acc_solutions

acc_solutions - Chapter 1 Managerial Accounting and the...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 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 A strategy is a game plan that enables a company to attract customers by distinguishing itself from competitors. The focal point of a companys strategy should be its target customers. 1-3 Customer value propositions fall into three broad categoriescustomer intimacy, operational excellence, and product leadership. A company with a customer intimacy strategy attempts to better understand and respond to its customers individual needs than its competitors. A company that adopts an operational excellence strategy attempts to deliver products faster, more conveniently, and at a lower price than its competitors. A company that has a product leadership strategy attempts to offer higher quality products than its competitors. 1-4 Managers carry out three major activities in an organization: planning, directing and motivating, and controlling. Planning involves establishing a basic strategy, selecting a course of action, and specifying how the action will be implemented. Directing and motivating involves mobilizing people to carry out plans and run routine operations. Controlling involves ensuring that the plan is actually carried out and is appropriately modified as circumstances change. 1-5 The Planning and Control Cycle involves formulating plans, implementing plans, measuring performance, and evaluating differences between planned and actual performance. 1-6 In contrast to financial accounting, managerial accounting: (1) focuses on the needs of managers rather than outsiders; (2) emphasizes decisions affecting the future rather than the financial consequences of past actions; (3) emphasizes relevance rather than objectivity and verifiability; (4) emphasizes timeliness rather than precision; (5) emphasizes the segments of an organization rather than summary data concerning the entire organization; (6) is not governed by GAAP; and (7) is not mandatory. 1-7 A person in a line position is directly involved in achieving the basic objectives of the organization. A person in a staff position provides services and assistance to other parts of the organization, but is not directly involved in achieving the basic objectives of the organization. 1-8 The Chief Financial Officer is responsible for providing timely and relevant data to support planning and control activities and for preparing financial statements for external users. 1-9 The three main categories of inventories in a manufacturing company are raw materials, work in process, and finished goods. 1-10 The five steps in the lean thinking model are: (1) identify value in specific products and services; (2) identify the business process that delivers value; (3) organize work arrangements around the flow of the business process; (4) create a pull system that responds to customer orders; and (5) continuously pursue perfection in the business process. 1-11 Successful implementation of the lean thinking model should result in lower inventories, fewer defects, less wasted effort, and quicker customer response times. 1-12 In a pull production system, production is not initiated until a customer order is received. Inventories are reduced to a minimum by purchasing raw materials and producing products only as needed to meet customer demand. 1-13 Some benefits from improvement efforts come from cost reductions, but the primary benefit is often an increase in capacity. At non-constraints, increases in capacity just add to the already-existing excess capacity. Therefore, improvement efforts should ordinarily focus on the constraint. 1-14 Six Sigma is a process improvement method that relies on customer feedback and factbased data gathering and analysis techniques to drive process improvement. The goal is to reduce defect rates below 3.4 defects per million. 