,+,<<< @ /<,<<< units Y R)<.B<
per unit
?i7relay: R02B,<<< @ )<,<<< units Y R02.B<
per unit
$. Ksing activity7$ased costing, the unit product cost of each
product would $e:
Mono/
rela% Bi/rela%
>irect materials R,0.<< R /B.<<
>irect la$or C.<< )+.<<
(a$ove* )<.B< 02.B<
otal unit product cost R0/.B< R))2.B<
3olutions Manual, "hapter B +0B
&ro'lem "-3$ (continued*
/. Although the $i7relay accounts for only +<P of the companyGs
total production, it is responsi$le for two7thirds of the part
types carried in inventory and 2<P of the machine7hours
worked. &t is also responsi$le for well over half of the tests
needed for 4uality control. hese factors have $een concealed
as a result of using direct la$or7hours as the $ase for assigning
overhead cost to products. 3ince the $i7relay is responsi$le for
a majority of the activity, under activity7$ased costing it is
assigned a larger amount of overhead cost.
Managers should $e cautious a$out drawing 'rm conclusions
a$out the pro'ta$ility of products from the a$ove activity7
$ased cost analysis. he A?" system used in this company is
not completely suita$le for making decisions. !roduct costs
pro$a$ly include costs of idle capacity and organization7
sustaining costs. hey also e.clude nonmanufacturing costs
that may $e caused $y the products. Aevertheless, the a$ove
analysis is suggestive. he $i7relay may not $e as pro'ta$le as
management $elieves, and this may $e the reason for the
companyGs declining pro'ts. Aote that from part ()*, the unit
product cost of the $i7relay is RB0. &n part (,*, however, the
activity7$ased costing system sets the unit product cost of the
$i7relay at R))2.B<. his is a di#erence of R,).B< per unit. &f
the RB0 cost 'gure is $eing used as the $ase for determining a
selling price for the $i7relay, the company may $e losing money
on this product.
3olutions Manual, "hapter B +0C
Case "-31 (C< minutes*
). a. he predetermined overhead rate would $e computed as
follows:
E.pected manufacturing overhead cost R+,+<<,<<<
Y
Estimated direct la$or7hours 0<,<<< >=;s
YR// per >=;
$. he unit product cost per pound, using the companyGs
present costing system, would $e:
Cen%a
!ar&
Viet
Select
>irect materials (given*....... R/.0< R+.C<
>irect la$or (given*.............. <.+/ <.+/
<.<+ >=; V R// per >=;... <.BB <.BB
otal unit product cost......... R0.2+ R/.<+
+. a. Dverhead rates $y activity center:
Activit% Center
'a+
Estimate
d
$verhea
d Costs
'b+
Expected
Activit%
'a+ P 'b+
Predetermined
$verhead 2ate
!urchasing......... R02<,<<< +,<<< orders R+B< per order
Material
handling..........
R)C,,<<< ),<<< setups R)C, per setup
6uality control. . . RC<,<<< 0<< $atches R)B< per $atch
8oasting............. R),</0,<
<<
C0,<<< roasting
hours
R)) per
roasting
hour
?lending............ R)C+,<<< ,+,<<< $lending
hours
R2 per
$lending
hour
!ackaging.......... R)+<,<<< +/,<<< packagin
g hours
R0 per
packagin
g hour
3olutions Manual, "hapter B +2<
Case "-31 (continued*
?efore we can determine the amount of overhead cost to
assign to the products we must 'rst determine the activity
for each of the products in the si. activity centers. he
necessary computations follow:
Aum$er of purchase orders:
Uenya >ark: B<,<<< pounds [ +<,<<< pounds per order Y /
orders
Iiet 3elect: /,<<< pounds [ 0<< pounds per order Y B orders
Aum$er of $atches:
Uenya >ark: B<,<<< pounds [ 0,<<< pounds per $atch Y )2
$atches
Iiet 3elect: /,<<< pounds [ 0<< pounds per $atch Y B
$atches
Aum$er of setups:
Uenya >ark: )2 $atches V + setups per $atch Y ,+ setups
Iiet 3elect: B $atches V + setups per $atch Y )2 setups
8oasting hours:
Uenya >ark: B<,<<< pounds V ).0 roasting hours per )<<
pounds Y
),+<< roasting hours
Iiet 3elect: /,<<< pounds V ).0 roasting hours per )<<
pounds Y
2< roasting hours
?lending hours:
Uenya >ark: B<,<<< pounds V <.0 $lending hours per )<<
pounds Y
/<< $lending hours
Iiet 3elect: /,<<< pounds V <.0 $lending hours per )<<
pounds Y
+< $lending hours
!ackaging hours:
Uenya >ark: B<,<<< pounds V <., packaging hours per )<<
pounds Y
+/< packaging hours
Iiet 3elect: /,<<< pounds V <., packaging hours per )<<
pounds Y
)+ packaging hours
3olutions Manual, "hapter B +2)
Ksing the activity 'gures, manufacturing overhead costs can $e assigned to the two
Cen%a !ar&
Activit% 2ate Expected Activit% Amoun
t
!urchasing.............. R+B< per order / orders R ),)+<
Material handling.... R)C, per setup ,+ setups 2,)@2
6uality control........ R)B< per $atch )2 $atches +,BB<
8oasting.................. R)) per roasting hour ),+<< roasting hours ),,+<<
?lending.................. R2 per $lending hour /<< $lending hours +,/<<
!ackaging...............
R0 per packaging
hour
+/< packaging
hours
),+<<
otal overhead
cost......................
R+2,C@2
Viet Select
Activit% 2ate Expected Activit% Amoun
t
!urchasing.............. R+B< per order B orders R+,+/<
Material handling.... R)C, per setup )2 setups ,,<BB
6uality control........ R)B< per $atch B $atches ),//<
8oasting.................. R)) per roasting hour 2< roasting hours 22<
?lending.................. R2 per $lending hour +< $lending hours )+<
!ackaging...............
R0 per packaging
hour
)+ packaging
hours
2<
otal overhead
cost......................
R@,2<B
3olutions Manual, "hapter B +2+
$. According to the activity7$ased costing system, the
manufacturing overhead cost per pound is:
Cen%a
!ar&
Viet
Select
otal overhead cost assigned (a$ove*
(a*.........................................................................
R+2,C@2 R@,2<B
Aum$er of pounds manufactured ($*...................... B<,<<< /,<<<
"ost per pound (a* [ ($*......................................... R<.,/ R).C<
c. he unit product costs according to the activity7$ased
costing system are:
Cen%a
!ar&
Viet
Select
>irect materials (given* R/.0< R+.C<
>irect la$or (given* <.+/ <.+/
Manufacturing overhead <.,/ ).C<
otal unit product cost R0.EA: Analysis of 53&Gs data shows that
several activities other than direct la$or drive the companyGs
manufacturing overhead costs. hese activities include
purchase orders issued, num$er of setups for material
processing, and num$er of $atches processed. he companyGs
present costing system, which relies on direct la$or time as the
sole $asis for assigning overhead cost to products, signi'cantly
undercosts low7volume products, such as the Iiet 3elect co#ee,
and signi'cantly overcosts high7volume products, such as our
Uenya >ark co#ee.
An implication of the activity7$ased costing analysis is that our
low7volume products may not $e covering the costs of the
manufacturing resources they use. For e.ample, Iiet 3elect
co#ee is currently priced at R0.<, per pound (R/.<+ plus +0P
markup*, $ut this price is $elow its activity7$ased cost of R0.ark co#ee, may $e
su$sidizing our low7volume products. 3ome adjustments in
prices may $e re4uired. ;owever, $efore taking such an action,
3olutions Manual, "hapter B +2,
an action analysis report (discussed in Appendi. BA* should $e
prepared.
3olutions Manual, "hapter B +2/
A=E8AA&IE 3D=K&DA:
Most students will compute the manufacturing overhead cost
per pound of the two co#ees as shown a$ove. ;owever, the per
pound cost can also $e computed as shown $elow. ,his
alternative approach provides additional insight into the data
and facilitates emphasis of some points made in the chapter*
Cen%a !ar& Viet Select
,otal
Per Pound
'P H:A:::+ ,otal
Per Pound
'P 7A:::+
!urchasing R ),)+< R<.<)/ R+,+/< R<.02<
Material
handling
2,)@2
<.<@@
,,<BB
<.@@+
6uality control +,BB< <.<,2 ),//< <.,2<
8oasting ),,+<< <.)20 22< <.)20
?lending +,/<< <.<,< )+< <.<,<
!ackaging ),+<< <.<)0 2< <.<)0
otal R+2,C@2 R<.,,@ R@,2<B R).C<+
Aote particularly how $atch size impacts unit cost data. For
e.ample, the cost to the company to process a purchase order
is R+B<, regardless of how many pounds of co#ee are
contained in the order. wenty thousand pounds of the Uenya
>ark co#ee are purchased per order (with four orders per year*,
and just 0<< pounds of the Iiet 3elect co#ee are purchased per
order (with eight orders per year*. hus, the purchase order
cost per pound for the Uenya >ark co#ee is just )./ cents,
whereas the purchase order cost per pound for the Iiet 3elect
co#ee is /< times as much, or 02 cents. As stated in the te.t,
this is one reason why unit costs of low7volume products, such
as the Iiet 3elect co#ee, increase so dramatically when
activity7$ased costing is used.
). he total direct la$or7hours worked for the year would $e:
S7+<: ,<,<<< units V + >=;s per unit............................... 2<,<<<
Q7,<: 0,<<< units V , >=;s per unit................................. )0,<<<
otal >=;s............................................................... @0,<<<
he predetermined overhead rate for the year would therefore
$e:
Manufacturing overhead cost R),B<<,<<<
Y
>irect la$or7hours @0,<<< >=;s
YR+/ per >=;
+. he unit product costs would $e:
B/5: -/6:
>irect materials (given*........................................... R0< RB<
>irect la$or (given*.................................................+/ ,2
R+/ per >=; V + >=;s per unit, , >=;s per
unit......................................................................./B @+
otal unit product cost............................................. R)++ R)BB
,. his part of the case is open7ended, $ut students should
provide data such as given $elow.
Dverhead rates for the activities are:
Activit%
'a+
Estimated
$verhead
Costs
'b+
Expected Activit%
'a+ P 'b+
Predetermined
$verhead 2ate
Machine
setups...........
R+<B,<<< ),2<<
setups
R),<.<
<per setup
6uality control
R,2<,<<< C,<<<inspectio
ns
R/<.<<per
inspection
!urchase
orders...........
RC<,<<< ),+<<
orders
R@0.<<
per order
3oldering.........
R/0<,<<< +<<,<<
<joints
R+.+0
per joint
3hipments....... R),+,<<< 2<<shipment R++<.<per
s <shipment
Machine
related..........
R02<,<<< @<,<<<
M;s
RB.<<
per M;
3olutions Manual, "hapter B +2@
Dverhead cost assigned to each product:
B/5:
Activit% 2ate Expected Activit% Amount
Machine setups.......................R),<.<< per setup ),<<< setups R),<,<<<
6uality inspections..................
R/<.<< per
inspection
/,<<< inspection
s
)2<,<<<
!urchase orders...................... R@0.<< per order B/< orders 2,,<<<
3oldering................................. R+.+0 per joint 2<,<<< joints ),0,<<<
3hipments...............................
R++<.<< per
shipment
/<< shipments BB,<<<
Machine related...................... RB.<< per M; ,<,<<< M;s +/<,<<<
otal overhead cost (a*............ RB)2,<<<
Aum$er of units produced ($* ,<,<<<
Dverhead cost per unit (a* [
($*.........................................
R+@.+<
-/6:
Activit% 2ate Expected Activit% Amount
Machine setups.......................R),<.<< per setup 2<< setups R @B,<<<
6uality inspections..................
R/<.<< per
inspection
0,<<< inspection
s
+<<,<<<
!urchase orders...................... R@0.<< per order ,2< orders +@,<<<
3oldering.................................
R+.+0 per joint )/<,<<
<
joints ,)0,<<<
3hipments...............................
R++<.<< per
shipment
+<< shipments //,<<<
3olutions Manual, "hapter B +2B
Machine related...................... RB.<< per M; /<,<<< M;s ,+<,<<<
otal overhead cost (a*............ RCB/,<<<
Aum$er of units produced ($* 0,<<<
Dverhead cost per unit (a* [
($*.........................................
R)C2.B<
3olutions Manual, "hapter B +2C
he unit product cost of each product under activity7$ased
costing is given $elow. For comparison, the costs computed in
part + a$ove are also provided.
Activit%/Based
Costing
!irect )abor/
<our Base
B/5: -/6: B/5: -/6:
>irect materials R 0<.<< R B<.<< R 0<.<< R B<.<<
>irect la$or +/.<< ,2.<< +/.<< ,2.<<
Manufacturing
overhead
+@.+< )C2.B< /B.<< @+.<<
otal unit product cost R)<).+< R,)+.B< R)++.<< R)BB.<<
As shown $y the a$ove analysis, unit product costs may have
$een distorted as a result of using direct la$or7hours as the
$ase for assigning overhead costs to products. hese distorted
costs may have had a major impact on managementGs pricing
policies and on managementGs perception of the margin $eing
realized on each product. According to the activity7$ased
costing approach, Model Q7,< is $eing sold at a loss:
Activit%/Based
Costing
!irect )abor/
<our Base
B/5: -/6: B/5: -/6:
3elling price per unitZ R+<<.<< R+0<.<<
R+<<.<
<
R+0<.<
<
=ess unit product cost
(a$ove* )<).+< ,)+.B< )++.<< )BB.<<
1ross margin (loss* R CB.B< (R2+.B<* R @B.<< R 2+.<<
Zotal sales [ the num$er of units sold.
/. &t is not surprising that the Q7,< Msells itselfN since the company
is selling it at an apparent loss of R2+.B<. his pro$a$ly
e.plains why ?ranson "ompany couldnGt meet "utler !roductsG
price.
&n addition, "utler !roductsG distorted unit costs e.plain why
?ranson "ompany is a$le to undercut "utlerGs price on the S7+<
units. "utlerGs management thin&s that the S7+< costs more to
manufacture than it really does according to the activity7$ased
costing system.
3olutions Manual, "hapter B +@<
0. 3tudents may suggest many possi$le strategies9there is no
single MrightN answer. wo possi$le strategies are: (a* raise the
selling price of the Q7,< enough to provide a satisfactory
margin% and ($* discontinue the Q7,< and focus all availa$le
resources on the S7+<. he price of the S7+< might even $e
decreased to increase the volume of sales, if the company has
ade4uate capacity to do so. ?efore taking any action, an action
analysis report should $e prepared as discussed in Appendi.
BA.
3olutions Manual, "hapter B +@)
Case "-33 ()+< minutes*
). a. he predetermined overhead rate is computed as follows:
!redetermined
Y
overhead rate
R@B<,<<<
Y Y R@.B< per >=;
)<<,<<< >=;s
$. he margins for the windows ordered $y the two customers are computed as follows
under the traditional costing system:
CusKi& Builders 0estern <omes
3ales.......................................................................
R)+,0<
< R2B,<<<
"osts:
>irect materials.................................................... R/,+<< R)B,0<<
>irect la$or........................................................... 0,/<< ,2,<<<
Manufacturing overhead (_ R@.B< per
>=;*................................................................... +,,/< )),C/< )0,2<< @<,)<<
Margin..................................................................... R 02< (R +,)<<*
3olutions Manual, "hapter B +@+
+. a. he 'rst7stage allocation of costs to activity cost pools appears $elow:
Ma&ing
0indo1
s
Processi
ng
$rders
Custome
r
2elations $ther ,otals
&ndirect factory wages
R)+<,<<
<
R)2<,<<
< R /<,<<< R B<,<<< R/<<,<<<
!roduction e4uipment
depreciation +@<,<<< < < ,<,<<< ,<<,<<<
Dther factory costs +/,<<< < < 02,<<< B<,<<<
salaries < 2<,<<< C<,<<< )0<,<<< ,<<,<<<
DEce e.penses < )+,<<< /,<<< +/,<<< /<,<<<
Marketing e.penses < < )0<,<<< )<<,<<< +0<,<<<
otal cost
R/)/,<<
<
R+,+,<<
< R+B/,<<< R//<,<<< R),,@<,<<<
According to the data in the pro$lem, ,<P of the indirect factory wages are attri$uta$le
to activities associated with making windows.
,<P of R/<<,<<< Y R)+<,<<<
he other entries in the ta$le are determined in a similar manner.
3olutions Manual, "hapter B +@,
+. $. he activity rates are computed as follows:
Ma&ing
0indo1s
Processin
g $rders
Customer
2elations
otal activity )<<,<<< >=;s
+,<<<
orders )<< customers
&ndirect factory wages R).+< RB<.<< R /<<.<<
depreciation +.@<
Dther factory costs <.+/
salaries ,<.<< C<<.<<
DEce e.penses 2.<< /<.<<
Marketing e.penses <.<< <.<< ),0<<.<<
otal cost R/.)/ R))2.<< R+,B/<.<<
E.ample: R)+<,<<< [ )<<,<<< >=;s Y R).+< per >=;
&ndirect factory wages attri$uta$le to the activity making windows from the 'rst7stage
allocation a$ove.
3olutions Manual, "hapter B +@/
+. c. he overhead cost of serving Uuszik ?uilders is computed as follows:
Ma&ing
0indo1
s
Processin
g
$rders
Customer
2elations ,otal
Activity for Uuszik ?uilders ,<< >=;s + orders ) customer
&ndirect factory wages R ,2< R)2< R /<< R C+<
depreciation B)< B)<
Dther factory costs @+ @+
salaries 2< C<< C2<
DEce e.penses )+ /< 0+
Marketing e.penses < < ),0<< ),0<<
otal cost
R),+/
+ R+,+ R+,B/< R/,,)/
E.ample: R).+< per >=; V ,<< >=;s Y R,2<
Activity rate for indirect wages for the activity making windows.
3olutions Manual, "hapter B +@0
he overhead cost of serving Oestern ;omes is computed as follows:
Ma&ing
0indo1s
Processing
$rders
Custome
r
2elation
s ,otal
Activity for Oestern ;omes +,<<< >=;s , orders
)
customer
&ndirect factory wages R+,/<< R+/< R /<< R ,,</<
depreciation 0,/<< 0,/<<
Dther factory costs /B< /B<
salaries C< C<< CC<
DEce e.penses )B /< 0B
Marketing e.penses < < ),0<< ),0<<
otal cost RB,+B< R,/B R+,B/<
R)),/2
B
E.ample: R).+< per >=; V +,<<< >=;s Y R+,/<<
Activity rate for indirect wages for the activity making windows.
3olutions Manual, "hapter B +@2
+. d. he action analyses can $e constructed using the row totals
from the overhead cost analysis in part (+c* a$ove.
CusKi& Builders
3ales R)+,0<<
1reen costs:
>irect materials R/,+<< /,+<<
1reen margin B,,<<
Qellow costs:
>irect la$or 0,/<<
&ndirect factory wages C+<
depreciation B)<
Dther factory costs @+
DEce e.penses 0+
Marketing e.penses ),0<< B,@0/
Qellow margin (/0/*
8ed costs:
salaries C2< C2<
8ed margin (R ),/)/*
3olutions Manual, "hapter B +@@
0estern <omes
3ales R2B,<<<
1reen costs:
>irect materials R)B,0<< )B,0<<
1reen margin /C,0<<
Qellow costs:
>irect la$or ,2,<<<
&ndirect factory wages ,,</<
depreciation 0,/<<
Dther factory costs /B<
DEce e.penses 0B
Marketing e.penses ),0<< /2,/@B
Qellow margin ,,<++
8ed costs:
salaries CC< CC<
8ed margin R +,<,+
3olutions Manual, "hapter B +@B
,. According to the activity7$ased costing analysis, "lassic
Oindows may $e losing money dealing with Uuszik ?uilders.
?oth the red and yellow margins are negative. his means that
if "lassic Oindows could actually avoid the yellow costs (or
redeploy these resources to more pro'ta$le uses* $y dropping
Uuszik ?uilders as a customer, the company would $e $etter o#
without this customer.
he activity7$ased costing and traditional costing systems do
not agree concerning the pro'ta$ility of these two customers.
he traditional costing system regards Uuszik ?uilders as a
pro'ta$le customer and Oestern ;omes as a money7losing
customer. he activity7$ased costing system comes to e.actly
the opposite conclusion. he activity7$ased costing system
provides more useful data for decision making for several
reasons. First, the traditional costing system assigns all
manufacturing costs to products9even costs that are not
actually caused $y the products such as costs of idle capacity
and organization7sustaining costs. 3econd, the traditional
costing system e.cludes all nonmanufacturing costs from
product costs9even those that are caused $y the product such
as some oEce e.penses. hird, the traditional costing system
spreads manufacturing overhead uniformly among products
$ased on direct la$or7hours. his penalizes high7volume
products with large amounts of direct la$or7hours. =ow7volume
products with relatively small amounts of direct la$or7hours
$ene't since the costs of $atch7level activities like processing
orders are pushed onto the high7volume products.
3olutions Manual, "hapter B +@C
). Dverhead rates:
'a+
Estimate
d
$verhea
d Costs 'b+ Expected Activit%
'a+ 'b+
Predetermined
$verhead 2ate
!urchasing................ R)+,<<< +<< orders
)
R2< per order
Material handling...... R)0,<<< ,<< receipts
+
R0< per receipt
!roduction orders
and e4uipment
setup...................... R+<,+0< +0< setup hours
,
RB) per setup hour
&nspection................. R)2,<<< B<<
inspection
hours
/
R+< per inspection hour
Frame assem$ly........ RB,<<< ),2<<
assem$ly
hours R0 per assem$ly hour
Machine related........ R,<,<<<
)<,<<
<
machine7
hours
0
R, per machine7hour
/< \ 2< \ )<< Y +<< orders.
+
2< \ B< \ )2< Y ,<< receipts.
,
3tandard: 0< setups V ) hour per setup................ 0< hours
3pecialty: )<< setups V + hours per
setup.................................................................... +<< hours
otal setup hours.................................................... +0< hours
/
,<< \ 0<< Y B<< hours.
0
3tandard: )<,<<< units V <.0 hours per
unit....................................................................... 0,<<< hours
3pecialty: +,0<< units V + hours per unit............... 0,<<< hours
3olutions Manual, "hapter B +B<
otal machine7hours............................................... )<,<<< hours
3olutions Manual, "hapter B +B)
Dverhead cost charged to each product:
Standard Specialt%
Activit
%
Amoun
t
Activit
%
Amoun
t
!urchasing _ R2< per order:
=eather....................................... ,/ R +,</< 2 R ,2<
Fa$ric.......................................... /B +,BB< )+ @+<
3ynthetic.................................... < < )<< 2,<<<
Material handling _ R0< per
receipt:
=eather....................................... 0+ +,2<< B /<<
Fa$ric.......................................... 2/ ,,+<< )2 B<<
3ynthetic.................................... < < )2< B,<<<
!roduction orders and e4uipment
setup _ RB) per hour................. 0< /,<0< +<< )2,+<<
&nspection _ R+< per hour............ ,<< 2,<<< 0<< )<,<<<
Frame assem$ly _ R0 per hour..... B<< /,<<< B<< /,<<<
Machine related _ R, per hour.....0,<<< )0,<<< 0,<<< )0,<<<
otal overhead cost....................... R,C,@@<
R2),/B
<
Manufacturing overhead cost per unit of product:
3tandard: R,C,@@< [ )<,<<< units Y R,.CB per unit (rounded*
3pecialty: R2),/B< [ +,0<< units Y R+/.0C per unit (rounded*
3olutions Manual, "hapter C +,0
+. he unit product cost of each product line under activity7$ased
costing is given $elow. For comparison, the costs computed $y
the companyGs accounting department using conventional
costing are also provided.
Activit%/Based
Costing
!irect )abor/
<our Base
Standar
d
Specialt
%
Standar
d
Specialt
%
>irect materials............ R+<.<< R)@.0< R+<.<< R)@.0<
>irect la$or................... 2.<< ,.<< 2.<< ,.<<
Manufacturing
overhead.................... ,.CB +/.0C C.<< /.0<
otal unit product cost... R+C.CB R/0.<C R,0.<< R+0.<<
,. he president was pro$a$ly correct in $eing concerned a$out
the pro'ta$ility of the products, $ut the pro$lem is apparently
with the specialty product line rather than the standard product
line. raditional overhead cost assignment using a volume7
$ased measure has resulted in the high7volume product
su$sidizing the low7volume product. hus, unit costs for $oth
products are $adly distorted. hese distorted costs have had a
major impact on managementGs pricing policies and on
managementGs perception of the margin $eing realized on each
product. he specialty $riefcases are apparently $eing sold at a
loss even without considering nonmanufacturing costs:
Standard
Briefcases
Specialt%
Briefcases
3elling price per unit........ R,2.<< R/<.<<
Knit product cost.............. +C.CB /0.<C
1ross margin (loss* per
unit................................ R 2.<+ (R 0.<C*
?ased on these data, the company should not shift its
resources entirely to the production of specialty $riefcases.
Ohether or not the specialty $riefcases can $e made pro'ta$le
depends on a num$er of factors including the sensitivity of the
market to an increase in the selling price of the specialty line.
3olutions Manual, "hapter C +,2
(ote to the "nstructorG Qou may want to mention to your class
that $efore any decision can $e made regarding dropping a
product, a careful analysis will have to $e made of the potential
avoida$le costs. 3ome of the costs included in the unit product
costs are pro$a$ly costs of idle capacity and organization7
sustaining costs that are not relevant.
/. !erhaps the competition hasnGt $een a$le to touch "arryAllGs
price $ecause "arryAll has $een selling its specialty $riefcases
at a price that may $e $elow its cost. hus, rather than
MgougingN its customers, "arryAllGs competitor is pro$a$ly just
pricing its specialty items at a normal markup over their cost.
&ndeed, according to the activity7$ased costing system, if
"arryAll is to realize a pro't on its specialty items it may need
to charge a price more in line with its competitorGs price.
Ohen a company sells a product at a price su$stantially $elow
that of its competitors, the companyGs management should
take a careful look at the costing system to $e sure that the
product is $eing assigned all the costs for which it is
responsi$le.
3olutions Manual, "hapter C +,@
,roup E%ercise "-35
he most e4uita$le way to divide the dinner $ill among a group of
friends is pro$a$ly to 'gure out the cost of what each individual
consumed and divide up the $ill accordingly. ;owever, it would $e
easier to simply divide the total $ill $y the num$er of individuals.
Everyone would then pay e.actly the same amount. his issue
relates to material in the chapter $ecause the former method of
charging individuals for the costs of what they consume is similar
to activity7$ased costing and the method of just dividing the $ill
e4ually is similar to traditional costing methods. Figuring out the
cost of what each individual consumes is the most accurate
method, $ut it may take too much time and energy to $e worth
the $other.
3olutions Manual, "hapter C +,B
,roup E%ercise "-3
An activity7$ased costing system typically reduces the amount of
overhead cost that is allocated $ased on direct la$or7hours9
shifting the overhead to other cost pools. Knder an activity7$ased
costing system, some of the overhead will $e allocated $ased on
the num$er of $atches run, the num$er of products in the
companyGs active list, and so on. his shifts costs from high7
volume products produced in large $atches to low7volume
products produced in small $atches. Dnce this is understood, the
answers to the 4uestions posed in the group e.ercise can $e
easily answered.
). he unit product cost of a low7volume product made in small
$atches will typically increase in an activity7$ased costing
system. he $atch7level and product7level costs are spread
across a small num$er of units, increasing the average unit
cost.
+. he unit product cost of a high7volume product made in large
$atches with automated e4uipment and few direct la$or7hours
will typically go up under activity7$ased costing. ?ecause of the
low direct la$or7hour re4uirement for the product, the unit
product cost under a traditional direct la$or7$ased costing
system would $e arti'cially low. Knder an activity7$ased
costing system, the product would $e charged for its use of
automated e4uipment and for $atch7level and product7level
costs.
,. he unit product cost of a high7volume product that re4uires
little machine work $ut a lot of direct la$or typically will
decrease under activity7$ased costing. ?ecause of the high
direct la$or7hour re4uirement for the product, the unit product
cost under a traditional direct la$or7$ased costing system
would $e arti'cially high. he activity7$ased costing system
would shift some of the overhead costs that had $een assigned
to this product to other products that are made in smaller
volumes.
3olutions Manual, "hapter C +,C
Chapter #
&ro/t &lanning
#-1 A $udget is a detailed plan
outlining the ac4uisition and use of
'nancial and other resources over a given
time period. As such, it represents a plan
for the future e.pressed in formal
4uantitative terms. ?udgetary control
involves the use of $udgets to control the
actual activities of a 'rm.
#-2
). ?udgets provide a means of
communicating managementGs plans
throughout the organization.
+. ?udgets force managers to think
a$out and plan for the future.
,. he $udgeting process provides a
means of allocating resources to those
parts of the organization where they can
$e used most e#ectively.
/. he $udgeting process can uncover
potential $ottlenecks $efore they occur.
0. ?udgets coordinate the activities of
the entire organization. ?udgeting helps to
ensure that everyone in the organization is
pulling in the same direction.
2. ?udgets de'ne goals and o$jectives
that can serve as $enchmarks for
evaluating su$se4uent performance.
#-3 8esponsi$ility accounting is a
system in which a manager is held
responsi$le for those items of revenues
and costs9and only those items9that the
manager can control to a signi'cant
e.tent. Each line item in the $udget is
made the responsi$ility of a manager who
is then held responsi$le for di#erences
$etween $udgeted and actual results.
#-4 A master $udget represents a
summary of all of managementGs plans
and goals for the future, and outlines the
way in which these plans are to $e
accomplished. he master $udget is
composed of a num$er of smaller, speci'c
$udgets encompassing sales, production,
raw materials, direct la$or, manufacturing
overhead, selling and administrative
e.penses, and inventories. he master
$udget generally also contains a $udgeted
income statement, $udgeted $alance
sheet, and cash $udget.
#-5 he level of sales impacts virtually
every other aspect of the 'rmGs activities.
&t determines the production $udgets,
cash collections, cash dis$ursements, and
selling and administrative $udgets that in
turn determine the cash $udget and
$udgeted income statement and $alance
sheet.
#- Ao. !lanning and control are
di#erent, although related, concepts.
!lanning involves developing o$jectives
and formulating steps to achieve those
o$jectives. "ontrol, $y contrast, involves
the means $y which management ensures
that the o$jectives set down at the
planning stage are attained.
#-! he -ow of information moves in
two directions9upward and downward.
he initial -ow should $e from the $ottom
of the organization upward. Each person
having responsi$ility over revenues or
costs should prepare the $udget data
against which his or her su$se4uent
performance will $e measured. As the
$udget data are communicated upward,
higher7level managers should review the
$udgets for consistency with the overall
goals of the organization and the plans of
other units in the organization. Any issues
3olutions Manual, "hapter C +/<
should $e resolved in discussions $etween
the individuals who prepared the $udgets
and their managers.
All levels of an organization should
participate in the $udgeting process9not
just top management or the accounting
department. 1enerally, the lower levels
will $e more familiar with detailed, day7to7
day operating data, and for this reason will
have primary responsi$ility for developing
the speci'cs in the $udget. op levels of
management will have a $etter
perspective concerning the companyGs
strategy.
#-" A self7imposed $udget is one in
which persons with responsi$ility over cost
control prepare their own $udgets, i.e., the
$udget is not imposed from a$ove. he
major advantages are: ()* the views and
judgments of persons from all levels of an
organization are represented in the 'nal
$udget document% (+* $udget estimates
generally are more accurate and relia$le,
since they are prepared $y those who are
closest to the pro$lems% (,* managers
generally are more motivated to meet
$udgets which they have participated in
setting% (/* self7imposed $udgets reduce
the amount of upward M$lamingN resulting
from ina$ility to meet $udget goals. Dne
caution must $e e.ercised in the use of
self7imposed $udgets. he $udgets
prepared $y lower7level managers should
$e carefully reviewed to prevent too much
slack.
#-# ?udgeting can assist a 'rm in its
employment policies $y providing
information on pro$a$le future staEng
needs. ?udgeting can also assist in
sta$ilizing a companyGs work force. ?y
careful planning through the $udget
process, a company can often Msmooth
outN its activities and avoid erratic hiring
and laying o# employees.
#-1$ Ao, although this is clearly one of
the purposes of the cash $udget. he
principal purpose is to provide information
on pro$a$le cash needs during the $udget
period, so that $ank loans and other
sources of 'nancing can $e anticipated
and arranged well in advance.
#-11 eero7$ased $udgeting re4uires that
managers start at zero levels every year
and justify all costs as if all programs were
$eing proposed for the 'rst time. &n
traditional $udgeting, $y contrast, $udgets
are usually $ased on the previous yearGs
data.
3olutions Manual, "hapter C +/)
E%ercise #-1 (+< minutes*
). April Ma% 9une ,otal
Fe$ruary sales:
R+,<,<<< V )<P....... R+,,<<< R+,,<<<
March sales:
R+2<,<<< V @<P,
)<P.......................... )B+,<<< R +2,<<< +<B,<<<
April sales: R,<<,<<<
V +<P, @<P, )<P..... 2<,<<< +)<,<<<
R
,<,<<< ,<<,<<<
May sales: R0<<,<<<
V +<P, @<P............. )<<,<<< ,0<,<<< /0<,<<<
5une sales: R+<<,<<<
V +<P...................... /<,<<<
/<,<<
<
otal cash collections. .
R+20,<<
< R,,2,<<<
R/+<,<<
<
R),<+),<<
<
D$serve that even though sales peak in May, cash collections
peak in 5une. his occurs $ecause the $ulk of the companyGs
customers pay in the month following sale. he lag in
collections that this creates is even more pronounced in some
companies. &ndeed, it is not unusual for a company to have the
least cash availa$le in the months when sales are greatest.
+. Accounts receiva$le at 5une ,<:
From May sales: R0<<,<<< V )<P...................
R
0<,<<<
From 5une sales: R+<<,<<< V (@<P \ )<P*..... )2<,<<<
otal accounts receiva$le at 5une ,<...............
R+)<,<<
<
3olutions Manual, "hapter C +/+
E%ercise #-2 ()< minutes*
April Ma% 9une
8uarte
r
?udgeted sales in units......... 0<,<<< @0,<<< C<,<<<
+)0,<<
<
Add desired ending
inventoryZ........................... @,0<< C,<<< B,<<< B,<<<
otal needs............................ 0@,0<< B/,<<< CB,<<<
++,,<<
<
=ess $eginning inventory...... 0,<<< @,0<< C,<<< 0,<<<
8e4uired production.............. 0+,0<< @2,0<< BC,<<<
+)B,<<
<
Z)<P of the following monthGs sales in units.
3olutions Manual, "hapter C +/,
E%ercise #-3 ()0 minutes*
-ear 5 -ear 6
First Second ,hird Fourth First
8e4uired production in $ottles................ 2<,<<< C<,<<< )0<,<<< )<<,<<< @<,<<<
Aum$er of grams per $ottle.................... V, V, V, V, V,
otal production needs9grams............... )B<,<<< +@<,<<< /0<,<<< ,<<,<<< +)<,<<<
-ear 5
First Second ,hird Fourth -ear
!roduction needs9grams (a$ove*........... )B<,<<< +@<,<<< /0<,<<< ,<<,<<<
),+<<,<<
<
Add desired ending inventory9grams..... 0/,<<< C<,<<< 2<,<<< /+,<<< /+,<<<
otal needs9grams................................. +,/,<<< ,2<,<<< 0)<,<<< ,/+,<<<
),+/+,<<
<
=ess $eginning inventory9grams........... ,2,<<< 0/,<<< C<,<<< 2<,<<< ,2,<<<
8aw materials to $e purchased9
grams................................................... )CB,<<< ,<2,<<< /+<,<<< +B+,<<<
),+<2,<<
<
"ost of raw materials to $e purchased
at )0< rou$les per kilogram.................. +C,@<< /0,C<< 2,,<<< /+,,<< )B<,C<<
3olutions Manual, "hapter C +//
E%ercise #-4 (+< minutes*
). Assuming that the direct la$or workforce is adjusted each 4uarter, the direct la$or
$udget would $e:
4st
8uarter
5nd
8uarter
6rd
8uarter
7th
8uarter -ear
Knits to $e produced.................................. B,<<< 2,0<< @,<<< @,0<< +C,<<<
>irect la$or time per unit (hours*............... V <.,0 V <.,0 V <.,0 V <.,0 V <.,0
otal direct la$or7hours needed.................. +,B<< +,+@0 +,/0< +,2+0 )<,)0<
>irect la$or cost per hour..........................
V
R)+.<<
V
R)+.<<
V
R)+.<<
V
R)+.<<
V
R)+.<<
otal direct la$or cost.................................
R ,,,2<
< R +@,,<<
R +C,/<
<
R ,),0<
<
R)+),B<
<
+. Assuming that the direct la$or workforce is not adjusted each 4uarter and that overtime
wages are paid, the direct la$or $udget would $e:
4st
8uarter
5nd
8uarter
6rd
8uarter
7th
8uarter -ear
Knits to $e produced................................. B,<<< 2,0<< @,<<< @,0<< +C,<<<
>irect la$or time per unit (hours*.............. V <.,0 V <.,0 V <.,0 V <.,0 V <.,0
otal direct la$or7hours needed................. +,B<< +,+@0 +,/0< +,2+0 )<,)0<
8egular hours paid.................................... +,2<< +,2<< +,2<< +,2<< )<,/<<
Dvertime hours paid................................. +<< 7 7 +0 ++0
Oages for regular hours (_ R)+.<< per
hour*....................................................... R,),+<< R,),+<< R,),+<< R,),+<<
R)+/,B<
<
Dvertime wages (_ R)+.<< per hour V
).0*......................................................... ,,2<< 7 7 /0< /,<0<
otal direct la$or cost................................ R,/,B<< R,),+<< R,),+<< R,),20< R)+B,B0
3olutions Manual, "hapter C +/0
<
3olutions Manual, "hapter C +/2
E%ercise #-5 ()0 minutes*
). Quvwell "orporation
Manufacturing $verhead Budget
4st
8uarte
r
5nd
8uarte
r
6rd
8uarte
r
7th
8uarte
r -ear
?udgeted direct la$or7hours........................... B,<<< B,+<< B,0<< @,B<< ,+,0<<
Iaria$le overhead rate...................................
V
R,.+0 V R,.+0 V R,.+0 V R,.+0 V R,.+0
Iaria$le manufacturing overhead..................
R+2,<<
<
R+2,20
<
R+@,2+
0
R+0,,0
<
R)<0,2+
0
Fi.ed manufacturing overhead....................... /B,<<< /B,<<< /B,<<< /B,<<<
)C+,<<
<
otal manufacturing overhead....................... @/,<<< @/,20< @0,2+0 @,,,0< +C@,2+0
=ess depreciation........................................... )2,<<< )2,<<< )2,<<< )2,<<<
2/,<<
<
"ash dis$ursements for manufacturing
overhead.....................................................
R0B,<<
<
R0B,20
<
R0C,2+
0
R0@,,0
<
R+,,,2+
0
+.
otal $udgeted manufacturing overhead for the
year (a*................................................................... R+C@,2+0
otal $udgeted direct la$or7hours for the year ($*..... ,+,0<<
Manufacturing overhead rate for the year (a* [ ($*. . R C.)2
3olutions Manual, "hapter C +/@
E%ercise #- ()0 minutes*
Oeller "ompany
3elling and Administrative E.pense ?udget
4st
8uarter
5nd
8uarter
6rd
8uarter
7th
8uarter -ear
?udgeted unit sales...................................... )0,<<< )2,<<< )/,<<< ),,<<< 0B,<<<
Iaria$le selling and administrative e.pense
per unit.......................................................
V
R+.0<
V
R+.0<
V
R+.0<
V
R+.0< V R+.0<
Iaria$le e.pense...........................................
R ,@,0<
<
R
/<,<<<
R
,0,<<<
R
,+,0<<
R)/0,<<
<
Fi.ed selling and administrative e.penses:
Advertising.................................................. B,<<< B,<<< B,<<< B,<<< ,+,<<<
E.ecutive salaries....................................... ,0,<<< ,0,<<< ,0,<<< ,0,<<< )/<,<<<
&nsurance.................................................... 0,<<< 0,<<< )<,<<<
!roperty ta.es............................................. B,<<< B,<<<
>epreciation...............................................
+<,<<
<
+<,<<
<
+<,<<
<
+<,<<
< B<,<<<
otal '.ed e.pense........................................
2B,<<
<
@),<<
<
2B,<<
<
2,,<<
< +@<,<<<
otal selling and administrative e.penses..... )<0,0<<
))),<<
<
)<,,<<
< C0,0<< /)0,<<<
=ess depreciation..........................................
+<,<<
<
+<,<<
<
+<,<<
<
+<,<<
< B<,<<<
"ash dis$ursements for selling and
administrative e.penses.............................
R B0,0<
<
R
C),<<<
R
B,,<<<
R
@0,0<<
R,,0,<<
<
3olutions Manual, "hapter C +/B
E%ercise #-! (+< minutes*
8uarter '::: omitted+
4 5 6 7 -ear
"ash $alance, $eginning......................... R2 Z R0 R0 R0 R2
Add collections from customers.............. 20 @< C2 Z C+ ,+, Z
otal cash availa$le................................. @) Z @0 )<) C@ ,+C
=ess dis$ursements:
!urchase of inventory........................... ,0 Z /0 Z /B ,0 Z )2,
Dperating e.penses.............................. +B ,< Z ,< Z +0 )), Z
E4uipment purchases........................... B Z B Z )< Z )< ,2 Z
>ividends.............................................. + Z + Z + Z + Z B
otal dis$ursements................................ @, B0 Z C< @+ ,+<
E.cess (de'ciency* of cash availa$le
over dis$ursements.............................. (+*Z ()<* )) Z +0 C
Financing:
?orrowings............................................ @ )0 Z 9 9 ++
8epayments (including interest*........... 9 9 (2* ()@*Z (+,*
otal 'nancing......................................... @ )0 (2* ()@* ()*
"ash $alance, ending.............................. R0 R0 R0 RB RB
Z1iven.
3olutions Manual, "hapter C +/C
&ro'lem #-" (,< minutes*
). he $udget at 3pring'eld is an imposed Mtop7downN $udget
that fails to consider $oth the need for realistic data and the
human interaction essential to an e#ective $udgetingHcontrol
process. he !resident has not given any $asis for his goals, so
one cannot know whether they are realistic for the company.
rue participation of company employees in preparation of the
$udget is minimal and limited to mechanical gathering and
manipulation of data. his suggests there will $e little
enthusiasm for implementing the $udget.
he sales $y product line should $e $ased on an accurate sales
forecast of the potential market. herefore, the sales $y
product line should have $een developed 'rst to derive the
sales target rather than the reverse.
he initial meeting $etween the Iice !resident of Finance,
E.ecutive Iice !resident, Marketing Manager, and !roduction
Manager should $e held earlier. his meeting is held too late in
the $udget process.
+. 3pring'eld should consider adopting a M$ottom7upN $udget
process. his means that the people responsi$le for
performance under the $udget would participate in the
decisions $y which the $udget is esta$lished. &n addition, this
approach re4uires initial and continuing involvement of sales,
'nancial, and production personnel to de'ne sales and pro't
goals that are realistic within the constraints under which the
company operates. Although time consuming, the approach
should produce a more accepta$le, honest, and worka$le goal7
control mechanism.
he sales forecast should $e developed considering internal
sales7forecasts as well as e.ternal factors. "osts within
departments should $e divided into '.ed and varia$le,
controlla$le and noncontrolla$le, discretionary and
nondiscretionary. Fle.i$le $udgeting techni4ues could then
allow departments to identify costs that can $e modi'ed in the
planning process.
3olutions Manual, "hapter C +0<
&ro'lem #-" (continued*
,. he functional areas should not necessarily $e e.pected to cut
costs when sales volume falls $elow $udget. he time frame of
the $udget (one year* is short enough so that many costs are
relatively '.ed. For costs that are '.ed, there is little hope for a
reduction as a conse4uence of short7run changes in volume.
;owever, the functional areas should $e e.pected to cut costs
should sales volume fall $elow target when:
a. control is e.ercised over the costs within their function.
$. $udgeted costs were more than ade4uate for the originally
targeted sales, i.e., slack was present.
c. $udgeted costs vary to some e.tent with changes in sales.
d. there are discretionary costs that can $e delayed or omitted
with no serious e#ect on the department.
(Adapted unoEcial "MA 3olution*
3olutions Manual, "hapter C +0)
&ro'lem #-# (/0 minutes*
). 3chedule of e.pected cash collections:
Month
9ul% August
Septemb
er 8uarter
From accounts
receiva$le:
May sales
R+0<,<<< V ,P.......
R @,0<
<
R @,0<
<
5une sales
R,<<,<<< V @<P..... +)<,<<< +)<,<<<
R,<<,<<< V ,P....... R C,<<< C,<<<
From $udgeted sales:
5uly sales
R/<<,<<< V +0P..... )<<,<<< )<<,<<<
R/<<,<<< V @<P..... +B<,<<< +B<,<<<
R/<<,<<< V ,P....... R )+,<<< )+,<<<
August sales
R2<<,<<< V +0P..... )0<,<<< )0<,<<<
R2<<,<<< V @<P..... /+<,<<< /+<,<<<
3eptem$er sales
R,+<,<<< V +0P..... B<,<<<
B<,<<
<
otal cash collections. . .
R,)@,0<
<
R/,C,<<
<
R0)+,<<
<
R),+2B,0<
<
3olutions Manual, "hapter C +0+
&ro'lem #-# (continued*
+. "ash $udget:
Month
9ul% August
Septem
ber 8uarter
"ash $alance,
$eginning....................
R
//,0<<
R
+B,<<<
R
+,,<<< R //,0<<
Add receipts:
"ollections from
customers.................
,)@,0<
< /,C,<<<
0)+,<<
< ),+2B,0<<
otal cash availa$le.......
,2+,<<
< /2@,<<<
0,0,<<
< ),,),,<<<
=ess dis$ursements:
Merchandise
purchases................. )B<,<<< +/<,<<< ,0<,<<< @@<,<<<
3alaries and wages.....
.................................
................................. /0,<<< 0<,<<< /<,<<< ),0,<<<
Advertising.................. ),<,<<< )/0,<<< B<,<<< ,00,<<<
8ent payments............ C,<<< C,<<< C,<<< +@,<<<
E4uipment purchases..
)<,<<
< 9 9 )<,<<<
otal dis$ursements.......
,@/,<<
< ///,<<<
/@C,<<
< ),+C@,<<<
E.cess (de'ciency* of
receipts over
dis$ursements............ ()+,<<<* +,,<<< 02,<<< )2,<<<
Financing:
?orrowings.................. /<,<<< 9 9 /<,<<<
8epayments................ 9 9 (/<,<<<* (/<,<<<*
&nterest....................... 9 9 (),+<<* (),+<<*
otal 'nancing...............
/<,<<
< 9 (/),+<<* (),+<<*
"ash $alance, ending....
R
+B,<<<
R
+,,<<<
R
)/,B<< R )/,B<<
,. &f the company needs a R+<,<<< minimum cash $alance to
start each month, then the loan cannot $e repaid in full $y
3eptem$er ,<. &f the loan is repaid in full, the cash $alance will
3olutions Manual, "hapter C +0,
drop to only R)/,B<< on 3eptem$er ,<, as shown a$ove. 3ome
portion of the loan $alance will have to $e carried over to
Dcto$er, at which time the cash in-ow should $e suEcient to
complete repayment.
3olutions Manual, "hapter C +0/
&ro'lem #-1$ (/0 minutes*
). a. he reasons that Marge Atkins and !ete 1ranger use
$udgetary slack include the following:
L hese employees are hedging against the une.pected (reducing
uncertaintyHrisk*.
L he use of $udgetary slack allows employees to e.ceed
e.pectations andHor show consistent performance. his is
particularly important when performance is evaluated on the
$asis of actual results versus $udget.
L Employees are a$le to $lend personal and organizational goals
through the use of $udgetary slack as good performance
generally leads to higher salaries, promotions, and $onuses.
$. he use of $udgetary slack can adversely a#ect Atkins and
1ranger $y:
L limiting the usefulness of the $udget to motivate their
employees to top performance.
L a#ecting their a$ility to identify trou$le spots and take
appropriate corrective action.
L reducing their credi$ility in the eyes of management.
Also, the use of $udgetary slack may a#ect management
decision7making as the $udgets will show lower contri$ution
margins (lower sales, higher e.penses*. >ecisions regarding
the pro'ta$ility of product lines, staEng levels, incentives,
etc., could have an adverse e#ect on AtkinsG and 1rangerGs
departments.
3olutions Manual, "hapter C +00
&ro'lem #-1$ (continued*
+. he use of $udgetary slack, particularly if it has a detrimental
e#ect on the company, may $e unethical. &n assessing the
situation, the speci'c standards contained in M3tandards of
Ethical "onduct for Management AccountantsN that should $e
considered are listed $elow.
Competence
"lear reports using relevant and relia$le information should $e
prepared.
Con/dentialit)
he standards of con'dentiality do not apply in this situation.
(ntegrit)
L Any activity that su$verts the legitimate goals of the company
should $e avoided.
L Favora$le as well as unfavora$le information should $e
communicated.
*'+ectivit)
L &nformation should $e fairly and o$jectively communicated.
L All relevant information should $e disclosed.
(KnoEcial "MA 3olution*
&ro'lem #-11 (/0 minutes*
). !roduction $udget: 9ul% August
Septem
ber
$ctobe
r
?udgeted sales (units*........ ,0,<<< /<,<<< 0<,<<< ,<,<<<
Add desired ending
inventory.......................... )),<<< ),,<<< C,<<< @,<<<
otal needs.......................... /2,<<< 0,,<<< 0C,<<< ,@,<<<
=ess $eginning inventory.... )<,<<< )),<<< ),,<<< C,<<<
8e4uired production............ ,2,<<< /+,<<< /2,<<< +B,<<<
+. >uring 5uly and August the company is $uilding inventories in
anticipation of peak sales in 3eptem$er. herefore, production
e.ceeds sales during these months. &n 3eptem$er and Dcto$er
inventories are $eing reduced in anticipation of a decrease in
sales during the last months of the year. herefore, production
is less than sales during these months to cut $ack on inventory
levels.
,. 8aw direct materials $udget:
9ul% August
Septe
mber
,hird
8uarte
r
8e4uired production
(units*............................... ,2,<<< /+,<<< /2,<<<
)+/,<<
<
Material ;,<< needed per
unit................................... V, cc V, cc V, cc V, cc
!roduction needs (cc*.........
)<B,<<
<
)+2,<<
<
),B,<<
<
,@+,<<
<
Add desired ending
inventory (cc*................... 2,,<<< 2C,<<< /+,<<< Z /+,<<<
otal material ;,<< needs. .
)@),<<
<
)C0,<<
<
)B<,<<
<
/)/,<<
<
=ess $eginning inventory
(cc*................................... 0/,<<< 2,,<<< 2C,<<< 0/,<<<
Material ;,<< purchases
(cc*...................................
))@,<<
<
),+,<<
<
))),<<
<
,2<,<<
<
Z +B,<<< units (Dcto$er production* V , cc per unit Y B/,<<<
cc%
B/,<<< cc V )H+ Y /+,<<< cc.
3olutions Manual, "hapter C +0@
As shown in part ()*, production is greatest in 3eptem$er%
however, as shown in the raw direct materials $udget,
purchases of materials are greatest a month earlier9in August.
he reason for the large purchases of materials in August is
that the materials must $e on hand to support the heavy
production scheduled for 3eptem$er.
3olutions Manual, "hapter C +0B
&ro'lem #-12 (,< minutes*
).
)
.
ean "orporation
>irect Materials ?udget
4st
8uarter
5nd
8uarter
6rd
8uarter
7th
8uarter -ear
8e4uired production (units*....... 0,<<< B,<<< @,<<< 2,<<< +2,<<<
8aw materials per unit
(grams*................................... V B V B V B V B V B
!roduction needs (grams*......... /<,<<< 2/,<<< 02,<<< /B,<<< +<B,<<<
Add desired ending inventory
(grams*................................... )2,<<< )/,<<< )+,<<< B,<<< B,<<<
otal needs (grams*.................. 02,<<< @B,<<< 2B,<<< 02,<<< +)2,<<<
(grams*................................... 2,<<< )2,<<< )/,<<< )+,<<< 2,<<<
8aw materials to $e
purchased (grams*................. 0<,<<< 2+,<<< 0/,<<< //,<<< +)<,<<<
"ost of raw materials to $e
purchased at R).+< per gram. R2<,<<< R@/,/<< R2/,B<< R0+,B<<
R+0+,<<
<
3chedule of E.pected "ash >is$ursements for Materials
Accounts paya$le, $eginning
$alance................................... R +,BB< R +,BB<
)st 6uarter purchases............... ,2,<<< R+/,<<< 2<,<<<
+nd 6uarter purchases.............. //,2/< R+C,@2< @/,/<<
,rd 6uarter purchases.............. ,B,BB< R+0,C+< 2/,B<<
/th 6uarter purchases.............. ,),2B< ,),2B<
3olutions Manual, "hapter C +0C
otal cash dis$ursements for
materials................................ R,B,BB< R2B,2/< R2B,2/< R0@,2<<
R+,,,@2
<
3olutions Manual, "hapter C +2<
&ro'lem #-12 (continued*
+.
)
.
ean "orporation
>irect =a$or ?udget
4st
8uarter
5nd
8uarter
6rd
8uarter
7th
8uarter -ear
8e4uired production (units*....... 0,<<< B,<<< @,<<< 2,<<< +2,<<<
>irect la$or7hours per unit........ V <.+< V <.+< V <.+< V <.+< V <.+<
otal direct la$or7hours
needed...................................
),<<< ),2<< ),/<< ),+<< 0,+<<
>irect la$or cost per hour......... V
R)).0<
V R)).0< V
R)).0<
V
R)).0<
V
R)).0<
otal direct la$or cost................ R )),0<< R )B,/<< R )2,)<< R ),,B<< R 0C,B<<
3olutions Manual, "hapter C +2)
).
)
.
)
.
;ruska "orporation
>irect =a$or ?udget
4st
8uarter
5nd
8uarter
6rd
8uarter
7th
8uarter -ear
Knits to $e produced................. )+,<<< )<,<<< ),,<<< )/,<<< /C,<<<
>irect la$or time per unit
(hours*....................................
<.+ <.+ <.+ <.+ <.+
needed...................................
+,/<< +,<<< +,2<< +,B<< C,B<<
>irect la$or cost per hour......... R)+.<< R)+.<< R)+.<< R)+.<< R)+.<<
otal direct la$or cost................ R+B,B<< R+/,<<< R,),+<< R,,,2<< R))@,2<
<
+.
)
.
)
.
;ruska "orporation
Manufacturing Dverhead ?udget
4st 5nd 6rd 7th -ear
3olutions Manual, "hapter C +2+
8uarter 8uarter 8uarter 8uarter
?udgeted direct la$or7hours...... +,/<< +,<<< +,2<< +,B<< C,B<<
Iaria$le overhead rate.............. R).@0 R).@0 R).@0 R).@0 R).@0
overhead................................ R /,+<< R ,,0<< R /,00< R /,C<< R )@,)0<
Fi.ed manufacturing overhead.. B2,<<< B2,<<< B2,<<< B2,<<< ,//,<<<
otal manufacturing overhead... C<,+<< BC,0<< C<,00< C<,C<< ,2),)0<
=ess depreciation...................... +,,<<< +,,<<< +,,<<< +,,<<< C+,<<<
"ash dis$ursements for
manufacturing overhead........ R2@,+<< R22,0<< R2@,00< R2@,C<<
R+2C,)0
<
3olutions Manual, "hapter C +2,
). >ecem$er cash sales.............................. RB,,<<<
"ollections on account:
Dcto$er sales: R/<<,<<< V )BP........... @+,<<<
Aovem$er sales: R0+0,<<< V 2<P....... ,)0,<<<
>ecem$er sales: R2<<,<<< V +<P....... )+<,<<<
otal cash collections............................ R0C<,<<<
+. !ayments to suppliers:
Aovem$er purchases (accounts
paya$le*............................................. R)2),<<<
>ecem$er purchases: R+B<,<<< V
,<P.................................................... B/,<<<
otal cash payments............................. R+/0,<<<
,. A3;DA "DM!AAQ
"ash ?udget
For the Month of >ecem$er
"ash $alance, $eginning........................... R /<,<<<
Add cash receipts: "ollections from
customers............................................... 0C<,<<<
otal cash availa$le $efore current
'nancing................................................. 2,<,<<<
=ess dis$ursements:
!ayments to suppliers for inventory........
R+/0,<<
<
3elling and administrative e.pensesZ..... ,B<,<<<
Aew we$ server...................................... @2,<<<
>ividends paid........................................ C,<<<
otal dis$ursements.................................. @)<,<<<
over
dis$ursements........................................ (B<,<<<*
Financing:
?orrowings.............................................. )<<,<<<
8epayments............................................ 9
&nterest................................................... 9
otal 'nancing........................................... )<<,<<<
"ash $alance, ending................................ R +<,<<<
3olutions Manual, "hapter C +2/
ZR/,<,<<< X R0<,<<< Y R,B<,<<<.
&ro'lem #-15 (2< minutes*
). 3chedule of cash receipts:
"ash sales9May........................................... R2<,<<<
"ollections on account receiva$le:
April ,< $alance.......................................... 0/,<<<
May sales (0<P V R)/<,<<<*...................... @<,<<<
otal cash receipts......................................... R)B/,<<<
3chedule of cash payments for purchases:
April ,< accounts paya$le $alance................ R2,,<<<
May purchases (/EA "DM!AAQ
"ash ?udget
For the Month of May
"ash $alance, $eginning............................... R C,<<<
Add receipts from customers (a$ove*............ )B/,<<<
otal cash availa$le....................................... )C,,<<<
=ess dis$ursements:
!urchase of inventory (a$ove*.................... ))),<<<
Dperating e.penses.................................... @+,<<<
!urchases of e4uipment............................. 2,0<<
otal cash dis$ursements.............................. )BC,0<<
E.cess of receipts over dis$ursements......... ,,0<<
Financing:
?orrowing9note......................................... +<,<<<
8epayments9note..................................... ()/,0<<*
&nterest....................................................... ()<<*
otal 'nancing............................................... 0,/<<
"ash $alance, ending.................................... R B,C<<
+.
M&A>EA "DM!AAQ
For the Month of May
3ales.....................................................
R+<<,<<
<
"ost of goods sold:
?eginning inventory............................ R,<,<<<
Add purchases.................................... )+<,<<<
1oods availa$le for sale...................... )0<,<<<
Ending inventory................................. /<,<<<
"ost of goods sold................................. ))<,<<<
1ross margin......................................... C<,<<<
Dperating e.penses (R@+,<<< \
R+,<<<*............................................... @/,<<<
Aet operating income............................ )2,<<<
&nterest e.pense.................................... )<<
Aet income............................................ R)0,C<<
,.
M&A>EA "DM!AAQ
?udgeted ?alance 3heet
May ,)
Assets
"ash...................................................................... R B,C<<
Accounts receiva$le (0<P V R)/<,<<<*................ @<,<<<
&nventory............................................................... /<,<<<
?uildings and e4uipment, net of depreciation
(R+<@,<<< \ R2,0<< X R+,<<<*............................ +)),0<<
otal assets........................................................... R,,<,/<<
)iabilities and E?uit%
Accounts paya$le (2<P V )+<,<<<*...................... R @+,<<<
Aote paya$le........................................................ +<,<<<
"apital stock......................................................... )B<,<<<
8etained earnings (R/+,0<< \ R)0,C<<*............... 0B,/<<
otal lia$ilities and e4uity..................................... R,,<,/<<
3olutions Manual, "hapter C +2@
). "ollections on sales:
April Ma% 9une 8uarter
"ash sales....................
R)+<,<<
<
R)B<,<<
<
R)<<,<<
<
R /<<,<<
<
3ales on account:
Fe$ruary: R+<<,<<<
V B<P V +<P.......... ,+,<<< ,+,<<<
March: R,<<,<<< V
B<P V @<P, +<P..... )2B,<<< /B,<<< +)2,<<<
April: R2<<,<<< V
B<P V )<P, @<P,
+<P......................... /B,<<< ,,2,<<< C2,<<< /B<,<<<
May: RC<<,<<< V
B<P V )<P, @<P..... @+,<<< 0</,<<< 0@2,<<<
5une: R0<<,<<< V
B<P V )<P............. /<,<<<
/<,<<
<
otal cash collections....
R,2B,<<
<
R2,2,<<
<
R@/<,<<
<
R),@//,<<
<
+. a. &nventory purchases $udget:
April Ma% 9une 9ul%
?udgeted cost of goods
sold...................................
R/+<,<<
<
R2,<,<<
<
R,0<,<<
<
R+B<,<<
<
Add desired ending
inventoryZ.........................
)+2,<<
< @<,<<<
02,<<
<
otal needs.......................... 0/2,<<< @<<,<<< /<2,<<<
=ess $eginning inventory....
B/,<<
<
)+2,<<
<
@<,<<
<
8e4uired inventory
purchases.........................
R/2+,<<
<
R0@/,<<
<
R,,2,<<
<
Z+<P of the ne.t monthGs $udgeted cost of goods sold.
$. 3chedule of e.pected cash dis$ursements for inventory:
Accounts
paya$le, March
,).......................
R)+2,<<< R )+2,<<
<
3olutions Manual, "hapter C +2B
April purchases..... +,),<<< R+,),<<< /2+,<<<
May purchases...... +B@,<<< R+B@,<<< 0@/,<<<
5une purchases...... )2B,<<< )2B,<<<
otal cash
dis$ursements.... R,0@,<<< R0)B,<<< R/00,<<<
R),,,<,<<
<
3olutions Manual, "hapter C +2C
,.
1A8>EA 3A=E3, &A".
"ash ?udget
For the 6uarter Ended 5une ,<
"ash $alance,
$eginning......................
R
0+,<<< R /<,<<< R /<,<<< R0+,<<<
Add collections from
sales............................. ,2B,<<< 2,2,<<< @/<,<<<
),@//,<<
<
otal cash availa$le......... /+<,<<< 2@2,<<< @B<,<<<
),@C2,<<
<
=ess dis$ursements:
!urchases for
inventory.................... ,0@,<<< 0)B,<<< /00,<<< ),,,<,<<<
3elling e.penses........... @C,<<< )+<,<<< 2+,<<< +2),<<<
Administrative
e.penses.................... +0,<<< ,+,<<< +),<<< @B,<<<
=and purchases............. 9 )2,<<< 9 )2,<<<
>ividends paid.............. /C,<<< 9 9 /C,<<<
otal dis$ursements...... 0)<,<<< 2B2,<<< 0,B,<<<
),@,/,<<
<
cash.............................. (C<,<<<* ()<,<<<* +/+,<<< 2+,<<<
Financing:
?orrowings.................... ),<,<<< 0<,<<< 9 )B<,<<<
8epayments.................. 9 9
()B<,<<<
* ()B<,<<<*
&nterestZ....................... 9 9 (/,C<<*
(/,C<<
*
otal 'nancing................. ),<,<<< 0<,<<<
()B/,C<<
*
(/,C<<
*
"ash $alance, ending...... R /<,<<< R /<,<<<
R
0@,)<<
R 0@,)<
<
Z R),<,<<< V )+P V ,H)+
Y
R,,C<
<
R0<,<<< V )+P V +H)+
Y ),<<<
3olutions Manual, "hapter C +@<
R/,C<
<
3olutions Manual, "hapter C +@)
&ro'lem #-1! (2< minutes*
). he sales $udget for the third 4uarter:
Month
9ul% August
Septembe
r 8uarter
?udgeted sales in
units....................... ,<,<<< @<,<<< 0<,<<< )0<,<<<
3elling price per
unit......................... V R)+ V R)+ V R)+ V R)+
?udgeted sales.........
R,2<,<<
< RB/<,<<< R2<<,<<<
R),B<<,<<
<
he schedule of e.pected cash collections from sales:
Accounts
receiva$le, 5une
,<:
R,<<,<<< V 20P.....
R)C0,<<
< R )C0,<<<
5uly sales:
R,2<,<<< V ,<P,
20P........................ )<B,<<<
R+,/,<<
< ,/+,<<<
August sales:
RB/<,<<< V ,<P,
20P........................ +0+,<<< R0/2,<<< @CB,<<<
3eptem$er sales:
R2<<,<<< V ,<P..... )B<,<<< )B<,<<<
otal cash
collections..............
R,<,,<<
<
R/B2,<<
< R@+2,<<<
R),0)0,<<
<
+. he production $udget for 5uly7Dcto$er:
9ul% August
Septemb
er
$ctobe
r
?udgeted sales in units..... ,<,<<< @<,<<< 0<,<<< +<,<<<
Add desired ending
inventory........................ )<,0<< @,0<< ,,<<< ),0<<
otal needs........................ /<,0<< @@,0<< 0,,<<< +),0<<
=ess $eginning inventory. . /,0<< )<,0<< @,0<< ,,<<<
8e4uired production.......... ,2,<<< 2@,<<< /0,0<< )B,0<<
3olutions Manual, "hapter C +@+
&ro'lem #-1! (continued*
,. he direct materials $udget for the third 4uarter:
Month
9ul% August
Septemb
er 8uarter
8e4uired production
(a$ove*.................... ,2,<<< 2@,<<< /0,0<< )/B,0<<
8aw material needs
per unit (feet*.......... V / V / V / V /
!roduction needs
(feet*........................ )//,<<< +2B,<<< )B+,<<< 0C/,<<<
Add desired ending
inventory (feet*........ ),/,<<< C),<<< ,@,<<< Z
,@,<<
< Z
otal needs (feet*....... +@B,<<< ,0C,<<< +)C,<<< 2,),<<<
=ess $eginning
inventory (feet*........ @+,<<<
),/,<<
< C),<<<
@+,<<
<
8aw materials to $e
purchased (feet*...... +<2,<<<
++0,<<
< )+B,<<<
00C,<<
<
"ost of raw materials
to $e purchased at
R<.B< per foot..........
R)2/,B<
<
R)B<,<<
< R)<+,/<<
R//@,+<
<
Z)B,0<< units (Dcto$er* ' V / feet per unit Y @/,<<< feet% '
@/,<<< feet V f Y ,@,<<< feet
he schedule of e.pected cash payments:
9ul% August
Septemb
er 8uarter
Accounts paya$le,
5une ,<....................... R @2,<<< R @2,<<<
5uly purchases:
R)2/,B<< V 0<P,
0<P............................ B+,/<< R B+,/<< )2/,B<<
August purchases:
R)B<,<<< V 0<P,
0<P............................ C<,<<< R C<,<<< )B<,<<<
3eptem$er purchases:
R)<+,/<< V 0<P,
0<P............................ 0),+<< 0),+<<
3olutions Manual, "hapter C +@,
otal cash payments.....
R)0B,/<
<
R)@+,/<
< R)/),+<<
R/@+,<<
<
3olutions Manual, "hapter C +@/
&ro'lem #-1" (2< minutes*
). a. 3chedule of e.pected cash collections:
(ext -earUs 8uarter
First Second ,hird Fourth ,otal
"urrent year9Fourth 4uarter
sales:
R+<<,<<< V ,,P....................... R 22,<<< R 22,<<<
Ae.t year9First 4uarter sales:
R,<<,<<< V 20P....................... )C0,<<< )C0,<<<
R,<<,<<< V ,,P.......................
R CC,<<
< CC,<<<
Ae.t year93econd 4uarter
sales:
R/<<,<<< V 20P....................... +2<,<<< +2<,<<<
R/<<,<<< V ,,P.......................
R),+,<<
< ),+,<<<
Ae.t year9hird 4uarter sales:
R0<<,<<< V 20P....................... ,+0,<<< ,+0,<<<
R0<<,<<< V ,,P.......................
R)20,<<
< )20,<<<
Ae.t year9Fourth 4uarter
sales:
R+<<,<<< V 20P....................... ),<,<<<
),<,<<
<
otal cash collections...................
R+2),<<
<
R,0C,<<
<
R/0@,<<
<
R+C0,<<
<
R),,@+,<<
<
3olutions Manual, "hapter C +@0
&ro'lem #-1" (continued*
$. 3chedule of $udgeted cash dis$ursements for merchandise purchases for ne.t year:
8uarter
First Second ,hird Fourth ,otal
"urrent year9Fourth 4uarter
purchases:
R)+2,<<< V +<P.............................
R +0,+<
<
R +0,+<
<
Ae.t year9First 4uarter purchases:
R)B2,<<< V B<P............................. )/B,B<< )/B,B<<
R)B2,<<< V +<P.............................
R ,@,+<
< ,@,+<<
Ae.t year93econd 4uarter
purchases:
R+/2,<<< V B<P............................. )C2,B<< )C2,B<<
R+/2,<<< V +<P.............................
R /C,+<
< /C,+<<
Ae.t year9hird 4uarter
purchases:
R,<0,<<< V B<P............................. +//,<<< +//,<<<
R,<0,<<< V +<P.............................
R 2),<<
< 2),<<<
Ae.t year9Fourth 4uarter
purchases:
R)+2,<<< V B<P.............................
)<<,B<
<
)<<,B<
<
otal cash payments..........................
R)@/,<<
<
R+,/,<<
<
R+C,,+<
<
R)2),B<
<
RB2,,<<
<
3olutions Manual, "hapter C +@2
+. ?udgeted operating e.penses for ne.t year:
8uarter
?udgeted sales........... R,<<,<<< R/<<,<<< R0<<,<<<
R+<<,<<
<
R),/<<,<<
<
Iaria$le e.pense rate. V )0P V )0P V )0P V )0P V )0P
Iaria$le e.penses....... /0,<<< 2<,<<< @0,<<< ,<,<<< +)<,<<<
Fi.ed e.penses............ 0<,<<< 0<,<<< 0<,<<< 0<,<<< +<<,<<<
otal e.penses............ C0,<<< ))<,<<< )+0,<<< B<,<<< /)<,<<<
=ess depreciation........ +<,<<< +<,<<< +<,<<< +<,<<< B<,<<<
"ash dis$ursements.... R @0,<<< R C<,<<< R)<0,<<< R 2<,<<< R ,,<,<<<
3olutions Manual, "hapter C +@@
,. "ash $udget for ne.t year:
8uarter
"ash $alance, $eginning........
R
)<,<<< R)+,<<<
R
)<,<<<
R
)<,B<< R )<,<<<
Add collections from sales......
+2),<<
< ,0C,<<<
/0@,<<
< +C0,<<< ),,@+,<<<
otal cash availa$le................
+@),<<
< ,@),<<<
/2@,<<
< ,<0,B<< ),,B+,<<<
=ess dis$ursements:
Merchandise purchases....... )@/,<<< +,/,<<< +C,,+<< )2),B<< B2,,<<<
Dperating e.penses
(a$ove*............................. @0,<<< C<,<<< )<0,<<< 2<,<<< ,,<,<<<
>ividends............................ )<,<<< )<,<<< )<,<<< )<,<<< /<,<<<
=and.................................... XX @0,<<<
/B,<<
< XX )+,,<<<
otal dis$ursements...............
+0C,<<
< /<C,<<<
/02,+<
< +,),B<< ),,02,<<<
receipts over
dis$ursements.....................
)+,<<
< (,B,<<<* )<,B<< @/,<<< +2,<<<
Financing:
?orrowings.......................... XX /B,<<< XX XX /B,<<<
8epayments........................ XX XX XX (/B,<<<* (/B,<<<*
&nterestZ.............................. XX XX XX
(,,2<<
* (,,2<<*
3olutions Manual, "hapter C +@B
otal 'nancing........................ XX /B,<<< XX (0),2<<* (,,2<<*
"ash $alance, ending.............
R
)+,<<< R)<,<<<
R
)<,B<<
R
++,/<< R ++,/<<
ZR/B,<<< V )<P V CH)+ Y R,,2<<
3olutions Manual, "hapter C +@C
&ro'lem #-1# ()+< minutes*
"ash sales...................
R,2,<<
< Z
R/,,+<
< R0/,<<<
R),,,+<
<
"redit sales
)
................ +<,<<< Z +/,<<< +B,B<< @+,B<<
otal collections...........
R02,<<
< Z
R2@,+<
< RB+,B<<
R+<2,<<
<
)
/<P of the preceding monthGs sales.
Z1iven.
+. &nventory purchases $udget:
?udgeted cost of
goods sold
)
................
R/0,<<
< Z
R 0/,<<
< Z R2@,0<<
R)22,0<
<
Add desired ending
inventory
+
.................. /,,+<< Z
0/,<<
< +B,B<< +B,B<<
otal needs................... BB,+<< Z
)<B,<<
< C2,,<< )C0,,<<
=ess $eginning
inventory................... ,2,<<< Z
/,,+<
< 0/,<<< ,2,<<<
8e4uired purchases......
R0+,+<
< Z
R 2/,B<
< R/+,,<<
R)0C,,<
<
)
For April sales: R2<,<<< sales V @0P cost ratio Y R/0,<<<.
+
At April ,<: R0/,<<< V Bis$ursements9!urchases
March purchases.......... R+),@0 Z R +),@0 Z
April purchases............ +2,)<< Z R+2,)< Z 0+,+<< Z
May purchases............. ,+,/<< R,+,/< 2/,B<<
5une purchases............. +),)0< +),)0
otal dis$ursements.....
R/@,B0
<
Z
R0B,0<
<
R0,,00
<
R)0C,C<
<
3olutions Manual, "hapter C +B<
Z1iven.
3olutions Manual, "hapter C +B)
&ro'lem #-1# (continued*
,. 3chedule of E.pected "ash >is$ursements9Dperating
E.penses
"ommissions............. R@,+<< Z
R
B,2/<
R)<,B<
< R+2,2/<
8ent........................... +,0<< Z +,0<< +,0<< @,0<<
Dther e.penses......... ,,2<< Z /,,+< 0,/<< ),,,+<
otal dis$ursements...
R),,,<
< Z
R)0,/2
<
R)B,@<
< R/@,/2<
Z1iven.
/. "ash $udget:
"ash $alance,
$eginning................ RB,<<< Z R/,,0< R/,0C< R B,<<<
Add cash collections. . 02,<<< Z 2@,+<< B+,B<< +<2,<<<
otal cash availa$le. . . 2/,<<< Z @),00< B@,,C< +)/,<<<
=ess dis$ursements:
For inventory........... /@,B0< Z 0B,0<< 0,,00< )0C,C<<
For e.penses........... ),,,<< Z )0,/2< )B,@<< /@,/2<
For e4uipment......... ),0<< Z 9 9 ),0<<
otal dis$ursements... 2+,20< Z @,,C2< @+,+0< +<B,B2<
E.cess (de'ciency*
of cash.................... ),,0< Z (+,/)<* )0,)/< 0,)/<
Financing:
?orrowings.............. ,,<<< @,<<< 9 )<,<<<
8epayments............ 9 9 ()<,<<<* ()<,<<<*
&nterest.................... 9 9 (+,<*
)
(+,<*
otal 'nancing........... ,,<<< @,<<< ()<,+,<* (+,<*
"ash $alance,
ending..................... R/,,0< R/,0C< R/,C)< R /,C)<
R,,<<< V )+P V ,H)+
Y
R C<
@,<<< V )+P V +H)+
Y
)/<
otal interest R+,<
Z 1iven.
3olutions Manual, "hapter C +B+
0.
3;&=DO "DM!AAQ
&ncome 3tatement
For the 6uarter Ended 5une ,<
3ales (R2<,<<< \ R@+,<<< \ RC<,<<<*. .
R+++,<<
<
?eginning inventory (1iven*...............
R
,2,<<<
Add purchases (!art +*........................
)0C,,<
<
1oods availa$le for sale...................... )C0,,<<
Ending inventory (!art +*....................
+B,B<
< )22,0<< Z
1ross margin......................................... 00,0<<
"ommissions (!art ,*.......................... +2,2/<
8ent (!art ,*........................................ @,0<<
>epreciation (RC<< V ,*...................... +,@<<
Dther e.penses (!art ,*......................
),,,+
< 0<,)2<
Aet operating income............................ 0,,/<
=ess interest e.pense (!art /*............... +,<
Aet income............................................ R 0,))<
ZA simpler computation would $e: R+++,<<< V @0P Y
R)22,0<<.
3olutions Manual, "hapter C +B,
2.
3;&=DO "DM!AAQ
?alance 3heet
5une ,<
Assets
"urrent assets:
"ash (!art /*......................................................... R /,C)<
Accounts receiva$le (RC<,<<< V /<P*.................. ,2,<<<
&nventory (!art +*.................................................. +B,B<<
otal current assets................................................. 2C,@)<
?uilding and e4uipment9net
(R)+<,<<< \ R),0<< X R+,@<<*.............................. ))B,B<<
otal assets.............................................................
R)BB,0)
<
Accounts paya$le (!art +: R/+,,<< V
0<P*................................................... R +),)0<
3tockholdersG e4uity:
"apital stock (1iven*...........................
R)0<,<<
<
8etained earningsZ............................. )@,,2< )2@,,2<
otal lia$ilities and e4uity......................
R)BB,0)
<
Z 8etained earnings, $eginning............. R)+,+0<
Add net income.................................. 0,))<
8etained earnings, ending................. R)@,,2<
3olutions Manual, "hapter C +B/
&ro'lem #-2$ ()+< minutes*
9anuar%
Februar
% March 8uarter
"ash sales................. R B<,<<< Z
R)+<,<<
< R 2<,<<<
R
+2<,<<<
"redit sales................ ++/,<<< Z ,+<,<<< /B<,<<<
),<+/,<<
<
otal cash
collections...............
R,</,<<
< Z
R//<,<<
<
R0/<,<<
<
R),+B/,<<
<
Z1iven.
+. a. &nventory purchases $udget:
9anuar%
Februar
% March 8uarter
?udgeted cost of
goods sold
)
..........
R+/<,<<
< Z
R,2<,<<
<
R)B<,<<
< R@B<,<<<
Add desired
ending
inventory
+
............ C<,<<< Z /0,<<< ,<,<<< ,<,<<<
otal needs........... ,,<,<<< Z /<0,<<< +)<,<<< B)<,<<<
=ess $eginning
inventory.............. 2<,<<< Z C<,<<< /0,<<< 2<,<<<
8e4uired
purchases............
R+@<,<<
< Z
R,)0,<<
<
R)20,<<
<
R@0<,<<
<
)
For 5anuary sales: R/<<,<<< V 2<P cost ratio Y R+/<,<<<.
+
At 5anuary ,): R,2<,<<< V +0P Y RC<,<<<. At March ,):
R+<<,<<< April sales V 2ecem$er
purchases........... R C,,<<< Z
R C,,<<
< Z
5anuary
purchases........... ),0,<<< Z
R),0,<<
< Z +@<,<<< Z
3olutions Manual, "hapter C +B0
Fe$ruary
purchases........... )0@,0<<
R)0@,0<
< ,)0,<<<
March purchases... B+,0<<
B+,0<
<
otal cash
dis$ursements
for purchases......
R++B,<<
< Z
R+C+,0<
<
R+/<,<<
<
R@2<,0<
<
Z1iven.
3olutions Manual, "hapter C +B2
,. 3chedule of cash dis$ursements for operating e.penses:
9anuar%
Februar
% March 8uarter
3alaries and
wages.................
R
+@,<<< Z
R
+@,<<< R+@,<<<
R
B),<<<
Advertising............ @<,<<< Z @<,<<< @<,<<< +)<,<<<
3hipping................ +<,<<< Z ,<,<<< )0,<<< 20,<<<
Dther e.penses..... )+,<<< Z )B,<<< C,<<< ,C,<<<
otal cash
dis$ursements
for operating
e.penses............
R)+C,<<
< Z
R)/0,<<
<
R)+),<<
<
R,C0,<<
<
Z1iven.
/. "ash $udget:
9anuar%
Februar
% March 8uarter
"ash $alance,
$eginning.................
R
/B,<<< Z
R
,<,<<<
R
,<,B<<
R /B,<<
<
Add cash collections...
,</,<<
< Z
//<,<<
< 0/<,<<<
),+B/,<<
<
otal cash availa$le....
,0+,<<
< Z
/@<,<<
< 0@<,B<<
),,,+,<<
<
=ess dis$ursements:
&nventory
purchases.............. ++B,<<< Z +C+,0<< +/<,<<< @2<,0<<
Dperating
e.penses............... )+C,<<< Z )/0,<<< )+),<<< ,C0,<<<
E4uipment
purchases.............. 9 ),@<< B/,0<< B2,+<<
"ash dividends........
/0,<<
< Z 9 9 /0,<<<
otal dis$ursements. . .
/<+,<<
< Z
/,C,+<
< //0,0<<
),+B2,@<
<
E.cess (de'ciency*
of cash.....................
(0<,<<<
*Z
,<,B<
< )+0,,<< /0,,<<
Financing:
3olutions Manual, "hapter C +B@
?orrowings............... B<,<<< 9 9 B<,<<<
8epayments............. 9 9 (B<,<<<* (B<,<<<*
&nterest
)
................... 9 9
(+,/<<
*
(+,/<<
*
otal 'nancing............
B<,<<
< 9
(B+,/<<
*
(+,/<<
*
"ash $alance,
ending.....................
R
,<,<<<
R
,<,B<<
R
/+,C<<
R /+,C<
<
Z1iven.
)
RB<,<<< V )+P V ,H)+ Y
R+,/<<.
3olutions Manual, "hapter C +BB
0. &ncome statement:
;&==QA8> "DM!AAQ
&ncome 3tatement
3ales.....................................................
R),,<<,<<
<
?eginning inventory (1iven*............... R2<,<<<
Add purchases (!art +*........................ @0<,<<<
1oods availa$le for sale...................... B)<,<<<
Ending inventory (!art +*.................... ,<,<<< @B<,<<< Z
1ross margin......................................... 0+<,<<<
3alaries and wages (!art ,*................ B),<<<
Advertising (!art ,*............................. +)<,<<<
3hipping (!art ,*................................. 20,<<<
>epreciation (R)/,<<< V ,*................ /+,<<<
Dther e.penses (!art ,*...................... ,C,<<< /,@,<<<
Aet operating income............................ B,,<<<
=ess interest e.pense (!art /*............... +,/<<
Aet income............................................ R B<,2<<
Z1iven.
3olutions Manual, "hapter C +BC
2. ?alance sheet:
;&==QA8> "DM!AAQ
?alance 3heet
March ,)
Assets
"urrent assets:
"ash (!art /*.........................................................
R
/+,C<<
Accounts receiva$le (B<P V R,<<,<<<*................ +/<,<<<
&nventory (!art +*.................................................. ,<,<<<
otal current assets................................................. ,)+,C<<
?uildings and e4uipment, net
(R,@<,<<< \ RB2,+<< X R/+,<<<*.......................... /)/,+<<
otal assets.............................................................
R@+@,)<
<
"urrent lia$ilities:
Accounts paya$le (!art +: 0<P V
R)20,<<<*...............................................
R
B+,0<<
"apital stock.............................................
R0<<,<<
<
8etained earningsZ...................................
)//,2<
< 2//,2<<
otal lia$ilities and e4uity............................
R@+@,)<
<
Z 8etained earnings, $eginning.............
R)<C,<<
<
Add net income.................................. B<,2<<
otal................................................... )BC,2<<
>educt cash dividends....................... /0,<<<
8etained earnings, ending..................
R)//,2<
<
3olutions Manual, "hapter C +C<
). "ollection pattern:
Percentage of Sales
Uncollected at 9une
6:3
Percentage to Be
Collected in 9ul%
a. March.............. )fP )fP
$. April................ 2P ($* X (a* Y /fP
c. May................. +<P (c* X ($* Y )/P
d. 5une................. )<<P (d* X (c* Y B<P
Z1iven.
3chedule of e.pected cash collections:
From March sales ()fP V R/,<,<<<*............ R2,/0<
From April sales (/fP V R0C<,<<<*.............. +2,00<
From May sales ()/P V R2/<,<<<*................ BC,2<<
From 5une sales (B<P V R@+<,<<<*................ 0@2,<<<
otal.............................................................. 2CB,2<<
=ess cash discounts (R0@2,<<< V 0<P V
+fP*.......................................................... @,+<<
Aet cash collections...................................... R2C),/<<
+. a. ?udgeted cash payments for raw materials purchases:
Accounts paya$le, 5une ,<................. R)@+,<<<
5uly purchases: f (R,/+,<<< \
R)B,<<<*.......................................... )B<,<<<
otal cash payments........................... R,0+,<<<
$. ?udgeted cash payments for overhead:
&ndirect la$or..................................... R,2,<<<
Ktilities.............................................. ),C<<
!ayroll $ene'ts:
"ompany pension plan
(R@,<<< X RB<<*............................ R 2,+<<
1roup insurance (2 V RC<<*............ 0,/<<
Knemployment insurance................ ),,<<
Iacation pay.................................... )/,)<< +@,<<<
otal cash payments.......................... R2/,C<<
3olutions Manual, "hapter C +C)
,.
OA==A"E !8D>K"3, =>.
"ash ?udget
5uly
"ash $alance, $eginning........................
R
@B,<<<
Add collections from customers............. 2C),/<<
otal cash availa$le................................ @2C,/<<
=ess dis$ursements:
8aw material purchases (a$ove*.......... R,0+,<<<
>irect la$or.......................................... C0,<<<
Dverhead (a$ove*................................ 2/,C<<
Advertising........................................... ))<,<<<
3ales salaries....................................... 0<,<<<
Administrative salaries........................ ,0,<<<
3hipping............................................... +,)<<
E4uipment purchases.......................... /0,<<< @0/,<<<
E.cess (de'ciency* of cash.................... )0,/<<
Financing:
?orrowings........................................... 2<,<<<
8epayments......................................... 9
&nterest................................................ 9
otal 'nancing........................................ 2<,<<<
"ash $alance, ending.............................
R
@0,/<<
/. he statement is incorrect. Even though the cash $udget shows
an overall e.cess of cash during the month, there is no
assurance that shortages will not develop on a day7to7day $asis
during the month. For e.ample, cash receipts may come later
in the month than cash payments9resulting in temporary cash
shortages. Knless cash receipts and payments occur uniformly
over time, cash $udgeting may need to $e done on a weekly or
daily $asis. &n addition, une.pected events can create a cash
shortage.
3olutions Manual, "hapter C +C+
&ro'lem #-22 (C< minutes*
). 9ul% August
Septemb
er
8uarte
r
?udgeted sales...................... 0,<<< 2,<<< @,<<< )B,<<<
Add desired ending
inventoryZ........................... /,B<< 0,2<< 2,<<< 2,<<<
otal needs............................ C,B<< )),2<< ),,<<< +/,<<<
=ess $eginning inventory....... /,<<< /,B<< 0,2<< /,<<<
8e4uired production.............. 0,B<< 2,B<< @,/<< +<,<<<
ZB<P of the ne.t monthGs sales.
+. Material g)<):
9ul% August
Septemb
er 8uarter
8e4uired production
(units*............................. 0,B<< 2,B<< @,/<< +<,<<<
Material g)<) per unit
(ounces*......................... V 2 V 2 V 2 V 2
!roduction needs
(ounces*......................... ,/,B<< /<,B<< //,/<< )+<,<<<
Add desired ending
inventory (ounces*..........
+<,/<
< ++,+<< +,,@<< Z +,,@<<
otal needs (ounces*......... 00,+<< 2,,<<< 2B,)<< )/,,@<<
(ounces*.........................
,0,<<
< +<,/<< ++,+<< ,0,<<<
8aw materials to $e
purchased (ounces*........
+<,+<
< /+,2<< /0,C<< )<B,@<<
"ost of raw materials to
$e purchased at R+./<
per ounce.......................
R/B,/B
<
R)<+,+/
<
R))<,)2
<
R+2<,BB
<
Z Dcto$er production: @,0<< \ 2,/<< X 2,<<< Y @,C<< units.
@,C<< units V 2 ounces per unit Y /@,/<< ounces%
/@,/<< ounces V <.0 Y +,,@<< ounces
3olutions Manual, "hapter C +C,
Material g+)):
9ul% August
Septemb
er 8uarter
8e4uired production
(units*......................... 0,B<< 2,B<< @,/<< +<,<<<
Material g+)) per unit
(pounds*..................... V / V / V / V /
!roduction needs
(pounds*..................... +,,+<< +@,+<< +C,2<< B<,<<<
Add desired ending
inventory (pounds*..... ),,2<< )/,B<< )0,B<< Z )0,B<<
otal needs (pounds*..... ,2,B<< /+,<<< /0,/<< C0,B<<
=ess $eginning
inventory (pounds*..... ,<,<<< ),,2<< )/,B<< ,<,<<<
8aw materials to $e
purchased (pounds*.... 2,B<< +B,/<< ,<,2<< 20,B<<
"ost of raw material to
$e purchased at R0
per pound................... R,/,<<<
R)/+,<<
<
R)0,,<<
< R,+C,<<<
Z
Dcto$er production: @,0<< \ 2,/<< X 2,<<< Y @,C<<
units.
@,C<< units V / pounds per unit Y ,),2<< pounds%
,),2<< pounds V <.0 Y )0,B<< pounds
,. >irect la$or $udget:
!irect )abor
<ours
Units
Produce
d
Per
Unit ,otal
Cost
per
!)<
,otal
Cost
Forming......... +<,<<< <./< B,<<< R)2.<< R)+B,<<<
Assem$ly...... +<,<<< ).<< +<,<<< R)).<< ++<,<<<
Finishing........ +<,<<< <.)< +,<<< R)0.<< ,<,<<<
otal.............. ,<,<<< R,@B,<<<
3olutions Manual, "hapter C +C/
/. Manufacturing overhead $udget:
E.pected production for the year (units*............. 20,<<<
Actual production through 5une ,< (units*........... +@,<<<
E.pected production, 5uly through >ecem$er
(units*............................................................... ,B,<<<
Iaria$le manufacturing overhead rate per unit
(R)/B,0<< [ +@,<<< units*................................ V R0.0<
Iaria$le manufacturing overhead....................... R+<C,<<<
Fi.ed manufacturing overhead (R)B2,<<< [ +*... C,,<<<
otal manufacturing overhead............................. ,<+,<<<
=ess depreciation (RB2,/<< [ +*......................... /,,+<<
"ash dis$ursements for manufacturing
overhead.......................................................... R+0B,B<<
3olutions Manual, "hapter C +C0
Case #-23 (/0 minutes*
). he $udgetary control system has several important
shortcomings that reduce its e#ectiveness and may cause it to
interfere with good performance. 3ome of the shortcomings are
itemized and e.plained $elow.
a. )ac& of Coordinated @oals* Emory had $een led to $elieve
high 4uality output is the goal% it now appears low cost is the
goal. Employees do not know what the goals are and thus
cannot make decisions that further the goals.
$. "nSuence of Uncontrollable Factors* Actual performance
relative to $udget is greatly in-uenced $y uncontrolla$le
factors (i.e., rush orders, lack of prompt maintenance*. hus,
the variance reports serve little purpose for performance
evaluation or for locating controlla$le factors to improve
performance. As a result, the system does not encourage
coordination among departments.
c. ,he Short/2un Perspectives* Monthly evaluations and $udget
tightening on a monthly $asis results in a very short7run
perspective. his results in inappropriate decisions (i.e.,
inspect forklift trucks rather than repair inoperative
e4uipment, fail to report supplies usage*.
d. S%stem !oes (ot Motivate* he $udgetary system appears to
focus on performance evaluation even though most of the
essential factors for that purpose are missing. he focus on
evaluation and the weaknesses take away an important
$ene't of the $udgetary system9employee motivation.
+. he improvements in the $udgetary control system should
correct the de'ciencies descri$ed a$ove. he system should:
a. more clearly de'ne the companyGs o$jectives.
$. develop an accounting reporting system that $etter matches
controlla$le factors with supervisor responsi$ility and
authority.
c. esta$lish $udgets for appropriate time periods that do not
change monthly simply as a result of a change in the prior
monthGs performance.
3olutions Manual, "hapter C +C2
he entire company from top management down should $e
educated in sound $udgetary procedures.
3olutions Manual, "hapter C +C@
Case #-24 ()+< minutes or longer*
). a. 3ales $udget:
?udgeted unit
sales...................... 20,<<< )<<,<<< 0<,<<< +)0,<<<
3elling price per
unit........................
V
R)<
V
R)< V R)< V R)<
otal sales................
R20<,<<
<
R),<<<,<<
<
R0<<,<<
<
R+,)0<,<<
<
$. 3chedule of e.pected cash collections:
Fe$ruary sales
()<P*.....................
R
+2,<<<
R
+2,<<<
March sales
(@<P, )<P*............ +B<,<<< R/<,<<< ,+<,<<<
April sales
(+<P, @<P, )<P*... ),<,<<< /00,<<< R20,<<< 20<,<<<
May sales
(+<P, @<P*............ +<<,<<< @<<,<<< C<<,<<<
5une sales (+<P*...... )<<,<<<
)<<,<<
<
otal cash
collections.............
R/,2,<<
< R2C0,<<< RB20,<<<
R),CC2,<<
<
c. ?udgeted merchandise purchases:
?udgeted unit
sales...................... 20,<<< )<<,<<< 0<,<<< +)0,<<<
Add desired ending
inventoryZ.............
/<,<<
< +<,<<< )+,<<<
)+,<<
<
otal needs............... )<0,<<< )+<,<<< 2+,<<< ++@,<<<
=ess $eginning
inventory...............
+2,<<
< /<,<<< +<,<<<
+2,<<
<
8e4uired purchases..
@C,<<
< B<,<<< /+,<<<
+<),<<
<
"ost of purchases
at R/ per unit.........
R,)2,<<
< R,+<,<<< R)2B,<<<
R B</,<<
<
Z/<P of the ne.t monthGs unit sales.
d. E.pected cash payments for merchandise purchases:
3olutions Manual, "hapter C +CB
Accounts paya$le......
R)<<,<<
<
R )<<,<<
<
April purchases......... )0B,<<< R)0B,<<< ,)2,<<<
May purchases.......... )2<,<<<
R)2<,<<
< ,+<,<<<
5une purchases.......... B/,<<< B/,<<<
otal cash payments.
R+0B,<<
< R,)B,<<<
R+//,<<
<
R B+<,<<
<
3olutions Manual, "hapter C +CC
Case #-24 (continued*
+. EA88&A13 KA=&M&E>
"ash ?udget
For the hree Months Ending 5une ,<
"ash $alance...............
R
@/,<<< R0<,<<< R0<,<<<
R @/,<<
<
Add collections from
customers................. /,2,<<< 2C0,<<< B20,<<<
),CC2,<<
<
otal cash availa$le..... 0)<,<<< @/0,<<< C)0,<<<
+,<@<,<<
<
=ess dis$ursements:
Merchandise
purchases............... +0B,<<< ,)B,<<< +//,<<< B+<,<<<
Advertising............... +<<,<<< +<<,<<< +<<,<<< 2<<,<<<
8ent.......................... )B,<<< )B,<<< )B,<<< 0/,<<<
3alaries..................... )<2,<<< )<2,<<< )<2,<<< ,)B,<<<
"ommissions (/P of
sales*..................... +2,<<< /<,<<< +<,<<< B2,<<<
Ktilities..................... @,<<< @,<<< @,<<< +),<<<
E4uipment
purchases............... 9 )2,<<< /<,<<< 02,<<<
>ividends paid.......... )0,<<< 9 9 )0,<<<
otal dis$ursements.... 2,<,<<< @<0,<<< 2,0,<<<
),C@<,<<
<
receipts over
dis$ursements.......... ()+<,<<<* /<,<<< +B<,<<<
)<<,<<
<
Financing:
?orrowings................ )@<,<<< )<,<<< 9 )B<,<<<
8epayments.............. 9 9 ()B<,<<<* ()B<,<<<*
&nterest..................... 9 9 (0,,<<*Z
(0,,<<
*
otal 'nancing............. )@<,<<< )<,<<< ()B0,,<<*
(0,,<<
*
"ash $alance, ending. .
R
0<,<<< R0<,<<< RC/,@<<
R C/,@<
<
Z R)@<,<<< V )+P V R0,)<<
3olutions Manual, "hapter C ,<<
,H)+............................
R )<,<<< V )+P V
+H)+............................ +<<
otal interest.................. R0,,<<
3olutions Manual, "hapter C ,<)
,. EA88&A13 KA=&M&E>
For the hree Months Ended 5une ,<
3ales revenue (!art ) a.*......................
R+,)0<,<<
<
"ost of goods sold _ R/ per unit....... RB2<,<<<
"ommissions _ /P of sales............... B2,<<<
C/2,<<
<
"ontri$ution margin............................. ),+</,<<<
=ess '.ed e.penses:
Advertising (R+<<,<<< V ,*................ 2<<,<<<
8ent (R)B,<<< V ,*............................ 0/,<<<
3alaries (R)<2,<<< V ,*..................... ,)B,<<<
Ktilities (R@,<<< V ,*.......................... +),<<<
&nsurance (R,,<<< V ,*...................... C,<<<
>epreciation (R)/,<<< V ,*................ /+,<<<
),<//,<<
<
Aet operating income........................... )2<,<<<
=ess interest e.pense (!art +*..............
0,,<
<
Aet income...........................................
R )0/,@<
<
3olutions Manual, "hapter C ,<+
/. EA88&A13 KA=&M&E>
?udgeted ?alance 3heet
5une ,<
Assets
"ash........................................................................
R
C/,@<<
Accounts receiva$le (see $elow*............................. 0<<,<<<
&nventory ()+,<<< units _ R/ per unit*................... /B,<<<
!repaid insurance (R+),<<< X RC,<<<*..................... )+,<<<
!roperty and e4uipment, net
(RC0<,<<< \ R02,<<< X R/+,<<<*.......................... C2/,<<<
otal assets.............................................................
R),2)B,@<
<
)iabilities and Stoc&holdersU E?uit%
Accounts paya$le, purchases (0ividends paya$le................................................... )0,<<<
"apital stock........................................................... B<<,<<<
8etained earnings (see $elow*................................ @)C,@<<
otal lia$ilities and stockholdersG e4uity..................
R),2)B,@<
<
Accounts receiva$le at 5une ,<:
)<P V May sales of R),<<<,<<<.......
R)<<,<<
<
B<P V 5une sales of R0<<,<<<......... /<<,<<<
otal.................................................
R0<<,<<
<
8etained earnings at 5une ,<:
?alance, March ,)...........................
R0B<,<<
<
Add net income (part ,*................... )0/,@<<
otal................................................. @,/,@<<
=ess dividends declared................... )0,<<<
?alance, 5une ,<..............................
R@)C,@<
<
3olutions Manual, "hapter C ,<,
3olutions Manual, "hapter C ,</
Case #-25 (@0 minutes*
). ?efore a cash $udget can $e prepared, the following supporting computations must $e
made:
Cash pa%ments for crossbo1 purchasesG
Februar% March April Ma% 9une 9ul%
?udgeted sales..............
R+,<<<,<<
<
R),B<<,<<
<
R+,+<<,<<
<
R+,0<<,<<
<
R+,B<<,<<
<
R,,<<<,<<
<
"ost of cross$ows
(0<P*.......................... ),<<<,<<< C<<,<<< ),)<<,<<< ),+0<,<<< ),/<<,<<< ),0<<,<<<
"ross$ow purchases:
For ne.t monthGs
salesZ........................ 0/<,<<< 22<,<<< @0<,<<< B/<,<<< C<<,<<<
For this monthGs
salesZZ...................... /<<,<<<
,2<,<<
<
//<,<<
< 0<<,<<< 02<,<<<
otal cost of purchases...
R C/<,<<
<
R),<+<,<<
<
R),)C<,<<
<
R),,/<,<<
<
R),/2<,<<
<
!ayments for
purchases:
Fe$ruary purchases:
C/<,<<< V +<P.........
R )BB,<<
<
March purchases:
),<+<,<<< V B<P,
+<P.......................... B)2,<<<
R +</,<<
<
April purchases:
),)C<,<<< V B<P,
+<P.......................... C0+,<<<
R +,B,<<
<
May purchases:
),,/<,<<< V B<P...... ),<@+,<<<
3olutions Manual, "hapter C ,<0
otal cash payments......
R),<</,<<
<
R),)02,<<
<
R),,)<,<<
<
Z 2<P of ne.t monthGs sales.
ZZ /<P of this monthGs sales.
3olutions Manual, "hapter C ,<2
@eneral and administrative expensesG
Februar
%
March
April Ma% 9une 9ul%
3alaries ()H)+ of annual*...... R /<,<<< R /<,<<< R /<,<<<
!romotion ()H)+ of annual*. . 00,<<< 00,<<< 00,<<<
!roperty ta.es ()H/ of
annual*.............................. 9 9 2<,<<<
&nsurance ()H)+ of annual*... ,<,<<< ,<,<<< ,<,<<<
Ktilities ()H)+ of annual*....... +0,<<< +0,<<< +0,<<<
>epreciation (non7cash
item*.................................. 9 9 9
otal cash payments............
R)0<,<<
<
R)0<,<<
<
R+)<,<<
<
&ncome ta. e.pense:
Aote that R2)+,<<< is the companyGs net income% the income $efore ta. would $e:
R2)+,<<< [ <.2< Y R),<+<,<<<. hus, the income ta. would $e: R),<+<,<<< V <./< Y
R/<B,<<<.
Cash receipts from salesG
Fe$ruary sales: R+,<<<,<<< V /<P........
R B<<,<<
<
R B<<,<<
<
March sales: R),B<<,<<< V 2<P, /<P.... ),<B<,<<<
R @+<,<<
< ),B<<,<<<
April sales: R+,+<<,<<< V 2<P, /<P...... ),,+<,<<<
R BB<,<<
< +,+<<,<<<
May sales: R+,0<<,<<< V 2<P............... ),0<<,<< ),0<<,<<
3olutions Manual, "hapter C ,<@
< <
otal cash receipts.................................
R),BB<,<<
<
R+,</<,<<
<
R+,,B<,<<
<
R2,,<<,<<
<
3olutions Manual, "hapter C ,<B
@iven the above dataA the cash budget can be prepared as follo1sG
"ash $alance, $eginning........................
R
)<<,<<<
R
)<<,<<<
R
)<<,<<<
R
)<<,<<<
Add cash receipts...................................
),BB<,<<
<
+,</<,<<
<
+,,B<,<<
<
2,,<<,<<
<
otal cash availa$le................................
),CB<,<<
<
+,)/<,<<
<
+,/B<,<<
<
2,/<<,<<
<
=ess cash dis$ursements:
"ross$ow purchases............................ ),<</,<<< ),)02,<<< ),,)<,<<< ,,/@<,<<<
Oages (+<P of sales*.......................... //<,<<< 0<<,<<< 02<,<<< ),0<<,<<<
1eneral and administrative................. )0<,<<< )0<,<<< +)<,<<< 0)<,<<<
&ncome ta.es....................................... /<B,<<< 9 9 /<B,<<<
E4uipment and facilities...................... +B,<<<
,+/,<<
< 9 ,0+,<<<
otal dis$ursements...............................
+,<,<,<<
<
+,),<,<<
<
+,<B<,<<
<
2,+/<,<<
<
over dis$ursements............................. (0<,<<<* )<,<<< /<<,<<< )2<,<<<
Financing:
?orrowings........................................... )0<,<<< C<,<<< 9 +/<,<<<
8epayments........................................ 9 9 (+/<,<<<* (+/<,<<<*
&nterest................................................ 9 9 (B,<<<* (B,<<<*
&nvested funds..................................... 9 9
(0+,<<<
* (0+,<<<*
otal 'nancing........................................ )0<,<< C<,<<< (,<<,<<< (2<,<<<*
3olutions Manual, "hapter C ,<C
< *
"ash $alance, ending.............................
R )<<,<<
<
R
)<<,<<<
R
)<<,<<<
R
)<<,<<<
3olutions Manual, "hapter C ,)<
+. "ash $udgeting is particularly important for a rapidly
e.panding company such as "rossMan "orporation $ecause as
sales grow rapidly, so do e.penditures. hese e.penditures
generally precede cash receipts, often $y a considera$le
amount of time, and a growing company must $e prepared to
'nance this increasing gap $etween e.penditures and receipts.
hus, cash $udgeting is essential $ecause it will forewarn
managers of impending cash pro$lems. And, if it $ecomes
necessary to arrange for 'nancing, a cash $udget will often $e
re4uired $y lenders.
3olutions Manual, "hapter )< ,,
,roup E%ercise #-2
). Across7the7$oard cuts may $e politically palata$le and may $e
perceived as fair $y many, $ut they are indiscriminate. "uts are
taken out of programs without regard to their importance to the
university and students.
+. Ohen determining which programs should receive greater or
smaller reductions in their $udgets, administrators must make
judgments a$out which programs can $e cut with the least
harm to central purposes of the university.
,. &f cuts are likely to continue, administrators should $e
particularly vigilant to monitor the 4uality and e#ectiveness of
programs and to closely watch how well programs use 'nancial
resources.
/. o increase understanding and cooperation, the decision7
making process should $e participative. hose who will $e
a#ected $y the decisions should have some say in the decision7
making.
0. ?y allowing individuals to participate in the $udgeting process
and $y attempting to $uild consensus, the animosity that may
$e felt $y those a#ected $y cuts may $e reduced. ;owever,
this is a two7edged sword. Allowing lower7level administrators
to participate in the decision7making may invite turf7protecting
tactics. Moreover, it may $e impossi$le to $uild consensus
$ecause of resistance to change. hese are not easy pro$lems
to deal with.
3olutions Manual, "hapter )< ,/
Chapter 1$
Standard Costs and the Balanced
Scorecard
1$-1 A 4uantity standard indicates how
much of an input should $e used to make
a unit of output. A price standard indicates
how much the input should cost.
1$-2 &deal standards assume perfection
and do not allow for any ineEciency. hus,
ideal standards are rarely, if ever,
attained. !ractical standards can $e
attained $y employees working at a
reasona$le, though eEcient pace and
allow for normal $reaks and work
interruptions.
1$-3 "hronic ina$ility to meet a
standard is likely to $e demoralizing and
may result in decreased productivity.
1$-4 A $udget is usually e.pressed in
terms of total dollars, whereas a standard
is e.pressed on a per unit $asis. A
standard might $e viewed as the
$udgeted cost for one unit.
1$-5 A variance is the di#erence
$etween what was planned or e.pected
and what was actually accomplished. A
standard cost system has at least two
types of variances. A price variance
focuses on the di#erence $etween
standard and actual prices. A 4uantity
variance is concerned with the di#erence
$etween the standard 4uantity of input
allowed for the actual output and the
actual amount of the input used.
1$- Knder management $y e.ception,
managers focus their attention on results
that deviate from e.pectations. &t is
assumed that results that meet
e.pectations do not re4uire investigation.
1$-! 3eparating an overall variance into
a price variance and a 4uantity variance
provides more information. Moreover,
price and 4uantity variances are usually
the responsi$ilities of di#erent managers.
1$-" he materials price variance is
usually the responsi$ility of the purchasing
manager. he materials 4uantity and la$or
eEciency variances are usually the
responsi$ility of production managers and
supervisors.
1$-# he materials price variance can $e
computed either when materials are
purchased or when they are placed into
production. &t is usually $etter to compute
the variance when materials are
purchased since that is when the
purchasing manager, who has
responsi$ility for this variance, has
completed his or her work. &n addition,
recognizing the price variance when
materials are purchased allows the
company to carry its raw materials in the
inventory accounts at standard cost, which
greatly simpli'es $ookkeeping.
1$-1$ his com$ination of variances may
indicate that inferior 4uality materials
were purchased at a discounted price, $ut
the low 4uality materials created
production pro$lems.
1$-11 &f standards are used to 'nd who to
$lame for pro$lems, they can $reed
resentment and undermine morale.
3olutions Manual, "hapter )< ,0
3tandards should not $e used to conduct
witch7hunts, or as a means of 'nding
someone to $lame for pro$lems.
1$-12 3everal factors other than the
contractual rate paid to workers can cause
a la$or rate variance. For e.ample, skilled
workers with high hourly rates of pay can
$e given duties that re4uire little skill and
that call for low hourly rates of pay,
resulting in an unfavora$le rate variance.
Dr unskilled or untrained workers can $e
assigned to tasks that should $e 'lled $y
more skilled workers with higher rates of
pay, resulting in a favora$le rate variance.
Knfavora$le rate variances can also arise
from overtime work at premium rates.
1$-13 &f poor 4uality materials create
production pro$lems, a result could $e
e.cessive la$or time and therefore an
unfavora$le la$or eEciency variance. !oor
4uality materials would not ordinarily
a#ect the la$or rate variance.
1$-14 he varia$le overhead eEciency
variance and the direct la$or eEciency
variance will always $e favora$le or
unfavora$le together if overhead is
applied on the $asis of direct la$or7hours.
?oth variances are computed $y
comparing the num$er of direct la$or7
hours actually worked to the standard
hours allowed. hat is, in each case the
formula is:
EEciency Iariance Y 38(A; X 3;*
Dnly the M38N part of the formula di#ers
$etween the two variances.
1$-15 A statistical control chart is a
graphical aid that helps workers identify
variances that should $e investigated.
Kpper and lower limits are set on the
control chart. Any variances falling
$etween those limits are considered to $e
normal. Any variances falling outside of
those limits are considered a$normal and
are investigated.
1$-1 &f la$or is a '.ed cost and
standards are tight, then the only way to
generate favora$le la$or eEciency
variances is for every workstation to
produce at capacity. ;owever, the output
of the entire system is limited $y the
capacity of the $ottleneck. &f workstations
$efore the $ottleneck in the production
process produce at capacity, the
$ottleneck will $e una$le to process all of
the work in process. &n general, if every
workstation is attempting to produce at
capacity, then work in process inventory
will $uild up in front of the workstations
with the least capacity.
1$-1! A companyGs $alanced scorecard
should $e derived from and support its
strategy. 3ince di#erent companies have
di#erent strategies, their $alanced
scorecards should $e di#erent.
1$-1" he $alanced scorecard is
constructed to support the companyGs
strategy, which is a theory a$out what
actions will further the companyGs goals.
Assuming that the company has 'nancial
goals, measures of 'nancial performance
must $e included in the $alanced
scorecard as a check on the reality of the
theory. &f the internal $usiness processes
improve, $ut the 'nancial outcomes do
not improve, the theory may $e -awed
and the strategy should $e changed.
1$-1# he di#erence $etween the
delivery cycle time and the throughput
time is the waiting period $etween when
an order is received and when production
on the order is started. he throughput
time is made up of process time,
inspection time, move time, and 4ueue
time. hese four elements can $e
classi'ed $etween value7added time
(process time* and non7value7added time
(inspection time, move time, and 4ueue
time*.
1$-2$ An M"E of less than ) means that
the production process includes non7value7
added time. An M"E of <./<, for e.ample,
means that /<P of throughput time
consists of actual processing, and that the
other 2<P consists of moving, inspection,
and other non7value7added activities.
1$-21 Formal entry tends to give
variances more emphasis than o#7the7
3olutions Manual, "hapter )< ,2
record computations. And, the use of
standard costs in the journals simpli'es
the $ookkeeping process $y allowing all
inventories to $e carried at standard,
rather than actual, cost.
3olutions Manual, "hapter )< ,@
E%ercise 1$-1 (+< minutes*
). "ost per )07gallon container...................................R))0.<<
=ess +P cash discount............................................ +.,<
Aet cost................................................................... ))+.@<
Add shipping cost per container (R),< [ )<<*........ ).,<
otal cost per )07gallon container (a*......................R))/.<<
Aum$er of 4uarts per container
()0 gallons V / 4uarts per gallon* ($*................... 2<
3tandard cost per 4uart purchased (a* [ ($*........... R).C<
+. "ontent per $ill of materials.................................... @.2 4uarts
Add allowance for evaporation and
spillage
(@.2 4uarts [ <.C0 Y B.< 4uarts%
B.< 4uarts X @.2 4uarts Y <./ 4uarts*................... <./ 4uarts
otal........................................................................ B.< 4uarts
Add allowance for rejected units
(B.< 4uarts [ /< $ottles*....................................... <.+ 4uarts
3tandard 4uantity per sala$le $ottle of
solvent.................................................................. B.+ 4uarts
,.
"tem
Standard
8uantit%
Standard
Price
Standard
Cost per
Bottle
Echol B.+ 4uarts
R).C< per
4uart R)0.0B
3olutions Manual, "hapter )) ),)
). Aum$er of helmets................................................. ,0,<<<
3tandard kilograms of plastic per helmet................ V <.2
otal standard kilograms allowed............................ +),<<<
3tandard cost per kilogram..................................... V 8M B
otal standard cost..................................................
8M
)2B,<<<
Actual cost incurred (given*....................................
8M
)@),<<<
otal standard cost (a$ove*..................................... )2B,<<<
otal material variance9unfavora$le...................... 8M ,,<<<
+. Actual
6uantity of
&nput, at
Actual !rice
Actual 6uantity of &nput,
at 3tandard !rice
3tandard 6uantity
Allowed for Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
++,0<< kilograms V +),<<< kilogramsZ V
8M B per kilogram 8M B per kilogram
8M )@),<<< Y 8M )B<,<<< Y 8M )2B,<<<

