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REVIEW MANAGEMENT ACCOUNTING

QUESTION 1
T. Stark is the managing partner of a business that has just finished building a 60
room motel. Stark anticipates that he will rent these rooms for 15.000 nights next year (or
15.000 room-nights). All rooms are similar and will rent for the same price. Stark
estimates the following operating costs for next year:

The capital invested in the motel is $900.000. The partnership’s target return on
investment is 25%. Stark expects demand for rooms to be uniform throughout the year. He
plans to price the rooms at full cost plus a markup on full cost to earn the target return on
investment.

Instruction:
1. What price should Stark charge for a room-night? What is the markup as a percentage
of the full cost of a room-night?
2. Stark’s market research indicates that if the price of a room-night determined in
requirement 1 is reduced by 10%.the expected number of room-nights Stark could rent
would increase by 10%. Should Stark reduce prices by 10%? Show your calculations.

QUESTION 2
Emas Permata, Inc., based in Bandung, has two divisions:
- South African mining division, which mines a rich diamond vein in South Africa
- U.S. processing division, which polishes raw diamonds for use in industrial cutting
tools
The processing division’s yield is 50%: It takes 2 pounds of raw diamonds to
produce 1 pound of top-quality polished industrial diamonds. Although all of the mining
division’s output of 8,000 pounds of raw diamonds is sent for processing in the United

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States, there is also an active market for raw diamonds in South Africa. The foreign
exchange rate is 6 ZAR (South African Rand) = $1 U.S. The following information is
known about the two divisions:

South African Mining Division

Variable cost per pound of raw diamonds 600 ZAR
Fixed cost per pound of raw diamonds 1,200 ZAR
Market price per pound of raw diamonds 3,600 ZAR
Tax rate 25%
U.S. Processing Division
Variable cost per pound of raw diamonds 220 U.S Dollars
Fixed cost per pound of raw diamonds 850 U.S Dollars
Market price per pound of raw diamonds 3,500 U.S Dollars
Tax rate 40%

Instructions:
1. Compute the annual pretax operating income, in U.S. dollars, of each division under the
following transfer-pricing methods: (a) 250% of full cost and (b) market price.
2. Compute the after-tax operating income, in U.S. dollars, for each division under the
transfer-pricing methods in requirement 1. (Income taxes are not included in the
computation of cost-based transfer price, and Industrial Diamonds does not pay U.S.
income tax on income already taxed in South Africa.)

QUESTION 3
CATs Corporation is a specialist in making a many-purpose machine, C475, that
used in the food industry. CATs has designed the C475 machine for 2017 to be distinct
from its competitors. It has been generally regarded as a superior machine. CATs presents
the following data for 2016 and 2017.

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CATs produces no defective machines, but it wants to reduce direct materials usage
per C475 machine in 2013. Conversion costs in each year depend on production capacity
defined in terms of C475 units that can be produced, not the actual units produced. Selling
and customer-service costs depend on the number of customers that CATs can support,
not the actual number of customers it serves. CATs has 125 customers in 2016 and 130
customers in 2017.

Instruction:
Calculate the growth, price-recovery, and productivity components from 2016 to 2017.
(Determine the characteristic of the result, is it favorable or unfavorable?)

QUESTION 4
PT LDRA produces a wide variety of outdoor sports equipment. Its newest
division, Golf Technology, manufactures and sells a single product-AccuDriver, a golf
club that uses global positioning satellite technology to improve the accuracy of golfers’
shots. The demand for AccuDriver is relatively insensitive to price changes. The following
data are available for Golf Technology, which is an investment center for Outdoor Sports:
Total annual fixed costs $30,000,000
Variable cost per AccuDriver $ 500
Number of AccuDrivers sold each year 150,000
Average operating assets invested in the division $48,000,000

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Instructions:
1. Compute Golf Technology’s ROI if the selling price of AccuDrivers is $720 per club.
2. If management requires an ROI of at least 25% from the division, what is the minimum
selling price that the Golf Technology Division should charge per AccuDriver club?
3. Assume that Outdoor Sports judges the performance of its investment centers on the
basis of RI rather than ROI. What is the minimum selling price that Golf Technology
should charge per AccuDriver if the company’s required rate of return is 20%?

QUESTION 5
Costen, Inc., produces cell phone equipment. Jessica Tolmy, Costen’s president,
decided to devote more resources to the improvement of product quality after learning that
her company had been ranked fourth in product quality in a 2009 survey of cell phone
users. Costen’s quality-improvement program has now been in operation for two years,
and the cost report shown here has recently been issued.

Semi-Annual COQ Report, Costen, Inc

(in thousand)

30/06/2010 31/12/2010 30/06/2011 31/12/2011

Prevention Costs
Machine maintenance $ 440 $ 440 $ 390 $ 330
Supplier Training 20 100 50 40
Design reviews 50 214 210 200
Total prevention costs $ 510 $ 754 $ 650 $ 570
Appraisal Costs
Incoming inspections $ 108 $ 123 $ 90 $ 63
Final testing 332 332 293 203
Total appraisal costs $ 440 $ 455 $ 383 $ 266
Internal Failure Cost
Rework $ 231 $ 202 $ 165 $ 112
Scrap 124 116 71 67
Total internal failure costs $ 355 $ 318 $ 236 $ 179
External Failure Costs
Warranty repairs $ 165 $ 85 $ 72 $ 68
Customer returns 570 547 264 188
Total external failure costs $ 735 $ 632 $ 336 $ 256
Total quality costs $ 2.040 $ 2.159 $ 1.605 $ 1.271

Total Revenues $ 8.240 $ 9.080 $ 9.300 $ 9.020

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Instructions:
1. For each period, calculate the ratio of each COQ category to revenues and to total
quality costs!
2. Based on the results of requirement 1, would you conclude that Costen’s quality
program has been successful? Prepare a short report to present your case!
3. Based on the 2009 survey, Jessica Tolmy believed that Costen had to improve product
quality. In making her case to Costen management, how might Tolmy have estimated
the opportunity cost of not implementing the quality-improvement program?