1-15 The five stages in the Six Sigma DMAIC Framework are (1) Define; (2) Measure; (3) Analyze; (4) Improve; and (5) Control. The goals for the define stage are to establish the scope and purpose of the project, to diagram the flow of the current process, and to establish the customers requirements for the process. The goals for the measure stage are to gather baseline performance data related to the existing process and to narrow the scope of the project to the most important problems. The goal in the analyze stage is to identify the root causes of the problems identified in the measure stage. The goal in the improve stage is to develop, evaluate, and implement solutions to the problems. The goals in the control stage are to ensure the problems remain fixed and to seek to improve the new methods over time. 1-16 An enterprise system is supposed to overcome the problems that result from having separate, unintegrated software applications that support specific business functions. It does this by integrating data across an organization in a single software system that enables all employees to have simultaneous access to a common set of data. 1-17 If people generally did not act ethically in business, no one would trust anyone else and people would be reluctant to enter into business transactions. The result would be less funds raised in capital markets, fewer goods and services available for sale, lower quality, and higher prices. 1-18 Corporate governance is the system by which a company is directed and controlled. If properly implemented, the corporate governance system should provide incentives for the board of directors and top management to pursue objectives that are in the best interests of the companys owners and it should provide for effective monitoring of performance. 1-19 Enterprise risk management is a process used by a company to proactively identify the risks that it faces and to manage those risks. Exercise 1-1 (10 minutes) 1. Managerial accounting, financial accounting 2. Planning 3. directing and motivating 4. feedback 5. decentralization 6. line 7. staff 8. controller 9. budgets 10. performance report 11. Chief Financial Officer 12. precision; nonmonetary data Exercise 1-2 (20 minutes) 1. strategy 2. Six Sigma 3. business process 4. corporate governance 5. enterprise risk management 6. just-in-time 7. Internet 8. constraint 9. nonconstraint 10. value chain 11. enterprise system 12. supply chain management 13. lean thinking model; pulls 14. customer value proposition 15. budget 16. non-value-added activity 17. Theory of Constraints Exercise 1-3 (15 minutes) If cashiers routinely short-changed customers whenever the opportunity presented itself, most of us would be careful to count our change before leaving the counter. Imagine what effect this would have on the line at your favorite fast-food restaurant. How would you like to wait in line while each and every customer laboriously counts out his or her change? Additionally, if you cant trust the cashiers to give honest change, can you trust the cooks to take the time to follow health precautions such as washing their hands? If you cant trust anyone at the restaurant would you even want to eat out? Generally, when we buy goods and services in the free market, we assume we are buying from people who have a certain level of ethical standards. If we could not trust people to maintain those standards, we would be reluctant to buy. The net result of widespread dishonesty would be a shrunken economy with a lower growth rate and fewer goods and services for sale at a lower overall level of quality. Formatted: Text Left Chapter 2 Cost Terms, Concepts, and Classifications Solutions to Questions 2-1 The three major elements of product costs in a manufacturing company are direct materials, direct labor, and manufacturing overhead. 2-2 A. DIRECT MATERIALS ARE AN INTEGRAL PART OF A FINISHED PRODUCT AND THEIR COSTS CAN BE CONVENIENTLY TRACED TO IT. B. INDIRECT MATERIALS ARE GENERALLY SMALL ITEMS OF MATERIAL SUCH AS GLUE AND NAILS. THEY MAY BE AN INTEGRAL PART OF A FINISHED PRODUCT BUT THEIR COSTS CAN BE TRACED TO THE PRODUCT ONLY AT GREAT COST OR INCONVENIENCE. C. DIRECT LABOR INCLUDES THOSE LABOR COSTS THAT CAN BE EASILY TRACED TO PARTICULAR PRODUCTS. DIRECT LABOR IS ALSO CALLED TOUCH LABOR. D. INDIRECT LABOR INCLUDES THE LABOR COSTS OF JANITORS, SUPERVISORS, MATERIALS HANDLERS, AND OTHER FACTORY WORKERS THAT CANNOT BE CONVENIENTLY TRACED TO PARTICULAR PRODUCTS. THESE LABOR COSTS ARE INCURRED TO SUPPORT PRODUCTION, BUT THE WORKERS INVOLVED DO NOT DIRECTLY WORK ON THE PRODUCT. E. MANUFACTURING OVERHEAD INCLUDES ALL MANUFACTURING COSTS EXCEPT DIRECT MATERIALS AND DIRECT LABOR. CONSEQUENTLY, MANUFACTURING OVERHEAD INCLUDES INDIRECT MATERIALS AND INDIRECT LABOR AS WELL AS OTHER MANUFACTURING COSTS. 