!rice Iariance,
8M C,<<< F
6uantity Iariance,
8M )+,<<< K
otal Iariance,
8M ,,<<< K
Z,0,<<< helmets V <.2 kilograms per helmet Y +),<<<
kilograms
Alternatively:
Materials price variance Y A6 (A! X 3!*
++,0<< kilograms (8M @.2< per kilogramZ X 8M B.<< per
kilogram*
Y 8M C,<<< F
Z 8M )@),<<< [ ++,0<< kilograms Y 8M @.2< per kilogram
Materials 4uantity variance Y 3! (A6 X 36*
8M B per kilogram (++,0<< kilograms X +),<<< kilograms*
Y 8M )+,<<< K
3olutions Manual, "hapter )) ),+
). Aum$er of meals prepared...................................... /,<<<
3tandard direct la$or7hours per
meal..................................................................... V <.+0
otal direct la$or7hours allowed............................... ),<<<
3tandard direct la$or cost per hour......................... V RC.@0
otal standard direct la$or cost............................... RC,@0<
Actual cost incurred................................................ RC,2<<
otal standard direct la$or cost
(a$ove*................................................................. C,@0<
otal direct la$or variance....................................... R )0< Favora$le
+. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
C2< hours V
R)<.<< per hour
C2< hours V
RC.@0 per hour
),<<< hours V
RC.@0 per hour
Y RC,2<< Y RC,,2< Y RC,@0<

8ate Iariance,
R+/< K
EEciency Iariance,
R,C< F
otal Iariance,
R)0< F
Alternatively, the variances can $e computed using the
formulas:
=a$or rate variance Y A;(A8 X 38*
Y C2< hours (R)<.<< per hour X RC.@0 per
hour*
Y R+/< K
=a$or eEciency variance Y 38(A; X 3;*
Y RC.@0 per hour (C2< hours X ),<<<
hours*
Y R,C< F
3olutions Manual, "hapter )) ),,
). Aum$er of items shipped........................................ )+<,<<<
3tandard direct la$or7hours per item....................... V <.<+
otal direct la$or7hours allowed............................... +,/<<
3tandard varia$le overhead cost per hour.............. V R,.+0
otal standard varia$le overhead cost..................... R @,B<<
Actual varia$le overhead cost incurred................... R@,,2<
otal standard varia$le overhead cost
(a$ove*................................................................. @,B<<
otal varia$le overhead variance............................. R //< Favora$le
+. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
+,,<< hours V
R,.+< per hourZ
+,,<< hours V
R,.+0 per hour
+,/<< hours V
R,.+0 per hour
Y R@,,2< Y R@,/@0 Y R@,B<<

Iaria$le Dverhead
3pending Iariance,
R))0 F
Iaria$le Dverhead
EEciency Iariance,
R,+0 F
otal Iariance,
R//< F
ZR@,,2< [ +,,<< hours YR,.+< per hour
Alternatively, the variances can $e computed using the
formulas:
Iaria$le overhead spending variance:
A;(A8 X 38* Y +,,<< hours (R,.+< per hour X R,.+0 per
hour*
Y R))0 F
Iaria$le overhead eEciency variance:
38(A; X 3;* Y R,.+0 per hour (+,,<< hours X +,/<< hours*
Y R,+0 F
3olutions Manual, "hapter )) ),/
E%ercise 1$-5 (/0 minutes*
). M!"Gs previous manufacturing strategy was focused on high7
volume production of a limited range of paper grades. he goal
of this strategy was to keep the machines running constantly to
ma.imize the num$er of tons produced. "hangeovers were
avoided $ecause they lowered e4uipment utilization.
Ma.imizing tons produced and minimizing changeovers helped
spread the high '.ed costs of paper manufacturing across
more units of output. he new manufacturing strategy is
focused on low7volume production of a wide range of products.
he goals of this strategy are to increase the num$er of paper
grades manufactured, decrease changeover times, and
increase yields across non7standard grades. Ohile M!" realizes
that its new strategy will decrease its e4uipment utilization, it
will still strive to optimize the utilization of its high '.ed cost
resources within the con'nes of -e.i$le production. &n an
economistGs terms the old strategy focused on economies of
scale while the new strategy focuses on economies of scope.
+. Employees focus on improving those measures that are used to
evaluate their performance. herefore, strategically7aligned
performance measures will channel employee e#ort towards
improving those aspects of performance that are most
important to o$taining strategic o$jectives. &f a company
changes its strategy $ut continues to evaluate employee
performance using measures that do not support the new
strategy, it will $e motivating its employees to make decisions
that promote the old strategy, not the new strategy. And if
employees make decisions that promote the new strategy,
their performance measures will su#er.
3ome performance measures that would $e appropriate for
M!"Gs old strategy include: e4uipment utilization percentage,
num$er of tons of paper produced, and cost per ton produced.
hese performance measures would not support M!"Gs new
strategy $ecause they would discourage increasing the range
of paper grades produced, increasing the num$er of
changeovers performed, and decreasing the $atch size
produced per run.
3olutions Manual, "hapter )) ),0
E%ercise 1$-5 (continued*
,. 3tudentsG answers may di#er in some details from this solution.
3olutions Manual, "hapter )) ),2
3ales "ontri$ution
margin per
ton
>inancial
ime to 'll
an order
"ustomer satisfaction with
$readth of product o#erings
Aum$er of new
customers ac4uired
Customer
Average change7
over time
Aum$er of di#erent
paper grades
produced
Average
manufacturing
yield
(nternal
Business
&rocess
Aum$er of
employees trained
to support the
-e.i$ility strategy
;earning
and ,ro5th
\
X \
\
X \
\
\ \
/. he hypotheses underlying the $alanced scorecard are
indicated $y the arrows in the diagram. 8eading from the
$ottom of the $alanced scorecard, the hypotheses are:
h &f the num$er of employees trained to support the -e.i$ility
strategy increases, then the average changeover time will
decrease and the num$er of di#erent paper grades produced
and the average manufacturing yield will increase.
h &f the average change7over time decreases, then the time to
'll an order will decrease.
h &f the num$er of di#erent paper grades produced increases,
then the customer satisfaction with $readth of product
o#erings will increase.
h &f the average manufacturing yield increases, then the
contri$ution margin per ton will increase.
h &f the time to 'll an order decreases, then the num$er of new
customers ac4uired, sales, and the contri$ution margin per
ton will increase.
h &f the customer satisfaction with $readth of product o#erings
increases, then the num$er of new customers ac4uired,
sales, and the contri$ution margin per ton will increase.
h &f the num$er of new customers ac4uired increases, then
sales will increase.
Each of these hypotheses is 4uestiona$le to some degree. For
e.ample, the time to 'll an order is a function of additional
factors a$ove and $eyond changeover times. hus, M!"Gs
average changeover time could decrease while its time to 'll
an order increases if, for e.ample, the shipping department
proves to $e incapa$le of eEciently handling greater product
diversity, smaller $atch sizes, and more fre4uent shipments.
he fact that each of the hypotheses mentioned a$ove can $e
4uestioned does not invalidate the $alanced scorecard. &f the
scorecard is used correctly, management will $e a$le to identify
which, if any, of the hypotheses are invalid and modify the
$alanced scorecard accordingly.
3olutions Manual, "hapter )) ),@
E%ercise 1$- (+< minutes*
).
hroughput time
Y
!rocess time \ &nspection time \ Move time
\
6ueue time
Y +.@ days \ <., days \ ).< days \ 0.< days
Y C.< days
+. Dnly process time is value7added time% therefore the
manufacturing cycle eEciency (M"E* is:
7 (alue a))e) ti*e 2"! )a+s
,-E . . . 0"%0
Throu/hput ti*e #"0 )a+s
,. &f the M"E is ,<P, then the complement of this 'gure, or @elivery cycle time
Y Oait time \ hroughput time
Y )/.< days \ C.< days
Y +,.< days
0. &f all 4ueue time in production is eliminated, then the
throughput time drops to only / days (+.@ \ <., \ ).<*. he
M"E $ecomes:
7 (alue a))e) ti*e 2"! )a+s
,-E . . . 0"6!$
Throu/hput ti*e 4"0 )a+s
hus, the M"E increases to 2@.0P. his e.ercise shows 4uite
dramatically how the 5& approach can improve the eEciency of
operations and reduce throughput time.
3olutions Manual, "hapter )) ),B
E%ercise 1$-! (+< minutes*
). he general ledger entry to record the purchase of materials for
the month is:
8aw Materials
()+,<<< meters at R,.+0 per meter*..................... ,C,<<<
Materials !rice Iariance
()+,<<< meters at R<.)< per meter F*........... ),+<<
Accounts !aya$le
()+,<<< meters at R,.)0 per meter*............. ,@,B<<
+. he general ledger entry to record the use of materials for the
month is:
Oork in !rocess
()<,<<< meters at R,.+0 per meter*.....................
,+,0<
<
Materials 6uantity Iariance
(0<< meters at R,.+0 per meter K*....................... ),2+0
8aw Materials
()<,0<< meters at R,.+0 per meter*............. ,/,)+0
,. he general ledger entry to record the incurrence of direct
la$or cost for the month is:
Oork in !rocess (+,<<< hours at R)+.<< per
hour*..................................................................... +/,<<<
=a$or 8ate Iariance
(),C@0 hours at R<.+< per hour K*........................ ,C0
=a$or EEciency Iariance
(+0 hours at R)+.<< per hour F*.................... ,<<
Oages !aya$le
(),C@0 hours at R)+.+< per hour*.................. +/,<C0
3olutions Manual, "hapter )) ),C
E%ercise 1$-" (+< minutes*
). he standard price of a kilogram of white chocolate is
!urchase price, 'nest grade white chocolate............... i@.0<
=ess purchase discount, BP of the purchase price of
i@.0<......................................................................... (<.2<*
3hipping cost from the supplier in ?elgium.................. <.,<
8eceiving and handling cost........................................ <.</
3tandard price per kilogram of white chocolate........... i@.+/
+. he standard 4uantity, in kilograms, of white chocolate in a
dozen trujes is computed as follows:
Material re4uirements......................... <.@<
Allowance for waste............................ <.<,
Allowance for rejects........................... <.<+
3tandard 4uantity of white chocolate.. <.@0
,. he standard cost of the white chocolate in a dozen trujes is
3tandard 4uantity of white chocolate
(a*........................................................ <.@0
kilogram
3tandard price of white chocolate ($*. . . . i@.+/ per kilogram
3tandard cost of white chocolate (a* V
($*........................................................ i0./,
3olutions Manual, "hapter )) )/<
E%ercise 1$-# (,< minutes*
). a. Aotice in the solution $elow that the materials price variance
is computed on the entire amount of materials purchased,
whereas the materials 4uantity variance is computed only on
the amount of materials used in production.
Actual 6uantity
of &nput, at
Actual !rice
Actual 6uantity of
&nput, at 3tandard
!rice
3tandard 6uantity
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
+0,<<< microns V
R<./B per micron
+0,<<< microns V
R<.0< per micron
)B,<<< micronsZ V
R<.0< per micron
Y R)+,<<< Y R)+,0<< Y RC,<<<

!rice Iariance,
R0<< F
+<,<<< microns V R<.0< per micron
Y R)<,<<<
6uantity Iariance,
R),<<< K
Z,,<<< toys V 2 microns per toy Y )B,<<< microns
Alternatively:
+0,<<< microns (R<./B per micron X R<.0< per micron* Y
R0<< F
R<.0< per micron (+<,<<< microns X )B,<<< microns* Y
R),<<< K
3olutions Manual, "hapter )) )/)
E%ercise 1$-# (continued*
$. >irect la$or variances:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
/,<<< hours V
RB.<< per hour
,,C<< hoursZ V
RB.<< per hour
R,2,<<< Y R,+,<<< Y R,),+<<

8ate Iariance,
R/,<<< K
EEciency Iariance,
RB<< K
otal Iariance,
R/,B<< K
Z,,<<< toys V )., hours per toy Y ,,C<< hours
Alternatively:
=a$or rate variance Y A; (A8 X 38*
/,<<< hours (RC.<< per hourZ X RB.<< per hour* Y R/,<<< K
ZR,2,<<< [ /,<<< hours Y RC.<< per hour
=a$or eEciency variance Y 38 (A; X 3;*
RB.<< per hour (/,<<< hours X ,,C<< hours* Y RB<< K
3olutions Manual, "hapter )) )/+
E%ercise 1$-# (continued*
+. A variance usually has many possi$le e.planations. &n
particular, we should always keep in mind that the standards
themselves may $e incorrect. 3ome of the other possi$le
e.planations for the variances o$served at >awson oys appear
$elow:
Materials Price Variancek3ince this variance is favora$le, the
actual price paid per unit for the material was less than the
standard price. his could occur for a variety of reasons including
the purchase of a lower grade material at a discount, $uying in
an unusually large 4uantity to take advantage of 4uantity
discounts, a change in the market price of the material, or
particularly sharp $argaining $y the purchasing department.
Materials 8uantit% Variancek3ince this variance is unfavora$le,
more materials were used to produce the actual output than
were called for $y the standard. his could also occur for a
variety of reasons. 3ome of the possi$ilities include poorly
trained or supervised workers, improperly adjusted machines,
and defective materials.
)abor 2ate Variancek3ince this variance is unfavora$le, the
actual average wage rate was higher than the standard wage
rate. 3ome of the possi$le e.planations include an increase in
wages that has not $een re-ected in the standards,
unanticipated overtime, and a shift toward more highly paid
workers.
)abor EVcienc% Variancek3ince this variance is unfavora$le,
the actual num$er of la$or hours was greater than the standard
la$or hours allowed for the actual output. As with the other
variances, this variance could have $een caused $y any of a
num$er of factors. 3ome of the possi$le e.planations include
poor supervision, poorly trained workers, low 4uality materials
re4uiring more la$or time to process, and machine $reakdowns.
&n addition, if the direct la$or force is essentially '.ed, an
unfavora$le la$or eEciency variance could $e caused $y a
reduction in output due to decreased demand for the companyGs
products.
&t is worth noting that all of these variances could have $een
3olutions Manual, "hapter )) )/,
caused $y the purchase of low 4uality materials at a cut7rate
price.
3olutions Manual, "hapter )) )//
E%ercise 1$-1$ (+< minutes*
). &f the total variance is RC, unfavora$le, and the rate variance
is RB@ favora$le, then the eEciency variance must $e R)B<
unfavora$le, since the rate and eEciency variances taken
together always e4ual the total variance. Unowing that the
eEciency variance is R)B< unfavora$le, one approach to the
solution would $e:
EEciency variance Y 38 (A; X 3;*
RC.<< per hour (A; X )+0 hoursZ* Y R)B< K
RC.<< per hour V A; X R),)+0 Y R)B<ZZ
RC.<< per hour V A; Y R),,<0
A; Y R),,<0 [ RC.<< per hour
A; Y )/0 hours
Z0< jo$s V +.0 hours per jo$ Y )+0 hours
ZZOhen used with the formula, unfavora$le variances are
positive and favora$le variances are negative.
+. 8ate variance Y A; (A8 X 38*
)/0 hours (A8 X RC.<< per hour* Y RB@ F
)/0 hours V A8 X R),,<0 Y XRB@Z
)/0 hours V A8 Y R),+)B
A8 Y R),+)B [ )/0 hours
A8 Y RB./< per hour
ZOhen used with the formula, unfavora$le variances are
3olutions Manual, "hapter )) )/0
E%ercise 1$-1$ (continued*
An alternative approach to each solution would $e to work from
known to unknown data in the columnar model for variance
analysis:
Actual ;ours of
&nput, at the Actual
8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
)/0 hours V
RB./< per hour
)/0 hours V
RC.<< per hourZ
)+0 hours
l
V
RC.<< per hourZ
Y R),+)B Y R),,<0 Y R),)+0

8ate Iariance,
RB@ FZ
EEciency Iariance,
R)B< K
otal Iariance,
RC, KZ
l
0< tune7upsZ V +.0 hours per tune7upZ Y )+0 hours
Z1iven
3olutions Manual, "hapter )) )/2
E%ercise 1$-11 (,< minutes*
). Aum$er of units manufactured................................ +<,<<<
3tandard la$or time per unit................................... V<.,Z
otal standard hours of la$or time allowed.............. 2,<<<
3tandard direct la$or rate per hour......................... VR)+
otal standard direct la$or cost............................... R@+,<<<
Z)B minutes [ 2< minutes per hour Y <.,
hours
Actual direct la$or cost............................................ R@,,2<<
3tandard direct la$or cost....................................... @+,<<<
otal variance9unfavora$le.................................... R),2<<
+. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
0,@0< hours V
R)+.<< per hour
2,<<< hoursZ V
R)+.<< per hour
R@,,2<< Y R2C,<<< Y R@+,<<<

8ate Iariance,
R/,2<< K
EEciency Iariance,
R,,<<< F
otal Iariance,
R),2<< K
Z+<,<<< units V <., hours per unit Y 2,<<< hours
Alternative 3olution:
0,@0< hours (R)+.B< per hourZ X R)+.<< per hour* Y R/,2<< K
ZR@,,2<< [ 0,@0< hours Y R)+.B< per hour
R)+.<< per hour (0,@0< hours X 2,<<< hours* Y R,,<<< F
3olutions Manual, "hapter )) )/@
,. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
0,@0< hours V
R/.<< per hour
2,<<< hours V
R/.<< per hour
R+),B0< Y R+,,<<< Y R+/,<<<

3pending Iariance,
R),)0< F
EEciency Iariance,
R),<<< F
otal Iariance,
R+,)0< F
Iaria$le overhead spending variance Y A; (A8 X 38*
0,@0< hours (R,.B< per hourZ X R/.<< per hour* Y R),)0< F
ZR+),B0< [ 0,@0< hours Y R,.B< per hour
Iaria$le overhead eEciency variance Y 38 (A; X 3;*
R/.<< per hour (0,@0< hours X 2,<<< hours* Y R),<<< F
3olutions Manual, "hapter )) )/B
). Actual 6uantity
of &nput, at
Actual !rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard
6uantity Allowed
for Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
+<,<<< pounds V
R+.,0 per pound
+<,<<< pounds V
R+.0< per pound
)B,/<< poundsZ V
R+.0< per pound
Y R/@,<<< Y R0<,<<< Y R/2,<<<

!rice Iariance,
R,,<<< F
6uantity Iariance,
R/,<<< K
otal Iariance,
R),<<< K
Z/,<<< units V /.2 pounds per unit Y )B,/<< pounds
Alternatively:
+<,<<< pounds (R+.,0 per pound X R+.0< per pound* Y
R,,<<< F
R+.0< per pound (+<,<<< pounds X )B,/<< pounds* Y R/,<<<
K
3olutions Manual, "hapter )) )/C
+. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
@0< hours V
R)+.<< per hour
B<< hoursZ V
R)+.<< per hour
R)<,/+0 Y RC,<<< Y RC,2<<

8ate Iariance,
R),/+0 K
EEciency Iariance,
R2<< F
otal Iariance,
RB+0 K
Z/,<<< units V <.+ hours per unit Y B<< hours
Alternatively:
@0< hours (R),.C< per hourZ X R)+.<< per hour* Y R),/+0 K
Z)<,/+0 [ @0< hours Y R),.C< per hour
R)+.<< per hour (@0< hours X B<< hours* Y R2<< F
3olutions Manual, "hapter )) )0<
E%ercise 1$-13 ()0 minutes*
Aotice in the solution $elow that the materials price variance is
computed for the entire amount of materials purchased,
whereas the materials 4uantity variance is computed only for
the amount of materials used in production.
Actual 6uantity of
&nput, at Actual
!rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for
Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
+<,<<< pounds V
R+.,0 per pound
+<,<<< pounds V
R+.0< per pound
),,B<< poundsZ V
R+.0< per pound
Y R/@,<<< Y R0<,<<< Y R,/,0<<

!rice Iariance,
R,,<<< F
)/,@0< pounds V R+.0< per pound
Y R,2,B@0
6uantity Iariance,
R+,,@0 K
Z,,<<< units V /.2 pounds per unit Y ),,B<< pounds
Alternatively:
+<,<<< pounds (R+.,0 per pound X R+.0< per pound* Y
R,,<<< F
R+.0< per pound ()/,@0< pounds X ),,B<< pounds* Y R+,,@0
K
3olutions Manual, "hapter )) )0)
). 3tudentsG answers may di#er in some details from this solution.
3olutions Manual, "hapter )) )0+
8evenue per employee 3ales
!ro't margin
>inancial
8atio of $illa$le
hours to total hours
Average num$er of
errors per ta.
return
Average time needed
to prepare a return
!ercentage of jo$
o#ers accepted
Employee
morale
Amount of compensation
paid a$ove industry
average
Average num$er of
years to $e promoted
Customer
(nternal Business
&rocesses
;earning
And ,ro5th
\ X
\ \
\
X
"ustomer
satisfaction
with
e#ectiveness
"ustomer
satisfaction
with
eEciency
"ustomer
satisfaction
with
service
Aum$er of new
customers
ac4uired
\ \ \
\
\ \
\
X
+. he hypotheses underlying the $alanced scorecard are
h &f the amount of compensation paid a$ove the industry
average increases, then the percentage of jo$ o#ers
accepted and the level of employee morale will increase.
h &f the average num$er of years to $e promoted decreases,
then the percentage of jo$ o#ers accepted and the level of
employee morale will increase.
h &f the percentage of jo$ o#ers accepted increases, then the
ratio of $illa$le hours to total hours should increase while the
average num$er of errors per ta. return and the average
time needed to prepare a return should decrease.
h &f employee morale increases, then the ratio of $illa$le hours
to total hours should increase while the average num$er of
errors per ta. return and the average time needed to prepare
a return should decrease.
h &f employee morale increases, then the customer satisfaction
with service 4uality should increase.
h &f the ratio of $illa$le hours to total hours increases, then the
revenue per employee should increase.
h &f the average num$er of errors per ta. return decreases,
then the customer satisfaction with e#ectiveness should
increase.
h &f the average time needed to prepare a return decreases,
then the customer satisfaction with eEciency should
increase.
h &f the customer satisfaction with e#ectiveness, eEciency and
service 4uality increases, then the num$er of new customers
ac4uired should increase.
h &f the num$er of new customers ac4uired increases, then
sales should increase.
h &f revenue per employee and sales increase, then the pro't
margin should increase.
3olutions Manual, "hapter )) )0,
e.ample, ArielGs customers may de'ne e#ectiveness as a
function of minimizing their ta. lia$ility which is not necessarily
the same as minimizing the num$er of errors in a ta. return. &f
some of ArielGs customers $ecame aware through a
knowledgea$le third party that Ariel overlooked legal ta.
minimizing opportunities, it is likely that the Mcustomer
satisfaction with e#ectivenessN measure would decline. his
decline would pro$a$ly puzzle Ariel $ecause, although the 'rm
prepared what it $elieved to $e error7free returns, it overlooked
important ta. minimization strategies. &n this e.ample, ArielGs
internal $usiness process measure related to the average
num$er of errors per ta. return does not capture all of the
factors that drive the customersG satisfaction with
e#ectiveness. he fact that each of the hypotheses mentioned
a$ove can $e 4uestioned does not invalidate the $alanced
scorecard. &f the scorecard is used correctly, management will
$e a$le to identify which, if any, of the hypotheses are invalid
and then modify the $alanced scorecard accordingly.
,. he performance measure Mtotal dollar amount of ta. refunds
generatedN would motivate ArielGs employees to aggressively
search for ta. minimization opportunities for its clients.
;owever, employees may $e too aggressive and recommend
4uestiona$le or illegal ta. practices to clients. his undesira$le
$ehavior could generate unfavora$le pu$licity and lead to
major pro$lems for the company as well as its customers.
Dverall, it would pro$a$ly $e unwise to use this performance
measure in ArielGs scorecard.
;owever, if Ariel wanted to create a scorecard measure to
capture this aspect of its client service responsi$ilities, it may
make sense to focus the performance measure on its training
process. !roperly trained employees are more likely to
recognize via$le ta. minimization opportunities.
3olutions Manual, "hapter )) )0/
/. Each oEceGs individual performance should $e $ased on the
scorecard measures only if the measures are controlla$le $y
those employed at the $ranch oEces. &n other words, it would
not make sense to attempt to hold $ranch oEce managers
responsi$le for measures such as the percent of jo$ o#ers
accepted or the amount of compensation paid a$ove industry
average. 8ecruiting and compensation decisions are not
typically made at the $ranch oEces. Dn the other hand, it
would make sense to measure the $ranch oEces with respect
to internal $usiness process, customer, and 'nancial
performance. 1athering this type of data would $e useful for
evaluating the performance of employees at each oEce.
3olutions Manual, "hapter )) )00
). a.
Actual 6uantity
of &nput, at
Actual !rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for Dutput,
at 3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
)<,<<< yards V
R),.B< per yard
)<,<<< yards V
R)/.<< per yard
@,0<< yardsZ V
R)/.<< per yard
Y R),B,<<< Y R)/<,<<< Y R)<0,<<<

!rice Iariance,
R+,<<< F
B,<<< yards V R)/.<< per yard
Y R))+,<<<
6uantity Iariance,
R@,<<< K
Z,,<<< units V +.0 yards per unit Y @,0<< yards
Alternatively:
)<,<<< yards (R),.B< per yard X R)/.<< per yard* Y R+,<<< F
R)/.<< per yard (B,<<< yards X @,0<< yards* Y R@,<<< K
$. he journal entries would $e:
8aw Materials
()<,<<< yards V )/.<< per yard*........................... )/<,<<<
()<,<<< yards V R<.+< per yard F*................ +,<<<
Accounts !aya$le
()<,<<< yards V R),.B< per yard*................. ),B,<<<
Oork in !rocess
(@,0<< yards V R)/.<< per yard*........................... )<0,<<<
(0<< yards K V R)/.<< per yard*.......................... @,<<<
8aw Materials
(B,<<< yards V R)/.<< per yard*................... ))+,<<<
+. a.
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
0,<<< hours V
RB.<< per hour
/,B<< hoursZ V
RB.<< per hour
R/,,<<< Y R/<,<<< Y R,B,/<<

8ate Iariance,
R,,<<< K
EEciency Iariance,
R),2<< K
otal Iariance,
R/,2<< K
Z,,<<< units V ).2 hours per unit Y /,B<< hours
3olutions Manual, "hapter )) )0@
0,<<< hours (RB.2< per hourZ X RB.<< per hour* Y R,,<<< K
ZR/,,<<< [ 0,<<< hours Y RB.2< per hour
RB.<< per hour (0,<<< hours X /,B<< hours* Y R),2<< K
$. he journal entry would $e:
Oork in !rocess
(/,B<< hours V RB.<< per hour*............................ ,B,/<<
=a$or 8ate Iariance
(0,<<< hours V R<.2< per hour K*......................... ,,<<<
(+<< hours K V RB.<< per hour*............................ ),2<<
Oages !aya$le
(0,<<< hours V RB.2< per hour*....................
/,,<<
<
,. he entries are: entry (a*, purchase of materials% entry ($*,
issue of materials to production% and entry (c*, incurrence of
direct la$or cost.
(a* )/<,<<< ))+,<<< ($* ($* )<0,<<<
?al.Z +B,<<< (c* ,B,/<<
Accounts !aya$le Oages !aya$le
),B,<<< (a* /,,<<< (c*
Materials !rice Iariance Materials 6uantity Iariance
+,<<< (a* ($* @,<<<
=a$or 8ate Iariance =a$or EEciency Iariance
(c* ,,<<< (c* ),2<<
Z+,<<< yards of material at a standard cost of R)/.<< per yard
3olutions Manual, "hapter )) )0B
&ro'lem 1$-1 (/0 minutes*
). he standard 4uantity of plates allowed for tests performed
during the month would $e:
?lood tests................................. ),B<<
3mears...................................... +,/<<
otal........................................... /,+<<
!lates per test............................ V +
3tandard 4uantity allowed......... B,/<<
he variance analysis for plates would $e:
Actual 6uantity of
&nput, at Actual
!rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for
Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
)+,<<< plates V
R+.0< per plate
B,/<< plates V
R+.0< per plate
R+B,+<< Y R,<,<<< Y R+),<<<

!rice Iariance,
R),B<< F
)<,0<< plates V R+.0< per plate
Y R+2,+0<
6uantity Iariance,
R0,+0< K
)+,<<< plates (R+.,0 per plateZ X R+.0< per plate* Y R),B<< F
ZR+B,+<< [ )+,<<< plates Y R+.,0 per plate.
R+.0< per plate ()<,0<< plates X B,/<< plates* Y R0,+0< K
3olutions Manual, "hapter )) )0C
&ro'lem 1$-1 (continued*
Aote that all of the price variance is due to the hospitalGs 2P
4uantity discount. Also note that the R0,+0< 4uantity variance
for the month is e4ual to +0P of the standard cost allowed for
plates.
+. a. he standard hours allowed for tests performed during the
month would $e:
?lood tests: <., hour per test V ),B<< tests.... 0/< hours
3mears: <.)0 hour per test V +,/<< tests....... ,2< hours
otal standard hours allowed........................... C<< hours
he variance analysis would $e:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
),)0< hours V
R)/.<< per hour
C<< hours V
R)/.<< per hour
R),,B<< Y R)2,)<< Y R)+,2<<

8ate Iariance,
R+,,<< F
EEciency Iariance,
R,,0<< K
otal Iariance,
R),+<< K
),)0< hours (R)+.<< per hourZ X R)/.<< per hour* Y R+,,<< F
ZR),,B<< [ ),)0< hours Y R)+.<< per hour
R)/.<< per hour (),)0< hours X C<< hours* Y R,,0<< K
3olutions Manual, "hapter )) )2<
$. he policy pro$a$ly should not $e continued. Although the
hospital is saving R+ per hour $y employing more assistants
than senior technicians, this savings is more than o#set $y
other factors. oo much time is $eing taken in performing la$
tests, as indicated $y the large unfavora$le la$or eEciency
variance. And, it seems likely that most (or all* of the
hospitalGs unfavora$le 4uantity variance for plates is
tracea$le to inade4uate supervision of assistants in the la$.
,. he varia$le overhead variances follow:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
),)0< hours V
R2.<< per hour
C<< hours V
R2.<< per hour
R@,B+< Y R2,C<< Y R0,/<<

3pending Iariance,
RC+< K
EEciency Iariance,
R),0<< K
otal Iariance,
R+,/+< K
),)0< hours (R2.B< per hourZ X R2.<< per hour* Y RC+< K
ZR@,B+< [ ),)0< hours Y R2.B< per hour
R2.<< per hour (),)0< hours X C<< hours* Y R),0<< K
Qes, the two variances are closely related. ?oth are computed
$y comparing actual la$or time to the standard hours allowed
for the output of the period. hus, if the la$or eEciency
variance is favora$le (or unfavora$le*, then the varia$le
overhead eEciency variance will also $e favora$le (or
unfavora$le*.
3olutions Manual, "hapter )) )2)
&ro'lem 1$-1! (/0 minutes*
). a. &n the solution $elow, the materials price variance is
computed on the entire amount of materials purchased
whereas the materials 4uantity variance is computed only on
the amount of materials used in production:
Actual 6uantity
of &nput, at
Actual !rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for Dutput,
at 3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
)+,<<< ounces V
R+<.<< per ounce
C,,@0 ouncesZ V
R+<.<< per ounce
R++0,<<< Y R+/<,<<< Y R)B@,0<<

!rice Iariance,
R)0,<<< F
C,0<< ounces V R+<.<< per ounce
Y R)C<,<<<
6uantity Iariance,
R+,0<< K
Z,,@0< units V +.0 ounces per unit Y C,,@0 ounces
Alternatively:
)+,<<< ounces (R)B.@0 per ounceZ X R+<.<< per ounce* Y
R)0,<<< F
ZR++0,<<< [ )+,<<< ounces Y R)B.@0 per ounce
R+<.<< per ounce (C,0<< ounces X C,,@0 ounces* Y R+,0<< K
$. Qes, the contract pro$a$ly should $e signed. he new price of
R)B.@0 per ounce is su$stantially lower than the old price of
R+<.<< per ounce, resulting in a favora$le price variance of
R)0,<<< for the month. Moreover, the material from the new
supplier appears to cause little or no pro$lem in production
as shown $y the small materials 4uantity variance for the
month.
3olutions Manual, "hapter )) )2+
&ro'lem 1$-1! (continued*
+. a.
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
0,2<< hoursZ V
R)+.<< per hour
0,2<< hours V
R)+.0< per hour
0,+0< hoursZZ V
R)+.0< per hour
Y R2@,+<< Y R@<,<<< Y R20,2+0

8ate Iariance,
R+,B<< F
EEciency Iariance,
R/,,@0 K
otal Iariance,
R),0@0 K
Z,0 technicians V )2< hours per technician Y 0,2<<
hours
ZZ,,@0< units V )./ hours per technician Y 0,+0< hrs
Alternatively:
0,2<< hours (R)+.<< per hour X R)+.0< per hour* Y R+,B<< F
R)+.0< per hour (0,2<< hours X 0,+0< hours* Y R/,,@0 K
$. Ao, the new la$or mi. pro$a$ly should not $e continued.
Although it decreases the average hourly la$or cost from
R)+.0< to R)+.<<, there$y causing a R+,B<< favora$le la$or
rate variance, this savings is more than o#set $y a large
unfavora$le la$or eEciency variance for the month. hus,
the new la$or mi. increases overall la$or costs.
3olutions Manual, "hapter )) )2,
,. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
0,2<< hoursZ V
R,.0< per hour
0,+0< hoursZZ V
R,.0< per hour
R)B,+<< Y R)C,2<< Y R)B,,@0

3pending Iariance,
R),/<< F
EEciency Iariance,
R),++0 K
otal Iariance,
R)@0 F
Z ?ased on direct la$or hours:
,0 technicians V )2< hours per technician Y 0,2<<
hours
ZZ ,,@0< units V )./ hours per unit Y 0,+0< hours
Alternatively:
0,2<< hours (R,.+0 per hourZ X R,.0< per hour* Y R),/<< F
ZR)B,+<< [ 0,2<< hours Y R,.+0 per hour
R,.0< per hour (0,2<< hours X 0,+0< hours* Y R),++0 K
?oth the la$or eEciency variance and the varia$le overhead
eEciency variance are computed $y comparing actual la$or7
hours to standard la$or7hours. hus, if the la$or eEciency
variance is unfavora$le, then the varia$le overhead eEciency
variance will $e unfavora$le as well.
3olutions Manual, "hapter )) )2/
&ro'lem 1$-1" (2< minutes*
). a.
Actual 6uantity of
&nput, at Actual
!rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for Dutput,
at 3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
,+,<<< feet V
R/.B< per foot
,+,<<< feet V
R0.<< per foot
+C,2<< feetZ V
R0.<< per foot
Y R)0,,2<< Y R)2<,<<< Y R)/B,<<<

!rice Iariance,
R2,/<< F
6uantity Iariance,
R)+,<<< K
otal Iariance,
R0,2<< K
ZB,<<< foot$alls V ,.@ ft. per foot$all Y +C,2<< feet
,+,<<< feet (R/.B< per foot X R0.<< per foot* Y R2,/<< F
R0.<< per foot (,+,<<< feet X +C,2<< feet* Y R)+,<<< K
$.
8aw Materials (,+,<<< feet V R0.<< per
foot*...................................................................... )2<,<<<
(,+,<<< feet V R<.+< per foot F*................... 2,/<<
Accounts !aya$le
(,+,<<< feet V R/.B< per foot*...................... )0,,2<<
Oork in !rocess
(+C,2<< feet V R0.<< per foot*.............................. )/B,<<<
(+,/<< feet K V R0.<< per foot*............................. )+,<<<
8aw Materials
(,+,<<< feet V R0.<< per foot*...................... )2<,<<<
&ro'lem 1$-1" (continued*
+. a.
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
2,/<< hoursZ V
RB.<< per hour
2,/<< hours V
R@.0< per hour
@,+<< hoursZZ V
R@.0< per hour
Y R0),+<< Y R/B,<<< Y R0/,<<<

8ate Iariance,
R,,+<< K
EEciency Iariance,
R2,<<< F
otal Iariance,
R+,B<< F
Z B,<<< foot$alls V <.B hours per foot$all Y 2,/<<
hours
ZZ B,<<< foot$alls V <.C hours per foot$all Y @,+<<
hours
2,/<< hours (RB.<< per hour X R@.0< per hour* Y R,,+<< K
R@.0< per hour (2,/<< hours X @,+<< hours* Y R2,<<< F
$.
Oork in !rocess (@,+<< hours V R@.0< per
hour*.....................................................................
0/,<<
<
=a$or 8ate Iariance
(2,/<< hours V R<.0< per hour K*......................... ,,+<<
(B<< hours F V R@.0< per hour* ................... 2,<<<
Oages !aya$le
(2,/<< hours V RB.<< per hour*....................
0),+<
<
,. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
2,/<< hours V
R+.@0 per hour
2,/<< hours V
R+.0< per hour
@,+<< hours V
R+.0< per hour
Y R)@,2<< Y R)2,<<< Y R)B,<<<

3pending Iariance,
R),2<< K
EEciency Iariance,
R+,<<< F
otal Iariance,
R/<< F
2,/<< hours (R+.@0 per hour X R+.0< per hour* Y R),2<< K
R+.0< per hour (2,/<< hours X @,+<< hours* Y R+,<<< F
/. Ao. ;e is not correct in his statement. he company has a
large, unfavora$le materials 4uantity variance that should $e
investigated. Also, the overhead spending variance e4uals )<P
of standard, which should also $e investigated.
&t appears that the companyGs strategy to increase output $y
giving raises was e#ective. Although the raises resulted in an
unfavora$le rate variance, this variance was more than o#set
$y a large, favora$le eEciency variance.
3olutions Manual, "hapter )) )2@
0. he variances have many possi$le causes. 3ome of the more
likely causes include the following:
Materials variancesG
Favora$le price variance: Fortunate purchase, inferior 4uality
materials, unusual discount due to 4uantity purchased, drop in
market price, less costly method of freight, outdated or
inaccurate standards.
Knfavora$le 4uantity variance: "arelessness, poorly adjusted
machines, unskilled workers, inferior 4uality materials,
outdated or inaccurate standards.
)abor variancesG
Knfavora$le rate variance: Kse of highly skilled workers,
change in pay scale, overtime, outdated or inaccurate
standards.
Favora$le eEciency variance: Kse of highly skilled workers,
high 4uality materials, new e4uipment, outdated or inaccurate
standards.
Variable overhead variancesG
Knfavora$le spending variance: &ncrease in costs, waste, theft,
spillage, purchases in uneconomical lots, outdated or
Favora$le eEciency variance: 3ame as for la$or eEciency
variance.
3olutions Manual, "hapter )) )2B
&ro'lem 1$-1# (/0 minutes*
). a.
Actual 6uantity of
&nput, at Actual
!rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for
Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
2<,<<< pounds V
R).C0 per pound
2<,<<< pounds V
R+.<< per pound
/0,<<< poundsZ V
R+.<< per pound
Y R))@,<<< Y R)+<,<<< Y RC<,<<<

!rice Iariance,
R,,<<< F
/C,+<< pounds V R+.<< per pound
Y RCB,/<<
6uantity Iariance,
RB,/<< K
Z)0,<<< pools V ,.< pounds per pool Y /0,<<< pounds
2<,<<< pounds (R).C0 per pound X R+.<< per pound* Y
R,,<<< F
R+.<< per pound (/C,+<< pounds X /0,<<< pounds* Y RB,/<<
K
3olutions Manual, "hapter )) )2C
&ro'lem 1$-1# (continued*
$.
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
)),B<< hours V
R@.<< per hour
)),B<< hours V
R2.<< per hour
)+,<<< hoursZ V
R2.<< per hour
Y RB+,2<< Y R@<,B<< Y R@+,<<<

8ate Iariance,
R)),B<< K
EEciency Iariance,
R),+<< F
otal Iariance,
R)<,2<< K
Z)0,<<< pools V <.B hours per pool Y )+,<<< hours
)),B<< hours (R@.<< per hour X R2.<< per hour* Y R)),B<< K
R2.<< per hour ()),B<< hours X )+,<<< hours* Y R),+<< F
3olutions Manual, "hapter )) )@<
c.
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
0,C<< hours V
R,.<< per hour
2,<<< hoursZ V
R,.<< per hour
R)B,+C< Y R)@,@<< Y R)B,<<<

3pending Iariance,
R0C< K
EEciency Iariance,
R,<< F
otal Iariance,
R+C< K
Z)0,<<< pools V <./ hours per pool Y 2,<<< hours
0,C<< hours (R,.)< per hourZ X R,.<< per hour* Y R0C< K
ZR)B,+C< [ 0,C<< hours Y R,.)< per hour
R,.<< per hour (0,C<< hours X 2,<<< hours* Y R,<< F
3olutions Manual, "hapter )) )@)
+. 3ummary of variances:
Material price variance..................... R ,,<<< F
Material 4uantity variance................ B,/<< K
=a$or rate variance.......................... )),B<< K
=a$or eEciency variance.................. ),+<< F
Iaria$le overhead spending
variance......................................... 0C< K
Iaria$le overhead eEciency
variance......................................... ,<< F
Aet variance..................................... R)2,+C< K
he net unfavora$le variance of R)2,+C< for the month caused
the plantGs varia$le cost of goods sold to increase from the
$udgeted level of R)B<,<<< to R)C2,+C<:
?udgeted cost of goods sold at R)+ per pool. .
R)B<,<<
<
Add the net unfavora$le variance, as a$ove... )2,+C<
Actual cost of goods sold................................
R)C2,+C
<
his R)2,+C< net unfavora$le variance also accounts for the
di#erence $etween the $udgeted net operating income and the
actual net operating income for the month.
?udgeted net operating income...................... R,2,<<<
>educt the net unfavora$le variance added
to cost of goods sold for the month............... )2,+C<
Aet operating income...................................... R )C ,@)<
,. he two most signi'cant variances are the materials 4uantity
variance and the la$or rate variance. !ossi$le causes of the
variances include:
Materials 4uantity
variance:
Dutdated standards, unskilled
workers, poorly adjusted
machines, carelessness, poorly
trained workers, inferior 4uality
materials.
=a$or rate variance: Dutdated standards, change in
pay scale, overtime pay.
3olutions Manual, "hapter )) )@+
&ro'lem 1$-2$ (2< minutes*
). ?oth companies view training as important% $oth companies
need to leverage technology to succeed in the marketplace%
and $oth companies are concerned with minimizing defects.
here are numerous di#erences $etween the two companies.
For e.ample, Applied !harmaceuticals is a product7focused
company and >estination 8esorts &nternational (>8&* is a
service7focused company. Applied !harmaceuticalsG training
resources are focused on their engineers $ecause they hold the
key to the success of the organization. >8&Gs training resources
are focused on their front7line employees $ecause they hold
the key to the success of their organization. Applied
!harmaceuticalsG technology investments are focused on
supporting the innovation that is inherent in the product
development side of the $usiness. >8&Gs technology
investments are focused on supporting the day7to7day
e.ecution that is inherent in the customer interface side of the
$usiness. Applied !harmaceuticals de'nes a defect from an
internal manufacturing standpoint, while >8& de'nes a defect
from an e.ternal customer interaction standpoint.
3olutions Manual, "hapter )) )@,
&ro'lem 1$-2$ (continued*
+. 3tudentsG answers may di#er in some details from this solution.
Applied &harmaceuticals
3olutions Manual, "hapter )) )@/
8eturn on
3tockholdersG
E4uity
>inancial
"ustomer perception of
'rst7to7market
capa$ility
"ustomer perception
of product 4uality
Customer
8J> Qield >efect rates
(nternal
Business
&rocess
>ollars invested in
engineering
technology
!ercentage of jo$
o#ers accepted
>ollars invested in
engineering training per
engineer
;earning
and
,ro5th
\
\ \
\ X
\ \
\
1estination =esorts (nternational
3olutions Manual, "hapter )) )@0
3ales
>inancial
Aum$er of repeat customers
Customer
!ercentage of
error7free repeat
customer check7ins
Average time to
resolve customer
complaint
8oom
cleanliness
(nternal
Business
&rocess
Aum$er of employees
receiving data$ase
training
Employee
turnover
3urvey of
employee
morale
;earning
and
,ro5th
X
\
\
\
\
X
\
\
,. he hypotheses underlying the $alanced scorecards are
indicated $y the arrows in each diagram. 8eading from the
$ottom of each $alanced scorecard, the hypotheses are:
Applied &harmaceuticals
o &f the dollars invested in engineering technology increase,
then the 8J> yield will increase.
o &f the percentage of jo$ o#ers accepted increases, then the
8J> yield will increase.
o &f the dollars invested in engineering training per engineer
increase, then the 8J> yield will increase.
o &f the 8J> yield increases, then customer perception of 'rst7
to7market capa$ility will increase.
o &f the defects per million opportunities decrease, then the
customer perception of product 4uality will increase.
o &f the customer perception of 'rst7to7market capa$ility
increases, then the return on stockholdersG e4uity will
increase.
o &f the customer perception of product 4uality increases, then
the return on stockholdersG e4uity will increase.
1estination =esort (nternational
o &f the employee turnover decreases, then the percentage of
error7free repeat customer check7ins and room cleanliness
will increase and the average time to resolve customer
complaints will decrease.
o &f the num$er of employees receiving data$ase training
increases, then the percentage of error7free repeat customer
check7ins will increase.
o &f employee morale increases, then the percentage of error7
free repeat customer check7ins and room cleanliness will
increase and the average time to resolve customer
complaints will decrease.
o &f the percentage of error7free repeat customer check7ins
increases, then the num$er of repeat customers will
increase.
o &f the room cleanliness increases, then the num$er of repeat
customers will increase.
3olutions Manual, "hapter )) )@2
o &f the average time to resolve customer complaints
decreases, then the num$er of repeat customers will
increase.
o &f the num$er of repeat customers increases, then sales will
increase.
3olutions Manual, "hapter )) )@@
e.ample, in the case of Applied !harmaceuticals, 8J> yield is
not the sole driver of the customersG perception of 'rst7to7
market capa$ility. More speci'cally, if Applied !harmaceuticals
e.perimented with nine possi$le drug compounds in year one
and three of those compounds proved to $e successful in the
marketplace it would result in an 8J> yield of ,,P. &f in year
two, it e.perimented with four possi$le drug compounds and
two of those compounds proved to $e successful in the
marketplace it would result in an 8J> yield of 0<P. Ohile the
8J> yield has increased from year one to year two, it is 4uite
possi$le that the customerGs perception of 'rst7to7market
capa$ility would decrease. he fact that each of the
hypotheses mentioned a$ove can $e 4uestioned does not
invalidate the $alanced scorecard. &f the scorecard is used
correctly, management will $e a$le to identify which, if any, of
the hypotheses are invalid and the $alanced scorecard can
then $e appropriately modi'ed.
3olutions Manual, "hapter )) )@B
&ro'lem 1$-21 (,< minutes*
). a., $., and c.
Month
4 5 6 7
hroughput time9days:
!rocess time (.*............................. +.) +.< ).C ).B
&nspection time.............................. <.2 <.@ <.@ <.2
Move time...................................... <./ <., <./ <./
6ueue time.................................... /., 0.< 0.B 2.@
otal throughput time (y*................ @./ B.< B.B C.0
Manufacturing cycle eEciency
(M"E*:
!rocess time (.* [
hroughput time (y*..................... +B./P+0.elivery cycle time9days:
Oait time from order to start of
production.................................... )2.< )@.0 )C.< +<.0
hroughput time............................. @./ B.< B.B C.0
otal delivery cycle time................. +,./ +0.0 +@.B ,<.<
+. All of the performance measures display unfavora$le trends.
hroughput time per unit is increasing9largely $ecause of an
increase in 4ueue time. Manufacturing cycle eEciency is
declining and delivery cycle time is increasing. &n addition, the
percentage of on7time deliveries has dropped as has the total
throughput.
3olutions Manual, "hapter )) )@C
,. a. and $.
Month
; E
hroughput time9days:
!rocess time (.*.................................................... ).B ).B
&nspection time..................................................... <.2 <.<
Move time............................................................. <./ <./
6ueue time........................................................... <.< <.<
otal throughput time (y*...................................... +.B +.+
Manufacturing cycle eEciency (M"E*:
!rocess time (.* [ hroughput time (y*................ 2/.,P B).BP
As a company reduces non7value7added activities, the
manufacturing cycle eEciency increases rapidly. he goal, of
course, is to have an eEciency of )<<P. his will $e achieved
when all non7value7added activities have $een eliminated and
process time is e4ual to throughput time.
3olutions Manual, "hapter )) )B<
&ro'lem 1$-22 (,< minutes*
). 3ale. 4uantity standard:
8e4uired per )<7liter $atch (C.2 liters [ <.B*. )+.< liters
=oss from rejected $atches ()H0 V )+ liters*. . +./ liters
otal 4uantity per good $atch........................ )/./ liters
Ayclyn 4uantity standard:
8e4uired per )<7liter $atch ()+ kilograms [
<.B*.............................................................. )0.<
kilogram
s
=oss from rejected $atches ()H0 V )0
kilograms*................................................... ,.<
kilogram
s
otal 4uantity per good $atch........................ )B.<
kilogram
s
!rotet 4uantity standard:
8e4uired per )<7liter $atch............................ 0.<
kilogram
s
=oss from rejected $atches ()H0 V 0
kilograms*................................................... ).<
kilogram
s
otal 4uantity per good $atch........................ 2.<
kilogram
s
+. otal minutes per B7hour day............................ /B< minutes
=ess rest $reaks and cleanup........................... 2< minutes
!roductive time each day................................. /+< minutes
!roductive time each day /+< minutes per day
Y Y)+ $atches per day
ime re4uired per $atch ,0 minutes per $atch
ime re4uired per $atch................................... ,0 minutes
8est $reaks and clean up time
(2< minutes [ )+ $atches*............................ 0 minutes
otal................................................................. /< minutes
=oss from rejected $atches ()H0 V /<
minutes*........................................................ B minutes
otal time per good $atch................................ /B minutes
3olutions Manual, "hapter )) )B)
,. 3tandard cost card:
Standard
8uantit% or
,ime
Standard Price
or 2ate
Standar
d Cost
3ale.................... )/./ liters R).0< per liter R+).2<
Ayclyn................. )B.<
kilogram
s R+.B< per kilogram 0<./<
!rotet.................. 2.<
kilogram
s R,.<< per kilogram )B.<<
=a$or time...........
/B
or <.B
minutes,
hour RC.<< per hour @.+<
otal standard
cost per
accepta$le
$atch................ RC@.+<
3olutions Manual, "hapter )) )B+
). Materials price variance Y (A6 V A!* X (A6 V 3!*
(R/+/,B<<* X ()B<,<<< yards V R+./< per yard* Y R@,+<< F
+. a. and $.
)ot (umber
7H 7= ;: ,otal
3tandard yards:
Knits in lot (dozen* ),0<< C0< +,)<< /,00<
3tandard yards per
dozen V ,+ V ,+ V ,+ V ,+
otal yards allowed
/B,<<
<
,<,/<
< 2@,+<< )/0,2<<
Actual yards used
/B,,<
<
,<,)/
< 2@,+0< )/0,2C<
6uantity variance in yards ,<< K +2< F 0< K C< K
6uantity variance in
dollars
_ R+./< per yard R@+< K R2+/ F R)+< K R+)2 K
,. =a$or rate variance Y (A; V A8* X (A; V 38*
(R)C+,+B<* X (+0,,<< hoursZ V R@.0< per hour* Y R+,0,< K
ZB,C<< hours \ 2,),< hours \ )<,+@< hours Y +0,,<< hours
/. a. and $.
)ot (umber
7H 7= ;: ,otal
3tandard hours:
Knits in lot (dozen* ),0<< C0< +,)<< /,00<
3tandard hours per
dozen V 2 V 2 V 2 V 2
otal standard hours
C,<<< 0,@<< )+,2<<
+@,,<
<
!ercentage completed
V )<<P V )<<P
V B<
P
otal standard hours
allowed C,<<< 0,@<< )<,<B<
+/,@B
<
Actual hours worked B,C<< 2,),< )<,+@<
+0,,<
<
3olutions Manual, "hapter )) )B,
=a$or eEciency
variance in hours )<< F /,< K )C< K
0+
< K
=a$or eEciency
variance in dollars _
R@.0< per hour R@0< F R,,++0 K R),/+0 K
R,,C<
< K
3olutions Manual, "hapter )) )B/
0. 3ome supervisors and managers rarely deal with, or think in
terms of, dollars in their daily work. &nstead they think in terms
of hours, units, eEciency, and so on. For these managers, it
may $e $etter to e.press 4uantity variances in units (hours,
yards, etc.* rather than in dollars. For other managers, 4uantity
variances e.pressed in terms of dollars may $e more useful9
particularly to convey a notion of the materiality of the
variance. &n some cases, managers may prefer that the
variances $e e.pressed in terms of $oth dollars and units.
Dn the other hand, price variances e.pressed in units (hours,
yards* would make little sense. 3uch variances should always
$e e.pressed in dollars.
3olutions Manual, "hapter )) )B0
). a. Materials 4uantity variance Y 3! (A6 X 36*
R0.<< per foot (A6 X C,2<< feetZ* Y R/,0<< K
R0.<< per foot V A6 X R/B,<<< Y R/,0<<ZZ
R0.<< per foot V A6 Y R0+,0<<
A6 Y )<,0<< feet
Z R,,+<< units V , foot per unit
ZZ Ohen used with the formula, unfavora$le variances
are positive and favora$le variances are
negative.
herefore, R00,20< [ )<,0<< feet Y R0.,< per foot
$. Materials price variance Y A6 (A! X 3!*
)<,0<< feet (R0.,< per foot X R0.<< per foot* Y R,,)0< K
he total variance for materials would $e:
Materials price variance.......................................... R,,)0< K
Materials 4uantity variance..................................... /,0<< K
otal variance.......................................................... R@,20< K
Alternative approach to parts (a* and ($*:
Actual 6uantity of
&nput, at Actual
!rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for Dutput,
at 3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
)<,0<< feet V
R0.,< per foot
)<,0<< feet V
R0.<< per footZ
C,2<< feetZZ V
R0.<< per footZ
Y R00,20<Z Y R0+,0<< Y R/B,<<<

!rice Iariance,
R,,)0< K
6uantity Iariance,
R/,0<< KZ
otal Iariance,
R@,20< K
Z 1iven
ZZ ,,+<< units V , foot per unit Y C,2<< feet
3olutions Manual, "hapter )) )B2
+. a. =a$or rate variance Y A; (A8 X 38*
/,C<< hours (R@.0< per hourZ X 38* Y R+,/0< FZZ
R,2,@0< X /,C<< hours V 38 Y XR+,/0<ZZZ
/,C<< hours V 38 Y R,C,+<<
38 Y RB.<<
Z R,2,@0< [ /,C<< hours
ZZ R),20< F \ RB<< K.
ZZZ Ohen used with the formula, unfavora$le
variances are positive and favora$le variances
are negative.
$. =a$or eEciency variance Y 38 (A; X 3;*
RB per hour (/,C<< hours X 3;* Y RB<< K
R,C,+<< X RB per hour V 3; Y RB<<Z
RB per hour V 3; Y R,B,/<<
3; Y /,B<< hours
Z Ohen used with the formula, unfavora$le variances are
Alternative approach to parts (a* and ($*:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
/,C<< hoursZ V
RB.<< per hour
/,B<< hours V
RB.<< per hour
R,2,@0<Z Y R,C,+<< Y R,B,/<<

8ate Iariance,
R+,/0< F
EEciency Iariance,
RB<< KZ
otal Iariance,
R),20< FZ
Z1iven.
c. he standard hours allowed per unit of product would $e:
3olutions Manual, "hapter )) )B@
/,B<< hours [ ,,+<< units Y ).0 hours per unit
3olutions Manual, "hapter )) )BB
&ro'lem 1$-25 (@0 minutes*
). a. ?efore the variances can $e computed, we must 'rst
compute the standard and actual 4uantities of material per
hockey stick. he computations are:
>irect materials added to work in
process (a*............................................................
R))0,+<
<
3tandard direct materials cost per foot
($*......................................................................... R,.<<
3tandard 4uantity of direct materials (a*
[ ($*..................................................................... ,B,/<< feet
3tandard 4uantity of direct materials (a*................. ,B,/<< feet
Aum$er of sticks produced ($*................................ B,<<<
3tandard 4uantity per stick (a* [ ($*....................... /.B feet
Actual 4uantity of direct materials used per stick last year:
/.B feet \ <.+ feet Y 0.< feet.
Oith these 'gures, the variances can $e computed as follows:
Actual 6uantity
of &nput, at
Actual !rice
Actual 6uantity of
&nput, at 3tandard
!rice
3tandard 6uantity
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
2<,<<< feet V
R,.<< per foot
,B,/<< feet V
R,.<< per foot
R)@/,<<< Y R)B<,<<< Y R))0,+<<

!rice Iariance,
R2,<<< F
/<,<<< feetZ V R,.<< per foot
Y R)+<,<<<
6uantity Iariance,
R/,B<< K
ZB,<<< units V 0.< feet per unit Y /<,<<< feet
3olutions Manual, "hapter )) )BC
2<,<<< feet (R+.C< per footZ X R,.<< per foot* Y R2,<<< F
ZR)@/,<<< [ 2<,<<< feet Y R+.C< per foot
R,.<< per foot (/<,<<< feet X ,B,/<< feet* Y R/,B<< K
$.
8aw Materials (2<,<<< feet V R,.<< per
foot*......................................................................
)B<,<<
<
(2<,<<< feet V R<.)< per foot F*...................... 2,<<<
Accounts !aya$le
(2<,<<< feet V R+.C< per foot*.........................
)@/,<<
<
Oork in !rocess (,B,/<< feet V R,.<< per
foot*......................................................................
))0,+<
<
(),2<< feet K V R,.<< per foot*............................. /,B<<
8aw Materials (/<,<<< feet V R,.<< per
foot*.................................................................
)+<,<<
<
3olutions Manual, "hapter )) )C<
+. a. ?efore the variances can $e computed, we must 'rst
determine the actual direct la$or hours worked for last year.
his can $e done through the varia$le overhead eEciency
variance, as follows:
R).,< per hour V (A; X )2,<<< hoursZ* Y R20< K
R).,< per hour V A; X R+<,B<< Y R20<ZZ
R).,< per hour V A; Y R+),/0<
A; Y R+),/0< [ R).,< per hour
A; Y )2,0<< hours
Z B,<<< units V +.< hours per unit Y )2,<<< hours
ZZ Ohen used in the formula, an unfavora$le variance is
positive.
Oe must also compute the standard rate per direct la$or
hour. he computation is:
=a$or rate variance Y (A; V A8* X (A; V 38*
R@C,+<< X ()2,0<< hours V 38* Y R,,,<< F
R@C,+<< X )2,0<< hours V 38 Y XR,,,<<Z
)2,0<< hours V 38 Y RB+,0<<
38 Y RB+,0<< [ )2,0<< hours
38 Y R0.<< per hour
Z Ohen used in the formula, a favora$le variance is negative.
3olutions Manual, "hapter )) )C)
1iven these 'gures, the variances are:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
)2,0<< hours V
R0.<< per hour
)2,<<< hours V
R0.<< per hour
R@C,+<< Y RB+,0<< Y RB<,<<<