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SOLUTIONS
SOLUTION 1
1. Target operating income (25% of $900.000) $225.000

Total fixed costs $375.000

Target contribution margin $600.000

Target contribution per room-night. ($600.000 ÷ 15.000) $40

Add variable costs per room-night $ 5

Price to be charged per room-night $45

The full cost of a room = variable cost per room + fixed cost per room

= $5 + ($375.000 ÷ 15.000) = $5 + $25 = $30

Markup per room = Rental price per room – Full cost of a room

= $45 – $30 = $15

Markup percentage as a fraction of full cost = $15 ÷ $30 = 50%

2. The new price per room would be 90% of $45 $40,5

The number of rooms Stark expects to rent is 110% of 15.000 $16.500

The contribution margin per room would be $40,50 – $5 $35,50

Contribution margin ($35,50 16.500) $585.750

Because the contribution margin of $585.750 at the reduced price of $40.50 is less than the
contribution margin of $600.000 at a price of $45, Stark should not reduce the price of the
rooms. Note that the fixed costs of $375.000 will be the same under the $45 and the $40.50
price alternatives and hence, are irrelevant to the analysis.

SOLUTION 2
This is a two-country two-division transfer-pricing problem with two alternative transfer-
pricing methods.
Summary data in U.S. dollars are:
South Africa Mining Division
Variable costs: 600 ZAR ÷ 6 = $100 per lb. of raw diamonds
Fixed costs: 1,200 ZAR ÷ 6 = $200 per lb. of raw diamonds

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Market price: 3,600 ZAR ÷ 6 = $600 per lb. of raw diamonds
U.S. Processing Division
Variable costs = $220 per lb. of polished industrial diamonds
Fixed costs = $850 per lb. of polished industrial diamonds
Market price = $3,500 per lb. of polished industrial diamonds

1. The transfer prices are:

a. 250% of full costs
Mining Division to Processing Division
= 2.5 × ($100 + $200) = $750 per lb. of raw diamonds
b. Market price
Mining Division to Processing Division
= $600 per lb. of raw diamonds

2.

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SOLUTION 3

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SOLUTION 4
1. Operating income = (Contribution margin per unit 150,000 units) – Fixed costs
= ($720 – $500) 150,000 – $30,000,000 = $3,000,000

ROI = = $3,000,000 ÷ $48,000,000 = 6.25%

2. Operating income = ROI Investment

[No. of pairs sold (Selling price – Var. cost per unit)] – Fixed costs = ROI Investment
Let $X = minimum selling price per unit to achieve a 25% ROI
150,000 ($X – $500) – $30,000,000 = 25% ($48,000,000)
$150,000X = $12,000,000 + $30,000,000 + $75,000,000
X = $780

3. Let $X = minimum selling price per unit to achieve a 20% rate of return
150,000 ($X – $500) – $30,000,000 = 20% ($48,000,000)
$150,000X = $9,600,000 + $30,000,000 + $75,000,000
X = $764

SOLUTION 5
1. The ratios of each COQ category to revenues and to total quality costs for each period
are as follows:

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2. From an analysis of the Cost of Quality Report, it would appear that Costen, Inc.’s
program has been successful because:
 Total quality costs as a percentage of total revenues have declined from 24.7% to
14.1%.
 External failure costs, those costs signaling customer dissatisfaction, have declined
from 8.9% of total revenues to 2.8% of total revenues and from 36% of all quality
costs to 20.1% of all quality costs. These declines in warranty repairs and customer
returns should translate into increased revenues in the future.
 Internal failure costs as a percentage of revenues have been halved from 4.3% to
2%.
 Appraisal costs have decreased from 5.3% to 3% of revenues. Preventing defects
from occurring in the first place is reducing the demand for final testing.
 Quality costs have shifted to the area of prevention where problems are solved
before production starts: total prevention costs (maintenance, supplier training, and
design reviews) have risen from 25% to 44.9% of total quality costs. The $60,000
increase in these costs is more than offset by decreases in other quality costs.
 Because of improved designs, quality training, and additional pre-production
inspections, scrap and rework costs have almost been halved while increasing sales
by 9.5%.
 Production does not have to spend an inordinate amount of time with customer
service since they are now making the product right the first time and warranty
repairs and customer returns have decreased.
3. To estimate the opportunity cost of not implementing the quality program and to help
her make her case, Jessica Tolmy could have assumed that:
 Sales and market share would continue to decline if the quality program was not
implemented and then calculated the loss in revenue and contribution margin.
 The company would have to compete on price rather than quality and calculated
the impact of having to lower product prices.
Opportunity costs are not recorded in accounting systems because they represent the
results of what might have happened if the company had not improved quality.
Nevertheless, opportunity costs of poor quality can be significant. It is important for
Costen to take these costs into account when making decisions about quality.

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