2-3 A PRODUCT COST IS ANY COST INVOLVED IN PURCHASING OR MANUFACTURING GOODS. IN THE CASE OF MANUFACTURED GOODS, THESE COSTS CONSIST OF DIRECT MATERIALS, DIRECT LABOR, AND MANUFACTURING OVERHEAD. A PERIOD COST IS A COST THAT IS TAKEN DIRECTLY TO THE INCOME STATEMENT AS AN EXPENSE IN THE PERIOD IN WHICH IT IS INCURRED. 2-4 THE INCOME STATEMENT OF A MANUFACTURING COMPANY DIFFERS FROM THE INCOME STATEMENT OF A MERCHANDISING COMPANY IN THE COST OF GOODS SOLD SECTION. A MERCHANDISING COMPANY SELLS FINISHED GOODS THAT IT HAS PURCHASED FROM A SUPPLIER. THESE GOODS ARE LISTED AS PURCHASES IN THE COST OF GOODS SOLD SECTION. SINCE A MANUFACTURING COMPANY PRODUCES ITS GOODS RATHER THAN BUYING THEM FROM A SUPPLIER, IT LISTS COST OF GOODS MANUFACTURED IN PLACE OF PURCHASES. ALSO, THE MANUFACTURING COMPANY IDENTIFIES ITS INVENTORY IN THIS SECTION AS FINISHED GOODS INVENTORY, RATHER THAN AS MERCHANDISE INVENTORY. 2-5 THE SCHEDULE OF COST OF GOODS MANUFACTURED LISTS THE MANUFACTURING COSTS THAT HAVE BEEN INCURRED DURING THE PERIOD. THESE COSTS ARE ORGANIZED UNDER THE THREE CATEGORIES OF DIRECT MATERIALS, DIRECT LABOR, AND MANUFACTURING OVERHEAD. THE TOTAL COSTS INCURRED ARE ADJUSTED FOR ANY CHANGE IN THE WORK IN PROCESS INVENTORY TO DETERMINE THE COST OF GOODS MANUFACTURED (I.E. FINISHED) DURING THE PERIOD. THE SCHEDULE OF COST OF GOODS MANUFACTURED TIES INTO THE INCOME STATEMENT THROUGH THE COST OF GOODS SOLD SECTION. THE COST OF GOODS MANUFACTURED IS ADDED TO THE BEGINNING FINISHED GOODS INVENTORY TO DETERMINE THE GOODS AVAILABLE FOR SALE. IN EFFECT, THE COST OF GOODS MANUFACTURED TAKES THE PLACE OF THE PURCHASES ACCOUNT IN A MERCHANDISING FIRM. 2-6 A MANUFACTURING COMPANY HAS THREE INVENTORY ACCOUNTS: RAW MATERIALS, WORK IN PROCESS, AND FINISHED GOODS. A MERCHANDISING COMPANY GENERALLY IDENTIFIES ITS INVENTORY ACCOUNT SIMPLY AS MERCHANDISE INVENTORY. 2-7 PRODUCT COSTS ARE ASSIGNED TO UNITS AS THEY ARE PROCESSED AND HENCE ARE INCLUDED IN INVENTORIES. THE FLOW IS FROM DIRECT MATERIALS, DIRECT LABOR, AND MANUFACTURING OVERHEAD TO WORK IN PROCESS INVENTORY. AS GOODS ARE COMPLETED, THEIR COST IS REMOVED FROM WORK IN PROCESS INVENTORY AND TRANSFERRED TO FINISHED GOODS INVENTORY. AS GOODS ARE SOLD, THEIR COST IS REMOVED FROM FINISHED GOODS INVENTORY AND TRANSFERRED TO COST OF GOODS SOLD. COST OF GOODS SOLD IS AN EXPENSE ON THE INCOME STATEMENT. 2-8 YES, COSTS SUCH AS SALARIES AND DEPRECIATION CAN END UP AS PART OF ASSETS ON THE BALANCE SHEET IF THESE ARE MANUFACTURING COSTS. MANUFACTURING COSTS ARE INVENTORIED UNTIL THE ASSOCIATED FINISHED GOODS ARE SOLD. THUS, IF SOME UNITS ARE STILL IN INVENTORY, SUCH COSTS MAY BE PART OF EITHER WORK IN PROCESS INVENTORY OR FINISHED GOODS INVENTORY AT THE END OF A PERIOD. 2-9 Cost behavior refers to how a cost reacts to changes in the level of activity. 2-10 No. A variable cost is a cost that varies, in total, in direct proportion to changes in the level of activity. A variable cost is constant per unit of product. A fixed cost is fixed in total, but the average cost per unit changes with the level of activity. 2-11 When fixed costs are involved, the average cost of a unit of product will depend on the number of units being manufactured. As production increases, the average cost per unit will fall as the fixed cost is spread over more units. Conversely, as production declines, the average cost per unit will rise as the fixed cost is spread over fewer units. 2-12 Manufacturing overhead is an indirect cost since these costs cannot be easily and conveniently traced to particular units of products. 2-13 A differential cost is a cost that differs between alternatives in a decision. An opportunity cost is the potential benefit that is given up when one alternative is selected over another. A sunk cost is a cost that has already been incurred and cannot be altered by any decision taken now or in the future. 2-14 No; differential costs can be either variable or fixed. For example, the alternatives might consist of purchasing one machine rather than another to make a product. The difference in the fixed costs of purchasing the two machines would be a differential cost. 2-15 Direct labor cost (34 hours $15 per hour) .....$510 Manufacturing overhead cost (6 hours $15 per hour) ......90 Total wages earned ............$600 2-16 Direct labor cost (45 hours $14 per hour) .....