8ate Iariance,
R,,,<< F
EEciency Iariance,
R+,0<< K
otal Iariance,
RB<< F
)2,0<< hours (R/.B< per hourZ X R0.<< per hour* Y R,,,<< F
Z@C,+<< [ )2,0<< hours Y R/.B< per hour
R0.<< per hour ()2,0<< hours X )2,<<< hours* Y R+,0<< K
$. Oork in !rocess
()2,<<< hours V R0.<< per hour*.......................... B<,<<<
(0<< hours K V R0.<< per hour*............................ +,0<<
=a$or 8ate Iariance
()2,0<< hours V R<.+< per hour F*................... ,,,<<
Oages !aya$le
()2,0<< hours V R/.B< per hour*..................... @C,+<<
3olutions Manual, "hapter )) )C+
,. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
(A; V A8* (A; V 38* (3; V 38*
)2,0<< hours V
R).,< per hour
)2,<<< hours V
R).,< per hour
R)C,B<< Y R+),/0< Y R+<,B<<

3pending Iariance,
R),20< F
EEciency Iariance,
R20< K
otal Iariance,
R),<<< F
)2,0<< hours (R).+< per hourZ X R).,< per hour* Y R),20< F
ZR)C,B<< [ )2,0<< hours Y R).+< per hour
R).,< per hour ()2,0<< hours X )2,<<< hours* Y R20< K
3olutions Manual, "hapter )) )C,
/. For materialsG
Favora$le price variance: >ecrease in outside purchase price%
fortunate $uy% inferior 4uality materials% unusual discounts
due to 4uantity purchased% less costly method of freight%
Knfavora$le 4uantity variance: &nferior 4uality materials%
carelessness% poorly adjusted machines% unskilled workers%
For laborG
Favora$le rate variance: Knskilled workers (paid lower rates*%
piecework% inaccurate standards.
Knfavora$le eEciency variance: !oorly trained workers% poor
4uality materials% faulty e4uipment% work interruptions% '.ed
la$or and insuEcient demand to 'll capacity% inaccurate
standards.
For variable overheadG
Favora$le spending variance: >ecrease in supplier prices% less
usage of lu$ricants or indirect materials than planned%
Knfavora$le eEciency variance: 3ee comments under direct
la$or eEciency variance a$ove.
0.
Standard
8uantit% or
<ours
Standard
Price or 2ate
Standard
Cost
>irect materials /.B feet R,.<< per foot R)/./<
>irect la$or +.< hours R0.<< per hour )<.<<
Iaria$le overhead +.< hours R).,< per hour +.2<
otal standard cost R+@.<<
3olutions Manual, "hapter )) )C/
&ro'lem 1$-2 (2< minutes*
). 3tandard cost for March production:
Materials................................................................. R)2,B<<
>irect la$or............................................................. )<,0<<
Iaria$le manufacturing overhead............................ /,+<<
otal standard cost (a*............................................. R,),0<<
Aum$er of $ackpacks produced ($*......................... ),<<<
3tandard cost of a single $ackpack (a* [ ($*........... R,).0<
+. 3tandard cost of a single $ackpack (a$ove*............. R,).0<
>educt di#erence $etween standard and actual
cost...................................................................... <.)0
Actual cost per $ackpack........................................ R,).,0
,.
otal standard cost of materials used during
March (a*.............................................................. R)2,B<<
Aum$er of $ackpacks produced during March ($*. . ),<<<
3tandard materials cost per $ackpack (a* [ ($*..... R)2.B<
3tandard materials cost per $ackpack R)2.B< per $ackpack
Y
3tandard materials cost per yard R2.<< per yard
Y +.B yards per $ackpack
/. 3tandard cost of material used.......
R)2,B<
<
Actual cost of material used............ )0,<<<
otal variance..................................
R
),B<< F
he price and 4uantity variances together e4ual the total
variance. &f the 4uantity variance is R),+<< K, then the price
variance must $e R,,<<< F:
!rice variance.................................
R
,,<<< F
6uantity variance............................ ),+<< K
otal variance..................................
R
),B<< F
3olutions Manual, "hapter )) )C0
Actual 6uantity
of &nput, at
Actual !rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for
Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
,,<<< yards V
R0.<< per yard
,,<<< yards V
R2.<< per yardZ
+,B<< yardsZZ V
R2.<< per yardZ
Y R)0,<<<Z Y R)B,<<< Y R)2,B<<Z

!rice Iariance,
R,,<<< F
6uantity Iariance,
R),+<< KZ
otal Iariance,
R),B<< F
Z 1iven.
ZZ ),<<< units V +.B yards per unit Y +,B<< yards
0. he 'rst step in computing the standard direct la$or rate is to
determine the standard direct la$or7hours allowed for the
monthGs production. he standard direct la$or7hours can $e
computed $y working with the varia$le manufacturing
overhead costs, since they are $ased on direct la$or7hours
worked:
3tandard varia$le manufacturing overhead cost for
March (a*......................................................................
R/,+<
<
3tandard varia$le manufacturing overhead rate per
direct la$or7hour ($*...................................................... R,.<<
3tandard direct la$or7hours for March (a* [ ($*............... ),/<<
otal standard direct la$or cost for March R)<,0<<
Y
otal standard direct la$or7hours for March ),/<< >=;s
YR@.0< per >=;
3olutions Manual, "hapter )) )C2
2. ?efore the la$or variances can $e computed, it is necessary to
compute the actual direct la$or cost for the month:
Actual cost per $ackpack produced (part
+*.......................................................................... R,).,0
Aum$er of $ackpacks produced.............................. V ),<<<
otal actual cost of production................................. R,),,0<
=ess: Actual cost of materials.................................. R)0,<<<
Actual cost of varia$le manufacturing
overhead...................................................... ,,2<< )B,2<<
Actual cost of direct la$or........................................ R)+,@0<
Oith this information, the variances can $e computed:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
),0<< hoursZ V
R@.0< per hour
R)+,@0< Y R)),+0< R)<,0<<Z

8ate Iariance,
R),0<< K
EEciency Iariance,
R@0< K
otal Iariance,
R+,+0< K
Z1iven.
3olutions Manual, "hapter )) )C@
@. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
),0<< hoursZ V
R,.<< per hourZ
R,,2<<Z Y R/,0<< R/,+<<Z

3pending Iariance,
RC<< F
EEciency Iariance,
R,<< K
otal Iariance,
R2<< F
Z1iven.
B.
Standard
8uantit% or
<ours
Standard
Price or
2ate
Standar
d
Cost
>irect materials +.B yards
)
R2 per yard R)2.B<
>irect la$or )./ hours
+
R@.0< per
hour
,
)<.0<
Iaria$le
manufacturing
overhead )./ hours R, per hour /.+<
otal standard cost R,).0<
)
From part ,.
+
),/<< standard hours (from part 0* [ ),<<< $ackpacks
Y )./ hours per $ackpack.
,
From part 0.
3olutions Manual, "hapter )) )CB
&ro'lem 1$-2! (@0 minutes*
).
Actual 6uantity of
&nput, at Actual
!rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for
Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
0)<,<<< feet V
R,.+< per foot
0)<,<<< feet V
R,.<< per foot
0/<,<<< feetZ V
R,.<< per foot
Y R),2,+,<<< Y R),0,<,<<< Y R),2+<,<<<

!rice Iariance,
R)<+,<<< K
6uantity Iariance,
RC<,<<< F
otal Iariance,
R)+,<<< K
Z,<,<<< units V )B feet per unit Y 0/<,<<< feet
0)<,<<< feet (R,.+< per foot X R,.<< per foot* Y R)<+,<<< K
R, per foot (0)<,<<< feet X 0/<,<<< feet* Y RC<,<<< F
Qes, the decrease in waste is apparent $ecause of the RC<,<<<
favora$le 4uantity variance.
&f the company wants to continue to compute the material price
variance, then the standard price per foot should $e changed
to re-ect current 5& purchase costs. he old standard price of
R,.<< per foot is no longer relevant.
3olutions Manual, "hapter )) )CC
+. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
C<,<<< hours V
R@.B0 per hour
C<,<<< hours V
RB.<< per hour
@0,<<< hoursZ V
RB.<< per hour
Y R@<2,0<< Y R@+<,<<< Y R2<<,<<<

8ate Iariance,
R),,0<< F
EEciency Iariance,
R)+<,<<< K
otal Iariance,
R)<2,0<< K
Z,<,<<< units V +.0 hours per unit Y @0,<<< hours
C<,<<< hours (R@.B0 per hour X RB.<< per hour* Y R),,0<< F
RB.<< per hour (C<,<<< hours X @0,<<< hours* Y R)+<,<<< K
3olutions Manual, "hapter )) +<<
Ao, the la$or eEciency variance is not appropriate as a
measure of performance in this situation. he reasons are:
L =a$or is largely a '.ed cost rather than a varia$le cost since the
company maintains a sta$le workforce to operate its -ow line.
hus, the variance is not an e#ective measure of eEciency.
L &n a 5& environment the goal is to produce only as needed to
meet demand. his often con-icts with the goal of having high
la$or eEciency, which re4uires that la$or $e fully utilized
producing output. &f that output is not really demanded $y
customers, the result of fully utilizing la$or is a $uildup of
e.cess work in process and 'nished goods inventories. his is
anathema in a 5& environment. Knfortunately, the situation
posed in the pro$lem is a common one as companies switch
from a traditional system to 5&, and sometimes 5& doesnGt work
$ecause of misplaced emphasis on eEciency variances. &n a 5&
setting, it is an interesting parado. that one of the McostsN of
greater eEciency on the production line is greater MineEciencyN
on the part of la$or as it is occasionally idle or as it spends time
at various tasks other than producing goods.
3olutions Manual, "hapter )) +<)
,. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
C<,<<< hours V
R+.B< per hour
@0,<<< hoursZ V
R+.B< per hour
R+<@,<<< Y R+0+,<<< Y R+)<,<<<

3pending Iariance,
R/0,<<< F
EEciency Iariance,
R/+,<<< K
otal Iariance,
R,,<<< F
Z,<,<<< units V +.0 hours per unit Y @0,<<< hours
Iaria$le overhead spending variance Y A; V A8 X A; V 38
R+<@,<<< X C<,<<< hours V R+.B< per hour Y R/0,<<< F
R+.B< per hour (C<,<<< hours X @0,<<< hours* Y R/+,<<< K
&t is dou$tful that a correlation still e.ists $etween direct la$or
and varia$le manufacturing overhead cost. >irect la$or time is
now largely a '.ed cost. Iaria$le manufacturing overhead,
however, will tend to rise and fall with actual changes in
production. &f varia$le manufacturing overhead cost was indeed
correlated with direct la$or, then the actual varia$le
manufacturing overhead cost for 5une should have $een a$out
R+0+,<<< (C<,<<< hours V R+.B< per hour*. ?ut actual varia$le
manufacturing overhead cost was far $elow this 'gure, as
shown $y the large favora$le spending variance for the month.
&ndeed, the actual varia$le manufacturing overhead cost of
R+<@,<<< is very near the R+)<,<<< standard cost allowed for
the monthGs output. hus, it appears that as production has
$een cut $ack, varia$le manufacturing overhead cost has also
decreased, even though direct la$or time has remained 4uite
sta$le.
3olutions Manual, "hapter )) +<+
/. a. and $.
Month
April Ma% 9une
hroughput time9hours:
!rocessing time (.*............................................... +.2 +.0 +./
&nspection time..................................................... )., <.C <.)
Move time............................................................. ).C )./ <.2
6ueue time........................................................... B.+ 0.+ ).C
otal throughput time (y*...................................... )/.< )<.< 0.<
!rocessing time (.* [ hroughput
time (y*.............................................................. )B.2P +0. <P /B.<P
Aote that the manufacturing cycle eEciency has improved
dramatically over the last three months. his means that non7
value7added time is $eing eliminated.
0. Knder 5& the goal of the company is to produce to meet
demand rather than to just 'll la$or time. hus, the traditional
la$or variances are often unfavora$le. hroughput time and
M"E focus on all elements of manufacturing9not just la$or
time. hese other elements, which are independent of la$or
time, are showing greater eEciency each month as the
company eliminates non7value7added activities.
hroughput time and M"E are more appropriate in this situation
since they focus on those elements that are of greatest
importance in a 5& environment. he la$or eEciency variance
has little or no signi'cance in such an environment.
3olutions Manual, "hapter )) +<,
=earning
and
1rowth
&nternal
?usiness
!rocesses
Financial
"ustomer
&ro'lem 1$-2" (/0 minutes*
). 3tudentsG answers may di#er in some details from this solution.
3olutions Manual, "hapter )) +</
Oeekly pro't
Oeekly
sales
Aum$er of
menu items
>ining area
cleanliness
!ercentag
e of
kitchen
sta#
completin
g cooking
course
\
\
\
\
"ustomer
satisfaction with
service
"ustomer
satisfaction with
menu choices
\ \
Average time
to prepare an
order
Average time
to take an
order
!ercentag
e of dining
room sta#
completing
hospitality
course
\
\
X
X
+. he hypotheses underlying the $alanced scorecard are
o &f the percentage of dining room sta# who complete the
$asic hospitality course increases, then the average time to
take an order will decrease.
o &f the percentage of dining room sta# who complete the
$asic hospitality course increases, then dining room
cleanliness will improve.
o &f the percentage of kitchen sta# who complete the $asic
cooking course increases, then the average time to prepare
an order will decrease.
o &f the percentage of kitchen sta# who complete the $asic
cooking course increases, then the num$er of menu items
will increase.
o &f the dining room cleanliness improves, then customer
satisfaction with service will increase.
o &f the average time to take an order decreases, then
customer satisfaction with service will increase.
o &f the average time to prepare an order decreases, then
customer satisfaction with service will increase.
o &f the num$er of menu items increases, then customer
satisfaction with menu choices will increase.
o &f customer satisfaction with service increases, weekly sales
will increase.
o &f customer satisfaction with menu choices increases, weekly
sales will increase.
o &f sales increase, weekly pro'ts for the =odge will increase.
e.ample, the items added to the menu may not appeal to
customers. 3o even if the num$er of menu items increases,
customer satisfaction with the menu choices may not increase.
he fact that each of the hypotheses can $e 4uestioned does
not, however, invalidate the $alanced scorecard. &f the
scorecard is used correctly, management will $e a$le to identify
which, if any, of the hypotheses are incorrect. ]3ee $elow.^
3olutions Manual, "hapter )) +<0
,. Management will $e a$le to tell if a hypothesis is false if an
improvement in a performance measure at the $ottom of an
arrow does not, in fact, lead to improvement in the
performance measure at the tip of the arrow. For e.ample, if
the num$er of menu items is increased, $ut customer
satisfaction with the menu choices does not increase,
management will immediately know that something was wrong
with that particular hypothesis.
3olutions Manual, "hapter )) +<2
&ro'lem 1$-2# (/0 minutes*
he answers $elow are not the only possi$le answers. &ngenious
people can 'gure out many di#erent ways of making performance
look $etter even though it really isnGt. his is one of the reasons
for a balanced scorecard. ?y having a num$er of di#erent
measures that ultimately are linked to overall 'nancial goals,
MgamingN the system is more diEcult.
). 3peed7to7market can $e improved $y taking on less am$itious
projects. &nstead of working on major product innovations that
re4uire a great deal of time and e#ort, 8J> may choose to
work on small, incremental improvements in e.isting products.
here is also a danger that in the rush to push products out the
door, the products will $e inade4uately tested and developed.
+. !erformance measures that are ratios or percentages present
special dangers. A ratio can $e increased either $y increasing
the numerator or $y decreasing the denominator. Ksually, the
intention is to increase the numerator in the ratio, $ut a
manager may react $y decreasing the denominator instead. &n
this case (which actually happened*, the managers pulled
telephones out of the high7crime areas. his eliminated the
pro$lem for the managers, $ut was not what the "ED or the
city oEcials had intended. hey wanted the phones '.ed, not
eliminated.
,. &n real life, the production manager simply added several
weeks to the delivery cycle time. &n other words, instead of
promising to deliver an order in four weeks, the manager
promised to deliver in si. weeks. his increase in delivery cycle
time did not, of course, please customers and drove some
$usiness away, $ut it dramatically improved the percentage of
orders delivered on time.
3olutions Manual, "hapter )) +<@
/. As stated a$ove, ratios can $e improved $y changing either the
numerator or the denominator. Managers who are under
pressure to increase the revenue per employee may 'nd it
easier to eliminate employees than to increase revenues. Df
course, eliminating employees may reduce total revenues and
total pro'ts, $ut the revenue per employee will increase as long
as the percentage decline in revenues is less than the
percentage cut in num$er of employees. 3uppose, for e.ample,
that a manager is responsi$le for $usiness units with a total of
),<<< employees, R)+< million in revenues, and pro'ts of R+
million. Further suppose that a manager can eliminate one of
these $usiness units that has +<< employees, revenues of R)<
million, and pro'ts of R).+ million.
Before
eliminating the
business unit
After
eliminating the
business unit
otal revenue R)+<,<<<,<<< R))<,<<<,<<<
otal employees ),<<< B<<
8evenue per
employee R)+<,<<< R),@,0<<
otal pro'ts R+,<<<,<<< RB<<,<<<
As these e.amples illustrate, performance measures should $e
selected with a great deal of care and managers should avoid
placing too much emphasis on any one performance measure.
3olutions Manual, "hapter )) +<B
&ro'lem 1$-3$ (,< minutes*
). a., $., and c.
Month
4 5 6 7
hroughput time in days:
!rocess time +.) +.< ).C ).B
&nspection time <.B <.@ <.@ <.@
Move time <., <./ <./ <.0
6ueue time during production
+.B /./ 2.< @.<
otal throughput time 2.< @.0 C.< )<.<
Manufacturing cycle eEciency
(M"E*:
!rocess time [ hroughput
time ,0.elivery cycle time in days:
Oait time to start of production
C.< )).0 )+.< )/.<
hroughput time 2.< @.0 C.< )<.<
otal delivery cycle time )0.< )C.< +).< +/.<
+. a. Areas where the company is improving:
8ualit% control* he num$er of defects has decreased $y
over 0<P in the last four months. Moreover, $oth warranty
claims and customer complaints are down sharply. &n short,
overall 4uality appears to have signi'cantly improved.
Material control* he purchase order lead time is only half of
what it was four months ago, which indicates that purchases
are arriving in less time. his trend may $e a result of the
companyGs move toward 5& purchasing.
!eliver% performance* he process time has decreased from
+.) days to ).B days over the last four months.
3olutions Manual, "hapter )) +<C
$. Areas of deterioration:
Material control* 3crap as a percentage of total cost has
tripled over the last four months.
Machine performance* Machine downtime has dou$led over
the last four months. his may $e a result of the greater
setup time, or it may just re-ect e#orts to get the new
e4uipment operating properly. Also note that use of the
machines as a percentage of availa$ility is declining rapidly.
he use of the machines may $e declining as a conse4uence
of the shift to 5&. Machines may $e utilized less $ecause they
are not $eing used to $uild e.cess inventories.
!eliver% performance* All delivery performance measures
are moving in the wrong direction. hroughput time and
delivery cycle time are $oth increasing, and the
manufacturing cycle eEciency is decreasing.
,. a. and $.
Month
; E
hroughput time in days:
!rocess time......................................................... ).B ).B
&nspection time..................................................... <.@ <.<
Move time............................................................. <.0 <.0
6ueue time during production.............................. <.< <.<
otal throughput time........................................... ,.< +.,
!rocess time [ hroughput time........................... 2<.<P @B.,P
As non7value7added activities are eliminated, the
manufacturing cycle eEciency improves. he goal, of course, is
to have an eEciency of )<<P. his is achieved when all non7
value7added activities have $een eliminated and process time
e4uals throughput time.
3olutions Manual, "hapter )) +)<
his pro$lem is more diEcult than it looks. Allow ample time for
discussion.
).
Actual 6uantity of
&nput, at Actual
!rice
Actual 6uantity
of &nput, at
3tandard !rice
3tandard 6uantity
Allowed for
Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
)+,<<< yards V
R/.<< per yardZ
)),+<< yardsZZ V
R/.<< per yardZ
R/0,2<< Y R/B,<<< Y R//,B<<

!rice Iariance,
R+,/<< F
6uantity Iariance,
R,,+<< K
otal Iariance,
RB<< K
Z R++./< [ 0.2 yards Y R/.<< per yard
ZZ +,<<< sets V 0.2 yards per set Y )),+<< yards
)+,<<< yards (R,.B< per yardZ X R/.<< per yard* Y R+,/<< F
ZR/0,2<< [ )+,<<< yards Y R,.B< per yard
R/.<< per yard ()+,<<< yards X )),+<< yards* Y R,,+<< K
3olutions Manual, "hapter )) +))
+. Many students will miss parts + and , $ecause they will try to
use product costs as if they were hourl% costs. !ay particular
attention to the computation of the standard direct la$or time
per unit and the standard direct la$or rate per hour.
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
+,B<< hours V
R2.<< per hourZ
,,<<< hoursZZ V
R2.<< per hourZ
R)B,+<< Y R)2,B<< Y R)B,<<<

8ate Iariance,
R),/<< K
EEciency Iariance,
R),+<< F
otal Iariance,
R+<< K
Z +,B0< standard hours [ ),C<< sets Y ).0 standard hours
per set, RC.<< standard cost per set [ ).0 standard
hours per set Y R2.<< standard rate per hour.
ZZ +,<<< sets V ).0 standard hours per set Y ,,<<< standard
hours.
+,B<< hours (R2.0< per hourZ X R2.<< per hour* Y R),/<< K
ZR)B,+<< [ +,B<< hours Y R2.0< per hour
R2.<< per hour (+,B<< hours X ,,<<< hours* Y R),+<< F
3olutions Manual, "hapter )) +)+
,. Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
+,B<< hours V
R+./< per hourZ
,,<<< hours V
R+./< per hourZ
R@,<<< Y R2,@+< Y R@,+<<

3pending Iariance,
R+B< K
EEciency Iariance,
R/B< F
otal Iariance,
R+<< F
ZR,.2< standard cost per set [ ).0 standard hours per set
Y R+./< standard rate per hour
+,B<< hours (R+.0< per hourZ X R+./< per hour* Y R+B< K
ZR@,<<< [ +,B<< hours Y R+.0< per hour
R+./< per hour (+,B<< hours X ,,<<< hours* Y R/B< F
3olutions Manual, "hapter )) +),
). 3tandard cost for a ten7gallon $atch of rasp$erry sher$et.
>irect material:
8asp$erries (@.0 4uarts
)
V R<.B< per 4uart*......... R2.<<
Dther ingredients ()< gallons V R<./0 per
gallon*................................................................ /.0< R)<.0<
>irect la$or:
3orting ()B minutes
+
[ 2< minutes per hour*
V RC.<< per hour................................................ +.@<
?lending ()+ minutes [ 2< minutes per hour*
V RC.<< per hour................................................ ).B< /.0<
!acking (/< 4uarts
,
V R<.,B per 4uart*................. )0.+<
3tandard cost per ten7gallon $atch......................... R,<.+<
)
2 4uarts V (0 [ /* Y @.0 4uarts re4uired to o$tain 2 accepta$le
4uarts.
+
, minutes per 4uart V 2 4uarts.
,
/ 4uarts per gallon V )< gallons Y /< 4uarts.
+. a. &n general, the purchasing manager is held responsi$le for
unfavora$le material price variances. "auses of these
variances include the following:
L &ncorrect standards.
L Failure to correctly forecast price increases.
L !urchasing in nonstandard or uneconomical lots.
L Failure to take availa$le purchase discounts.
L Failure to control transportation costs.
L !urchasing from suppliers other than those o#ering the
most favora$le terms.
;owever, failure to meet price standards may $e caused $y a
rush of orders or changes in production schedules. &n this
case, the responsi$ility for unfavora$le material price
variances should rest with the sales manager or the manager
of production planning. Iariances may also $e caused $y
e.ternal events that are uncontrolla$le, e.g., a strike at a
supplierGs plant.
3olutions Manual, "hapter )) +)/
$. &n general, the production manager or foreman is held
responsi$le for unfavora$le la$or eEciency variances.
"auses of these variances include the following:
L &ncorrect standards.
L !oorly trained la$or.
L 3u$standard or ineEcient e4uipment.
L &nade4uate supervision.
L Machine $reakdowns from poor maintenance.
L !oorly motivated employees.
L Fi.ed la$or force with demand less than capacity.
Failure to meet la$or eEciency standards may also $e
caused $y the use of inferior materials or poor production
planning. &n these cases, responsi$ility should rest with the
purchasing manager or the manager of production planning.
Iariances may also $e caused $y e.ternal events that are
uncontrolla$le, e.g., low unemployment leading to the
ina$ility to hire and retain skilled workers.
3olutions Manual, "hapter )) +)0
=earning
and
1rowth
&nternal
?usiness
!rocesses
"ustomer
Financial
Case 1$-33 (2< minutes*
). 3tudent answers may di#er concerning which category9
learning and growth, internal $usiness processes, customers, or
'nancial9a particular performance measure $elongs to.
3olutions Manual, "hapter )) +)2
otal pro't
Average age of
accounts
receiva$le
Oritten7o#
accounts
receiva$le as a
percentage of
sales
"ustomer
satisfaction with
accuracy of
charge account
$ills
!ercentage of
charge account
$ills containing
errors
Knsold inventory
at end of season
as a percentage
of total cost of
sales
!ercentage of
suppliers making
just7in7time
deliveries
!ercentage of sales
clerks trained to
correctly enter
data on charge
account slips
\
\
\
\
Case 1$-33 (continued*

A num$er of the performance measures suggested $y
managers have not $een included in the a$ove $alanced
scorecard. he e.cluded performance measures may have an
impact on total pro't, $ut they are not linked in any o$vious
way with the two key pro$lems that have $een identi'ed $y
management9accounts receiva$les and unsold inventory. &f
every performance measure that potentially impacts pro't is
included in a companyGs $alanced scorecard, it would $ecome
unwieldy and focus would $e lost.
+. he results of operations can $e e.ploited for information a$out
the companyGs strategy. Each link in the $alanced scorecard
should $e regarded as a hypothesis of the form M&f ..., then ...N.
For e.ample, the $alanced scorecard on the previous page
contains the hypothesis M&f customers e.press greater
satisfaction with the accuracy of their charge account $ills,
then the average age of accounts receiva$le will improve.N &f
customers in fact do e.press greater satisfaction with the
accuracy of their charge account $ills, $ut the average age of
accounts receiva$le does not improve, this would have to $e
considered evidence that is inconsistent with the hypothesis.
Management should try to 'gure out why the average age of
receiva$les has not improved. (3ee the answer $elow for
possi$le e.planations.* he answer may suggest a shift in
strategy.
&n general, the most important results are those that provide
evidence inconsistent with the hypotheses em$edded in the
$alanced scorecard. 3uch evidence suggests that the
companyGs strategy needs to $e ree.amined.
3olutions Manual, "hapter )) +)@
,. a. his evidence is inconsistent with two of the hypotheses
underlying the $alanced scorecard. he 'rst of these
hypotheses is M&f customers e.press greater satisfaction with
the accuracy of their charge account $ills, then the average
age of accounts receiva$le will improve.N he second of
these hypotheses is M&f customers e.press greater
satisfaction with the accuracy of their charge account $ills,
then there will $e improvement in $ad de$ts.N here are a
num$er of possi$le e.planations. wo possi$ilities are that
the companyGs collection e#orts are ine#ective and that the
companyGs credit reviews are not working properly. &n other
words, the pro$lem may not $e incorrect charge account $ills
at all. he pro$lem may $e that the procedures for collecting
overdue accounts are not working properly. Dr, the pro$lem
may $e that the procedures for reviewing credit card
applications let through too many poor credit risks. &f so, this
would suggest that e#orts should $e shifted from reducing
charge account $illing errors to improving the internal
$usiness processes dealing with collections and credit
screening. And in that case, the $alanced scorecard should
$e modi'ed.
$. his evidence is inconsistent with three hypotheses. he 'rst
of these is M&f the average age of receiva$les declines, then
pro'ts will increase.N he second hypothesis is M&f the
written7o# accounts receiva$le decrease as a percentage of
sales, then pro'ts will increase.N he third hypothesis is M&f
unsold inventory at the end of the season as a percentage of
cost of sales declines, then pro'ts will increase.N
Again, there are a num$er of possi$le e.planations for the
lack of results consistent with the hypotheses. Managers
may have decreased the average age of receiva$les $y
simply writing o# old accounts earlier than was done
previously. his would actually decrease reported pro'ts in
the short term. ?ad de$ts as a percentage of sales could $e
decreased $y drastically cutting $ack on e.tensions of credit
to customers9perhaps even canceling some charge
accounts. (?ad de$ts would $e zero if there were no credit
3olutions Manual, "hapter )) +)B
sales.* his would have the e#ect of reducing $ad de$ts, $ut
might irritate otherwise loyal credit customers and reduce
sales and pro'ts.
3olutions Manual, "hapter )) +)C
he reduction in unsold inventories at the end of the season
as a percentage of cost of sales could have occurred for a
num$er of reasons that are not necessarily good for pro'ts.
For e.ample, managers may have $een too cautious a$out
ordering goods to restock low inventories9creating
stockouts and lost sales. Dr, managers may have cut prices
drastically on e.cess inventories in order to eliminate them
$efore the end of the season. his may have reduced the
willingness of customers to pay the storeGs normal prices. Dr,
managers may have gotten rid of e.cess inventories $y
selling them to discounters before the end of the season.
3olutions Manual, "hapter )) ++<
Case 1$-34 (,< minutes*
his case may $e diEcult for some students to grasp since it
re4uires looking at standard costs from an entirely di#erent
perspective. &n this case, standard costs have $een
inappropriately used as a means to manipulate reported earnings
rather than as a way to control costs.
). =ansing has evidently set very loose standards in which the
standard prices and standard 4uantities are far too high. his
guarantees that favora$le variances will ordinarily result from
operations. &f the standard costs are set arti'cially high, the
standard cost of goods sold will $e arti'cially high and thus the
divisionGs net operating income will $e depressed until the
favora$le variances are recognized. &f =ansing saves the
favora$le variances, he can release just enough in the second
and third 4uarters to show some improvement and then he can
release all of the rest in the last 4uarter, creating the annual
M"hristmas present.N
+. =ansing should not $e permitted to continue this practice for
several reasons. First, it distorts the 4uarterly earnings for $oth
the division and the company. he distortions of the divisionGs
4uarterly earnings are trou$ling $ecause the manipulations
may mask real signs of trou$le. he distortions of the
companyGs 4uarterly earnings are trou$ling $ecause they may
mislead e.ternal users of the 'nancial statements. 3econd,
=ansing should not $e rewarded for manipulating earnings. his
sets a moral tone in the company that is likely to lead to even
deeper trou$le. &ndeed, the permissive attitude of top
management toward the manipulation of earnings may indicate
the e.istence of other, even more serious, ethical pro$lems in
the company. hird, a clear message should $e sent to division
managers like =ansing that their jo$ is to manage their
operations, not their earnings. &f they keep on top of operations
and manage well, the earnings should take care of themselves.
3olutions Manual, "hapter )) ++)
,. 3tacy "ummins does not have any easy alternatives availa$le.
3he has already taken the pro$lem to the !resident, who was
not interested. &f she goes around the !resident to the ?oard of
>irectors, she will $e putting herself in a politically diEcult
position with little likelihood that it will do much good if, in fact,
the ?oard of >irectors already knows what is going on.
Dn the other hand, if she simply goes along, she will $e
violating the MD$jectivityN standard of ethical conduct for
management accountants. he ;ome 3ecurity >ivisionGs
manipulation of 4uarterly earnings does distort the entire
companyGs 4uarterly reports. And the D$jectivity standard
clearly stipulates that Mmanagement accountants have a
responsi$ility to disclose fully all relevant information that
could reasona$ly $e e.pected to in-uence an intended userGs
recommendations presented.N Apart from the ethical issue,
there is also a very practical consideration. &f Merced ;ome
!roducts $ecomes em$roiled in controversy concerning
4uestiona$le accounting practices, 3tacy "ummins will $e
viewed as a responsi$le party $y outsiders and her career is
likely to su#er dramatically and she may even face legal
pro$lems.
Oe would suggest that Ms. "ummins 4uietly $ring the
manipulation of earnings to the attention of the audit
committee of the ?oard of >irectors, carefully laying out in a
non7confrontational manner the pro$lems created $y =ansingGs
practice of manipulating earnings. &f the !resident and the
?oard of >irectors are still not interested in dealing with the
pro$lem, she may reasona$ly conclude that the $est
alternative is to start looking for another jo$.
3olutions Manual, "hapter )) +++
Case 1$-35 (C< minutes*
his is a very rigorous case% $e sure that students understand
variances and journal entries $efore it is assigned.
).
3tandard cost of Material A used in production
(a*.........................................................................R0,@2<
3tandard cost of Material A per $atch
(2 gallons V RB.<< per gallon* ($*......................... R/B
Aum$er of $atches produced last week (a* [ ($*.... )+<
+. a. 3tandard cost of last weekGs purchases
(),<<< gallons V RB.<< per gallon*........................ RB,<<<
>educt favora$le price variance.............................. ,<<
Actual cost of last weekGs purchases....................... R@,@<<
Materials price variance Y (A6 V A!* X (A6 V 3!*
(),<<< gallons V A!* X (),<<< gallons V RB.<< per gallon* Y
R,<< F
(),<<< gallons V A!* X RB,<<< Y XR,<<Z
(),<<< gallons V A!* Y R@,@<<
ZOhen used in the formula, a favora$le variance is
negative.
$. he num$er of gallons of Material A used in production can
$e computed through analysis of the raw materials inventory
account:
?alance, Material A, ,H).......................................... R <
Add purchases (),<<< gallons V RB.<< per
gallon*..................................................................B,<<<
otal Material A availa$le........................................ B,<<<
=ess $alance, Material A, ,H@................................... +,<<<
otal Material A used (at standard cost*.................. R2,<<<
otal cost of material A used R2,<<<
Y Y @0< gallons used
3tandard cost per gallon RB.<< per gallon
3olutions Manual, "hapter )) ++,
c. Materials 4uantity variance Y 3! (A6 X 36*
RB.<< per gallon (@0< gallons X @+< gallonsZ* Y R+/< K
Z)+< $atches V 2 gallons per $atch Y @+< gallons
d.
8aw materials (),<<< gallons V RB.<< per
gallon*.................................................................. B,<<<
Materials price variance
(),<<< gallons V R<.,< per gallon F*................ ,<<
Accounts paya$le
(),<<< gallons V R@.@< per gallonZ*.................
@,@<
<
ZR@,@<< [ ),<<< gallons Y R@.@< per gallon
Oork in process (@+< gallons V RB.<< per
gallon*.................................................................. 0,@2<
Materials 4uantity variance
(,< gallons K V RB.<< per gallon*......................... +/<
8aw materials
(@0< gallons V RB.<< per gallon*......................
2,<<
<
,. a. he standard cost per pound of Material ? can $e computed
$y analyzing the raw materials inventory account:
Material ? used in production..................................
R+,0<
<
Add $alance, Material ?, ,H@.................................... ),/<<
otal Material ? availa$le last week......................... ,,C<<
>educt $alance, Material ?, ,H).............................. @<<
!urchases of Material ? (at standard cost*..............
R,,+<
<
!urchases of Material ? R,,+<<
Y Y R/.<< per pound
Aum$er of pounds purchased B<< l$s.
$. Material ? drawn
from inventory
R+,0<
<
[
R/.<<Hpound Y 2+0 pounds used
>educt
unfavora$le
4uantity
variance )<<
3olutions Manual, "hapter )) ++/
3tandard cost of
material used
R+,/<
<
[
R/.<<Hpound
Y 2<< pounds
allowed
3olutions Manual, "hapter )) ++0
Alternative solution for standard 4uantity:
Materials 4uantity variance Y (A6 V 3!* X (36 V 3!*
R+,0<< X (36 V R/.<< per pound* Y R)<< K
R+,0<< X R/ per pound V 36
Y R)<<Z
R/ per pound V 36 Y R+,/<<
36 Y
2<<
pounds
ZOhen used with the formula, an unfavora$le variance is
positive.
c. 2<< pounds [ )+< $atches Y 0 pounds per $atch
d. otal cost of purchases of materials
(accounts paya$le*............................................... R)),/2<
=ess cost of Material A purchases (!art +*............... @,@<<
"ost of Material ? purchases................................... R ,,@2<
Materials price variance Y (A6 V A!* X (A6 V 3!*
R,,@2< X (B<< pounds V R/.<< per pound* Y R,,@2< X R,,+<<
Y R02< K
e.
8aw materials (B<< pounds V R/.<< per
pound*.................................................................. ,,+<<
Materials price variance
(B<< pounds V R<.@< per pound K*....................... 02<
Accounts paya$le
(B<< pounds V R/.@< per poundZ*.................... ,,@2<
ZR,,@2< [ B<< pounds Y R/.@< per pound
Oork in process (2<< pounds V R/.<< per
pound*.................................................................. +,/<<
Materials 4uantity variance
(+0 pounds K V R/.<< per pound*......................... )<<
8aw materials (2+0 pounds V R/.<< per
pound*............................................................. +,0<<
3olutions Manual, "hapter )) ++2
/. a. =a$or rate variance Y
(A; V A8* X (A; V
38*
(R/,)<<* X (/<< hoursZ V
38* Y R0<< K
R/,)<< X /<< hours V 38 Y R0<<ZZ
/<< hours V 38 Y R,,2<<
38 Y RC.<< per hour
Z )< workers V /< hours per worker Y /<< hours
ZZ Ohen used with the formula, an unfavora$le variance is
positive.
$. he standard hours per $atch can $e o$tained $y working
through the standard cost card for Ma.itol.
3tandard cost per $atch (given*.............................. RCC.0<
=ess standard materials cost:
Material A standard cost
(2 gallons V RB.<< per gallon*............................ R/B.<<
Material ? standard cost
(0 pounds V R/.<< per pound*........................... +<.<< 2B.<<
>irect la$or standard cost per $atch....................... R,).0<
>irect la$or standard cost per $atch R,).0< per $atch
Y
3tandard rate per direct la$or7hour RC.<< per >=;
Y ,.0 >=;s per $atch
c. )+< $atches V ,.0 hours per $atch Y /+< hours
d. =a$or eEciency variance Y (A; V 38* X (3; V 38*
(/<< hours V RC.<< per hour* X
(/+< hours V RC.<< per hour* Y R)B< F
e. Oork in process (/+< hours V RC.<< per hour*........ ,,@B<
=a$or rate variance (/<< hours V R).+0 per
hour K*................................................................. 0<<
=a$or eEciency variance
(+< hours F V RC.<< per hour*.......................... )B<
Oages paya$le (/<< hours V R)<.+0 per /,)<<
3olutions Manual, "hapter )) ++@
hourZ*..............................................................
ZR/,)<< [ /<< hours Y R)<.+0 per hour
3olutions Manual, "hapter )) ++B
0.
Standar
d
8uantit
% or
<ours
Standard
Price or 2ate
Standar
d Cost
Material A 2 gal.
RB.<< per
gallon R/B.<<
Material ?
0
pounds
R/.<< per
pound +<.<<
>irect la$or
,.0
hours
RC.<< per
hour ,).0<
3tandard cost per $atch RCC.0<
3olutions Manual, "hapter )) ++C
Case 1$-3 (,< minutes*
). ?ased on the conversation $etween erry ravers and 3ally
"hristensen, it seems likely that their motivation would $e
sti-ed $y the variance reporting system at Aurora
Manufacturing "ompany. heir $ehavior may include any of the
following:
L 3u$optimization, a condition in which individual managers
disregard major company goals and focus their attention solely
on their own divisionGs activities.
L Frustration from untimely reports and formats that are not
useful in their daily activities.
+. a. he $ene'ts that can $e derived $y $oth the company and
its employees from a properly implemented variance
reporting system include the following:
L Iariance analysis can provide standards and measures for
incentive and performance evaluation programs.
L Iariance reporting can emphasize teamwork and
interdepartmental dependence.
L imely reporting provides useful feed$ack, helps to identify
pro$lems, and aids in solving these pro$lems. 8esponsi$ility can
$e assigned for the resolution of pro$lems.
$. Aurora Manufacturing "ompany could improve its variance
reporting system, so as to increase employee motivation, $y
implementing the following:
L &ntroduce a -e.i$le $udgeting system that relates actual
e.penditures to actual levels of production on a monthly $asis.
&n addition, the $udgeting process should $e participative rather
than imposed.
L Dnly those costs that are controlla$le $y managers should $e
included in the variance analysis.
L >istri$ute reports on a timelier $asis to allow 4uick resolution of
pro$lems.
3olutions Manual, "hapter )) +,<
L 8eports should $e stated in terms that are most understanda$le
to the users, i.e., units of output, hours, etc.
3olutions Manual, "hapter )) +,)
,roup E%ercise 1$-3!
he answers to the 4uestions in this group e.ercise will depend on
the particular auto repair company that is investigated.
3olutions Manual, "hapter )) +,+
,roup E%ercise 1$-3"
he answers to the 4uestions in this group e.ercise will depend on
the particular company that is investigated.
3olutions Manual, "hapter )) +,,
Chapter 11
>le%i'le Budgets and *verhead Anal)sis
11-1 A static $udget is a $udget
prepared for a single level of activity that
remains unchanged even if the activity
level su$se4uently changes.
11-2 A -e.i$le $udget can $e adjusted
to re-ect any level of activity. ?y contrast,
a static $udget is prepared for a single
level of activity and is not su$se4uently
adjusted.
11-3 "riteria for choosing an activity
$ase:
). he activity $ase and overhead cost
should $e causally related.
+. he activity $ase should not $e
e.pressed in dollars.
,. he activity $ase should $e simple
and easy to understand.
11-4 &f the -e.i$le $udget is $ased on
actual hours worked, then only a spending
variance will $e produced on the
performance report. ?oth a spending and
an eEciency variance will $e produced if
the -e.i$le $udget is $ased on $oth actual
hours and standard hours.
11-5 3tandard hours allowed means the
time that should have $een taken to
complete the actual output of the period.
11- he materials price variance
consists entirely of di#erences in price
paid from standard. he varia$le overhead
spending variance consists of two
elements. Dne element is like a price
variance and results from di#erences
$etween actual and standard prices for
varia$le overhead inputs. he other
element is like a 4uantity variance and
results from di#erences $etween the
amount of varia$le overhead inputs that
should have $een used and the amounts
that were actually used. Drdinarily these
two elements are not separated.
11-! he overhead eEciency variance
does not really measure eEciency in the
use of overhead. &t actually measures
eEciency in the use of the $ase
underlying the -e.i$le $udget. his $ase
could $e direct la$or7hours, machine7
hours, or some other measure of activity.
11-" A -e.i$le $udget provides the cost
and activity data needed to compute the
predetermined overhead rate, which is
used in product costing.
11-# he denominator level of activity is
the denominator in the predetermined
overhead rate.
11-1$ A normal costing system was used
in "hapter ,, whereas in "hapter )) a
standard cost system is used. 3tandard
costing ensures that the same amount of
overhead is applied to a product
regardless of the actual amount of the
application $ase (such as machine7hours
or direct la$or7hours* that is used during a
period.
11-11 &n a standard cost system $oth a
$udget variance and a volume variance
are computed for '.ed manufacturing
overhead cost.
11-12 he '.ed overhead $udget
variance is the di#erence $etween total
$udgeted '.ed overhead cost and the
total amount of '.ed overhead cost
3olutions Manual, "hapter )) +,/
incurred. &f actual costs e.ceed $udgeted
costs, the variance is la$eled unfavora$le.
11-13 he volume variance is favora$le
when the activity level for a period, at
standard, is greater than the denominator
activity level. "onversely, if the activity
level, at standard, is less than the
denominator level of activity, the volume
variance is unfavora$le. he variance does
not measure deviations in spending. &t
measures deviations in actual activity
from the denominator level of activity.
11-14 &f '.ed costs are e.pressed on a
per unit $asis, managers may $e misled
into thinking that they are really varia$le.
his can lead to faulty predictions
concerning cost $ehavior and to $ad
decisions and erroneous performance
evaluations.
11-15 Knder7 or overapplied overhead
can $e factored into varia$le overhead
spending and eEciency variances and the
'.ed overhead $udget and volume
variances.
11-1 he total of the overhead variances
would $e favora$le, since overapplied
overhead is e4uivalent to a favora$le
variance.
3olutions Manual, "hapter )) +,0
Emory "orporation
Fle.i$le ?udget
Cost
Formul
a Machine/<ours
'per
M<+ 4;A::: 5:A::: 5;A:::
Iaria$le costs:
Ktilities..................... R<.,<
R
/,0<<
R 2,<<
< R @,0<<
&ndirect la$or............ )./< +),<<< +B,<<< ,0,<<<
3upplies.................... <.+< ,,<<< /,<<< 0,<<<
Maintenance............. <.)< ),0<< +,<<< +,0<<
otal varia$le cost....... R+.<< ,<,<<< /<,<<< 0<,<<<
Fi.ed costs:
&ndirect la$or............ 0+,<<< 0+,<<< 0+,<<<
Maintenance............. )B,<<< )B,<<< )B,<<<
>epreciation............. C<,<<< C<,<<< C<,<<<
otal '.ed cost............ )2<,<<< )2<,<<< )2<,<<<
otal overhead cost.....
R)C<,<<
<
R+<<,<<
< R+)<,<<<
3olutions Manual, "hapter )) +,2
).
Drcas ?oat "harter 3ervice
Fle.i$le ?udget !erformance 8eport
For the Month Ended 5uly ,)
"ost
Formula
(per
charter*
Actual "osts
&ncurred for
)2< "harters
?udget
?ased on
)2<
"harters
Iarianc
e
Iaria$le overhead costs:
"leaning........................... R 2<.0< R C,//< R C,2B< R +/< F
Maintenance.................... ,0.+0 0,CB< 0,2/< ,/< K
!ort fees........................... )0 .@0 +,2@< +,0+< )0< K
otal varia$le overhead
costs....................................
R))) .0< )B,<C< )@,B/< +0< K
Fi.ed overhead costs:
3alaries and wages.......... C,+<< C,)0< 0< K
>epreciation.................... )+,B<< )+,)<< @<< K
Ktilities............................. B,0 B2< +0 F
Moorage........................... 0,,2< /,CB< ,B< K
otal '.ed overhead costs.... +B,)C0 +@,<C< ),)<0 K
otal overhead costs............ R/2,+B0 R//,C,< R),,00 K
+. he addition of a new $oat to the charter -eet apparently increased depreciation and
moorage charges for the month a$ove what had $een anticipated. (A new $oat adds to
depreciation charges and a new $oat needs to $e moored, hence the higher moorage
charges.* hese two items are responsi$le for most of the R),,00 unfavora$le total
3olutions Manual, "hapter )) +,@
variance for the month.
3olutions Manual, "hapter )) +,B
Qung "orporation
Iaria$le Dverhead !erformance 8eport
?udgeted direct la$or7hours.......................... ,B,<<<
Actual direct la$or7hours............................... ,/,<<<
3tandard direct la$or7hours allowed.............. ,0,<<<
$verhead Costs
Cost
Formula
'per
!)<+
Actual
Costs
"ncurred
67A:::
!)<s
'A< T A2+
Budget
Based on
67A:::
!)<s
'A< T S2+
Spendin
g
Varianc
e
&ndirect la$or............. R<.2< R+),+<< R+<,/<< RB<< K
3upplies.................... <.)< ,,+<< ,,/<< +<< F
Electricity.................. <.<0 ),2<< ),@<< )<< F
otal varia$le
overhead cost......... R<.@0 R+2,<<< R+0,0<< R0<< K
3olutions Manual, "hapter )) +,C
Qung "orporation
?udgeted direct la$or7hours...................... ,B,<<<
Actual direct la$or7hours........................... ,/,<<<
3tandard direct la$or7hours allowed.......... ,0,<<<
$verhead Costs
Cost
Formula
'per
!)<+
'4+
Actual
Costs
"ncurred
67A:::
!)<s
'A< T
A2+
'5+
Budget
Based on
67A:::
!)<s
'A< T
S2+
'6+
Budget
Based on
6;A:::
!)<s
'S< T
S2+
'7+
,otal
Varianc
e
'4+/'6+
Spendin
g
Varianc
e
'4+/'5+
EVcienc
%
Variance
'5+/'6+
&ndirect la$or............ R<.2< R+),+<< R+<,/<< R+),<<< R+<< K RB<< K R2<< F
3upplies................... <.)< ,,+<< ,,/<< ,,0<< ,<< F +<< F )<< F
Electricity................. <.<0 ),2<< ),@<< ),@0< )0< F )<< F 0< F
otal varia$le
overhead cost........ R<.@0 R+2,<<< R+0,0<< R+2,+0< R+0< F R0<< K R@0< F
3olutions Manual, "hapter )) +/<
). he total overhead cost at the denominator level of activity
must $e determined $efore the predetermined overhead rate
can $e computed.
otal '.ed overhead cost per year...........................
R+0<,<<
<
otal varia$le overhead cost
(R+ per >=; V /<,<<< >=;s*................................. B<,<<<
otal overhead cost at the denominator level of
activity..................................................................
R,,<,<<
<
Dverhead at the denominator level of activity
!redetermined
Y
overhead rate
>enominator level of activity
R,,<,<<<
Y YRB.+0 per >=;
/<,<<< >=;s
+. 3tandard direct la$or7hours allowed
for the actual output (a*.................. ,B,<<< >=;s
!redetermined overhead rate ($*....... RB.+0 per >=;
Dverhead applied (a* V ($*................ R,),,0<<
3olutions Manual, "hapter )) +/)
).
Fi.ed overhead
Fi.ed portion of the
Y
predetermined overhead rate
>enominator level of activity
R+0<,<<<
Y
+0,<<< >=;s
Y R)<.<< per >=;
+.
?udget Actual '.ed ?udgeted '.ed
Y 7
variance overhead cost overhead cost
Y R+0/,<<< 7 R+0<,<<<
Y R/,<<< K
( *
Fi.ed portion of
Iolume >enominator 3tandard hours
Y the predeterminedV 7
variance hours allowed
overhead rate
Y R)<.<< per >=; (+0,<<< >=;s 7 +2,<<< >=;s*
Y R)<,<<< F
3olutions Manual, "hapter )) +/+
Aote: Oith the e.ception of the num$er of cars, all amounts $elow
are in 3wiss francs.
=avage 8apide
Fle.i$le ?udget
Cost
Formul
a Activit% 'cars+
$verhead Costs
'per
car+ HA::: =A:::
4:A::
:
"leaning supplies..................... <.B< 2,/<< @,+<< B,<<<
Electricity ................................ <.,< +,/<< +,@<< ,,<<<
Maintenance............................ <.+< ),2<< ),B<< +,<<<
otal varia$le overhead cost....... ).,<
)<,/<
<
)),@<
< ),,<<<
Dperator wages....................... C,<<< C,<<< C,<<<
>epreciation............................ 2,<<< 2,<<< 2,<<<
8ent......................................... B,<<< B,<<< B,<<<
otal '.ed overhead cost...........
+,,<<
< +,,<<< +,,<<<
otal overhead cost....................
,,,/<
< ,/,@<< ,2,<<<
3olutions Manual, "hapter )) +/,
=avage 8apide
3tatic ?udget
?udgeted num$er of cars.................... B,B<<
?udgeted varia$le overhead costs:
"leaning supplies (_ <.B< 3Fr per
car*................................................. @,</< 3Fr
Electricity (_ <.,< 3Fr per car*......... +,2/<
Maintenance (_ <.+< 3Fr per car*..... ),@2<
otal varia$le overhead cost................ )),//<
?udgeted '.ed overhead costs:
Dperator wages ............................... C,<<<
>epreciation .................................... 2,<<<
8ent.................................................. B,<<<
otal '.ed overhead cost..................... +,,<<<
otal $udgeted overhead cost............. ,/,//< 3Fr
3olutions Manual, "hapter )) +//
Aote: Oith the e.ception of the num$er of cars, all amounts $elow
are in 3wiss francs.
=avage 8apide
?udgeted num$er of cars........ B,B<<
Actual num$er of cars............. B,C<<
$verhead Costs
Cost
Formul
a
'per
car+
Actual
Costs
"ncurred
for
HA=::
Cars
Budget
Based
on
HA=::
Cars
Varianc
e
"leaning supplies................ <.B< @,<B< @,)+< /< F
Electricity............................ <.,< +,/2< +,2@< +)< F
Maintenance....................... <.+< ),00< ),@B< +,< F
otal varia$le overhead cost
).,< )),<C< )),0@< /B< F
Dperator wages.................. C,)<< C,<<< )<< K
>epreciation....................... @,<<< 2,<<< ),<<< K
8ent.................................... B,<<< B,<<< <
otal '.ed overhead cost....... +/,)<< +,,<<< ),)<< K
otal overhead cost............... ,0,)C< ,/,0@< 2+< K
3tudents may 4uestion the variances for '.ed costs. Dperator
wages can di#er from what was $udgeted for a variety of reasons
including an unanticipated increase in the wage rate% changes in
the mi. of workers $etween those earning lower and higher
wages% changes in the num$er of operators on duty% and
overtime. >epreciation may have increased $ecause of the
ac4uisition of new e4uipment or $ecause of a loss on e4uipment
that must $e scrapped9perhaps due to poor maintenance. (his
assumes that the loss -ows through the depreciation account on
the performance report.*
3olutions Manual, "hapter )) +/0
E%ercise 11-1$ (+< minutes*
). Murray "ompany
?udgeted machine7hours........ )+,<<<
Actual machine7hours
worked.................................. )),0<<
Actual Budget Spending
Variance 44A;::
hours
44A;::
hours
Iaria$le overhead
costs:
3upplies.................... R +,/<< R +,,<< R )<< K
Maintenance............. B,<<< C,+<< ),+<< F
Ktilities..................... ),)<< ),)0< 0< F
8ework time............. 0,,<< /,2<< @<< K
otal varia$le
overhead cost........ R)2,B<< R)@,+0< R /0< F
+. Favora$le variances can $e as much a matter of concern as
unfavora$le variances. &n particular, the favora$le maintenance
variance should $e investigated. &s scheduled preventative
maintenance $eing carried outF &n terms of percentage
deviation from $udgeted allowances, the rework time variance
is even more signi'cant (e4ual to )0P of the $udget
allowance*. his unfavora$le rework time variance may $e a
result of poor maintenance of machines. 3ome may say that if
the two variances are related, then the trade7o# is a good one,
since the savings in maintenance cost is greater than the
added cost of rework time. ?ut this is shortsighted reasoning.
!oor maintenance can reduce the life of e4uipment, as well as
decrease overall output, there$y costing far more in the long
run than any short7run savings.
3olutions Manual, "hapter )) +/2
"olum$ia Aational ?ank
"heck "learing DEce
For the Month Ended 3eptem$er ,<
?udgeted la$or7hours......................................................................... ,,<B<
Actual la$or7hours.............................................................................. ,,)<<
3tandard la$or7hours allowed for the actual num$er of checks processed ,,+<<
'4+
Actual
Costs
"ncurre
d
'5+
Budget
Based
on
'6+
Budget
Based on
Brea&do1n of the
,otal Variance
$verhead Costs
Cost
Formula
'per
labor/
hour+
for 6A4::
)abor/
<ours
'A< T
A2+
6A4::
)abor/
<ours
'A< T S2+
6A5::
)abor/
<ours
'S< T
S2+
,otal
Varianc
e '4+ W
'6+
Spendin
g
Variance
'4+ W '5+
EVcien
c%
Varianc
e '5+ W
'6+
Iaria$le overhead
costs:
DEce supplies............. R<.)< R ,20 R ,)< R ,+< R /0 K R 00 K R )< F
3ta# co#ee lounge...... <.+< 0+< 2+< 2/< )+< F )<< F +< F
&ndirect la$or............... <.C< +,@)< +,@C< +,BB< )@< F B< F C< F
otal varia$le
overhead cost........... R).+< R,,0C0 R,,@+< R,,B/< R+/0 F R)+0 F R)+< F
3olutions Manual, "hapter )) +/@
). otal overhead from the -e.i$le
$udget at the denominator activity
!redetermined
Y
overhead rate
>enominator activity
R++0,<<<
Y
,<,<<< >=;s
YR@.0< per >=;
Iaria$le element: R0@,<<< [ ,<,<<< >=;s Y R).C< per >=;
Fi.ed element: R)2B,<<< [ ,<,<<< >=;s Y R0.2< per >=;
+. >irect materials, +.0 yards _ RB.2< per yard.. R+).0<
>irect la$or, , >=;sZ _ R)+.<< per >=;......... ,2.<<
Iaria$le overhead, , >=;s _ R).C< per >=;. . 0.@<
Fi.ed overhead, , >=;s _ R0.2< per >=;....... )2.B<
otal standard cost per unit............................. RB<.<<
Z,<,<<< >=;s [ )<,<<< units Y , >=;s per unit.
3olutions Manual, "hapter )) +/B
). C,0<< units V / hours per unit Y ,B,<<< hours.
+. and ,.
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R)CB,@<<Z R+<<,<<< ,B,<<< hours V R0 per
hourZ
Y R)C<,<<<

?udget Iariance,
R),,<< F
Iolume Iariance,
R)<,<<< KZ
Z1iven.
/.
R+<<,<<<
Y
Y R0 per hour
0u)/ete) 1ixe) overhea) 2ost
Fixe) ele*ent o1 the
.
pre)eter*ine) overhea) rate
3eno*inator a2tivit+
herefore, the denominator activity is: R+<<,<<< [ R0 per hour
Y /<,<<< hours.
3olutions Manual, "hapter )) +/C
).
R/B<,<<<
otal rate: Y RB per M;
2<,<<< M;s
R)B<,<<<
Iaria$le rate: Y R, per M;
2<,<<< M;s
R,<<,<<<
Fi.ed rate: Y R0 per M;
2<,<<< M;s
+. he standard hours per unit of product are:
2<,<<< hours [ /<,<<< units Y ).0 hours per unit
1iven this 'gure, the standard hours allowed for the actual
production would $e:
/+,<<< units V ).0 hours per unit Y 2,,<<< standard hours
allowed.
,. Iaria$le overhead spending variance:
Iaria$le overhead spending variance Y (A; V A8* X (A; V
38*
(R)B0,2<<* X (2/,<<< hours V R, per hour* Y R2,/<< F
Iaria$le overhead eEciency variance:
R, per hour (2/,<<< hours X 2,,<<< hours* Y R,,<<< K
he '.ed overhead variances would $e as follows:
Actual Fi.ed
Dverhead "ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R,<+,/<< R,<<,<<<Z
2,,<<< hours V R0 per
hour
Y R,)0,<<<

?udget Iariance,
R+,/<< K
Iolume Iariance,
R)0,<<< F
ZAs originally $udgeted. his 'gure can $e e.pressed as:
2<,<<< denominator hours V R0 per hour Y R,<<,<<<.
3olutions Manual, "hapter )) +0<
Alternative approach to the $udget variance:
Y 7
Y R,<+,/<< 7 R,<<,<<<
Y R+,/<< K
Alternative approach to the volume variance:
Fi.ed portion of 3tandard
Iolume >enominator
Y the predetermined 7 hours
Iariance hours
overhead rate allowed
Y R0 per hour (2<,<<< hours 7 2,,<<< hours*
Y R)0,<<< F
m n
[
o
[
o
[
o
[
o
[
o
p q
3olutions Manual, "hapter )) +0)
). )/,<<< units produced V , M;s per unit Y /+,<<< M;s
+. Actual '.ed overhead costs incurred. .
R+2@,<<
<
Add: Favora$le $udget variance.......... ,,<<<
?udgeted '.ed overhead cost.............
R+@<,<<
<
R+@<,<<<
Y
/0,<<< M;s
Y R2 per M;
.
,.
Iolume >enominator
Iariance hours
Y R2 per M; (/0,<<< M;s 7 /+,<<< M;s*
Y R)B,<<< K
m n
[
o
[
o
[
o
[
o
[
o
p q
Alternative solution to parts )7,:
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied
to Oork in !rocess
R+2@,<<<Z R+@<,<<<
)
/+,<<< M;s
+
V R2 per
M;
,
Y R+0+,<<<

?udget Iariance,
R,,<<< FZ
Iolume Iariance,
R)B,<<< K
)
R+2@,<<< \ R,,<<< Y R+@<,<<<.
+
)/,<<< units V , M;s per unit Y /+,<<< M;s
,
R+@<,<<< [ /0,<<< denominator M;s Y R2 per M;
3olutions Manual, "hapter )) +0+
Z1iven.
3olutions Manual, "hapter )) +0,
"ompany
A:
his company has a favora$le volume variance since
the standard hours allowed for the actual production
are greater than the denominator hours.
"ompany
?:
his company has an unfavora$le volume variance
since the standard hours allowed for the actual
production are less than the denominator hours.
"ompany
":
his company has no volume variance since the
standard hours allowed for the actual production and
the denominator hours are the same.
3olutions Manual, "hapter )) +0/
). he cost formulas in the -e.i$le $udget $elow report were
o$tained $y dividing the costs on the static $udget in the
pro$lem statement $y the $udgeted level of activity (0<<
liters*. he '.ed costs are carried over from the static $udget.
3t. =ucia ?lood ?ank
For the Month Ended 3eptem$er ,<
?udgeted activity (in liters*......... 0<<
Actual activity (in liters*.............. 2+<
Costs
Cost
Formul
a
'per
liter+
Actual
Costs
"ncurre
d for
E5:
)iters
Budget
Based
on E5:
)iters Variance
Iaria$le costs:
Medical supplies.......... R)0.<< R C,,0< R C,,<< R 0< K
=a$ tests..................... )+.<< 2,)B< @,//< ),+2< F
8efreshments for
donors....................... +.<< ),,/< ),+/< )<< K
Administrative
supplies.................... <.0< /<< ,)< C< K
otal varia$le cost.......... R+C.0< )@,+@< )B,+C< ),<+< F
Fi.ed costs:
3ta# salaries............... )<,<<< )<,<<< <
E4uipment
depreciation.............. +,B<< +,0<< ,<< K
8ent............................. ),<<< ),<<< <
Ktilities........................ 0@< 0<< @< K
otal '.ed cost............... )/,,@< )/,<<< ,@< K
otal cost....................... R,),2/< R,+,+C< R 20< F
3olutions Manual, "hapter )) +00
+. he overall variance is favora$le and none of the unfavora$le
variances is particularly large. Aevertheless, the large
favora$le variance for la$ tests is worrisome. !erhaps the $lood
$ank has not $een doing all of the la$ tests for ;&I, hepatitis,
and other $lood7transmitta$le diseases that it should $e doing.
his is well worth investigating% favora$le variances may
warrant attention as much as unfavora$le variances.
3ome may wonder why depreciation has a variance. Fi.ed costs
can change% they just donGt vary with the level of activity.
>epreciation may have increased $ecause of the ac4uisition of
new e4uipment or $ecause of a loss on e4uipment that must
$e scrapped. (his assumes that the loss -ows through the
depreciation account on the performance report.*
&ro'lem 11-1" (/0 minutes*
). >irect materials price and 4uantity variances:
2/,<<< feet (RB.00 per foot X RB./0 per foot* Y R2,/<< K
RB./0 per foot (2/,<<< feet X 2<,<<< feetZ* Y R,,,B<< K
Z,<,<<< units V + feet per unit Y 2<,<<< feet
+. >irect la$or rate and eEciency variances:
/,,0<< >=;s (R)0.B< per >=; X R)2.<< per >=;* Y RB,@<< F
R)2.<< per >=; (/,,0<< >=;s X /+,<<< >=;sZ* Y R+/,<<< K
Z,<,<<< units V )./ >=;s per unit Y /+,<<< >=;s
,. a. Iaria$le overhead spending and eEciency variances:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
R)<B,<<< /,,0<< >=;s
V R+.0< per >=;
/+,<<< >=;s
V R+.0< per >=;
Y R)<B,@0< Y R)<0,<<<

3pending Iariance,
R@0< F
EEciency Iariance,
R,,@0< K
38*
(R)<B,<<<* X (/,,0<< >=;s V R+.0< per >=;* Y R@0< F
R+.0< per >=; (/,,0<< >=;s X /+,<<< >=;s* Y R,,@0< K
3olutions Manual, "hapter )) +0@
$. Fi.ed overhead $udget and volume variances:
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R+)),B<< R+)<,<<<Z /+,<<< >=;s V R2 per
>=;
Y R+0+,<<<

?udget Iariance,
R),B<< K
Iolume Iariance,
R/+,<<< F
ZAs originally $udgeted. his 'gure can also $e e.pressed as:
,0,<<< denominator >=;s V R2 per >=; Y R+)<,<<<.
?udget variance:
Y 7
Y R+)),B<< 7 R+)<,<<<
Y R),B<< K
Iolume variance:
Iolume >enominator
Iariance hours
Y R2.<< per >=; (,0,<<< >=;s 7 /+,<<< >=;s*
Y R/+,<<< F
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3olutions Manual, "hapter )) +0B
/. he total of the variances would $e:
>irect materials variances:
!rice variance............................................... R 2,/<< K
6uantity variance......................................... ,,,B<< K
>irect la$or variances:
8ate variance................................................ B,@<< F
EEciency variance........................................ +/,<<< K
Iaria$le manufacturing overhead variances:
3pending variance........................................ @0< F
EEciency variance........................................ ,,@0< K
Fi.ed manufacturing overhead variances:
?udget variance............................................ ),B<< K
Iolume variance........................................... /+,<<< F
otal variance..................................................R)B,,<< K
Aote that the total of the variances agrees with the R)B,,<<
variance mentioned $y the president.
&t appears that not everyone should $e given a $onus for good
cost control. he materials 4uantity variance and the la$or
eEciency variance are 2.@P and ,.2P, respectively, of the
standard cost allowed and thus would warrant investigation.
he companyGs large unfavora$le variances (for materials
4uantity and la$or eEciency* do not show up more clearly
$ecause they are o#set for the most part $y the favora$le
volume variance. his favora$le volume variance is a result of
the company operating at an activity level that is well a$ove
the denominator activity level used to set predetermined
overhead rates. (he company operated at an activity level of
/+,<<< standard hours% the denominator activity level set at
the $eginning of the year was ,0,<<< hours.* As a result of the
large favora$le volume variance, the unfavora$le 4uantity and
eEciency variances have $een concealed in a small MnetN
'gure. he large favora$le volume variance may have $een
achieved $y $uilding up inventories.
3olutions Manual, "hapter )) +0C
). >irect materials, , yards at R/./< per yard..................... R),.+<
>irect la$or, ) >=; at R)+.<< per >=;............................ )+.<<
Iaria$le manufacturing overhead, ) >=; at R0.<< per
>=;Z............................................................................. 0.<<
Fi.ed manufacturing overhead, ) >=; at R)).B< per
>=;ZZ........................................................................... )).B<
3tandard cost per unit..................................................... R/+.<<
Z
R+0,<<< [ 0,<<< >=;s Y R0.<< per
>=;.
ZZ
R0C,<<< [ 0,<<< >=;s Y R)).B< per
>=;.
+. Materials variances:
+/,<<< yards (R/.B< per yard X R/./< per yard* Y RC,2<< K
R/./< per yard ()B,0<< yards X )B,<<< yardsZ* Y R+,+<< K
Z2,<<< units V , yards per unit Y )B,<<< yards
=a$or variances:
0,B<< >=;s (R),.<< per >=; X R)+.<< per >=;* Y R0,B<< K
R)+.<< per >=; (0,B<< >=;s X 2,<<< >=;sZ* Y R+,/<< F
Z2,<<< units V ) >=; per unit Y 2,<<< >=;s
3olutions Manual, "hapter )) +2<
,. Iaria$le overhead variances:
Actual >=;s of
&nput, at the
Actual 8ate
Actual >=;s of
&nput, at the
3tandard 8ate
3tandard >=;s
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
R+C,0B< 0,B<< >=;s
V R0.<< per >=;
2,<<< >=;s
V R0.<< per >=;
Y R+C,<<< Y R,<,<<<

3pending Iariance,
R0B< K
EEciency Iariance,
R),<<< F
otal Iariance,
R/+< F
Alternative solution for the varia$le overhead variances:
38*
(R+C,0B<* X (0,B<< >=;s V R0.<< per >=;* Y R0B< K
R0.<< per >=; (0,B<< >=;s X 2,<<< >=;s* Y R),<<< F
Fi.ed overhead variances:
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead
"ost Applied to
Oork in !rocess
R2<,/<< R0C,<<< 2,<<< >=;s
V R)).B< per >=;
Y R@<,B<<

?udget Iariance,
R),/<< K
Iolume Iariance,
R)),B<< F
3olutions Manual, "hapter )) +2)
Alternative approach to the $udget variance:
Y 7
Y R2<,/<< 7 R0C,<<<
Y R),/<< K
Alternative approach to the volume variance:
Iolume >enominator
Iariance hours
Y R)).B< per >=; (0,<<< >=;s 7 2,<<< >=;s*
Y R)),B<< F
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/. he choice of a denominator activity level a#ects standard unit
costs in that the higher the denominator activity level chosen,
the lower standard unit costs will $e. he reason is that the
'.ed portion of overhead costs is spread over more units as the
denominator activity rises.
he volume variance cannot $e controlled $y controlling
spending. he volume variance simply re-ects whether actual
activity was greater than or less than the denominator activity.
hus, the volume variance is controlla$le only through activity.
3olutions Manual, "hapter )) +2+
). he reports as presently prepared are of little use to the
company. he pro$lem is that the company is using a static
$udget to compare $udgeted performance at one level of
activity to actual performance at another level of activity.
Although the reports do a good jo$ of showing whether or not
the $udgeted level of activity was attained, they do not tell
whether costs were controlled for the activity level that was
actually worked during the period.
+. he company should use a -e.i$le $udget approach to
evaluate control over costs. Knder the -e.i$le $udget
approach, the actual costs incurred during the 4uarter in
working ,0,<<< machine7hours should $e compared to
$udgeted costs at that activity level.
,. Oestmont "ompany
Dverhead !erformance 8eport9Assem$ly >epartment
?udgeted machine7hours.... /<,<<<
Actual machine7hours.......... ,0,<<<
Cost
Formula
'per
M<+
Actual
6;A:::
hours
Budget
6;A:::
hours
Spendin
g or
Budget
Variance
Iaria$le costs:
&ndirect materials...... R<.B<
R
+C,@<<
R
+B,<<<
R),@<
< K
8ework time.............. <.+< @,C<< @,<<< C<< K
Ktilities..................... )./< 0),B<< /C,<<< +,B<< K
Machine setup.......... <.,< )),2<< )<,0<<
),)<
< K
otal varia$le cost....... R+.@< )<),<<< C/,0<<
2,0<
< K
Fi.ed costs:
Maintenance............. @C,+<< B<,<<< B<< F
&nspection................. 2<,<<< 2<,<<< <
otal '.ed cost............ ),C,+<< )/<,<<< B<< F
3olutions Manual, "hapter )) +2,
R+/<,+<
<
R+,/,0<
<
R0,@<
< K
3olutions Manual, "hapter )) +2/
).
!e+C@,0<<
otal rate: Y !eB.0< per hour
,0,<<< hours
!eB@,0<<
Iaria$le rate: Y !e+.0< per hour
,0,<<< hours
!e+)<,<<<
Fi.ed rate: Y !e2.<< per hour
,0,<<< hours
+. ,+,<<< standard hours V !eB.0< per hour Y !e+@+,<<<.
,. Iaria$le overhead variances:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
at the 3tandard
8ate
(A; V A8* (A; V 38* (3; V 38*
!e@B,<<< ,<,<<< hours V
!e+.0< per hour
,+,<<< hours V
!e+.0< per hour
Y !e@0,<<< Y !eB<,<<<

3pending Iariance,
!e,,<<< K
EEciency Iariance,
!e0,<<< F
38*
(!e@B,<<<* X (,<,<<< hours V !e+.0< per hour* Y !e,,<<< K
!e+.0< per hour (,<,<<< hours X ,+,<<< hours* Y !e0,<<< F
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
!e+<C,/<< !e+)<,<<< ,+,<<< hours V
!e2 per hour Y
!e)C+,<<<

?udget Iariance,
!e2<< F
Iolume Iariance,
!e)B,<<< K
?udget variance:
Y 7
Y !e+<C,/<< 7 !e+)<,<<<
Y !e2<< F
Iolume variance:
Iolume >enominator
Iariance hours
Y !e2.<< per hour (,0,<<< hours 7 ,+,<<< hours*
Y !e)B,<<< K
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Ieri'cation:
Iaria$le overhead:
3pending variance............ !e ,,<<< K
EEciency variance........... 0,<<< F
Fi.ed overhead:
?udget variance............... 2<< F
Iolume variance............... )B,<<< K
Knderapplied overhead......!e)0,/<< K
/. Iaria$le overhead
Spending varianceG his variance includes $oth price and
4uantity elements. he overhead spending variance re-ects
di#erences $etween actual and standard prices for varia$le
overhead items. &t also re-ects di#erences $etween the
amounts of varia$le overhead inputs that were actually used
and the amounts that should have $een used for the actual
output of the period. 3ince the varia$le overhead spending
variance is unfavora$le, either too much was paid for varia$le
overhead items or too many of them were used.
EVcienc% varianceG he term Mvaria$le overhead eEciency
varianceN is a misnomer, since the variance does not measure
eEciency in the use of overhead items. &t measures the indirect
e#ect on varia$le overhead of the eEciency or ineEciency with
which the activity $ase is utilized. &n this company, the activity
$ase is la$or7hours. &f varia$le overhead is really proportional to
la$or7hours, then more e#ective use of la$or7hours has the
indirect e#ect of reducing varia$le overhead. 3ince +,<<< fewer
la$or7hours were re4uired than indicated $y the la$or
standards, the indirect e#ect was presuma$ly to reduce
varia$le overhead spending $y a$out !e 0,<<< (!e +.0< per
hour V +,<<< hours*.
Fi.ed overhead
Budget varianceG his variance is simply the di#erence
$etween the $udgeted '.ed cost and the actual '.ed cost. &n
this case, the variance is favora$le which indicates that actual
'.ed costs were lower than anticipated in the $udget.
Volume varianceG his variance occurs as a result of actual
activity $eing di#erent from the denominator activity in the
predetermined overhead rate. &n this case, the variance is
unfavora$le, so actual activity was less than the denominator
activity. &t is diEcult to place much of a meaningful economic
interpretation on this variance. &t tends to $e large, so it often
swamps the other, more meaningful variances if they are
simply netted against each other.
3olutions Manual, "hapter )) +2@
). ;arper "ompany
Fle.i$le ?udget9Assem$ly >epartment
?udgeted direct la$or7hours........ @0,<<<
Cost
Formula !irect )abor/<ours
$verhead Costs
'per
!)<+ E:A::: F;A::: =:A:::
Iaria$le costs:
Ktilities..................... R<.2<
R
,2,<<<
R
/0,<<<
R
0/,<<<
&ndirect la$or............ <.C< 0/,<<< 2@,0<< B),<<<
3upplies.................... <.,< )B,<<< ++,0<< +@,<<<
otal varia$le cost....... R).B< )<B,<<< ),0,<<< )2+,<<<
Fi.ed costs:
&nsurance.................. B,<<< B,<<< B,<<<
3upervisory
salaries................... C<,<<< C<,<<< C<,<<<
>epreciation............. )2<,<<< )2<,<<< )2<,<<<
E4uipment rental...... /+,<<< /+,<<< /+,<<<
otal '.ed cost............ ,<<,<<< ,<<,<<< ,<<,<<<
R/<B,<<
<
R/,0,<<
<
R/2+,<<
<
+.
R/,0,<<<
otal rate: Y R0.B< per >=;
@0,<<< >=;s
R),0,<<<
Iaria$le rate: Y R).B< per >=;
@0,<<< >=;s
R,<<,<<<
Fi.ed rate: Y R/.<< per >=;
@0,<<< >=;s
,. a. Manufacturing Dverhead
Actual costs /+0,@<< /<2,<<<Z Applied costs
Knderapplied
overhead )C,@<<
3olutions Manual, "hapter )) +2B
Z@<,<<< standard hours V 0.B< per hour Y R/<2,<<<.
3olutions Manual, "hapter )) +2C
$. Iaria$le overhead variances:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
R)+/,)<< @,,<<< hours V
R).B< per hour
@<,<<< hours V
R).B< per hour
Y R),),/<< Y R)+2,<<<

3pending Iariance,
R@,,<< F
EEciency Iariance,
R0,/<< K
38*
(R)+/,)<<* X (@,,<<< hours V R).B< per hour* Y R@,,<< F
R).B< per hour (@,,<<< hours X @<,<<< hours* Y R0,/<< K
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R,<),2<< R,<<,<<<Z @<,<<< hours V R/ per
hour
Y R+B<,<<<

?udget Iariance,
R),2<< K
Iolume Iariance,
R+<,<<< K
Z As originally $udgeted. @0,<<< denominator hours V R/ per hour
Y R,<<,<<<.
3olutions Manual, "hapter )) +@<
?udget variance:
Y 7
Y R,<),2<< 7 R,<<,<<<
Y R),2<< K
Iolume variance:
Iolume >enominator
Iariance hours
Y R/ per hour (@0,<<< hours 7 @<,<<< hours*
Y R+<,<<< K
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he overhead variances can $e summarized as follows:
Iaria$le overhead:
3pending variance............................ R@,,<< F
EEciency variance............................ 0,/<< K
Fi.ed overhead:
?udget variance................................ ),2<< K
Iolume variance............................... +<,<<< K
Knderapplied overhead for the year.... R)C,@<< K
3olutions Manual, "hapter )) +@)
). he company is using a static $udget approach in which
$udgeted performance at one level of activity is compared to
actual performance at a higher level of activity. he varia$le
overhead variances are all unfavora$le $ecause of this
mismatching of activity levels. he report in this format is not
useful for measuring either operating eEciency or cost control.
he only accurate piece of information it gives is that the
department worked more than the ,0,<<< machine7hours
$udgeted for the month. &t does not tell whether the actual
output for the month was produced eEciently, nor does it tell
whether overhead spending has $een controlled during the
month.
+. 3ee the ne.t page.
,. he stolen supplies would $e included as part of the varia$le
overhead spending variance for the month. Knlike the price
variance for materials and the rate variance for la$or, the
spending variance measures $oth price and 4uantity (waste,
theft* elements. his is why the variance is called a MspendingN
variance% total spending can $e a#ected as much $y waste or
theft as $y greater (or lesser* prices paid for items.
3olutions Manual, "hapter )) +@+
+. Freemont "ompany
Dverhead !erformance 8eport9Machining >epartment
?udgeted machine7hours.....,0,<<<
Actual machine7hours...........,B,<<<
3tandard machine7hours....../<,<<< Z
$verhead Costs
Cost
Formula
'per M<+
Actual
Costs
"ncurred
'4+
Budget
Based on
6HA:::
M<s
'5+
Budget
Based on
7:A:::
M<s
'6+
,otal
Varianc
e '4+ W
'6+
Spendin
g
Variance
'4+ W '5+
EVcienc
%
Varianc
e '5+ W
'6+
Iaria$le costs:
Ktilities............... R<./<
R
)0,@<< R)0,+<< R)2,<<< R ,<< F R 0<< K R B<< F
&ndirect la$or...... +.,< B2,0<< B@,/<< C+,<<< 0,0<< F C<< F /,2<< F
3upplies.............. <.2< +2,<<< ++,B<< +/,<<< +,<<< K ,,+<< K ),+<< F
Maintenance....... ).+< //,C<< /0,2<< /B,<<< ,,)<< F @<< F +,/<< F
otal varia$le
cost..................... R/.0< )@,,)<< )@),<<< )B<,<<< 2,C<< F R+,)<< K RC,<<< F
Fi.ed costs:
3upervision......... ,B,<<< ,B,<<< ,B,<<< <
Maintenance....... C+,/<< C+,<<< C+,<<< /<< K
>epreciation....... B<,<<< B<,<<< B<,<<< <
otal '.ed cost...... +)<,/<< +)<,<<< +)<,<<< /<< K
otal cost...............
R,B,,0<
< R,B),<<< R,C<,<<< R2,0<< F
Z)2,<<< units V +.0 hours per unit Y /<,<<< hours
3olutions Manual, "hapter )) +@,
?udgeted machine7hours................ )),+0<
Actual machine7hours..................... C,+0<
3tandard machine7hours allowed.... C,<<<
'4+ '5+ '6+
Brea&do1n of the
,otal Variance
$verhead "tem
Cost
Formula
'per M<+
Actual
Costs
"ncurred
=A5;: M<s
Budget
Based on
=A5;:
M<s
Budget
Based on
=A:::
M<s
,otal
Varianc
e '4+ W
'6+
Spendin
g
Varianc
e '4+ W
'5+
EVcienc
%
Variance
'5+ W '6+
!ower................. R<.,< R+,/<0 R+,@@0 R+,@<< R +C0 F R ,@< F R@0 K
3etup time......... <.+< +,<,0 ),B0< ),B<< +,0 K )B0 K 0< K
!olishing
wheels............. <.)2 ),))< ),/B< ),//< ,,< F ,@< F /< K
Maintenance...... <.)B C+0 ),220 ),2+< 2C0 F @/< F /0 K
otal varia$le
cost................ R<.B/ R2,/@0 R@,@@< R@,02<
R),<B0
F R),+C0 F R+)< K
3olutions Manual, "hapter )) +@/
).
R/,+,<<<
otal rate: Y R)<.B< per >=;
/<,<<< >=;s
R@+,<<<
Iaria$le rate: Y R).B< per >=;
/<,<<< >=;s
R,2<,<<<
Fi.ed rate: Y RC per >=;
/<,<<< >=;s
+. >irect materials: B yards at R/.0< per yard..... R,2.<<
>irect la$or: +.0 >=;s at R)+.<< per >=;....... ,<.<<
Iaria$le overhead: +.0 >=;s at R).B< per
>=;.............................................................. /.0<
Fi.ed overhead: +.0 >=;s at RC per >=;......... ++.0<
3tandard cost per unit.................................... RC,.<<
,. 3ee the graph at the end of this solution.
/. a. Fi.ed overhead variances:
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R,2),B<< R,2<,<<< ,0,<<< >=;sZ V RC per
>=;
Y R,)0,<<<

?udget Iariance,
R),B<< K
Iolume Iariance,
R/0,<<< K
Z)/,<<< units V +.0 >=;s per unit Y ,0,<<< >=;s
3olutions Manual, "hapter )) +@0
Alternative approach:
?udget variance:
Y 7
Y R,2),B<< 7 R,2<,<<<
Y R),B<< K
Iolume variance:
Iolume >enominator
Iariance hours
Y RC per >=; (/<,<<< >=;s 7 ,0,<<< >=;s*
Y R/0,<<< K
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$. 3ee the graph at the end of this solution.
0. a. he '.ed overhead $udget variance will not change. he
'.ed overhead volume variance will $e:
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R,2),B<< R,2<,<<< 0<,<<< >=;sZ V RC per
>=;
Y R/0<,<<<

?udget Iariance,
R),B<< K
Iolume Iariance,
RC<,<<< F
Z+<,<<< units V +.0 >=;s per unit Y 0<,<<< >=;s
3olutions Manual, "hapter )) +@2
Alternative solution to the volume variance:
Iolume >enominator
Iariance hours
Y RC per >=; (/<,<<< >=;s 7 0<,<<< >=;s*
Y RC<,<<< F
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$. 3ee the graph on the following page.
3olutions Manual, "hapter )) +@@

R,2<,<<<
,0,<<< /<,<<< 0<,<<<
3tandard >irect =a$or7;ours
Knfavora$le
Iolume Iariance,
R/0,<<< (!art /*
>enominator
;ours
Applied at
RC per >=;
Favora$le
Iolume
Iariance,
RC<,<<<
(!art 0*
F
i
.
e
d

