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STUDENT SOLUTIONS MANUAL

CHAPTER 3: BASIC COST MANAGEMENT CONCEPTS


EXERCISES
3-32 Classification of Costs (10 min)
1. direct and variable
2. indirect and fixed
3. indirect and variable
4. indirect and fixed
5. direct and variable
6. indirect and fixed
7. indirect and variable
8. direct and variable
9. indirect and fixed
10. indirect and fixed

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3-34 Activity Levels and Cost Drivers (10 Min)

f
g

Cost Object
product line or
customer
product line
product line
product line
product line or
customer order
each product
product line

h
I
j

customer
each product
product line

a
b
c
d
e

Cost Driver
each product line, or each custom order requiring
design
number of customer orders
number of customer orders
number of purchase orders
number of orders
units produced
cannot be traced to product or customer; must
allocated using some reasonable method,
example, materials cost in each order
number of customers
units produced
cannot be traced to product or customer; must
allocated using some reasonable method,
example, the number of units produced

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be
for

be
for

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3-36 Complexity of Operations and the Effect on Cost (15 min)


The observations made by the consultant show that the manufacturer was
incurring large costs in operations, distribution, and administration due to
the high level of complexity in its products. Maintaining relationships with
10 vendors for a single item contributed to high purchasing and stocking
costs. Similarly, most of the firms volume was made up of products with
five color combinations, with the result that manufacturing, warehousing,
shipping and selling costs were high relative to fewer color combinations.
Also, the high product variety required smaller batch production and more
frequent set-ups, which caused increased manufacturing costs. And the
variety of different customers, prices, and promotional programs created
increased manufacturing, shipping and customer service costs as well as
increased costs in accounting for the customers invoices and account
balances.
The solution? Reduce complexity. This was done by reducing the
number of customers; the low value customers were reviewed and some
were not continued. Also, a process of review was developed for the
introduction of new products or new variations on existing products, to
ensure the likely profitability of the new product. Further, the complexity of
equipment set-ups was reduced so that the firm could meet the customers
demands for smaller batch sizes without increasing overall costs. The
result of the program was that overall profit margins improved. The firm
had found a way to deal with the cost consequences of its strategic
initiative.
Also, the firm adopted new cost management practices that included
new non-financial measures such as set-up time and frequency, percent of
orders shipped on time, percent of orders on just-in-time, and number of
vendors for the top 20 commodity raw materials items. In addition, the firm
began to calculate and regularly review customer profitability, by type of
market and customer size.
Based on information in: Managing Complexity Through Performance
Measurement, by Frank A. J. Gonsalves and Robert G. Eiler,
Management Accounting, August 1996, pp 34-39.

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3-38 Cost Classification for Dance Studio (15 min)


1. While a variety of possible cost objects are possible for the dance
studio, the most reasonable choice is the studio since managements
goal is to analyze the profitability of the studios.
2. Studios as the cost object
1. a,c,e
2. a,c,f
3. a,c,e
4. a,c,e
5. a,c,e
6. b,c,f
7. a,c,e
8. a,d,e
Or,
Lessons as the cost object
1. a,d,e
2. b,d,f
3. b,d,e
4. b,d,e
5. b,d,e
6. b,d,f
7. b,d,e
8. b,d,e

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3-40 Fixed, Variable and Mixed Costs (5 min)


Department A
Department B
Department C
Department D
Department E

fixed
variable
mixed
mixed
variable

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3-42 Military Downsizing and Direct vs. Indirect Costs (20 min)
In recognition of this problem, and of the large number of contract
appeals it has caused, the various federal boards of contract appeals
have ruled in favor of treating certain indirect costs as direct costs in
these situations:
1) In an appeal filed by Fiesta Leasing & Sales, Inc., the board
allowed depreciation on buses purchased for a bus leasing contract
when the Defense Department terminated the contract. The board
allowed depreciation costs because the costs were incurred for the
contract and because these costs could not be discontinued after the
contract was terminated.
2) In an appeal brought by Essex Electric Engineers, Inc., the
Department of Transportation (DOT) Contract Appeals Board allowed
recovery of the full cost of equipment remaining at a plant when the
contract was terminated for the convenience of the DOT. The reason
for the ruling is that the equipment purchased by Essex for the DOT
contract was far beyond its needs for its other business.
Source: Based on information from: Margaret M. Worthington, As
Military Downsizes, Contract Termination Becomes a Challenge,
Journal of Accountancy, March 1992, p88-90.