$630 Manufacturing overhead cost (5 hours $7 per hour) .........35 Total wages earned ............$665 2-17 Costs associated with the quality of conformance can be broken down into prevention costs, appraisal costs, internal failure costs, and external failure costs. Prevention costs are incurred in an effort to keep defects from occurring. Appraisal costs are incurred to detect defects before they can create further problems. Internal and external failure costs are incurred as a result of producing defective units. 2-18 Total quality costs are usually minimized by increasing prevention and appraisal costs in order to reduce internal and external failure costs. Total quality costs usually decrease as prevention and appraisal costs increase. 2-19 Shifting the focus to prevention and away from appraisal is usually the most effective way to reduce total quality costs. It is usually more effective to prevent defects than to attempt to fix them after they have occurred. 2-20 First, a quality cost report helps managers see the financial consequences of defects. Second, the report may help managers identify the most important areas for improvement. Third, the report helps managers see whether quality costs are appropriately distributed among prevention, appraisal, internal failure, and external failure costs. 2-21 Most accounting systems do not track and accumulate the costs of quality. It is particularly difficult to get a feel for the magnitude of quality costs since they are incurred in many departments throughout the organization. Exercise 2-1 (15 minutes) 1. The wages of employees who build the sailboats: direct labor cost. 2. The cost of advertising in the local newspapers: marketing and selling cost. 3. The cost of an aluminum mast installed in a sailboat: direct materials cost. 4. The wages of the assembly shops supervisor: manufacturing overhead cost. 5. Rent on the boathouse: a combination of manufacturing overhead, administrative, and marketing and selling cost. The rent would most likely be prorated on the basis of the amount of space occupied by manufacturing, administrative, and marketing operations. 6. The wages of the companys bookkeeper: administrative cost. 7. Sales commissions paid to the companys salespeople: marketing and selling cost. 8. Depreciation on power tools: manufacturing overhead cost. Exercise 2-2 (15 minutes) Product (Inventoriable) Cost Period Cost 1. The cost of the memory chips used in a radar set ...X 2. Factory heating costs ..............................X 3. Factory equipment maintenance costs ........... X 4. Training costs for new administrative employees ....................X 5. The cost of the solder that is used in assembling the radar sets .....X 6. The travel costs of the companys salespersons ..................X 7. Wages and salaries of factory security personnel ...........X 8. The cost of air-conditioning executive offices ...... X 9. Wages and salaries in the department that handles billing customers ......... X 10. Depreciation on the equipment in the fitness room used by factory workers ... X 11. Telephone expenses incurred by factory management............X 12. The costs of shipping completed radar sets to customers ............ X 13. The wages of the workers who assemble the radar sets......... X 14. The presidents salary.......X 15. Health insurance premiums for factor personnel ...........X Exercise 2-3 (15 minutes) Mountain High Income Statement Sales ..................................................$3,200,000 Cost of goods sold: Beginning merchandise inventory ................. $ 140,000 Add: Purchases ..................................2,550,000 Goods available for sale ........................2,690,000 Deduct: Ending merchandise inventory ......... 180,000 2,510,000 Gross margin ....................................690,000 Selling and administrative expenses: Selling expense .................................110,000 Administrative expense ......................... 470,000 580,000 Net operating income ............................$ 110,000 Exercise 2-4 (15 minutes) Mannerman Fabrication Schedule of Cost of Goods Manufactured Direct materials: Beginning raw materials inventory........$ 55,000 Add: Purchases of raw materials .........440,000 Raw materials available for use .........495,000 Deduct: Ending raw materials inventory . 65,000 Raw materials used in production .......