D
v
e
r
h
e
a
d

"
o
s
t

R/0<,<<<
R+0<,<<<
,<,<<<
R,)0,<<<
3olutions Manual, "hapter )) +@B
). A -e.i$le $udget is clearer if the varia$le and '.ed costs are
shown separately, as illustrated in the te.t, and if individual
cost formulas are given. Fi.ed and varia$le costs can $e
separated (and cost formulas determined* $y the high7low
method. &ncorporating these ideas, the revised -e.i$le $udget
would $e:
1ant !roducts, &nc.
Fle.i$le ?udget
Cost
Formula Percentage of Capacit%
$verhead Costs 'per M<+ H:J =:J 4::J
Machine7hours................ 7AH:: ;A7:: EA:::
Iaria$le costs:
Maintenance................. R<.)< R /B< R 0/< R 2<<
3upplies........................ <./< ),C+< +,)2< +,/<<
Ktilities......................... <.,< ),//< ),2+< ),B<<
Machine setup.............. <.+< C2< ),<B< ),+<<
otal varia$le cost........... R).<< /,B<< 0,/<< 2,<<<
Fi.ed costs:
Maintenance................. ),<<< ),<<< ),<<<
Ktilities......................... 0<< 0<< 0<<
3upervision................... ,,<<< ,,<<< ,,<<<
otal '.ed cost................ /,0<< /,0<< /,0<<
otal overhead cost......... RC,,<< RC,C<< R)<,0<<
+. he cost formula for all overhead costs would $e R/,0<< plus
R).<< per machine7hour.
3olutions Manual, "hapter )) +@C
,. 1ant !roducts, &nc.
Dverhead !erformance 8eport
For the Month of April
?udgeted machine7hours.... 2,<<<
3tandard machine7hours..... 0,2<<
Actual machine7hours......... 0,@<< Z
$verhead Costs
Cost
Formula
'per
M<+
Actual
;AF:: M<
Budgete
d ;AF::
M<
Spendin
g
Varianc
e
Iaria$le overhead:
Maintenance............ R<.)< R),<B, ZZ R0@< R 0), K
3upplies.................. <./< ,,/+< +,+B< ),)/< K
Ktilities.................... <.,< +,)22 ZZ ),@)< /02 K
Machine setup......... <.+< B00 ),)/< +B0 F
otal varia$le cost...... R).<< @,0+/ 0,@<< ),B+/ K
Fi.ed overhead:
Maintenance............ ),<<< ),<<< <
Ktilities.................... 0<< 0<< <
3upervision............. ,,<<< ,,<<< <
otal '.ed cost........... /,0<< /,0<< <
otal overhead cost.... R)+,<+/ R)<,+<< R),B+/ K
Z C0P V 2,<<< M;s Y 0,@<< M;s
ZZ R+,<B, less R),<<< '.ed Y R),<B,.
R+,222 less R0<< '.ed Y R+,)22.
/. a. Assuming that the varia$le overhead really should $e
proportional to actual machine7hours, the unfavora$le
spending variance in this situation could $e the result of
either higher prices or waste. Knlike the price variance for
materials and the rate variance for la$or, the spending
variance for varia$le overhead measures $oth price and
waste elements. his is why the variance is called a
MspendingN variance. otal spending can $e a#ected as much
$y waste as it can $y greater (or lesser* prices paid for items.
3olutions Manual, "hapter )) +B<
$. EEciency variance Y 38 (A; X 3;*
R) per M; (0,@<< M;s X 0,2<< M;s* Y R)<< K
he overhead eEciency variance is misnamed, since it does
not measure eEciency (waste* in use of varia$le overhead
items. he variance arises solely $ecause of ineEciency in
the base underlying the incurrence of varia$le overhead cost.
&f the incurrence of varia$le overhead costs is directly tied to
the actual machine7hours worked, then the e.cessive
num$er of machine7hours worked during April has caused
the incurrence of an additional R)<< in varia$le overhead
costs.
3olutions Manual, "hapter )) +B)
&ro'lem 11-2! (/0 minutes*
).
R2<<,<<<
otal rate: Y R)< per >=;
2<,<<< >=;s
R)+<,<<<
Iaria$le rate: Y R+ per >=;
2<,<<< >=;s
R/B<,<<<
Fi.ed rate: Y RB per >=;
2<,<<< >=;s
+. >irect materials: , pounds at R@ per pound.... R+)
>irect la$or: ).0 >=;s at R)+ per >=;............ )B
Iaria$le overhead: ).0 >=;s at R+ per >=;.... ,
Fi.ed overhead: ).0 >=;s at RB per >=;......... )+
3tandard cost per unit.................................... R0/
,. a. /+,<<< units V ).0 >=;s per unit Y 2,,<<< standard >=;s.
$. Manufacturing Dverhead
Actual
costs
2<2,0<< 2,<,<<< Z Applied costs
+,,0<< Dverapplied overhead
Z2,,<<< standard >=;s V R)< per >=; Y R2,<,<<<.
/. Iaria$le overhead variances:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for Dutput,
(A; V A8* (A; V 38* (3; V 38*
R)+,,0<< 20,<<< >=;s V
R+ per >=;
2,,<<< >=;s V
R+ per >=;
Y R),<,<<< Y R)+2,<<<

3pending Iariance,
R2,0<< F
EEciency Iariance,
R/,<<< K
3olutions Manual, "hapter )) +B+
38*
(R)+,,0<<* X (20,<<< >=;s V R+ per >=;* Y R2,0<< F
R+ per >=; (20,<<< >=;s X 2,,<<< >=;s* Y R/,<<< K
Actual Fi.ed
Dverhead "ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R/B,,<<< R/B<,<<<Z 2,,<<< >=;s V RB per
>=;
Y R0</,<<<

?udget Iariance,
R,,<<< K
Iolume Iariance,
R+/,<<< F
Z"an $e e.pressed as: 2<,<<< denominator >=;s V RB per >=;
Y R/B<,<<<
?udget variance:
Y 7
Y R/B,,<<< 7 R/B<,<<<
Y R,,<<< K
Iolume variance:
Iolume >enominator
Iariance hours
Y RB per >=; (2<,<<< >=;s 7 2,,<<< >=;s*
Y R+/,<<< F
m n
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3olutions Manual, "hapter )) +B,
he companyGs overhead variances can $e summarized as
follows:
Iaria$le overhead:
3pending variance......................
R
2,0<< F
EEciency variance..................... /,<<< K
Fi.ed overhead:
?udget variance......................... ,,<<< K
Iolume variance......................... +/,<<< F
Dverapplied overhead9see part
,
R+,,0<
< F
0. Dnly the volume variance would have changed. &t would have
$een unfavora$le since the standard >=;s allowed for the
yearGs production (2,,<<< >=;s* would have $een less than the
denominator >=;s (20,<<< >=;s*.
3olutions Manual, "hapter )) +B/
). FA? "DM!AAQ
Fle.i$le ?udget
For the Month Ended March ,)
Cost
Formula Machine/<ours
$verhead Costs
'per
M<+ 5:A::: 5;A::: 6:A:::
Iaria$le costs:
Ktilities....................... R<.C< R )B,<<<
R
++,0<< R+@,<<<
Maintenance............... ).2< ,+,<<< /<,<<< /B,<<<
Machine setup............ <.,< 2,<<< @,0<< C,<<<
&ndirect la$or.............. <.@< )/,<<<
)@,0<
< +),<<<
otal varia$le cost......... R,.0< @<,<<<
B@,0<
< )<0,<<<
Fi.ed costs:
Maintenance.............. /<,<<< /<,<<< /<,<<<
&ndirect la$or.............. ),<,<<< ),<,<<< ),<,<<<
>epreciation.............. @<,<<<
@<,<<
< @<,<<<
otal '.ed cost............. +/<,<<<
+/<,<<
< +/<,<<<
otal overhead cost......
R,)<,<<
<
R,+@,0<
< R,/0,<<<
3olutions Manual, "hapter )) +B0
+. FA? "ompany
Dverhead !erformance 8eport
For the Month Ended March ,)
?udgeted machine7hours.... ,<,<<<
Actual machine7hours......... +2,<<<
$verhead Costs
Cost
Formula
'per
M<+
Actual
5EA:::
<ours
Budget
5EA:::
<ours
Spending
or
Budget
Variance
Iaria$le costs:
Ktilities................ R<.C<
R
+/,+<<
R
+,,/<< R B<< K
MaintenanceZ...... ).2< ,B,)<< /),2<< ,,0<< F
Machine setup..... <.,< B,/<< @,B<< 2<< K
&ndirect la$or....... <.@< )C,2<< )B,+<< ),/<< K
otal varia$le cost. . R,.0< C<,,<< C),<<< @<< F
Fi.ed costs:
Maintenance........ /<,<<< /<,<<< <
&ndirect la$or....... ),<,<<< ),<,<<< <
>epreciation........ @),0<< @<,<<< ),0<< K
otal '.ed cost....... +/),0<< +/<,<<< ),0<< K
otal overhead
cost.....................
R,,),B<
<
R,,),<<
< R B<< K
Z R@B,)<< total maintenance cost, less R/<,<<< '.ed
maintenance cost, e4uals R,B,)<< varia$le maintenance
cost. he varia$le element of other costs is computed in
the same way.
,. &n order to compute an overhead eEciency variance, it would
$e necessary to know the standard hours allowed for the
)0,<<< units produced during March.
3olutions Manual, "hapter )) +B2
). and +. Per !irect )abor/<our
Variabl
e Fixed ,otal
>enominator of ,<,<<< >=;s:
R),0,<<< [ ,<,<<< >=;s............. R/.0< R/.0<
R+@<,<<< [ ,<,<<< >=;s............. RC.<< C.<<
otal predetermined rate................. R),.0<
>enominator of /<,<<< >=;s:
R)B<,<<< [ /<,<<< >=;s............. R/.0< R/.0<
R+@<,<<< [ /<,<<< >=;s............. R2.@0 2.@0
otal predetermined rate................. R)).+0
,.
!enominator Activit%G
6:A::: !)<s
!enominator Activit%G
7:A::: !)<s
>irect materials, / feet
_ RB.@0 per foot......... R,0.<< 3ame......................... R,0.<<
>irect la$or, + >=;s _
R)0 per >=;............... ,<.<< 3ame......................... ,<.<<
Iaria$le overhead, +
>=;s _ R/.0< per
>=;............................. C.<< 3ame......................... C.<<
Fi.ed overhead, +
>=;s _ RC per >=;.... )B.<<
Fi.ed overhead, +
>=;s _ R2.@0 per
>=;......................... ),.0<
3tandard cost per unit... RC+.<<
3tandard cost per
unit......................... RB@.0<
/. a. )B,<<< units V + >=;s per unit Y ,2,<<< standard >=;s.
$. Manufacturing Dverhead
Actual
costs //2,/<< /B2,<<< Z Applied costs
,C,2<< Dverapplied overhead
Z,2,<<< standard >=;s V R),.0< predetermined rate per
>=; Y R/B2,<<<.
3olutions Manual, "hapter )) +B@
c. Iaria$le overhead variances:
Actual >=;s of
&nput, at the
Actual 8ate
Actual >=;s of
&nput, at the
3tandard 8ate
3tandard >=;s
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
R)@/,B<< ,B,<<< >=;s V
R/.0< per >=;
,2,<<< >=;s V
R/.0< per >=;
Y R)@),<<< Y R)2+,<<<

3pending Iariance,
R,,B<< K
EEciency Iariance,
RC,<<< K
38*
(R)@/,B<<* X (,B,<<< >=;s V R/.0< per >=;* Y R,,B<< K
R/.0< per >=; (,B,<<< >=;s X ,2,<<< >=;s* Y RC,<<< K
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R+@),2<< R+@<,<<<Z ,2,<<< >=;s V RC per
>=;
Y R,+/,<<<

?udget Iariance,
R),2<< K
Iolume Iariance,
R0/,<<< F
Z"an $e e.pressed as: ,<,<<< denominator >=;s V RC per
>=; Y R+@<,<<<.
3olutions Manual, "hapter )) +BB
?udget variance:
Y 7
Y R+@),2<< 7 R+@<,<<<
Y R),2<< K
Iolume variance:
Iolume >enominator
Iariance hours
Y RC.<< per >=; (,<,<<< >=;s 7 ,2,<<< >=;s*
Y R0/,<<< F
m n
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3ummary of variances:
Iaria$le overhead spending variance. . . R,,B<< K
Iaria$le overhead eEciency variance. . C,<<< K
Fi.ed overhead $udget variance........... ),2<< K
Fi.ed overhead volume variance.......... 0/,<<< F
Dverapplied overhead.......................... R,C,2<< F
3olutions Manual, "hapter )) +BC
0. he major disadvantage of using normal activity is the large
volume variance that ordinarily results. his occurs $ecause the
denominator activity used to compute the predetermined
overhead rate is di#erent from the activity level that is
anticipated for the period. &n the case at hand, the company
has used a long7run normal activity 'gure of ,<,<<< >=;s to
compute the predetermined overhead rate, whereas activity for
the period was e.pected to $e /<,<<< >=;s. his has resulted
in a huge favora$le volume variance that may $e diEcult for
management to interpret. &n addition, the large favora$le
volume variance in this case has masked the fact that the
company did not achieve the $udgeted level of activity for the
period. he company had planned to work /<,<<< >=;s, $ut
managed to work only ,2,<<< >=;s (at standard*. his
unfavora$le result is concealed due to using a denominator
'gure that is out of step with current activity.
Dn the other hand, using long7run normal activity as the
denominator results in unit costs that are sta$le from year to
year. hus, managementGs decisions are not clouded $y unit
costs that jump up and down as the activity level rises and
falls.
3olutions Manual, "hapter )) +C<
). he computations of the cost formulas appear $elow.
Cost
Variable
1ith respect
to
Activit%
level
Cost per
unit of
activit%
Actors and directorsG wages..........................
i+)2,<<
< performances )<B i +,<<<
3tagehandsG wages...................................... i,+,/<< performances )<B i,<<
icket $ooth personnel and ushersG wages. . . i)2,+<< performances )<B i)0<
3cenery, costumes, and props......................
i)<B,<<
< productions 2 i)B,<<<
heater hall rent........................................... i0/,<<< performances )<B i0<<
!rinted programs.......................................... i+@,<<< performances )<B i+0<
!u$licity........................................................ i)+,<<< productions 2 i+,<<<
Administrative e.penses ()0P*.................... i2,/B< productions 2 i),<B<
Administrative e.penses ()<P*.................... i/,,+< performances )<B i/<
Fi.ed administrative e.penses (@0P*........... i,+,/<< 9 9 9
+. he performance report is clearest when it is organized $y cost $ehavior. he costs that
are varia$le with respect to the num$er of productions come 'rst, then the costs that are
varia$le with respect to performances, then the administrative e.penses as a special
category.
he =ittle heatre
Actual num$er of productions.......................... @
Actual num$er of performances per
production..................................................... +/
3olutions Manual, "hapter )) +C)
Actual total num$er of performances............... )2B
,he performance report is continued on the next page*
3olutions Manual, "hapter )) +C+
Costs
Cost
Formula
Per Unit of
Activit%
Actual
Costs
"ncurred
Budget
Based on
Actual
Activit% Variance
Iaria$le costs of productions:
(Fle.i$le $udget $ased on @
productions*
3cenery, costumes, and props................ i)B,<<< i),<,2<< i)+2,<<< i /,2<< K
!u$licity.................................................. +,<<< )0,)<< )/,<<< ),)<< K
otal varia$le cost per productionZ............ i+<,<<< )/0,@<< )/<,<<< 0,@<< K
Iaria$le costs of performances:
(Fle.i$le $udget $ased on )2B
performances*
Actors and directorsG wages.................... i+,<<< ,/),B<< ,,2,<<< 0,B<< K
3tagehandsG wages................................. ,<< /C,@<< 0<,/<< @<< F
icket $ooth personnel and ushersG
wages................................................... )0< +0,C<< +0,+<< @<< K
heater hall rent..................................... 0<< @B,<<< B/,<<< 2,<<< F
!rinted programs.................................... +0< ,B,,<< /+,<<< ,,@<< F
otal varia$le cost per performanceZ......... i,,+<< 0,,,@<< 0,@,2<< ,,C<< F
Iaria$le per production........................... i),<B< @,02<
Iaria$le per performance....................... i/< 2,@+<
Fi.ed....................................................... ,+,/<<
otal administrative e.penses................... /@,0<< /2,2B< B+< K
otal cost................................................... i@+2,C<< i@+/,+B< i +,2+< K
ZE.cluding varia$le portion of administrative e.penses
3olutions Manual, "hapter )) +C,
3olutions Manual, "hapter )) +C/
,. he overall unfavora$le variance is a very small percentage of
the total cost, less than <./P. hat suggests that costs are well
under control. &n addition, the pattern of the variances may
re-ect good management. he largest unfavora$le variances
are for value7added activities (scenery, costumes, props, actors
and directors* that may warrant additional spending. hese
unfavora$le variances are o#set $y favora$le variances for
theater hall rent and the printed programs. Assuming that the
4uality of the printed programs has not noticea$ly declined and
that the favora$le variance for the rent re-ects a lower
negotiated rental fee, management should $e congratulated.
hey have saved in some areas and have apparently
transferred the funds to other areas that may favora$ly impact
the 4uality of the theaterGs productions.
/. he average costs may not $e very good indicators of the
additional costs of any particular production or performance.
he averages gloss over considera$le variations in costs. For
e.ample, a production of !eter the 8a$$it may re4uire only half
a dozen actors and actresses and fairly simple costumes and
props. Dn the other hand, a production of "inderella may
re4uire dozens of actors and actresses and very ela$orate and
costly costumes and props. "onse4uently, $oth the production
costs and the cost per performance will $e much higher for
"inderella than for !eter the 8a$$it. Managers of theater
companies know that they must estimate the costs of each new
production individually9the average costs are of little use for
this purpose.
3olutions Manual, "hapter )+ +<)
Case 11-31 (,< minutes*
&t is diEcult to imagine how om Uemper could ethically agree to
go along with reporting the favora$le R+),<<< variance for
industrial engineering on the 'nal report, even if the $ill were not
actually received $y the end of the year. &t would $e misleading to
include all of the original contract price of R+)<,<<< on the report,
$ut to e.clude part of the 'nal cost of the contract. "olla$orating
in this attempt to mislead corporate head4uarters would appear
to $e a violation of three of the 3tandards of Ethical "onduct for
Management Accountants: "ompetence, &ntegrity, and D$jectivity.
hese three violations are discussed $elow:
Competencekhe competence standard re4uires that
management accountants Mprepare complete and clear reports
and recommendations after appropriate analyses of relevant and
relia$le information.N A report that omits mentioning the entire
amount owed on the industrial engineering contract could hardly
$e called complete.
"ntegrit%khe integrity standard re4uires that management
accountants Mcommunicate unfavora$le as well as favora$le
information...N Oithholding unfavora$le information such as the
entire amount owed on the industrial engineering contract
violates this standard.
$bectivit%khe o$jectivity standard re4uires that management
accountants Mdisclose fully all relevant information that could
reasona$ly $e e.pected to in-uence the userTs understanding of
the reports, comments, and recommendations presented.N Failing
to disclose the entire amount owed on the industrial engineering
contract violates this standard.
&ndividuals will di#er in how they think om Uemper should handle
this situation. &n our opinion, he should 'rmly state that he is
willing to call =aura, $ut even if the $ill does not arrive, he is
ethically $ound to properly accrue the e.penses on the report9
which will mean an unfavora$le variance for industrial
engineering and an overall unfavora$le variance. his would
re4uire a great deal of personal courage. &f the general manager
insists on keeping the misleading R+),<<< favora$le variance on
the report, Uemper would have little choice under the 3tandards
3olutions Manual, "hapter )+ +<+
of Ethical "onduct. ;e would have to take the dispute to the ne.t
higher managerial level in the company.
3olutions Manual, "hapter )+ +<,
&t is important to note that the pro$lem may $e a conse4uence of
inappropriate use of performance reports $y corporate
head4uarters. &f the performance report is $eing used as a way of
M$eating upN managers, corporate head4uarters may $e creating
a climate in which managers such as the general manager at the
Oichita plant will feel like they must always turn in positive
reports. his creates pressure to $end the truth since reality isnGt
always positive.
3ome students may suggest that Uemper redo the performance
report to recognize eEciency variances. his might make the
performance look $etter, or it might make the performance look
worse% we cannot tell from the data in the case. Moreover, it is
unlikely that corporate head4uarters would permit a performance
report that does not follow the usual format, which apparently
does not recognize eEciency variances.
3olutions Manual, "hapter )+ +</
). !erformance report:
Kniversity Motor !ool
?udget 8eport for March
March
Actual
Flexible
Budget Variance
1asoline............................... R /,,<< R /,/)< R))< F
Dil, minor repairs, and
parts.................................. ,B< ,@B + K
Dutside repairs..................... 0< +,2 )B2 F
&nsurance............................. 0+0 0+0 <
3alaries and $ene'ts............ +,0<< +,0<< <
>epreciation of vehicles....... +,,)< +,,)< <
otal cost.............................. R)<,<20 R)<,,0C R+C/ F
Aum$er of automo$iles in
use..................................... +) +) <
Actual miles......................... 2,,<<< 2,,<<< <
"ost per mile........................ R<.)0CB R<.)2// R<.<</2 F
3upporting calculations for -e.i$le $udget amounts:
1asoline:
2,,<<< miles
V R).@0 per gallon Y R/,/)<
+0 miles per gallon
Dil, minor repairs, and parts:
2,,<<< miles V R<.<<2 per mile Y R,@B
Dutside repairs:
R),0 per auto V +) autos
YR+,2.+0
)+ months
&nsurance:
R2,<<< [ +< autos Y R,<< per auto
+) autos V R,<< per auto Y R2,,<<
R2,,<< [ )+ months Y R0+0 per month
3olutions Manual, "hapter )+ +<0
3alaries and $ene'ts (no change*:
R,<,<<< annual cost
Y R+,0<< per month
)+ months
>epreciation9Annual depreciation per auto:
R+2,/<< [ +< autos Y R),,+< per auto
>epreciation9Annual depreciation for +) autos:
R),,+< per auto V +) autos Y R+@,@+<
>epreciation9Monthly depreciation for +) autos:
R+@,@+< [ )+ months Y R+,,)< per month
+. he performance report as originally prepared is $ased on a
static $udget approach that does not allow for variations in the
num$er of miles driven from month to month, or for variations
in the num$er of automo$iles used. his causes the Mmonthly
$udgetN 'gures for $oth varia$le and '.ed costs to $e
unrealistic as $enchmarks against which to compare actual
costs for the month. For e.ample, actual varia$le costs such as
gasoline canGt $e compared to the M$udgetedN cost, since the
$udgeted 'gure is $ased on only 0<,<<< miles% actual '.ed
costs such as insurance canGt $e compared to the M$udgetedN
costs, since the $udgeted 'gure is $ased on only +<
automo$iles.
he performance report in !art ()* a$ove is more realistic since
the $enchmark 'gures are $ased on actual miles driven and on
the actual num$er of automo$iles used during the month.
3olutions Manual, "hapter )+ +<2
). he num$er of units produced can $e computed $y using the
total standard cost applied for the period for an% input
(materials, la$or, or overhead*, or it can $e computed $y using
the total standard cost applied for all inputs together. Ksing
only the standard cost applied for materials, we have:
otal standard cost applied for the period R/<0,<<<
Y
3tandard cost per unit R)B per unit
Y ++,0<< units
he same answer can $e o$tained $y using any other cost
input.
+. ),B,<<< pounds% see $elow for a detailed analysis.
,. R+.C0 per pound% see $elow for a detailed analysis.
/. )C,/<< direct la$or7hours% see $elow for a detailed analysis.
0. R)0.@0 per direct la$or7hour% see $elow for a detailed analysis.
2. 3tandard varia$le overhead cost
applied........................................... R0/,<<<
Add: Dverhead eEciency variance.... /,+<< K (see $elow*
>educt: Dverhead spending
variance.......................................... ),,<< F
Actual varia$le overhead cost
incurred.......................................... R02,C<<
@. 3tandard '.ed overhead cost
applied...........................................
R)+2,<<
<
Add: Knfavora$le volume variance. . . )/,<<< K
?udgeted '.ed overhead cost...........
R)/<,<<
<
B.
3olutions Manual, "hapter )+ +<@
?udgeted '.ed overhead cost R)/<,<<<
Y
Fi.ed portion of the predetermined overhead rate R@ per >=;
Y +<,<<< >=;s
3olutions Manual, "hapter )+ +irect materials analysis:
Actual 6uantity of
&nputs, at Actual
!rice
Actual 6uantity
of &nputs, at
3tandard !rice
3tandard 6uantity
Allowed for
Dutput, at
3tandard !rice
(A6 V A!* (A6 V 3!* (36 V 3!*
),B,<<< pounds
V R+.C0 per
poundZZZ
),B,<<<
poundsZZ
V R, per pound
),0,<<< poundsZ
V R, per pound
Y R/<@,)<< Y R/)/,<<< Y R/<0,<<<
!rice Iariance,
R2,C<< F
6uantity Iariance,
RC,<<< K
otal Iariance,
R+,)<< K
Z ++,0<< units V 2 pounds per unit Y ),0,<<<
pounds
ZZ R/)/,<<< [ R, per pound Y ),B,<<< pounds
ZZZ R/<@,)<< [ ),B,<<< pounds Y R+.C0 per
pound
>irect la$or analysis:
Actual ;ours of
8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
)C,/<< >=;s V
R)0.@0 per >=;ZZZ
)C,/<< >=;sZZ V
R)0 per >=;
)B,<<< >=;sZ V
R)0 per >=;
Y R,<0,00< Y R+C),<<< Y R+@<,<<<

8ate Iariance,
R)/,00< K
EEciency Iariance,
R+),<<< K
otal Iariance,
R,0,00< K
Z ++,0<< units V <.B >=;s per unit Y )B,<<<
3olutions Manual, "hapter )+ +<C
>=;s
ZZ R+C),<<< [ R)0 per >=; Y )C,/<< >=;s
ZZZ R,<0,00< [ )C,/<< >=;s Y R)0.@0 per >=;
3olutions Manual, "hapter )+ +)<
Iaria$le overhead analysis:
Actual ;ours of
8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
R02,C<<ZZ )C,/<< >=;s V
R, per >=;
)B,<<< >=;s V
R, per >=;
Y R0B,+<< Y R0/,<<<
3pending Iariance,
R),,<< F
EEciency Iariance,
R/,+<< KZ
Z "omputed using )C,/<< actual >=;s at the R, per >=;
standard rate.
ZZ R0B,+<< X R),,<< Y R02,C<<.
Fi.ed overhead analysis:
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R),C,0<<ZZ R)/<,<<<Z )B,<<< hours V R@ per
hour
Y R)+2,<<<

?udget Iariance,
R0<< F
Iolume Iariance,
R)/,<<< K
Z
R)+2,<<< \ R)/,<<< Y
R)/<,<<<.
ZZ R)/<,<<< X R0<< Y R),C,0<<.
3olutions Manual, "hapter )+ +))
Case 11-34 (/0 minutes for each company% C< minutes in total*
(Aote to the &nstructor: Qou may wish to assign only one
company.*
Compan% A Compan% B
). >enominator activity in machine7
hours............................................ ,0,<<< /<,<<< Z
+. 3tandard machine7hours allowed
for units produced........................ ,+,<<< Z /+,<<<
,. Actual machine7hours worked......... ,<,<<< Z /0,<<<
/. Fle.i$le $udget varia$le overhead
per machine7hour......................... R).@0 R+.B< Z
0. ?udgeted '.ed overhead (total*..... R+)<,<<< R,<<,<<<
2. Actual varia$le overhead cost......... R0/,<<< Z R))@,<<< Z
@. Actual '.ed overhead cost.............. R+<C,/<< Z R,<+,)<< Z
B. Iaria$le overhead cost applied to
production.................................... R02,<<< R))@,2<< Z
C. Fi.ed overhead cost applied to
production.................................... R)C+,<<< Z R,)0,<<<
)<. Iaria$le overhead spending
variance....................................... R),0<< K RC,<<< F
)). Iaria$le overhead eEciency
variance....................................... R,,0<< FZ RB,/<< KZ
)+. Fi.ed overhead $udget variance..... R2<< F R+,)<< KZ
),. Fi.ed overhead volume variance..... R)B,<<< KZ R)0,<<< F
)/. Iaria$le portion of the
predetermined overhead rate....... R).@0 R+.B<
)0. Fi.ed portion of the
predetermined overhead rate....... R2.<< R@.0<
)2. Knderapplied (or overapplied*
overhead...................................... R)0,/<< (R),,0<<*
Z1iven.
3olutions Manual, "hapter )+ +)+
Anal%sis for Compan% AG
Iaria$le overhead:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
R0/,<<<Z ,<,<<< M;sZ V
R).@0 per M;
,+,<<< M;sZ V
R).@0 per M;ZZ
Y R0+,0<< Y R02,<<<

3pending Iariance,
R),0<< K
EEciency Iariance,
R,,0<< FZ
Fi.ed overhead:
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead "ost
Applied to Oork in
!rocess
R+<C,/<<Z R+)<,<<< ,+,<<< M;sZ V R2 per M;
Y R)C+,<<<Z

?udget Iariance,
R2<< F
Iolume Iariance,
R)B,<<< KZ
Z 1iven.
ZZ
R,,0<<
Y R).@0 per M;
,+,<<< M;s 7 ,<,<<< M;s
3olutions Manual, "hapter )+ +),
>enominator activity in hours:
R+)<,<<<
Y
Y R2 per M;
.
herefore, the denominator activity is: R+)<,<<< [ R2 per M;
Y ,0,<<< M;s.
Knderapplied overhead:
Iaria$le overhead spending variance. . R ),0<< K
Iaria$le overhead eEciency variance. ,,0<< F
Fi.ed overhead $udget variance.......... 2<< F
Fi.ed overhead volume variance......... )B,<<< K
Knderapplied overhead....................... R)0,/<< K
Anal%sis for Compan% BG
Iaria$le overhead:
Actual ;ours of
&nput, at the
Actual 8ate
Actual ;ours of
&nput, at the
3tandard 8ate
3tandard ;ours
Allowed for
Dutput, at the
3tandard 8ate
(A; V A8* (A; V 38* (3; V 38*
R))@,<<<Z /0,<<< M;s
V R+.B< per M;Z
/+,<<< M;s
V R+.B< per M;Z
Y R)+2,<<< Y R))@,2<<Z

3pending Iariance,
RC,<<< F
EEciency Iariance,
RB,/<< KZ
Z1iven.
3olutions Manual, "hapter )+ +)/
Fi.ed overhead:
Actual Fi.ed
Dverhead
"ost
?udgeted Fi.ed
Dverhead "ost
Fi.ed Dverhead
"ost Applied to
Oork in !rocess
R,<+,)<<Z R,<<,<<< /+,<<< M;s V
R@.0< per M;ZZ
Y R,)0,<<<
?udget Iariance,
R+,)<< KZ
Iolume Iariance,
R)0,<<< F
Z 1iven
ZZ R,<+,)<< X R+,)<< Y R,<<,<<<% R,<<,<<< [ /<,<<<
denominator M;s Y R@.0< '.ed predetermined overhead
rate.
Dverapplied overhead:
Iaria$le overhead spending variance. . RC,<<< F
Iaria$le overhead eEciency variance.. B,/<< K
Fi.ed overhead $udget variance.......... +,)<< K
Fi.ed overhead volume variance.......... )0,<<< F
Dverapplied overhead.......................... R),,0<< F
3olutions Manual, "hapter )+ +)0
Chapter 12
Segment =eporting and
1ecentraliAation
12-1 &n a decentralized organization,
decision7making authority isnGt con'ned to
a few top e.ecutives, $ut rather is spread
throughout the organization with lower7
level managers and other employees
empowered to make decisions.
12-2 he $ene'ts of decentralization
include: ()* freeing top managers to focus
on strategy, higher7level decision making,
and coordinating activity% (+* improving
operational decision making, since lower7
level managers often have $etter
information a$out local conditions% (,*
ena$ling 4uicker response to customer
needs% (/* training lower7level managers
to take on greater responsi$ility% and (0*
providing greater motivation and jo$
satisfaction for lower7level managers.
12-3 A cost center manager has control
over cost, $ut not revenue or investment
funds. A pro't center manager has control
over $oth cost and revenue. An
investment center manager has control
over cost and revenue and investment
funds.
12-4 A segment is any part or activity of
an organization a$out which a manager
seeks cost, revenue, or pro't data.
E.amples of segments include
departments, operations, sales territories,
divisions, product lines, and so forth.
12-5 Knder the contri$ution approach,
costs are assigned to a segment if and
only if the costs are tracea$le to the
segment. "ommon costs are not allocated
to segments under the contri$ution
approach.
12- A tracea$le cost of a segment is a
cost that arises speci'cally $ecause of the
e.istence of that segment. &f the segment
were eliminated, the cost would disappear.
A common cost, $y contrast, is a cost that
supports more than one segment, $ut is
not tracea$le in whole or in part to any
one of the segments. &f the departments
of a company are treated as segments,
then e.amples of the tracea$le costs of a
department would include the salary of
the departmentGs supervisor, depreciation
of machines used e.clusively $y the
department, and the costs of supplies
used $y the department. E.amples of
common costs would include the salary of
the general counsel of the entire
company, the lease cost of the
head4uarters $uilding, corporate image
advertising, and periodic depreciation of
machines shared $y several departments.
12-! he contri$ution margin is the
di#erence $etween sales revenue and
varia$le e.penses. he segment margin is
the amount remaining after deducting
tracea$le '.ed e.penses from the
contri$ution margin. he contri$ution
margin is useful as a planning tool for
3olutions Manual, "hapter )+ +)2
many decisions, including those in which
'.ed costs donGt change. he segment
margin is useful in assessing the overall
pro'ta$ility of a segment.
12-" &f common costs were allocated to
segments, then the costs of segments
would $e overstated and their margins
would $e understated. As a conse4uence,
some segments may appear to $e
unpro'ta$le and managers may $e
tempted to eliminate them. &f a segment
were eliminated $ecause of the e.istence
of ar$itrarily allocated common costs, the
overall pro't of the company would
decline $y the amount of the segment
margin $ecause the common cost would
remain. he common cost that had $een
allocated to the segment would then $e
reallocated to the remaining segments9
making them appear less pro'ta$le.
12-# here are often limits to how far
down an organization a cost can $e
traced. herefore, costs that are tracea$le
to a segment may $ecome common as
that segment is divided into smaller
segment units. For e.ample, the costs of
national I and print advertising might $e
tracea$le to a product line, $ut $e a
common cost of the geographic sales
territories in which that product line is
sold.
12-1$ Margin refers to the ratio of net
operating income to total sales. urnover
refers to the ratio of total sales to average
operating assets. he product of the two
num$ers is the 8D&.
12-11 8esidual income is the net
operating income an investment center
earns a$ove the companyGs minimum
re4uired rate of return on operating
assets.
12-12 &f 8D& is used to evaluate
performance, a manager of an investment
center may reject a pro'ta$le investment
opportunity whose rate of return e.ceeds
the companyGs re4uired rate of return $ut
whose rate of return is less than the
investment centerGs current 8D&. he
residual income approach overcomes this
pro$lem since any project whose rate of
return e.ceeds the companyGs minimum
re4uired rate of return will result in an
increase in residual income.
12-13 A transfer price is the price
charged for a transfer of goods or services
$etween segments of the same
organization, such as two departments or
divisions. ransfer prices are needed for
performance evaluation purposes. he
selling unit gets credit for the transfer
price and the $uying unit must deduct the
transfer price as an e.pense.
12-14 &f the selling division has idle
capacity, any transfer price a$ove the
varia$le cost of producing an item for
transfer will generate some additional
pro't.
12-15 &f the selling division has no idle
capacity, then the transfer price would
have to cover at least the divisionGs
varia$le cost plus the contri$ution margin
on lost sales.
12-1 "ost7$ased transfer prices are
widely used $ecause they are easily
understood and convenient to use. heir
disadvantages are that they can lead to
poor decisions regarding whether transfers
should $e made, they provide little
incentive for cost control, and the selling
division makes no pro't.
12-1! Ksing the market price as the
transfer price can lead to incorrect
decisions. Ohen the selling division has
idle capacity, the cost to the company of
the transfer is just the varia$le cost of the
item transferred. ;owever, if the market
price is used as the transfer price, the
$uying division regards the market price
as the cost. &f the market price e.ceeds
the varia$le cost (which will ordinarily
happen*, managers in the $uying division
will make less than optimal pricing and
other decisions concerning the product.
3olutions Manual, "hapter )+ +)@
3olutions Manual, "hapter )+ +)B
,otal 0eedban @reengro1
Amount J Amount P Amount J
3alesZ........................
R,<<,<<
< )<< RC<,<<< )<< R+)<,<<< )<<
=ess varia$le
e.penses................ )B,,<<< 2) ,2,<<< /< )/@,<<< @<
"ontri$ution margin. . ))@,<<< ,C 0/,<<< 2< 2,,<<< ,<
=ess tracea$le '.ed
e.penses................ 22,<<< ++ /0,<<< 0< +),<<< )<
!roduct line
segment margin..... 0),<<< )@ RC,<<< )< R/+,<<< +<
=ess common '.ed
e.penses not
tracea$le to
products................. ,,,<<< ))
Aet operating
income....................
R
)B,<<< 2
Z Oeed$an: )0,<<< units V R2 per unit Y RC<,<<<.
1reengrow: +B,<<< units V R@.0< per unit Y R+)<,<<<.
Iaria$le e.penses are computed in the same way.
3olutions Manual, "hapter )+ +)C
).
Margin Y
3ales
R2<<,<<<
Y Y BP
R@,0<<,<<<
+. 3ales
urnover Y
Average operating assets
R@,0<<,<<<
Y Y ).0
R0,<<<,<<<
,. 8D& Y Margin V urnover
Y BP V ).0 Y )+P
3olutions Manual, "hapter )+ ++<
Average operating assets.................. i+,B<<,<<<
Aet operating income........................ i2<<,<<<
Minimum re4uired return:
)BP V average operating assets.... i0</,<<<
8esidual income................................ i C2,<<<
3olutions Manual, "hapter )+ ++)
). a. he lowest accepta$le transfer price from the perspective of
the selling division is given $y the following formula:

on lost sales
Iaria$le cost
ransfer price \
per unit
Aum$er of units transferred
r
3ince there is enough idle capacity to 'll the entire order
from the ;i7Fi >ivision, no outside sales are lost. And since
the varia$le cost per unit is R/+, the lowest accepta$le
transfer price as far as the selling division is concerned is
also R/+.
R<
ransfer price R/+ \ Y R/+
0,<<<
r
$. he ;i7Fi division can $uy a similar speaker from an outside
supplier for R0@. herefore, the ;i7Fi >ivision would $e
unwilling to pay more than R0@ per speaker.
i Trans1er pri2e -ost o1 4u+in/ 1ro* outsi)e supplier . $$!
c. "om$ining the re4uirements of $oth the selling division and
the $uying division, the accepta$le range of transfer prices in
this situation is:
i i $42 Trans1er pri2e $$!
Assuming that the managers understand their own
$usinesses and that they are cooperative, they should $e
a$le to agree on a transfer price within this range and the
transfer should take place.
d. From the standpoint of the entire company, the transfer
should take place. he cost of the speakers transferred is
only R/+ and the company saves the R0@ cost of the
speakers purchased from the outside supplier.
3olutions Manual, "hapter )+ +++
+. a. Each of the 0,<<< units transferred to the ;i7Fi >ivision must
displace a sale to an outsider at a price of R2<. herefore,
the selling division would demand a transfer price of at least
R2<. his can also $e computed using the formula for the
lowest accepta$le transfer price as follows:
( *
( *
R2< 7 R/+ V 0,<<<
ransfer price R/+ \
0,<<<
Y R/+ \ R2< 7 R/+ Y R2<
r
$. As $efore, the ;i7Fi >ivision would $e unwilling to pay more
than R0@ per speaker.
c. he re4uirements of the selling and $uying divisions in this
instance are incompati$le. he selling division must have a
price of at least R2< whereas the $uying division will not pay
more than R0@. An agreement to transfer the speakers is
e.tremely unlikely.
d. From the standpoint of the entire company, the transfer
should not take place. ?y transferring a speaker internally,
the company gives up revenue of R2< and saves R0@, for a
loss of R,.
3olutions Manual, "hapter )+ ++,
). !ivision
,otal Compan% East Central 0est
Amount J Amount J Amount J Amount J
3ales............................. R),<<<,<<<
)<<.
< R+0<,<<<
)<
<
R/<<,<<
< )<<
R,0<,<<
< )<<
=ess varia$le e.penses. ,C<,<<< ,C.< ),<,<<< 0+ )+<,<<< ,<
)/<,<<
< /<
"ontri$ution margin...... 2)<,<<< 2).< )+<,<<ivisional segment
margin........................ @0,<<< @.0 R(/<,<<<* ()2*
R
B<,<<< +<
R
,0,<<< )<
=ess common '.ed
e.penses not
tracea$le to
divisionsZ.................... C<,<<< C.<
(loss*........................... R()0,<<<* ().0*
ZR2+0,<<< X R0,0,<<< Y RC<,<<<.
+. &ncremental sales (R,0<,<<< V +<P*... R@<,<<<
"ontri$ution margin ratio..................... V2<P
&ncremental contri$ution margin.......... /+,<<<
=ess incremental advertising e.pense. )0,<<<
&ncremental net operating income....... R+@,<<<
Qes, the advertising program should $e initiated.
3olutions Manual, "hapter )+ ++/
3olutions Manual, "hapter )+ ++0
). Aet operating income
Margin Y
3ales
R)0<,<<<
Y Y 0.<<P
R,,<<<,<<<
3ales
urnover Y
R,,<<<,<<<
Y Y /.<<
R@0<,<<<
8D& Y Margin V urnover
Y 0P V / Y +<P
+. Aet operating income
Margin Y
3ales
R)0<,<<<().<< \ +.<<*
Y
R,,<<<,<<<().<< \ <.0<*
R/0<,<<<
Y Y )<.<<P
R/,0<<,<<<
3ales
urnover Y
R,,<<<,<<< ().<< \ <.0<*
Y
R@0<,<<<
R/,0<<,<<<
Y
R@0<
Y 2.<<
,<<<
Y )<P V 2 Y 2<P
3olutions Manual, "hapter )+ ++2
E%ercise 12- (continued*
,.
Margin Y
3ales
R)0<,<<< \ R+<<,<<<
Y
R,,<<<,<<< \ R),<<<,<<<
R,0<,<<<
Y Y B.@0P
R/,<<<,<<<
3ales
urnover Y
R,,<<<,<<< \ R),<<<,<<<
Y
R@0<,<<< \ R+0<,<<<
R/,<<<,
Y
<<<
Y /.<<
R),<<<,<<<
Y B.@0P V / Y ,0P
3olutions Manual, "hapter )+ ++@
). R@0,<<< V /<P "M ratio Y R,<,<<< increased contri$ution
margin in Minneapolis. 3ince the '.ed costs in the oEce and in
the company as a whole will not change, the entire R,<,<<<
would result in increased net operating income for the
company.
&t is not correct to multiply the R@0,<<< increase in sales $y
MinneapolisG +/P segment margin ratio. his approach
assumes that the segmentGs tracea$le '.ed e.penses increase
in proportion to sales, $ut if they did, they would not $e '.ed.
+. a. he segmented income statement follows:
Segments
,otal
Compan% Chicago Minneapolis
3ales........................
R0<<,<<
< )<<.<
R+<<,<<
< )<<
R,<<,<<
< )<<
=ess varia$le
e.penses............... +/<,<<< /B.< 2<,<<< ,< )B<,<<< 2<
"ontri$ution margin. +2<,<<< 0+.< )/<,<<< @< )+<,<<< /<
=ess tracea$le '.ed
e.penses............... )+2,<<< +0.+ @B,<<< ,C /B,<<< )2
DEce segment
margin................... ),/,<<< +2.B
R
2+,<<< ,)
R
@+,<<< +/
=ess common '.ed
e.penses not
tracea$le to
segments............... 2,,<<< )+.2
Aet operating
income...................
R
@),<<< )/.+
$. he segment margin ratio rises and falls as sales rise and fall
due to the presence of '.ed costs. he '.ed costs are spread
over a larger $ase as sales increase.
&n contrast to the segment ratio, the contri$ution margin
ratio is sta$le so long as there is no change in either the
varia$le e.penses or the selling price per unit of service.
3olutions Manual, "hapter )+ ++B
). he company should focus its campaign on the >ental market.
he computations are:
Medical !ental
&ncreased sales........................................ R/<,<<< R,0,<<<
Market "M ratio........................................ V' ,2P V/BP '
&ncremental contri$ution margin.............. )/,/<< )2,B<<
=ess cost of the campaign........................ 0,<<< 0,<<<
&ncreased segment margin and net
operating income for the company as
a whole.................................................. R C,/<< R)),B<<
+. he R/B,<<< in tracea$le '.ed e.penses in E.ercise )+7@ is
now partly tracea$le and partly common. Ohen we segment
Minneapolis $y market, only R,,,<<< remains a tracea$le '.ed
e.pense. his amount represents costs such as advertising and
salaries of individuals that arise $ecause of the e.istence of the
Medical and >ental markets. he remaining R)0,<<< (R/B,<<< X
R,,,<<<* $ecomes a common cost when Minneapolis is
segmented $y market. his amount would include costs such
as the salary of the manager of the Minneapolis oEce that
could not $e avoided $y eliminating either of the two market
segments.
3olutions Manual, "hapter )+ ++C
E%ercise 12-# (,< minutes*
). Aet operating income
Margin Y
3ales
R@<,<<<
Y Y 0P
R),/<<,<<<
3ales
urnover Y
R),/<<,<<<
Y Y /.<<
R,0<,<<<
Y 0P V / Y +<P
+.
Margin Y
3ales
R@<,<<< \ R)B,+<<
Y
R),/<<,<<< \ R@<,<<<
RBB,+<<
Y Y 2P
R),/@<,<<<
3ales
urnover Y
R),/<<,<<< \ R@<,<<<
Y
R,0<,<<<
R),/@<,<<<
Y Y /.+
R,0<,<<<
Y 2P V /.+< Y +0.+P
3olutions Manual, "hapter )+ +,<
,.
Margin Y
3ales
R@<,<<< \ R)/,<<<
Y
R),/<<,<<<
RB/,<<<
Y Y 2P
R),/<<,<<<
3ales
urnover Y
R),/<<,<<<
Y Y /
R,0<,<<<
Y 2P V / Y +/P
/. Aet operating income
Margin Y
3ales
R@<,<<<
Y Y 0P
R),/<<,<<<
3ales
urnover Y
R),/<<,<<<
Y
R,0<,<<< 7 R@<,<<<
R),/<<,<<<
Y Y 0
R+B<,<<<
Y 0P V 0 Y +0P
3olutions Manual, "hapter )+ +,)
E%ercise 12-1$ (+< minutes*
). 'b+ 'c+
(et Average
'a+
$peratin
g
$peratin
g 2$"
Sales "ncome3 Assets 'b+ P 'c+
R+,0<<,<<
< R/@0,<<<
R),<<<,<<
< /@.0P
R+,2<<,<<
< R0<<,<<<
R),<<<,<<
< 0<.<P
R+,@<<,<<
< R0+0,<<<
R),<<<,<<
< 0+.0P
R+,B<<,<<
< R00<,<<<
R),<<<,<<
< 00.<P
R+,C<<,<<
< R0@0,<<<
R),<<<,<<
< 0@.0P
R,,<<<,<<
< R2<<,<<<
R),<<<,<<
< 2<.<P
Z3ales V "ontri$ution Margin 8atio X Fi.ed E.penses
+. he 8D& increases $y +.0P for each R)<<,<<< increase in sales.
his happens $ecause each R)<<,<<< increase in sales $rings
in an additional pro't of R+0,<<<. Ohen this additional pro't is
divided $y the average operating assets of R),<<<,<<<, the
result is an increase in the companyGs 8D& of +.0P.
&ncrease in sales.............................................. R)<<,<<< (a*
"ontri$ution margin ratio................................. +0P ($*
&ncrease in contri$ution margin and net
operating income (a* V ($*............................ R+0,<<< (c*
Average operating assets.................................
R),<<<,<<
< (d*
&ncrease in return on investment (c* [ (d*....... +.0P
3olutions Manual, "hapter )+ +,+
!ivision
Alpha Bravo Charlie
3ales................................
R/,<<<,<<
<
R)),0<<,<<
< Z
R,,<<<,<<
<
Aet operating income....... R)2<,<<< RC+<,<<< Z R+)<,<<< Z
Average operating
assets............................ RB<<,<<< Z R/,2<<,<<<
R),0<<,<<
<
Margin.............................. /PZ BP @PZ
urnover........................... 0Z +.0 +
8eturn on investment
(8D&*.............................. +ivisions Alpha and ?ravo use di#erent strategies to
o$tain the same +ivision Alpha has a low margin and
a high turnover, whereas >ivision ?ravo has just the opposite.
Z1iven.
3olutions Manual, "hapter )+ +,,
). 8D& computations:
Aet operating income 3ales
Y V
3ales Average operating assets
>ivision A:
R2<<,<<< R)+,<<<,<<<
8D& Y V
R)+,<<<,<<< R,,<<<,<<<
Y 0P V / Y +ivision ?:
R02<,<<< R)/,<<<,<<<
8D& Y V
R)/,<<<,<<< R@,<<<,<<<
Y /P V + Y BP
>ivision ":
RB<<,<<< R+0,<<<,<<<
8D& Y V
R+0,<<<,<<< R0,<<<,<<<
Y ,.+P V 0 Y )2P
+. !ivision
A !ivision B
!ivision
C
Average operating assets......
R,,<<<,<<
<
R@,<<<,<<
<
R0,<<<,<<
<
8e4uired rate of return.......... V )/P V )<P V)2P
8e4uired operating income. . .
R
/+<,<<< R @<<,<<<
R B<<,<<
<
Actual operating income........
R 2<<,<<
<
R 02<,<<
<
R B<<,<<
<
8e4uired operating income
(a$ove*............................... /+<,<<< @<<,<<< B<<,<<<
8esidual income....................
R )B<,<<
<
R()/<,<<<
* R <
3olutions Manual, "hapter )+ +,/
,. a. and $.
!ivision
A
!ivision
B
!ivision
C
8eturn on investment (8D&*....... +<P BP )2P
herefore, if the division is
presented with an
investment opportunity
yielding )0P, it pro$a$ly
would...................................... 8eject Accept 8eject
Minimum re4uired return for
computing residual income..... )/P )<P )2P
herefore, if the division is
presented with an
investment opportunity
yielding )0P, it pro$a$ly
would...................................... Accept Accept 8eject
&f performance is $eing measured $y 8D&, $oth >ivision A and
>ivision " pro$a$ly would reject the )0P investment
opportunity. hese divisionsG 8D&s currently e.ceed )0P%
accepting a new investment with a )0P rate of return would
reduce their overall 8D&s. >ivision ? pro$a$ly would accept the
)0P investment opportunity, since accepting it would increase
the divisionGs overall rate of return.
&f performance is measured $y residual income, $oth >ivision A
and >ivision ? pro$a$ly would accept the )0P investment
opportunity. he )0P rate of return promised $y the new
investment is greater than their re4uired rates of return of )/P
and )<P, respectively, and would therefore add to the total
amount of their residual income. >ivision " would reject the
opportunity, since the )0P return on the new investment is
less than its )2P re4uired rate of return.
3olutions Manual, "hapter )+ +,0
Y V
6ueensland >ivision:
R,2<,<<< R/,<<<,<<<
8D& Y V
R/,<<<,<<< R+,<<<,<<<
Y CP V + Y )BP
Aew 3outh Oales >ivision:
R/+<,<<< R@,<<<,<<<
8D& Y V
R@,<<<,<<< R+,<<<,<<<
Y 2P V ,.0 Y +)P
+. he manager of the Aew 3outh Oales >ivision seems to $e
doing the $etter jo$. Although her margin is three percentage
points lower than the margin of the 6ueensland >ivision, her
turnover is higher (a turnover of ,.0, as compared to a turnover
of two for the 6ueensland >ivision*. he greater turnover more
than o#sets the lower margin, resulting in a +)P 8D&, as
compared to an )BP 8D& for the other division.
Aotice that if you look at margin alone, then the 6ueensland
>ivision appears to $e the stronger division. his fact
underscores the importance of looking at turnover as well as at
margin in evaluating performance in an investment center.
3olutions Manual, "hapter )+ +,2
Y V
Dsaka >ivision:
`+)<,<<< `,,<<<,<<<
8D& Y V
`,,<<<,<<< `),<<<,<<<
Y @P V , Y +)P
Qokohama >ivision:
`@+<,<<< `C,<<<,<<<
8D& Y V
`C,<<<,<<< `/,<<<,<<<
Y BP V +.+0 Y )BP
+. $sa&a -o&ohama
Average operating assets (a*................
`),<<<,<<
<
`/,<<<,<<
<
`
+)<,<<<
`
@+<,<<<
Minimum re4uired return on average
operating assets: )0P V (a*............... )0<,<<< 2<<,<<<
8esidual income....................................
`
2<,<<<
`
)+<,<<<
,. Ao, the Qokohama >ivision is simply larger than the Dsaka
>ivision and for this reason one would e.pect that it would
have a greater amount of residual income. 8esidual income
canGt $e used to compare the performance of divisions of
di#erent sizes. =arger divisions will almost always look $etter,
not necessarily $ecause of $etter management $ut simply
$ecause they are larger. &n fact, in the case a$ove, the
Qokohama >ivision does not appear to $e as well managed as
the Dsaka >ivision. Aote from !art ()* that Qokohama has only
3olutions Manual, "hapter )+ +,@
an )BP 8D& as compared to +)P for Dsaka.
3olutions Manual, "hapter )+ +,B
).
!ivision A !ivision B
,otal
Compan%
3ales...........................
R+,0<<,<<<
)
R),+<<,<<
<
+
R,,+<<,<<<
,
=ess e.penses:
Added $y the
division................... ),B<<,<<< /<<,<<< +,+<<,<<<
ransfer price paid.... 0<<,<<<
otal e.penses............ ),B<<,<<< C<<,<<< +,+<<,<<<
Aet operating income.
R
@<<,<<<
R
,<<,<<< R),<<<,<<<
)
+<,<<< units V R)+0 per unit Y
R+,0<<,<<<.
+
/,<<< units V R,<< per unit Y
R),+<<,<<<.
,
>ivision A outside sales
()2,<<< units V R)+0 per unit*...............
R+,<<<,<<
<
>ivision ? outside sales
(/,<<< units V R,<< per unit*................. ),+<<,<<<
otal outside sales....................................
R,,+<<,<<
<
Aote that the R0<<,<<< in intracompany sales has $een
eliminated.
+. >ivision A should transfer the ),<<< additional circuit $oards to
>ivision ?. Aote that >ivision ?Gs processing adds R)@0 to each
unitGs selling price (?Gs R,<< selling price, less AGs R)+0 selling
price Y R)@0 increase*, $ut it adds only R)<< in cost.
herefore, each $oard transferred to >ivision ? ultimately
yields R@0 more in contri$ution margin (R)@0 X R)<< Y R@0* to
the company than can $e o$tained from selling to outside
customers. hus, the company as a whole will $e $etter o# if
>ivision A transfers the ),<<< additional $oards to >ivision ?.
3olutions Manual, "hapter )+ +,C
Compan%
A B C
3ales.....................................
RC,<<<,<<
<
Z R@,<<<,<<
<
Z R/,0<<,<<
<
Z
Aet operating income............ R0/<,<<< R+B<,<<< Z R,2<,<<<
Average operating assets......
R,,<<<,<<
<
Z R+,<<<,<<
<
R),B<<,<<
<
Z
8eturn on investment (8D&*... )BPZ )/PZ +ollar amount..................... R/B<,<<< R,+<,<<< Z R+@<,<<<
8esidual income.................... R2<,<<< R(/<,<<<* RC<,<<< Z
Z1iven.
3olutions Manual, "hapter )+ +/<
). he lowest accepta$le transfer price from the perspective of