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3-44 Interpreting Average Cost (10 min)


This question is based upon an article in the January 1997, Journal of
Accountancy, How Does Your Finance Department Measure Up? pp5051.
The main point of this exercise, as for 3-43 above, is to help the student
understand the importance of taking activity levels into account when
interpreting average cost information.
The Journal of Accountancy article shows, as represented by the
information presented in the exercise, that average fixed costs decline with
higher levels of activity. Larger companies, with higher levels of
transaction volume, will have higher total fixed costs, but average fixed
costs should be lower due to economies of scale (as noted in the article,
p50). Looked at another way, if a given firm were to grow, and its volume
of transactions grew as well, then average fixed costs (or in this case the
ratio of total accounting costs to total revenue) would have to fall. Average
fixed cost would continue to fall with increasing numbers of transactions,
until the firm felt it necessary to increase capacity in the accounting
department, thereby increasing fixed costs. (Note there is a controversy
in microeconomics about whether the long run average cost curve is flat or
U-shaped. See Karl Case and Ray Fair, Principles of Microeconomics,
Fourth Ed, 1996, page 239.)
Thus, the data presented by the Journal is as we would expect larger
firms will have lower average costs. We would not expect otherwise.
Average fixed costs should be lower for the larger firms.

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PROBLEMS
3-46 Product Costs and Period Costs (20 min)
Product cost=Direct Labor + Direct Material + Factory Overhead
Direct Labor for Galletas Americanas
Salaries & Wages
Labor fringe benefits
Total
Direct Material for Galletas Americanas
Ingredients for cookies

$15,000
1,000
$16,000
$27,000

Factory Overhead for Galletas Americanas


Indirect Material
Paper
Indirect Labor
Manager Salary

$10,000

Manufacturing Costs
Depreciation of Plant & Equipment
Insurance
Utilities
Equipment maintenance
Overtime Premiums
Idle time
Uniforms
Boxes, Bags
Total Factory Overhead
Total Product Cost

$ 1,500
600
1,600
600
2,000
400
300
700
$17,770
$60,770

Period Costs
Rent
Administrative Costs
Advertising
Total Period Cost

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$ 13,200
800
1,500
$15,500

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Problem 3-46 (continued)


2. a. All the additional costs are likely to be product costs except for
the increase in advertising, which is a period cost.
b. The baking facilities cost are not relevant since they will not
change, but all the other costs are relevant (the increase in materials
and labor; the increase in advertising and packaging; the increase in
documentation and inspection costs).

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3-48 Structural Cost Drivers (25 min)


Case A: A key structural issue for Food Fare is complexity. As the
menu has changed, so will costs and service. More complexity
means higher food purchasing costs, higher operating costs, and
more complex operations. This will require new types of training for
employees and perhaps additional employees. Moreover, it will be a
challenge for Food Fare to continue to provide the speed of service
that was possible with the shorter menu. The change will require
careful attention to operations and to cost management issues for the
firm to continue to be profitable. Employee training and new uses of
technology to streamline the process of order taking and order filling
are likely to be necessary. Scale might also be an important issue in
this case how large must each restaurant become, and how many
restaurants must the chain have in order to justify the increased
purchasing and stocking costs, and the new training and technology
costs?
Case B: A key issue in this case is the speed with which Gilman can
provide customer service. The speed of service provides value to the
customer and also increases profitability. In order to increase the
speed of service, Gilman needs effective communication and
coordination among the service teams. This is probably being
accomplished now by cell phone. Gilman can research new and
more effective ways to accomplish this, perhaps using hand-held
internet access devices or modem-equipped notebook computers.
The advantage of computer-based access is that computer based
tools can be used in the scheduling and assignment of the service
teams. Additionally, the computer can be used by each service team
to quickly determine the availability of parts in the firms warehouse or
in other service vehicles, thereby allowing faster service time. Also,
the computer can be used to develop real time analyses of customer
demand and profitability in order to better understand which
services and which types of customers are most profitable. Is it in
installation or service, Brand X or Brand Y, residential or commercial,
etc.? Scale is also an important cost driver for Gilman. To serve the
large area it now serves, there should be a careful strategic analysis
to get the right balance between order getting costs (advertising and
promotion to obtain new customers) plus the costs of maintaining the