$ 430,000 Direct labor .............................215,000 Manufacturing overhead ..................380,000 Total manufacturing costs ..............1,025,000 Add: Beginning work in process inventory..........190,000 1,215,000 Deduct: Ending work in process inventory ..........220,000 Cost of goods manufactured ............$ 995,000 Exercise 2-5 (15 minutes) Cost Behavior Cost (Measure of Activity) Variable Fixed 1. The cost of small glass plates used for lab tests in a hospital (Number of lab tests performed) ......... X 2. A boutique jewelry stores cost of leasing retail space in a mall (Dollar sales) ...........................X 3. Top management salaries at FedEx (Total sales) ...X 4. Electrical costs of running production equipment at a Toyota factory (Number of vehicles produced) ..................................................X 5. The cost of insuring a dentists office against fire (Patient visits) ....X 6. The cost of commissions paid to salespersons at a Honda dealer (Total sales)...................X 7. The cost of heating the intensive care unit at Swedish Hospital (Patient-days) ................ X 8. The cost of batteries installed in trucks produced at a GM factory (Number of trucks produced) ...... X 9. The salary of a university professor (Number of students taught by the professor) ............. X 10. The costs of cleaning supplies used at a fast-food restaurant to clean the kitchen and dining areas at the end of the day (Number of customers served) ...........X *May include a small variable element. Exercise 2-6 (15 minutes) Direct Indirect Cost Cost Object Cost 1. The salary of the head chef The hotels restaurant X 2. The salary of the head chef A particular restaurant customer X 3. Room cleaning supplies A particular hotel guest X 4. Flowers for the reception desk A particular hotel guest X 5. The wages of the doorman A particular hotel guest X 6. Room cleaning supplies The housecleaning department X 7. Fire insurance on the hotel building The hotels gym X 8. Towels used in the gym The hotels gym X Note: The room cleaning supplies would most likely be considered an indirect cost of a particular hotel guest because it would not be practical to keep track of exactly how much of each cleaning supply was used in the guests room. Exercise 2-7 (15 minutes) Differential Opportunity Sunk Cost Cost 1. Cost of the new flat-panel displays .................... X 2. Cost of the old computer terminals .......................X 3. Rent on the space occupied by the registration desk .......x 4. Wages of registration desk personnel ....................x 5. Benefits from a new freezer .... X 6. Costs of maintaining the old computer terminals ............... X 7. Cost of removing the old computer terminals ..................... X 8. Cost of existing registration desk wiring .......................... X Note: The costs of the rent on the space occupied by the registration desk and the wages of registration desk personnel are neither differential costs, opportunity costs, nor sunk costs. These are costs that do not differ between the alternatives and are therefore irrelevant in the decision, but they are not sunk costs since they occur in the future. Exercise 2-8 (15 minutes) 1. No. It appears that the overtime spent completing the job was simply a matter of how the job happened to be scheduled. Under these circumstances, an overtime premium probably should not be charged to a customer whose job happens to fall at the tail end of the days schedule. 2. Direct labor cost: 9 hours $20 per hour ..........$180 General overhead cost: 1 hour $10 per hour .. 10 Total labor cost .........................................$190 3. A charge for an overtime premium might be justified if the customer requested that the work be done on a rush basis. Exercise 2-9 (15 minutes) 1.Prevention Costs Appraisal Costs Internal Failure Costs External Failure Costs a. Repairs of goods still under warranty ................. X b. Customer returns due to defects ......................... X c. Statistical process control ............................... X d. Disposal of spoiled goods ........................... X e. Maintaining testing equipment .................... X f. Inspecting finished goods ........................... X g. Downtime caused by quality problems X h. Debugging errors in software ....................... X i. Recalls of defective products ....................... X j. Training quality engineers ............................ X k. Re-entering data due to typing errors ................X l. Inspecting materials received from suppliers ..... X m. Audits of the quality system .............................. X n. Supervision of testing personnel .................... Rework labor ................... x 2. Prevention costs and appraisal costs are incurred to keep poor quality of conformance from occurring. Internal and external failure costs are incurred because poor quality of conformance has occurred. Exercise 2-10 (30 minutes) 1.a. Emblems purchased ...........................................35,000 Emblems drawn from inventory ................................31,000 Emblems remaining in inventory ...............................4,000 Cost per emblem .............................................. $2 Cost in Raw Materials Inventory at May 31 ....................$ 8,000 b. Emblems used in production (31,000 1,000) ............... 30,000 Units completed and transferred to Finished Goods (90%30,000) ...27,000 Units still in Work in Process at May 31 ..................3,000 Cost per emblem ........................................... $2 Cost in Work in Process Inventory at May 31 ..............$ 6,000 c. Units completed and transferred to Finished Goods (above) ..............27,000 Units sold during the month (75% 27,000) .............. 20,250 Units still in Finished Goods at May 31 ...................6,750 Cost per emblem ........................................... $2 Cost in Finished Goods Inventory at May 31 ................$13,500 d. Units sold during the month (above) .....................20,250 Cost per emblem ......................................... $2 Cost in Cost of Goods Sold at May 31 ...................$40,500 e. Emblems used in advertising ..........................1,000 Cost per emblem ....................................... $2 Cost in Advertising Expense at May 31 ...............$ 2,000 2. Raw Materials Inventorybalance sheet Work in Process Inventorybalance sheet Finished Goods Inventorybalance sheet Cost of Goods Soldincome statement Advertising Expenseincome statement Exercise 2-11 (30 minutes) 1. Eccles Company Schedule of Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning ............. $ 8,000 Add: Purchases of raw materials .................. 132,000 Raw materials available for use ................... 140,000 Deduct: Raw materials inventory, ending ..... 10,000 Raw materials used in production ............... $130,000 Direct labor ...................................... 90,000 Manufacturing overhead: Rent, factory building .............................80,000 Indirect labor .....................................56,300 Utilities, factory .................................9,000 Maintenance, factory equipment .................. 24,000 Supplies, factory .....................................700 Depreciation, factory equipment .................. 40,000 Total manufacturing overhead costs ............ 210,000 Total manufacturing costs .............................. 430,000 Add: Work in process, beginning .................... 5,000 435,000 Deduct: Work in process, ending .................... 20,000 Cost of goods manufactured .......................... $415,000 2. The cost of goods sold section would be: Finished goods inventory, beginning ............... $ 70,000 Add: Cost of goods manufactured .................. 415,000 Goods available for sale ................................ 485,000 Deduct: Finished goods inventory, ending ....... 25,000 Cost of goods sold ........................................$460,000 Exercise 2-12 (15 minutes) Cost Behavior Selling and Administrative Cost Product Cost Cost Item Variable Fixed 1.The costs of turn signal switches used at a General Motors plant . 2. Interest expense on CBSs long-term debt ................... 3. Salespersons commissions at Avon Products ..................... 4. Insurance on one of Cincinnati Milacrons factory buildings 5. The costs of shipping brass fittings to customers in California ... 6.Depreciation on the book-shelves at Reston Bookstore ............ 7. The costs of X-ray film at the Mayo Clinics radiology lab .... 8.The cost of leasing an 800 telephone number at L.L. Bean ....... 9. The depreciation on the playground equipment at a McDonalds outlet ................ 