on lost sales
Iaria$le cost
ransfer price \
per unit
r
.
here is no idle capacity, so each of the /<,<<< units
transferred from >ivision S to >ivision Q reduces sales to
outsiders $y one unit. he contri$ution margin per unit on
outside sales is R+< (Y RC< X R@<*.
R+< V /<,<<<
ransfer price (R@< 7 R,* \
/<,<<<
Y R2@ \ R+< Y RB@
r
he $uying division, >ivision Q, can $uy a similar unit from an
outside supplier for RB2. herefore, >ivision Q would $e
unwilling to pay more than RB2 per unit.
i Trans1er pri2e -ost o1 4u+in/ 1ro* outsi)e supplier . $86
he re4uirements of the two divisions are incompati$le and no
transfer will take place.
+. &n this case, >ivision S has enough idle capacity to satisfy
>ivision QGs demand. herefore, there are no lost sales and the
lowest accepta$le price as far as the selling division is
concerned is the varia$le cost of R2< per unit.
R<
ransfer price R2<\ YR2<
/<,<<<
r
he $uying division, >ivision Q, can $uy a similar unit from an
outside supplier for R@/. herefore, >ivision Q would $e
unwilling to pay more than R@/ per unit.
i Trans1er pri2e -ost o1 4u+in/ 1ro* outsi)e supplier . $!4
&n this case, the re4uirements of the two divisions are
compati$le and a transfer hopefully will take place at a transfer
price within the range:
3olutions Manual, "hapter )+ +/)
i i $60 Trans1er pri2e $!4
3olutions Manual, "hapter )+ +/+
). Sales ,erritor%
,otal Compan% (orthern Southern
3ales...............................................
R@0<,<<
< )<<.< P
R,<<,<<
< )<< P
R/0<,<<
<
)<
< P
=ess varia$le e.penses................... ,,2,<<< //.B
)02,<<
< 0+
)B<,<<
< /<
"ontri$ution margin........................ /)/,<<< 00.+ )//,<<< /B +@<,<<< 2<
=ess tracea$le '.ed e.penses........ ++B,<<< ,<./
)+<,<<
< /<
)<B,<<
< +/
erritorial segment margin.............. )B2,<<< +/.B
R
+/,<<< B P
R)2+,<<
< ,2 P
=ess common '.ed e.penses not
tracea$le to sales territories
(R,@B,<<< X R++B,<<< Y
R)0<,<<<*..................................... )0<,<<< +<.<
Aet operating income.....................
R
,2,<<< /.B P
Product )ine
(orthern
,erritor% Pa&s ,ibs
3ales..............................................
R,<<,<<
< )<<.< P R0<,<<< )<< P
R+0<,<<
< )<< P
=ess varia$le e.penses..................
)02,<<
< 0+.< )),<<< ++
)/0,<<
< 0B
"ontri$ution margin....................... )//,<<< /B.< ,C,<<< @B )<0,<<< /+
3olutions Manual, "hapter )+ +/,
=ess tracea$le '.ed e.penses........
@<,<<
< +,., ,<,<<< 2<
/<,<<
< )2
!roduct line segment margin......... @/,<<< +/.@ RC,<<< )B P
R
20,<<< +2 P
=ess common '.ed e.penses not
tracea$le to product lines
(R)+<,<<< X R@<,<<< Y
R0<,<<<*...................................... 0<,<<< )2.@
erritorial segment margin.............
R
+/,<<< B.< P
3olutions Manual, "hapter )+ +//
+. wo insights should $e $rought to the attention of
management. First, compared to the 3outhern territory, the
Aorthern territory has a low contri$ution margin ratio. 3econd,
the Aorthern territory has high tracea$le '.ed e.penses.
Dverall, compared to the 3outhern territory, the Aorthern
territory is very weak.
,. Again, two insights should $e $rought to the attention of
management. First, the Aorthern territory has a poor sales mi..
Aote that the territory sells very little of the !aks product,
which has a high contri$ution margin ratio. his poor sales mi.
accounts for the low overall contri$ution margin ratio in the
Aorthern territory mentioned in part (+* a$ove. 3econd, the
tracea$le '.ed e.penses of the !aks product seem very high in
relation to sales. hese high '.ed e.penses may simply mean
that the !aks product is highly leveraged% if so, then an
increase in sales of this product line would greatly enhance
pro'ts in the Aorthern territory and in the company as a whole.
3olutions Manual, "hapter )+ +/0
). ?reaking the 8D& computation into two separate elements
helps the manager to see important relationships that might
remain hidden if net operating income were simply related to
operating assets. First, the importance of turnover of assets as
a key element to overall pro'ta$ility is emphasized. !rior to use
of the 8D& formula, managers tended to allow operating assets
to swell to e.cessive levels. 3econd, the importance of sales
volume in pro't computations is stressed and e.plicitly
recognized. hird, $reaking the 8D& computation into margin
and turnover elements stresses the possi$ility of trading one
o# for the other in attempts to improve the overall pro't
picture. hat is, a company may shave its margins slightly
hoping for a great enough increase in turnover to increase the
overall rate of return. Fourth, ratios make it easier to make
comparisons $etween segments of the organization.
+. Companies in the Same "ndustr%
A B C
3ales...................................
R2<<,<<
<
Z
R0<<,<<<
Z R+,<<<,<
<<
Aet operating income......... RB/,<<< Z R@<,<<< Z R@<,<<<
Average operating assets. . .
R,<<,<<
<
Z R),<<<,<
<<
R),<<<,<
<<
Z
Margin................................ )/P )/P ,.0P Z
urnover.............................. +.< <.0 +.< Z
8eturn on investment
(8D&*................................. +BP @P
Z
@P
Z1iven.
?ecause of di#erences in size $etween "ompany A and the
other two companies (notice that ? and " are e4ual in income
and assets*, it is diEcult to say much a$out comparative
performance looking at net operating income and operating
assets alone. hat is, it is impossi$le to determine whether
"ompany AGs higher 8D& is a result of its lower assets or its
higher income. his points up the need to speci'cally include
sales as an element in 8D& computations. ?y including sales,
light is shed on the comparative performance and possi$le
3olutions Manual, "hapter )+ +/2
pro$lems in the three companies.
3olutions Manual, "hapter )+ +/@
(AA 2eport (o* 6; states (p. ,0*:
M&ntroducing sales to measure level of operations helps to
disclose speci'c areas for more intensive investigation.
"ompany ? does as well as "ompany A in terms of pro't
margin, for $oth companies earn )/P on sales. ?ut "ompany ?
has a much lower turnover of capital than does "ompany A.
Ohereas a dollar of investment in "ompany A supports two
dollars in sales each period, a dollar investment in "ompany ?
supports only 'fty cents in sales each period. his suggests
that the analyst should look carefully at "ompany ?Gs
investment. &s the company keeping an inventory larger than
necessary for its sales volumeF Are receiva$les $eing collected
promptlyF Dr did "ompany A ac4uire its '.ed assets at a price
level which was much lower than that at which "ompany ?
purchased its plantFN
hus, $y including sales speci'cally in 8D& computations the
manager is a$le to discover possi$le pro$lems, as well as
reasons underlying a strong or a weak performance. =ooking at
"ompany A compared to "ompany ", notice that "Gs turnover
is the same as AGs, $ut "Gs margin on sales is much lower. Ohy
would " have such a low marginF &s it due to ineEciency, is it
due to geographical location (re4uiring higher salaries or
transportation charges*, is it due to e.cessive materials costs,
or is it due to other factorsF 8D& computations raise 4uestions
such as these, which form the $asis for managerial action.
o summarize, in order to $ring ?Gs 8D& into line with AGs, it
seems o$vious that ?Gs management will have to concentrate
its e#orts on increasing turnover, either $y increasing sales or
$y reducing assets. &t seems unlikely that ? can apprecia$ly
increase its 8D& $y improving its margin on sales. Dn the other
hand, "Gs management should concentrate its e#orts on the
margin element $y trying to pare down its operating e.penses.
3olutions Manual, "hapter )+ +/B
). Present (e1 )ine ,otal
()* 3ales....................... R)<,<<<,<<<
R+,<<<,<<
<
R)+,<<<,<<
<
(+*
Aet operating
income................. RB<<,<<< R)2<,<<< Z RC2<,<<<
(,* Dperating assets..... R/,<<<,<<<
R),<<<,<<
< R0,<<<,<<<
(/* Margin (+* [ ()*...... BP BP BP
(0* urnover ()* [ (,*. . . +.0 +.< +./
(2* 8D& (/* V (0*........... +<.<P )2.<P )C.+P
Z
3ales.......................................................
R+,<<<,<<
<
=ess varia$le e.penses (2<P V
R+,<<<,<<<*..........................................
),+<<,<<
<
"ontri$ution margin................................ B<<,<<<
=ess '.ed e.penses................................ 2/<,<<<
Aet operating income.............................
R )2<,<<
<
+. >ell ;avasi will $e inclined to reject the new product line, since
accepting it would reduce his divisionGs overall rate of return.
,. he new product line promises an 8D& of )2P, whereas the
companyGs overall 8D& last year was only )0P. hus, adding
the new line would increase the companyGs overall 8D&.
/. a. Present (e1 )ine ,otal
Dperating assets.................
R/,<<<,<<
<
R),<<<,<<
<
R0,<<<,<<
<
Minimum return re4uired..... V)+P V)+P V)+P
Minimum net operating
income..............................
R /B<,<<
< R )+<,<<<
R 2<<,<<
<
Actual net operating
income..............................
R B<<,<<
< R )2<,<<<
R C2<,<<
<
Minimum net operating
income (a$ove*................. /B<,<<< )+<,<<< 2<<,<<<
8esidual income..................
R ,+<,<<
< R /<,<<<
R ,2<,<<
<
3olutions Manual, "hapter )+ +/C
$. Knder the residual income approach, >ell ;avasi would $e
inclined to accept the new product line, since adding the line
would increase the total amount of his divisionGs residual
income, as shown a$ove.
3olutions Manual, "hapter )+ +0<
). he lowest accepta$le transfer price from the perspective of
\ r
Total 2ontri4ution *ar/in on lost sales
(aria4le 2ost
Trans1er pri2e
per unit
5u*4er o1 units trans1erre)
he !ulp >ivision has no idle capacity, so transfers from the
!ulp >ivision to the "arton >ivision would cut directly into
normal sales of pulp to outsiders. 3ince the costs are the same
whether the pulp is transferred internally or sold to outsiders,
the only relevant cost is the lost revenue of R@< per ton from
the pulp that could $e sold to outsiders. his is con'rmed
$elow:
(R@< 7 R/+* V 0,<<<
ransfer price R/+ \ Y R/+ \ (R@< 7 R/+* Y R@<
0,<<<
r
herefore, the !ulp >ivision will refuse to transfer at a price
less than R@< a ton.
he "arton >ivision can $uy pulp from an outside supplier for
R@< a ton, less a )ivision would $e unwilling to pay more than
R2, per ton.
"ost of $uying from outside supplier Y R2, i Trans1er pri2e
he re4uirements of the two divisions are incompati$le. he
"arton >ivision wonGt pay more than R2, and the !ulp >ivision
will not accept less than R@<. hus, there can $e no mutually
agreea$le transfer price and no transfer will take place.
+. he price $eing paid to the outside supplier, net of the 4uantity
discount, is only R2,. &f the !ulp >ivision meets this price, then
pro'ts in the !ulp >ivision and in the company as a whole will
drop $y R,0,<<< per year:
=ost revenue per ton........................ R@<
Dutside supplierGs price.................... R2,
=oss in contri$ution margin per ton. . R@
Aum$er of tons per year.................. V 0,<<<
otal loss in pro'ts............................ R,0,<<<
3olutions Manual, "hapter )+ +0)
!ro'ts in the "arton >ivision will remain unchanged, since it
will $e
paying the same price internally as it is now paying e.ternally.
,. he !ulp >ivision has idle capacity, so transfers from the !ulp
>ivision to the "arton >ivision do not cut into normal sales of
pulp to outsiders. &n this case, the minimum price as far as the
"arton >ivision is concerned is the varia$le cost per ton of R/+.
his is con'rmed in the following calculation:
R<
ransfer price R/+ \ Y R/+
0,<<<
r
he "arton >ivision can $uy pulp from an outside supplier for
R2, a ton and would $e unwilling to pay more than that for
pulp in an internal transfer. &f the managers understand their
own $usinesses and are cooperative, they should agree to a
transfer and should settle on a transfer price within the range:
i i $42 Trans1er pri2e $6%
/. Qes, R0C is a $ona 'de outside price. Even though R0C is less
than the !ulp >ivisionGs R2< Mfull costN per unit, it is within the
range given in !art , and therefore will provide some
contri$ution to the !ulp >ivision.
&f the !ulp >ivision does not meet the R0C price, it will lose
RB0,<<< in potential pro'ts:
!rice per ton....................................... R0C
=ess varia$le costs............................. /+
"ontri$ution margin per ton............... R)@
0,<<< tons V R)@ per ton Y RB0,<<< potential increased
pro'ts
his RB0,<<< in potential pro'ts applies to the !ulp >ivision and
to the company as a whole.
0. Ao, the "arton >ivision should pro$a$ly $e free to go outside
and get the $est price it can. Even though this would result in
su$optimization for the company as a whole, the $uying
3olutions Manual, "hapter )+ +0+
division should pro$a$ly not $e forced to $uy inside if $etter
prices are availa$le outside.
3olutions Manual, "hapter )+ +0,
2. he !ulp >ivision will have an increase in pro'ts:
3elling price......................................... R@<
=ess varia$le costs............................... /+
"ontri$ution margin per ton................. R+B
0,<<< tons V R+B per ton Y R)/<,<<< increased pro'ts
he "arton >ivision will have a decrease in pro'ts:
&nside purchase price........................... R@<
Dutside purchase price........................ 0C
&ncreased cost per ton.......................... R))
0,<<< tons V R)) per ton Y R00,<<< decreased pro'ts
he company as a whole will have an increase in pro'ts:
&ncreased contri$ution margin in the !ulp >ivision. R+B
>ecreased contri$ution margin in the "arton
>ivision................................................................. ))
&ncreased contri$ution margin per ton.................... R)@
0,<<< tons V R)@ per ton Y RB0,<<< increased pro'ts
3o long as the selling division has idle capacity, pro'ts in the
company as a whole will increase if internal transfers are made.
;owever, there is a 4uestion of fairness as to how these pro'ts
should $e split $etween the selling and $uying divisions. he
in-e.i$ility of management in this situation damages the
pro'ts of the "arton >ivision and greatly enhances the pro'ts
of the !ulp >ivision.
3olutions Manual, "hapter )+ +0/
). ,otal Compan% Coo&boo& ,ravel @uide <and% Speller
3ales...................................
R,<<,<<
< )<< P
RC<,<<
< )<< P
R)0<,<<
<
)<
< P
R2<,<<
< )<< P
!rinting cost...................... )<+,<<< ,/ +@,<<< ,< 2,,<<< /+ )+,<<< +<
3ales commissions............ ,<,<<< )< C,<<< )< )0,<<< )< 2,<<< )<
otal varia$le e.penses....... ),+,<<< // ,2,<<< /< @B,<<< 0+ )B,<<< ,<
"ontri$ution margin............ )2B,<<< 02 0/,<<< 2< @+,<<< /B /+,<<< @<
=ess tracea$le '.ed
e.penses:
Advertising........................ ,2,<<< )+ ),,0<< )0 )C,0<< ), ,,<<< 0
3alaries............................. ,,,<<< )) )B,<<< +< C,<<< 2 2,<<< )<
E4uipment depreciationZ C,<<< , +,@<< , /,0<< , ),B<< ,
Oarehouse rentZZ............. )+,<<< / ),B<< + 2,<<< / /,+<< @
otal tracea$le '.ed
e.penses.......................... C<,<<< ,< ,2,<<< /< ,C,<<< +2 )0,<<< +0
!roduct line segment
margin.............................. @B,<<< +2
R)B,<<
< +epreciation9oEce
facilities.......................... ,,<<< )
otal common '.ed
e.penses.......................... 2,,<<< +)
Aet operating income.......... R 0 P
3olutions Manual, "hapter )+ +00
)0,<<<
ZRC,<<< V ,<P, 0<P, and +<P, respectively.
ZZR/B,<<< s4uare feet V R, per s4uare foot Y R)//,<<<% R)//,<<< [ )+ months Y R)+,<<< per
month.
R)+,<<< [ /B,<<< s4uare feet Y R<.+0 per s4uare foot per month.
R<.+0 V @,+<< s4uare feet, +/,<<< s4uare feet, and )2,B<< s4uare feet, respectively.
+. a. Ao, the cook$ook line should not $e eliminated. he
cook$ook is covering all of its own costs and is generating an
R)B,<<< segment margin toward covering the companyGs
common costs and toward pro'ts. (Aote: !ro$lems relating to
the elimination of a product line are covered in more depth in
"hapter ),.*
$. Ao, it is pro$a$ly unwise to focus all availa$le resources on
promoting the travel guide. he company is already spending
nearly as much on the promotion of this line as it is on the
other two lines together. Furthermore, the travel guide has
the lowest contri$ution margin ratio of the three products.
Aevertheless, we cannot say for sure which product should
$e emphasized in this situation without more information. &f
the e4uipment is $eing fully utilized, increasing the
production of any one product would re4uire cutting $ack on
one of the other products. &n "hapter ), we will discuss how
to choose the most pro'ta$le product when there is a
constraint that forces such a trade7o# $etween products.
,. At least three additional points should $e $rought to the
attention of management:
i. "ompared to the other two lines, salaries are very high for
the cook$ook line. his should $e investigated to 'nd the
reason for the wide di#erence in cost.
ii. he company pays a commission of )<P on the selling price
of any $ook. "onsideration should $e given to revising the
commission structure to $ase it on contri$ution margin,
rather than on sales.
iii.Management should consider 5& deliveries to reduce
warehouse costs.
3olutions Manual, "hapter )+ +0@
). Dperating assets do not include investments in other
companies or in undeveloped land.
Ending
Balances
Beginning
Balances
"ash..................................................R )+<,<<< R )/<,<<<
Accounts receiva$le.......................... 0,<,<<< /0<,<<<
&nventory........................................... ,B<,<<< ,+<,<<<
!lant and e4uipment (net*................ 2+<,<<< 2B<,<<<
otal operating assets.......................
R),20<,<<
< R),0C<,<<<
R),20<,<<< \ R),0C<,<<<
Average operating assets Y Y R),2+<,<<<
+
Margin Y
3ales
R/<0,<<<
Y Y )<P
R/,<0<,<<<
3ales
urnoverY
R/,<0<,<<<
Y Y +.0
R),2+<,<<<
Y )<P V +.0 Y +0P
+. Aet operating income..................................... R/<0,<<<
Minimum re4uired return ()0P V
R),2+<,<<<*.................................................. +/,,<<<
8esidual income.............................................. R)2+,<<<
3olutions Manual, "hapter )+ +0B
). From the standpoint of the selling division, Alpha >ivision:
otal contri$ution margin on lost sales
Iaria$le cost
ransfer price \
per unit
r
( *
(R,< 7 R)B* V 0,<<<
ransfer price R)B 7 R+ \ Y R)2 \ R)+ Y R+B
0,<<<
r
?ut, from the standpoint of the $uying division, ?eta >ivision:
i Trans1er pri2e -ost o1 4u+in/ 1ro* outsi)e supplier . $2!
?eta >ivision wonGt pay more than R+@ and Alpha >ivision will
not accept less than R+B, so no deal is possi$le. here will $e
no transfer.
+. a. From the standpoint of the selling division, Alpha >ivision:
Iaria$le cost
ransfer price \
per unit
r
( *
(RC< 7 R20* V ,<,<<<
ransfer price R20 7 R0 \ Y R2< \ R+0 Y RB0
,<,<<<
r
From the standpoint of the $uying division, ?eta >ivision:
i Trans1er pri2e -ost o1 4u+in/ 1ro* outsi)e supplier . $8#
&n this instance, an agreement is possi$le within the range:
i i $8$ Trans1er pri2e $8#
Even though $oth managers would $e $etter o# with an%
transfer price within this range, they may disagree a$out the
e.act amount of the transfer price. &t would not $e surprising to
hear the $uying division arguing strenuously for RB0 while the
selling division argues just as strongly for RBC.
3olutions Manual, "hapter )+ +0C
$. he loss in potential pro'ts to the company as a whole will
$e:
?eta >ivisionGs outside purchase price................. RBC
Alpha >ivisionGs varia$le cost on the internal
transfer............................................................. B0
!otential added contri$ution margin lost to the
company as a whole.......................................... R /
Aum$er of units................................................... V,<,<<<
!otential added contri$ution margin and
company pro'ts forgone.................................... R)+<,<<<
Another way to derive the same answer is to look at the loss
in potential pro'ts for each division and then total the losses
for the impact on the company as a whole. he loss in
potential pro'ts in Alpha >ivision will $e:
3uggested selling price per unit........................... RBB
Alpha >ivisionGs varia$le cost on the internal
transfer............................................................. B0
!otential added contri$ution margin per unit....... R ,
Aum$er of units................................................... V ,<,<<<
divisional pro'ts forgone................................... R C<,<<<
he loss in potential pro'ts in ?eta >ivision will $e:
Dutside purchase price per unit........................... RBC
3uggested price per unit inside........................... BB
!otential cost avoided per unit............................ R )
Aum$er of units................................................... V ,<,<<<
divisional pro'ts forgone................................... R,<,<<<
he total of these two amounts e4uals the R)+<,<<< loss in
potential pro'ts for the company as a whole.
,. a. From the standpoint of the selling division, Alpha >ivision:
Iaria$le cost
ransfer price \
per unit
r
3olutions Manual, "hapter )+ +2<
R<
ransfer price R/< \ Y R/<
+<,<<<
r
3olutions Manual, "hapter )+ +2)
From the standpoint of the $uying division, ?eta >ivision:
ransfer price "ost of $uying from outside supplier
ransfer price R@0 7 (<.<B V R@0* Y R2C
i
i
&n this case, an agreement is possi$le within the range:
i i $40 Trans1er pri2e $6#
&f the managers understand what they are doing and are
reasona$ly cooperative, they should $e a$le to come to an
agreement with a transfer price within this range.
$. Alpha >ivisionGs 8D& should increase. 3ince the division has
idle capacity, there should $e little or no increase needed in
the divisionGs operating assets as a result of selling +<,<<<
units a year to ?eta >ivision. herefore, Alpha >ivisionGs
turnover should increase. he divisionGs margin earned on
sales should also increase, since its contri$ution margin will
increase $y R/<<,<<< as a result of the new sales, with no
o#setting increase in '.ed costs:
3elling price................................. R2<
=ess varia$le costs....................... /<
"ontri$ution margin..................... R+<
Aum$er of units........................... V +<,<<<
Added contri$ution margin.......... R/<<,<<<
hus, with $oth the margin and the turnover increasing, the
divisionGs 8D& would also increase.
/. From the standpoint of the selling division, Alpha >ivision:
Iaria$le cost
ransfer price \
per unit
r
( * R0< 7 R+2 V /0,<<<
ransfer price R+) \ Y R+) \ RC Y R,<
)+<,<<<
r
3olutions Manual, "hapter )+ +2+
). he disadvantages or weaknesses to the companyGs format are
as follows:
a. he company should include a column showing the com$ined
results of the three regions taken together.
$. Additional columns showing percentages would $e helpful in
assessing performance and pinpointing areas of diEculty.
c. he regional e.penses should $e segregated into varia$le
and '.ed categories to permit the computation of $oth a
contri$ution margin and a regional segment margin.
d. he corporate e.penses are pro$a$ly common to the regions
and should not $e ar$itrarily allocated.
+. "orporate advertising e.penses have $een allocated on the
$asis of sales dollars% the general administrative e.penses
have $een allocated evenly among the three regions. 3uch
allocations should not $e made under the contri$ution
approach, since they can $e misleading to management and
tend to call attention away from the segment margin. he
segment margin should $e used to measure the performance of
a segment, not the Mnet operating incomeN or Mnet lossN after
allocating common e.penses.
3olutions Manual, "hapter )+ +2,
,. ,otal 0est Central East
3ales..................................
R+,<<<,<
<<
)<<.
<
R/0<,<<
< )<<.<
RB<<,<<
<
)<<.
<
R@0<,<<
<
)<<.
<
"ost of goods sold........... B)C,/<< /).< )2+,C<< ,2.+ +B<,<<< ,0.< ,@2,0<< 0<.+
3hipping e.pense............
@@,2<
< ,.C )@,)<< ,.B ,+,<<< /.<
+B,0<
< ,.B
otal varia$le e.penses......
BC@,<<
< //.C )B<,<<< /<.< ,)+,<<< ,C.<
/<0,<<
< 0/.<
),)<,,<<
< 00.) +@<,<<< 2<.< /BB,<<< 2).<
,/0,<<
< /2.<
=ess tracea$le '.ed
e.penses:
Advertising...................... 0)B,<<< +0.C )<B,<<< +/.< +<<,<<< +0.< +)<,<<< +B.<
3alaries............................ ,),,<<< )0.2 C<,<<< +<.< BB,<<< )).< ),0,<<< )B.<
Ktilities............................ /<,0<< +.< ),,0<< ,.< )+,<<< ).0 )0,<<< +.<
>epreciation....................
B0,<<
< /., +@,<<< 2.< +B,<<< ,.0
,<,<<
< /.<
otal tracea$le '.ed
e.penses.........................
C02,0<
< /@.B +,B,0<< 0,.<
,+B,<<
< /).<
,C<,<<
< 0+.<
8egional segment margin. .
)/2,0<
< @., R,),0<< @.<
R)2<,<<
< +<.<
R(/0,<<<
* (2.<*
=ess common '.ed
e.penses not tracea$le to
the regions:
Advertising (general* B<,<<< /.<
3olutions Manual, "hapter )+ +2/
1eneral admin.
e.penses.......................
)0<,<<
< @.0
otal common '.ed
e.penses.........................
+,<,<<
< )).0
Aet loss..............................
R
(B,,0<<* (/.+*
Aote: !ercentage 'gures may not total down due to rounding.
/. he following points should $e $rought to the attention of
management:
a. 3ales in the Oest are much lower than in the other two
regions. his is not due to lack of salespeople since salaries
in the Oest are a$out the same as in the "entral 8egion,
which has the highest sales of the three regions.
$. he Oest is spending a$out half as much for advertising as
the "entral 8egion. !erhaps this is the reason for the OestGs
lower sales.
c. he East apparently is selling a large amount of low7margin
items. Aote that it has a contri$ution margin ratio of only
/2P, compared to 2<P or more for the other two regions.
d. he East appears to $e oversta#ed. &ts salaries are a$out
0<P greater than in either of the other two regions.
e. he East is not covering its own tracea$le costs. Major
attention should $e given to improving the sales mi. and
reducing e.penses in this region.
f. Apparently, the salespeople in all three regions are on a
salary $asis. !erhaps a change to a commission $asis would
encourage the sales sta# to $e more aggressive and improve
sales throughout the company.
). 'a+
,otal Cost
'b+
,otal Activit%
'a+ P 'b+
2ate
3ales support...........
R,,2<<,<<
< +/,<<< calls
R)0<
per call
Drder processing...... ),@+<,<<< B,2<< orders R+<< per order
Oarehousing............ C/<,<<< ))@,0<< s4uare feet RB per s4uare foot
!acking and
shipping................. 0+<,<<< )</,<<< pounds shipped
R0 per pound
shipped
Assignment of e.penses to markets:
Commercial Mar&et <ome Mar&et School Mar&et
Events or
,ransaction
s Amount
Events or
,ransactio
ns Amount
Events or
,ransactio
ns Amount
3ales support, at
R)0< per call........ B,<<<
R),+<<,<<
< 0,<<<
R @0<,<<
< )),<<<
R),20<,<<
<
Drder processing,
at R+<< per
order.................... ),@0< ,0<,<<< 0,+<< ),</<,<<< ),20< ,,<,<<<
Oarehousing, at
RB per s4uare
foot...................... ,0,<<< +B<,<<< 20,<<< 0+<,<<< )@,0<< )/<,<<<
!acking and
shipping, at R0
per pound............ +/,<<< )+<,<<< )2,<<< B<,<<< 2/,<<< ,+<,<<<
3olutions Manual, "hapter )+ +2@
+. he segmented income statement follows (All dollar amounts are in thousands of
dollars*:
Mar&et
,otal Commercial <ome School
Amoun
t J
Amoun
t J
Amoun
t J
Amoun
t J
3ales..............................
R+<,<<
< )<<.< RB,<<< )<<.< R0,<<<
)<<.
< R@,<<< )<<.<
"ost of goods sold....... C,0<< /@.0 ,,C<< /B.B +,/<< /B.< ,,+<< /0.@
3ales support............... ,,2<< )B.< ),+<< )0.< @0< )0.< ),20< +,.2
Drder processing.......... ),@+< B.2 ,0< /./ ),</< +<.B ,,< /.@
!acking and shipping.. . 0+< +.2 )+< ).0 B< ).2 ,+< /.2
otal varia$le e.penses. . )0,,/< @2.@ 0,0@< 2C.2 /,+@< B0./ 0,0<< @B.2
"ontri$ution margin....... /,22< +,., +,/,< ,<./ @,< )/.2 ),0<< +)./
=ess tracea$le '.ed
e.penses:
Oarehousing................ C/< /.@ +B< ,.0 0+< )<./ )/< +.<
Advertising................... ),/2< @., @<< B.B )B< ,.2 0B< B.,
1eneral mgmt9
salaries...................... /)< +.) )0< ).C )+< +./ )/< +.<
otal tracea$le '.ed
e.penses..................... +,B)< )/.) ),),< )/.) B+< )2./ B2< )+.,
Market segment margin. ),B0< C., R),,<< )2., R(C<* ().B* R 2/< C.)
]he statement is continued on the ne.t page^
3olutions Manual, "hapter )+ +2B
Mar&et
,otal Commercial <ome School
Amoun
t J
Amoun
t J
Amoun
t J
Amoun
t J
Market segment margin. ),B0< C., R),,<< )2., R(C<* ().B* R 2/< C.)
=ess common '.ed
e.penses not
tracea$le to markets:
Advertising................ +,< ).+
1eneral
management.......... C<< /.0
otal common '.ed
e.penses..................... ),),< 0.@
Aet operating income..... R @+< ,.2
Aote: !ercentage 'gures may not total down due to rounding.
3olutions Manual, "hapter )+ +2C
,. he following comments relate to the three markets:
"ommercial market:
L he commercial market is the companyGs strongest segment
rather than its weakest. &t is generating enough segment
margin $y itself to cover all of the companyGs common costs.
L he manager of the commercial market is doing an outstanding
jo$ of controlling e.penses. E.penses as a percentage of sales
are lower than the company average for every category e.cept
cost of sales and advertising, and these latter two costs do not
seem out of line.
;ome Market:
L he home market spends very little on advertising. A more
generous advertising $udget may yield a su$stantial increase
in sales in this segment.
L Drder processing e.penses are e.tremely high in the home
market. Aote from the data in the pro$lem that more orders are
written in this market (0,+<< orders* than in the other two
markets com$ined. his large num$er of orders, com$ined with
the low overall sales in the home market, means that the home
market is taking many small orders.
L Oarehousing e.penses are also high in the home market.
L he home market is not covering its own tracea$le costs. &f
sales canGt $e increased through a more generous advertising
$udget and through a concerted e#ort to make larger sales per
order and other actions, then consideration should $e given to
eliminating this market segment.
3chool Market:
L he school market has e.tremely high sales support e.penses.
his is $ecause nearly as many sales calls are made to this
market ()),<<< calls* as are made to the other two markets
com$ined. "an contacts $e made $y phone or $y other meansF
L Dver 2<P of the packing and shipping e.penses are tracea$le
3olutions Manual, "hapter )+ +@<
to the school market. he company may want to investigate
cheaper shipping methods.
3olutions Manual, "hapter )+ +@)
). 8D& Y Margin V urnover
Y V
R,2<,<<< R/,<<<,<<<
Y V
R/,<<<,<<< R+,<<<,<<<
Y CP V + Y )BP
+.
R,2<,<<< R/,<<<,<<<
8D& Y V
R/,<<<,<<< R),2<<,<<<
Y CP V +.0 Y ++.0P
(Knchanged* (&ncrease* (&ncrease*
,.
R,C+,<<< R/,<<<,<<<
8D& Y V
R/,<<<,<<< R+,<<<,<<<
Y C.BP V + Y )C.2P
(&ncrease* (Knchanged* (&ncrease*
/. &nterest is a 'nancing e.pense and thus it is not used to
compute net operating income.
R,B<,<<< R/,<<<,<<<
8D& Y V
R/,<<<,<<< R+,0<<,<<<
Y C.0P V ).2 Y )0.+P
(&ncrease* (>ecrease* (>ecrease*
3olutions Manual, "hapter )+ +@+
0. he company has a contri$ution margin ratio of ,<P (R+/ "M
per unit, divided $y the RB< selling price per unit*. herefore, a
+<P increase in sales would result in a new net operating
income of:
3ales ().+< V R/,<<<,<<<*................... R/,B<<,<<< )<< P
=ess varia$le e.penses........................ ,,,2<,<<< @<
"ontri$ution margin............................ ),//<,<<< ,< P
=ess '.ed e.penses............................. B/<,<<<
Aet operating income.......................... R 2<<,<<<
R2<<,<<< R/,B<<,<<<
8D& Y V
R/,B<<,<<< R+,<<<,<<<
Y )+.0P V +./ Y ,ecrease* (&ncrease* (>ecrease*
@.
R,2<,<<< R/,<<<,<<<
8D& Y V
R/,<<<,<<< R),B<<,<<<
Y CP V +.++ Y +<P
(Knchanged* (&ncrease* (&ncrease*
3olutions Manual, "hapter )+ +@,
). he average operating assets for the year must $e computed
$efore determining the 8D& and residual income. he
computation is:
Ending $alance......................................
R)+,C2<,<<
<
?eginning $alance (R)+,C2<,<<< [
).<B*................................................... )+,<<<,<<<
otal.......................................................
R+/,C2<,<<
<
Average $alance (R+/,C2<,<<< [ +*......
R)+,/B<,<<
<
a. 8D& Y Margin V urnover
Y V
R),B@+,<<< R,),+<<,<<<
Y V Y 2P V +.0 Y )0P
R,),+<<,<<< R)+,/B<,<<<
$. Aet operating income........................
R),B@+,<<
<
Minimum re4uired net operating
income:
Average operating assets...............
R)+,/B<,<<
<
Minimum re4uired return................ V ))P
),,@+,B<
<
8esidual income................................
R
/CC,+<<
+. he divisionGs management would have $een more likely to
accept the investment opportunity if residual income, rather
than 8D&, had $een used to evaluate performance and
determine $onuses. he investment would have lowered the
divisionGs 8D& $ecause its e.pected return of ),P is lower than
the divisionGs historical returns of )/P to )@P as well as its
most recent 8D& of )0P. &n contrast, the divisionGs residual
3olutions Manual, "hapter )+ +@/
income would $e increased $y the investment opportunity.
From the standpoint of the entire company, an investment
whose return e.ceeds the minimum re4uired return should $e
accepted. ;owever, when $onuses are $ased on 8D&, the
division will likely reject any investment that lowers the
divisionGs 8D& even if it e.ceeds the minimum re4uired rate of
return.
,. 8eigis must $e free to control all items related to pro't
(revenues and e.penses* and investment if it is to $e evaluated
fairly as an investment center. his is true under $oth the 8D&
and residual income approaches.
). he 6uark >ivision will pro$a$ly reject the R,/< price $ecause
it is $elow the divisionGs varia$le costs of R,0< per set. his
varia$le cost includes the R)/< transfer price from the "a$inet
>ivision, which in turn includes R,< per unit in '.ed costs.
Aevertheless, from the perspective of the 6uark >ivision, the
entire R)/< transfer price from the "a$inet >ivision is a
varia$le cost. hus, it will reject the o#ered R,/< price.
+. &f $oth the "a$inet >ivision and the 6uark >ivision have idle
capacity, then from the perspective of the entire company the
R,/< o#er should $e accepted. ?y rejecting the R,/< price, the
company will lose R2< in potential contri$ution margin per set:
!rice o#ered per set........................... R,/<
=ess varia$le costs per set:
"a$inet >ivision............................... R @<
6uark >ivision.................................. +)< +B<
!otential contri$ution margin per set. R2<
,. &f the "a$inet >ivision is operating at capacity, any ca$inets
transferred to the 6uark >ivision to 'll the overseas order will
have to $e diverted from outside customers. Ohether a ca$inet
is sold to outside customers or is transferred to the 6uark
>ivision, its production cost is the same. ;owever, if a set is
diverted from outside sales, the "a$inet >ivision (and the
entire company* loses the R)/< in revenue. As a conse4uence,
as shown $elow, there would $e a net loss of R)< on each I
3olutions Manual, "hapter )+ +@0
set sold for R,/<.
!rice o#ered per set........................................ R,/<
=ess:
=ost revenue from sales of ca$inets to
outsiders.................................................... R)/<
Iaria$le cost of 6uark >ivision..................... +)< ,0<
Aet loss per I................................................ (R )<*
3olutions Manual, "hapter )+ +@2
/. Ohen the selling division has no idle capacity, as in part (,*,
market price works very well as a transfer price. he cost to the
company of a transfer when there is no idle capacity is the lost
revenue from sales to outsiders. &f the market price is used as
the transfer price, the $uying division will view the market price
of the transferred item as its cost9which is appropriate since
that is the cost to the company. As a conse4uence, the
manager of the $uying division should $e motivated to make
decisions that are in the $est interests of the company.
Ohen the selling division has idle capacity, the cost to the
company of the transfer is just the varia$le cost of producing
the item. &f the market price is used as the transfer price, the
manager of the $uying division will view that as hisHher cost
rather than the real cost to the company, which is just varia$le
cost. ;ence, the manager will have the wrong cost information
for making decisions as we o$served in parts ()* and (+* a$ove.
3olutions Manual, "hapter )+ +@@
). 3egments de'ned as product lines:
Product )ine
@lass
!ivision Flat @lass Auto @lass
Specialt%
@lass
3ales..................................
82<<,<<
<
)<
<
8+<<,<<
< )<<
8,<<,<<
< )<< 8)<<,<<<
)<
<
=ess varia$le e.penses......
,<<,<<
< 0<
),<,<<
< 20
)+<,<<
< /< 0<,<<< 0<
,<<,<<
< 0<
@<,<<
< ,0
)B<,<<
< 2< 0<,<<< 0<
=ess tracea$le '.ed
e.penses:
Advertising...................... )+<,<<< +< ,<,<<< )0 /+,<<< )/ /B,<<epreciation.................... /B,<<< B )<,<<< 0 +/,<<< B )/,<<< )/
Administration.................
/+,<<
< @
)/,<<
< @
+),<<
< @ @,<<< @
otal...................................
+)<,<<
< ,0
0/,<<
< +@
B@,<<
< +C 2C,<<< 2C
margin............................. C<,<<< )0
8
)2,<<ivisional segment
margin.............................
8
,<,<<< 0
3olutions Manual, "hapter )+ +@C
+. 3egments de'ned as markets for 3pecialty 1lass:
Sales Mar&et
Specialt%
@lass !omestic Foreign
Amount J
Amoun
t J Amount J
3ales........................................ 8)<<,<<< )<< 82<,<<< )<< 8 /<,<<< )<<
=ess varia$le e.penses............ 0<,<<< 0< ,<,<<< 0< +<,<<< 0<
"ontri$ution margin................. 0<,<<< 0< ,<,<<< 0< +<,<<< 0<
=ess tracea$le '.ed
e.penses:
Advertising............................. /B,<<epreciation.......................... )/,<<< )/
Administration....................... @,<<< @
otal......................................... +),<<< +)
!roduct line segment margin. . . 8 ()C,<<<* ()C*
,.
Flat
@lass
Auto
@lass
&ncremental contri$ution margin:
,0P V 8/<,<<< increased sales......... 8)/,<<<
2<P V 8,<,<<< increased sales......... 8)B,<<<
3olutions Manual, "hapter )+ +B<
=ess cost of the promotional
campaign............................................ B,<<< B,<<<
&ncreased net operating income............ 8 2,<<< 8)<,<<<
?ased on these data, the campaign should $e directed toward Auto 1lass. Aote that the
analysis uses the contri$ution margin ratio rather than the segment margin ratio.
3olutions Manual, "hapter )+ +B)
). he num$er of valves that must $e sold would $e:
=et S Y units sold
R0S Y R,S \ R/2+,<<< \ RCB,<<<Z
R+S Y R02<,<<<
S Y +B<,<<< valves, or R),/<<,<<< in sales
ZR@<<,<<< V )/P Y RCB,<<<.
a. Aet operating income RCB,<<<
Margin Y Y Y @P
3ales R),/<<,<<<
$. 3ales R),/<<,<<<
urnover Y Y Y +.<
Dperating assets R@<<,<<<
+. and ,. Sales Volume
Knits sold.............................. +2<,<<< +B<,<<< ,<<,<<<
()* 3ales _ R0.+<Z, R0.<< and
R/.B<Z................................
R),,0+,<<
<
R),/<<,<<
<
R),//<,<<
<
=ess varia$le e.pense _ R,..
@B<,<<
<
B/<,<<
<
C<<,<<
<
"ontri$ution margin.............. 0@+,<<< 02<,<<< 0/<,<<<
=ess '.ed e.penses..............
/2+,<<
<
/2+,<<
<
/2+,<<
<
(+* Aet operating income...........
R ))<,<<
< R CB,<<< R @B,<<<
(,* otal assets...........................
R 20<,<<
<
R @<<,<<
<
R @0<,<<
<
(/* Margin (+* [ ()*.................... B.)/P @.<<P 0./+P
(0* urnover ()* [ (,*................. +.<B +.<< ).C+
8D& (/* V (0*......................... )2.C,P )/.<<P )<./)P
ZR0.<< V ).</ Y R0.+<% R0.<< V <.C2 Y R/.B<.
Aote: he R+B<,<<< column is not re4uired.
3olutions Manual, "hapter )+ +B+
/.
Present
Sales
(e1
Sales
,otal
Sales
Knits sold..................................
+B<,<<
<
+<,<<
<
,<<,<<
<
()* 3ales _ R0.<< and R/.+0. . .
R),/<<,<<
<
RB0,<<
<
R),/B0,<<
<
=ess varia$le e.penses _
R,....................................
B/<,<<
< 2<,<<<
C<<,<<
<
"ontri$ution margin........... 02<,<<< +0,<<< 0B0,<<<
=ess '.ed e.penses...........
/2+,<<
< <
/2+,<<
<
(+* Aet operating income........
R
CB,<<<
R+0,<<
<
R
)+,,<<<
(,* otal assets........................ R @<<,<<
<
R0<,<<
<
R @0<,<<
<
(/* Margin (+* [ ()*................. @.<ivision should accept the R/.+0
price.
3olutions Manual, "hapter )+ +B,
). he varia$le cost of the new tu$e will $e:
>irect materials............................... R 2<
>irect la$or...................................... /C
Iaria$le overhead ()H, V R0/*......... )B
otal varia$le cost............................ R)+@
he lost contri$ution margin on outside sales will $e:
3elling price (regular tu$es*............. R)@<
>irect materials............................. R,B
>irect la$or.................................... +@
Iaria$le overhead (+0P V R/<*..... )<
administrativeZ........................... 0 B<
"ontri$ution margin per tu$e........... R C<
Zotal selling and administrative........ R,C<,<<<
=ess '.ed portion............................ ,0<,<<<
Iaria$le portion............................... R /<,<<<
R/<,<<< [ B,<<< tu$es Y R0 per
tu$e.
he lowest accepta$le transfer price from the perspective of
Iaria$le
ransfer price \
cost
r
RC< V ,,<<<
ransfer price R)+@\ Y R)+@ \ R)ivision and the entire company. &f the u$e
>ivision meets a price of R+<<, then pro'ts will decrease $y
RB@,0<< as show $elow:
Minimum transfer price........................................... R+,0
Dutside supplierGs price........................................... +<<
!otential decrease in contri$ution margin............... R ,0
Aum$er of units...................................................... V +,0<
3olutions Manual, "hapter )+ +B/
<
otal potential decrease in contri$ution margin
and net operating income.....................................
RB@,0<
<
3olutions Manual, "hapter )+ +B0
).
,otal Compan% Product A Product B Product C
3ales....................................
R),0<<,<<
<
)<<.
<
R2<<,<<
< )<<
R/<<,<<
< )<<
R0<<,<<
< )<<
!roduction.......................... ,,2,<<< ++./ )<B,<<< )B )+B,<<< ,+ )<<,<<< +<
3elling................................
)/+,<<
< C.0 2<,<<< )< ,+,<<< B 0<,<<< )<
otal varia$le e.penses........
/@B,<<
< ,).C )2B,<<< +B )2<,<<< /< )0<,<<< ,<
"ontri$ution margin.............
),<++,<<
< 2B.) /,+,<<< @+ +/<,<<< 2< ,0<,<<< @<
=ess tracea$le '.ed
e.penses:
!roduction.......................... ,@2,<<< +0.) )B<,<<< ,< ,2,<<< C )2<,<<< ,+
3elling................................
+B+,<<
< )B.B )<+,<<< )@ B<,<<< +< )<<,<<< +<
otal tracea$le '.ed
e.penses...........................
20B,<<
< /,.C +B+,<<< /@ ))2,<<< +C +2<,<<< 0+
!roduct segment margin...... ,2/,<<< +/.,
R)0<,<<
< +0
R)+/,<<
< ,) R C<,<<< )B
=ess common '.ed
e.penses:
!roduction.......................... +)<,<<< )/.<
Administrative...................
)B<,<<
< )+.<
3olutions Manual, "hapter )+ +B2
otal common '.ed
e.penses...........................
,C<,<<
< +2.<
Aet loss
R (+2,<<
<* ().@*
3olutions Manual, "hapter )+ +B@
+. !roduct " should not $e eliminated. As shown on the income
statement in part ), product " is covering all of its own
tracea$le costs and it is generating a segment margin of
RC<,<<< per month. &f the product is eliminated, all of this
segment margin will $e lost to the company, resulting in even
larger overall monthly losses.
,. Ao, the company should concentrate its remaining inventory of
S@ chips on making product A, not product ?. he company
should focus on the product that will provide the greatest
amount of contri$ution margin. Knder the conditions posed,
product A will provide the greatest amount of contri$ution
margin since ()* it has a "M ratio of @+P as compared to only
2<P for product ?% (+* the two products have the same selling
price, and therefore, due to its higher "M ratio, product A will
generate a greater amount of contri$ution margin per chip than
product ?% and (,* the two products re4uire the same num$er
of chips per unit.
/. a. An income statement showing product " segmented $y
markets appears on the ne.t page.
$. he following insights should $e $rought to the attention of
management:
). 3ales in the vending market are very low as compared
to the home market.
+. Iaria$le selling e.penses are +BP of sales in the
vending market as compared to only BP in the home
market. &s this just the nature of the markets, or are the
high varia$le selling e.penses in the vending market a
result of poor cost controlF
,. he tracea$le '.ed selling e.penses in the vending
market are 0<P higher than in the home market, even
though the vending market has only a fraction of the sales
of the home market. Ohy would these costs $e so high in
the vending marketF
/. he vending market has a negative segment margin. &f
3olutions Manual, "hapter )+ +BB
sales canGt $e increased enough in future months to
permit the market to cover its own costs, then
consideration should $e given to eliminating the market.
(&nstructorGs note: he 4uestion of elimination of product
lines and other segments is covered in more detail in
"hapter ),.*
3olutions Manual, "hapter )+ +BC
Product C
Vending
Mar&et <ome Mar&et
3ales......................................... R0<<,<<< )<< R 0<,<<< )<< R/0<,<<< )<<.<
!roduction............................... )<<,<<< +< )<,<<< +< C<,<<< +<.<
3elling..................................... 0<,<<< )< )/,<<< +B ,2,<<< B.<
otal varia$le e.penses............. )0<,<<< ,< +/,<<< /B )+2,<<< +B.<
"ontri$ution margin.................. ,0<,<<< @< +2,<<< 0+ ,+/,<<< @+.<
=ess tracea$le '.ed e.penses:
3elling..................................... @0,<<< )0 /0,<<< C< ,<,<<< 2.@
Market segment margin............ +@0,<<< 00
R()C,<<<
* (,B* R+C/,<<< 20.,
=ess common '.ed e.penses
not tracea$le to market
segments:
!roduction............................... )2<,<<< ,+
3ellingZ................................... +0,<<< 0
otal common '.ed e.penses. . . )B0,<<< ,@
!roduct segment margin........... R C<,<<< )B
Zotal '.ed selling e.penses................................... R)<<,<<<
=ess '.ed selling e.penses tracea$le to the
markets................................................................ @0,<<<
Fi.ed selling e.penses common to the markets.... R +0,<<<
3olutions Manual, "hapter )+ +C<
). he Electrical >ivision is presently operating at capacity%
therefore, any sales of S0+ electrical 'tting to the ?rake
>ivision will re4uire that the Electrical >ivision give up an e4ual
num$er of sales to outside customers. Ksing the transfer
pricing formula, we get a minimum transfer price of:
Iaria$le cost
ransfer price \
per unit
r
R/.+0 \ (R@.0< 7 R/.+0* r Trans1er pri2e
R/.+0 \ R,.+0 r Trans1er pri2e
R@.0< r Trans1er pri2e
hus, the Electrical >ivision should not supply the 'tting to the
?rake >ivision for R0 each. he Electrical >ivision must give up
revenues of R@.0< on each 'tting that it sells internally. 3ince
management performance in the Electrical >ivision is
measured $y 8D&, selling the 'ttings to the ?rake >ivision for
R0 would adversely a#ect these performance measurements.
+. he key is to realize that the RB in '.ed overhead and
administrative costs contained in the ?rake >ivisionGs R/C.0<
McostN per $rake unit is not relevant. here is no indication that
winning this contract would actually a#ect any of the '.ed
costs. &f these costs would $e incurred regardless of whether or
not the ?rake >ivision gets the airplane $rake contract, they
should $e ignored when determining the e#ects of the contract
on the companyGs pro'ts. Another key is that the varia$le cost
of the Electrical >ivision is not relevant either. Ohether the
'ttings are used in the $rake units or sold to outsiders, the
production costs of the 'ttings would $e the same. he only
di#erence $etween the two alternatives is the revenue on
outside sales that is given up when the 'ttings are transferred
within the company.
3olutions Manual, "hapter )+ +C)
3elling price of the $rake units........................... R0<.<<
=ess:
he cost of the 'ttings used in the $rakes
(i.e. the lost revenue from sale of 'ttings to
outsiders*...................................................... R @.0<
Iaria$le costs of the ?rake >ivision
e.cluding the 'tting (R++.0< \ R)/.<<*........ ,2.0< //.<<
Aet positive e#ect on the companyGs pro't........ R 2.<<
herefore, the company as a whole would $e $etter o# $y
R2.<< for each $rake unit that is sold to the airplane
manufacturer.
,. As shown in part ()* a$ove, the Electrical >ivision would insist
on a transfer price of at least R@.0< for the 'tting. Oould the
?rake >ivision make any money at this priceF Again, the '.ed
costs are not relevant in this decision since they would not $e
a#ected. Dnce this is realized, it is evident that the ?rake
>ivision would $e ahead $y R2.<< per $rake unit if it accepts
the R@.0< transfer price.
3elling price of the $rake units.......................... R0<.<<
=ess:
!urchased parts (from outside vendors*.........
R++.0
<
Electrical 'tting S0+ (assumed transfer
price*............................................................ @.0<
Dther varia$le costs........................................ )/.<< //.<<
?rake >ivision contri$ution margin................... R 2.<<
&n fact, since there is a positive contri$ution margin of R2, any
transfer price within the range of R@.0< to R),.0< (Y R@.0< \
R2.<<* will improve the pro'ts of $oth divisions. 3o yes, the
managers should $e a$le to agree on a transfer price.
/. &t is in the $est interests of the company and of the divisions to
come to an agreement concerning the transfer price. As
demonstrated in part (,* a$ove, any transfer price within the
range R@.0< to R),.0< would improve the pro'ts of $oth
divisions. Ohat happens if the two managers do not come to an
3olutions Manual, "hapter )+ +C+
agreementF
3olutions Manual, "hapter )+ +C,
&n this case, top management knows that there should $e a
transfer and could step in and force a transfer at some price
within the accepta$le range. ;owever, such an action, if done
on a fre4uent $asis, would undermine the autonomy of the
managers and turn decentralization into a sham.
Dur advice to top management would $e to ask the two
managers to meet to discuss the transfer pricing decision. op
management should not dictate a course of action or what is to
happen in the meeting, $ut should carefully o$serve what
happens in the meeting. &f there is no agreement, it is
important to know why. here are at least three possi$le
reasons. First, the managers may have $etter information than
the top managers and refuse to transfer for very good reasons.
3econd, the managers may $e uncooperative and unwilling to
deal with each other even if it results in lower pro'ts for the
company and for themselves. hird, the managers may not $e
a$le to correctly analyze the situation and may not understand
what is actually in their own $est interests. For e.ample, the
manager of the ?rake >ivision may $elieve that the '.ed
overhead and administrative cost of RB per $rake unit really
does have to $e covered in order to avoid a loss.
&f the refusal to come to an agreement is the result of
uncooperative attitudes or an ina$ility to correctly analyze the
situation, top management can take some positive steps that
are completely consistent with decentralization. &f the pro$lem
is uncooperative attitudes, there are many training companies
that would $e happy to put on a short course in team $uilding
for the company. &f the pro$lem is that the managers are
una$le to correctly analyze the alternatives, they can $e sent
to e.ecutive training courses that emphasize economics and
managerial accounting.
3olutions Manual, "hapter )+ +C/
Case 12-35 (@0 minutes*
). 3ee the segmented statement on the second following page.
3upporting computations for the statement are given $elow:
8evenues:
Mem$ership dues (+<,<<< V R)<<*.....................
R+,<<<,<<
<
Assigned to Magazine 3u$scriptions >ivision
(+<,<<< V R+<*................................................. /<<,<<<
Assigned to Mem$ership >ivision.......................
R),2<<,<<
<
Aon7mem$er magazine su$scriptions (+,0<< V
R,<*................................................................. R @0,<<<
8eports and te.ts (+B,<<< V R+0*.......................
R
@<<,<<<
"ontinuing education courses:
Dne7day (+,/<< V R@0*.....................................
R )B<,<<
<
wo7day (),@2< V R)+0*................................... ++<,<<<
otal revenue......................................................
R /<<,<<
<
3alary and personnel costs:
Salaries
Personnel Costs
'5;J of
Salaries+
Mem$ership >ivision.................
R+)<,<<
< R 0+,0<<
Magazine 3u$scriptions
>ivision.................................. )0<,<<< ,@,0<<
?ooks and 8eports >ivision....... ,<<,<<< @0,<<<
"ontinuing Education >ivision. . )B<,<<< /0,<<<
otal assigned to divisions........ B/<,<<< +)<,<<<
"orporate sta#.......................... B<,<<< +<,<<<
otal..........................................
RC+<,<<
< R+,<,<<<
3olutions Manual, "hapter )+ +C0
3ome may argue that, e.cept for the R0<,<<< in rental cost
directly attri$uted to the ?ooks and 8eports >ivision,
occupancy costs are common costs that should not $e
allocated. he correct treatment of the occupancy costs
depends on whether they could $e avoided in part $y
eliminating a division. &n the solution $elow, we have assumed
they could $e avoided.
Dccupancy costs (R+,<,<<< allocated \ R0<,<<< direct to the
?ooks and
8eports >ivision Y R+B<,<<<*:
Allocated to:
Mem$ership >ivision
(R+,<,<<< V <.+*.......................................
R /2,<<
<
Magazine 3u$scriptions >ivision
(R+,<,<<< V <.+*....................................... /2,<<<
?ooks and 8eports >ivision
(R+,<,<<< V <., \ R0<,<<<*..................... ))C,<<<
"ontinuing Education >ivision
(R+,<,<<< V <.+*....................................... /2,<<<
"orporate sta#
(R+,<,<<< V <.)*....................................... +,,<<<
otal occupancy costs..................................
R+B<,<<
<
!rinting and paper costs................................
R,+<,<<
<
Assigned to:
(++,0<< V R@*.........................................
R)0@,0<
<
(+B,<<< V R/*.........................................
))+,<<
<
+2C,0<
<
8emainder9"ontinuing Education
>ivision...................................................
R 0<,0<
<
!ostage and shipping costs............................
R)@2,<<
<
Assigned to:
(++,0<< V R/*.........................................
R C<,<<
<
3olutions Manual, "hapter )+ +C2
(+B,<<< V R+*......................................... 02,<<<
)/2,<<
<
8emainder9corporate sta#.......................
R ,<,<<
<
3olutions Manual, "hapter )+ +C@
!ivision
Associatio
n ,otal
Membersh
ip
MagaKine
Subscription
s
Boo&s >
2eports
Continuin
g
Educatio
n
8evenues:
Mem$ership dues.......................
R+,<<<,<<
< R),2<<,<<< R/<<,<<<
Aon7mem$er magazine
su$scriptions............................ @0,<<< @0,<<<
Advertising................................. )<<,<<< )<<,<<<
8eports and te.ts....................... @<<,<<<
R@<<,<<
<
"ontinuing education courses. . . . /<<,<<< R/<<,<<<
otal revenues............................ ,,+@0,<<< ),2<<,<<< 0@0,<<< @<<,<<< /<<,<<<
E.penses tracea$le to segments:
3alaries...................................... B/<,<<< +)<,<<< )0<,<<< ,<<,<<< )B<,<<<
!ersonnel costs........................... +)<,<<< 0+,0<< ,@,0<< @0,<<< /0,<<<
Dccupancy costs........................ +0@,<<< /2,<<< /2,<<< ))C,<<< /2,<<<
8eim$ursement of mem$er costs
to local chapters......................... 2<<,<<< 2<<,<<<
Dther mem$ership services........ 0<<,<<< 0<<,<<<
!rinting and paper...................... ,+<,<<< )0@,0<< ))+,<<< 0<,0<<
!ostage and shipping................. )/2,<<< C<,<<< 02,<<<
&nstructorsG fees.......................... B<,<<< B<,<<<
otal tracea$le e.penses............ +,C0,,<<< ),/<B,0<< /B),<<< 22+,<<< /<),0<<
>ivision segment margin.............. ,++,<<< R )C),0<< RC/,<<< R ,B ,<<< R(),0<<*
3olutions Manual, "hapter )+ +CB
]he statement is continued on the ne.t page.^
3olutions Manual, "hapter )+ +CC
]"ontinuation of the segmented income statement.^
!ivision
Associatio
n ,otal
Membersh
ip
MagaKine
Subscription
s
Boo&s >
2eports
Continuin
g
Educatio
n
>ivision segment margin.............. ,++,<<< R )C),0<< RC/,<<< R ,B ,<<< R(),0<<*
=ess common e.penses not
tracea$le to divisions:
3alaries9corporate sta#............ B<,<<<
!ersonnel costs........................... +<,<<<
Dccupancy costs........................ +,,<<<
!ostage and shipping................. ,<,<<<
1eneral and administrative........ ,B,<<<
otal common e.penses................ )C),<<<
E.cess of revenues over
e.penses.................................... R ),),<<<
3olutions Manual, "hapter )+ ,<<
+. Ohile we do not favor the allocation of common costs to
segments, the most common reason given for this practice is
that segment managers need to $e aware of the fact that
common costs do e.ist and that they must $e covered.
Arguments against allocation of all costs:
L Allocation $ases will need to $e chosen ar$itrarily since no
cause7and7e#ect relationship e.ists $etween common costs
and the segments to which they are allocated.
L Management may $e misled into eliminating a pro'ta$le
segment that appears to $e unpro'ta$le $ecause of
allocated common costs.
L 3egment managers usually have little control over common
costs. hey should not $e held accounta$le for costs over
which they have no control.
L Allocations of common costs undermine the credi$ility of
performance reports. 3egment managers may resent such
allocations and ignore the entire performance report as
ar$itrary and unfair.
3olutions Manual, "hapter ), ),
,roup E%ercise 12-3
he answers to this 4uestion will depend on the nature of the
'nancial reports students o$tain from their college.
3olutions Manual, "hapter ), )/
,roup E%ercise 12-3!
Aote: his is a very diEcult pro$lem that re4uires an e.cellent
understanding of the course to this point and analytical skills.
he two groups9representing managers in a transfer pricing
negotiation9should $e a$le to come to an agreement concerning
the transfer price.
From the standpoint of the "onsumer !roducts >ivision, a deal
with the &ndustrial !roducts >ivision to ac4uire the electric motors
at the transfer price M!N makes sense only if the deal will
increase the divisionGs residual income over and a$ove what it
would $e without producing and selling the new sor$et maker. &n
other words, the residual income from the sor$et maker itself,
after taking into account the deduction for the cost of the electric
motor, must $e positive:
8esidual income from the sor$et maker R<
"ontri$ution margin 7 Fi.ed cost 7 Minimum re4uired return R<
(RBC 7 R0/ 7 !* 0<,<<< 7 R)B<,<<< 7 <.+< R,,<<<,<<< R<
(R,0 7 !* 0<,<<< 7 R)B<,<<< 7 R2<<,<<< R<
(R
b
b
s s b
s b
,0 7 !* 0<,<<< 7 R@B<,<<< R<
(R,0 7 !* 0<,<<< R@B<,<<<
(R,0 7 !* R)0.2<
! R)C./<
s b
s b
b
a
herefore, any transfer price that is less than R)C./< will result in
an increase in the "onsumer !roduct >ivisionGs residual income if
the sor$et maker product is launched.
3olutions Manual, "hapter ), )0
,roup E%ercise 12-3! (continued*
Dn the other hand, from the standpoint of the &ndustrial
!roducts >ivision, selling the electric motor to the "onsumer
!roducts >ivision will make sense only if the &ndustrial !roducts
>ivisionGs residual income is increased. his will occur if and only
if:
8esidual income from selling the electric motor R<
"ontri$ution margin 7 Fi.ed cost 7 Minimum re4uired return R<
(! 7 R),* 0<,<<< 7 R,<,<<< 7 <.+< R/<<,<<< R<
(! 7 R),* 0<,<<< 7 R,<,<<< 7 RB<,<<< R<
(
b
b
s s b
s b
! 7 R),* 0<,<<< R))<,<<<
(! 7 R),* R+.+<
! R)0.+<
s b
b
b
herefore, any transfer price in e.cess of R)0.+< will result in an
increase in the &ndustrial !roduct >ivisionGs residual income if the
sor$et maker product is launched.
"om$ining the two re4uirements, any transfer price within the
range R)0.+< a ! a R)C./< will result in an increase in $oth
>ivisionsG residual incomes. herefore, the two groups should $e
a$le to come to a mutually satisfactory agreement.
;owever, they may fail to come to an agreement. his could
occur for a num$er of reasons, just as in the real world. hey may
not $e a$le to 'gure out what is in their own $est interests. hey
may get caught up in the negotiations and lose sight of their goal
9which should $e to ma.imize residual income. Dr negotiations
may $reak down over fairness and e4uity issues.
3olutions Manual, "hapter ), )2
Chapter 13
=elevant Costs 7or 1ecision Ma?ing
13-1 A relevant cost is a cost that di#ers
in total $etween the alternatives in a
decision.
13-2 An incremental cost (or $ene't* is
the change in cost (or $ene't* that will
result from some proposed action. An
opportunity cost is the $ene't that is lost
or sacri'ced in rejecting some course of
action. A sunk cost is a cost that has
already $een incurred and that cannot $e
changed $y any future decision.
13-3 Ao. Iaria$le costs are relevant
costs only if they di#er in total $etween
the alternatives under consideration.
13-4 Ao. Aot all '.ed costs are sunk9
only those for which the cost has already
$een irrevoca$ly incurred. A varia$le cost
can $e a sunk cost, if it has already $een
incurred.
13-5 Ao. A varia$le cost is a cost that
varies in total amount in direct proportion
to changes in the level of activity. A
di#erential cost measures the di#erence in
cost $etween two alternatives. &f the level
of activity is the same for the two
alternatives, a varia$le cost will $e
una#ected and it will $e irrelevant.
13- Ao. Dnly those future costs that
di#er $etween the alternatives under
consideration are relevant.
13-! Dnly those costs that can $e
avoided as a result of dropping the
product line are relevant in the decision.
"osts that will not di#er regardless of
whether the line is retained or
discontinued are irrelevant.
13-" Aot necessarily. An apparent loss
may $e the result of allocated common
costs or of sunk costs that cannot $e
avoided if the product line is dropped. A
product line should $e discontinued only if
the contri$ution margin that will $e lost as
a result of dropping the line is less than
the '.ed costs that can $e avoided. Even
in that situation there may $e arguments
in favor of retaining the product line if its
presence promotes the sale of other
products.
13-# Allocations of common '.ed costs
can make a product line (or other
segment* appear to $e unpro'ta$le,
whereas in fact it may $e pro'ta$le.
13-1$ &f a company decides to make a
part internally rather than to $uy it from
an outside supplier, then a portion of the
companyGs facilities have to $e used to
make the part. he companyGs opportunity
cost is measured $y the $ene'ts that
could $e derived from the $est alternative
use of the facilities.
13-11 Any resource that is re4uired to
make products and get them into the
hands of customers could $e a constraint.
3ome e.amples are machine time, direct
la$or time, -oor space, raw materials,
investment capital, supervisory time, and
storage space. Ohile not covered in the
te.t, constraints can also $e intangi$le
and often take the form of a formal or
informal policy that prevents the
organization from furthering its goals.
13-12 Assuming that '.ed costs are not
a#ected, pro'ts are ma.imized when the
total contri$ution margin is ma.imized. A
3olutions Manual, "hapter ), )@
company can ma.imize its contri$ution
margin $y focusing on the products with
the greatest amount of contri$ution
margin per unit of the constrained
resource.
13-13 5oint products are two or more
products that are produced from a
common input. 5oint costs are the costs
that are incurred up to the split7o# point.
he split7o# point is the point in the
manufacturing process where joint
products can $e recognized as individual
products.
13-14 5oint costs should not $e allocated
among joint products. &f joint costs are
allocated among the joint products, then
managers may think they are avoida$le
costs of the end products. ;owever, the
joint costs will continue to $e incurred as
long as the process is run regardless of
what is done with one of the end products.
hus, when making decisions a$out the
end products, the joint costs are not
avoida$le and are irrelevant.
13-15 As long as the incremental revenue
from further processing e.ceeds the
incremental costs of further processing,
the product should $e processed further.
13-1 Most costs of a -ight are either
sunk costs, or costs that do not depend on
the num$er of passengers on the -ight.
>epreciation of the aircraft, salaries of
personnel on the ground and in the air,
and fuel costs, for e.ample, are the same
whether the -ight is full or almost empty.
herefore, adding more passengers at
reduced fares at certain times of the week
when seats would otherwise $e empty
does little to increase the total costs of
making the -ight, $ut can do much to
increase the total contri$ution and total
pro't.
3olutions Manual, "hapter ), )B
Case 1 Case 2
"tem
2eleva
nt
(ot
2eleva
nt
2elevan
t
(ot
2elevan
t
a. 3ales revenue S S
$. >irect materials S S
c. >irect la$or S S
d. Iaria$le
manufacturing
overhead S S
e. >epreciation9 Model
?)<< machine S S
f. ?ook value9 Model
?)<< machine S S
g. >isposal value9
Model ?)<<
machine S S
h. Market value9Model
?,<< machine
(cost* S S
i. Fi.ed manufacturing
overhead S S
j. Iaria$le selling
e.pense S S
k. Fi.ed selling e.pense S S
l. 1eneral
administrative
overhead S S
3olutions Manual, "hapter ), )C
). Ao, production and sale of the racing $ikes should not $e
discontinued. &f the racing $ikes were discontinued, then the
net operating income for the company as a whole would
decrease $y R)),<<< each 4uarter:
=ost contri$ution margin.........................................R(+@,<<<*
Fi.ed costs that can $e avoided:
Advertising, tracea$le...........................................
R
2,<<<
3alary of the product line manager.......................
)<,<<
< )2,<<<
>ecrease in net operating income for the
company as a whole.............................................R()),<<<*
he depreciation of the special e4uipment is a sunk cost and is
not relevant to the decision. he common costs are allocated
and will continue regardless of whether or not the racing $ikes
are discontinued% thus, they are not relevant to the decision.
Current
,otal
,otal "f
2acing
Bi&es
Are
!ropped
!i#erenc
eG (et
$perating
"ncome
"ncrease
or
'!ecrease
+
3ales
R,<<,<<
< R+/<,<<< R(2<,<<<*
)+<,<<
< B@,<<< ,,,<<<
"ontri$ution margin
)B<,<<
< )0,,<<< (+@,<<<*
=ess '.ed e.penses:
Advertising, tracea$le ,<,<<< +/,<<< 2,<<<
>epreciation on special
e4uipmentZ +,,<<< +,,<<< <
3alaries of product ,0,<<< +0,<<< )<,<<<
3olutions Manual, "hapter ), +<
managers
"ommon allocated costs
2<,<<
< 2<,<<< <
otal '.ed e.penses
)/B,<<
< ),+,<<< )2,<<<
R ,+,<<
< R +),<<< R ()),<<<*
Z&ncludes pro7rated loss on the special e4uipment if it is
disposed of.
3olutions Manual, "hapter ), +)
+. he segmented report can $e improved $y eliminating the
allocation of the common '.ed e.penses. Following the format
introduced in "hapter )+ for a segmented income statement, a
$etter report would $e:
,otal
!irt
Bi&es
Mountai
n Bi&es
2acing
Bi&es
3ales
R,<<,<<
<
RC<,<<
<
R)0<,<<
< R2<,<<<
=ess varia$le
manufacturing and
selling e.penses
)+<,<<
< +@,<<< 2<,<<< ,,,<<<
"ontri$ution margin
)B<,<<
< 2,,<<< C<,<<< +@,<<<
=ess tracea$le '.ed
e.penses:
Advertising ,<,<<< )<,<<< )/,<<< 2,<<<
>epreciation of special
e4uipment +,,<<< 2,<<< C,<<< B,<<<
3alaries of the product
line managers
,0,<<
< )+,<<< ),,<<< )<,<<<
otal tracea$le '.ed
e.penses
BB,<<
< +B,<<< ,2,<<< +/,<<<
margin C+,<<<
R,0,<<
<
R
0/,<<< R,,<<<
=ess common '.ed
e.penses
2<,<<
<
R
,+,<<<
3olutions Manual, "hapter ), ++
). Per Unit
!i#erenti
al Costs 4;A::: units
Ma&
e Bu% Ma&e Bu%
"ost of purchasing.................. R,0
R0+0,<<
<
>irect materials...................... R)/
R+)<,<<
<
>irect la$or............................. )< )0<,<<<
overhead.............................. , /0,<<<
Fi.ed manufacturing
overhead, tracea$le
)
............. + ,<,<<<
Fi.ed manufacturing
overhead, common...............
otal costs............................... R+C R,0
R/,0,<<
<
R0+0,<<
<
>i#erence in favor of
continuing to make the
car$uretors........................... R2 RC<,<<<
Dnly the supervisory salaries can $e avoided if the
car$uretors are purchased. he remaining $ook value of the
special e4uipment is a sunk cost% hence, the R/ per unit
depreciation e.pense is not relevant to this decision. ?ased
on these data, the company should reject the o#er and
should continue to produce the car$uretors internally.
+. Ma&e Bu%
"ost of purchasing (part )*.......................
R0+0,<<
<
"ost of making (part )*............................
R/,0,<<
<
Dpportunity cost9segment margin
foregone on a potential new product
line........................................................ )0<,<<<
otal cost.................................................. R0B0,<< R0+0,<<
3olutions Manual, "hapter ), +,
< <
>i#erence in favor of purchasing from
the outside supplier..............................................
R2<,<<
<
hus, the company should accept the o#er and purchase the
car$uretors from the outside supplier.
3olutions Manual, "hapter ), +/
Dnly the incremental costs and $ene'ts are relevant. &n particular,
only the varia$le manufacturing overhead and the cost of the
special tool are relevant overhead costs in this situation. he
other manufacturing overhead costs are '.ed and are not
a#ected $y the decision.
Per
Unit
,otal
for 5:
Bracelets
&ncremental revenue........................
R)2C.C
0
R,,,CC.<
<
&ncremental costs:
Iaria$le costs:
>irect materials........................... R B/.<< ),2B<.<<
>irect la$or.................................. /0.<< C<<.<<
overhead................................... /.<< B<.<<
3pecial 'ligree............................. +.<< /<.<<
otal varia$le cost..........................
R),0.<
< +,@<<.<<
Fi.ed costs:
!urchase of special tool............... +0<.<<
otal incremental cost...................... +,C0<.<<
&ncremental net operating income. . . R //C.<<
Even though the price for the special order is $elow the
companyTs regular price for such an item, the special order would
add to the companyTs net operating income and should $e
accepted. his conclusion would not necessarily follow if the
special order a#ected the regular selling price of $racelets or if it
re4uired the use of a constrained resource.
3olutions Manual, "hapter ), +0
). A B C
()* "ontri$ution margin per unit................................... R0/ R)irect material cost per unit.................................... R+/ R@+ R,+
(,* >irect material cost per pound................................ RB RB RB
(/*
!ounds of material re4uired per unit (+*
[ (,*..................................................................... , C /
(0* "ontri$ution margin per pound ()* [ (/*................. R)B R)+ R)0
+. he company should concentrate its availa$le material on
product A:
A B C
"ontri$ution margin per pound
(a$ove* R )B R )+ R )0
!ounds of material availa$le V 0,<<< V 0,<<<
V
0,<<<
otal contri$ution margin RC<,<<< R2<,<<<
R@0,<<
<
Although product A has the lowest contri$ution margin per unit
and the second lowest contri$ution margin ratio, it is preferred
over the other two products since it has the greatest amount of
contri$ution margin per pound of material, and material is the
companyGs constrained resource.
,. he price ?arlow "ompany would $e willing to pay per pound
for additional raw materials depends on how the materials
would $e used. &f there are un'lled orders for all of the
products, ?arlow would presuma$ly use the additional raw
materials to make more of product A. Each pound of raw
materials used in product A generates R)B of contri$ution
margin over and a$ove the usual cost of raw materials.
herefore, ?arlow should $e willing to pay up to R+2 per pound
(RB usual price plus R)B contri$ution margin per pound* for the
additional raw material, $ut would of course prefer to pay far
less. he upper limit of R+2 per pound to manufacture more
product A signals to managers how valua$le additional raw
materials are to the company.
&f all of the orders for product A have $een 'lled, ?arlow
3olutions Manual, "hapter ), +2
"ompany would then use additional raw materials to
manufacture product ". he company should $e willing to pay
up to R+, per pound (RB usual price plus R)0 contri$ution
margin per pound* for the additional raw materials to
manufacture more product ", and up to R+< per pound (RB
usual price plus R)+ contri$ution margin per pound* to
manufacture more product ? if all of the orders for product "
have $een 'lled as well.
3olutions Manual, "hapter ), +@
E%ercise 13- ()< minutes*
A B C
3elling price after further
processing................................... R+< R), R,+
3elling price at the split7o# point. . . )2 B +0
&ncremental revenue per pound
or gallon...................................... R / R 0 R @
otal 4uarterly output in pounds
or gallons.....................................
V )0,<<
< V +<,<<< V /,<<<
otal incremental revenue.............. R2<,<<<
R)<<,<<
<
R+B,<<
<
otal incremental processing
costs............................................ 2,,<<< B<,<<< ,2,<<<
otal incremental pro't or loss....... R(,,<<<*R +<,<<<
R(B,<<<
*
herefore, only product ? should $e processed further.
3olutions Manual, "hapter ), +B
). Fi.ed cost per mile (R0,<<<Z [ 0<,<<<
miles*....................................................... R<.)<
Iaria$le cost per mile................................. <.<@
Average cost per mile................................. R<.)@
Z
&nsurance.......................
R),2<
<
=icenses......................... +0<
a.es.............................. )0<
1arage rent.................... ),+<<
>epreciation................... ),B<<
otal...............................
R0,<<
<
his answer assumes the resale value of the truck does not
decline $ecause of the wear and tear that comes with use.
+. he insurance, the licenses, and the varia$le costs (gasoline,
oil, tires, and repairs* would all $e relevant to the decision,
since these costs are avoida$le $y not using the truck.
(;owever, the owner of the garage might insist that the truck
$e insured and licensed if it is left in the garage. &n that case,
the insurance and licensing costs would not $e relevant since
they would $e incurred regardless of the decision.* he ta.es
would not $e relevant, since they must $e paid regardless of
use% the garage rent would not $e relevant, since it must $e
paid to park the truck% and the depreciation would not $e
relevant, since it is a sunk cost. ;owever, any decrease in the
resale value of the truck due to its use would $e relevant.
,. Dnly the varia$le costs of R<.<@ would $e relevant, since they
are the only costs that can $e avoided $y having the delivery
done commercially.
/. &n this case, only the '.ed costs associated with the second
truck would $e relevant. he varia$le costs would not $e
relevant, since they would not di#er $etween having one or two
trucks. (3tudents are inclined to think that varia$le costs are
always relevant in decision7making, and to think that '.ed
3olutions Manual, "hapter ), +C
costs are always irrelevant. his re4uirement helps to dispel
that notion.*
3olutions Manual, "hapter ), ,<
E%ercise 13-" (,< minutes*
Ao, the $ilge pump product line should not $e discontinued. he
computations are:
"ontri$ution margin lost if the line is
dropped......................................................
d(/2<,<<
<*
Fi.ed costs that can $e avoided:
Advertising.................................................
d+@<,<<
<
3alary of the product line manager............ ,+,<<<
&nsurance on inventories............................
B,<<
<
,)<,<<
<
Aet disadvantage of dropping the line..........
d ()0<,<<
<*
he same solution can $e o$tained $y preparing comparative
income statements:
Ceep
Product
)ine
!rop
Product
)ine
!i#erence
G (et
$perating
"ncome
"ncrease
or
'!ecrease+
3ales.............................................
d B0<,<<
< d < d (B0<,<<<*
e.penses.................................. ,,<,<<< < ,,<,<<<
3ales commissions...................... /+,<<< < /+,<<<
3hipping.....................................
)B,<<
< < )B,<<<
otal varia$le e.penses.................
,C<,<<
< < ,C<,<<<
"ontri$ution margin......................
/2<,<<
< < (/2<,<<<*
=ess '.ed e.penses:
Advertising................................. +@<,<<< < +@<,<<<
>epreciation of e4uipment......... B<,<<< B<,<<< <
1eneral factory overhead........... )<0,<<< )<0,<<< <
3olutions Manual, "hapter ), ,)
3alary of product line manager... ,+,<<< < ,+,<<<
&nsurance on inventories............. B,<<< < B,<<<
!urchasing department
e.penses..................................
/0,<<
<
/0,<<
< <
otal '.ed e.penses......................
0/<,<<
<
+,<,<<
< ,)<,<<<
Aet operating loss.........................
d (B<,<<
<*
d (+,<,<<
<* d ()0<,<<<*
3olutions Manual, "hapter ), ,+
E%ercise 13-# (+< minutes*
he costs that are relevant in a make7or7$uy decision are those
costs that can $e avoided as a result of purchasing from the
outside. he analysis for this e.ercise is:
Per Unit
!i#erential
Costs 6:A::: Units
Ma&e Bu% Ma&e Bu%
"ost of purchasing................
R+).<
<
R2,<,<<
<
"ost of making:
>irect materials.................. R,.2< R)<B,<<<
>irect la$or......................... )<.<< ,<<,<<<
Iaria$le overhead............... +./< @+,<<<
Fi.ed overhead................... ,.<< Z C<,<<<
otal cost...............................
R)C.<
<
R+).<
< R0@<,<<<
R2,<,<<
<
he remaining R2 of '.ed overhead cost would not $e
relevant, since it will continue regardless of whether the
company makes or $uys the parts.
he RB<,<<< rental value of the space $eing used to produce part
372 represents an opportunity cost of continuing to produce the
part internally. hus, the completed analysis would $e:
Ma&e Bu%
otal cost, as a$ove..................................... R0@<,<<< R2,<,<<<
8ental value of the space (opportunity
cost*......................................................... B<,<<<
otal cost, including opportunity cost.......... R20<,<<< R2,<,<<<
Aet advantage in favor of $uying..................
R+<,<<
<
3olutions Manual, "hapter ), ,,
E%ercise 13-1$ ()0 minutes*
). Annual pro'ts will $e increased $y R,C,<<<:
Per
Unit
4;A:::
Units
&ncremental sales............................. R)/.<<
R+)<,<<
<
&ncremental costs:
>irect materials............................. 0.)< @2,0<<
>irect la$or.................................... ,.B< 0@,<<<
Iaria$le manufacturing overhead.. ).<< )0,<<<
administrative............................. ).0< ++,0<<
otal incremental costs.................... ))./< )@),<<<
&ncremental pro'ts........................... R+.2<
R
,C,<<<
he '.ed costs are not relevant to the decision, since they will
$e incurred regardless of whether the special order is accepted
or rejected.
+. he relevant cost is R).0< (the varia$le selling and
administrative e.penses*. All other varia$le costs are sunk,
since the units have already $een produced. he '.ed costs
would not $e relevant, since they will not change in total as a
conse4uence of the price charged for the left7over units.
3olutions Manual, "hapter ), ,/
he company should accept orders 'rst for ", second for A, and
third for ?. he computations are:
A B C
()* >irect materials re4uired per
unit............................................. R+/ R)0 RC
(+* "ost per pound.............................. R, R, R,
(,* !ounds re4uired per unit ()* [
(+*............................................... B 0 ,
(/* "ontri$ution margin per unit......... R,+ R)/ R+)
(0* "ontri$ution margin per pound
of materials used (/* [ (,*.......... R/.<< R+.B< R@.<<
3ince " uses the least amount of material per unit of the three
products, and since it is the most pro'ta$le of the three in terms
of its use of materials, some students will immediately assume
that this is an infalli$le relationship. hat is, they will assume that
the way to spot the most pro'ta$le product is to 'nd the one
using the least amount of the constrained resource. he way to
dispel this notion is to point out that product A uses more material '
(the constrained resource* than does product ?, $ut yet it is
preferred over product ?. ,he &e% factor is not ho1 much of a
constrained resource a product usesA but rather ho1 much
contribution margin the product generates per unit of the
constrained resource*
3olutions Manual, "hapter ), ,0
3ales value if processed further
(@,<<< units V R)+ per unit*........................... RB/,<<<
3ales value at the split7o# point
(@,<<< units V RC per unit*............................. 2,,<<<
&ncremental revenue......................................... +),<<<
=ess cost of processing further......................... C,0<<
Aet advantage of processing further................ R)),0<<
3olutions Manual, "hapter ), ,2
). he relevant costs of a hunting trip would $e:
ravel e.pense ()<< miles _ R<.+) per
mile*...................................................... R+)
3hotgun shells.......................................... +<
Dne $ottle of whiskey............................... )0
otal......................................................... R02
his answer assumes that ?ill would not $e drinking the $ottle
of whiskey anyway. &t also assumes that the resale values of
the camper, pickup truck, and $oat are not a#ected $y taking
one more hunting trip.
he money lost in the poker game is not relevant $ecause ?ill
would have played poker even if he did not go hunting. ;e
plays poker every weekend.
he other costs are sunk at the point at which the decision is
made to go on another hunting trip.
+. &f ?ill gets lucky and $ags another two ducks, all of his costs are
likely to $e a$out the same as they were on his last trip.
herefore, it really doesnGt cost him anything to shoot the last
two ducks9e.cept possi$ly the costs for e.tra shotgun shells.
he costs are really incurred in order to $e a$le to hunt ducks
and would $e the same whether one, two, three, or a dozen
ducks were actually shot. All of the costs, with the possi$le
e.ception of the costs of the shotgun shells, are $asically '.ed
with respect to how many ducks are actually $agged during
any one hunting trip.
,. &n a decision of whether to give up hunting entirely, more of the
costs listed $y 5ohn are relevant. &f ?ill did not hunt, he would
not need to pay for: gas, oil, and tires% shotgun shells% the
hunting license% and the whiskey. &n addition, he would $e a$le
to sell his camper, e4uipment, $oat, and possi$ly pickup truck,
the proceeds of which would $e considered relevant in this
decision. he original costs of these items are not relevant, $ut
their resale values are relevant.
3olutions Manual, "hapter ), ,@
hese three re4uirements illustrate the slippery nature of costs.
A cost that is relevant in one situation can $e irrelevant in the
ne.t. Aone of the costs9e.cept possi$ly the cost of the
shotgun shells9are relevant when we compute the cost of
$agging a particular duck% some of them are relevant when we
compute the cost of a hunting trip% and more of them are
relevant when we consider the possi$ility of giving up hunting.
3olutions Manual, "hapter ), ,B
"ontri$ution margin lost if the =inen >epartment is
dropped:
=ost from the =inen >epartment....................................
R2<<,<<
<
=ost from the ;ardware >epartment ()<P V
R+,)<<,<<<*................................................................. +)<,<<<
otal lost contri$ution margin........................................... B)<,<<<
=ess '.ed costs that can $e avoided (RB<<,<<< X
R,/<,<<<*...................................................................... /2<,<<<
>ecrease in pro'ts for the company as a whole...............
R,0<,<<
<
3olutions Manual, "hapter ), ,C
he target production level is /<,<<< starters per period, as
shown $y the relations $etween per7unit and total '.ed costs.
NCost
O Per
!i#erential
Costs
Unit Ma&e Bu% Explanation
>irect materials. . . R,.)< R,.)<
"an $e avoided $y
$uying
>irect la$or.......... +.@< +.@<
"an $e avoided $y
$uying
Iaria$le
manufacturing
overhead........... <.2< <.2<
"an $e avoided $y
$uying
3upervision.......... ).0< ).0<
"an $e avoided $y
$uying
>epreciation ).<< 9 3unk "ost
8ent..................... <.,< 9 Allocated "ost
Dutside
purchase price...
RB./
<
otal cost.............. RC.+< R@.C<
RB./
<
he company should make the starters, rather than continuing
to $uy from the outside supplier. Making the starters will result
in a R<.0< per starter cost savings, or a total savings of
R+<,<<< per period:
R<.0< per starter V /<,<<< starters Y R+<,<<<
3olutions Manual, "hapter ), /<
). "ontri$ution margin lost if the -ight is
discontinued.................................................
R()+,C0<
*
Flight costs that can $e avoided if the -ight
is discontinued:
Flight promotion........................................... R @0<
Fuel for aircraft............................................. 0,B<<
=ia$ility insurance ()H, V R/,+<<*................. ),/<<
3alaries, -ight assistants.............................. ),0<<
Dvernight costs for -ight crew and
assistants................................................... ,<< C,@0<
Aet decrease in pro'ts if the -ight is
discontinued................................................. R(,,+<<*
he following costs are not relevant to the decision:
Cost 2eason
3alaries, -ight crew Fi.ed annual salaries, which
will not change.
>epreciation of aircraft 3unk cost.
=ia$ility insurance (two7
thirds*
wo7thirds of the lia$ility
insurance is una#ected $y
this decision.
?aggage loading and -ight
preparation
his is an allocated cost that
will continue even if the -ight
is discontinued.
3olutions Manual, "hapter ), /)
Ceep
the
Flight
!rop
the
Flight
!i#erenc
eG (et
$perating
"ncome
"ncrease
or
'!ecrease
+
icket revenue.................................. R)/,<<< R < R()/,<<<*
=ess varia$le e.penses.................... ),<0< < ),<0<
"ontri$ution margin......................... )+,C0< < ()+,C0<*
=ess -ight e.penses:
3alaries, -ight crew....................... ),B<< ),B<< <
Flight promotion............................ @0< < @0<
>epreciation of aircraft.................. ),00< ),00< <
Fuel for aircraft.............................. 0,B<< < 0,B<<
=ia$ility insurance.......................... /,+<< +,B<< ),/<<
3alaries, -ight assistants............... ),0<< < ),0<<
?aggage loading and -ight
preparation.................................. ),@<< ),@<< <
Dvernight costs for -ight crew and
assistants at destination.............. ,<< < ,<<
otal -ight e.penses......................... )@,2<< @,B0< C,@0<
Aet operating loss............................ R (/,20<* R (@,B0<* R (,,+<<*
+. he goal of increasing the seat occupancy could $e o$tained $y
eliminating -ights with a lower7than7average seat occupancy.
?y eliminating these -ights and keeping the -ights with a
higher average seat occupancy, the overall average seat
occupancy for the company as a whole would $e improved.
his could reduce pro'ts, however, in at least two ways. First,
the -ights that are eliminated could have contri$ution margins
that e.ceed their avoida$le costs (such as in the case of -ight
/B+ in part )*. &f so, then eliminating these -ights would reduce
the companyGs total contri$ution margin more than it would
reduce total costs, and pro'ts would decline. 3econd, these
-ights might $e acting as MfeederN -ights, $ringing passengers
3olutions Manual, "hapter ), /+
to cities where connections to more pro'ta$le -ights are made.
3olutions Manual, "hapter ), /,
&ro'lem 13-1! ()0 minutes*
).
Per 4E/
$unce ,/
Bone
8evenue from further processing:
3ales price of one 'let mignon (2 ounces
V R/.<< per pound [ )2 ounces per
pound*..................................................... R).0<
3ales price of one Aew Qork cut (B ounces
V R+.B< per pound [ )2 ounces per
pound*..................................................... )./<
otal revenue from further processing.......... +.C<
=ess sales revenue from one 7$one steak.... +.+0
&ncremental revenue from further
processing.................................................. <.20
=ess cost of further processing..................... <.+0
!ro't per pound from further processing...... R<./<
+. he 7$one steaks should $e processed further into the 'let
mignon and the Aew Qork cut. his will yield R<./< per pound in
added pro't for the company. he R<./0 Mpro'tN per pound
shown in the te.t is not relevant to the decision, since it
contains allocated joint costs. he company will incur the joint
costs regardless of whether the 7$one steaks are sold outright
or processed further% thus, this cost should $e ignored in the
decision.
3olutions Manual, "hapter ), //
). he simplest approach to the solution is:
1ross margin lost if the store is closed.... R(,)2,B<<*
"osts that can $e avoided:
3ales salaries........................................
R@<,<<
<
>irect advertising.................................. 0),<<<
3tore rent.............................................. B0,<<<
>elivery salaries.................................... /,<<<
3tore management salaries
(R+),<<< X R)+,<<<*........................... C,<<<
3alary of new manager......................... )),<<<
1eneral oEce compensation................. 2,<<<
&nsurance on inventories (R@,0<< V
+H,*..................................................... 0,<<<
Ktilities.................................................. ,),<<<
Employment ta.es................................
)0,<<
< Z +B@,<<<
>ecrease in company pro'ts if the
Aorth 3tore is closed............................. R (+C,B<<*
Z3alaries avoided $y closing the store:
3ales salaries....................................... R@<,<<<
>elivery salaries.................................. /,<<<
3tore management salaries................. C,<<<
3alary of new manager........................ )),<<<
1eneral oEce compensation................ 2,<<<
otal avoided.......................................... )<<,<<<
Employment ta. rate.............................. V)0P
Employment ta.es avoided.................... R)0,<<<
3olutions Manual, "hapter ), /0
(orth
Store
Cept
$pen
(orth
Store
Closed
!i#erence
G (et
$perating
"ncome
"ncrease
or
'!ecrease+
3ales........................................ R@+<,<<< R <
R(@+<,<<<
*
=ess cost of goods sold............. /<,,+<< < /<,,+<<
1ross margin............................ ,)2,B<< < (,)2,B<<*
Dperating e.penses:
3elling e.penses:
3ales salaries...................... @<,<<< < @<,<<<
>irect advertising................ 0),<<< < 0),<<<
1eneral advertising............. )<,B<< )<,B<< <
3tore rent............................ B0,<<< < B0,<<<
>epreciation of store
'.tures.............................. /,2<< /,2<< <
>elivery salaries.................. @,<<< ,,<<< /,<<<
>epreciation of delivery
e4uipment........................ ,,<<< ,,<<< <
otal selling e.penses............ +,),/<< +),/<< +)<,<<<
3tore management
salaries............................. +),<<< )+,<<< C,<<<
3alary of new manager........ )),<<< < )),<<<
1eneral oEce
compensation................... )+,<<< 2,<<< 2,<<<
&nsurance on '.tures and
inventory.......................... @,0<< +,0<< 0,<<<
Ktilities................................ ,),<<< < ,),<<<
Employment ta.es............... )B,)0< ,,)0< )0,<<< Z
1eneral oEce9other........... )B,<<< )B,<<< <
otal administrative
e.penses............................. ))B,20< /),20< @@,<<<
otal operating e.penses.......... ,0<,<0< 2,,<0< +B@,<<<
3olutions Manual, "hapter ), /2
Aet operating income (loss*..... R(,,,+0<*
R(2,,<0<
* R (+C,B<<*
Z3ee the computation on the prior page.
3olutions Manual, "hapter ), /@
+. ?ased on the data in ()*, the Aorth 3tore should not $e closed.
&f the store is closed, then the companyGs overall net operating