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3-48 (continued)
truck fleet and service teams versus the opportunity to provide
additional services to existing customers.

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3-50 Cost of Goods Manufactured and Sold (30 min)

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3.52 Cost of Goods Manufactured and Sold (20 min)


Blue Water Equipment, Inc
Statement of Cost of Goods Manufactured
December 31, 2007
Direct Materials Used
Direct Materials Inventory, Beginning
$33,000
Direct Materials Purchases
190,000
Total Direct Materials Available
223,000
Direct Materials Inventory, Ending
$28,000
Direct Materials Used
$195,000
Direct Labor
$345,000
Factory Overhead
Insurance on Plant
$44,000
Supplies--Plant
21,000
Repairs on Plant Building
34,000
Depreciation Expense--Plant and Equip. 197,000
Heat and Light for Plant
23,000
Indirect Labor
128,000
Supervisor's Salary Plant
85,000
Total Factory Overhead
532,000
Total Manufacturing Costs Incurred during year
1,072,000
Work-in-Process Inventory, Beginning
14,000
Total Manufacturing Costs to Account for
1,086,000
Work-in-Process Inventory, Ending
11,000
Cost of Goods Manufactured
$1,075,000
Blue Water Equipment, Inc
Income Statement
For the Year Ended December 31, 2007
Sales Revenue
$1,675,000
Cost of Goods Sold
Finished Goods Inventory, Beginning
$66,000
Cost of Goods Manufactured
1,075,000
Total Goods Available for Sale
1,141,000
Finished Goods Inventory, Ending
43,000
Cost of Goods Sold

1,098,000
$577,000

Gross Margin
Advertising Expenses
$ 16,000
Sales Representatives' Salaries
216,000
Supplies--Administrative Office
42,000
Depreciation Expense--Admin. Office
73,000
Depreciation Expense - Delivery Trucks
34,000
Total Selling & Administrative Expenses
Net Income

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381,000
$196,000

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3-54 Cost of Good Manufactured and Income Statement (40 min)


Norton Industries
Statement of Cost of Goods Manufactured
For the Month Ended May 31, 2007
($000 omitted)
Direct materials
Inventory of direct materials, April 30
$ 28
Purchase of direct materials
510
Freight-in
15
Total direct materials available for use $ 553
Inventory of direct materials, May 31
23
Direct materials used in production
$ 530
Direct labor
260
Indirect factory labor
$ 90
Utilities (135 x .8)
108
Property tax
60
Insurance (20 x .6)
12
Depreciation (20 + 30)
50
Manufacturing overhead
$320
Total manufacturing costs
$1,110
Plus: Inventory of WIP April 30
150
Less:Inventory of WIP May 31
220
Cost of goods manufactured
$1,040

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Problem 3-54 (continued)


2.
Norton Industries
Income Statement
For the Month Ended May 31, 2007
($000 omitted)
Sales
Less Sales discounts
Net Sales

$ 1,488
20
1,468

Cost of Goods Sold


Finished Goods Inventory, 4/30
Cost of Goods Manufactured
Cost of Goods Available for Sale
Finished Good Inventory, 5/31
Gross Margin

247
1,040
1,287
175

General, Selling, and Administrative Expense


Office Salaries
$ 122
Sales Salaries
42
Insurance ($20 x .4)
8
Utilities ($135 x .2)
27
Rent
9
Depreciation
4
Interest
6
Income from operations
Other revenue
Net Income

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1,112
356

218
$ 138
2
$ 140

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