10. The cost of the mozzarella cheese used at a Pizza Hut outlet .. Exercise 2-13 (15 minutes) 1. Direct labor cost: 34 hours $12 per hour ...........$408 Manufacturing overhead cost: 6 hours $12 per hour . 72 Total cost ............................................$480 2. Direct labor cost: 50 hours $12 per hour .........$600 Manufacturing overhead cost: 10 hours $6 per hour =60 Total cost ......................................................$660 3. The company could treat the cost of fringe benefits relating to direct labor workers as part of manufacturing overhead. This approach spreads the cost of such fringe benefits over all units of output. Alternatively, the company could treat the cost of fringe benefits relating to direct labor workers as additional direct labor cost. This latter approach charges the costs of fringe benefits to specific jobs rather than to all units of output. Chapter 3 Systems Design: Job-Order Costing Solutions to Questions 3-1 By definition, manufacturing overhead consists of costs that cannot be practically traced to products or jobs. Therefore, if these costs are to be assigned to products or jobs, they must be allocated rather than traced. 3-2 Job-order costing is used in situations where many different products or services that require separate costing are produced each period. Process costing is used in situations where a single, homogeneous product, such as cement, bricks, or gasoline, is produced for long periods. 3-3 The job cost sheet is used to record all costs that are assigned to a particular job. These costs include direct materials costs traced to the job, direct labor costs traced to the job, and manufacturing overhead costs applied to the job. When a job is completed, the job cost sheet is used to compute the unit product cost. 3-4 A predetermined overhead rate is used to apply overhead to jobs. It is computed before a period begins by dividing the periods estimated total manufacturing overhead by the periods estimated total amount of the allocation base. Thereafter, overhead is applied to jobs by multiplying the predetermined overhead rate by the actual amount of the allocation base that is incurred for each job. The most common allocation base is direct labor-hours. 3-5 A sales order is issued after an agreement has been reached with a customer on quantities, prices, and shipment dates for goods. The sales order forms the basis for the production order. The production order specifies what is to be produced and forms the basis for the job cost sheet. The job cost sheet, in turn, is used to summarize the various production costs incurred to complete the job. These costs are entered on the job cost sheet from materials requisition forms, direct labor time tickets, and by applying overhead. 3-6 Some production costs such as a factory managers salary cannot be traced to a particular product or job, but rather are incurred as a result of overall production activities. In addition, some production costs such as indirect materials cannot be easily traced to jobs. If these costs are to be assigned to products, they must be allocated to the products. 3-7 If actual manufacturing overhead cost is applied to jobs, then the company must wait until the end of the accounting period to apply ovehead and to cost jobs. If the company computes actual overhead rates more frequently to get around this problem, the rates may fluctuate widely. Overhead cost tends to be incurred somewhat evenly from month to month (due to the presence of fixed costs), whereas production activity often fluctuates. The result would be high overhead rates in periods with low activity and low overhead rates in periods with high activity. For these reasons, most companies use predetermined overhead rates to apply manufacturing overhead costs to jobs. 3-8 The measure of activity used as the allocation base should drive the overhead cost; that is, the base should cause the overhead cost. If the allocation base does not really cause the overhead, then costs will be incorrectly attributed to products and jobs and product costs will be distorted. 3-10 The Manufacturing Overhead account is credited when overhead cost is applied to Work in Process. Generally, the amount of overhead applied will not be the same as the amount of actual cost incurred, since the predetermined overhead rate is based on estimates. 