income will decrease $y R+C,B<< per 4uarter. &f the store space
cannot $e su$leased or the lease $roken without penalty, a
decision to close the store would cause an even greater decline
in the companyGs overall net income. &f the RB0,<<< rent cannot
$e avoided and the Aorth 3tore is closed, the companyGs
overall net operating income would $e reduced $y R))/,B<<
per 4uarter (R+C,B<< \ RB0,<<<*.
,. Knder these circumstances, the Aorth 3tore should $e closed.
he computations are as follows:
1ross margin lost if the Aorth 3tore is closed (part
)*..........................................................................
R(,)2,B<<
*
1ross margin gained from the East 3tore:
R@+<,<<< V )H/ Y R)B<,<<<% R)B<,<<< V /0PZ
Y RB),<<<............................................................. B),<<<
Aet operating loss in gross margin.......................... (+,0,B<<*
=ess costs that can $e avoided if the Aorth 3tore
is closed (part )*................................................... +B@,<<<
Aet advantage of closing the Aorth 3tore................ R 0),+<<
Zhe East 3toreGs gross margin percentage is:
R/B2,<<< [ R),<B<,<<< Y /0P
3olutions Manual, "hapter ), /B
&ro'lem 13-1# (2< minutes*
). he -+.B< per drum general overhead cost is not relevant to
the decision, since this cost will $e the same regardless of
whether the company decides to make or $uy the drums. Also,
the present depreciation 'gure of -).2< per drum is not a
relevant cost, since it represents a sunk cost (in addition to the
fact that the old e4uipment is worn out and must $e replaced*.
he cost of supervision is relevant to the decision, since this
cost can $e avoided $y $uying the drums.
!i#erential Costs
Per !rum
,otal !i#erential Costs
DE:A::: !rums
Ma&e Bu% Ma&e Bu%
Dutside supplierGs
price......................... -)B.<< -),<B<,<<<
>irect materials.......... -)<.,0 -2+),<<<
>irect la$or
(-2.<< V @<P*.......... /.+< +0+,<<<
Iaria$le overhead
(-).0< V @<P*.......... ).<0 2,,<<<
3upervision................. <.@0 /0,<<<
E4uipment rentalZ....... +.+0 Z
),0,<<
<
otal cost..................... -)B.2< -)B.<<
-),))2,<<
< -),<B<,<<<
$uying -<.2< -,2,<<<
-),0,<<< per year [ 2<,<<< drums Y -+.+0 per
drum.
3olutions Manual, "hapter ), /C
+. a. Aotice that unit costs for $oth supervision and e4uipment
rental decrease with the greater volume since these '.ed
costs are spread over more units.
!i#erential
Cost Per
!rum
,otal !i#erential
CostDF;A::: !rums
Ma&e Bu% Ma&e Bu%
Dutside supplierGs
price...........................
-)B.<
<
-),,0<,<<
<
>irect materials............. -)<.,0 -@@2,+0<
>irect la$or................... /.+< ,)0,<<<
Iaria$le overhead......... ).<0 @B,@0<
3upervision
(-/0,<<< [ @0,<<<
drums*........................ <.2< /0,<<<
E4uipment rental
(-),0,<<< [ @0,<<<
drums*........................ ).B< ),0,<<<
otal cost....................... -)B.<<
-)B.<
<
-),,0<,<<
<
-),,0<,<<
<
>i#erence..................... -< -<
he company would $e indi#erent $etween the two alternatives
if @0,<<< drums were needed each year.
3olutions Manual, "hapter ), 0<
$. Again, notice that the unit costs for $oth supervision and
e4uipment rental decrease with the greater volume of units.
!i#erential
Costs Per
!rum
,otal !i#erential
CostD=:A::: !rums
Ma&e Bu% Ma&e Bu%
Dutside supplierGs
price...........................
-)B.<
<
-),2+<,<<
<
>irect materials............ -)<.,0 -C,),0<<
>irect la$or................... /.+< ,@B,<<<
Iaria$le overhead......... ).<0 C/,0<<
3upervision
(-/0,<<< [ C<,<<<
drums*........................ <.0< /0,<<<
E4uipment rental
(-),0,<<< [ C<,<<<
drums*........................ ).0< ),0,<<<
otal cost....................... -)@.2<
-)B.<
<
-),0B/,<<
<
-),2+<,<<
<
making..........................
-<./
< -,2,<<<
he company should purchase the new e4uipment and make
the drums if C<,<<< units per year are needed.
3olutions Manual, "hapter ), 0)
,. Dther factors that the company should consider include:
a. Oill volume in future years $e increasing, or will it remain
constant at 2<,<<< units per yearF (&f volume increases, then
renting the new e4uipment $ecomes more desira$le, as
shown in the computations a$ove.*
$. "an 4uality control $e maintained if the drums are purchased
from the outside supplierF
c. Oill costs for materials and la$or increase in future years,
there$y increasing the cost of making the drumsF
d. Oill the outside supplier $e dependa$le in meeting shipping
schedulesF
e. "an the company $egin making the drums again if the
supplier proves to $e undependa$le, or are there alternative
suppliersF
f. Ohat is the la$or outlook in the supplierGs industry (e.g., are
fre4uent la$or strikes likely*F
g. &f the outside supplierGs o#er is accepted and the need for
drums increases in future years, will the supplier have the
added capacity to provide more than 2<,<<< drums per yearF
3olutions Manual, "hapter ), 0+
). 3elling price per unit....................................... R,+
=ess varia$le e.penses per unit...................... )B Z
"ontri$ution margin per unit........................... R)/
ZR)<.<< \ R/.0< \ R+.,< \ R).+< Y R)B.<<
&ncreased sales in units (2<,<<< units V
+0P*............................................................. )0,<<<
"ontri$ution margin per unit........................... V R)/
&ncremental contri$ution margin.....................
R+)<,<<
<
=ess added '.ed selling e.penses................... B<,<<<
&ncremental net operating income..................
R),<,<<
<
Qes, the increase in '.ed selling e.penses would $e justi'ed.
+. Iaria$le manufacturing cost per unit..............
R)2.B
< Z
&mport duties per unit..................................... ).@<
!ermits and licenses (RC,<<< [ +<,<<<
units*............................................................ <./0
3hipping cost per unit..................................... ,.+<
?reak7even price per unit................................
R++.)
0
ZR)< \ R/.0< \ R+.,< Y R)2.B<.
,. he relevant cost is R).+< per unit, which is the varia$le selling
e.pense per >ak. 3ince the irregular units have already $een
produced, all production costs (including the varia$le
production costs* are sunk. he '.ed selling e.penses are not
relevant since they will $e incurred whether or not the irregular
units are sold. >epending on how the irregular units are sold,
the varia$le e.pense of R).+< per unit may not even $e
relevant. For e.ample, the units may $e disposed of through a
li4uidator without incurring the normal varia$le selling
e.pense.
/. &f the plant operates at ,<P of normal levels, then only ,,<<<
units will $e produced and sold during the two7month period:
3olutions Manual, "hapter ), 0,
2<,<<< units per year ' V +H)+ Y )<,<<< units.
)<,<<< units V ,<P Y ,,<<< units produced and sold. '
3olutions Manual, "hapter ), 0/
1iven this information, the simplest approach to the solution is:
"ontri$ution margin lost if the plant is
closed (,,<<< units V R)/ per unitZ* ' ........... R(/+,<<<*
Fi.ed costs that can $e avoided if the plant
is closed:
Fi.ed manufacturing overhead cost
(R,<<,<<< V +H)+ Y R0<,<<<% R0<,<<<
V /<P* ' .....................................................
R+<,<<
<
Fi.ed selling cost (R+)<,<<< V +H)+ Y
R,0,<<<% R,0,<<< V +<P* ' ........................ @,<<< +@,<<<
Aet disadvantage of closing the plant........... R()0,<<<*
ZR,+.<< X (R)<.<< \ R/.0< \ R+.,< \ R).+<* Y R)/.<<
3ome students will take a longer approach such as that shown
$elow:
Continue
to
$perate
Close
the Plant
3ales (,,<<< units V R,+ per unit*........... R C2,<<< R <
=ess varia$le e.penses (,,<<< units V
R)B per unit*......................................... 0/,<<< <
"ontri$ution margin................................ /+,<<< <
=ess '.ed e.penses:
Fi.ed manufacturing overhead cost:
R,<<,<<< V +H)+................................ 0<,<<<
R,<<,<<< V +H)+ V 2<P..................... ,<,<<<
Fi.ed selling e.pense:
R+)<,<<< V +H)+................................ ,0,<<<
R+)<,<<< V +H)+ V B<P..................... +B,<<<
otal '.ed e.penses................................ B0,<<< 0B,<<<
Aet operating income (loss*.................... R(/,,<<<* R(0B,<<<*
3olutions Manual, "hapter ), 00
0. he relevant costs are those that can $e avoided $y purchasing
from the outside manufacturer. hese costs are:
Iaria$le manufacturing costs................................ R)2.B<
Fi.ed manufacturing overhead cost (R,<<,<<< V
@0P Y R++0,<<<% R++0,<<< [ 2<,<<< units* ' ....... ,.@0
Iaria$le selling e.pense (R).+< V )H,* '' .................. <./<
otal costs avoided................................................ R+<.C0
o $e accepta$le, the outside manufacturerGs 4uotation must
$e less than R+<.C0 per unit.
). !roduct 8172 yields a contri$ution margin of RB per unit (R++ X
R)/ Y RB*. &f the plant closes, this contri$ution margin will $e
lost on the )2,<<< units (B,<<< units per month V + months*
that could have $een sold during the two7month period.
;owever, the company will $e a$le to avoid certain '.ed costs
as a result of closing down. he analysis is:
"ontri$ution margin lost $y closing the plant
for two months (RB per unit V )2,<<<
units*..........................................................
R()+B,<<<
*
"osts avoided $y closing the plant for two
months:
Fi.ed manufacturing overhead cost
R/0,<<< per month V + months Y
RC<,<<<*...................................................
RC<,<<
<
Fi.ed selling costs (R,<,<<< per month V
)<P V + months*..................................... 2,<<< C2,<<<
Aet disadvantage of closing, $efore start7up
costs........................................................... (,+,<<<*
Add start7up costs......................................... B,<<<
>isadvantage of closing the plant.................
R (/<,<<<
*
Ao, the company should not close the plant% it should continue
to operate at the reduced level of B,<<< units produced and
sold each month. "losing will result in a R/<,<<< greater loss
over the two7month period than if the company continues to
operate. An additional factor is the potential loss of goodwill
among the customers who need the B,<<< units of 8172 each
month. ?y closing down, the needs of these customers will not
$e met (no inventories are on hand*, and their $usiness may $e
permanently lost to another supplier.
3olutions Manual, "hapter ), 0@
Plant
Cept
$pen
Plant
Closed
!i#erenc
eG (et
$perating
"ncome
"ncrease
or
'!ecrease
+
3ales (B,<<< units V R++
per unit V +*.....................
R ,0+,<<
< R < R(,0+,<<<*
(B,<<< units V R)/ per
unit V +*............................
++/,<<
< < ++/,<<<
"ontri$ution margin.............
)+B,<<
< < ()+B,<<<*
=ess '.ed costs:
Fi.ed manufacturing
overhead costs
(R)0<,<<< V +*............... ,<<,<<< +)<,<<< C<,<<<
Fi.ed selling costs
(R,<,<<< V +*.................
2<,<<
<
0/,<<
< Z 2,<<<
otal '.ed costs...................
,2<,<<
<
+2/,<<
< C2,<<<
Aet operating loss $efore
start7up costs.................... (+,+,<<<* (+2/,<<<* (,+,<<<*
3tart7up costs...................... <
(B,<<<
* (B,<<<*
Aet operating loss...............
R(+,+,<<
<*
R(+@+,<<
<* R (/<,<<<*
Z R,<,<<< V C<P Y R+@,<<< V + Y R0/,<<<
3olutions Manual, "hapter ), 0B
+. ?irch "ompany will $e indi#erent at a level of )),<<< total units
sold over the two7month period. he computations are:
"ost avoided $y closing the plant for two
months (see a$ove*......................................... RC2,<<<
=ess start7up costs............................................. B,<<<
Aet avoida$le costs............................................ RBB,<<<
Aet avoida$le costs RBB,<<<
Y
!er unit contri$ution margin RB per unit
Y )),<<< units
Ieri'cation:
$perate
at 44A:::
Units for
,1o
Months
Close for
,1o
Months
3ales ()),<<< units V R++ per unit*..... R +/+,<<< R <
=ess varia$le e.penses ()),<<< units
V R)/ per unit*................................. )0/,<<< <
"ontri$ution margin............................ BB,<<< <
=ess '.ed e.penses:
Manufacturing overhead (R)0<,<<<
and R)<0,<<<, V +*........................ ,<<,<<< +)<,<<<
3elling (R,<,<<< and R+@,<<<, V +*. . 2<,<<< 0/,<<<
otal '.ed e.penses............................ ,2<,<<< +2/,<<<
3tart7up costs...................................... < B,<<<
otal costs........................................... ,2<,<<< +@+,<<<
Aet operating loss............................... R(+@+,<<<*
R(+@+,<<<
*
3olutions Manual, "hapter ), 0C
). he RC<,<<< in '.ed overhead costs charged to the new
product is a common cost that will $e the same whether the
tu$es are produced internally or purchased from the outside.
;ence, they are not relevant. he varia$le manufacturing
overhead per $o. of "hap7D# would $e R<.0<, as shown $elow:
otal manufacturing overhead cost per $o. of
"hap7D#............................................................... R)./<
=ess '.ed portion (RC<,<<< [ )<<,<<< $o.es*........ <.C<
Iaria$le overhead cost per $o................................ R<.0<
he total varia$le costs of producing one $o. of "hap7D# would
$e:
>irect materials....................................................... R,.2<
>irect la$or............................................................. +.<<
Iaria$le manufacturing overhead........................... <.0<
otal varia$le cost per $o....................................... R2.)<
&f the tu$es for the "hap7D# are purchased from the outside
supplier, then the varia$le cost per $o. of "hap7D# would $e:
>irect materials (R,.2< V @0P*............................... R+.@<
>irect la$or (R+.<< V C<P* '' ..................................... ).B<
Iaria$le manufacturing overhead (R<.0< V C<P* '' . . . <./0
"ost of tu$e from outside........................................ ).,0
otal varia$le cost per $o....................................... R2.,<
herefore, the company should reject the outside supplierGs
o#er. A savings of R<.+< per $o. of "hap7D# will $e realized $y
producing the tu$es internally.
3olutions Manual, "hapter ), 2<
Another approach to the solution would $e:
"ost avoided $y purchasing the tu$es:
>irect materials (R,.2< V +0P* ''' ..................... R<.C<
>irect la$or (R+.<< V )<P* ' ............................ <.+<
Iaria$le manufacturing overhead (R<.0< V
)<P*........................................................... <.<0
otal costs avoided........................................... R).)0 Z
"ost of purchasing the tu$es from the
outside.......................................................... R).,0
"ost savings per $o. $y making internally....... R<.+<
Z his R).)0 is the cost of making one $o. of tu$es
internally, since it represents the overall cost savings
that will $e realized per $o. of "hap7D# $y purchasing
the tu$es from the outside.
+. he ma.imum purchase price would $e R).)0 per $o.. he
company would not $e willing to pay more than this amount,
since the R).)0 represents the cost of producing one $o. of
tu$es internally, as shown in !art ). o make purchasing the
tu$es attractive, however, the purchase price should $e less
than R).)0 per $o..
3olutions Manual, "hapter ), 2)
,. At a volume of )+<,<<< $o.es, the company should $uy the
tu$es. he computations are:
"ost of making )+<,<<< $o.es:
)+<,<<< $o.es V R).)0 per $o...............
R),B,<<
<
8ental cost of e4uipment........................ /<,<<<
otal cost...................................................
R)@B,<<
<
"ost of $uying )+<,<<< $o.es:
)+<,<<< $o.es V R).,0 per $o...............
R)2+,<<
<
Dr, on a total cost $asis, the
computations are:
"ost of making )+<,<<< $o.es:
)+<,<<< $o.es V R2.)< per $o...............
R@,+,<<
<
8ental cost of e4uipment........................ /<,<<<
otal cost...................................................
R@@+,<<
<
"ost of $uying )+<,<<< $o.es:
)+<,<<< $o.es V R2.,< per $o...............
R@02,<<
<
hus, $uying the $o.es will save the company R)2,<<< per
year.
3olutions Manual, "hapter ), 2+
/. Knder these circumstances, the company should make the
)<<,<<< $o.es of tu$es and purchase the remaining +<,<<<
$o.es from the outside supplier. he costs would:
"ost of making: )<<,<<< $o.es V R).)0 per
$o.................................................................
R))0,<<
<
"ost of $uying: +<,<<< $o.es V R).,0 per
$o................................................................. +@,<<<
otal cost..........................................................
R)/+,<<
<
Dr, on a total cost $asis, the computation would $e:
"ost of making: )<<,<<< $o.es V R2.)< per
$o................................................................. R2)<,<<<
"ost of $uying: +<,<<< $o.es V R2.,< per
$o................................................................. )+2,<<<
otal cost.......................................................... R@,2,<<<
3ince the amount of cost under this alternative is R+<,<<< less
than the $est alternative in !art ,, the company should make
as many tu$es as possi$le with the current e4uipment and $uy
the remaining tu$es from the outside supplier.
0. Management should take into account at least the following
additional factors:
a* he a$ility of the supplier to meet re4uired delivery
schedules.
$* he 4uality of the tu$es purchased from the supplier.
c* Alternative uses of the capacity that would $e used to make
the tu$es.
d* he a$ility of the supplier to supply tu$es if volume increases
in future years.
e* he pro$lem of alternative sources of supply if the supplier
proves undependa$le.
3olutions Manual, "hapter ), 2,
). 3ince the '.ed costs will not change as a result of the order,
they are not relevant to the decision. he cost of the new
machine is relevant, and this cost will have to $e recovered $y
the current order since there is no assurance of future $usiness
from the retail chain.
Uni
t
,otalD
;A:::
units
8evenue from the order (R0< V B/P*............ R/+ R+)<,<<<
=ess costs associated with the order:
>irect materials.......................................... )0 @0,<<<
>irect la$or................................................. B /<,<<<
Iaria$le manufacturing overhead............... , )0,<<<
Iaria$le selling e.pense (R/ V +0P*........... ) 0,<<<
3pecial machine (R)<,<<< [ 0,<<< units*. . . + )<,<<<
otal costs..................................................... +C )/0,<<<
Aet increase in pro'ts................................... R), R 20,<<<
+. 8evenue from the order:
8eim$ursement for costs of production
(varia$le production costs of R+2, plus '.ed
manufacturing overhead cost of RC Y R,0
per unit% R,0 per unit V 0,<<< units*................ R)@0,<<<
Fi.ed fee (R).B< per unit V 0,<<< units*............. C,<<<
otal revenue........................................................ )B/,<<<
=ess incremental costs9varia$le production
costs
(R+2 per unit V 0,<<< units*............................... ),<,<<<
Aet increase in pro'ts........................................... R 0/,<<<
,. 3ales revenue:
From the K.3. Army (a$ove*................................ R)B/,<<<
From regular channels (R0< per unit V 0,<<<
units*................................................................ +0<,<<<
Aet decrease in revenue....................................... (22,<<<*
=ess varia$le selling e.penses avoided if the
ArmyGs order is accepted (R/ per unit V 0,<<<
units*.................................................................. +<,<<<
3olutions Manual, "hapter ), 2/
Aet decrease in pro'ts if the ArmyGs order is
accepted............................................................. R(/2,<<<*
). !ebbi
e ,rish Sarah Mi&e
Se1in
g Cit
>irect la$or cost per
unit R ,.+< R+.<< R 0.2< R /.<< R ).2<
>irect la$or hours per
unitZ (a* <./< <.+0 <.@< <.0< <.+<
3elling price R),.0< R0.0<
R+).<
<
R)<.<
< R B.<<
>irect materials /.,< ).)< 2.// +.<< ,.+<
>irect la$or ,.+< +.<< 0.2< /.<< ).2<
Iaria$le overhead <.B< <.0< )./< ).<< <./<
otal varia$le costs B.,< ,.2< ),.// @.<< 0.+<
"ontri$ution margin
($* R 0.+< R).C< R @.02 R ,.<< R +.B<
"ontri$ution margin
per >=; ($* [ (a* R),.<< R@.2<
R)<.B
< R 2.<< R)/.<<
Z >irect la$or cost per unit [ B direct la$or hour.
+.
Product
!)< Per
Unit
Estimate
d Sales
'units+
,otal
<ours
>e$$ie <./<
hour
s 0<,<<< +<,<<<
rish <.+0
hour
s /+,<<< )<,0<<
3arah <.@<
hour
s ,0,<<< +/,0<<
Mike <.0<
hour
s /<,<<< +<,<<<
3ewing Uit <.+<
hour
s ,+0,<<< 20,<<<
otal hours re4uired
)/<,<<
<
,. 3ince the Mike doll has the lowest contri$ution margin per la$or
hour, its production should $e reduced $y +<,<<< dolls ()<,<<<
e.cess hours divided $y <.0 hours production time per doll Y
+<,<<< dolls*. hus, production and sales of the Mike doll will
$e reduced to one7half of that planned, or +<,<<< dolls for the
year.
3olutions Manual, "hapter ), 2@
/. 3ince the additional capacity would $e used to produce the
Mike doll, the company should $e willing to pay up to R)/ per
hour (RB usual rate plus R2 contri$ution margin per hour* for
added la$or time. hus, the company could employ workers for
overtime at the usual time7and7a7half rate of R)+ per hour (RB
V ).0 Y R)+*, and still improve overall pro't.
0. Additional output could $e o$tained in a num$er of ways
including working overtime, adding another shift, e.panding
the workforce, contracting out some work to outside suppliers,
and eliminating wasted la$or time in the production process.
he 'rst four methods are costly, $ut the last method can add
capacity at very low cost.
Aote: 3ome would argue that direct la$or is a '.ed cost in this
situation and should $e e.cluded when computing the
contri$ution margin per unit. ;owever, when deciding which
products to emphasize, no harm is done $y misclassifying a
'.ed cost as a varia$le cost9providing that the '.ed cost is
the constraint. &f direct la$or were removed from the varia$le
cost category, the net e#ect would $e to $ump up the
contri$ution margin per direct la$or7hour $y RB for each of the
products. he products will $e ran&ed e.actly the same9in
terms of the contri$ution margin per unit of the constrained
resource9whether direct la$or is considered varia$le or '.ed.
;owever, this only works when the '.ed cost is the cost of the
constraint itself.
3olutions Manual, "hapter ), 2B
). A product should $e processed further so long as the
incremental revenue from the further processing e.ceeds the
incremental costs. he incremental revenue from further
processing of the 1rit ,,@ is:
3elling price of the silver polish, per jar........... R/.<<
3elling price of )H/ pound of 1rit ,,@ (R+.<<
[ /*.............................................................. <.0<
&ncremental revenue per jar............................ R,.0<
he incremental varia$le costs are:
Dther ingredients............................................ R<.20
>irect la$or..................................................... )./B
Iaria$le manufacturing overhead (+0P V
R)./B*........................................................... <.,@
Iaria$le selling costs (@.0P V R/*................... <.,<
&ncremental varia$le cost per jar..................... R+.B<
herefore, the incremental contri$ution margin is R<.@< per jar
(R,.0< X R+.B<*. he R).2< cost per pound (R<./< per )H/
pound* re4uired to produce the 1rit ,,@ would not $e relevant
in this computation, since it is incurred regardless of whether
the 1rit ,,@ is further processed into silver polish or sold
outright.
3olutions Manual, "hapter ), 2C
+. Dnly the cost of advertising and the cost of the production
supervisor are avoida$le if production of the silver polish is
discontinued. herefore, the num$er of jars of silver polish that
must $e sold each month to justify continued processing of the
1rit ,,@ into silver polish is:
!roduction supervisor.............................................. R,,<<<
Advertising9direct.................................................. /,<<<
Avoida$le '.ed costs............................................... R@,<<<
Avoida$le '.ed costs R@,<<<
Y
&ncremental "M per jar R<.@< per jar
Y )<,<<< jars per month
herefore, if )<,<<< jars of silver polish can $e sold each
month, the company would $e indi#erent $etween selling it or
selling all of the 1rit ,,@ as a cleaning powder. &f the sales of
the silver polish are greater than )<,<<< jars per month, then
continued processing of the 1rit ,,@ into silver polish would $e
advisa$le since the companyGs total pro'ts will $e increased. &f
the company canGt sell at least )<,<<< jars of silver polish each
month, then production of the silver polish should $e
discontinued. o verify this, we show on the ne.t page the total
contri$ution to pro'ts of sales of C,<<<, )<,<<< and )),<<< jars
of silver polish, contrasted to sales of e4uivalent amounts of
1rit ,,@ sold outright (i.e., )<,<<< jars of silver polish would
re4uire the use of +,0<< pounds of 1rit ,,@ that otherwise
could $e sold outright as cleaning powder, etc.*:
3olutions Manual, "hapter ), @<
=A:::
9ars of
PolishY
or
5A5;:
pounds
of @rit
66F
4:A:::
9ars of
PolishY
or
5A;::
pounds
of @rit
66F
44A:::
9ars of
PolishY
or
5AF;:
pounds
of @rit
66F
3ales of 3ilver !olish:
3ales _ R/.<< per jar..................... R,2,<<< R/<,<<< R//,<<<
!roduction cost of 1rit ,,@ _
R).2< per pound.......................... ,,2<< Z /,<<< Z /,/<< Z
Further processing and selling
costs of the polish _ R+.B< per
jar................................................ +0,+<< +B,<<< ,<,B<<
otal varia$le e.penses.................... +B,B<< ,+,<<< ,0,+<<
"ontri$ution margin......................... @,+<< B,<<< B,B<<
=ess avoida$le '.ed costs:
!roduction supervisor.................... ,,<<< ,,<<< ,,<<<
Advertising..................................... /,<<< /,<<< /,<<<
otal avoida$le '.ed costs................ @,<<< @,<<< @,<<<
otal contri$ution to common '.ed
costs and to pro'ts........................ R +<< R ),<<< R ),B<<
3ales of 1rit ,,@:
3ales _ R+.<< per pound R /,0<< R 0,<<< R 0,0<<
!roduction cost of 1rit ,,@ _
R).2< per pound.......................... ,,2<< Z /,<<< Z /,/<< Z
"ontri$ution to common '.ed
costs and to pro'ts........................ R C<< R ),<<< R ),)<<
Z his cost will $e incurred regardless of whether the 1rit ,,@ is
further processed into silver polish or sold outright as cleaning
powder% therefore, it is not relevant to the decision, as stated
earlier. &t is included in the computation a$ove for the speci'c
purpose of showing that it will $e incurred under either
alternative. he same thing could have $een done with the
3olutions Manual, "hapter ), @)
depreciation on the mi.ing e4uipment.
3olutions Manual, "hapter ), @+
). Dnly the avoida$le costs are relevant in a decision to drop the
Model ", lawnchair product. he avoida$le costs are:
>irect materials.............................................. 8)++,<<<
>irect la$or..................................................... @+,<<<
Fringe $ene'ts (+<P of direct la$or*............... )/,/<<
Iaria$le manufacturing overhead................... ,,2<<
!roduct managerGs salary................................ )<,<<<
3ales commissions (0P of sales*..................... )0,<<<
Fringe $ene'ts (+<P of salaries and
commissions*................................................ 0,<<<
3hipping.......................................................... )<,<<<
otal avoida$le cost........................................ 8+0+,<<<
he following costs are not relevant in this decision:
Cost 2eason not relevant
?uilding rent and
maintenance
All products use the same
facilities% no space would
$e freed if a product were
dropped.
>epreciation All products use the same
e4uipment so no
e4uipment can $e sold.
Furthermore, the
e4uipment does not wear
out through use.
1eneral administrative
e.penses
>ropping the Model ",
lawnchair would have no
e#ect on total general
administrative e.penses.
;aving determined the costs that can $e avoided if the Model
", lawnchair is dropped, we can now make the following
computation:
3ales revenue lost if the Model ", lawnchair is
dropped............................................................... 8,<<,<<<
=ess costs that can $e avoided (see a$ove*........... +0+,<<<
>ecrease in overall company net operating 8 /B,<<<
3olutions Manual, "hapter ), @,
income if the Model ", lawnchair is dropped.......
3olutions Manual, "hapter ), @/
hus, the Model ", lawnchair should not $e dropped unless the
company can 'nd more pro'ta$le uses for the resources
consumed $y the Model ", lawnchair.
+. o determine the minimum accepta$le level of sales, we must
'rst classify the avoida$le costs into varia$le and '.ed costs as
follows:
Variable Fixed
>irect materials.........................................
8)++,<<
<
>irect la$or................................................ @+,<<<
Fringe $ene'ts (+<P of direct la$or*.......... )/,/<<
Iaria$le manufacturing overhead.............. ,,2<<
!roduct managersG salaries........................
8)<,<<
<
3ales commissions (0P of sales*................ )0,<<<
Fringe $ene'ts
(+<P of salaries and commissions*.......... ,,<<< +,<<<
3hipping..................................................... )<,<<<
otal costs..................................................
8+/<,<<
<
8)+,<<
<
he Model ", lawnchair should $e retained as long as its
contri$ution
margin covers its avoida$le '.ed costs. ?reak7even analysis
can $e used to 'nd the sales volume where the contri$ution
margin just e4uals the avoida$le '.ed costs.
he contri$ution margin ratio is computed as follows:
"ontri$ution margin
"M ratio Y
3ales
8,<<,<<<78+/<,<<<
Y Y +<P
8,<<,<<<
3olutions Manual, "hapter ), @0
he $reak7even sales volume can $e found using the $reak7
even
formula:
Fi.ed costs
?reak7even point Y
"M ratio
8)+,<<<
Y Y 82<,<<<
<.+<
herefore, as long as the sales revenue from the Model ",
lawnchair e.ceeds 82<,<<<, it is covering its own avoida$le
'.ed costs and is contri$uting toward covering the common
'.ed costs and toward the pro'ts of the entire company.
3olutions Manual, "hapter ), @2
Case 13-2! (2< minutes*
). he original cost of the facilities at "layton is a sunk cost and
should $e ignored in any decision. he decision $eing considered
here is whether to continue operations at "layton. he only
relevant costs are the future facility costs that would $e a#ected
$y this decision. &f the facility were shut down, the "layton
facility has no resale value. &n addition, if the "layton facility
were sold, the company would have to rent additional space at
the remaining processing centers. Dn the other hand, if the
facility were to remain in operation, the $uilding should last
inde'nitely, so the company does not have to $e concerned
a$out eventually replacing it. Essentially, there is no real cost at
this point of using the "layton facility despite what the 'nancial
performance report indicates. &ndeed, it might $e a $etter idea
to consider shutting down the other facilities since the rent on
those facilities might $e avoided.
he costs that are relevant in the decision to shut down the
"layton facility are:
&ncrease in rent at ?illings and 1reat Falls........... R2<<,<<<
>ecrease in local administrative e.penses.......... (C<,<<<*
Aet increase in costs........................................... R0)<,<<<
&n addition, there would $e costs of moving the e4uipment from
"layton and there might $e some loss of sales due to disruption
of services. &n sum, closing down the "layton facility would
almost certainly lead to a decline in ?3"Gs pro'ts.
Even though closing down the "layton facility would result in a
decline in overall company pro'ts, it would result in an
improved performance report for the 8ocky Mountain 8egion
(ignoring the costs of moving e4uipment and potential loss of
revenues from disruption of service to customers*.
3olutions Manual, "hapter ), @@
Financial Performance
After Shutting !o1n the Cla%ton Facilit%
2oc&% Mountain 2egion
,otal
3ales.........................................................
R0<,<<<,<<
<
Dperating e.penses:
>irect la$or............................................. ,+,<<<,<<<
Iaria$le overhead................................... B0<,<<<
E4uipment depreciation.......................... ,,C<<,<<<
Facility e.penseZ..................................... +,,<<,<<<
=ocal administrative e.penseZZ.............. ,2<,<<<
8egional administrative e.pense............ ),0<<,<<<
"orporate administrative e.pense.......... /,@0<,<<<
otal operating e.pense............................ /0,22<,<<<
Aet operating income................................ R /,,/<,<<<
Z R+,B<<,<<< X R),)<<,<<< \ R2<<,<<< Y R+,,<<,<<<
ZZ R/0<,<<< X RC<,<<< Y R,2<,<<<
+. &f the "layton facility is shut down, ?3"Gs pro'ts will decline,
employees will lose their jo$s, and customers will at least
temporarily su#er some decline in service. herefore, 8omeros
is willing to sacri'ce the interests of the company, its
employees, and its customers just to make her performance
report look $etter.
Ohile 8omeros is not a management accountant, the 3tandards
of Ethical "onduct for Management Accountants still provide
useful guidelines.
a* ?y recommending closing the "layton facility, 8omeros
would violate the "ompetence 3tandard that stipulates
recommendations should $e $ased on appropriate analysis of
relevant and relia$le information.
$* he &ntegrity 3tandard re4uires that management
accountants Mavoid actual or apparent con-icts of interest
and advise all appropriate parties of any potential con-ict.N
8omeros has a con-ict of interest in this case, since her
recommendation will serve to make her own performance
3olutions Manual, "hapter ), @B
look $etter while actually leading to a decline in the
companyGs pro'ts.
3olutions Manual, "hapter ), @C
c* he &ntegrity 3tandard is also violated in that her
recommendation to close down the "layton facility would
Msu$vert the attainment of the organizationGs legitimate and
ethical o$jectives.N
d* 8omeros would also $e violating the D$jectivity 3tandard
that re4uires a management accountant to Mdisclose fully all
relevant information that could reasona$ly $e e.pected to
in-uence an intended userGs understanding of the reports,
comments, and recommendations presented.N !resuma$ly, if
the corporate $oard were fully informed of the conse4uences
of this action, they would disapprove.
&n sum, it is diEcult to descri$e the recommendation to close
the "layton facility as ethical $ehavior. &n 8omerosG defense,
however, it is not fair to hold her responsi$le for the mistake
made $y her predecessor.
&t should $e noted that the performance report re4uired $y
corporate head4uarters is likely to lead to other pro$lems such
as the one illustrated here. he ar$itrary allocations of
corporate and regional administrative e.penses to processing
centers may make other processing centers appear to $e
unpro'ta$le even though they are not. &n this case, the
pro$lems created $y these ar$itrary allocations were
compounded $y using an irrelevant facilities e.pense 'gure on
the performance report.
,. !rices should $e set ignoring the depreciation on the "layton
facility. As argued in part ()* a$ove, the real cost of using the
"layton facility is zero. Any attempt to recover the sunk cost of
the original cost of the $uilding $y charging higher prices than
the market will $ear will lead to less $usiness and lower pro'ts.
3olutions Manual, "hapter ), B<
Case 13-2" (2< minutes*
). "ontinuing to o$tain covers from its own >enver "over !lant
would allow 6ual3upport to maintain its current level of control
over the 4uality of the covers and the timing of their delivery.
Ueeping the >enver "over !lant open also allows 6ual3upport
more -e.i$ility than purchasing the coverings from outside
suppliers. 6ual3upport could more easily alter the coveringsG
design and change the 4uantities produced, especially if long7
term contracts are re4uired with outside suppliers. 6ual3upport
should also consider the economic impact that closing >enver
"over will have on the community and how this might a#ect
6ual3upportGs other operations in the region.
+. a. he following costs can $e avoided $y closing the plant, and
therefore are relevant to the decision:
Materials.................................
R)/,<<<,<<
<
=a$or:
>irect....................................
R),,)<<,<<
<
3upervision........................... C<<,<<<
&ndirect plant........................ /,<<<,<<< )B,<<<,<<<
>i#erential pension cost
(R0,<<<,<<< X R,,<<<,<<<*. . . +,<<<,<<<
otal annual relevant costs......
R,/,<<<,<<
<
$. he following costs canGt $e avoided $y closing the plant,
and therefore are not relevant to the decision:
>epreciation9e4uipment................................. R ,,+<<,<<<
>epreciation9$uilding..................................... @,<<<,<<<
"ontinuing pension cost (R0,<<<,<<< X
R+,<<<,<<<*................................................... ,,<<<,<<<
!lant manager and sta#................................... B<<,<<<
"orporate allocation......................................... /,<<<,<<<
otal annual continuing costs...........................
R)B,<<<,<<
<
3olutions Manual, "hapter ), B)
>epreciation is not relevant $ecause it represents e.piration
of a sunk cost. hree7'fths of the annual pension e.pense
(R,,<<<,<<<* is not relevant $ecause it would continue
whether or not the plant is closed. he amount for plant
manager and sta# is not relevant $ecause Iosilo and his sta#
would continue with 6ual3upport and administer the three
remaining plants. he corporate allocation is not relevant
$ecause this represents costs incurred outside >enver "over
and assigned to the plant.
c. he following nonrecurring costs would arise in the year that
the plant is closed, $ut would not $e incurred in any other
year:
ermination charges on canceled material
orders
(R)/,<<<,<<< V +<P*..................................... R+,B<<,<<<
Employment assistance.................................... ),0<<,<<<
otal recurring costs.......................................... R/,,<<,<<<
hese two costs are relevant to the decision $ecause they
will $e incurred only if the plant is closed.
,. Ao, the plant should not $e closed. he computations are:
First -ear $ther -ears
"ost of purchasing the covers
outside...........................................
R(,0,<<<,<<
<*
R(,0,<<<,<<
<*
"osts avoided $y closing the plant
(!art +a*......................................... ,/,<<<,<<< ,/,<<<,<<<
"ost of closing the plant ('rst year
only*...............................................
(/,,<<,<<<
*
3alvage value of e4uipment and
$uilding.......................................... ,,+<<,<<<
Aet advantage (disadvantage* of
closing the plant.............................
R (+,)<<,<<<
*
R (),<<<,<<
<*
3olutions Manual, "hapter ), B+
/. Factors that should $e considered $y 6ual3upport $efore
making a decision include:
a. Alternative uses of the $uilding and e4uipment.
$. Any ta. implications.
c. he outside supplierGs prices in future years.
d. he cost to manufacture coverings at the >enver "over !lant
in future years.
e. he value of the time Iosilo and his sta# would have spent
managing the >enver "over !lant. his time may $e spent
on other important matters.
f. he morale of 6ual3upport employees at remaining plants.
3olutions Manual, "hapter ), B,
Case 13-2# (@0 minutes*
his is a diEcult case that will challenge the $est students. !art of the challenge is simply
to understand the alternatives. As an aid, a diagram of the two alternatives, which we will
call Alternatives A and ?, is show $elow, together with the relevant data.
3olutions Manual, "hapter ), B/
+,<<< parts
Alternative A
+,<<< motors
1rathin >ivision A$le
>ivision
Facet >ivision
varia$le cost:
R+<< per part
transfer price:
R/<< per part
varia$le cost:
R/0< per motor
transfer price:
R),2<< per part
Alternative B
+,<<< parts +,<<< motors
1rathin >ivision Oaverly "orp. Facet >ivision
varia$le cost:
R)@0 per part
selling price:
R,0< per part
selling price:
R),0<< per motor
A41
+,0<< parts +,0<< motors
1rathin >ivision
A$le >ivision
;ighech "orp.
varia$le cost:
R)<< per part
transfer price:
R+<< per part
varia$le cost:
R0<< per motor
selling price:
R),+<< per motor
&n $oth parts of the case the general '.ed overhead costs are
irrelevant since they are allocated costs that will remain the same
regardless of which alternative is accepted. Also note that the
same amount of total machine time would $e consumed in $oth
the 1rathin >ivisionGs plant and the A$le >ivisionGs plant
regardless of which order is accepted. hus, the amount of
machine time that would $e re4uired is not a factor in the
decision.
1rathinGs plant:
Facet >ivision order:
+,<<< motors V +.0 hours per motor Y 0,<<< hours.
;ighech "orporation order:
+,0<< motors V +.< hours per motor Y 0,<<< hours.
A$leGs plant:
Facet >ivision order:
+,<<< motors V 0.< hours per motor Y )<,<<< hours.
;ighech "orporation order:
+,0<< motors V /.< hours per motor Y )<,<<< hours.
). he A$le >ivision would accept the order from the Facet
>ivision. "omputations to support this conclusion follow:
E.pected contri$ution margin from the Facet >ivision order:
3ales revenue to A$le >ivision
(+,<<< motors V R),2<< per
motor*.............................................
R,,+<<,<<
<
ransfer price to 1rathin >ivision
(+,<<< parts V R/<< per part*....... RB<<,<<<
Dther varia$le costs
(+,<<< motors V R/0< per
motor*.......................................... C<<,<<< ),@<<,<<<
"ontri$ution margin..........................
R),0<<,<<
<
3olutions Manual, "hapter ), B0
E.pected contri$ution margin from ;ighech "orporation order:
3ales revenue to A$le >ivision
(+,0<< motors V R),+<< per
motor*.............................................
R,,<<<,<<
<
ransfer price to 1rathin >ivision
(+,0<< parts V R+<< per part*....... R 0<<,<<<
Dther varia$le costs
(+,0<< motors V R0<< per
motor*.......................................... ),+0<,<<< ),@0<,<<<
"ontri$ution margin..........................
R),+0<,<<
<
hus, the A$le >ivision will net R+0<,<<< (R),0<<,<<< X
R),+0<,<<<* more in contri$ution margin $y taking the order
from the Facet >ivision.
+. From the perspective of the company as a whole, the situation
is at once simpler and more comple.. &t is simpler $ecause
transfer prices are irrelevant. Ohatever one division pays, the
other receives. From the standpoint of the entire company,
money is taken out of one pocket and put into the other. he
situation is more comple. in that the company must take into
account that if A$le >ivision accepts the order from ;ighech
"orporation, Facet >ivision will need to ac4uire its motors from
Oaverly "orporation rather than from A$le >ivision. his is
Alternative ? in the diagram on the 'rst page of the solution.
?ut letGs start with Alternative A, the simpler alternative. From
the standpoint of the entire company, the cost of the motors
transferred to Facet >ivision is R20< per motor, the varia$le
costs of 1rathin >ivision plus the varia$le costs of A$le
>ivision. he total cost of the motors would $e R),,<<,<<<
(+,<<< motors _ R20< per motor*. his is restated in slightly
di#erent form $elow:
Alternative A
Facet >ivision ac4uires motors from A$le >ivision, which
ac4uires parts from 1rathin >ivision
1rathin >ivisionGs varia$le e.penses R /<<,<<<
3olutions Manual, "hapter ), B2
(+,<<< parts V R+<< per part*.......................
A$le >ivisionGs varia$le e.penses
(+,<<< motors V R/0< per motor*................. C<<,<<<
otal cost of Alternative A................................ R),,<<,<<<
3olutions Manual, "hapter ), B@
Alternative B
his alternative is more comple. than Alternative A. here
are really two parts to this alternative. &n the 'rst part, Facet
>ivision purchases the re4uired motors from Oaverly
"orporation, which purchases parts from 1rathin >ivision. &n
the second part, A$le >ivision sells motors to ;ighech
"orporation using parts supplied $y 1rathin >ivision. (8efer
$ack to the diagram.* Oe will compute the 'nancial
conse4uences of these two parts separately and then
com$ine them.
Part 4G Facet !ivisionUs purchase of motors
Facet >ivisionGs payment to Oaverly
"orporation (+,<<< motors V R),0<< per
motor*........................................................... R,,<<<,<<<
Oaverly "orporationGs payments to 1rathin
>ivision (+,<<< parts V R,0< per part*.......... (@<<,<<<*
1rathin >ivisionGs varia$le e.penses
(+,<<< parts V R)@0 per part*....................... ,0<,<<<
otal cost (a*.................................................... R+,20<,<<<
Part 5G <igh,ech CorporationUs purchase of
motors
;ighech "orporationGs payments to A$le
>ivision
(+,0<< motors V R),+<< per motor*.............. R,,<<<,<<<
A$le >ivisionGs varia$le e.penses
(+,0<< motors V R0<< per motor*................. (),+0<,<<<*
1rathin >ivisionGs varia$le e.penses
(+,0<< motors V R)<< per motor*................. (+0<,<<<*
otal contri$ution margin ($*........................... R),0<<,<<<
Aet cost to the company of Alternative ? (a*
X ($*.............................................................. R),)0<,<<<
3ince the R),)0<,<<< cost of Alternative ? is less than the
R),,<<,<<< cost of Alternative A, it is the preferred
alternative.
3olutions Manual, "hapter ), BB
Case 13-3$ (,< minutes*
). As much yarn as possi$le should $e processed into sweaters.
!roducts should $e processed further so long as the added
revenues from further processing are greater than the added
costs. &n the case at hand, the added revenues and costs are:
Per S1eater
Added revenue (R,<.<< X R+<.<<*. . . R)<.<<
Added costs:
?uttons, thread, lining................... R+.<<
>irect la$or................................... 0.B< @.B<
Added contri$ution margin.............. R +.+<
hus, the company will gain R+.+< in contri$ution margin for
each spindle of yarn that is further processed into a sweater.
he '.ed manufacturing overhead costs are not relevant to the
decision, since they will $e the same regardless of whether the
yarn is sold or processed further. Also, in making this
computation we must omit the R)2.<< cost of manufacturing
the yarn, since this cost will $e incurred whether the yarn is
sold as is or is used in sweaters.
+. he lowest price the company should accept is R+@.B< per
sweater. he simplest approach to this answer is:
!resent selling price per sweater.... R,<.<<
=ess added contri$ution margin
$eing realized on each sweater
sold.............................................. +.+<
Minimum selling price per
sweater........................................ R+@.B<
A more involved approach to the R+@.B< 'gure is to reason as
follows:
&f the wool yarn is sold outright, then the company will realize a
contri$ution margin of RC./< per spindle:
Per Spindle
3elling price........................ R+<.<<
8aw wool.......................... R@.<<
>irect la$or...................... ,.2< )<.2<
3olutions Manual, "hapter ), BC
"ontri$ution margin........... R C./<
3olutions Manual, "hapter ), C<
his RC./< represents an opportunity cost to the company%
thus, the price of the sweaters must $e high enough to include
this minimum contri$ution margin 'gure. &n addition, the
company must $e a$le to cover all of its varia$le costs from the
time the raw wool is purchased until the sweater is completed.
herefore, the minimum price would $e:
Iaria$le costs of producing a spindle of
yarn:
8aw wool............................................... R@.<<
>irect la$or........................................... ,.2< R)<.2<
Added varia$le costs of producing a
sweater:
?uttons, etc........................................... +.<<
>irect la$or........................................... 0.B< @.B<
otal varia$le costs.................................. )B./<
Dpportunity cost9contri$ution margin
if the yarn is sold outright..................... C./<
Minimum selling price per sweater.......... R+@.B<
3olutions Manual, "hapter ), C)
). he lowest price Oesco could $id for the one7time special order
of +<,<<< pounds (+< lots* without losing money would $e
R+/,+<<9the relevant cost of the order, as shown $elow.
>irect materials:
A170: ,<< pounds per lot V +< lots Y 2,<<< pounds.
3u$stitute ?;7, on a one7for7one $asis to its total of
,,0<< pounds. &f ?;7, is not used in this order, it
will $e salvaged for R2<<. herefore, the relevant
cost is......................................................................... R 2<<
he remaining +,0<< pounds would $e A170 at a
cost of R).+< per pound.............................................. ,,<<<
U=7+: +<< pounds per lot V +< lots Y /,<<< pounds at
R).<0 per pound......................................................... /,+<<
"O7@: )0< pounds per lot V +< lots Y ,,<<< pounds
at R).,0 per pound..................................................... /,<0<
>F72: )@0 pounds per lot V +< lots Y ,,0<< pounds.
Kse ,,<<< pounds in inventory at R<.2< per pound
(R<.@< market price X R<.)< handling charge*, and
purchase the remaining 0<< pounds at R<.@< per
pound.........................................................................
+,)0
<
otal direct materials cost.............................................
)/,<<
<
>irect la$or: +0 >=;s per lot V +< lots Y 0<< >=;s. ?ecause
only /<< hours can $e scheduled during regular time this
month, overtime would have to $e used for the remaining
)<< hours.
/<< >=;s V R)/.<< per >=;......................................... 0,2<<
)<< >=;s V R+).<< per >=;.........................................
+,)<
<
otal direct la$or cost....................................................
@,@<
<
Dverhead: his special order will not increase '.ed overhead
costs. herefore, only the varia$le overhead is relevant.
0<< >=;s V R,.<< per >=;........................................... ),0<<
otal relevant cost of the special order...........................
R+,,+<
<
3olutions Manual, "hapter ), C+
+. &n this part, we calculate the price for recurring orders of
+<,<<< pounds (+< lots* using the companyGs rule of marking
up its full manufacturing cost. his is not the $est pricing policy
to follow, $ut is a common practice in $usiness.
>irect materials: ?ecause the initial order will e.haust e.isting
inventories of ?;7, and >F72 and new supplies would have to
$e purchased, all raw materials should $e charged at their
e.pected future cost, which is the current market price.
A170: 2,<<< pounds V R).+< per pound...................... R@,+<<
U=7+: /,<<< pounds V R).<0 per pound....................... /,+<<
"O7@: ,,<<< pounds V R).,0 per pound..................... /,<0<
>F72: ,,0<< pounds V R<.@< per pound...................... +,/0<
otal direct materials cost........................................... )@,C<<
>irect la$or: C=;s* of the production of a $atch
can $e done on regular time% $ut the remaining production (i.e.,
0< >=;s* must $e done on overtime.
8egular time /0< >=;s V R)/.<< per >=;.................. 2,,<<
Dvertime premium 0< >=;s V R+).<< per >=;........... ),<0<
otal direct la$or cost.................................................. @,,0<
Dverhead: he full manufacturing cost includes $oth '.ed and
varia$le manufacturing overhead.
0<< >=;s V R),.0< per >=;..................................... 2,@0<
Full manufacturing cost................................................. ,+,<<<
Markup (/<P V R,+,<<<*.............................................. )+,B<<
3elling price (full manufacturing cost plus markup*...... R//,B<<
3olutions Manual, "hapter ), C,
Case 13-32 ()+< minutes*
). he product margins computed $y the accounting department
for the drums and $ike frames should not $e used in the
decision of which product to make. he product margins are
lower than they should $e due to the presence of allocated
'.ed common costs that are irrelevant in this decision.
Moreover, even after the irrelevant costs have $een removed,
what matters is the pro'ta$ility of the two products in relation
to the amount of the constrained resource9welding time9that
they use. A product with a very low margin may $e desira$le if
it uses very little of the constrained resource. &n short, the
'nancial data provided $y the accounting department are
useless and potentially misleading for making this decision.
+. 3tudents may have answered this 4uestion assuming that
direct la$or is a varia$le cost, even though the case strongly
hints that direct la$or is a '.ed cost. he solution is shown here
assuming that direct la$or is '.ed. he solution assuming that
direct la$or is varia$le will $e shown in part (/*.
Solution assuming direct labor is fxed
Manufactured
Purchase
d 0V!
!rums
0V!
!rums
Bi&e
Frames
3elling price................................ R)/C.<< R)/C.<< R+,C.<<
Materials................................... ),B.<< 0+.)< CC./<
overhead................................
<.<< ).,0 ).C<
administrative........................
<.@0 <.@0 ).,<
otal varia$le cost....................... ),B.@0 0/.+< )<+.2<
"ontri$ution margin.................... R )<.+0 R C/.B< R),2./<
3olutions Manual, "hapter ), C/
,. 3ince the demand for the welding machine e.ceeds the +,<<<
hours that are availa$le, products that use the machine should
$e prioritized $ased on their contri$ution margin per 1elding
hour. he computations are carried out $elow under the
assumption that direct la$or is a '.ed cost and then under the
assumption that it is a varia$le cost.
Solution assuming direct labor is fxed
Manufactured
0V!
!rums
Bi&e
Frames
"ontri$ution margin per unit (a$ove* (a*..... RC/.B< R),2./<
Oelding hours per unit ($*........................... <./ hour <.0 hour
"ontri$ution margin per welding hour (a*
[ ($*.........................................................
R+,@.<<
per hour
R+@+.B<
per hour
3olutions Manual, "hapter ), C0
3ince the contri$ution margin per unit of the constrained resource (i.e., welding time* is
larger for the $ike frames than for the OI> drums, the frames make the most pro'ta$le
use of the welding machine. "onse4uently, the company should manufacture as many $ike
frames as possi$le up to demand and then use any leftover capacity to produce OI>
drums. ?uying the drums from the outside supplier can 'll any remaining unsatis'ed
demand for OI> drums. he necessary calculations are carried out $elow.
Analysis assuming direct labor is a fxed cost
'a+ 'b+ 'c+ 'a+ T 'c+
'a+ T
'b+
8uantit%
Unit
Contri/
bution
Margin
0eldin
g ,ime
per
Unit
,otal
0eldin
g ,ime
Balanc
e of
0eldin
g ,ime
,otal
Contri/
bution
otal hours availa$le............... +,<<<
?ike frames produced............. ),2<<
R),2./
< <.0 B<< ),+<<
R+)B,+/
<
OI> >rums9make................ ,,<<< RC/.B< <./ ),+<< < +B/,/<<
OI> >rums9$uy................... ,,<<< R)<.+0
,<,@0
<
otal contri$ution margin........ 0,,,,C<
=ess: "ontri$ution margin
from present operations:
0,<<< drums V RC/.B< "M
per drum..............................
/@/,<<
<
&ncreased contri$ution R 0C,,C
3olutions Manual, "hapter ), C2
margin and net operating
income................................. <
3olutions Manual, "hapter ), C@
/. he computation of the contri$ution margins and the analysis
of the $est product mi. are repeated here under the
assumption that direct la$or costs are varia$le.
Solution assuming direct labor is a variable cost
Manufactured
Purchase
d 0V!
!rums
0V!
!rums
Bi&e
Frames
3elling price................................ R)/C.<< R)/C.<< R+,C.<<
Materials................................... ),B.<< 0+.)< CC./<
>irect la$or............................... <.<< ,.2< +B.B<
overhead................................
<.<< ).,0 ).C<
administrative........................
<.@0 <.@0 ).,<
otal varia$le cost....................... ),B.@0 0@.B< ),)./<
"ontri$ution margin.................... R )<.+0 R C).+< R)<@.2<
Manufactured
0V!
!rums
Bi&e
Frames
"ontri$ution margin per unit (a$ove* (a*..... RC).+< R)<@.2<
Oelding hours per unit ($*........................... <./ hour <.0 hour
"ontri$ution margin per welding hour (a*
[ ($*.........................................................
R++B.<<
per hour
R+)0.+<
per hour
Ohen direct la$or is assumed to $e a varia$le cost, the
conclusion is reversed from the case in which direct la$or is
assumed to $e a '.ed cost9the OI> drums appear to $e a
$etter use of the constraint than the $ike frames. he
assumption a$out the $ehavior of direct la$or really does
matter.
3olutions Manual, "hapter ), CB
'a+ 'b+ 'c+ 'a+ T 'c+
'a+ T
'b+
8uantit%
Unit
Contri/
bution
Margin
0eldin
g ,ime
per
Unit
,otal
0eldin
g ,ime
Balanc
e of
0eldin
g ,ime
,otal
Contri/
bution
otal hours availa$le............... +,<<<
OI> >rums9make................ 0,<<< RC).+< <./ +,<<< <
R/02,<<
<
?ike frames produced............. <
R)<@.2
< <.0 < < <
OI> >rums9$uy................... ),<<< R)<.+0
)<,+0
<
otal contri$ution margin........ /22,+0<
=ess: "ontri$ution margin
from present operations:
0,<<< drums V RC).+< "M
per drum..............................
/02,<<
<
&ncreased contri$ution
margin and net operating
income.................................
R )<,+0
<
3olutions Manual, "hapter ), CC
0. he case strongly suggests that direct la$or is '.ed: Mhe $ike
frames could $e produced with e.isting e4uipment and
personnel.N Aevertheless, it would $e a good idea to e.amine
how much la$or time is really needed under the two opposing
plans.
Production
!irect )abor/
<ours Per Unit
,otal
!irect
)abor/
<ours
!lan ):
?ike frames.............. ),2<< ).2Z +,02<
OI> drums.............. ,,<<< <.+ZZ 2<<
,,)2<
!lan +:
OI> drums.............. 0,<<< <.+ZZ ),<<<
Z R+B.B< [ R)B.<< per hour Y ).2 hour
ZZ R,.2< [ R)B.<< per hour Y <.+ hour
3ome caution is advised. !lan ) assumes that direct la$or is a
'.ed cost. ;owever, this plan re4uires +,)2< more direct la$or7
hours than !lan + and the present situation. At /< hours per
week a typical full7time employee works a$out ),C<< hours a
year, so the added workload is e4uivalent to more than one
full7time employee. >oes the plant really have that much idle
time at presentF &f so, and if shifting workers over to making
$ike frames would not jeopardize operations elsewhere, then
!lan ) is indeed the $etter plan. ;owever, if taking on the $ike
frame as a new product would lead to pressure to hire another
worker, more analysis is in order. &t is still $est to view direct
la$or as a '.ed cost, $ut taking on the frames as a new product
could lead to a jump in '.ed costs of a$out R,/,+<< (),C<<
hours V R)B per hour*9assuming that the remaining +2< hours
could $e made up using otherwise idle time. 3ee the additional
analysis on the ne.t page.
3olutions Manual, "hapter )/ B,
"ontri$ution margin from !lan ):
?ike frames produced (),2<< V R),2./<*............... +)B,+/<
OI> >rums9make (,,<<< V RC/.B<*.................... +B/,/<<
OI> >rums9$uy (,,<<< V R)<.+0*....................... ,<,@0<
otal contri$ution margin....................................... 0,,,,C<
=ess: Additional '.ed la$or costs.............................. ,/,+<<
Aet e#ect of !lan ) on net operating income............
R/CC,)C
<
"ontri$ution margin from !lan +:..............................
OI> >rums9make (0,<<< V RC/.B<*....................
R/@/,<<
<
OI> >rums9$uy (),<<< V R)<.+0*....................... )<,+0<
Aet e#ect of !lan + on net operating income............
R/B/,+0
<
&f an additional direct la$or employee would have to $e hired,
!lan ) is still optimal.
3olutions Manual, "hapter )/ B/
Chapter 14
Capital Budgeting 1ecisions
14-1 "apital $udgeting screening
decisions concern whether a proposed
investment project passes a preset hurdle,
such as a )0P rate of return. "apital
$udgeting preference decisions are
concerned with choosing from among two
or more alternative investment projects,
each of which has passed the hurdle.
14-2 he Mtime value of moneyN refers
to the fact that a dollar received today is
more valua$le than a dollar received in
the future. A dollar received today can $e
invested to yield more than a dollar in the
future.
14-3 >iscounting is the process of
computing the present value of a future
cash -ow. >iscounting gives recognition to
the time value of money and makes it
possi$le to meaningfully add together
cash -ows that occur at di#erent times.
14-4 Accounting net income is $ased on
accruals rather than on cash -ows. ?oth
the net present value and internal rate of
return methods focus on cash -ows.
14-5 >iscounted cash -ow methods are
superior to other methods of making
capital $udgeting decisions $ecause they
give speci'c recognition to the time value
of money.
14- Aet present value is the present
value of cash in-ows less the present
value of the cash out-ows. he net
present value can $e negative if the
present value of the out-ows is greater
than the present value of the in-ows.
14-! Dne simplifying assumption is that
all cash -ows occur at the end of a period.
Another is that all cash -ows generated $y
an investment project are immediately
reinvested at a rate of return e4ual to the
discount rate.
14-" Ao. he cost of capital is not simply
the interest paid on long7term de$t. he
cost of capital is a weighted average of
the individual costs of all sources of
'nancing, $oth de$t and e4uity.
14-# he internal rate of return is the
rate of return of an investment project
over its life. &t is computed $y 'nding that
discount rate that results in a zero net
present value for the project.
14-1$ he cost of capital is a hurdle that
must $e cleared $efore an investment
project will $e accepted. &n the case of the
net present value method, the cost of
capital is used as the discount rate. &f the
net present value of the project is positive,
then the project is accepta$le, since its
rate of return will $e greater than the cost
of capital. &n the case of the internal rate
of return method, the cost of capital is
compared to a projectGs internal rate of
return. &f the projectGs internal rate of
return is greater than the cost of capital,
then the project is accepta$le.
14-11 Ao. As the discount rate increases,
the present value of a given future cash
-ow decreases. For e.ample, the factor for
a discount rate of )+P for cash to $e
received ten years from now is <.,++,
whereas the factor for a discount rate of
)/P over the same period is <.+@<. &f the
cash to $e received in ten years is
3olutions Manual, "hapter )/ B0
R)<,<<<, the present value in the 'rst
case is R,,++<, $ut only R+,@<< in the
second case. hus, as the discount rate
increases, the present value of a given
future cash -ow decreases.
14-12 he internal rate of return is more
than )/P since the net present value is
positive. he internal rate of return would
$e )/P only if the net present value
(evaluated using a )/P discount rate* is
zero. he internal rate of return would less
than )/P only if the net present value
(evaluated using a )/P discount rate* is
negative.
14-13 he project pro'ta$ility inde. is
computed $y dividing the net present
value of the cash -ows from an
investment project $y the investment
re4uired. he inde. measures the pro't (in
terms of net present value* provided $y
each dollar of investment in a project. he
higher the project pro'ta$ility inde., the
more desira$le is the investment project.
14-14 Ao. &f the project pro'ta$ility inde.
is negative, then the net present value of
the project is negative, indicating that it
does not provide the re4uired minimum
rate of return.
14-15 he pay$ack period is the length of
time for an investment to fully recover its
own initial cost out of the cash receipts
that it generates.
he pay$ack method acts as a
screening tool in weeding out investment
proposals. &f a proposal doesnGt provide a
pay$ack within some speci'ed period,
there may $e no need to consider it
further. Also, the pay$ack method is often
very useful to 'rms that are e.periencing
diEculties in maintaining a strong cash
position. &t can help identify projects that
will return the initial investment very
4uickly. he pay$ack method is also used
in industries where products $ecome
o$solete very rapidly.
14-1 Aeither method considers the time
value of money. Knder $oth the pay$ack
method and the simple rate of return
method, a dollar received today is
weighed e4ually with a dollar received in
the future. Furthermore, the pay$ack
method ignores all cash -ows that occur
after the initial investment has $een
recovered.
14-1! An outlay that is ta. deducti$le
results in some savings in ta.es. he after7
ta. cost of an item is the amount of the
outlay less the ta. savings. &n capital
$udgeting decisions, all ta.7deducti$le
cash e.penses should $e included on an
after7ta. cost $asis, since the after7ta.
amount represents the actual net cash
out-ow.
14-1" he depreciation ta. shield refers
to the ta. deducti$ility of depreciation,
which is not a cash out-ow. From a capital
$udgeting point of view, the depreciation
ta. shield triggers a cash in-ow (ta.
reduction* e4ual to the depreciation
deduction multiplied $y the ta. rate.
14-1# An increase in the ta. rate would
tend to make the new investment less
attractive, since net after7ta. cash in-ows
would $e reduced.
14-2$ Dne cash in-ow would $e the
proceeds from the sale of the piece of
e4uipment. he other cash in-ow would
$e the income ta. reduction that results
from the loss on the e4uipment.
14-21 he purchase of the e4uipment
should $e shown as a cash out-ow of
R/<,<<<. he initial cost of an asset is not
immediately deducti$le for ta. purposes.
8ather, the cost is deducted in later
periods in the form of depreciation.
3olutions Manual, "hapter )/ B2
).
"tem -ear's+
Cash
Flo1
45J
Facto
r
Present
Value of
Cash
Flo1s
Annual cost
savings................ )7B R@,<<< /.C2B R ,/,@@2
&nitial investment. . . Aow
R(/<,<<
<* ).<<< (/<,<<<*
Aet present value... R (0,++/*
+.
"tem
Cash
Flo1 -ears
,otal
Cash
Flo1s
Annual cost
savings................ R@,<<< B R 02,<<<
&nitial investment. . .
R(/<,<<
<* ) (/<,<<<*
Aet cash -ow......... R )2,<<<
3olutions Manual, "hapter )/ B@
). Annual savings in part7time help....................... R,,B<<
Added contri$ution margin from e.panded
sales (),<<< dozen V R).+< per dozen*.......... ),+<<
Annual cash in-ows.......................................... R0,<<<
+.
&nvestment re4uired
Factor of the internal
Y
rate of return
Annual cash in-ow
R)B,2<<
Y Y ,.@+<
R0,<<<
=ooking in a$le )/"7/, and scanning along the si.7period line,
we can see that a factor of ,.@+< falls closest to the )2P rate
of return.
,. he cash -ows will not $e even over the si.7year life of the
machine $ecause of the e.tra RC,)+0 in-ow in the si.th year.
herefore, the approach used a$ove cannot $e used to
compute the internal rate of return in this situation. Ksing trial7
and7error or some other method, the internal rate of returns out
to $e ++P:
"tem -ear's+
Amount
of Cash
Flo1s
55J
Facto
r
Present
Value of
Cash
Flo1s
&nitial investment. . Aow R()B,2<<* ).<<< R()B,2<<*
Annual cash
in-ows................ )72 R0,<<< ,.)2@ )0,B,0
3alvage value....... 2 RC,)+0 <.,<, +,@20
Aet present value. R <
3olutions Manual, "hapter )/ BB
). Aote: All present value factors in the computation $elow have
$een taken from a$le )/"7, in Appendi. )/", using a )+P
discount rate.
Amount of the investment.....................
R)</,C0
<
=ess present value of Qear ) and Qear
+ cash in-ows:
Qear ): R,<,<<< V <.BC,...................... R+2,@C<
Qear +: R/<,<<< V <.@C@...................... ,),BB< 0B,2@<
!resent value of Qear , cash in-ow........ R /2,+B<
herefore, the e.pected cash in-ow for Qear , would $e:
R/2,+B< [ <.@)+ Y R20,<<<.
+. he e4uipmentGs net present value without considering the
intangi$le $ene'ts would $e:
"tem -ear's+
Amount of
Cash Flo1s
5:J
Facto
r
Present
Value of
Cash Flo1s
"ost of the
e4uipment.............. Aow
R(+,0<<,<<<
* ).<<< R(+,0<<,<<<*
Annual cost savings. . )7)0 R/<<,<<< /.2@0 ),B@<,<<<
Aet present value...... R (2,<,<<<*
he annual value of the intangi$le $ene'ts would have to $e
great enough to o#set a R2,<,<<< negative present value for
the e4uipment. his annual value can $e computed as follows:
8e4uired increase in present value R2,<,<<<
Y Y R),/,@0C
Factor for )0 years /.2@0
,.
&nvestment in the project
Y
rate of return
Annual cash in-ow
R)<2,@<<
Y Y 0.,,0
R+<,<<<
=ooking in a$le )/"7/, and scanning do1n the )<P column,
3olutions Manual, "hapter )/ BC
we 'nd that a factor of 0.,,0 e4uals B periods. hus, the
e4uipment will have to $e used for B years in order to yield a
return of )<P.
3olutions Manual, "hapter )/ C<
). he project pro'ta$ility inde. for each proposal would $e:
Proposa
l
(umber
(et Present
Value
'a+
"nvestmen
t 2e?uired
'b+
Proect
Pro.tabilit% "ndex
'a+ 'b+
A R,2,<<< RC<,<<< <./<
? R()<,<<<* R)<<,<<< 7<.)<
" R,0,<<< R@<,<<< <.0<
> R/<,<<< R)+<,<<< <.,,
+. he ranking would $e:
Proposa
l
(umber
Proect
Pro.tabilit%
"ndex
" <.0<
A <./<
> <.,,
? 7<.)<
wo points should $e noted a$out the ranking. First, proposal ?
is not an accepta$le proposal at all, since it has a negative net
present value. 3econd, proposal > has the highest net present
value, $ut it ranks lowest of the three accepta$le proposals in
terms of the project pro'ta$ility inde..
3olutions Manual, "hapter )/ C)
). he pay$ack period is determined as follows:
-ear
"nvestme
nt
Cash
"nSo1
Unrecovered
"nvestment
) R)0,<<< R),<<< R)/,<<<
+ RB,<<< R+,<<< R+<,<<<
, R+,0<< R)@,0<<
/ R/,<<< R),,0<<
0 R0,<<< RB,0<<
2 R2,<<< R+,0<<
@ R0,<<< R<
B R/,<<< R<
C R,,<<< R<
)< R+,<<< R<
he investment in the project is fully recovered in the @th year.
o $e more e.act, the pay$ack period is appro.imately 2.0
years.
+. 3ince the investment is recovered prior to the last year, the
amount of the cash in-ow in the last year has no e#ect on the
pay$ack period.
3olutions Manual, "hapter )/ C+
E%ercise 14- ()< minutes*
his is a cost reduction project, so the simple rate of return would
$e computed as follows:
"ost of the new machine............... R)+<,<<<
3crap value of old machine........... /<,<<<
&nitial investment.......................... R B<,<<<
Dperating cost of old machine...... R ,<,<<<
Dperating cost of new machine..... )+,<<<
Annual cost savings...................... R )B,<<<
"ost of new machine..................... R)+<,<<<
=ess salvage value........................ <
>eprecia$le cost of new machine.. )+<,<<<
Kseful life of new machine............ )< years
Annual depreciation on new
machine...................................... R )+,<<< per year
Annual depreciation
Annual cost savings 7
on new e4uipment
3imple rate
Y
of return
&nitial investment
R)B,<<< 7 R)+,<<<
Y Y @.0P
RB<,<<<
3olutions Manual, "hapter )/ C,
). a. From a$le )/"7/, the factor for )2P for B periods is /.,//.
he computer system should $e purchased only if its net
present value is positive. his will occur only if the purchase
price is less:
R@,<<< V /.,// Y R,<,/<B
$. From a$le )/"7/, the factor for +<P for B periods is ,.B,@.
herefore, the ma.imum purchase price would $e:
R@,<<< V ,.B,@ Y R+2,B0C
+. a. From a$le )/"7/, the factor for )+P for +< periods is @./2C.
hus, the present value of Mr. Drms$yGs winnings is:
RB<,<<< V @./2C Y R0C@,0+<
$. Ohether or not it is correct to call him the stateGs newest
millionaire depends on your point of view. ;e will receive
more than a million dollars over the ne.t +< years% however,
he is not a millionaire as shown $y the present value
computation a$ove, nor will he ever $e a millionaire if he
spends his winnings rather than investing them.
,. a. From a$le )/"7,, the factor for )<P for 0 periods is <.2+).
herefore, the company must invest:
R0<<,<<< V <.2+) Y R,)<,0<<
$. From a$le )/"7,, the factor for )/P for 0 periods is <.0)C.
herefore, the company must invest:
R0<<,<<< V <.0)C Y R+0C,0<<
3olutions Manual, "hapter )/ C/
a. Management development program cost................ R)<<,<<<
Multiply $y ) X <.,<................................................. V @<P
After7ta. cost........................................................... R@<,<<<
$. &ncreased contri$ution margin................................. R/<,<<<
Multiply $y ) X <.,<................................................. V @<P
After7ta. cash -ow ($ene't*.................................... R+B,<<<
c. he depreciation deduction is R+)<,<<< [ @ years Y R,<,<<<
per year, which has the e#ect of reducing ta.es $y ,<P of that
amount, or RC,<<< per year.
3olutions Manual, "hapter )/ C0
E%ercise 14-# ()< minutes*
-ear's+
Amount
of Cash
Flo1s
47J
Facto
r
Present
Value of
Cash
Flo1s
!urchase of the
stock........................ Aow R(),,<<<* ).<<< R(),,<<<*
Annual cash
dividends................. )7, R/+< +.,++ C@0
3ale of the stock......... , R)2,<<< <.2@0 )<,B<<
Aet present value....... R (),++0*
Ao, Uathy did not earn a )/P return on the Malti "ompany stock.
he negative net present value indicates that the rate of return on
the investment is less than the minimum re4uired rate of return of
)/P.
3olutions Manual, "hapter )/ C2
E%ercise 14-1$ ()0 minutes*
). he pay$ack period would $e:
&nvestment re4uired
!ay$ack period Y
Aet annual cash in-ow
`/,+,<<<
Y Y /.B years
`C<,<<<
Ao, the e4uipment would not $e purchased, since the pay$ack
period (/.B years* e.ceeds the companyGs ma.imum pay$ack
time (/.< years*.
+. he simple rate of return would $e:
Annual cost savings 7 Annual depreciation
3imple rate of return Y
&nitial investment
`C<,<<< 7 `,2,<<<Z
Y Y )+.0P
`/,+,<<<
Z`/,+,<<< [ )+ years Y R,2,<<< per year.
Ao, the e4uipment would not $e purchased, since its )+.0P rate
of return is less than the companyGs )/P re4uired rate of return.
3olutions Manual, "hapter )/ C@
"tem -ear's+
Amount of
Cash
"nSo1s
47J
Facto
r
Present
Value of
Cash Flo1s
!roject A:
"ost of
e4uipment.......... Aow R()<<,<<<* ).<<< R()<<,<<<*
Annual cash
in-ows................ )72 R+),<<< ,.BBC B),22C
3alvage value of
the e4uipment.... 2 RB,<<< <./02 ,,2/B
Aet present value. R ()/,2B,*
!roject ?:
Oorking capital
investment......... Aow R()<<,<<<* ).<<< R()<<,<<<*
Annual cash
in-ows................ )72 R)2,<<< ,.BBC 2+,++/
Oorking capital
released............. 2 R)<<,<<< <./02 /0,2<<
Aet present value. R @,B+/
he R)<<,<<< should $e invested in !roject ? rather than in
!roject A. !roject ? has a positive net present value whereas
!roject A has a negative net present value.
3olutions Manual, "hapter )/ CB
).
"tem -ear's+
Amount
of Cash
Flo1s
47J
Factor
Present
Value of
Cash Flo1s
&nitial investment.... Aow R(B/,C<<* ).<<< R(B/,C<<*
Annual cash
in-ows.................. )7)+ R)0,<<< 0.22< B/,C<<
Aet present value. . . R <
Qes, this is an accepta$le investment since it provides e.actly
the minimum re4uired )/P rate of return.
+.
&nvestment in the project
Y
rate of return
Annual cash in-ow
"ost of the new press
Y
Annual cost savings
R+)@,0<<
Y Y @.+0<
R,<,<<<
=ooking in a$le )/"7/, and reading along the )B7period line,
we 'nd that a factor of @.+0< represents an internal rate of
return of )+P. 3ince the re4uired rate of return is )2P, the
investment is not accepta$le.
,. &nvestment in the project
Y
rate of return
Annual cash in-ow
Oe know that the investment is R+)@,0<<, and we can
determine the factor for an internal rate of return of )2P $y
looking in a$le )/"7/ along the )B7period line. his factor is
0.B)B. Ksing these 'gures in the formula, we get:
Y 0.B)B (factor for )2P for )B years*
$21!,$00
Annual 2ash in1lo6
herefore, the annual cash in-ow would have to $e: R+)@,0<<
[ 0.B)B Y R,@,,B/.
3olutions Manual, "hapter )/ CC
). "omputation of the annual cash in-ow associated with the new
pin$all machines:
Aet operating income...................................... R/<,<<<
Add noncash deduction for depreciation......... ,0,<<<
Aet annual cash in-ow.................................... R@0,<<<
he pay$ack computation would $e:
&nvestment re4uired
!ay$ack period Y
R,<<,<<<
Y Y /.< years
R@0,<<< per year
Qes, the pin$all machines would $e purchased. he pay$ack
period is less than the ma.imum 0 years re4uired $y the
company.
Annual incremental Annual incremental e.penses,
7
revenues including depreciation
3imple rate
Y
of return
&nitial investment
Annual incremental net income
Y
&nitial investment
R/<,<<<
Y Y ),.,P
R,<<,<<<
Qes, the pin$all machines would $e purchased. he ),.,P
return e.ceeds )+P.
3olutions Manual, "hapter )/ )<<
). a. From a$le )/"7,, the factor for )<P for , periods is <.@0).
herefore, the present value of the investment re4uired is:
RB,<<< V <.@0) Y R2,<<B.
$. he a$le )/"7,, the factor for )/P for , periods is <.2@0.
herefore, the present value of the investment re4uired is:
RB,<<< V <.2@0 Y R0,/<<.
+. Amount of
Cash Flo1s 4HJ
Present Value
of Cash Flo1s
-ear A B
Facto
r A B
) R,,<<<
R)+,<<
< <.B/@ R +,0/)
R)<,)2
/
+ R2,<<< RC,<<< <.@)B /,,<B 2,/2+
, RC,<<< R2,<<< <.2<C 0,/B) ,,20/
/
R)+,<<
< R,,<<< <.0)2 2,)C+ ),0/B
R)B,0+
+
R+),B+
B
&nvestment project ? is $est.
,. he present value of the 'rst option is R)0<,<<<, since the
entire amount would $e received immediately.
he present value of the second option is:
Annual annuity: R)/,<<< V @./2C (a$le )/"7/*. . R)</,022
=ump7sum payment: R2<,<<< V <.)</ (a$le
)/"7,*.............................................................. 2,+/<
otal present value.............................................. R))<,B<2
hus, she should accept the 'rst option, which has a much
higher present value.
Dn the surface, the second option appears to $e a $etter
choice since it promises a total cash in-ow of R,/<,<<< over
the +<7year period (R)/,<<< V +< Y R+B<,<<<% R+B<,<<< \
R2<,<<< Y R,/<,<<<*, whereas the 'rst option promises a cash
in-ow of only R)0<,<<<. ;owever, the cash in-ows under the
3olutions Manual, "hapter )/ )<)
second option are spread out over +< years, causing the
present value to $e far less.
3olutions Manual, "hapter )/ )<+
"tem -ear's+
Amount
of Cash
Flo1s
4HJ
Factor
Present
Value of
Cash
Flo1s
!roject S:
&nitial
investment........ Aow R(,0,<<<* ).<<< R(,0,<<<*
Annual cash
in-ow................ )7)< RC,<<< /./C/ /<,//2
Aet present
value................. R 0,//2
!roject Q:
&nitial
investment........ Aow R(,0,<<<* ).<<< R(,0,<<<*
3ingle cash
in-ow................ )< R)0<,<<< <.)C) +B,20<
Aet present
value................. R( 2,,0<*
!roject S should $e selected. !roject Q does not provide the
re4uired )BP return, as shown $y its negative net present value.
3olutions Manual, "hapter )/ )<,
).
&nvestment re4uired
Y
rate of return
Annual cash in-ow
R),<,/<<
Y Y 0.+)2
R+0,<<<
=ooking in a$le )/"7/ and scanning along the )<7period line, a
factor of 0.+)2 represents an internal rate of return of )/P.
+.
"tem
-ear's
+
Amount
of Cash
Flo1s
47J
Facto
r
Present
Value of
Cash
Flo1s
&nitial investment........ Aow
R(),<,/<<
* ).<<< R(),<,/<<*
Aet annual cash
in-ows...................... )7)< R+0,<<< 0.+)2 ),<,/<<
Aet present value........ R <
he reason for the zero net present value is that )/P (the
discount rate we have used* represents the machineGs internal
rate of return. he internal rate of return is the discount rate
that results in a zero net present value.
,.
&nvestment re4uired
Y
rate of return
Annual cash in-ow
R),<,/<<
Y Y 0.@C2 (rounded*
R++,0<<
=ooking in a$le )/"7/ and scanning along the )<7period line, a
factor of 0.@C2 falls closest to the factor for ))P. hus, to the
nearest whole percent, the internal rate of return is ))P.
3olutions Manual, "hapter )/ )</
"tems and Computations
-ear's
+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
45J
Factor
Present
Value of
Cash
Flo1s
!roject A:
&nvestment in heavy trucks. . Aow
R(),<,<<
<* 9 R(),<,<<<* ).<<< R(),<,<<<*
Aet annual cash in-ows........ )7C R+0,<<< ) X <.,< R)@,0<< 0.,+B C,,+/<
>epreciation deductionsZ..... )70 R+2,<<< <.,< R@,B<< ,.2<0 +B,))C
3alvage value of the trucks. . C R)0,<<< ) X <.,< R)<,0<< <.,2) ,,@C)
Aet present value................. R (/,B0<*
!roject ?:
&nvestment in working
capital................................ Aow
R(),<,<<
<* 9 R(),<,<<<* ).<<< R(),<,<<<*
Aet annual cash in-ows........ )7C R+0,<<< ) X <.,< R)@,0<< 0.,+B C,,+/<
8elease of working capital.... C R),<,<<< 9 R),<,<<< <.,2) /2,C,<
Aet present value................. R )<,)@<
ZR),<,<<< [ 0 years Y R+2,<<< per year
3olutions Manual, "hapter )/ )<0
E%ercise 14-1" (+< minutes*
). Annual cost of operating the present
e4uipment..................................................... RB0,<<<
Annual cost of the new dishwashing
machine:
"ost for wages of operators........................... R/B,<<<
"ost for maintenance..................................... +,<<< 0<,<<<
Aet annual cost savings (cash in-ow*.............. R,0,<<<
+. he net present value analysis would $e as follows:
-ear's
+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
47J
Facto
r
Present
Value of
Cash
Flo1s
"ost of the new dishwashing
machine...................................... Aow
R()/<,<<
<* 9
R()/<,<<<
* ).<<<
R()/<,<<<
*
Aet annual cost savings (a$ove*. . . )7)+ R,0,<<< ) X <.,< R+/,0<< 0.22< ),B,2@<
>epreciation deductionsZ.............. )7@ R+<,<<< <.,< R2,<<< /.+BB +0,@+B
"ost of the new water jets............. 2 R()0,<<<* ) X <.,< R()<,0<<* <./02 (/,@BB*
3alvage value of the new
machine...................................... )+ RC,<<< ) X <.,< R2,,<< <.+<B ),,)<
Aet present value.......................... R+<,C+<
ZR)/<,<<< [ @ years Y R+<,<<< per year
Qes, the new dishwashing machine should $e purchased.
3olutions Manual, "hapter )/ )<2
&ro'lem 14-1# (+< minutes*
"tem
-ear's
+
Amount
of Cash
Flo1s
5:J
Facto
r
Present
Value of
Cash
Flo1s
"ost of new e4uipment....... Aow
8(+@0,<<<
* ).<<<
8(+@0,<<<
*
Oorking capital re4uired..... Aow
8()<<,<<<
* ).<<< ()<<,<<<*
Aet annual cash receipts..... )7/ 8)+<,<<< +.0BC ,)<,2B<
"ost to construct new
roads................................ , 8(/<,<<<* <.0@C (+,,)2<*
3alvage value of
e4uipment........................ / 820,<<< <./B+ ,),,,<
Oorking capital released..... / 8)<<,<<< <./B+ /B,+<<
Aet present value................ 8 (@,C0<*
Ao, the project should not $e accepted% it has a negative net
present value at a +<P discount rate. his means that the rate of
return on the investment is less than the companyGs re4uired rate
of return of +<P.
3olutions Manual, "hapter )/ )<@
). he net annual cost savings would $e:
8eduction in la$or costs..................................... R)<B,<<<
8eduction in material waste.............................. 2,0<<
otal................................................................... ))/,0<<
=ess increased maintenance costs (R,,<<< V
)+*.................................................................. ,2,<<<
Aet annual cost savings..................................... R @B,0<<
+. Ksing this cost savings 'gure, and other data from the te.t, the
net present value analysis would $e:
"tem
-ear's
+
Amount
of Cash
Flo1s
4EJ
Facto
r
Present
Value of
Cash
Flo1s
"ost of the machine......... Aow
R(0<<,<<<
* ).<<< R(0<<,<<<*
3oftware and installation. . Aow R(B<,<<<* ).<<< (B<,<<<*
3alvage of the old
e4uipment..................... Aow R)+,<<< ).<<< )+,<<<
Annual cost savings
(a$ove*.......................... )7)+ R@B,0<< 0.)C@ /<@,C20
8eplacement of parts....... @ R(/0,<<<* <.,0/ ()0,C,<*
3alvage of the new
machine......................... )+ R+<,<<< <.)2B ,,,2<
Aet present value............. R()@+,2<0*
Ao, the automated welding machine should not $e purchased.
&t has a negative net present value at a )2P discount rate.
,. he dollar value per year that would $e re4uired for the
intangi$le $ene'ts would $e:
Aegative net present value to $e o#set R)@+,2<0
Y Y R,,,+)+
!resent value factor 0.)C@
hus, the automated welding machine should $e purchased if
management $elieves that the intangi$le $ene'ts are worth at
least R,,,+)+ per year.
3olutions Manual, "hapter )/ )<B
). he formula for the project pro'ta$ility inde. is:
Aet present value of the project
!roject pro'ta$ility inde. Y
&nvestment re4uired $y the project
he inde.es for the projects under consideration would $e:
!roject ): R22,)/< [ R+@<,<<< Y <.+/
!roject +: R@+,C@< [ R/0<,<<< Y <.)2
!roject ,: 7R+<,+/< [ R/<<,<<< Y 7<.<0
!roject /: R@,,/<< [ R,2<,<<< Y <.+<
!roject 0: RB@,+@< [ R/B<,<<< Y <.)B
+. a., $., and c.
(et
Present
Value
Proect
Pro.tabilit
% "ndex
"nternal
2ate of
2eturn
First preference....... 0 ) +
3econd preference. . / / )
hird preference...... + 0 0
Fourth preference.... ) + /
Fifth preference....... , , ,
3olutions Manual, "hapter )/ )<C
,. Ohich ranking is $est will depend on 8evco !roductsG
opportunities for reinvesting funds as they are released from
the project. he internal rate of return method assumes that
any released funds are reinvested at the internal rate of return.
his means that funds released from project g+ would have to
$e reinvested in another project yielding a rate of return of
)CP. Another project yielding such a high rate of return might
$e diEcult to 'nd.
he project pro'ta$ility inde. approach assumes that funds
released from a project are reinvested in other projects at a
rate of return e4ual to the discount rate, which in this case is
only )<P. Dn $alance, the project pro'ta$ility inde. is the most
dependa$le method of ranking competing projects.
he net present value is inferior to the project pro'ta$ility
inde. as a ranking device, since it looks only at the total
amount of net present value from a project and does not
consider the amount of investment re4uired. For e.ample, it
ranks project g) as fourth in terms of preference $ecause of its
low net present value% yet this project is the $est availa$le in
terms of the amount of cash in-ow generated for each dollar of
investment (as shown $y the pro'ta$ility inde.*.
3olutions Manual, "hapter )/ ))<
). he income statement would $e:
3ales revenue....................................... R,<<,<<<
"ost of ingredients (+<P V
R,<<,<<<*........................................ R2<,<<<
"ommissions ()+.0P V R,<<,<<<*..... ,@,0<< C@,0<<
"ontri$ution margin............................. +<+,0<<
3alaries.............................................. R@<,<<<
8ent (R,,0<< V )+*............................ /+,<<<
>epreciationZ..................................... )2,B<<
&nsurance........................................... ,,0<<
Ktilities.............................................. +@,<<< )0C,,<<
Aet operating income........................... R /,,+<<
Z R+@<,<<< X R)B,<<< Y R+0+,<<<
R+0+,<<< [ )0 years Y R)2,B<< per year.
+. he formula for the simple rate of return is:
Annual incremental net operating income
3imple rate of return Y
&nitial investment
R/,,+<<
Y Y )2.<P
R+@<,<<<
Qes, the franchise would $e ac4uired since it promises a rate of
return in e.cess of )+P.
3olutions Manual, "hapter )/ )))
,. he formula for the pay$ack period is:
&nvestment re4uired
!ay$ack period Y
R+@<,<<<
Y Y /.0 years
R2<,<<<Z
ZR/,,+<< Aet operating income \ R)2,B<< >epreciation Y
R2<,<<< Aet annual cash in-ow
According to the pay$ack computation, the franchise would not
$e ac4uired. he /.0 years pay$ack is greater than the
ma.imum / years allowed. !ay$ack and simple rate of return
can give con-icting signals as in this e.ample.
3olutions Manual, "hapter )/ ))+
"tems and Computations -ear's+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
4EJ
Factor
Present
Value of
Cash
Flo1s
&nvestment in the new trucks...... Aow
R(,0<,<<
<* 9
R(,0<,<<<
* ).<<<
R(,0<,<<<
*
3alvage from sale of the old
trucks....................................... Aow R)2,<<< ) X <.,< R)),+<< ).<<< )),+<<
Aet annual cash receipts............. )7@ R)<0,<<< ) X <.,< R@,,0<< /.<,C +C2,B2@
>epreciation deductionsZ............ )70 R@<,<<< <.,< R+),<<< ,.+@/ 2B,@0/
8eplacement of motors............... / R(/0,<<<* ) X <.,< R(,),0<<* <.00+ ()@,,BB*
3alvage from the new trucks....... @ R)B,<<< ) X <.,< R)+,2<< <.,0/ /,/2<
Aet present value........................ R ),,BC,
ZR,0<,<<< [ 0 years Y R@<,<<< per year
3ince the project has a positive net present value, the contract should $e accepted.
3olutions Manual, "hapter )/ )),
). he net annual cash in-ows would $e:
8eduction in annual operating costs:
Dperating costs, present hand method.........R,<,<<<
Dperating costs, new machine...................... @,<<<
Annual savings in operating costs................. +,,<<<
&ncreased annual contri$ution margin:
2,<<< $o.es V R).0< per $o......................... C,<<<
otal net annual cash in-ows...........................R,+,<<<
+.
"tem
-ear's
+
Amount
of Cash
Flo1s
5:J
Factor
Present
Value of
Cash
Flo1s
"ost of the machine....... Aow
R()+<,<<<
* ).<<< R()+<,<<<*
8eplacement of parts..... 2 R(C,<<<* <.,,0 (,,<)0*
Annual cash in-ows
(a$ove*........................ )7)+ R,+,<<< /./,C )/+,</B
3alvage value of the
machine....................... )+ R@,0<< <.))+ B/<
Aet present value........... R )C,B@,
3olutions Manual, "hapter )/ ))/
). he present value of cash -ows would $e:
"tem
-ear's
+
Amount
of Cash
Flo1s
4HJ
Factor
Present
Value of
Cash
Flo1s
!urchase alternative:
!urchase cost of the cars
()< V R)@,<<<*............... Aow
R()@<,<<<
* ).<<<
R()@<,<<<
*
Annual cost of servicing,
etc.................................. )7, R(,,<<<* +.)@/ (2,0++*
8epairs:
First year........................ ) R(),0<<* <.B/@ (),+@)*
3econd year................... + R(/,<<<* <.@)B (+,B@+*
hird year....................... , R(2,<<<* <.2<C (,,20/*
8esale value of the cars.... , RB0,<<< <.2<C 0),@20
!resent value of cash
-ows...............................
R(),+,00/
*
=ease alternative:
3ecurity deposit................ Aow R()<,<<<* ).<<< R()<,<<<*
Annual lease payments..... )7, R(00,<<<* +.)@/ ())C,0@<*
8efund of deposit.............. , R)<,<<< <.2<C 2,<C<
!resent value of cash
-ows...............................
R()+,,/B<
*
Aet present value in favor
of leasing the cars............ R C,<@/
As shown a$ove, the company should lease the cars since this
alternative has the lowest present value of total costs.
+. Ohen a company has a high cost of capital, such as the
company in this pro$lem, it is usually $etter to avoid tying up
funds in e4uipment and facilities and to lease. &n contrast,
pension funds, insurance companies, and similar organizations
re4uire a relatively low rate of return. hey can $uy assets and
then lease them to others, keeping the lease payments low
enough to appeal to companies with high costs of capital.
3olutions Manual, "hapter )/ ))0
).
&nvestment re4uired
Y
rate of return
R,,<,<<<
Y Y /.)+0
RB<,<<<
From a$le )/"7/, reading along the C7period line, a factor of
/.)+0 is closest to )CP.
+. &nvestment re4uired
Y
rate of return
Oe know the investment is R,,<,<<<, and we can determine
the factor for an internal rate of return of )/P $y looking in
a$le )/"7/ along the C7period line. his factor is /.C/2. Ksing
these 'gures in the formula, we get:
R,,<,<<<
Y /.C/2
herefore, the annual cash in-ow would $e: R,,<,<<< [ /.C/2
Y R22,@+).
,. a. 27year useful life:
he factor for the internal rate of return would still $e /.)+0
]as computed in ()* a$ove^. From a$le )/"7/, reading along
the 27period line, a factor of /.)+0 falls closest to )+P.
$. )+7year useful life:
he factor of the internal rate of return would again $e
/.)+0. From a$le )/"7/, reading along the )+7period line, a
factor of /.)+0 falls closest to ++P.
3olutions Manual, "hapter )/ ))2
he )+P return in part (a* is less than the )/P minimum return
that Ms. Oinder wants to earn on the project. Df e4ual or even
greater importance, the following diagram should $e pointed
out to Ms. Oinder:
As this illustration shows, a decrease in years has a much
greater impact on the rate of return than an increase in years.
his is $ecause of the time value of money% added cash in-ows
far into the future do little to enhance the rate of return, $ut
loss of cash in-ows in the near term can do much to reduce it.
herefore, Ms. Oinder should $e ver% concerned a$out any
potential decrease in the life of the e4uipment, while at the
same time realizing that any increase in the life of the
e4uipment will do little to enhance her rate of return.
3olutions Manual, "hapter )/ ))@

2
Qears
)+P
C
Qears
)CP
)+
Qears
++P
A decrease
of @P
An increase of
,P
% +ears shorter , years longer
/. a. he e.pected annual cash in-ow would $e:
RB<,<<< V B<P Y R2/,<<<.
R,,<,<<<
Y 0.)02 (rounded*
R2/,<<<
0.)02 is closest to ),P.
$. he e.pected annual cash in-ow would $e:
RB<,<<< V )+<P Y RC2,<<<.
R,,<,<<<
Y ,./,B (rounded*
RC2,<<<
,./,B is closest to +0P.
Knlike changes in time, increases and decreases in cash So1s
at a given point in time have $asically the same impact on the
rate of return, as shown $elow:
3olutions Manual, "hapter )/ ))B

R2/,<<<
"ash &n-ow
),P
RB<,<<<
"ash &n-ow
)CP
RC2,<<<
"ash &n-ow
+0P
A decrease
of 2P
+<P decrease
+<P increase
An increase
of 2P
0. 3ince the cash -ows are not even over the B7year period (there
is an e.tra R),0,//< cash in-ow from sale of the e4uipment at
the end of the eighth year*, some other method has to $e used
to compute the internal rate of return. Ksing trial7and7error or
more sophisticated methods, it turns out that the internal rate
of return is )<P. his can $e veri'ed $y computing the net
present value of the project, which is zero at the discount rate
of )<P, as shown $elow:
"tem
-ear's
+
Amount
of Cash
Flo1s
4:J
Facto
r
Present
Value of
Cash
Flo1s
&nvestment in the
e4uipment...................... Aow
R(,,<,<<<
* ).<<<
R(,,<,<<<
*
Annual cash in-ow............ )7B R0<,<<< 0.,,0 +22,@0<
3ale of the e4uipment....... B R),0,//< <./2@ 2,,+0<
Aet present value R <
3olutions Manual, "hapter )/ ))C
). "omputation of the net annual cost savings:
3avings in la$or costs (+0,<<< hours V R)2 per
hour*................................................................
R/<<,<<
<
3avings in inventory carrying costs..................... +)<,<<<
otal.................................................................... 2)<,<<<
=ess increased power and maintenance cost
(R+,0<< per month V )+ months*..................... ,<,<<<
Aet annual cost savings......................................
R0B<,<<
<
+.
-ear's
+
Amount of
Cash Flo1s
5:J
Facto
r
Present
Value of
Cash Flo1s
"ost of the ro$ot........ Aow
R(),B<<,<<<
* ).<<<
R(),B<<,<<<
*
&nstallation and
software................... Aow R(C<<,<<<* ).<<< (C<<,<<<*
"ash released from
inventory................. ) R/<<,<<< <.B,, ,,,,+<<
Aet annual cost
savings.................... )7)< R0B<,<<< /.)C+ +,/,),,2<
3alvage value............ )< R@<,<<< <.)2+ )),,/<
Aet present value....... R @0,C<<
Qes, the ro$ot should $e purchased. &t has a positive net
present value at a +<P discount rate.
,. 8ecomputation of the net annual cost savings:
3avings in la$or costs (++,0<< hours V R)2 per
hour*................................................................
R,2<,<<
<
3avings in inventory carrying costs.................... +)<,<<<
otal.................................................................... 0@<,<<<
=ess increased power and maintenance cost
(R+,0<< per month V )+ months*..................... ,<,<<<
Aet annual cost savings......................................
R0/<,<<
<
3olutions Manual, "hapter )/ )+<
8ecomputation of the net present value of the project:
-ear's
+
Amount of
Cash Flo1s
5:J
Factor
Present
Value of
Cash Flo1s
"ost of the ro$ot......... Aow
R(),B<<,<<<
* ).<<<
R(),B<<,<<<
*
&nstallation and
software.................... Aow R(C@0,<<<* ).<<< (C@0,<<<*
"ash released from
inventory.................. ) R/<<,<<< <.B,, ,,,,+<<
Aet annual cost
savings..................... )7)< R0/<,<<< /.)C+ +,+2,,2B<
3alvage value............. )< R@<,<<< <.)2+ )),,/<
Aet present value........
R
()22,@B<*
&t appears that the company did not make a wise investment
since the rate of return that will $e earned $y the new
e4uipment is less than +<P. ;owever, see !art / $elow. his
pro$lem shows the diEculty often encountered in estimating
data going into capital $udgeting analyses, and also shows
what a heavy impact even seemingly small changes in the data
can have on overall net present value. o mitigate these
pro$lems, some companies re4uire several analyses when
major investments are involved9one showing the Mmost likelyN
results, one showing the Mmost optimisticN results, and one
showing the Mmost pessimisticN results. !ro$a$ility analysis is
also used in those cases where a range of possi$le results and
the pro$a$ility of their occurrence can $e esta$lished.
3olutions Manual, "hapter )/ )+)
/. a. 3everal intangi$le $ene'ts are usually associated with
investments in automated e4uipment. hese intangi$le
$ene'ts include such items as:
L Faster throughput time.
L &ncreased manufacturing -e.i$ility.
L Faster response to market shifts.
L ;igher 4uality.
he value of these $ene'ts can e4ual or e.ceed any savings
that may come from reduced la$or cost. ;owever, these
$ene'ts are hard to 4uantify.
$. Aegative net present value to $e o#set R)22,@B<
Y Y R,C,@B0
!resent value factor, )< years at +<P /.)C+
hus, the intangi$le $ene'ts in (a* would have to generate a
cash in-ow of R,C,@B0 per year in order for the ro$ot to yield
a +<P rate of return.
3olutions Manual, "hapter )/ )++
). he project pro'ta$ility inde. is computed as follows:
Proect
(et
Present
Value
'a+
"nvestme
nt
2e?uired
'b+
Proect
Pro.tabili
t%
"ndex
'a+ P 'b+
A........... R//,,+, R)2<,<<
<
<.+B
?........... R/+,<<< R),0,<<
<
<.,)
"........... R,0,<,0 R)<<,<<
<
<.,0
>........... R,B,),2 R)@0,<<
<
<.++
E........... R(B,2C2* R)0<,<<
<
7<.<2
+. a., $., and c.
(et Present
Value
Proect
Pro.tabilit
% "ndex
"nternal
2ate of
2eturn
First preference....... A " >
3econd preference. . ? ? "
hird preference...... > A A
Fourth preference. . . " > ?
Fifth preference....... E E E
3olutions Manual, "hapter )/ )+,
,. D.ford "ompanyGs opportunities for reinvesting funds as they
are released from a project will determine which ranking is
$est. he internal rate of return method assumes that any
released funds are reinvested at the rate of return shown for a
project. his means that funds released from project > would
have to $e reinvested in another project yielding a rate of
return of ++P. Another project yielding such a high rate of
return might $e diEcult to 'nd.
he project pro'ta$ility inde. approach also assumes that
funds released from a project are reinvested in other projects.
?ut the assumption is that the return earned $y these other
projects is e4ual to the discount rate, which in this case is only
)<P. Dn $alance, the project pro'ta$ility inde. is generally
regarded as $eing the most dependa$le method of ranking
competing projects.
he net present value is inferior to the project pro'ta$ility
inde. as a ranking device, since it looks only at the total
amount of net present value from a project and does not
consider the amount of investment re4uired. For e.ample, it
ranks project " as fourth in terms of preference $ecause of its
low net present value% yet this project is the $est availa$le in
terms of the net present value generated for each dollar of
investment (as shown $y the project pro'ta$ility inde.*.
3olutions Manual, "hapter )/ )+/
). he annual incremental net operating income can $e
icket revenue (0<,<<< V
R,.2<*.....................................
R)B<,<<
<
3alaries................................... RB0,<<<
&nsurance................................ /,+<<
Ktilities.................................... ),,<<<
>epreciationZ.......................... +@,0<<
Maintenance........................... C,B<<
otal operating e.penses........... ),C,0<<
Aet operating income................ R /<,0<<
ZR,,<,<<< [ )+ years Y R+@,0<< per year.
Annual incremental net operating income
3imple rate
Y
of return
&nitial investment (net of salvage from old e4uipment*
R/<,0<< R/<,0<<
Y Y Y )0P
R,,<,<<< 7 R2<,<<< R+@<,<<<
Qes, the water slide would $e constructed. &ts return is greater
than the speci'ed hurdle rate of )/P.
,. he pay$ack period would $e:
&nvestment re4uired (net of salvage from old e4uipment*
!ay$ack
Y
period
R,,<,<<< 7 R2<,<<< R+@<,<<<
Y Y Y ,.C@ years (rounded*
R2B,<<<Z R2B,<<<Z
ZAet operating income \ depreciation Y R/<,0<< \ R+@,0<<
Y R2B,<<<.
Qes, the water slide would $e constructed. he pay$ack period
is within the ma.imum 0 years re4uired $y Mr. 3harkey.
3olutions Manual, "hapter )/ )+0
). Average weekly use of the auto wash and the vacuum will $e:
R),,0<
Auto wash: Y 2@0 uses.
R+.<<
Iacuum: 2@0 V 2<P Y /<0 uses.
he e.pected net annual cash -ow from operations will $e:
Auto wash cash receipts (R),,0< V 0+*..... R@<,+<<
Iacuum cash receipts (/<0 V R).<< V
0+*.......................................................... +),<2<
otal cash receipts.................................. C),+2<
=ess cash dis$ursements:
Oater (2@0 V R<.+< V 0+*....................... R @,<+<
Electricity (/<0 V R<.)< V 0+*................ +,)<2
8ent (R),@<< V )+*................................. +<,/<<
"leaning (R/0< V )+*.............................. 0,/<<
&nsurance (R@0 V )+*.............................. C<<
Maintenance (R0<< V )+*....................... 2,<<<
otal cash dis$ursements.......................... /),B+2
Aet annual cash -ow from operations....... R/C,/,/
+.
"tem
-ear's
+
Amount
of Cash
Flo1s
4:J
Facto
r
Present
Value of
Cash Flo1s
"ost of e4uipment.......... Aow
R(+<<,<<<
* ).<<<
R(+<<,<<<
*
Oorking capital needed.. Aow R(+,<<<* ).<<< (+,<<<*
Aet annual cash -ow
from operations
(a$ove*........................ )7B R/C,/,/ 0.,,0 +2,,@,<
3alvage of e4uipment.... B R+<,<<< <./2@ C,,/<
Oorking capital
released....................... B R+,<<< <./2@ C,/
Aet present value........... R @+,<</
Qes, Mr. >uncan should open the auto wash. &t promises more
than a )<P rate of return.
3olutions Manual, "hapter )/ )+2
). !resent cost of transient workers................... R/<,<<<
=ess out7of7pocket costs to operate the cherry
picker:
"ost of an operator and assistant................
R)/,<<
<
&nsurance..................................................... +<<
Fuel.............................................................. ),B<<
Maintenance contract..................................
,,<<
< )C,<<<
Annual savings in cash operating costs.......... R+),<<<
+. he formula for the simple rate of return when a cost reduction
project is involved is as follows:
Annual depreciation on
Annual cost savings 7
new e4uipment
3imple rate
Y
of return
&nitial investment
R+),<<< 7 R@,0<< R),,0<<
Y Y Y )/.,P (rounded*
RC/,0<< RC/,0<<
RC/,0<< X R/,0<< Y RC<,<<<%
RC<,<<< [ )+ years Y R@,0<< per year.
Ao, the cherry picker would not $e purchased. he e.pected
return is less than the )2P return re4uired $y the farm.
,. he formula for the pay$ack period is:
&nvestment re4uired
!ay$ack period Y
RC/,0<<
Y Y /.0 years
R+),<<<Z
&n this case, the cash in-ow is measured $y the annual
savings in cash operating costs.
Qes, the cherry picker would $e purchased. he pay$ack period
is less than the 0 years ma.imum re4uired $y the farm. Aote
that this answer con-icts with the answer in !art +.
3olutions Manual, "hapter )/ )+@
/. he formula for the internal rate of return is:
&nvestment re4uired
Y
rate of return
RC/,0<<
Y Y /.0<<
R+),<<<
=ooking in a$le )/"7/, and reading along the )+7period line, a
factor of /.0<< represents an internal rate of return of
appro.imately +<P.
Ao, the simple rate of return is not an accurate guide in
investment decisions. &t ignores the time value of money.
3olutions Manual, "hapter )/ )+B
). he total7cost approach:
"tem
-ear's
+
Amount
of Cash
Flo1s
4EJ
Factor
Present
Value of
Cash
Flo1s
!urchase the new truck:
&nitial investment in
the new truck Aow R(,<,<<<* ).<<< R(,<,<<<*
3alvage of the old
truck Aow RC,<<< ).<<< C,<<<
Annual cash operating
costs )7B R(2,0<<* /.,// (+B,+,2*
3alvage of the new
truck B R/,<<< <.,<0 ),++<
!resent value of the net
cash out-ows R(/B,<)2*
Ueep the old truck:
Dverhaul needed now
Aow R(@,<<<* ).<<< R (@,<<<*
costs )7B R()<,<<<* /.,// (/,,//<*
3alvage of the old truck
B R),<<< <.,<0 ,<0
!resent value of the net
cash out-ows R(0<,),0*
Aet present value in
favor of purchasing the
new truck R + ,))C
he company should purchase the new truck, since the present
value of the net cash out-ows is lower for that alternative.
3olutions Manual, "hapter )/ )+C
+. he incremental7cost approach:
"tem
-ear's
+
Amount
of Cash
Flo1s
4EJ
Facto
r
Present
Value of
Cash
Flo1s
&ncremental investment
in the new truckZ Aow R(+,,<<<* ).<<< R(+,,<<<*
3alvage of the old truck Aow RC,<<< ).<<< C,<<<
3avings in annual cash
operating costs )7B R,,0<< /.,// )0,+</
>i#erence in salvage
value in B years B R,,<<< <.,<0 C)0
Aet present value in
favor of purchasing
the new truck R +,))C
ZR,<,<<< X R@,<<< Y R+,,<<<. he RC,<<< salvage value now of
the old truck could also $e deducted, leaving an incremental
investment for the new truck of only R)/,<<<.
3olutions Manual, "hapter )/ ),<
"tems and Computations -ear's+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
HJ
Facto
r
Present
Value of
Cash
Flo1s
Alternative ):
&nvestment in the $onds........... Aow
R(++0,<<
<* 9
R(++0,<<
<* ).<<<
R(++0,<<<
*
&nterest on the $onds
()<P V R++0,<<<*.................. )7)+ R++,0<< ) X <./< R),,0<< @.0,2 )<),@,2
Maturity of the $onds................ )+ R++0,<<< 9 R++0,<<< <.,C@ BC,,+0
Aet present value.....................
R (,,,C,C
*
3olutions Manual, "hapter )/ ),)
-ear's
+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
HJ
Facto
r
Present
Value of
Cash
Flo1s
Alternative +:
&nvestment in the $usiness............... Aow
R(++0,<<
<* 9
R(++0,<<
<* ).<<<
R(++0,<<
<*
Aet annual cash receipts
(RB0<,<<< X R@B<,<<< Y R@<,<<<*.... )7)+ R@<,<<<
) X
<./< R/+,<<< @.0,2 ,)2,0)+
>epreciation deductions:
Qear ): )/.,P of RB<,<<<............... ) R)),//< <./< R/,0@2 <.C+2 /,+,@
Qear +: +/.0P of RB<,<<<............... + R)C,2<< <./< R@,B/< <.B0@ 2,@)C
Qear ,: )@.0P of RB<,<<<............... , R)/,<<< <./< R0,2<< <.@C/ /,//2
Qear /: )+.0P of RB<,<<<............... / R)<,<<< <./< R/,<<< <.@,0 +,C/<
Qear 0: B.CP of RB<,<<<............... 0 R@,)+< <./< R+,B/B <.2B) ),C,C
Qear 2: B.CP of RB<,<<<............... 2 R@,)+< <./< R+,B/B <.2,< ),@C/
Qear @: B.CP of RB<,<<<............... @ R@,)+< <./< R+,B/B <.0B, ),22<
Qear B: /.0P of RB<,<<<............... B R,,2<< <./< R),//< <.0/< @@B
!ayment to $reak the lease................. )+ R(+,<<<*
) X
<./< R(),+<<* <.,C@ (/@2*
8ecovery of working capital
(R++0,<<< X RB<,<<< Y R)/0,<<<*..... )+ R)/0,<<< 9 R)/0,<<< <.,C@ 0@,020
Aet present value................................ R)@,,))/
Aet present value in favor of
alternative +..................................... R+<@.<0,
3olutions Manual, "hapter )/ ),+
). he net cash in-ow from sales of the device for each year
would $e:
-ear
4 5 6 7/45
3ales in units.................... 2,<<< )+,<<< )0,<<< )B,<<<
3ales in dollars
(_ R,0 each*................. R +)<,<<< R/+<,<<<
R0+0,<<
<
R2,<,<<
<
(_ R)0 each*................. C<,<<< )B<,<<< ++0,<<< +@<,<<<
"ontri$ution margin......... )+<,<<< +/<,<<< ,<<,<<< ,2<,<<<
=ess '.ed e.penses:
3alaries and otherZ........ ))<,<<< ))<,<<< ))<,<<< ))<,<<<
Advertising..................... )B<,<<< )B<,<<< )0<,<<< )+<,<<<
otal '.ed e.penses......... +C<,<<< +C<,<<< +2<,<<< +,<,<<<
Aet cash in-ow (out-ow*..
R()@<,<<<
*
R(0<,<<<
* R /<,<<<
R),<,<<
<
Z >epreciation is not a cash e.pense and therefore must $e
eliminated from this computation. he analysis is:
(R,)0,<<< X R)0,<<< Y R,<<,<<<* [ )+ years Y R+0,<<<
depreciation%
R),0,<<< total e.pense X R+0,<<< depreciation Y R))<,<<<.
3olutions Manual, "hapter )/ ),,
+. he net present value of the proposed investment would $e:
"tem
-ear's
+
Amount
of Cash
Flo1s
47J
Facto
r
Present
Value of
Cash
Flo1s
&nvestment in e4uipment. . . Aow
R(,)0,<<<
* ).<<<
R(,)0,<<
<*
Oorking capital needed...... Aow R(2<,<<<* ).<<< (2<,<<<*
Qearly cash -ows (see
a$ove*............................. )
R()@<,<<<
* <.B@@ ()/C,<C<*
a$ove*............................. + R(0<,<<<* <.@2C (,B,/0<*
a$ove*............................. , R/<,<<< <.2@0 +@,<<<
a$ove*............................. /7)+ R),<,<<< ,.,,B
Z
/,,,C/<
3alvage value of
e4uipment....................... )+ R)0,<<< <.+<B ,,)+<
8elease of working capital.. )+ R2<,<<< <.+<B )+,/B<
Aet present value...............
R (B2,<<<
*
Z !resent value factor for )+ periods................................0.22<
!resent value factor for , periods..................................+.,++
!resent value factor for C periods, starting / periods
in the future.................................................................,.,,B
3ince the net present value is negative, the company should
not accept the device as a new product.
3olutions Manual, "hapter )/ ),/
&ro'lem 14-35 (@0 minutes*
).
"tems
-ear's
+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
45J
Facto
r
Present
Value of
Cash
Flo1s
?uy the new trucks:
&nvestment in the trucks................. Aow
R(20<,<<
<* 9
R(20<,<<
<* ).<<<
R(20<,<<
<*
"ash from the sale of the old
trucks:
3ale price received....................... Aow RB0,<<< 9 RB0,<<< ).<<< B0,<<<
a. savings from loss on saleZ...... ) R,0,<<< <.,< R)<,0<< <.BC, C,,@@
Annual cash operating costs........... )7@
R())<,<<
<* ) X <.,< R(@@,<<<* /.02/ (,0),/+B*
>epreciation deductions
(R20<,<<< [ 0 years Y
R),<,<<< per year*...................... )70 R),<,<<< <.,< R,C,<<< ,.2<0 )/<,0C0
3alvage value of the new trucks..... @ R2<,<<< ) X <.,< R/+,<<< <./0+ )B,CB/
Aet present value...........................
R(@/@,/@
+*
Z
?ook value of old trucks. .
R)+<,<<
<
=ess sale price (a$ove*....
B0,<<
<
=oss on the sale..............
R
,0,<<<
3olutions Manual, "hapter )/ ),0
3olutions Manual, "hapter )/ ),2
-ear's
+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
45J
Facto
r
Present
Value of
Cash
Flo1s
Ueep the old trucks:
8epairs needed............................... )
R()@<,<<
<* ) X <.,<
R())C,<<
<* <.BC,
R()<2,+2
@*
Annual cash operating costs........... )7@
R(+<<,<<
<* ) X <.,<
R()/<,<<
<* /.02/ (2,B,C2<*
>epreciation deductions................. )7+ R2<,<<< <.,< R)B,<<< ).2C< ,<,/+<
3alvage value of the old trucks....... @ R)0,<<< ) X <.,< R)<,0<< <./0+ /,@/2
Aet present value...........................
R(@)<,<2
)*
keeping the old trucks..................
R ,@,/)
)
3olutions Manual, "hapter )/ ),@
+. he solution $y the incremental7cost approach $elow computes the net advantage (or
disadvantage* of investing in the new trucks versus keeping the old trucks.
-ear's
+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
45J
Factor
Present
Value of
Cash
Flo1s
&nvestment in the new trucks.......... Aow
R(20<,<<
<* 9 R(20<,<<<* ).<<<
R(20<,<<
<*
8epairs avoided on the old truck..... ) R)@<,<<< ) X <.,< R))C,<<< <.BC, )<2,+2@
"ash from the sale of the old
trucks:
3ale price received....................... Aow RB0,<<< 9 RB0,<<< ).<<< B0,<<<
a. savings from loss on sale........ ) R,0,<<< <.,< R)<,0<< <.BC, C,,@@
3avings in annual cash operating
costs (R+<<,<<< X R))<,<<<*........ )7@ RC<,<<< ) X <.,< R2,,<<< /.02/ +B@,0,+
>epreciation deductions:
>epreciation on new trucks.......... )70 R),<,<<< <.,< R,C,<<< ,.2<0 )/<,0C0
>epreciation forgone on old
trucks......................................... )7+ R(2<,<<<* <.,< R()B,<<<* ).2C< (,<,/+<*
>i#erence in salvage value in
seven years (R2<,<<< X R)0,<<<*.. @ R/0,<<< ) X <.,< R,),0<< <./0+ )/,+,B
Aet present value............................
R
(,@,/))*
3ince the net present value of investing in the new trucks rather than keeping the old
trucks is negative, the new trucks should not $e purchased.
3olutions Manual, "hapter )/ ),B
). 8achel ArnettGs revision of her 'rst proposal can $e considered
a violation of the 3tandards of Ethical "onduct. 3he discarded
her reasona$le projections and estimates after she was
4uestioned $y Oilliam Earle. 3he used 'gures that had a
remote chance of occurring. ?y doing this, she violated the
3tandard of D$jectivity9M"ommunicate information fairly and
o$jectivelyN and Mdisclose fully relevant information that could
reasona$ly $e e.pected to in-uence an intended userGs
recommendations presented.N ?y altering her analysis, she also
violated the 3tandard of &ntegrity. 3he engaged in an activity
that would prejudice her a$ility to carry out her duties ethically,
and she failed to communicate unfavora$le as well as favora$le
information and professional judgments or opinions. &n addition,
she violated the 3tandard of "ompetence9Mprepare complete
and clear reports and recommendations after appropriate
analysis of relevant and relia$le information.N
+. Earle was clearly in violation of the 3tandards of Ethical
"onduct for Management Accountants $ecause he tried to
persuade a su$ordinate to prepare a proposal with data that
was false and misleading. Earle has violated the 3tandards of
"ompetence (failure to perform professional duties in
accordance with t technical standards% prepare complete and
clear reports and recommendations after appropriate analyses
of relevant and relia$le information*, &ntegrity (engaged in an
activity that would prejudice his a$ility to carry out his duties
ethically, actively or passively su$vert the attainment of the
organizationGs legitimate and ethical o$jectives, failure to
communicate unfavora$le as well as favora$le information and
professional judgments or opinions, and supported activity that
would discredit the profession*, and D$jectivity (failed to
communicate information fairly and o$jectively and did not
disclose fully all relevant information that could reasona$ly $e
e.pected to in-uence an intended userGs understanding of the
reports, comments, and recommendations presented*.
3olutions Manual, "hapter )/ ),C
,. he internal controls Fore "orporation could implement to
prevent unethical $ehavior include:
approval of all formal capital e.penditure proposals $y the
"ontroller andHor the ?oard of >irectors.
designating a non7accountingH'nance manager to coordinate
capital e.penditure re4uests andHor segregating duties during
the preparation and approval of capital e.penditure re4uests.
re4uiring that all capital e.penditure proposals $e reviewed $y
senior operating management, which includes the "ontroller,
$efore the proposals are su$mitted for approval.
re4uiring the internal audit sta# to review all capital
e.penditure proposals or contracting e.ternal auditors to
review the proposal if the corporation lacks manpower.
(KnoEcial "MA 3olution*
3olutions Manual, "hapter )/ )/<
Case 14-3! (2< minutes*
). his least7cost pro$lem can $e worked either using the total7cost approach or the
incremental7cost approach. ?oth solutions are given $elow. 8egardless of which approach
is used, we must 'rst compute the annual production costs that would result from each
of the machines. he computations are:
-ear
4 5 6 7/4:
Knits produced.................................... /<,<<< 2<,<<< B<,<<< C<,<<<
Model /<<: otal cost at R<.B< per
unit...................................................
R,+,<<< R/B,<<< R2/,<<< R@+,<<<
Model B<<: otal cost at R<.2< per
unit...................................................
R+/,<<< R,2,<<< R/B,<<< R0/,<<<
Ksing these data, the solution $y the total7cost approach would $e:
"tem
-ear's
+
Amount
of Cash
Flo1s
5:J
Facto
r
Present
Value of
Cash
Flo1s
Alternative ): !urchase the model /<<
machine:
"ost of a new machine................................ Aow R()@<,<<<
*
).<<< R()@<,<<
<*
"ost of a new machine................................ @ R(+<<,<<<
*
<.+@C (00,B<<*
Market value of the replacement
machine...................................................
)< R)/<,<<< <.)2+ ++,2B<
!roduction costs (a$ove*............................. ) R(,+,<<<* <.B,, (+2,202*
!roduction costs (a$ove*............................. + R(/B,<<<* <.2C/ (,,,,)+*
3olutions Manual, "hapter )/ )/)
!roduction costs (a$ove*............................. , R(2/,<<<* <.0@C (,@,<02*
!roduction costs (a$ove*............................. /7)< R(@+,<<<* +.<B2 Z ()0<,)C+*
8epairs and maintenance (maintenance
for two Model /<< machines _ R+,0<<
per year*.................................................. )7)< R(0,<<<* /.)C+
(+<,C2<
*
!resent value of cash -ows......................... R(/@),+C
2*
Z 3ee the note on the ne.t page.
3olutions Manual, "hapter )/ )/+
"tem
-ear's
+
Amount
of Cash
Flo1s
5:J
Fact
or
Present
Value of
Cash
Flo1s
Alternative +: !urchase the model B<<
machine:
"ost of a new machine.............................. Aow R(,<<,<<<
*
).<<< R(,<<,<<<
*
!roduction costs (a$ove*........................... ) R(+/,<<<* <.B,, ()C,CC+*
!roduction costs (a$ove*........................... + R(,2,<<<* <.2C/ (+/,CB/*
!roduction costs (a$ove*........................... , R(/B,<<<* <.0@C (+@,@C+*
!roduction costs (a$ove*........................... /7)< R(0/,<<<* +.<B2 Z ())+,2//*
8epairs and maintenance.......................... )7)< R(,,B<<* /.)C+ ()0,C,<*
!resent value of cash -ows....................... R(0<),,/+
*
Aet present value in favor of purchasing
the model /<< machine............................ R ,<,</2
Z !resent value factor for )< periods................................................/.)C+
!resent value factor for , periods..................................................+.)<2
!resent value factor for @ periods starting / periods in the
future..........................................................................................+.<B2
Ohen doing an analysis $y the incremental7cost approach, it is necessary to proceed
from a perspective of one of the two alternatives. 3ince the model B<< is the more costly
of the two, we will proceed from the perspective of this alternative. he computations
are provided on the following page.
3olutions Manual, "hapter )/ )/,
he solution from an incremental7cost approach would $e:
"tem
-ear's
+
Amount
of Cash
Flo1s
5:J
Facto
r
Present
Value of
Cash
Flo1s
&ncremental cost of the model B<<
machine:
Aow R(),<,<<
<*
).<<< R(),<,<<<
*
"ost avoided on a replacement model /<<
machine........................................................
@ R+<<,<<< <.+@C 00,B<<
Market value forgone on the replacement....... )< R()/<,<<
<*
<.)2+ (++,2B<*
3avings in production costs............................. ) RB,<<< <.B,, 2,22/
3avings in production costs............................. + R)+,<<< <.2C/ B,,+B
3avings in production costs............................. , R)2,<<< <.0@C C,+2/
3avings in production costs............................. /7)< R)B,<<< +.<B2 ,@,0/B
3avings on repairs and maintenance costs..... )7)< R),+<< /.)C+ 0,<,<
Aet present value of purchasing a model
B<< machine rather than a second model
/<< machine................................................. R(,<,</2*
herefore, the company should purchase a second model /<< machine rather than
purchase the model B<< machine.
+. An increase in la$or costs would make the model B<< machine more desira$le since the
la$or cost per unit of product is only R<.)2 on the model B<< machine, as compared to
R<./C per unit on the model /<< machine.
3olutions Manual, "hapter )/ )//
,. An increase in materials cost would make the model B<< machine less desira$le since
the materials cost per unit of product is R<./< on the model B<< machine, as compared
to only R<.+0 per unit on the model /<< machine.
3olutions Manual, "hapter )/ )/0
Case 14-3" (@0 minutes*
?efore the net present value analysis can $e completed, the
following computations must $e made:
!urchase cost of the e4uipment:
=ist price............................................................ RC/0,<<<
=ess discount (+P V RC/0,<<<*......................... ()B,C<<*
Add freight......................................................... )),<<<
Add installation.................................................. ++,C<<
Aet installed cost............................................... RC2<,<<<
8elevant manufacturing costs:
"ost per unit:
>irect materials (R)< V ).,*.............................. R),
>irect la$or (RB V <.0*....................................... /
Iaria$le overhead (R2 V <.0*............................. ,
otal cost per unit.............................................. R+<
3olutions Manual, "hapter )/ )/2
,otal cost per %earG
4 5 6 7 ;
Aum$er of units needed.............. 0<,<<< 0<,<<< 0+,<<< 00,<<< 00,<<<
"ost per unit (a$ove*.................. V R+< V R+< V R+< V R+< V R+<
otal cost.....................................
R),<<<,<<
<
R),<<<,<<
<
R),</<,<<
<
R),)<<,<<
<
R),)<<,<<
<
Another approach would $e to include the R)) per unit in '.ed manufacturing cost along
with the varia$le costs. Oe havenGt included this 'gure in our computations since it is the
same under either alternative e.cept for the R/0,<<< in supervision cost avoided under the
M$uyN alternative. his R/0,<<< is included as a cost avoided under the M$uyN alternative on
the following page.
2elevant Nbu%O costsG
4 5 6 7 ;
Aum$er of units needed.............. 0<,<<< 0<,<<< 0+,<<< 00,<<< 00,<<<
!urchased cost per unit............... V R+B V R+B V R+B V R+B V R+B
otal cost.....................................
R),/<<,<<
<
R),/<<,<<
<
R),/02,<<
<
R),0/<,<<
<
R),0/<,<<
<
&f students include the R)) per unit in '.ed manufacturing cost on the MmakeN side a$ove,
then they must also include it on the M$uyN side less the R/0,<<< per year in supervisor
cost avoided.
3olutions Manual, "hapter )/ )/@
-ear's
+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
47J
Facto
r
Present
Value of
Cash
Flo1s
Make the containers:
"ost of the new e4uipment... Aow R(C2<,<<<* 9
R(C2<,<<
<* ).<<< R(C2<,<<<*
Oorking capital needed............ Aow R(+<,<<<* 9 R(+<,<<<* ).<<< (+<,<<<*
3alvage9old e4uipment........... Aow R),0<< ) X <.,< R),<0< ).<<< ),<0<
8elevant manufacturing
cost........................................ )
R(),<<<,<<<
*) X <.,<
R(@<<,<<
<* <.B@@ (2),,C<<*
cost........................................ +
R(),<<<,<<<
*) X <.,<
R(@<<,<<
<* <.@2C (0,B,,<<*
cost........................................ ,
R(),</<,<<<
*) X <.,<
R(@+B,<<
<* <.2@0 (/C),/<<*
cost........................................ /
R(),)<<,<<<
*) X <.,<
R(@@<,<<
<* <.0C+ (/00,B/<*
cost........................................ 0
R(),)<<,<<<
*) X <.,<
R(@@<,<<
<* <.0)C (,CC,2,<*
>epreciation deductions
(RC2<,<<< [ / years Y
R+/<,<<< per year*................)7/ R+/<,<<< <.,< R@+,<<< +.C)/ +<C,B<B
3alvage value of the new
e4uipment.............................. 0 R)0,<<< ) X <.,< R)<,0<< <.0)C 0,/0<
Oorking capital released........... 0 R+<,<<< 9 R+<,<<< <.0)C )<,,B<
Aet present value.....................
R(,,+0+,,B
+*
3olutions Manual, "hapter )/ )/B
-ear's
+
'4+
Amount
'5+
,ax
E#ect
'4+ T '5+
After/,ax
Cash
Flo1s
47J
Facto
r
Present
Value of
Cash
Flo1s
?uy the containers:
"ost to purchase..................... )
R(),/<<,<<<
* ) X <.,< R(CB<,<<<* <.B@@
R (B0C,/2<
*
"ost to purchase..................... +
R(),/<<,<<<
* ) X <.,< R(CB<,<<<* <.@2C (@0,,2+<*
"ost to purchase..................... ,
R(),/02,<<<
* ) X <.,<
R(),<)C,+<
<* <.2@0 (2B@,C2<*
"ost to purchase..................... /
R(),0/<,<<<
* ) X <.,<
R(),<@B,<<
<* <.0C+ (2,B,)@2*
"ost to purchase..................... 0
R(),0/<,<<<
* ) X <.,<
R(),<@B,<<
<* <.0)C (00C,/B+*
>ischarge of supervisor.......... )70 R/0,<<< ) X <.,< R,),0<< ,./,, )<B,)/<
Aet present value...................
R(,,,C<,00
B*
making the containers.......... R ),B,)@2
he company should continue to make its own containers.
3olutions Manual, "hapter )/ )/C
Case 14-3# (/0 minutes*
). 3ome students will have diEculty organizing the data in a
coherent format. !erhaps the clearest approach is as follows:
"tem
-ear's
+
Amount
of Cash
Flo1s
4EJ
Facto
r
Present
Value of
Cash Flo1s
!urchase of facilities:
&nitial payment9
property........................ Aow
R(,0<,<<<
* ).<<< R(,0<,<<<*
Annual payments9
property........................ )7/
R()@0,<<<
* +.@CB (/BC,20<*
costs.............................. )7)B R(+<,<<<* 0.B)B ())2,,2<*
8esale value of the
property........................ )B R0<<,<<< <.<2C ,/,0<<
Aet present value............ R(C+),0)<*
=ease of facilities:
&nitial deposit................... Aow R(B,<<<* ).<<< R (B,<<<*
First lease payment......... Aow
R()+<,<<<
* ).<<< ()+<,<<<*
8emaining lease
payments...................... )7)@
R()+<,<<<
* 0.@/C (2BC,BB<*
Annual cost of repairs,
etc................................. )7)B R(/,0<<* 0.B)B (+2,)B)*
8eturn of deposit............. )B RB,<<< <.<2C 00+
Aet present value............ R(B/,,0<C*
Aet present value in favor
of leasing the facilities..... R @B,<<)
his is a least7cost decision, and, as shown a$ove, the total7
cost approach is the simplest way to handle the data. he
pro$lem with 3am OatkinGs approach, in which he simply added
up the payments, is that it ignores the time value of money.
he purchase option ties up large amounts of funds that could
$e earning a return elsewhere.
3olutions Manual, "hapter )0 )/@
he incremental7cost7approach can also $e used, although this
approach is harder to follow and would not $e as clear in a
presentation to the e.ecutive committee. he data could $e
arranged as follows (students will have many variations*:
?uy rather than lease:
"tem
-ear's
+
Amount
of Cash
Flo1s
4EJ
Facto
r
Present
Value of
Cash Flo1s
&ncremental initial
payment (R,0<,<<< X
R)+<,<<< Y
R+,<,<<<*................... Aow
R(+,<,<<<
* ).<<< R(+,<,<<<*
>eposit avoided $y
purchasing.................. Aow RB,<<< ).<<< B,<<<
Annual payments9
property...................... )7/
R()@0,<<<
* +.@CB (/BC,20<*
=ease payments
avoided...................... )7)@ R)+<,<<< 0.@/C 2BC,BB<
Additional cash
operating costs
(R+<,<<< X R/,0<< Y
R)0,0<<*..................... )7)B R()0,0<<* 0.B)B (C<,)@C*
>i#erence $etween
resale value and
deposit at end
(R0<<,<<< X RB,<<<
Y R/C+,<<<*............... )B R/C+,<<< <.<2C ,,,C/B
Aet present value.......... R (@B,<<)*
+. &f 3am Oatkins $rings up the issue of the $uildingGs future sales
value, then it should $e pointed out that a property that can $e
sold for R0<<,<<< in )B years has a present value of only
R,/,0<< if a company can invest money at )2P. &n other
words, a high future sale value is often worth very little in
terms of present value when money can $e invested at a high
rate of return, such as in the case of op76uality 3tores. Aote
that the $uildingGs sale value could $e three times as high in )B
3olutions Manual, "hapter )0 )/B
years (i.e., R),0<<,<<<* and the lease alternative would still $e
$etter than the purchase alternative.
3olutions Manual, "hapter )0 )/C
,roup E%ercise 14-4$
3tudentsG answers will depend on the speci'c project they
investigate at your local university or college.
3olutions Manual, "hapter )0 )0<
Chapter 15
Service Department Costing:
An Activity Approach
15-1 Dperating departments are the
units in an organization within which the
central purposes of the organization are
carried out% these departments usually
generate revenue. ?y contrast, service
departments provide support or assistance
to the operating departments. E.amples
of service departments include laundry
services, internal auditing, airport
maintenance services (ground crews*,
cafeteria, personnel, cost accounting, and
so on.
15-2 3ervice department costs are
allocated to products and services in two
stages. 3ervice department costs are 'rst
allocated to the operating departments.
hese allocated costs are then included in
the operating departmentsG overhead
rates, which are used to cost products and
services.
15-3 &nterdepartmental service costs
e.ist whenever two service departments
perform services for each other. Knder the
step method, the costs of the service
department performing the greatest
amount of service for the other service
departments are allocated 'rst, the costs
of the service department performing the
ne.t greatest amount of service are
allocated ne.t, and so forth through all the
service departments. Dnce a service
departmentGs costs have $een allocated,
costs are not reallocated $ack to it under
the step method.
15-4 Knder the direct method, costs are
not allocated from one service department
to another. 8ather, all service department
costs are allocated directly to operating
departments.
15-5 &f a service department generates
revenues, these revenues should $e o#set
against the departmentGs costs and only
the net amount of cost remaining after
this o#set should $e allocated to other
departments.
15- wo general guidelines govern the
allocation of '.ed service department
costs to other departments: ()* allocate
only $udgeted costs, and (+* allocate '.ed
costs in predetermined, lump7sum
amounts, according to how much of the
service departmentGs capacity is ac4uired
to serve each of the other departments.
wo general guidelines also govern
the allocation of varia$le service
department costs to other departments:
()* allocate at $udgeted rates, and (+*
allocate the costs according to whatever
activity (direct la$or7hours, pounds of
laundry, etc.* causes their incurrence.
15-! &f a varia$le $ase is used to
allocate '.ed costs, the costs allocated to
one department will depend in large part
on what is happening in other
departments. As a conse4uence, the
amount of service department cost
allocated to a department will increase or
decrease depending on the activity in
other departments.
3olutions Manual, "hapter )0 )0)
3olutions Manual, "hapter )0 )0+
Service !epartments $perating !epartments
Admini/
stration
Facilit%
Services
Undergradua
te Programs
@raduate
Programs ,otal
>epartmental costs
$efore allocations.........
R+,/<<,<<
<
R),2<<,<<
< R+2,B<<,<<<
R0,@<<,<<
<
R,2,0<<,<
<<
Allocations:
Administration costs
(+<H+0, 0H+0*............
(+,/<<,<<<
* ),C+<,<<< /B<,<<<
Facility 3ervices
costs
(@<H)<<, ,<H)<<*Z. . . .
(),2<<,<<
<* ),)+<,<<< /B<,<<<
otal costs after
allocation..................... R < R < R+C,B/<,<<<
R2,22<,<<
<
R,2,0<<,<
<<
Z?ased on the space occupied $y the two operating departments, which is )<<,<<< s4uare
feet.
3olutions Manual, "hapter )0 )0,
Service
!epartments
$perating
!epartments
Admini/
stration
9anitori
al @roceries @ifts ,otal
>epartmental costs $efore
allocations......................................
R)0<,<<
<
R/<,<<
<
R+,,+<,<
<<
RC0<,<
<<
R,,/2<,<
<<
Allocations:
Administration costs
()2<H/,<<<, ,,)<<H/,<<<,
@/<H/,<<<*Z................................
()0<,<<
<* 2,<<< ))2,+0< +@,@0<
5anitorial costs
(/,<<<H0,<<<, ),<<<H0,<<<*u.......
(/2,<<<
*
,2,B<
<
C,+<
<
otal costs after allocation................ R
< R <
R+,/@,,<
0<
RCB2,C
0<
R,,/2<,<
<<
Z?ased on employee hours in the other three departments, )2< \ ,,)<< \ @/< Y /,<<<.
u?ased on space occupied $y the two operating departments, /,<<< \ ),<<< Y 0,<<<.
?oth the 5anitorial >epartment costs of R/<,<<< and the Administration costs of R2,<<<
that have $een allocated to the 5anitorial >epartment are allocated to the two operating
departments.
3olutions Manual, "hapter )0 )0/
(orthern
Plant
Souther
n Plant
Iaria$le costs:
R<.+0 per ton V )+<,<<< tons..... R,<,<<<
R<.+0 per ton V 2<,<<< tons....... R)0,<<<
Fi.ed costs:
@<P V R,<<,<<<......................... +)<,<<<
,<P V R,<<,<<<......................... C<,<<<
otal allocated costs...................... R+/<,<<< R)<0,<<<
3olutions Manual, "hapter )0 )00
). and +.
End7of7year allocations of varia$le costs should $e $ased on the
actual level of activity multiplied $y the budgeted rate. End7of7
year allocations of '.ed costs should $e $ased on the same
predetermined lump7sum amounts as at the $eginning of the
year. Actual costs in e.cess of (or less than* the $udgeted rate
for varia$le costs or the $udgeted total '.ed costs should not
$e allocated to the plants. herefore, the allocations of
transport services cost at the end of the year would $e:
(orthern
Plant
Souther
n Plant ,otal
Iaria$le costs:
R<.+0 per ton V ),<,<<<
tons................................... R ,+,0<<
R<.+0 per ton V 0<,<<<
tons................................... R )+,0<< R /0,<<<
Fi.ed costs:
@<P V R,<<,<<<.................. +)<,<<<
,<P V R,<<,<<<.................. C<,<<< ,<<,<<<
otal cost................................ R+/+,0<< R)<+,0<< R,/0,<<<
,. !art of the R,2/,<<< in total cost will not $e allocated to the
plants, as follows:
Variable
Cost
Fixed
Cost ,otal
otal cost incurred.................. R0/,<<< R,)<,<<< R,2/,<<<
otal cost allocated (a$ove*.... /0,<<< ,<<,<<< ,/0,<<<
Amount of cost not allocated.. R C,<<< R )<,<<< R )C,<<<
he cost not allocated represents cost incurred in e.cess of the
$udgeted R<.+0 per ton varia$le cost and $udgeted R,<<,<<<
in '.ed costs. his R)C,<<< in unallocated cost is the
responsi$ility of the ransport 3ervices >epartment and is a
cost variance for the year.
Service
!epartments
$perating
!epartments
Adminis
tration
9anitoria
l
Mainten
ance Binding Printing ,otal
Dverhead costs.............................
R)/<,<<
<
R)<0,<<
< R /B,<<<
R+@0,<<
<
R/,<,<<
<
RCCB,<<
<
Allocations:
Administration costs:
(0P, +<P, /0P, ,<P*Z.............
()/<,<<<
* @,<<< +B,<<< 2,,<<< /+,<<<
5anitorial costs: ()HB, +HB, 0HB*.....
())+,<<<
* )/,<<< +B,<<< @<,<<<
Maintenance costs: ()H,, +H,*...... (C<,<<<* ,<,<<< 2<,<<<
otal overhead costs after
allocations.................................. R < R < R <
R,C2,<<
<
R2<+,<<
<
RCCB,<<
<
Z Allocations can $e shown in percentages, in fractions, or as a rate per unit of activity. For
e.ample, Administration allocations have $een shown as percentages, $ut they could have
$een shown as )H+<% /H+<% CH+<% and 2H+< or they could have $een shown as R+<< per
employee. Fractions should $e used if percentages result in rounding errors.
3olutions Manual, "hapter )0 )0@
3upporting computations:
Administration costs allocated on the $asis of:
5anitorial................ ,0 employees 0 P
Maintenance......... )/< employees +<
?inding.................. ,)0 employees /0
!rinting................. +)< employees ,<
otal...................... @<< employees )<< P
5anitorial costs allocated on the $asis of:
Maintenance......... +<,<<< s4uare feet )HB
?inding.................. /<,<<< s4uare feet +HB
!rinting.................
)<<,<<< s4uare
feet 0HB
otal......................
)2<,<<< s4uare
feet BHB
Maintenance costs allocated on the $asis of:
?inding.................. ,<,<<< hours )H,
!rinting................. 2<,<<< hours +H,
otal...................... C<,<<< hours ,H,
3olutions Manual, "hapter )0 )0B
Service
!epartments
$perating
!epartments
Administ
ration 9anitorial
Mainten
ance Binding Printing ,otal
Dverhead costs....................... R)/<,<<< R)<0,<<< R /B,<<< R+@0,<<< R/,<,<<< RCCB,<<<
Allocation:
Administration costs: (,H0,
+H0*.................................... ()/<,<<<* B/,<<< 02,<<<
5anitorial costs: (+H@, 0H@*...... ()<0,<<<* ,<,<<< @0,<<<
Maintenance costs: ()H,,
+H,*.................................... (/B,<<<* )2,<<< ,+,<<<
allocations............................ R < R < R < R/<0,<<< R0C,,<<< RCCB,<<<
Administration 9anitorial Maintenance
?indin
g
,)0
employees ,H0
/<,<<< s4uare
feet +H@ ,<,<<< hours )H,
!rintin
g
+)<
employees +H0
)<<,<<< s4uare
feet 0H@ 2<,<<< hours +H,
otal.....
0+0
employees 0H0
)/<,<<< s4uare
feet @H@ C<,<<< hours ,H,
3olutions Manual, "hapter )0 )0C
). 2estaurants
2ic&Us
<arborside
"mperial
@arden
@inger
0o& ,otal
!ercentage of +<<0 sales............... ,+P 0<P )BP )<<P
Allocation of +<<0 '.ed
administrative e.penses ($ased
on the a$ove
percentages*............................... R2/<,<<< R),<<<,<<< R,2<,<<< R+,<<<,<<<
+. +<<0 allocation (a$ove*................. R2/<,<<< R),<<<,<<< R,2<,<<< R+,<<<,<<<
+<</ allocation.............................. B<<,<<< @0<,<<< /0<,<<< +,<<<,<<<
&ncrease (decrease* in allocation.... R()2<,<<<* R +0<,<<< R(C<,<<<* R <
he manager of the &mperial 1arden undou$tedly will $e upset a$out the increased
allocation of '.ed administrative e.pense. 3uch an increased allocation may $e viewed
as a penalty for an outstanding performance.
,. 3ales dollars is not ordinarily a good $ase for allocating '.ed costs. he departments
with the greatest sales will $e allocated the greatest amount of cost and the costs
allocated to a department will $e a#ected $y the sales in other departments. &n our
illustration a$ove, the sales in two restaurants remained static and the sales in the third
increased. As a result, less cost was allocated to the restaurants with static sales and
more cost was allocated to the one restaurant that showed improvement during the
period.
3olutions Manual, "hapter )0 )2<
he $udgeted rate of R)B per S7ray should $e multiplied $y the
actual num$er of S7rays provided for each operating department
for the end7of7year allocations.
'4+
Budgete
d 2ate
'5+
Actual
(umber
of B/ra%s
'4+ T '5+
,otal
Allocation
!ediatrics.................. R)B 2,<<< R)<B,<<<
D? "are..................... R)B ,,<<< 0/,<<<
1eneral ;ospital....... R)B )0,<<< +@<,<<<
otal.......................... +/,<<< R/,+,<<<
he di#erence $etween the $udgeted and actual cost per S7ray is
the responsi$ility of the 8adiology >epartment and is not
allocated to the operating departments. his variance totals
R/B,<<< for the year.
+/,<<< S7rays V (R+< X R)B Y R+ per S7ray* Y R/B,<<<.
3olutions Manual, "hapter )0 )2)
).
9anitorial
Services
2adiolog
%
Pediatric
s $B Care
@eneral
<ospital
"ost to $e allocated....................... R,@0,<<< R0C<,<<<
Allocations:
5anitorial 3ervices:
(/P, +<P, )2P, 2<P*............... (,@0,<<<* )0,<<< R@0,<<< R2<,<<< R++0,<<<
8adiology: (,H)<, +H)<, 0H)<*....... (2<0,<<<* )B),0<< )+),<<< ,<+,0<<
allocations................................... R < R < R+02,0<< R)B),<<< R0+@,0<<
5anitorial
3ervices: 8adiology:
8adiology.......... 2,<<< s4. ft. / P !ediatrics.......... C,<<< S7rays ,H)<
!ediatrics.......... ,<,<<< s4. ft. +< D? "are............. 2,<<< S7rays +H)<
D? "are............. +/,<<< s4. ft. )2
1eneral
;ospital.......... )0,<<< S7rays 0H)<
1eneral
;ospital.......... C<,<<< s4. ft. 2< ,<,<<< S7rays )<H)<
)0<,<<< s4.
ft. )<< P
+. he allocations would $e the same as in !art ), since $udgeted '.ed costs are always
allocated to consuming departments. hus, R2,<<< of the actual '.ed costs in 5anitorial
3ervices (R,B),<<< X R,@0,<<<* and R)<,<<< of the actual '.ed costs in 8adiology
(R2<<,<<< X R0C<,<<<* would not $e allocated to other departments.
3olutions Manual, "hapter )0 )2+
). ',housands of Z+
Factor%
Admini/
stration
Custodia
l
Services
Personn
el
Mainte/
nance
Machinin
g
Assembl
%
Step method
Dperating department
costs.................................. `,@2,,<< `)@0,C<<
"osts to $e allocated............
`+@<,<<
< ` 2B,@2< ` +B,B/< ` /0,+<<
Allocations:
Factory Administration
_ `),B<< per la$or7hour.
(+@<,<<<
* 0,/<< C,<<< ,C,2<< 0/,<<< )2+,<<<
"ustodial 3ervices
_ `@+< per s4uare foot... (@/,)2<* +,)2< @,+<< 0<,/<< )/,/<<
!ersonnel
_ `,+<,<<< per
employee........................ (/<,<<<* B,<<< )+,B<< )C,+<<
Maintenance
_ `),+0< per machine7
hour................................ ()<<,<<<* B@,0<< )+,0<<
otal overhead after
allocations......................... ` < ` < ` < ` < `0B),<<< `,B/,<<<
>ivide $y machine7hours
(thousands*....................... @<
>ivide $y direct la$or7
hours (thousands*.............. B<
Dverhead rate...................... ` B,,<< ` /,B<<
3olutions Manual, "hapter )0 )2,
3olutions Manual, "hapter )0 )2/
+. ',housands of Z+
Factor%
Admini/
stration
Custodia
l
Services
Personn
el
Mainte/
nance
Machinin
g
Assembl
%
!irect method
Dperating department
costs.................................. `,@2,,<< `)@0,C<<
"osts to $e allocated............
`+@<,<<
< `2B,@2< `+B,B/< `/0,+<<
Allocations:
Factory Administration
()H/, ,H/*.........................
(+@<,<<<
* 2@,0<< +<+,0<<
"ustodial 3ervices (@HC,
+HC*................................. (2B,@2<* 0,,/B< )0,+B<
!ersonnel (+H0, ,H0*........... (+B,B/<* )),0,2 )@,,</
Maintenance (@HB, )HB*...... (/0,+<<* ,C,00< 0,20<
otal overhead after
allocations......................... ` < ` < ` < ` < `0/B,,22 `/)2,2,/
>ivide $y machine7hours
(thousands*....................... @<
>ivide $y direct la$or7hours
(thousands*....................... B<
Dverhead rate...................... ` @,B,/ ` 0,+=;
)<<,<<< >=;s
/. he amount of overhead cost assigned to the jo$ would $e:
3tep method:
Machining >epartment: `B,,<< per machine7
hour V )C< machine7hours...............................
`),0@@,<<
<
Assem$ly >epartment: `/,B<< per direct la$or7
hour V @0 direct la$or7hours............................. ,2<,<<<
otal overhead cost...............................................
`),C,@,<<
<
>irect method:
Machining >epartment: `@,B,/ per machine7
hour V )C< machine7hours...............................
`),/BB,/2
<
Assem$ly department: `0,+<B per direct la$or7
hour V @0 direct la$or7hours............................. ,C<,2<<
`),B@C,<2
<
!lantwide method:
`C,20< per direct la$or7hour V )<< direct la$or7
hours................................................................
` C20,<<
<
he plantwide method, which is $ased on direct7la$or hours,
assigns very little overhead cost to the jo$ since it re4uires
little la$or time. Assuming that Factory Administrative costs
really do vary in proportion to la$or7hours, "ustodial 3ervices
with s4uare feet occupied, and so on, the company will tend to
undercost such jo$s if a plantwide overhead rate is used (and it
will tend to overcost jo$s re4uiring large amounts of la$or
time*. he direct method is $etter than the plantwide method,
$ut the step method will generally provide the most accurate
overhead rates of the three methods.
). Auto
!ivision
,ruc&
!ivision
Iaria$le costs:
R, per meal V ,0,<<<
meals................................ R)<0,<<<
R, per meal V +<,<<<
meals................................ R2<,<<<
Fi.ed costs:
20P V R/<,<<<.................... +2,<<<
,0P V R/<,<<<.................... )/,<<<
otal cost allocated................ R),),<<< R@/,<<<
he varia$le costs are allocated $y multiplying the $udgeted
rate per meal $y the $udgeted num$er of meals that will $e
served in each division during the month. he '.ed costs are
allocated in predetermined, lump7sum amounts $ased on the
peak7period need for meals in each division.
+. Auto
!ivision
,ruc&
!ivision
Iaria$le costs:
meals................................ R2<,<<<
meals................................ R2<,<<<
Fi.ed costs:
20P V R/<,<<<.................... +2,<<<
,0P V R/<,<<<.................... )/,<<<
otal cost allocated................ RB2,<<< R@/,<<<
he varia$le costs are allocated according to the $udgeted rate
per meal and not according to the actual rate. he '.ed costs
are again allocated in predetermined, lump7sum amounts,
$ased on $udgeted '.ed costs. Any di#erence $etween
$udgeted and actual costs is not allocated, $ut rather is treated
as a spending variance of the cafeteria:
Variable Fixed
otal actual costs for the month......... R)+B,<<< R/+,<<<
otal cost allocated a$ove.................. )+<,<<< /<,<<<
3olutions Manual, "hapter )0 )2@
3pending variance9not allocated...... R B,<<< R+,<<<
3olutions Manual, "hapter )0 )2B
,. Actual varia$le costs......... R)+B,<<<
Actual '.ed costs.............. /+,<<<
otal actual costs.............. R)@<,<<<
Dne7half of the cost, or RB0,<<<, would $e allocated to each
division, since an e4ual num$er of meals were served in each
division during the month.
/. his method has two major pro$lems. First, the spending
variances should not $e allocated, since this forces the
ineEciencies of the service department onto the using
departments. 3econd, the '.ed costs should not $e allocated
according to month7$y7month usage of services, since this
causes the allocation to one division to $e a#ected $y what
happens in another division.
0. heir strategy pro$a$ly will $e to underestimate their peak
period re4uirements in order to force a greater proportion of
any allocation onto other departments. op management can
control ploys of this type $y careful follow7up, with rewards
$eing given to those managers who estimate accurately, and
severe penalties assessed against those managers who
underestimate their peak period re4uirements. For e.ample,
departments whose managers underestimate their peak period
re4uirements may $e denied access to the cafeteria once their
estimates have $een e.ceeded.
3olutions Manual, "hapter )0 )2C
). Qes, there is merit to the complaint. he company is using a
varia$le $ase (hours of hangar use* to allocate costs that are
largely '.ed. hus, the amount of cost that is charged to a
division during a given month will depend to a large e.tent on
usage in other divisions. A reduction in usage in one division
can result in shifts of costs from it onto the other divisions,
even though the other divisions receive no more service.
+. <ours of Use ,otal Cost
)st 4uarter activity........... ,,<<< R)@+,<<<
+nd 4uarter activity.......... +,<<< )2B,<<<
>i#erence......................... ),<<< R/,<<<
"hange in cost
Iaria$le cost element Y
"hange in activity
R/,<<<
Y YR/ per hour
),<<< hours
Fi.ed cost per 4uarter:
otal cost, )st 4uarter.......................................... R)@+,<<<
=ess varia$le cost (R/ per hour V ,,<<< hours*... )+,<<<
Fi.ed cost............................................................ R)2<,<<<
hus, the cost formula is R)2<,<<< '.ed cost plus R/ per hour
varia$le cost.
3olutions Manual, "hapter )0 )@<
,. Even though the peak7period level of activity will not $e
reached until the fourth 4uarter, it should still $e used to
allocate the '.ed costs of the hangar. he reason is that peak7
period re4uirements determine the present level of '.ed costs.
he fact that the divisions do not need a peak7period level of
servicing every 4uarter is immaterial. &f the divisions re4uire
such servicing at certain times, then the capacity to deliver it
must $e availa$le, and it is the responsi$ility of the divisions to
$ear the cost of that capacity.
Freight
!omesti
c
Passeng
er
$versea
s
Passeng
er
)st 4uarter allocation:
Iaria$le cost:
R/ per hour V C<< hours............ R ,,2<<
R/ per hour V ),B<< hours......... R @,+<<
R/ per hour V ,<< hours............ R ),+<<
Fi.ed cost:
,<P V R)2<,<<<........................ /B,<<<
0<P V R)2<,<<<........................ B<,<<<
+<P V R)2<,<<<........................ ,+,<<<
otal cost allocation...................... R0),2<< RB@,+<< R,,,+<<
+nd 4uarter allocation:
Iaria$le cost:
R/ per hour V B<< hours............ R ,,+<<
R/ per hour V @<< hours............ R +,B<<
R/ per hour V 0<< hours............ R +,<<<
Fi.ed cost:
,<P V R)2<,<<<........................ /B,<<<
0<P V R)2<,<<<........................ B<,<<<
+<P V R)2<,<<<........................ ,+,<<<
otal cost allocation...................... R0),+<< RB+,B<< R,/,<<<
3olutions Manual, "hapter )0 )@)
<ouse/
&eepin
g
Service
s
Food
Services
Admini/
strative
Service
s
)aborato
r%
2adiolog
%
@eneral
<ospital
Iaria$le costs.......................... R <
R)C,,B2
<
R)0B,B/
< R+/,,2<< R,</,B<<
R
@/,0<<
Food 3ervices allocation:
R+.@< per meal V B<<
meals................................. (+,)2<* +,)2<
R+.@< per meal V +,<<<
meals................................. (0,/<<* 0,/<<
R+.@< per meal V ),<<<
meals................................. (+,@<<* +,@<<
R+.@< per meal V 2B,<<<
meals................................. ()B,,2<<* )B,,2<<
Admin. 3ervices allocation:
R,.0< per 'le V )/,<<< 'les. (/C,<<<* /C,<<<
R,.0< per 'le V @,<<< 'les. . . (+/,0<<* +/,0<<
R,.0< per 'le V +0,<<< 'les.
(B@,0<<
* B@,0<<
otal varia$le costs.................. R < R < R < R+CB,<<< R,,+,<<<
R,/0,2<
<
3olutions Manual, "hapter )0 )@+
<ouse/
&eepin
g
Service
s
Food
Services
Admini/
strative
Service
s
)aborato
r%
2adiolog
%
@eneral
<ospital
Fi.ed costs.............................. RB@,<<<
R)<@,+<
< RC<,)B< R)2+,,<< R+)0,@<< R/<),,<<
;ousekeeping 3ervices
allocation _ R<.2< per
s4uare foot:
R<.2< V ),,<<< s4uare feet. . (@,B<<* @,B<<
R<.2< V 2,0<< s4uare feet.... (,,C<<* ,,C<<
R<.2< V )<,<<< s4uare feet. . (2,<<<* 2,<<<
R<.2< V @,0<< s4uare feet.... (/,0<<* /,0<<
R<.2< V )<B,<<< s4uare
feet..................................... (2/,B<<* 2/,B<<
Food 3ervices allocation:
<.BP V R))0,<<<............... (C+<* C+<
+./P V R))0,<<<............... (+,@2<* +,@2<
).2P V R))0,<<<............... (),B/<* ),B/<
C0.+P V R))0,<<<............... ()<C,/B<* )<C,/B<
Admin. 3ervices allocation:
,<P V RC0,<<<.................... (+B,0<<* +B,0<<
+<P V RC0,<<<.................... ()C,<<<* )C,<<<
0<P V RC0,<<<.................... (/@,0<<* /@,0<<
3olutions Manual, "hapter )0 )@,
otal '.ed costs....................... R < R < R < R)CC,02< R+/),</<
R2+,,<B
<
otal overhead costs................ R < R < R < R/C@,02< R0@,,</<
RC2B,2B
<
3olutions Manual, "hapter )0 )@/
"omputation of allocation rates:
Iaria$le Food 3ervices:
Iaria$le food services costs
Allocation rateY
Meals served
R)C,,B2<
Y
@),B<< meals
YR+.@< per meal
Iaria$le Administrative 3ervices:
Iaria$le administrative services costs
Allocation rateY
Files processed
R)0B,B/< \ R+,)2<
Y
/2,<<< 'les
YR,.0< per 'le
Fi.ed ;ousekeeping 3ervices:
Fi.ed housekeeping services costs
Allocation rateY
34uare feet
RB@,<<<
Y
)0<,<<< s4uare feet 7 0,<<< s4uare feet
YR<.2< per s4uare foot
3olutions Manual, "hapter )0 )@0
). ?eginning7of7year allocations of varia$le costs are computed $y
multiplying the $udgeted rate $y the $udgeted level of activity.
Fi.ed costs are allocated in lump7sum amounts $ased on the
peak7period needs of the using departments. he computations
are:
Forming
!epartme
nt
Assembl%
!epartme
nt ,otal
Iaria$le costs:
R<./< per machine7hour
V )2<,<<< machine7
hours............................... R 2/,<<<
V B<,<<< machine7
hours............................... R,+,<<< R C2,<<<
Fi.ed costs:
@<P V R)0<,<<<................ )<0,<<<
,<P V R)0<,<<<................ /0,<<< )0<,<<<
otal cost allocated............... R)2C,<<< R@@,<<< R+/2,<<<
+. a. End7of7year allocations of varia$le costs are computed $y
multiplying the $udgeted rate $y the actual level of activity.
Fi.ed costs are again allocated in predetermined lump7sum
amounts $ased on $udgeted costs. he computations are:
Forming
!epartme
nt
Assembl%
!epartme
nt ,otal
Iaria$le costs:
V )C<,<<< machine7
hours............................... R @2,<<<
V @<,<<< machine7
hours............................... R+B,<<< R)</,<<<
Fi.ed costs:
@<P V R)0<,<<<................ )<0,<<<
,<P V R)0<,<<<................ /0,<<< )0<,<<<
3olutions Manual, "hapter )0 )@2
otal cost allocated............... R)B),<<< R@,,<<< R+0/,<<<
3olutions Manual, "hapter )0 )@@
$. Any di#erence $etween the $udgeted and actual varia$le
cost per machine7hour or $etween the $udgeted and actual
total '.ed cost would not $e allocated to the other
departments. he amount not allocated would $e:
Variable
Cost
Fixed
Cost ,otal
Actual cost incurred during the
year........................................... R))<,<<<
R)0,,<<
<
R+2,,<<
<
"ost allocated (a$ove*................. )</,<<< )0<,<<< +0/,<<<
"ost not allocated (spending
variance*................................... R 2,<<< R ,,<<< R C,<<<
he costs not allocated are spending variances of the
Maintenance >epartment and are the responsi$ility of the
Maintenance >epartmentGs manager.
3olutions Manual, "hapter )0 )@B
). and +.
Building
>
@rounds
Admini
stration
E?uipm
ent
Mainte
nance
Fabric/
ation
Finishin
g
Iaria$le costs to $e allocated............... 8 <
8++,+<
<
8)2,C<
<
Administration:
8+< per employee V ,< employees... (2<<* 2<<
8+< per employee V /0<
employees....................................... (C,<<<* 8 C,<<<
8+< per employee V 2,<
employees....................................... ()+,2<<* 8)+,2<<
E4uipment maintenance:
8<.)< per M; V @<,<<< M;s.............. (@,<<<* @,<<<
8<.)< per M; V )<0,<<< M;s............ ()<,0<<* )<,0<<
otals.................................................... 8 < 8 < 8 < 8)2,<<< 8+,,)<<
3olutions Manual, "hapter )0 )@C
Building
>
@rounds
Admini
stration
E?uipme
nt
Mainten
ance
Fabric/
ation Finishing
Fi.ed costs to $e allocated............... 8BB,+<<
82<,<<
< 8+/,<<<
?uilding J 1rounds:
8, per s4. ft. V 0<< s4. ft............... (),0<<* ),0<<
8, per s4. ft. V ),/<< s4. ft............ (/,+<<* /,+<<
8, per s4. ft. V )+,<<< s4. ft.......... (,2,<<<* 8,2,<<<
8, per s4. ft. V )0,0<< s4. ft.......... (/2,0<<* 8/2,0<<
Administration:
,P V 82),0<<.............................. (),B/0* ),B/0
,BP V 82),0<<.............................. (+,,,@<* +,,,@<
0CP V 82),0<<.............................. (,2,+B0* ,2,+B0
E4uipment Maintenance:
/<P V 8,<,</0.............................. ()+,<)B* )+,<)B
2<P V 8,<,</0.............................. ()B,<+@* )B,<+@
otal '.ed costs................................ 8 < 8 < 8 < 8 @),,BB 8)<<,B)+
otal allocated costs......................... 8 < 8 < 8 < 8 B@,,BB 8)+,,C)+
Dther $udgeted costs....................... 022,<<< B)<,<<<
otal overhead costs (a*................... 820,,,BB 8C,,,C)+
?udgeted machine7hours ($*............ @<,<<< )<0,<<<
($*.................................................. 8C.,, 8B.BC
3olutions Manual, "hapter )0 )B<
"omputation of allocation rates:
Iaria$le Administration:
Iaria$le administrative costs
Allocation rateY
Employees
8++,+<<
Y
,<\/0<\2,<Y),))< employees
Y8+< per employee
Iaria$le E4uipment Maintenance:
Iaria$le e4uipment maintenance costs
Allocation rateY
Machine7hours
8)2,C<< \ 82<<
Y
@<,<<<\)<0,<<<Y)@0,<<< M;s
Y8<.)< per M;
Fi.ed ?uilding J 1rounds:
Fi.ed $uilding and grounds costs
Allocation rateY
34uare feet
8BB,+<<
Y
0<<\),/<<\)+,<<<\)0,0<<Y+C,/<< s4uare feet
Y8, per s4uare foot
3olutions Manual, "hapter )0 )B)
Fi.ed Administration:
>epartment '.ed costs.................. 82<,<<<
Allocated from ?uilding J
1rounds....................................... ),0<<
"osts to $e allocated...................... 82),0<<
Employees at full capacity:
E4uipment Maintenance.............. /0 , P
Fa$rication................................... 0@< ,B
Finishing....................................... BB0 0C
otal............................................. 8),0<< )<epartment '.ed costs................ 8+/,<<<
Allocated from ?uilding J
1rounds..................................... /,+<<
Allocated from Administration...... ),B/0
"osts to $e allocated.................... 8,<,</0
Allocation percentages are given in the pro$lem.
,. E?uipm
ent
Mainte
nance
Fabric/
ation
Finishin
g ,otal
Iaria$le cost allocation:
8+< per employee V
,+ employees................. 82/< 8 2/<
8+< per employee V
/2< employees......................
8C,+<
< C,+<<
8+< per employee V
2+0 employees......................
8)+,0<
< )+,0<<
otal cost allocated..................... 8++,,/<
Actual varia$le
administration cost.................. 8+,,B<<
otal cost allocated9
a$ove....................................... ++,,/<
3pending variance9not
allocated.................................. 8 ),/2<
3olutions Manual, "hapter )0 )B+
@eneral
Adminis
tration
Cost
Accountin
g )aundr%
Conventio
n Center
Food
Services
@uest
)odging
Iaria$le costs....................... R < R@<,<<< R)/,,<<< R < R0+,<<< R +/,<<<
"ost Accounting allocation:
R0 per item V B<< items.... (/,<<<* /,<<<
R0 per item V ),+<<
items............................... (2,<<<* 2,<<<
R0 per item V ,,<<<
items............................... ()0,<<<* )0,<<<
R0 per item V C,<<<
items............................... (/0,<<<* /0,<<<
=aundry allocation:
R<.2< per pound V
+<,<<< pounds................ ()+,<<<* )+,<<<
R<.2< per pound V
)0,<<< pounds................ (C,<<<* C,<<<
R<.2< per pound V
+)<,<<< pounds.............. ()+2,<<<* )+2,<<<
otal varia$le costs............... R < R < R < R)B,<<< R@2,<<< R)C0,<<<
3olutions Manual, "hapter )0 )B,
@eneral
Adminis
tration
Cost
Accountin
g )aundr%
Conventio
n Center
Food
Service
s
@uest
)odging
Fi.ed costs...........................
R+<<,<<
< R))<,<<< R20,C<< R C0,<<<
R,@0,<<
< R/B2,<<<
1eneral Administration allocation:
)<P V R+<<,<<<................ (+<,<<<* +<,<<<
/P V R+<<,<<<................ (B,<<<* B,<<<
,<P V R+<<,<<<................ (2<,<<<* 2<,<<<
)2P V R+<<,<<<................ (,+,<<<* ,+,<<<
/<P V R+<<,<<<................ (B<,<<<* B<,<<<
"ost Accounting allocation:
@P V R),<,<<<................ (C,)<<* C,)<<
),P V R),<,<<<................ ()2,C<<* )2,C<<
+<P V R),<,<<<................ (+2,<<<* +2,<<<
2<P V R),<,<<<................ (@B,<<<* @B,<<<
=aundry allocation:
)<P V RB,,<<<.................. (B,,<<* B,,<<
2P V RB,,<<<.................. (/,CB<* /,CB<
B/P V RB,,<<<.................. (2C,@+<* 2C,@+<
otal '.ed costs.................... R < R < R < R)B<,+<<
R/,@,CB
< R@),,@+<
otal overhead costs............. R < R < R < R)CB,+<<
R0),,CB
< RC<B,@+<
3olutions Manual, "hapter )0 )B/
"omputations of allocation rates:
Iaria$le "ost Accounting:
Iaria$le cost accounting costs
Allocation rateY
&tems processed
R@<,<<<
Y
)0,<<<7),<<<Y)/,<<< items
YR0 per item
Iaria$le =aundry:
Iaria$le laundry costs
Allocation rateY
!ounds processed
R)/,,<<<\R/,<<<
Y
+/0,<<< pounds
YR<.2< per pound
3olutions Manual, "hapter )0 )B0
Case 15-1! (C< minutes*
). he plantwide rate would include overhead costs for $oth the
service departments and the manufacturing departments. &t
would $e computed as follows:
Manufacturing !epartments
Molding
Componen
t Assembl% ,otal
Iaria$le overhead. R +)<,0<< R),<<<,<<< R),20<,<<<
R+,B2<,0<
<
Fi.ed overhead...... ),@0<,<<< 2+<,<<< @/C,0<<
,,))C,0<
<
otal overhead.......
R),C2<,0<
< R),2+<,<<< R+,,CC,0<<
R0,CB<,<<
<
3ervice department overhead costs:
!ower department (R0<<,<<< \ R)/<,<<< \
R),+<<,<<<*............................................................. ),B/<,<<<
Maintenance department (R+0,<<< \ R,@0,<<<*....... /<<,<<<
otal company overhead costs..................................... RB,++<,<<<
Estimated direct la$or7hours:
Molding...................................................................... 0<,<<<
"omponent................................................................ +<<,<<<
Assem$ly................................................................... )0<,<<<
otal hours................................................................. /<<,<<<
Estimated overhead cost
!lantwide overhead rateY
RB,++<,<<<
Y
/<<,<<< >=;s
YR+<.00 per >=;
3olutions Manual, "hapter )0 )B2
+. a. Allocation rates for the service department costs would $e as
follows:
Iaria$le power costs:
=
$$00,000 7 $140,000
$8 per 86h
80,000 86hs
Iaria$le maintenance costs:
$2$,000
12,$00 hours
$2 per hour .
3olutions Manual, "hapter )0 )B@
1iven the a$ove data, the allocations $y the direct method would $e as follows:
Po1er
Maintenan
ce Molding
Compone
nt
Assembl
%
Iaria$le cost..................................
R 2/<,<<
< R +0,<<<
!ower allocation:
RB per kwh V ,2,<<< kwh............ (+BB,<<<*
R +BB,<<
<
RB per kwh V ,+,<<< kwh............ (+02,<<<* R+02,<<<
RB per kwh V )+,<<< kwh............ (C2,<<<* R C2,<<<
Maintenance allocations:
R+ per hour V C,<<< hours........... ()B,<<<* )B,<<<
R+ per hour V +,0<< hours........... (0,<<<* 0,<<<
R+ per hour V ),<<< hours........... (+,<<<* +,<<<
otal varia$le costs......................... R < R < ,<2,<<< +2),<<< CB,<<<
Fi.ed costs.....................................
R),+<<,<<
< R,@0,<<<
!ower allocations:
0<P V R),+<<,<<<....................... (2<<,<<<* 2<<,<<<
,0P V R),+<<,<<<....................... (/+<,<<<* /+<,<<<
)0P V R),+<<,<<<....................... ()B<,<<<* )B<,<<<
Maintenance allocations:
@<P V R,@0,<<<.......................... (+2+,0<<* +2+,0<<
+<P V R,@0,<<<.......................... (@0,<<<* @0,<<<
)<P V R,@0,<<<.......................... (,@,0<<* ,@,0<<
otal '.ed costs.............................. R < R < B2+,0< /C0,<<< +)@,0<<
3olutions Manual, "hapter )0 )BB
<
otal allocated costs.......................
R),)2B,0<
< R@02,<<< R,)0,0<<
3olutions Manual, "hapter )0 )BC
+. $. Molding
Compone
nt Assembl%
Allocated service
department costs
(a$ove*............................
R),)2B,0<
< R @02,<<< R ,)0,0<<
Manufacturing
department overhead
costs:
Iaria$le......................... +)<,0<< ),<<<,<<< ),20<,<<<
Fi.ed.............................. ),@0<,<<< 2+<,<<< @/C,0<<
otal overhead costs..........
R,,)+C,<<
<
R+,,@2,<<
<
R+,@)0,<<
<
>ivide $y machine7hours.... B@,0<<
>ivide $y direct la$or7
hours............................... +<<,<<< )0<,<<<
!redetermined overhead
rate.................................. R ,0.@2 R )).BB R )B.)<
,. a. Dverhead cost allocated under the plantwide rate:
@,0<< direct la$or7hours V R+<.00 per direct la$or7hour Y
R)0/,)+0
Dverhead cost allocated under the departmental rates:
Molding department:
R,0.@2 per machine7hour V ,,<<< machine7hours.
R)<@,+B
<
"omponent department:
R)).BB per direct la$or7hour V +,0<< direct la$or7
hours.................................................................... +C,@<<
Assem$ly department:
R)B.)< per direct la$or7hour V /,<<< direct la$or7
hours.................................................................... @+,/<<
otal cost allocated...................................................
R+<C,,B
<
3olutions Manual, "hapter )0 )C<
$. he use of a plantwide rate is resulting in too little overhead
cost $eing allocated to products that re4uire a large
proportion of machine7hours as compared to direct la$or7
hours. &n part ,a a$ove, for e.ample, the attachv case
(which re4uires a large proportion of machine7hours* is
allocated only R)0/,)+0 in overhead cost if a plantwide rate
is used, whereas it is allocated R+<C,,B< in overhead cost if
departmental rates are used. 3ince ;o$art !roducts is using
a plantwide rate, it is not surprising that the company is
pricing this attachv case well $elow the price of competitors.
Dn the other hand, use of a plantwide rate is resulting in too
much overhead cost $eing allocated to products that re4uire
a large proportion of direct la$or time as compared to
machine time. his pro$a$ly accounts for the fact that
;o$artGs prices for some products are well a$ove the prices
of competitors.
/. ;o$art !roducts could take two additional steps to improve its
overhead costing. First, it could use the step method to allocate
service department overhead costs. And second, it could use
activity7$ased costing (as discussed earlier in the $ook* to
assign overhead costs from operating departments to products.
3olutions Manual, "hapter )0 )C)
Case 15-1" (@0 minutes*
). 3tep method:
Personn
el
Custodia
l
Services
Mainte/
nance Printing Binding
otal cost $efore allocations...................... R,2<,<<< R)/),<<<
R+<),<<
<
R0+0,<<
< R,@,,0<<
Allocations:
!ersonnel (_ R),B<< per employee*Z..... (,2<,<<<* +@,<<< /0,<<< @+,<<< +)2,<<<
"ustodial services
(_ R).+< per s4uare foot*ZZ................. ()2B,<<<* +/,<<< C2,<<< /B,<<<
Maintenance (0H2, )H2*............................
(+@<,<<<
* ++0,<<< /0,<<<
otal overhead cost after allocations......... R < R < R <
RC)B,<<
< R2B+,0<<
>ivide $y machine7hours...........................
)0<,<<
<
>ivide $y direct la$or7hours...................... )@0,<<<
!redetermined overhead rate.................... R2.)+ R,.C<
Z ?ased on )0 \ +0 \ /< \ )+< Y +<< employees.
ZZ
?ased on +<,<<< \ B<,<<< \ /<,<<< Y )/<,<<< s4uare
feet.
3olutions Manual, "hapter )0 )C+
+. >irect method:
Personn
el
Custodia
l
Services
Mainte/
nance Printing Binding
otal costs $efore allocations.................... R,2<,<<< R)/),<<<
R+<),<<
<
R0+0,<<
< R,@,,0<<
Allocations:
!ersonnel ()H/, ,H/*Z............................... (,2<,<<<* C<,<<< +@<,<<<
"ustodial 3ervices (+H,, )H,*ZZ................ ()/),<<<* C/,<<< /@,<<<
Maintenance (0H2, )H2*............................
(+<),<<<
* )2@,0<< ,,,0<<
otal overhead cost after allocations......... R < R < R <
RB@2,0<
< R@+/,<<<
>ivide $y machine7hours...........................
)0<,<<
<
>ivide $y direct la$or7hours...................... )@0,<<<
!redetermined overhead rate.................... R0.B/ R/.)/
Z ?ased on /< \ )+< Y )2< employees.
ZZ ?ased on B<,<<< \ /<,<<< Y )+<,<<< s4uare feet.
3olutions Manual, "hapter )0 )C,
,. a. he amount of overhead cost assigned to the jo$ would $e:
3tep method:
!rinting department:
R2.)+ per machine7hour V )0,/<< machine7
hours................................................................
R
C/,+/B
?inding department:
R,.C< per direct la$or7hour V +,<<< direct la$or7
hours................................................................ @,B<<
R)<+,irect method:
!rinting department:
R0.B/ per machine7hour V )0,/<< machine7
hours................................................................ R BC,C,2
?inding department:
R/.)/ per direct la$or7hour V +,<<< direct la$or7
hours................................................................ B,+B<
otal overhead cost............................................... R CB,+)2
$. he step method provides a $etter $asis for computing
predetermined overhead rates than the direct method
$ecause it gives recognition to services provided $etween
service departments. &f this interdepartmental service is not
recognized, then either too much or too little of a service
departmentGs costs may $e allocated to a producing
department. he result will $e an inaccuracy in the producing
departmentGs predetermined overhead rate.
For e.ample, using the direct method and ignoring
interdepartmental services causes the predetermined
overhead rate in the !rinting >epartment to fall to only R0.B/
per M; (from R2.)+ per M; when the step method is used*,
and causes the predetermined overhead rate in the ?inding
>epartment to rise to R/.)/ per >=; (from R,.C< per >=;
when the step method is used*. hese inaccuracies in the
predetermined overhead rate can cause corresponding
inaccuracies in $ids for jo$s. 3ince the direct method in this
case understates the rate in the !rinting >epartment and
3olutions Manual, "hapter )2 )B@
overstates the rate in the ?inding >epartment, it is not
surprising that the company tends to $id low on jo$s
re4uiring a lot of printing work and tends to $id too high on
jo$s that re4uire a lot of $inding work.
3olutions Manual, "hapter )2 )BB
,roup E%ercise 15-1#
). he answer to this part will depend on the industry the group
selects.
+. he answer to this part will depend on the industry the group
selects.
,. he answer to this part will depend on the industry the group
selects.
/. J 0.
1enerally speaking, the wider the range of products made or
services o#ered, the greater the support costs. More products
and services re4uire additional support resources for
scheduling, planning, $illing, shipping, and so on. As the
resources demanded of the support departments increase,
their costs increase as well.
2. 3ervice department costs are reduced $y decreasing spending
on the resources the service departments consume. his can
$e accomplished $y: ()* decreasing the activities the service
departments are re4uired to perform9perhaps $y reducing the
range and comple.ity of products and services o#ered $y the
company% (+* improving the $usiness processes in the service
departments so that fewer resources are re4uired to carry out
those activities% or (,* spending less on the resources9perhaps
$y negotiating for $etter prices from suppliers.
3olutions Manual, "hapter )2 )BC
Chapter 1
B:o5 Cell Am ( 1oingDE
Statement o7 Cash >lo5s
1-1 he purpose of a statement of cash
-ows is to highlight the major activities
that have provided cash and that have
used cash during a period and to show the
resulting e#ect on the overall cash
$alance.
1-2 "ash e4uivalents are short7term,
highly li4uid investments such as reasury
$ills, commercial paper, and money
market funds. hey are included with cash
$ecause investments of this type are
made solely for the purpose of generating
a return on temporarily idle funds and
they can $e easily converted to cash.
1-3 ()* Dperating activities:
ransactions that enter into the
determination of net income are generally
classi'ed as operating activities.
(+* &nvesting activities:
ransactions that are involved in the
ac4uisition or disposition of noncurrent
assets are generally classi'ed as investing
activities.
(,* Financing activities:
ransactions (other than the payment of
interest* involving $orrowing from
creditors, and any transactions (e.cept for
stock dividends and stock splits* involving
the owners of a company, are generally
classi'ed as 'nancing activities.
1-4 &nterest is included as an operating
activity since it is part of net income.
Financing activities are narrowly de'ned to
include only the principal amount
$orrowed or repaid.
1-5 3ince the entire proceeds from a
sale of an asset (including any gain*
appear as a cash in-ow from investing
activities, the gain must $e deducted from
net income to avoid dou$le counting.
1- ransactions involving accounts
paya$le are not considered to $e 'nancing
activities $ecause such transactions relate
to a companyGs day7to7day operating
activities rather than to its 'nancing
activities.
1-! E.amples of direct e.changes
include issuing capital stock in e.change
for property or e4uipment, converting
long7term de$t into common stock, and
ac4uiring property and e4uipment through
a long7term lease. he e#ects of such
e.changes are provided in a separate
schedule that accompanies the statement
of cash -ows.
1-" he repayment of R,<<,<<< and
the $orrowing of R0<<,<<< must $oth $e
shown MgrossN on the statement of cash
-ows. hat is, the company would show
R0<<,<<< of cash provided $y 'nancing
activities and then show R,<<,<<< of cash
used $y 'nancing activities.
1-# he direct method reconstructs the
income statement on a cash $asis $y
restating sales, e.penses, and all other
income statement items in terms of cash
in-ows and out-ows. he indirect method
starts with net income and adjusts it to a
cash $asis to determine the cash provided
$y operating activities.
3olutions Manual, "hapter )2 )C<
1-1$ >epreciation is not really a source
of cash, even though it is listed as a
Msource.N Adding $ack depreciation
charges to net income to compute the
amount of cash provided $y operating
activities creates the illusion that
depreciation is a source of cash. &t isnGt.
"harges to the accumulated depreciation
account are added $ack to net income
since they are e4uivalent to a decrease in
an asset account. ]3ee E.hi$it )27+.^
1-11 &f the Accounts 8eceiva$le account
increases during a period, the increase
must $e deducted from net income under
the indirect method since this is an
increase in a noncash asset.
1-12 &f the Accounts !aya$le account
decreases during a period, the decrease
must $e added to cost of goods sold under
the direct method. &n other words, the cost
of goods sold is increased $y the amount
of the decrease in accounts paya$le. 3ince
the cost of goods sold is increased, the net
cash -ow provided $y operating activities
is decreased. Aote that this is how a
change in a lia$ility should $e handled
according to E.hi$it )27+. he e#ect of a
decrease in a lia$ility is a decrease in
cash.
1-13 he R2<,<<< cash dividend will $e
a use of cash in the 'nancing activities
section of the statement. he stock
dividend will not appear on the statement
of cash -ows, since a stock dividend
involves no cash.
1-14 A sale of e4uipment for cash would
$e an investing activity. Any transaction
involving the ac4uisition or disposition of
noncurrent assets is classi'ed as an
investing activity.
1-15
"ost of goods sold...................................... R+0<,<<<
>ecrease in inventory................................. X)0,<<<
>ecrease in accounts
paya$le................................................... \)<,<<<
"ost of goods sold adjusted
to a cash $asis........................................ R+/0,<<<
3olutions Manual, "hapter )2 )C)
Activit% (ot
,ransaction
$peratin
g
"nvestin
g
Financin
g
2eporte
d
Sourc
e Use
a. E4uipment was purchased............ S S
$. "ash dividends declared and
paid............................................. S S
c. Accounts receiva$le decreased..... S S
d. 3hort7term investments
purchased................................... SZ S
e. E4uipment was sold...................... S S
f. !referred stock was sold to
investors..................................... S S
g. A stock dividend was declared
and issued.................................. S
h. &nterest was paid to long7term
creditors...................................... S S
i. 3alaries and wages paya$le
decreased................................... S S
j. 3tock of another company was
purchased................................... S S
k. ?onds were issued......................... S S
l. 8ent was received from
su$leasing oEce space,
reducing rents receiva$le............ S S
m. "ommon stock was repurchased
and retired.................................. S S
Z his would $e a cash e4uivalent and thus not reported separately on the statement of
3olutions Manual, "hapter )2 )C+
cash -ows.
3olutions Manual, "hapter )2 )C,
Aet income................................................................... R,0,<<<
Adjustments to convert net income to a cash
$asis:
>epreciation charges................................................. R+<,<<<
&ncrease in accounts receiva$le................................. ()C,<<<*
&ncrease in inventory................................................. (,,,<<<*
>ecrease in prepaid e.penses................................... ),<<<
&ncrease in accounts paya$le..................................... )0,<<<
>ecrease in accrued lia$ilities................................... (+,<<<*
&ncrease in deferred income ta.es............................. /,<<< ()/,<<<*
Aet cash provided $y operating activities.................... R+),<<<
3olutions Manual, "hapter )2 )C/
3ales........................................................ R ,0<,<<<
Adjustments to a cash $asis:
=ess increase in accounts receiva$le... X )C,<<<
R,,),<<
<
"ost of goods sold.................................... )/<,<<<
!lus increase in inventory.................... \,,,<<<
=ess increase in accounts paya$le....... X )0,<<< )0B,<<<
Dperating e.penses................................. )2<,<<<
=ess decrease in prepaid e.penses..... X ),<<<
!lus decrease in accrued lia$ilities...... \ +,<<<
=ess depreciation charges................... X +<,<<< )/),<<<
&ncome ta.es............................................ )0,<<<
=ess increase in deferred income
ta.es................................................. X /,<<< )),<<<
Aet cash provided $y operating
activities................................................ R +),<<<
Aote that the R+),<<< a$ove agrees with the amount provided $y
operating activities under the indirect method in the previous
e.ercise.
3olutions Manual, "hapter )2 )C0
"tem Amount Add
!educ
t
Accounts 8eceiva$le............... RC<,<<< decrease S
Accrued &nterest 8eceiva$le.... R/,<<< increase S
&nventory.................................
R)+<,<<
< increase S
!repaid E.penses.................... R,,<<< decrease S
Accounts !aya$le.................... R20,<<< decrease S
Accrued =ia$ilities................... RB,<<< increase S
>eferred &ncome a.es
!aya$le................................. R)+,<<< increase S
3ale of e4uipment................... R@,<<< gain S
3ale of long7term investments R)<,<<< loss S
3olutions Manual, "hapter )2 )C2
). Aet income...................................................... R B/
$asis:
>epreciation charges..................................... R 2<
&ncrease in accounts receiva$le..................... ())<*
>ecrease in inventory.................................... @<
&ncrease in prepaid e.penses........................ (C*
&ncrease in accounts paya$le......................... ,0
>ecrease in accrued lia$ilities....................... (/*
1ain on sale of long7term investments.......... ()<*
=oss on sale of land....................................... 2
&ncrease in deferred income ta.es................. B /2
Aet cash provided $y operating activities........ R),<
+. !AID=&U "DM!AAQ
3tatement of "ash Flows
$perating activitiesG
Aet cash provided $y operating activities
from part ()* a$ove....................................... R),<
"nvesting activitiesG
!roceeds from sale of long7term investments. . R)2
!roceeds from sale of land............................... C
Additions to plant and e4uipment.................... (+<<*
Aet cash used for investing activities............... ()@0*
Financing activitiesG
&ncrease in $onds............................................. )0<
>ecrease in common stock.............................. (B<*
"ash dividends................................................. (,<*
Aet cash provided $y 'nancing activities......... /<
Aet decrease in cash (net cash -ow*................ (0*
"ash $alance, $eginning.................................. C<
"ash $alance, ending....................................... R B0
3olutions Manual, "hapter )2 )C@
Aote to the instructor: Although it is not a re4uirement of the e.ercise, a worksheet may
$e helpful.
Cash
Source Flo1 Adust/ Adusted Classi/
Change or useQ E#ect ments E#ect .cation
Assets (e.cept cash and cash e4uivalents*
"urrent assets:
Accounts receiva$le........ \))< Kse X))< X))< Dperating
&nventory........................ X@< 3ource \@< \@< Dperating
!repaid e.penses............ \C Kse XC XC Dperating
Aoncurrent assets:
=ong7term investments... X2 3ource \2 X2 < &nvesting
!lant and e4uipment....... \+<< Kse X+<< X+<< &nvesting
=and............................... X)0 3ource \)0 X)0 < &nvesting
)iabilitiesA Contra/assetsA and Stoc&holdersU E?uit%
"ontra7assets:
Accumulated
depreciation................. \2< 3ource \2< \2< Dperating
Accounts paya$le........... \,0 3ource \,0 \,0 Dperating
Accrued lia$ilities............ X/ Kse X/ X/ Dperating
Aoncurrent lia$ilities:
?onds paya$le................ \)0< 3ource \)0< \)0< Financing
>eferred income ta.es.... \B 3ource \B \B Dperating
3olutions Manual, "hapter )2 )CB
Cash
"ommon stock............... XB< Kse XB< XB< Financing
8etained earnings:
Aet income.................. \B/ 3ource \B/ \B/ Dperating
>ividends.................... X,< Kse X,< X,< Financing
Additional entries
!roceeds from sale of
long7term investments... \)2 \)2 &nvesting
1ain on sale of long7
term investments........... X)< X)< Dperating
land............................... \C \C &nvesting
=oss on sale of land.......... \2 \2 Dperating
otal................................. X 0 X 0
3olutions Manual, "hapter )2 )CC
3ales revenue....................................... R@<<
&ncrease in accounts receiva$le........ X ))< R0C<
"ost of goods sold................................. /<<
>ecrease in inventory...................... X@<
&ncrease in accounts paya$le........... X ,0 +C0
Dperating e.penses.............................. )B/
&ncrease in prepaid e.penses........... \C
>ecrease in accrued lia$ilities.......... \/
>epreciation charges........................ X 2< ),@
&ncome ta. e.pense.............................. ,2
&ncrease in deferred income ta.es.... X B +B
activities............................................. R),<
Aote that the R),< Mnet cash providedN 'gure agrees with the
indirect method in the previous e.ercise.
3olutions Manual, "hapter )2 +<<
E%ercise 1-! (,< minutes*
"A8MDAD "DM!AAQ
For the Qear Ended >ecem$er ,), +<<0
Aet income............................................................ R,0
$asis:
>epreciation charges.......................................... R)0
>ecrease in accounts receiva$le......................... +
&ncrease in inventory.......................................... ()<*
&ncrease in accounts paya$le.............................. / ))
Aet cash provided $y operating activities............. /2
&ncrease in plant and e4uipment........................... (/<*
Aet cash used for investing activities.................... (/<*
&ncrease in common stock..................................... 0
"ash dividends...................................................... ()/*
Aet cash used in 'nancing activities..................... (C*
Aet decrease in cash............................................. (,*
"ash, $eginning.................................................... 2
"ash, end.............................................................. R,
3olutions Manual, "hapter )2 +<)
E%ercise 1-! (continued*
Aote to the instructor: Although it is not a re4uirement of the e.ercise, a worksheet may
$e helpful.
Source
Cash
Flo1 Adust/ Adusted Classi/
Chang
e or useQ E#ect ments E#ect .cation
"urrent assets:
Accounts receiva$le...... X+ 3ource \+ \+ Dperating
&nventory....................... \)< Kse X)< X)< Dperating
Aoncurrent assets:
!lant and e4uipment..... \/< Kse X/< X/< &nvesting
"ontra7assets:
Accumulated
depreciation................ \)0 3ource \)0 \)0 Dperating
Accounts paya$le.......... \/ 3ource \/ \/ Dperating
"ommon stock.............. \0 3ource \0 \0 Financing
8etained earnings:
Aet income.................. \,0 3ource \,0 \,0 Dperating
>ividends.................... X)/ Kse X)/ X)/ Financing
Additional entries
Aone................................
3olutions Manual, "hapter )2 +<+
otal................................. X , X ,
3olutions Manual, "hapter )2 +<,
3ales.................................................... R+@0
>ecrease in accounts receiva$le..... \ + R+@@
"ost of goods sold................................ )0<
&ncrease in inventory....................... \ )<
&ncrease in accounts paya$le.......... X / )02
Dperating e.penses............................. C<
>epreciation charges....................... X )0 @0
activities............................................ R/2
3olutions Manual, "hapter )2 +</
&ro'lem 1-# (+< minutes*
Source
A 2eported (ot on
UseA or Activit%
in
Separate the
,ransaction
(eithe
r
$peratin
g
"nvestin
g
Financin
g ScheduleQ
Statemen
t
a. "ommon stock was sold for
cash................................... 3ource S
$. &nterest was paid on a note
decreasing &nterest
!aya$le.............................. Kse S
c. ?onds were retired............... Kse S
d. A long7term loan was made
to a su$sidiary................... Kse S
e. &nterest was received on
the loan in (d*.................... 3ource S
f. A stock dividend was
declared and issued on
common stock................... Aeither S
g. A $uilding was ac4uired $y
issuing shares of common
stock.................................. Aeither S
h. E4uipment was sold for
cash................................... 3ource S
i. 3hort7term investments
were sold........................... Aeither S
j. "ash dividends were Kse S
3olutions Manual, "hapter )2 +<0
declared and paid..............
k. !referred stock was
converted into common
stock.................................. Aeither S
3olutions Manual, "hapter )2 +<2
&ro'lem 1-# (continued*
Source
A 2eported (ot on
UseA or Activit%
in
Separate the
,ransaction
(eithe
r
$peratin
g
"nvestin
g
Financin
g ScheduleQ
Statemen
t
l. >eferred &ncome a.es, a
long7term lia$ility, was
reduced............................. Kse S
m.>ividends were received
on stock of another
company held as an
investment........................ 3ource S
n. E4uipment was purchased
$y giving a long7term
note to the seller............... Aeither S
3olutions Manual, "hapter )2 +<@
). and +.
5DQAE8 "DM!AAQ
For Qear +
Aet income...................................................... R02,<<<
Adjustments to convert net income to cash
$asis:
>epreciation charges.................................... R/+,<<<
&ncrease in accounts receiva$le.................... (B<,<<<*
&ncrease in inventory.................................... (0<,<<<*
>ecrease in prepaid e.penses...................... @,<<<
&ncrease in accounts paya$le........................ 2<,<<<
>ecrease in accrued lia$ilities...................... ()<,<<<*
1ain on sale of e4uipment............................ (B,<<<*
&ncrease in deferred income ta.es................ ,,<<< (,2,<<<*
Aet cash provided $y operating activities....... +<,<<<
!roceeds from the sale of e4uipment.............. )B,<<<
=oan to ;ymas "ompany................................ (/<,<<<*
Additions to plant and e4uipment...................
()0<,<<<
*
Aet cash used for investing activities..............
()@+,<<<
*
&ncrease in $onds paya$le............................... )+<,<<<
&ncrease in common stock............................... ,<,<<<
"ash dividends................................................ ()0,<<<*
Aet cash provided $y 'nancing activities........ ),0,<<<
Aet decrease in cash....................................... ()@,<<<*
"ash $alance, $eginning of year..................... +),<<<
"ash $alance, end of year............................... R /,<<<
3olutions Manual, "hapter )2 +<B
,. A relatively small amount of cash was provided $y operating
activities during the year as a result of large increases in
accounts receiva$le and inventory. Most of the cash that was
provided $y operating activities was paid out in dividends. he
small amount that remained, com$ined with the cash provided
$y the issue of $onds and the issue of common stock, was
insuEcient to purchase a large amount of e4uipment and make
a loan to another company. As a result, the cash on hand
declined sharply during the year.
3olutions Manual, "hapter )2 +<C
Aote to the instructor: Although it is not a re4uirement, a worksheet may $e helpful.
Cash
"urrent assets:
Accounts receiva$le....... \B< Kse XB< XB< Dperating
&nventory....................... \0< Kse X0< X0< Dperating
!repaid e.penses........... X@ 3ource \@ \@ Dperating
Aoncurrent assets:
=oan to ;ymas
"ompany..................... \/< Kse X/< X/< &nvesting
!lant and e4uipment...... \))< Kse X))< X/< X)0< &nvesting
"ontra7assets:
Accumulated
depreciation................ \)+ 3ource \)+ \,< \/+ Dperating
Accounts paya$le........... \2< 3ource \2< \2< Dperating
Accrued lia$ilities........... X)< Kse X)< X)< Dperating
?onds paya$le............... \)+< 3ource \)+< \)+< Financing
>eferred income ta.es... \, 3ource \, \, Dperating
3olutions Manual, "hapter )2 +)<
Cash
"ommon stock............... \,< 3ource \,< \,< Financing
8etained earnings:
Aet income.................. \02 3ource \02 \02 Dperating
>ividends.................... X)0 Kse X)0 X)0 Financing
Additional entries
e4uipment..................... \)B \)B &nvesting
1ain on sale of
e4uipment..................... XB X B Dperating
otal................................. X )@ X )@
3olutions Manual, "hapter )2 +))
). 3ales........................................................ RC<<,<<<
&ncrease in accounts receiva$le.......... X B<,<<< RB+<,<<<
"ost of goods sold.................................... 0<<,<<<
&ncrease in inventory........................... \0<,<<<
&ncrease in accounts paya$le.............. X 2<,<<< /C<,<<<
Dperating e.penses................................. ,+B,<<<
>ecrease in prepaid e.penses............. X@,<<<
>ecrease in accrued lia$ilities............. \)<,<<<
>epreciation charges.......................... X /+,<<< +BC,<<<
&ncome ta.es............................................ +/,<<<
&ncrease in deferred income ta.es....... X ,,<<< +),<<<
activities................................................ R+<,<<<
3olutions Manual, "hapter )2 +)+
+. 5DQAE8 "DM!AAQ
For Qear +
"ash received from customers................... RB+<,<<<
=ess cash dis$ursements for:
"ost of merchandise purchased...............R/C<,<<<
Dperating e.penses................................. +BC,<<<
&ncome ta.es........................................... +),<<<
otal cash dis$ursements........................... B<<,<<<
Aet cash provided $y operating activities. . +<,<<<
!roceeds from sale of e4uipment............... )B,<<<
=oan to ;ymas "ompany........................... (/<,<<<*
Additions to plant and e4uipment.............. ()0<,<<<*
Aet cash used for investing activities......... ()@+,<<<*
&ncrease in $onds paya$le.......................... )+<,<<<
&ncrease in common stock.......................... ,<,<<<
"ash dividends........................................... ()0,<<<*
Aet cash provided $y 'nancing activities... ),0,<<<
Aet decrease in cash.................................. ()@,<<<*
"ash $alance, $eginning of year................ +),<<<
"ash $alance, end of year.......................... R /,<<<
3olutions Manual, "hapter )2 +),
,. he decline in cash is e.plaina$le largely $y the companyGs
ina$ility to generate a signi'cant amount of cash from
operating activities. Aote that the company generated only
R+<,<<< from operating activities, although net income was
R02,<<< for the year. his small amount of cash generated is
due primarily to the $uildup of accounts receiva$le. Even
though an additional R)0<,<<< was o$tained from an issue of
$onds and an issue of common stock (R)+<,<<< \ R,<,<<< Y
R)0<,<<<*, the cash availa$le was not suEcient to e.pand the
plant, make a su$stantial loan to another company, and pay a
large cash dividend. As a result, cash declined during the year.
3olutions Manual, "hapter )2 +)/
). and +.
OEAIE8 "DM!AAQ
Aet income.................................................... R2,
$asis:
>epreciation charges.................................. R +/
&ncrease in accounts receiva$le................... ()<<*
>ecrease in inventory................................. 0<
&ncrease in prepaid e.penses...................... (/*
&ncrease in accounts paya$le...................... B<
>ecrease in accrued lia$ilities..................... ()+*
1ain on sale of investments........................ (@*
=oss on sale of e4uipment........................... /
&ncrease in deferred income ta.es............... 2 /)
Aet cash provided $y operating activities...... )</
!roceeds from sale of long7term
investments................................................ )<
!roceeds from sale of e4uipment................... +<
Additions to plant and e4uipment.................. ()B<*
Aet cash used for investing activities............ ()0<*
&ncrease in $onds paya$le............................. ))<
>ecrease in common stock............................ (/<*
"ash dividends.............................................. (,<*
Aet cash provided $y 'nancing activities....... /<
Aet decrease in cash..................................... (2*
"ash $alance, 5anuary ), +<<0...................... )0
"ash $alance, >ecem$er ,), +<<0................ RC
3olutions Manual, "hapter )2 +)0
Cash
"urrent assets:
Accounts receiva$le....... \)<< Kse X)<< X)<< Dperating
&nventory....................... X0< 3ource \0< \0< Dperating
!repaid e.penses........... \/ Kse X/ X/ Dperating
Aoncurrent assets:
=ong7term investments. . X, 3ource \, X, < &nvesting
!lant and e4uipment...... \)/< Kse X)/< X/< X)B< &nvesting
)iabilitiesA Contra/assetsA and Stoc&holdersU
E?uit%
"ontra7assets:
Accumulated
depreciation................ \B
3ource \B \)2 \+/ Dperating
Accounts paya$le........... \B< 3ource \B< \B< Dperating
Accrued lia$ilities........... X)+ Kse X)+ X)+ Dperating
3olutions Manual, "hapter )2 +)2
Cash
?onds paya$le............... \))< 3ource \))< \))< Financing
>eferred income ta.es... \2 3ource \2 \2 Dperating
"ommon stock............... X/< Kse X/< X/< Financing
8etained earnings:
Aet income.................. \2, 3ource \2, \2, Dperating
>ividends.................... X,< Kse X,< X,< Financing
Additional entries
investments................... \)< \)< &nvesting
1ain on sale of
investments................... X@ X@ Dperating
e4uipment..................... \+< \+< &nvesting
=oss on sale of
e4uipment..................... \/ \/ Dperating
otal................................. X 2 X 2
3olutions Manual, "hapter )2 +)@
). 3ales............................................................... RB<<
&ncrease in accounts receiva$le................. X )<< R@<<
"ost of goods sold........................................... 0<<
>ecrease in inventory................................ X0<
&ncrease in accounts paya$le..................... X B< ,@<
Dperating e.penses........................................ +),
&ncrease in prepaid e.penses..................... \/
>ecrease in accrued lia$ilities.................... \)+
>epreciation charges................................. X +/ +<0
&ncome ta.es.................................................. +@
&ncrease in deferred income ta.es............. X 2 +)
Aet cash provided $y operating activities....... R)</
3olutions Manual, "hapter )2 +)B
+. OEAIE8 "DM!AAQ
"ash received from customers............................ R@<<
"ost of merchandise purchased........................R,@<
Dperating e.penses.......................................... +<0
&ncome ta.es.................................................... +)
otal cash dis$ursements.................................... 0C2
Aet cash provided $y operating activities........... )</
!roceeds from sale of long7term investments..... )<
!roceeds from sale of e4uipment........................ +<
Additions to plant and e4uipment.......................
()B<
*
Aet cash used for investing activities.................. ()0<*
&ncrease in $onds paya$le.................................. ))<
>ecrease in common stock................................. (/<*
"ash dividends.................................................... (,<*
Aet cash provided $y 'nancing activities............ /<
Aet decrease in cash........................................... (2*
"ash $alance, 5anuary ), +<<0............................ )0
"ash $alance, >ecem$er ,), +<<0..................... RC
3olutions Manual, "hapter )2 +)C
). and +. 8K3"D !8D>K"3
For the Qear Ended 5uly ,), +<<0
Aet income................................................. R,<,<<<
$asis:
>epreciation charges................................ R+<,<<<
&ncrease in accounts receiva$le................ (/<,<<<*
&ncrease in inventory................................ (0<,<<<*
>ecrease in prepaid e.penses.................. /,<<<
&ncrease in accounts paya$le................... 2,,<<<
>ecrease in accrued lia$ilities.................. (C,<<<*
1ain on sale of investments..................... ()<,<<<*
=oss on sale of e4uipment........................ +,<<<
&ncrease in deferred income ta.es............ B,<<< ()+,<<<*
Aet cash provided $y operating activities. . . )B,<<<
!roceeds from sale investments................. ,<,<<<
!roceeds from sale of e4uipment................ B,<<<
Additions to plant and e4uipment...............
()0<,<<<
*
Aet cash used for investing activities..........
())+,<<<
*
&ncrease in $onds paya$le.......................... @<,<<<
&ncrease in common stock.......................... +<,<<<
"ash dividends............................................ (C,<<<*
Aet cash provided $y 'nancing activities.... B),<<<
Aet decrease in cash................................... (),,<<<*
"ash $alance, August ), +<</..................... +),<<<
"ash $alance, 5uly ,), +<<0........................
R
B,<<<
3chedule of noncash investing and
'nancing activities:
!referred stock converted into common R
3olutions Manual, "hapter )2 ++<
stock...................................................... )2,<<<
3olutions Manual, "hapter )2 ++)
,. Although the company reported a large net income for the
year, a relatively small amount of cash was provided $y
operations due to increases in $oth accounts receiva$le and
inventory. he cash provided $y operations, when added to the
cash provided $y the sale of investments, the issue of $onds,
and the sale of common stock, was not suEcient to cover the
purchase of plant and e4uipment during the year. Aote that the
company increased its investment in plant and e4uipment $y
almost 0<P. More care should have $een taken in planning for
this major investment in plant assets. Also, the company
should get $etter control over its accounts receiva$le and
inventory.
3olutions Manual, "hapter )2 +++
Cash
"urrent assets:
Accounts receiva$le....... \/< Kse X/< X/< Dperating
&nventory....................... \0< Kse X0< X0< Dperating
!repaid e.penses........... X/ 3ource \/ \/ Dperating
Aoncurrent assets:
=ong7term investments. . X+< 3ource \+< X+< < &nvesting
!lant and e4uipment...... \),< Kse X),< X+< X)0< &nvesting
E?uit%
"ontra7assets:
Accumulated
depreciation................ \)< 3ource \)< \)< \+< Dperating
Accounts paya$le........... \2, 3ource \2, \2, Dperating
Accrued lia$ilities........... XC Kse XC XC Dperating
3olutions Manual, "hapter )2 ++,
Cash
?onds paya$le............... \@< 3ource \@< \@< Financing
>eferred income ta.es... \B 3ource \B \B Dperating
!referred stock............... X)2 Kse \)2 <
"ommon stock............... \,2 3ource \,2 X)2 \+< Financing
8etained earnings:
Aet income.................. \,< 3ource \,< \,< Dperating
>ividends.................... XC Kse XC XC Financing
Additional entries
investments................... \,< \,< &nvesting
1ain on sale of
investments................... X)< X)< Dperating
e4uipment..................... \B \B &nvesting
=oss on sale of
e4uipment..................... \+ \+ Dperating
otal................................. X ), X ),
3olutions Manual, "hapter )2 ++/
). he income statement adjusted to a cash $asis:
3ales....................................................................... R0<<,<<<
&ncrease in accounts receiva$le.......................... X /<,<<< R/2<,<<<
"ost of goods sold................................................... ,<<,<<<
&ncrease in inventory.......................................... \0<,<<<
&ncrease in accounts paya$le............................. X 2,,<<< +B@,<<<
Dperating e.penses................................................ )0B,<<<
>ecrease in prepaid e.penses............................ X/,<<<
>ecrease in accrued lia$ilities............................ \C,<<<
>epreciation charges.......................................... X +<,<<< )/,,<<<
&ncome ta.es........................................................... +<,<<<
&ncrease in deferred income ta.es...................... X B,<<< )+,<<<
activities...............................................................R)B,<<<
3olutions Manual, "hapter )2 ++0
+. 8K3"D !8D>K"3
For the Qear Ended 5uly ,), +<<0
"ash received from customers................................ R/2<,<<<
"ost of merchandise purchased............................ R+B@,<<<
Dperating e.penses.............................................. )/,,<<<
&ncome ta.es........................................................ )+,<<<
otal cash dis$ursements........................................ //+,<<<
Aet cash provided $y operating activities............... )B,<<<
!roceeds from sale of investments.......................... ,<,<<<
!roceeds from sale of e4uipment............................ B,<<<
Additions to plant and e4uipment........................... ()0<,<<<*
Aet cash used for investing activities...................... ())+,<<<*
&ncrease in $onds paya$le....................................... @<,<<<
&ncrease in common stock....................................... +<,<<<
"ash dividends........................................................ (C,<<<*
Aet cash provided $y 'nancing activities................ B),<<<
Aet decrease in cash............................................... (),,<<<*
"ash $alance, August ), +<</................................. +),<<<
"ash $alance, 5uly ,), +<<0.................................... R B,<<<
3chedule of noncash investing and
'nancing activities:
!referred stock converted into common
stock..................................................................... R )2,<<<
3olutions Manual, "hapter )2 ++2
,. here are two reasons for the sharp decline in cash. First, note
that a relatively small amount of cash was provided $y
operations during the year. his is due to a $uild7up in accounts
receiva$le and inventory, which together have grown $y
RC<,<<<% the $uild7up of receiva$les reduced the amount of
cash received from customers, and the $uild7up of inventory
increased the amount of cash re4uired to purchase goods.
3econd, the company paid out in dividends half of the cash
provided $y operations, while at the same time increasing its
investment in plant and e4uipment $y almost 0<P. hese uses
of cash far outstripped the amount of cash availa$le through
operations and the sale of $onds, common stock, and
investments, resulting in a sharp decrease in the amount of
cash availa$le.
3olutions Manual, "hapter )2 ++@
?efore the statement of cash -ows can $e prepared, we must 'rst
determine the following amounts:
()* he gain on sale of e4uipment.
(+* he cost of plant and e4uipment purchased during the year.
(,* he depreciation charges.
(/* he loss on sale of long7term investments.
(0* he net income for the year.
Computations for items '4+A '5+A and '6+G
?al
.
+,@<<,<<
<
),/)<,<<
<
?al
.
(+* 2<<,<<< )<<,<<< ()* ()* @<,<<< )2<,<<< (,*
?al
.
,,+<<,<<
<
),0<<,<<
<
?al
.
E.planation of entries:
()* he entry to record the sale of e4uipment:
"ash......................................................
/<,<<
<
Accumulated >epreciation....................
@<,<<
<
!lant and E4uipment........................
)<<,<<
<
1ain on 3ale of E4uipment............... )<,<<<
(+* he $alancing entry to record the plant and e4uipment
purchased during the year (R2<<,<<<*.
(,* he $alancing entry to record the depreciation charges for
the year (R)2<,<<<*.
3olutions Manual, "hapter )2 ++B
Computation for item '7+
he entry to record the sale of long7term investments:
"ash...................................................... B<,<<<
=oss on 3ale of &nvestments.................. /<,<<<
=ong7erm &nvestments..................... )+<,<<<
Computation for item ';+
For the net income 'gure, the companyGs 8etained Earnings
account increased $y R2<,<<< during the year and cash dividends
totaled R,<,<<< for the year. herefore, net income must have
$een: R2<,<<< \ R,<,<<< Y RC<,<<<.
3olutions Manual, "hapter )2 ++C
1iven the amounts a$ove, the statement of cash -ows for last
year follows:
DS&>EA !8D>K"3
For the !ast Qear
Aet income..................................................... RC<,<<<
$asis:
>epreciation charges...................................R)2<,<<<
>ecrease in accounts receiva$le.................. B),<<<
&ncrease in inventory................................... (+,<,<<<*
>ecrease in prepaid e.penses..................... 2,<<<
>ecrease in accounts paya$le..................... (@<,<<<*
&ncrease in accrued lia$ilities....................... ,0,<<<
1ain on sale of e4uipment........................... ()<,<<<*
=oss on sale of long7term investments......... /<,<<<
&ncrease in deferred income ta.es............... B,<<< +<,<<<
Aet cash provided $y operating activities...... ))<,<<<
!roceeds from sale of e4uipment................... /<,<<<
investments................................................. B<,<<<
&ncrease in long7term loans to su$sidiaries. . . . ()<<,<<<*
Additions to plant and e4uipment.................. (2<<,<<<*
Aet cash used for investing activities............. (0B<,<<<*
&ncrease in $onds paya$le.............................. /<<,<<<
&ncrease in common stock.............................. +@<,<<<
>ecrease in preferred stock........................... ()B<,<<<*
"ash dividends............................................... (,<,<<<*
Aet cash provided $y'nancing activities........ /2<,<<<
Aet decrease in cash...................................... ()<,<<<*
"ash $alance, $eginning of the year.............. 0+,<<<
"ash $alance, end of the year........................ R/+,<<<
3olutions Manual, "hapter )2 +,<
Cash
Chang
"urrent assets:
Accounts receiva$le...................... XB) 3ource \B) \B) Dperating
&nventory...................................... \+,< Kse X+,< X+,< Dperating
!repaid e.penses.......................... X2 3ource \2 \2 Dperating
Aoncurrent assets:
=ong7term loans to su$sidiaries.... \)<< Kse X)<< X)<< &nvesting
=ong7term investments................. X)+< 3ource \)+< X)+< < &nvesting
!lant and e4uipment..................... \0<< Kse X0<< X)<< X2<< &nvesting
"ontra7assets:
Accumulated depreciation............ \C< 3ource \C< \@< \)2< Dperating
Accounts paya$le......................... X@< Kse X@< X@< Dperating
Accrued lia$ilities.......................... \,0 3ource \,0 \,0 Dperating
3olutions Manual, "hapter )2 +,)
Cash
Chang
?onds paya$le.............................. \/<< 3ource \/<< \/<< Financing
>eferred income ta.es.................. \B 3ource \B \B Dperating
!referred stock............................. X)B< Kse X)B< X)B< Financing
"ommon stock.............................. \+@< 3ource \+@< \+@< Financing
8etained earnings:
Aet income................................. \C< 3ource \C< \C< Dperating
>ividends................................... X,< Kse X,< X,< Financing
Additional entries
!roceeds from sale of investments.. \B< \B< &nvesting
=oss on sale of long7term
investments.................................. \/< \/< Dperating
!roceeds from sale of e4uipment.... \/< \/< &nvesting
1ain on sale of e4uipment.............. X)< X )< Dperating
otal................................................ X )< X )<
3olutions Manual, "hapter )2 +,+
&ro'lem 1-1! (@0 minutes*
). 3ee the worksheet at the end of this solution.
+. =DMAS "DM!AAQ
Aet income................................................. R)@<,<<<
$asis:
>epreciation charges................................ R C0,<<<
>ecrease in goodwill................................. 2,<<<
&ncrease in accounts receiva$le................ ()B<,<<<*
>ecrease in inventory............................... )+,<<<
&ncrease in prepaid e.penses................... (0,<<<*
&ncrease in accounts paya$le................... ,<<,<<<
>ecrease in accrued lia$ilities.................. ()@,<<<*
1ain on sale of long7term investments..... (2<,<<<*
=oss on sale of e4uipment........................ +<,<<<
&ncrease in deferred income ta.es............ )0,<<< )B2,<<<
Aet cash provided $y operating activities... ,02,<<<
investments.............................................. ))<,<<<
!roceeds from sale of e4uipment................ @<,<<<
&ncrease in loans to su$sidiaries................. (0<,<<<*
Additions to plant and e4uipment............... (@<<,<<<*
Aet cash used for investing activities.......... (0@<,<<<*
3olutions Manual, "hapter )2 +,,
&ssue of long7term notes.............................. 2<<,<<<
8etire long7term notes.................................
(,B<,<<<
*
&ncrease in common stock........................... C<,<<<
"ash dividends............................................. (@0,<<<*
Aet cash provided $y 'nancing activities..... +,0,<<<
Aet increase in cash and cash e4uivalents... +),<<<
"ash $alance, 5anuary ), +<<0..................... /<,<<<
"ash $alance, >ecem$er ,), +<<0.............. R2),<<<
3olutions Manual, "hapter )2 +,/
,. he large amount of cash provided $y operating activities is
tracea$le for the most part to the R,<<,<<< increase in
accounts paya$le. &f the accounts paya$le had remained
$asically unchanged, the same as inventory, then operating
activities would have provided very little cash and the company
might have e.perienced serious cash pro$lems.
Aote particularly that the cash provided $y operating activities
was used to purchase plant and e4uipment. hus, the company
is using cash derived from a short7term source ($uildup of
accounts paya$le* to 'nance long7term asset ac4uisitions. &n
short, although the company is generating su$stantial cash
from operating activities, the ?ualit% of this source is open to
4uestion.
Also, note the su$stantial increase in accounts receiva$le.
Apparently, the companyGs collections from customers are
lagging, perhaps $ecause of sales to customers whose credit is
weak. his may $e the result of trying to increase sales so fast
that proper credit checks are not $eing made. Again, this can
lead to serious cash pro$lems if the trend continues.
&n the companyGs 'nancing activities, it appears that long7term
de$t sources, rather than e4uity sources, are $eing used to
provide for e.pansion. Although companies fre4uently use de$t
to 'nance e.pansion, the level of de$t in this company is
increasing rapidly. (3ee "hapter )@ for a discussion of the >e$t7
to7E4uity ratio and other 'nancial ratios.*
3olutions Manual, "hapter )2 +,0
Cash
"urrent assets:
Accounts receiva$le........ \)B< Kse X)B< X)B< Dperating
&nventory........................ X)+ 3ource \)+ \)+ Dperating
!repaid e.penses............ \0 Kse X0 X0 Dperating
Aoncurrent assets:
=ong7term investments... X0< 3ource \0< X0< < &nvesting
=oans to su$sidiaries...... \0< Kse X0< X0< &nvesting
!lant and e4uipment....... \0@< Kse X0@< X),< X@<< &nvesting
1oodwill.......................... X2 3ource \2 \2 Dperating
E?uit%
"ontra7assets:
Accumulated
depreciation................. \00 3ource \00 \/< \C0 Dperating
Accounts paya$le........... \,<< 3ource \,<< \,<< Dperating
Accrued lia$ilities............ X)@ Kse X)@ X)@ Dperating
3olutions Manual, "hapter )2 +,2
Cash
=ong7term notes............. \++< 3ource \++< \,B< \2<< Financing
>eferred income ta.es.... \)0 3ource \)0 \)0 Dperating
"ommon stock................ \C< 3ource \C< \C< Financing
8etained earnings:
Aet income................... \)@< 3ource \)@< \)@< Dperating
>ividends..................... X@0 Kse X@0 X@0 Financing
Additional entries
8etire long7term notes....... X,B< X,B< Financing
e4uipment...................... \@< \@< &nvesting
=oss on sale of
e4uipment...................... \+< \+< Dperating
long7 term investments... \))< \))< &nvesting
1ain on sale of long7term
investments.................... 72< X 2< Dperating
otal.................................. \+) \+)
3olutions Manual, "hapter )2 +,@
3ales...................................................... R+,<<<,<<<
=ess increase in accounts
receiva$le....................................... X )B<,<<< R),B+<,<<<
"ost of goods sold.................................. ),,<<,<<<
>ecrease in inventory....................... X)+,<<<
&ncrease in accounts paya$le............ X ,<<,<<< CBB,<<<
Dperating e.penses............................... /C<,<<<
&ncrease in prepaid e.penses............ \0,<<<
>ecrease in accrued lia$ilities........... \)@,<<<
>epreciation charges......................... XC0,<<<
>ecrease in goodwill......................... X 2,<<< /)),<<<
&ncome ta. e.pense............................... B<,<<<
&ncrease in deferred income ta.es..... X )0,<<< 20,<<<
activities.............................................. R ,02,<<<
3olutions Manual, "hapter )2 +,B
?efore the statement of cash -ows can $e prepared, we must 'rst
determine the following amounts:
he gain on sale of e4uipment.
he cost of plant and e4uipment purchased during the year.
he depreciation charges for the year.
he net income for the year.
he computations follow:
?al
.
),0B<,<<
< 2@0,<<<
?al
.
(+* +@<,<<< 0<,<<< ()* ()* ,@,<<< /+,<<< (,*
?al
.
),B<<,<<
< 2B<,<<<
?al
.
E.planation of entries:
()* he entry to record the sale of e4uipment:
"ash..................................................... )0,<<<
Accumulated >epreciation.................... ,@,<<<
!lant and E4uipment....................... 0<,<<<
1ain on 3ale of E4uipment.............. +,<<<
(+* he $alancing entry to record the plant and e4uipment
purchased during the year (R+@<,<<<*.
(,* he $alancing entry to record the depreciation charges for
the year (R/+,<<<*.
For the net income 'gure, the companyGs 8etained Earnings
account increased $y R0<,<<< and cash dividends totaled
R+<,<<< for the year. herefore, the net income for the year must
have $een: R0<,<<< \
R+<,<<< Y R@<,<<<.
3olutions Manual, "hapter )2 +,C
1iven these amounts, the statement of cash -ows would $e as
follows:
Qoric "ompany
Aet income..................................................... R@<,<<<
$asis:
>epreciation charges................................... R /+,<<<
&ncrease in accounts receiva$le...................
())<,<<<
*
>ecrease in inventory.................................. 20,<<<
>ecrease in prepaid e.penses..................... B,<<<
&ncrease in accounts paya$le....................... ,+,<<<
>ecrease in accrued lia$ilities..................... (C,<<<*
1ain on sale of e4uipment........................... (+,<<<*
&ncrease in deferred income ta.es............... )2,<<< /+,<<<
Aet cash provided $y operating activities...... ))+,<<<
>ecrease in long7term loans to su$sidiaries... ,<,<<<
!roceeds from sale of e4uipment................... )0,<<<
Additions to long7term investments................ (B<,<<<*
Additions to plant and e4uipment..................
(+@<,<<<
*
Aet cash used for investing activities.............
(,<0,<<<
*
&ncrease in $onds paya$le.............................. /<<,<<<
>ecrease in common stock............................
()@<,<<<
*
"ash dividends...............................................
(+<,<<<
*
Aet cash provided $y 'nancing activities....... +)<,<<<
Aet increase in cash....................................... )@,<<<
"ash $alance, $eginning................................ +,,<<<
"ash $alance, ending..................................... R /<,<<<
3olutions Manual, "hapter )2 +/<
Cash
"urrent assets:
Accounts receiva$le............ \))< Kse X))< X))< Dperating
&nventory............................ X20 3ource \20 \20 Dperating
!repaid e.penses................ XB 3ource \B \B Dperating
Aoncurrent assets:
=ong7term loans to
su$sidiaries...................... X,< 3ource \,< \,< &nvesting
=ong7term investments....... \B< Kse XB< XB< &nvesting
!lant and e4uipment........... \++< Kse X++< X0< X+@< &nvesting
E?uit%
"ontra7assets:
Accumulated depreciation. . \0 3ource \0 \,@ \/+ Dperating
Accounts paya$le................ \,+ 3ource \,+ \,+ Dperating
Accrued lia$ilities................ XC Kse XC XC Dperating
3olutions Manual, "hapter )2 +/)
Cash
?onds paya$le.................... \/<< 3ource \/<< \/<< Financing
>eferred income ta.es........ \)2 3ource \)2 \)2 Dperating
"ommon stock.................... X)@< Kse X)@< X)@< Financing
8etained earnings:
Aet income....................... \@< 3ource \@< \@< Dperating
>ividends......................... X+< Kse X+< X+< Financing
Additional entries
e4uipment.......................... \)0 \)0 &nvesting
1ain on sale of e4uipment.... X+ X + Dperating
otal...................................... \)@ \)@
3olutions Manual, "hapter )2 +/+
,roup E%ercise 1-2$
he answer to this group e.ercise depends on the particular
annual report the students select.
Oarning: his assignment is very diEcult and should $e assigned
only to the most capa$le students who are resourceful, analytical,
and not easily frustrated.
3olutions Manual, "hapter )@ +,@
Chapter 1!
B:o5 Cell Am ( 1oingDE
>inancial Statement Anal)sis
1!-1 ;orizontal analysis involves
e.amining how a particular item on a
'nancial statement such as sales or cost
of goods sold $ehaves over time. Iertical
analysis involves analysis of items on an
income statement or $alance sheet for a
single year. &n vertical analysis, all the
items on the 'nancial statement are
stated as a percentage of a single item
such as sales revenues or total assets.
1!-2 ?y looking at trends, an analyst
hopes to get some idea of whether a
situation is improving, remaining the
same, or deteriorating. 3uch analyses can
provide insight into what is likely to
happen in the future. 8ather than looking
at trends, an analyst may compare one
company to another or to industry
averages using common7size 'nancial
statements.
1!-3 !rice7earnings ratios re-ect
investorsG e.pectations concerning future
earnings. he higher the price7earnings
ratio, the greater the growth in earnings
e.pected $y investors. For this reason, two
companies might have the same current
earnings and yet have 4uite di#erent
price7earnings ratios. ?y de'nition, a stock
with current earnings of R/ and a price7
earnings ratio of +< would $e selling for
RB< per share.
1!-4 A company in a rapidly growing
technological industry pro$a$ly would
have many opportunities to invest its
earnings at a rate of return higher than
stockholders could earn in other
investments. From the stockholdersG
perspective, in this situation it would $e
$etter for the company to reinvest its
earnings rather than pay out its earnings
in the form of dividends. hus, one would
e.pect the company to have a low
dividend payout ratio.
1!-5 he dividend yield is the return on
an investment from simply collecting
dividends. he other source of return on
an investment in stock is increases in
market value. he dividend yield is
computed $y dividing the dividend per
share $y the current market price per
share of common stock.
1!- Financial leverage results from
$orrowing funds at an interest rate that
di#ers from the rate of return on assets
ac4uired using those funds. &f the rate of
return on the assets is higher than the
interest rate at which the funds were
$orrowed, 'nancial leverage is positive
and stockholders gain. &f the return on the
assets is lower than the interest rate, then
'nancial leverage is negative and the
stockholders lose.
1!-! ;ow a stockholder would feel
would depend in large part on the sta$ility
of the company and its industry. &f the
company e.periences wide -uctuations in
earnings, stockholders might $e very
pleased that the company has no de$t. &n
hard times, interest payments might $e
very diEcult to meet.
Dn the other hand, if investments
within the company can earn a rate of
return that e.ceeds the cost of the de$t,
stockholders get the $ene'ts of positive
3olutions Manual, "hapter )@ +,B
leverage. A company that will not take on
de$t also places limitations on its own
a$ility to grow, due to the fact that its
sources of new investment funds will $e
limited to current earnings and new issues
of stock.
1!-" Ao, the market value of a share of
common stock often e.ceeds the $ook
value per share. ?ook value represents the
cumulative e#ects on the $alance sheet of
past activities, evaluated using historical
prices. he market value of the stock
re-ects investorsG e.pectations a$out the
companyGs future earnings. For most
companies market value e.ceeds $ook
value $ecause investors anticipate future
growth in earnings.
1!-# A +7to7) current ratio might not $e
ade4uate for several reasons. First, the
composition of the current assets may $e
heavily weighted toward slow7turning and
diEcult7to7li4uidate inventory, or the
inventory may contain large amounts of
o$solete goods. 3econd, the receiva$les
may $e low 4uality, including large
amounts of accounts that may $e diEcult
to collect.
3olutions Manual, "hapter )@ +,C
E%ercise 1!-1 ()0 minutes*
).
,his
-ear )ast -ear
3ales....................................... )<<.<P )<<.<P
=ess cost of goods sold........... 2+., 0B.2
1ross margin.......................... ,@.@ /)./
3elling e.penses................... )B.0 )B.+
Administrative e.penses...... B.C )<.,
otal e.penses........................ +@./ +B.0
Aet operating income............. )<., )+.C
=ess interest e.pense............. ).+ )./
Aet income $efore ta.es......... C.)P )).0P
+. he companyGs major pro$lem seems to $e the increase in cost
of goods sold, which increased from 0B.2P of sales last year to
2+.,P of sales this year. his suggests that the company is not
passing the increases in costs of its products on to its
customers. As a result, cost of goods sold as a percentage of
sales has increased and gross margin has decreased. his
change has $een o#set somewhat $y reduction in
administrative e.penses as a percentage of sales. Aote that
administrative e.penses decrease from )<.,P to only B.CP of
sales over the two years. ;owever, this decrease was not
enough to completely o#set the increased cost of goods sold,
so the companyGs net income decreased as a percentage of
sales this year.
E%ercise 1!-2 (,< minutes9
). "alculation of the gross margin percentage:
1ross margin
1ross margin percentage Y
3ales
R+@,<<<
Y Y ,/.+P
R@C,<<<
+. "alculation of the earnings per share:
Aet income 7 !referred dividends
Earnings per share Y
Average num$er of common

shares outstanding
R,,0/< 7 R)+<
Y Y R/.+B per share
B<< shares
,. "alculation of the price7earnings ratio:
Market price per share
!rice7earnings ratio Y
Earnings per share
R)B
Y Y /.+
R/.+B
/. "alculation of the dividend payout ratio:
>ividends per share
>ividend payout ratio Y
Earnings per share
R<.+0
Y Y 0.BP
R/.+B
0. "alculation of the dividend yield ratio:
>ividends per share
>ividend yield ratio Y
Market price per share
R<.+0
Y Y )./P
R)B.<<
3olutions Manual, "hapter ) +/)
E%ercise 1!-2 (continued*
2. "alculation of the return on total assets:
?eginning $alance, total assets
(a*................................................ R/0,C2<
Ending $alance, total assets ($*..... 0<,+B<
Average total assets ](a* \ ($*^H+... R/B,)+<
Aet income \
]&nterest e.pense V () 7 a. rate*^
8eturn on total assets Y
Average total assets

R,,0/< \ ]R2<< V () 7 <./<*^
Y Y B.)P
R/B,)+<
@. "alculation of the return on common stockholdersG e4uity:
?eginning $alance, stockholdersG
e4uity (a*.............................................. R,),22<
Ending $alance, stockholdersG e4uity
($*........................................................ ,/,BB<
Average stockholdersG e4uity ](a* \
($*^H+.................................................... ,,,+@<
Average preferred stock.......................... +,<<<
Average common stockholdersG e4uity. . . R,),+@<
8eturn on common
Y
stockholdersT e4uity
Average common stockholdersT e4uity
R,,0/< 7 R)+<
Y Y )<.CP
R,),+@<
B. "alculation of the $ook value per share:
otal stockholdersT e4uity 7 !referred stock
?ook value per share Y
Aum$er of common shares outstanding
R,/,BB< 7 R+,<<<
Y Y R/).)< per share
B<< shares
3olutions Manual, "hapter ) +/+
E%ercise 1!-3 (,< minutes*
). "alculation of working capital:
"urrent assets............. R+0,<B<
"urrent lia$ilities......... )<,/<<
Oorking capital........... R)/,2B<
+. "alculation of the current ratio:
"urrent assets
"urrent ratio Y
"urrent lia$ilities
R+0,<B<
Y Y +./
R)<,/<<
,. "alculation of the acid7test ratio:
"ash \ Marketa$le securities

\ "urrent receiva$les
Acid7test ratio Y
"urrent lia$ilities
R),+B< \ R< \ R)+,,<<
Y Y ).,
R)<,/<<
/. "alculation of accounts receiva$le turnover:
?eginning $alance, accounts receiva$le (a*........ R C,)<<
Ending $alance, accounts receiva$le ($*............. )+,,<<
Average accounts receiva$le $alance ](a* \
($*^H+................................................................ R)<,@<<
3ales on account
Accounts receiva$le
Y
turnover
Average accounts receiva$le $alance
R@C,<<<
Y Y @./
R)<,@<<
0. "alculation of the average collection period:
,20 days
Average collection period Y
Accounts receiva$le turnover
,20 days
Y Y /C., days
@./
3olutions Manual, "hapter ) +/,
E%ercise 1!-3 (continued*
2. "alculation of inventory turnover:
?eginning $alance, inventory (a*........................ RB,+<<
Ending $alance, inventory ($*............................. C,@<<
Average inventory $alance ](a* \ ($*^H+.............. RB,C0<
"ost of goods sold
&nventory turnover Y
Average inventory $alance
R0+,<<<
Y Y 0.B
RB,C0<
@. "alculation of the average sale period:
,20 days
Average sale period Y
&nventory turnover
,20 days
Y Y 2+.C days
0.B
3olutions Manual, "hapter ) +//
). "alculation of the times interest earned ratio:
Earnings $efore interest

e.pense and income ta.es
imes interest
Y
earned ratio
&nterest e.pense
R2,0<<
Y Y )<.B
R2<<
+. "alculation of the de$t7to7e4uity ratio:
otal lia$ilities
>e$t7to7e4uity ratio Y
3tockholdersT e4uity
R)0,/<<
Y Y <./
R,/,BB<
3olutions Manual, "hapter ) +/0
). 8eturn on total assets:
( *
( *
( *
Aet income \ &nterest e.pense V ) 7 a. rate
8eturn on
Y
total assets
R+B<,<<< \ R2<,<<< V ) 7 <.,<
Y
)H+ R,,<<<,<<< \ R,,2<<,<<<
R,++,<<<
Y Y C.BP (rounded*
R,,,<<,<<<
v w
x y
v w
x y
+. 8eturn on common stockholdersG e4uity:
Aet income as reported........................ R +B<,<<<
=ess preferred dividends: BP V
RC<<,<<<........................................... @+,<<<
Aet income remaining for common
(a*...................................................... R +<B,<<<
Average stockholdersG e4uity:
)H+ (R+,+<<,<<< \ R+,/<<,<<<*......... R+,,<<,<<<
=ess average preferred stock............... C<<,<<<
Average common stockholdersG
e4uity ($*........................................... R),/<<,<<<
8eturn on common stockholdersG
e4uity
(a* [ ($*............................................. )/.CP (rounded*
,. =everage is positive since the return on common stockholdersG
e4uity ()/.CP* is greater than the return on total assets (C.BP*.
his positive leverage arises from the long7term de$t, which
has an after7ta. interest cost of only B./P ])+P interest rate V
() X <.,<*^, and the preferred stock, which carries a dividend
rate of only BP. ?oth of these rates of return are smaller than
the return that the company is earning on its total assets% thus,
the di#erence goes to the common stockholders.
3olutions Manual, "hapter ) +/2
E%ercise 1!- ()0 minutes*
). "urrent assets
(UrC<,<<< \ Ur+2<,<<< \ Ur/C<,<<< \
Ur)<,<<<*............................................................ UrB0<,<<<
"urrent lia$ilities (UrB0<,<<< [ +.0*...................... ,/<,<<<
Oorking capital..................................................... Ur0)<,<<<
+.
"ash \ Marketa$le securities \ Accounts receiva$le
Acid7test
Y
ratio
"urrent lia$ilities
UrC<,<<< \ Ur< \ Ur+2<,<<<
Y Y ).<, (rounded*
Ur,/<,<<<
,. a. Oorking capital would not $e a#ected:
"urrent assets (UrB0<,<<< X Ur/<,<<<*.. . UrB)<,<<<
"urrent lia$ilities (Ur,/<,<<< X
Ur/<,<<<*............................................. ,<<,<<<
Oorking capital....................................... Ur0)<,<<<
$. he current ratio would rise:
"urrent assets
"urrent ratio Y
"urrent lia$ilities
UrB)<,<<<
Y Y +.@
Ur,<<,<<<
3olutions Manual, "hapter ) +/@
E%ercise 1!-! ()0 minutes*
). he trend percentages are:
-ear
; -ear 7
-ear
6
-ear
5
-ear
4
3ales............................. )+0.< )+<.< ))0.< ))<.< )<<.<
"ash.............................. 2<.< B<.< C2.< ),<.< )<<.<
Accounts receiva$le...... )C<.< )@<.< ),0.< ))0.< )<<.<
&nventory....................... )+0.< )+<.< ))0.< ))<.< )<<.<
otal.............................. )/+.) ),,.@ )+<., ))+.2 )<<.<
"urrent lia$ilities........... )2<.< )/0.< ),<.< ))<.< )<<.<
+.
3ales: he sales are increasing at a steady and
consistent rate.
Assets: he most noticea$le thing a$out the assets is that
the accounts receiva$le have $een increasing at a
rapid rate9far outstripping the increase in sales.
his disproportionate increase in receiva$les is
pro$a$ly the chief cause of the decrease in cash
over the 've7year period. he inventory seems to
$e growing at a well7$alanced rate in comparison
with sales.
=ia$ilities
:
he current lia$ilities are growing more rapidly
than the total current assets. he reason is
pro$a$ly tracea$le to the rapid $uildup in
receiva$les in that the company doesnGt have the
cash needed to pay $ills as they come due.
3olutions Manual, "hapter ) +/B
E%ercise 1!-" (,< minutes*
). 1ross margin percentage:
1ross margin R)+@,0<<
Y Y ,<./P (rounded*
3ales R/+<,<<<
+. "urrent ratio:
"urrent assets R))0,<<<
Y Y +.,
"urrent lia$ilities R0<,<<<
,. Acid7test ratio:
6uick assets R/),0<<
Y Y <.B,
"urrent lia$ilities R0<,<<<
/. >e$t7to7e4uity ratio:
otal lia$ilities R),<,<<<
Y Y <.@2 (rounded*
otal stockholdersT e4uity R)@<,<<<
0. Average collection period:
3ales on account R/+<,<<<
Y Y )/
Average accounts receiva$le R,<,<<<
,20 days
Y +2 days (rounded*
)/ times
2. Average sale period:
"ost of goods sold R+C+,0<<
Y Y /.0
Average inventory R20,<<<
,20 days
Y B) days (rounded*
/.0 times
@. imes interest earned:
Earnings $efore interest
and income ta.es R,B,<<<
Y Y /.@0
&nterest e.pense RB,<<<
3olutions Manual, "hapter ) +/C
E%ercise 1!-" (continued*
B. ?ook value per share:
3tockholdersT e4uity R)@<,<<<
Y Y R+B.,, per share
"ommon shares outstanding 2,<<< shares
3olutions Manual, "hapter ) +0<
E%ercise 1!-# (+< minutes*
). Earnings per share:
Aet income to common stock R+),<<<
Y Y R,.0< per share
Average num$er of common 2,<<< shares
shares outstanding
+. >ividend payout ratio:
>ividends paid per share R+.)<
Y Y 2ividend yield ratio:
>ividends paid per share R+.)<
Y Y 0P
Market price per share R/+.<<
/. !rice7earnings ratio:
Market price per share R/+.<<
Y Y )+
Earnings per share R,.0<
3olutions Manual, "hapter ) +0)
E%ercise 1!-1$ (+< minutes*
). 8eturn on total assets:
( *
( *
( *
Aet &ncome \ &nterest e.pense V ) 7 a. rate
8eturn on
Y
total assets
R+),<<< \ RB,<<< V ) 7 <.,<
Y
)H+ R+B<,<<< \ R,<<,<<<
R+2,2<<
Y Y C.+P (rounded*
R+C<,<<<
v w
x y
v w
x y
+. 8eturn on common stockholdersG e4uity:
( *
8eturn on common
Y
stockholdersT e4uity
Average common stockholdersT e4uity
R+),<<<
Y
)H+ R)2),2<<\R)@<,<<<
R+),<<<
Y Y )+.@P (rounded*
R)20,B<<
,. Financial leverage was positive, since the rate of return to the
common stockholders ()+.@P* was greater than the rate of
return on total assets (C.+P*. his positive leverage is tracea$le
in part to the companyGs current lia$ilities, which may have no
interest cost, and in part to the $onds paya$le, which have an
after7ta. interest cost of only @P.
)<P interest rate V () X <.,<* Y @P
3olutions Manual, "hapter ) +0+
&ro'lem 1!-11 (,< minutes*
). a. "omputation of working capital:
"urrent assets:
"ash.................................... R0<,<<<
Marketa$le securities.......... ,<,<<<
Accounts receiva$le, net..... +<<,<<<
&nventory............................. +)<,<<<
!repaid e.penses................ )<,<<<
otal current assets................ 0<<,<<<
Accounts paya$le................ )0<,<<<
Aotes due in one year......... ,<,<<<
Accrued lia$ilities................ +<,<<<
otal current lia$ilities............ +<<,<<<
Oorking capital...................... R,<<,<<<
$. "omputation of the current ratio:
"urrent assets R0<<,<<<
Y Y +.0
"urrent lia$ilities R+<<,<<<
c. "omputation of the acid7test ratio:
"ash \ Marketa$le securities \
Accounts receiva$le R+B<,<<<
Y Y )./
"urrent lia$ilities R+<<,<<<
3olutions Manual, "hapter ) +0,
&ro'lem 1!-11 (continued*
+. ,he E#ect on
0or&in
g Current
Acid/
,est
,ransaction Capital 2atio 2atio
(a* &ssued capital stock for cash.... &ncrease &ncrease &ncrease
($* 3old inventory at a gain........... &ncrease &ncrease &ncrease
(c* Orote o# uncollecti$le
accounts................................ Aone Aone Aone
(d*
>eclared a cash dividend.........
>ecreas
e
>ecreas
e >ecrease
(e* !aid accounts paya$le............. Aone &ncrease &ncrease
(f*
?orrowed on a short7term note Aone
>ecreas
e >ecrease
(g*
3old inventory at a loss............
>ecreas
e
>ecreas
e &ncrease
(h* !urchased inventory on
account................................. Aone
>ecreas
e >ecrease
(i* !aid short7term notes............... Aone &ncrease &ncrease
(j*
!urchased e4uipment for cash.
>ecreas
e
>ecreas
e >ecrease
(k* 3old marketa$le securities at a
loss........................................
>ecreas
e
>ecreas
e >ecrease
(l* "ollected accounts receiva$le.. Aone Aone Aone
3olutions Manual, "hapter ) +0/
&ro'lem 1!-12 (2< minutes*
,his -ear )ast -ear
). a. "urrent assets.................................... R),0+<,<<< R),<C<,<<<
"urrent lia$ilities................................ B<<,<<< /,<,<<<
Oorking capital.................................. R @+<,<<< R 22<,<<<
$. "urrent assets (a*.............................. R),0+<,<<< R),<C<,<<<
"urrent lia$ilities ($*.......................... RB<<,<<< R/,<,<<<
"urrent ratio (a* [ ($*........................ ).C< +.0,
c. 6uick assets (a*................................. R00<,<<< R/2B,<<<
"urrent lia$ilities ($*.......................... RB<<,<<< R/,<,<<<
Acid7test ratio (a* [ ($*...................... <.2C ).<C
d. 3ales on account (a*.......................... R0,<<<,<<< R/,,0<,<<<
Average receiva$les ($*..................... R,C<,<<< R+@0,<<<
Accounts receiva$les turnover (a* [
($*.................................................... )+.B )0.B
Average collection period:
,20 days [ turnover........................ +B.0 days +,.) days
e. "ost of goods sold (a*........................ R,,B@0,<<< R,,/0<,<<<
Average inventory ($*........................ R@@0,<<< R00<,<<<
&nventory turnover (a* [ ($*............... 0.< 2.,
Average sales period:
,20 days [ turnover........................ @, days 0B days
f. otal lia$ilities (a*............................... R),/<<,<<< R),<,<,<<<
3tockholdersG e4uity ($*..................... R),2<<,<<< R),/,<,<<<
>e$t7to7e4uity ratio (a* [ ($*............. <.B@0 <.@+<
g.
Aet income $efore interest and
ta.es (a*.......................................... R/@+,<<< R,0+,<<<
&nterest e.pense ($*........................... R@+,<<< R@+,<<<
imes interest earned (a* [ ($*.......... 2.2 /.C
+. a. 3A?&A E=E"8DA&"3
"ommon73ize ?alance 3heets
,his
-ear
)ast
-ear
"urrent assets:
"ash................................................. +.,P 2.)P
Marketa$le securities........................ <.< <.@
Accounts receiva$le, net................... )2.< )+.+
&nventory.......................................... ,).@ +/./
!repaid e.penses.............................. <.@ <.C
otal current assets............................. 0<.@ //.,
!lant and e4uipment, net.................... /C., 00.@
otal assets......................................... )<<.<P )<<.<P
"urrent lia$ilities................................. +2.@P )@.0P
?onds paya$le, )+P........................... +<.< +/./
otal lia$ilities................................... /2.@ /).C
!referred stock, R+0 par, BP............ B., )<.+
"ommon stock, R)< par.................... )2.@ +<.,
8etained earnings............................. +B., +@.2
otal stockholdersG e4uity.................... 0,., 0B.)
otal lia$ilities and e4uity.................... )<<.<P )<<.<P
$. 3A?&A E=E"8DA&"3
"ommon73ize &ncome 3tatements
,his
-ear
)ast
-ear
3ales................................................. )<<.<P )<<.< P
=ess cost of goods sold..................... @@.0 @C.,
1ross margin.................................... ++.0 +<.@
=ess operating e.penses.................. ),.) )+.2
Aet operating income....................... C./ B.)
=ess interest e.pense....................... )./ ).@
Aet income $efore ta.es................... B.< 2./
=ess income ta.es............................ +./ ).C
Aet income....................................... 0.2P /.0 P
,. he following points can $e made from the analytical work in
parts ()* and (+* a$ove:
a. he company has improved its pro't margin from last year.
his is attri$uta$le primarily to an increase in gross margin,
which is o#set somewhat $y a small increase in operating
e.penses. Dverall, the companyGs income statement looks
very good.
$. he companyGs current position has deteriorated signi'cantly
since last year. ?oth the current ratio and the acid7test ratio
are well $elow the industry average and are trending
downward. At the present rate, it will soon $e impossi$le for
the company to pay its $ills as they come due.
c. he drain on the cash account seems to $e a result mostly of
a large $uildup in accounts receiva$le and inventory. Aotice
that the average age of the receiva$les has increased $y 've
days since last year, and now is )< days over the industry
average. Many of the companyGs customers are not taking
their discounts, since the average collection period is +B
days and collections terms are +H)<, nH,<. his suggests
'nancial weakness on the part of these customers, or sales
to customers who are poor credit risks.
3olutions Manual, "hapter ) +0@
d. he inventory turned only 've times this year as compared
to over si. times last year. &t takes nearly two weeks longer
for the company to turn its inventory than the average for
the industry (@, days as compared to 2< days for the
industry*. his suggests that inventory stocks are higher than
they need to $e.
e. &n the authorsG opinion, the loan should $e approved only if
the company gets its accounts receiva$le and inventory $ack
under control. &f the accounts receiva$le collection period is
reduced to a$out +< days, and if the inventory is pared down
enough to reduce the turnover time to a$out 2< days,
enough funds could $e released to su$stantially improve the
companyGs cash position. hen a loan might not even $e
needed.
3olutions Manual, "hapter ) +0B
&ro'lem 1!-13 (/0 minutes*
,his
-ear
)ast
-ear
). a. Aet income......................................
R+B<,<<
<
R)C2,<<
<
=ess preferred dividends................. +<,<<< +<,<<<
(a*.................................................
R+2<,<<
<
R)@2,<<
<
shares ($*...................................... 0<,<<< 0<,<<<
Earnings per share (a* [ ($*............ R0.+< R,.0+
$. "ommon dividend per share (a*...... R).B< R).0<
Market price per share ($*............... R/<.<< R,2.<<
>ividend yield ratio (a* [ ($*........... /.0P /.+P
c. "ommon dividend per share (a*...... R).B< R).0<
Earnings per share ($*..................... R0.+< R,.0+
!ayout ratio (a* [ ($*....................... ,/.2P /+.2P
d. Market price per share (a*............... R/<.<< R,2.<<
Earnings per share ($*..................... R0.+< R,.0+
!rice7earnings ratio (a* [ ($*........... @.@ )<.+
&nvestors regard 3a$in Electronics less favora$ly than other
'rms in the industry. his is evidenced $y the fact that they
are willing to pay only @.@ times current earnings for a share
of 3a$inGs stock, as compared to )+ times current earnings
for the average of all stocks in the industry. &f investors were
willing to pay )+ times current earnings for 3a$inGs stock, it
would $e selling for a$out R2+./< per share ()+ V R0.+<*,
rather than for only R/< per share.
3olutions Manual, "hapter ) +0C
,his -ear )ast -ear
e. 3tockholdersG e4uity...........................
R),2<<,<<
<
R),/,<,<<
<
=ess preferred stock........................... +0<,<<<
+0<,<<
<
"ommon stockholdersG e4uity (a*.......
R),,0<,<<
<
R),)B<,<<
<
Aum$er of common shares ($*........... 0<,<<< 0<,<<<
?ook value per share (a* [ ($*........... R+@.<< R+,.2<
he market value is a$ove $ook value for $oth years.
;owever, this does not necessarily indicate that the stock is
overpriced. Market value re-ects investorsG perceptions of
future earnings, whereas $ook value is a result of already
completed transactions and is geared to the past.
+. a. Aet income....................................... R +B<,<<<
R
)C2,<<<
Add after7ta. cost of interest paid:
]R@+,<<< V () X <.,<*^................... 0<,/<< 0<,/<<
otal (a*............................................ R ,,<,/<<
R
+/2,/<<
Average total assets ($*...................R+,@,<,<<<
R+,,B<,<<
<
8eturn on total assets (a* [ ($*........ )+.)P )<./P
$. Aet income....................................... R +B<,<<<
R
)C2,<<<
=ess preferred dividends.................. +<,<<< +<,<<<
(a*.................................................. R +2<,<<<
R
)@2,<<<
Average total stockholdersG e4uity.. .R),0)0,<<<
R),,@C,0<
<
=ess average preferred stock........... +0<,<<< +0<,<<<
Average common e4uity ($*.............R),+20,<<<
R),)+C,0<
<
8eturn on common e4uity (a* [ ($*.. +<.2P )0.2P
3olutions Manual, "hapter ) +2<
c. Financial leverage is positive in $oth years, since the return
on common e4uity is greater than the return on total assets.
his positive 'nancial leverage is due to three factors: the
preferred stock, which has a dividend rate of only BP% the
$onds, which have an after7ta. interest cost of only B./P
])+P interest rate V () X <.,<* Y B./P^% and the accounts
paya$le, which may $ear no interest cost.
,. Oe would recommend purchase. he stockGs downside risk
seems small, since it is now selling for only @.@ times earnings
to )+ times earnings for the average 'rm in the industry. &n
addition, its earnings are strong and trending upward, and its
return on common e4uity (+<.2P* is e.tremely good. &ts return
on total assets ()+.)P* compares well with that of the industry.
he risk, of course, is whether the company can get its cash
pro$lem under control. "onceiva$ly, the cash pro$lem could
worsen, leading to an eventual reduction in pro'ts through
ina$ility to operate, a discontinuance of dividends, and a
precipitous drop in the market price of the companyGs stock.
his does not seem likely, however, since the company has
$orrowing capacity availa$le, and can easily control its cash
pro$lem through more careful management of accounts
receiva$le and inventory. he client must understand, of
course, that there is risk in the purchase of any stock% the risk
seems well justi'ed in this case since the upward potential of
the stock is great if the company gets its pro$lems under
control.
3olutions Manual, "hapter ) +2)
&ro'lem 1!-14 (C< minutes*
,his -ear )ast -ear
). a. Aet income......................................
R B/<,<<
< R 0</,<<<
Add after7ta. cost of interest:
R,2<,<<< V () X <.,<*................... +0+,<<<
R,<<,<<< V () X <.,<*................... +)<,<<<
otal (a*...........................................
R ),<C+,<<
< R @)/,<<<
Average total assets ($*..................
R)0,CC<,<<
<
R),,C+<,<<
<
8eturn on total assets (a* [ ($*....... 2.BP 0.)P
$. Aet income...................................... R B/<,<<< R 0</,<<<
=ess preferred dividends................. )//,<<< )//,<<<
Aet income remaining for
common (a*.................................. R 2C2,<<< R ,2<,<<<
Average total stockholdersG e4uity. . R C,,2<,<<< R C,<B/,<<<
=ess average preferred stock.......... ),B<<,<<< ),B<<,<<<
Average common e4uity ($*............ R @,02<,<<< R @,+B/,<<<
8eturn on common e4uity (a* [
($*................................................. C.+P /.CP
c. =everage is positive for this year, since the return on
common e4uity (C.+P* is greater than the return on total
assets (2.BP*. For last year, leverage is negative since the
return on common e4uity (/.CP* is less than the return on
total assets (0.)P*.
3olutions Manual, "hapter ) +2+
,his -ear )ast -ear
+. a.
(a*.................................................. R2C2,<<< R,2<,<<<
shares ($*....................................... @0,<<< @0,<<<
Earnings per share (a* [ ($*............. RC.+B R/.B<
$. "ommon dividend per share (a*....... R+.BB R).//
Market price per share ($*................ R@+.<< R/<.<<
>ividend yield ratio (a* [ ($*............ /.ividend payout ratio (a* [ ($*......... ,).<P ,<.<P
d. Market price per share (a*................. R@+.<< R/<.<<
Earnings per share ($*....................... RC.+B R/.B<
!rice7earnings ratio (a* [ ($*............. @.B B.,
Aotice from the data given in the pro$lem that the average
!HE ratio for 'rms in =yde. "ompanyGs industry is )<. 3ince
=yde. "ompany presently has a !HE ratio of only @.B,
investors appear to regard it less well than they do other
'rms in the industry. hat is, investors are willing to pay only
@.B times current earnings for a share of =yde. "ompanyGs
stock, as compared to )< times current earnings for a share
of stock for the average 'rm in the industry.
e. 3tockholdersG e4uity......................... RC,2<<,<<< RC,)+<,<<<
=ess preferred stock......................... ),B<<,<<< ),B<<,<<<
"ommon stockholdersG e4uity (a*..... R@,B<<,<<< R@,,+<,<<<
Aum$er of common shares ($*......... @0,<<< @0,<<<
?ook value per share (a* [ ($*......... R)</.<< RC@.2<
3olutions Manual, "hapter ) +2,
Aotice that market value is $elow $ook value for $oth years
for the common stock. his does not necessarily indicate that
the stock is selling at a $argain price. Market value re-ects
investorsG e.pectations concerning future earnings, whereas
$ook value is a result of already completed transactions and
is geared to the past.
,his -ear )ast -ear
1ross margin (a*............................... R,,)0<,<<< R+,0B<,<<<
3ales ($*...........................................
R)0,@0<,<<
<
R)+,/B<,<<
<
1ross margin percentage (a* [ ($*... +<.<P +<.@P
,his -ear )ast -ear
,. a. "urrent assets................................... R@,B<<,<<< R0,C/<,<<<
"urrent lia$ilities............................... ,,C<<,<<< +,@2<,<<<
Oorking capital................................. R,,C<<,<<< R,,)B<,<<<
$. "urrent assets (a*.............................. R@,B<<,<<< R0,C/<,<<<
"urrent lia$ilities ($*.......................... R,,C<<,<<< R+,@2<,<<<
"urrent ratio (a* [ ($*....................... +.< +.)0
c. 6uick assets (a*................................. R,,22<,<<< R,,,2<,<<<
"urrent lia$ilities ($*.......................... R,,C<<,<<< R+,@2<,<<<
Acid7test ratio (a* [ ($*..................... <.C/ ).++
d. 3ales on account (a*..........................
R)0,@0<,<<
<
R)+,/B<,<<
<
Average receiva$les ($*..................... R+,+0<,<<< R),2B<,<<<
urnover of receiva$les (a* [ ($*....... @ @./
Average collection period,
,20 days [ turnover....................... 0+ days /C days
3olutions Manual, "hapter ) +2/
,his -ear )ast -ear
e. "ost of goods sold (a*..............................................
R)+,2<<,<<
< RC,C<<,<<<
Average inventory ($*.............................................. R,,)0<,<<< R+,)2<,<<<
&nventory turnover (a* [ ($*.................................... /.< /.2
Average sale period,
,20 days [ turnover............................................. C).+0 days @C., days
f. otal lia$ilities (a*.................................................... R@,0<<,<<< R0,@2<,<<<
3tockholdersG e4uity ($*.......................................... RC,2<<,<<< RC,)+<,<<<
>e$t7to7e4uity ratio (a* [ ($*.................................. <.@B <.2,
g.
Aet income $efore interest and
ta.es (a*............................................................... R),02<,<<< R),<+<,<<<
&nterest e.pense ($*................................................ R,2<,<<< R,<<,<<<
imes interest earned (a* [ ($*............................... /., ,./
/. ?oth net income and sales are up from last year. he return on
total assets has improved from 0.)P to 2.BP, and the return on
common e4uity is up from /.CP to C.+P. ?ut this is the only
$right spot. Iirtually all other ratios are $elow the industry
average, and, more important, they are trending downward.
he deterioration in the gross margin percentage, while not
large, is worrisome. 3ales and inventories have increased
su$stantially. Drdinarily, this should result in an improvement in
the gross margin percentage due to '.ed costs $eing spread
over a greater num$er of units. ;owever, the gross margin
percentage has declined.
Aotice particularly that the average collection period has
lengthened to 0+ days9a$out three weeks over the industry
average. Dne wonders if the increase in sales was o$tained at
least in part $y e.tending credit to high7risk customers. Aotice
also that the de$t7to7e4uity ratio is rising rapidly. &f the
R,,<<<,<<< loan is granted, the ratio will rise further to ).<C.
Ohat the company pro$a$ly needs is more e4uity9not more
de$t. herefore, the loan should not $e approved. he company
should $e encouraged to issue more common stock to provide
a $roader e4uity $ase on which to operate.
). =Q>ES "DM!AAQ
"omparative ?alance 3heets
,his
-ear
)ast
-ear
"urrent assets:
"ash............................................... 0.2P B.0P
Marketa$le securities...................... <.< +.<
Accounts receiva$le, net................. )0.B )+.)
&nventory........................................ ++.B )2.)
!repaid e.penses............................ )./ ).+
otal current assets........................... /0.2 ,C.C
!lant and e4uipment, net.................. 0/./ 2<.)
otal assets....................................... )<<.<P )<<.<P
"urrent lia$ilities............................... ++.BP )B.0P
Aote paya$le, )<P............................ +).) +<.+
otal lia$ilities................................... /,.C ,B.@
!referred stock, BP, R,< par
value............................................ )<.0 )+.)
"ommon stock, RB< par value........ ,0.) /<.,
8etained earnings........................... )<.0 B.C
otal stockholdersG e4uity.................. 02.) 2).,
otal lia$ilities and e4uity.................. )<<.ES "DM!AAQ
"omparative &ncome 3tatements
,his
-ear
)ast
-ear
3ales................................................. )<<.<P )<<.<P
=ess cost of goods sold...................... B<.< @C.,
1ross margin..................................... +<.< +<.@
=ess operating e.penses................... )<.) )+.0
Aet operating income........................ C.C B.+
=ess interest e.pense........................ +., +./
Aet income $efore ta.es.................... @.2 0.B
=ess income ta.es (,<P*................... +., ).@
Aet income........................................ 0., P /.< PZ
Z >ue to rounding, 'gures may not fully reconcile down a
column.
,. he companyGs current position has declined su$stantially
$etween the two years. "ash this year represents only 0.2P of
total assets, whereas it represented )<.0P last year (cash \
marketa$le securities*. &n addition, $oth accounts receiva$le
and inventory are up from last year, which helps to e.plain the
decrease in the cash account. he company is $uilding
inventories, $ut not collecting from customers. (3ee !ro$lem
)@7)/ for a ratio analysis of the current assets.* Apparently a
part of the 'nancing re4uired to $uild inventories was supplied
$y short7term creditors, as evidenced $y the increase in current
lia$ilities.
=ooking at the income statement, as noted in the solution to
the preceding pro$lem there has $een a slight deterioration in
the gross margin percentage. Drdinarily, the increase in sales
(and in inventories* should have resulted in an increase in the
gross margin percentage since '.ed manufacturing costs would
$e spread across more units. Aote that the other operating
e.penses are down as a percentage of sales9possi$ly $ecause
many of them are likely to $e '.ed.
3olutions Manual, "hapter ) +2B
a. &t is $ecoming more diEcult for the company to pay its $ills as
they come due. Although the current ratio has improved over
the three years, the acid7test ratio is down. Also notice that the
accounts receiva$le and inventory are $oth turning more
slowly, indicating that an increasing portion of the current
assets is $eing made up of these items, from which $ills cannot
$e paid.
$. "ustomers are paying their $ills more slowly in Qear , than in
Qear ). his is evidenced $y the decline in accounts receiva$le
turnover.
c. he total of accounts receiva$le is increasing. his is evidenced
$oth $y a slowdown in turnover and in an increase in total
sales.
d. he level of inventory undou$tedly is increasing. Aotice that
the inventory turnover is decreasing. Even if sales (and cost of
goods sold* just remained constant, this would $e evidence of a
larger average inventory on hand. ;owever, sales are not
constant, $ut rather are increasing. Oith sales increasing (and
undou$tedly cost of goods sold also increasing*, the average
level of inventory must $e increasing as well to service the
larger volume of sales.
e. he market price is going down. he dividends paid per share
over the three7year period are unchanged, $ut the dividend
yield is going up. herefore, the market price per share of stock
must $e decreasing.
f. he amount of earnings per share is increasing. Again, the
dividends paid per share have remained constant. ;owever,
the dividend payout ratio is decreasing. &n order for the
dividend payout ratio to $e decreasing, the earnings per share
must $e increasing.
g. he price7earnings ratio is going down. &f the market price of
the stock is going down ]see !art (e* a$ove^, and the earnings
per share are going up ]see !art (f* a$ove^, then the price7
earnings ratio must $e decreasing.
h. &n Qear ) and in Qear + there was negative leverage, since in
$oth years the return on total assets e.ceeded the return on
3olutions Manual, "hapter ) +2C
common e4uity. &n Qear , there was positive leverage since in
that year the return on common e4uity e.ceeded the return on
total assets employed.
3olutions Manual, "hapter ) +@<
&ro'lem 1!-1! (/0 minutes*
E#ect on
2atio 2eason for "ncreaseA !ecreaseA or (o E#ect
). >ecrease >eclaring a cash dividend will increase current
lia$ilities, $ut have no e#ect on current assets.
herefore, the current ratio will decrease.
+. &ncrease A sale of inventory on account will increase the
4uick assets (cash, accounts receiva$le,
marketa$le securities* $ut have no e#ect on the
current lia$ilities. For this reason, the acid7test
ratio will increase. he same e#ect would result
regardless of whether the inventory was sold at
cost, at a pro't, or at a loss. hat is, the acid7test
ratio would increase in all cases% the only
di#erence would $e the amount of the increase.
,. &ncrease he interest rate on the $onds is only BP. 3ince
the companyGs assets earn at a rate of return of
)<P, positive leverage would come into e#ect,
increasing the return to the common stockholders.
/. >ecrease A decrease in net income would mean less income
availa$le to cover interest payments. herefore,
the times7interest7earned ratio would decrease.
0. &ncrease !ayment of a previously declared cash dividend will
reduce $oth current assets and current lia$ilities $y
the same amount. An e4ual reduction in $oth
current assets and current lia$ilities will always
result in an increase in the current ratio, so long as
the current assets e.ceed the current lia$ilities.
2. Ao E#ect he dividend payout ratio is a function of the
dividends paid per share in relation to the earnings
per share. "hanges in the market price of a stock
have no e#ect on this ratio.
3olutions Manual, "hapter ) +@)
&ro'lem 1!-1! (continued*
E#ect
on
@. &ncrease A write7o# of inventory will reduce the inventory
$alance, there$y increasing the turnover in relation
to a given level of sales.
B. >ecreas
e
3ale of inventory at a pro't will increase the assets
of a company. he increase in assets will $e
re-ected in an increase in retained earnings, which
is part of stockholdersG e4uity. An increase in
stockholdersG e4uity will result in a decrease in the
ratio of assets provided $y creditors as compared to
assets provided $y owners.
C. >ecreas
e
E.tended credit terms for customers means that
customers on the average will $e taking longer to
pay their $ills. As a result, the accounts receiva$le
will Mturn over,N or $e collected, less fre4uently
during a given year.
)<. >ecreas
e
A common stock dividend will result in a greater
num$er of shares outstanding, with no change in
the underlying assets. he result will $e a decrease
in the $ook value per share.
)). Ao
E#ect
?ook value per share is dependent on historical
costs of already completed transactions as re-ected
on a companyGs $alance sheet. &t is not a#ected $y
current market prices for the companyGs stock.
)+. Ao
E#ect
!ayments on account reduce cash and accounts
paya$le $y e4ual amounts% thus, the net amount of
working capital is not a#ected.
),. >ecreas
e
he stock dividend will increase the num$er of
common shares outstanding, there$y reducing the
earnings per share.
3olutions Manual, "hapter ) +@+
&ro'lem 1!-1! (continued*
E#ect
on
)/. >ecreas
e
!ayments to creditors will reduce the total lia$ilities
of a company, there$y decreasing the ratio of total
de$t to total e4uity.
)0. >ecreas
e
A purchase of inventory on account will increase
current lia$ilities, $ut will not increase the 4uick
assets (cash, accounts receiva$le, marketa$le
securities*. herefore, the ratio of 4uick assets to
current lia$ilities will decrease.
)2. Ao
E#ect
Orite7o# of an uncollecti$le account against the
Allowance for ?ad >e$ts will have no e#ect on total
current assets. For this reason, the current ratio will
remain unchanged.
)@. &ncrease he price7earnings ratio is o$tained $y dividing the
market price per share $y the earnings per share. &f
the earnings per share remains unchanged, and the
market price goes up, then the price7earnings ratio
will increase.
)B. >ecreas
e
he dividend yield ratio is o$tained $y dividing the
dividend per share $y the market price per share. &f
the dividend per share remains unchanged and the
market price goes up, then the yield will decrease.
3olutions Manual, "hapter ) +@,
&ro'lem 1!-1" (/0 minutes*
). he loan oEcer stipulated that the current ratio prior to
o$taining the loan must $e higher than +.<, the acid7test ratio
must $e higher than ).<, and the interest on the loan must $e
less than four times net operating income. hese ratios are
computed $elow:
"urrent assets
"urrent ratio Y
"urrent lia$ilities
R+C<,<<<
Y Y ).B (rounded*
R)2/,<<<
Acid7test ratio Y
-ash 7 ,ar8eta4le se2urities 7 -urrent re2eiva4les

-urrent lia4ilities
$!0,000 7 $0 7 $$0,000
. . 0"! 9roun)e):
$164,000
Aet operating income R+<,<<<
Y Y 0.<
&nterest on the loan RB<,<<< V <.)< V (2H)+*
he company would fail to 4ualify for the loan $ecause $oth its
current ratio and its acid7test ratio are too low.
3olutions Manual, "hapter ) +@/
&ro'lem 1!-1" (continued*
+. ?y reclassifying the R/0 thousand net $ook value of the old
machine as inventory, the current ratio would improve, $ut
there would $e no e#ect on the acid7test ratio. his happens
$ecause inventory is considered to $e a current asset $ut is not
included in the numerator when computing the acid7test ratio.
-urrent assets
-urrent ratio .
-urrent lia4ilities
$2#0,000 7 $4$,000
. . 2"0 9roun)e):
$164,000
Acid7test ratio Y

-urrent lia4ilities
$!0,000 7 $0 7 $$0,000
. . 0"! 9roun)e):
$164,000
Even if this tactic had succeeded in 4ualifying the company for
the loan, we strongly advise against it. &nventories are assets
the company has ac4uired for the sole purpose of selling them
to outsiders in the normal course of $usiness. Ksed production
e4uipment is not inventory9even if there is a clear intention to
sell it in the near future. 3ince the loan oEcer would not e.pect
used e4uipment to $e included in inventories, doing so would
$e intentionally misleading.
3olutions Manual, "hapter ) +@0
&ro'lem 1!-1" (continued*
Aevertheless, the old machine is an asset that could $e turned
into cash. &f this were done, the company would immediately
4ualify for the loan since the R/0 thousand in cash would $e
included in the numerator in $oth the current ratio and in the
acid7test ratio.
-urrent assets
-urrent ratio .
-urrent lia4ilities
$2#0,000 7 $4$,000
. . 2"0 9roun)e):
$164,000
Acid7test ratio Y

-urrent lia4ilities
$!0,000 7 $0 7 $$0,000 7 $4$,000
. . 1"0 9roun)e):
$164,000
;owever, other options may $e availa$le. After all, the old
machine is $eing used to relieve $ottlenecks in the plastic
injection molding process and it would $e desira$le to keep this
stand$y capacity. Oe would advise 8uss to fully and honestly
e.plain the situation to the loan oEcer. he loan oEcer might
insist that the machine $e sold $efore any loan is approved, $ut
she might instead grant a waiver of the current ratio and acid7
test ratio re4uirements on the $asis that they could $e satis'ed
$y selling the old machine. Dr she may approve the loan on the
condition that the machine is pledged as collateral. &n that
case, 8uss would only have to sell the machine if he would
otherwise $e una$le to pay $ack the loan.
3olutions Manual, "hapter ) +@2
&ro'lem 1!-1# (2< minutes or longer*
!E!!E8 &A>K38&E3
&ncome 3tatement
For the Qear Ended March ,)
Ce% to
Computatio
n
3ales............................................ R/,+<<,<<<
=ess cost of goods sold................ +,@,<,<<< (h*
1ross margin............................... ),/@<,<<< (i*
=ess operating e.penses............. C,<,<<< (j*
Aet operating income.................. 0/<,<<< (a*
=ess interest e.pense.................. B<,<<<
Aet income $efore ta.es.............. /2<,<<< ($*
=ess income ta.es (,<P*............. ),B,<<< (c*
Aet income.................................. R ,++,<<< (d*
!E!!E8 &A>K38&E3
?alance 3heet
March ,)
"urrent assets:
"ash.......................................... R @<,<<< (f*
Accounts receiva$le, net........... ,,<,<<< (e*
&nventory................................... /B<,<<< (g*
otal current assets...................... BB<,<<< (g*
!lant and e4uipment................... ),0+<,<<< (4*
otal assets.................................. R+,/<<,<<< (p*
"urrent lia$ilities......................... R ,+<,<<<
?onds paya$le, )<P.................... B<<,<<< (k*
otal lia$ilities.............................. ),)+<,<<< (l*
"ommon stock, R0 par value..... @<<,<<< (m*
8etained earnings..................... 0B<,<<< (o*
otal stockholdersG e4uity............ ),+B<,<<< (n*
otal lia$ilities and e4uity............ R+,/<<,<<< (p*
3olutions Manual, "hapter ) +@@
&ro'lem 1!-1# (continued*
"omputation of missing amounts:
a. Earnings $efore interest and ta.es
imes interest earned Y
&nterest e.pense
Earnings $efore interest and ta.es
Y
RB<,<<<
Y 2.@0
herefore, the earnings $efore interest and ta.es for the year
must $e R0/<,<<<.
$. R0/<,<<< X RB<,<<< Y R/2<,<<<.
c. &ncome ta. e.pense Y R/2<,<<< V ,<P ta. rate Y R),B,<<<.
d. R/2<,<<< X R),B,<<< Y R,++,<<<.
e. 3ales on account
Accounts receiva$le
Y
turnover
R/,+<<,<<<
Y
Y )/.<
herefore, the average accounts receiva$le $alance for the
year must have $een R,<<,<<<. 3ince the $eginning $alance
was R+@<,<<<, the ending $alance must have $een R,,<,<<<.
f. "ash \ Marketa$le securities \ "urrent receiva$les
Acid7test ratioY
"urrent lia$ilities

"ash \ Marketa$le securities \ "urrent receiva$les
Y
R,+<,<<<
Y ).+0
3olutions Manual, "hapter ) +@B
herefore, the total 4uick assets must $e R/<<,<<<. 3ince there
are no marketa$le securities and since the accounts receiva$le
are R,,<,<<<, the cash must $e R@<,<<<.
g. "urrent assets
"urrent ratio Y
"urrent lia$ilities
"urrent assets
Y
R,+<,<<<
Y +.@0
herefore, the current assets must total RBB<,<<<. 3ince the
4uick assets (cash and accounts receiva$le* total R/<<,<<< of
this amount, the inventory must $e R/B<,<<<.
h. "ost of goods sold
&nventory turnover Y
Average inventory
"ost of goods sold
Y
)H+(R,2<,<<<\R/B<,<<<*
"ost of goods sold
Y
R/+<,<<<
Y 2.0
herefore, the cost of goods sold for the year must $e
R+,@,<,<<<.
i. 1ross margin Y R/,+<<,<<< X R+,@,<,<<< Y R),/@<,<<<.
j. Aet operating income Y 1ross margin 7 Dperating e.penses
Dperating e.penses Y 1ross margin 7 Aet operating income
Y R),/@<,<<< 7 R0/<,<<<
Y RC,<,<<<
3olutions Manual, "hapter ) +@C
k. 3ince the interest e.pense for the year was RB<,<<< and the
interest rate was )<P, the $onds paya$le must total RB<<,<<<.
l. R,+<,<<< \ RB<<,<<< Y R),)+<,<<<.
m
.
Earnings per share Y
Average num$er of common shares outstanding
R,++,<<<
Y
Average num$er of common shares outstanding
Y R+.,<
herefore, there must $e )/<,<<< common shares outstanding.
3ince the stock is R0 par value per share, the total common
stock must $e R@<<,<<<.
n. otal lia$ilities
>e$t7to7e4uity ratio Y
R),)+<,<<<
Y
Y <.B@0
herefore, the total stockholdersG e4uity must $e R),+B<,<<<.
o. otal stockholdersT e4uity Y "ommon stock \ 8etained earnings
8etained earnings Y otal stockholdersT e4uity 7 "ommon 3tock
Y R),+B<,<<< 7 R@<<,<<< Y R0B<,<<<
3olutions Manual, "hapter ) +B<
p. otal assets Y =ia$ilities \ 3tockholdersT e4uity
Y R),)+<,<<< \ R),+B<,<<< Y R+,/<<,<<<
his answer can also $e o$tained using the return on total
assets:

Aet income \ ]&nterest e.pense V () 7 a. rate*^
8eturn on
Y
total assets
R,++,<<< \ ]RB<,<<< V () 7 <.,<*^
Y
R,@B,<<<
Y
Y )B.<P
herefore the average total assets must $e R+,)<<,<<<. 3ince
the total assets at the $eginning of the year were R),B<<,<<<,
the total assets at the end of the year must have $een
R+,/<<,<<< (which would also e4ual the total of the lia$ilities
and the stockholdersG e4uity*.
4. otal assets Y "urrent assets \ !lant and e4uipment
R+,/<<,<<< Y RBB<,<<< \ !lant and e4uipment
!lant and e4uipment Y R+,/<<,<<< 7 RBB<,<<<
Y R),0+<,<<<
3olutions Manual, "hapter ) +B)
&ro'lem 1!-2$ (2< minutes*
,his -ear )ast -ear
). a. Aet income................................... R),<0<,<<< R B/<,<<<
=ess preferred dividends............... )+<,<<< )+<,<<<
Aet income remaining for
common (a*................................ R C,<,<<< R @+<,<<<
shares outstanding ($*................ +<<,<<< Z +<<,<<< Z
Earnings per share (a* [ ($*.......... R/.20 R,.2<
kZR),<<<,<<< [ R0 par value Y +<<,<<<
shares.
$. "ash dividends per share (a*......... R).B< Z R)./< Z
Market price per share ($*............. R2<.<< R/0.<<
>ividend yield ratio (a* [ ($*......... ,.<P ,.)P
Z=ast Qear: R+B<,<<< [ +<<,<<< shares Y R)./< per share
his Qear: R,2<,<<< [ +<<,<<< shares Y R).B< per share
c. "ash dividends per share (a*......... R).B< R)./<
Earnings per share ($*................... R/.20 R,.2<
>ividend payout ratio (a* [ ($*..... ,B.@P ,B.CP
d. Market price per share (a*............. R2<.<< R/0.<<
Earnings per share ($*................... R/.20 R,.2<
!rice7earnings ratio (a* [ ($*......... )+.C )+.0
e. otal stockholdersG e4uity.............. R0,/@<,<<< R/,C<<,<<<
=ess preferred stock...................... ),0<<,<<< ),0<<,<<<
"ommon stockholdersG e4uity (a*. R,,C@<,<<< R,,/<<,<<<
"ommon shares outstanding ($*.. . +<<,<<< +<<,<<<
?ook value per share (a* [ ($*...... R)C.B0 R)@.<<
f. 1ross margin (a*........................... R@,<<<,<<< R2,<<<,<<<
3ales ($*........................................
R+<,<<<,<<
<
R)0,<<<,<<
<
1ross margin percentage (a* [
($*............................................... ,0P /<P
3olutions Manual, "hapter ) +B+
&ro'lem 1!-2$ (continued*
,his -ear )ast -ear
+. a. Aet income......................................... R),<0<,<<< R B/<,<<<
Add after7ta. cost of interest paid:
R+/<,<<< V () X <.,<*...................... )2B,<<< )2B,<<<
otal (a*.............................................. R),+)B,<<< R),<<B,<<<
Average total assets ($*...................... RB,C,0,<<< R@,+<<,<<<
8eturn on total assets (a* [ ($*.......... ),.2P )/.<P
$. Aet income......................................... R),<0<,<<< R B/<,<<<
=ess preferred dividends..................... )+<,<<< )+<,<<<
(a*.................................................... R C,<,<<< R @+<,<<<
Average common stockholdersG
e4uity ($*......................................... R,,2B0,<<< R,,)0<,<<<
8eturn on common stockholdersG
e4uity
(a* [ ($*........................................... +0.+P ++.CP
c. Financial leverage is positive in $oth years, since the return
on common e4uity is greater than the return on total assets.
his positive leverage arises from the preferred stock, which
has a dividend cost of only BP% and the $onds, which have
an after7ta. interest cost of only B./P ])+P interest rate V ()
X <.,<*^% and the current lia$ilities, which may have no
interest cost.
,. he companyGs common stock is pro$a$ly not an attractive
investment. Ohile most of the 'nancial ratios are near the
industry averages, the company has a relatively low price7
earnings ratio. his indicates that the market does not view the
companyGs future prospects as favora$ly as other companies in
the industry. he sharp deterioration in the gross margin
percentage is particularly trou$ling. ?oth sales and inventories
have $een growing, which should usually result in an
improvement in the gross margin percentage due to '.ed costs
$eing spread over a greater num$er of units. ;owever, the
gross margin percentage has declined from /<P down to ,0P.
3olutions Manual, "hapter ) +B,
his suggests the e.istence of some major operating pro$lems.
3olutions Manual, "hapter ) +B/
&ro'lem 1!-21 (/0 minutes*
,his -ear )ast -ear
). a. "urrent assets................................
R /,B<<,<<
< R+,0<<,<<<
"urrent lia$ilities............................ +,0<<,<<< ),<<<,<<<
Oorking capital...............................
R +,,<<,<<
< R),0<<,<<<
$. "urrent assets (a*........................... R/,B<<,<<< R+,0<<,<<<
"urrent lia$ilities ($*....................... R+,0<<,<<< R),<<<,<<<
"urrent ratio (a* [ ($*..................... ).C+ +.0<
c. 6uick assets (a*.............................. R),@<<,<<< R),+<<,<<<
"urrent lia$ilities ($*....................... R+,0<<,<<< R),<<<,<<<
Acid7test ratio (a* [ ($*................... <.2B ).+<
d. 3ales on account (a*.......................
R+<,<<<,<<
<
R)0,<<<,<<
<
Average accounts receiva$le ($*..... R),)0<,<<< R@<<,<<<
Accounts receiva$le turnover (a*
[ ($*............................................ )@./ +)./
Average collection period:
,20 days [ turnover.................... +).< days )@.) days
e. "ost of goods sold (a*.....................
R),,<<<,<<
< RC,<<<,<<<
Average inventory ($*..................... R+,)<<,<<< R),)<<,<<<
&nventory turnover (a* [ ($*........... 2.+ B.+
Average sale period:
,20 days [ turnover.................... 0B.C days //.0 days
f. Aet operating income (a*................ R),@/<,<<< R),//<,<<<
&nterest e.pense ($*....................... R+/<,<<< R+/<,<<<
imes interest earned (a* [ ($*....... @.+0 2.<
g. otal lia$ilities (a*........................... R/,0<<,<<< R,,<<<,<<<
otal stockholdersG e4uity ($*.......... R0,/@<,<<< R/,C<<,<<<
>e$t7to7e4uity ratio (a* [ ($*.......... <.B+ <.2)
3olutions Manual, "hapter ) +B0
+. he following comments can $e made relative to the
companyGs current 'nancial condition:
a. he working capital is increasing, $ut $oth the current ratio
and the acid7test ratio have deteriorated signi'cantly over
the last year. (his shows the danger of relying on working
capital alone in assessing the well7$eing of a company.* Oith
an acid7test ratio of only <.2B, it is not surprising that the
company is having diEculty paying its $ills.
$. he company is taking 0 days longer to collect an account
than the average for the industry. E4ually signi'cant, the
collection period has increased over the last year. his is the
result either of poor collection e#orts or sales to customers
who are poor credit risks.
c. he company is taking nearly )C days longer to turn its
inventory than the average for the industry. And the average
sale period has increased signi'cantly over the last year.
3low turnover of inventory is usually indicative of inventory
stocks that are too large or include too many unsala$le
goods.
d. he companyGs earning power is very strong, as evidenced
$y its e.cellent times7interest7earned ratio.
e. he companyGs <.B+ de$t7to7e4uity ratio is already a$ove the
industry average of <.@<, even without the proposed
R0<<,<<< loan.
,. >espite the pro$lems noted in (+* a$ove, we would approve the
loan. Oith the help of the R0<<,<<< in new funds, the company
should have $reathing room to tighten up the collection of its
accounts receiva$le and to reduce its inventory. &f the
receiva$les and inventory are $rought under control, then
several hundred thousand dollars should $ecome availa$le
either to pay o# the loan or to further strengthen the
companyGs current 'nancial condition. his is not a hopeless
situation% it is simply a situation where a good company has
allowed control over certain key assets to slip over the last year
or so.
3olutions Manual, "hapter ) +B2
). he income statement in common7size format would $e:
,his
-ear
)ast
-ear
3ales................................................. )<<.<P )<<.<P
=ess cost of goods sold..................... 20.< 2<.<
1ross margin..................................... ,0.< /<.<
=ess operating e.penses................... +2., ,<./
Aet operating income....................... B.@ C.2
=ess interest e.pense....................... ).+ ).2
Aet income $efore ta.es................... @.0 B.<
=ess income ta.es............................. +., +./
Aet income....................................... 0.+P 0.2P
he $alance sheet in common7size format would $e:
,his -ear )ast -ear
"urrent assets:
"ash............................................... +.<P 0.)P
Accounts receiva$le........................ )0.< )<.)
&nventory........................................ ,<.) )0.+
!repaid e.penses............................ ).< ).,
otal current assets............................ /B.) ,).2
!lant and e4uipment......................... 0).C 2B./
otal assets........................................ )<<.< P )<<.< P
=ia$ilities:
"urrent lia$ilities............................. +0.)P )+.@P
?onds paya$le, )+P........................ +<.) +0.,
otal lia$ilities.................................... /0.) ,B.<
!referred stock, BP, R)< par........... )0.< )C.<
"ommon stock, R0 par.................... )<.< )+.@
8etained earnings........................... +C.B ,<./
otal stockholdersG e4uity.................. 0/.C 2+.<
otal lia$ilities and stockholdersG
e4uity............................................. )<<.< P )<<.< P
"olumns do not total down in all cases due to rounding
di#erences.
3olutions Manual, "hapter ) +B@
+. he companyGs cost of goods sold has increased from 2<P of
sales last year to 20P of sales this year. his appears to $e the
major reason the companyGs pro'ts showed so little increase
$etween the two years. 3ome $ene'ts were realized from the
companyGs cost7cutting e#orts, as evidenced $y the fact that
operating e.penses were only +2.,P of sales this year as
compared to ,<./P last year. Knfortunately, this reduction in
operating e.penses was not enough to o#set the increase in
cost of goods sold. As a result, the companyGs net income
declined from 0.2P of sales last year to 0.+P of sales this year.
3olutions Manual, "hapter ) +BB
,roup E%ercise 1!-23
he answers to this 4uestion will depend on the company that the
students decide to analyze.
3olutions Manual, "hapter ) +BC
,roup E%ercise 13-33
). A manufacturing overhead rate of 0<<P of direct la$or means
that the total manufacturing overhead is 've times as large as
the total direct la$or. &t also means that for every R) of direct
la$or a product incurs, it is charged for R0 of manufacturing
overhead.
+. &f a product re4uires a large amount of direct la$or, the
overhead applied to that product will make that product
e.pensive relative to products that re4uire less direct la$or.
,. Ohen products are outsourced, any common '.ed
manufacturing overhead or joint costs that had $een allocated
to the outsourced products must $e allocated to the remaining
products. As a conse4uence, their apparent costs rise.
/. =a$or cost is a declining percentage of total cost in many
industries and approaches insigni'cant levels in some. 8ather
than o$sess on reducing la$or costs, it may $e $etter to attack
overhead costs, which are much more su$stantial, or to
concentrate time and e#ort on improving the product or
tapping new markets. he potential competitive advantage
from lower la$or costs is not as important as it once was and is
transitory9competitors can always go overseas too. &n
addition, locating production overseas increases transportation
costs and time delays in shipping goods and may increase
coordination pro$lems $etween marketing and production.
Moreover, the company may not have as much control over
4uality when production is moved to a new location.
0. As mentioned in part (,* a$ove, when products are outsourced,
the apparent costs of the remaining products almost inevita$ly
rise as '.ed overhead costs are spread over a smaller $ase. As
a conse4uence, the remaining products often $ecome
candidates for outsourcing as well. Df course, the second wave
of outsourcing leads to further increases in the costs of the
remaining products. his vicious cycle can lead managers to
eventually move all production out of the country.
3olutions Manual, "hapter ) +C<
,roup E%ercise 11-35
). he tighter standards for '.ed manufacturing costs are a
conse4uence of spreading '.ed costs over more units, resulting
in a smaller standard cost per unit. Knless the plant operates at
practical capacity, the volume variance will $e unfavora$le.
a. he possi$le negative $ehavioral e#ects include:
Employees may view the standards as unreasona$le.
Employees may react negatively to the change, feeling that
it has $een imposed $y the accounting department with
little input from those who would $e most a#ected.
Motivation may su#er if employees feel increased pressure
to meet the tighter standards.
1eneral resistance to change.
$. o reduce the negative $ehavioral e#ects, management
could:
E.plain what is e.pected and why this change will further
the companyGs o$jectives.
Adjust the performance evaluation system to re-ect this
change. For e.ample, production managers would not $e
held responsi$le for volume variances so long as demand
is satis'ed and orders are shipped on time.
+. ight standards can have positive $ehavioral e#ects $ecause:
Employees may $e energized $y the challenge.
ight standards may encourage teamwork.
ight standards may foster pro$lem7solving and creative
thinking.
,. 8epresentatives of all the parts of the organization that will $e
a#ected $y the change should participate in setting standards.
his would certainly include anyone whose performance
evaluation is a#ected $y a change in standards.
Employee participation in standard setting should result in
$etter goal congruence. he individuals who will $e a#ected $y
the standards have 'rst7hand operating knowledge, which
should $e invalua$le in the standard setting process. &n
addition, their participation in standard setting will increase the
likelihood that they will $e committed to meeting the standards
3olutions Manual, "hapter ) +C)
once they have $een set.
("MA unoEcial solution, adapted*
3olutions Manual, "hapter ) +C+
,roup E%ercise 11-3
he solution will depend on the particular college or university
that the students investigate.
3olutions Manual, "hapter ) +C,

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Case 1$-33 (continued*

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