3-11 Underapplied overhead occurs when the actual overhead cost exceeds the amount of overhead cost applied to Work in Process inventory during the period. Overapplied overhead occurs when the actual overhead cost is less than the amount of overhead cost applied to Work in Process inventory during the period. Underapplied or overapplied overhead is disposed of by either closing out the amount to Cost of Goods Sold or by allocating the amount among Cost of Goods Sold and ending inventories in proportion to the applied overhead in each account. The adjustment for underapplied overhead increases Cost of Goods Sold (and inventories) whereas the adjustment for overapplied overhead decreases Cost of Goods Sold (and inventories). 3-9 Assigning manufacturing overhead costs to jobs does not ensure a profit. The units produced may not be sold and if they are sold, they may not be sold at prices sufficient to cover all costs. It is a myth that assigning costs to products or jobs ensures that those costs will be recovered. Costs are recovered only by selling to customersnot by allocating costs. 3-12 Manufacturing overhead may be underapplied for several reasons. Control over overhead spending may be poor. Or, some of the overhead may be fixed and the actual amount of the allocation base was less than estimated at the beginning of the period. In this situation, the amount of overhead applied to inventory will be less than the actual overhead cost incurred. 3-13 Underapplied overhead implies that not enough overhead was assigned to jobs during the period and therefore cost of goods sold was understated. Therefore, underapplied overhead is added to cost of goods sold. Likewise, overapplied overhead is deducted from cost of goods sold. 3-14 Yes, overhead should be applied to value the Work in Process inventory at year-end. Since $6,000 of overhead was applied to Job A on the basis of $8,000 of direct labor cost, the companys predetermined overhead rate must be 75% of direct labor cost. Thus, $3,000 of overhead should be applied to Job B at year-end: $4,000 direct labor cost 75% = $3,000 applied overhead cost. 3-15 Direct material .................................. $10,000 Direct labor ...................................... 12,000 Manufacturing overhead: $12,000 125% .............15,000 Total manufacturing cost ................... $37,000 Unit product cost: $37,000 1,000 units .................... $37 3-16 A plantwide overhead rate is a single overhead rate used throughout all production departments in a plant. Some companies use multiple overhead rates rather than plantwide rates to more appropriately allocate overhead costs among products. Multiple overhead rates should be used, for example, in situations where one department is machine intensive and another department is labor intensive. 3-17 When automated equipment replaces direct labor, overhead increases and direct labor decreases. This results in an increase in the predetermined overhead rateparticularly if it is based on direct labor. 3-18 When the predetermined overhead rate is based on the amount of the allocation base at capacity and the plant is operated at less than capacity, overhead will ordinarily be underapplied. This occurs because actual activity is less than the activity the predetermined overhead rate is based on. 3-19 Critics of current practice advocate dis-closing underapplied overhead on the income statement as Cost of Unused Capacitya period expense. This would highlight the amount rather than burying it in other accounts. Exercise 3-1 (10 minutes) a. Job-order costing b. Job-order costing c. Process costing d. Job-order costing e. Process costing* f. Process costing* g. Job-order costing h. Job-order costing i. Job-order costing j. Job-order costing k. Process costing l. Process costing * Some of the listed companies might use either a process costing or a job-order costing system, depending on the nature of their operations and how homogeneous the final product is. For example, a plywood manufacturer might use job-order costing if it has a number of different plywood products that are constructed of different woods or come in markedly different sizes. Exercise 3-2 (15 minutes) 1. The direct materials and direct labor costs listed in the exercise would have been recorded on four different documents: the materials requisi-tion form for Job ES34, the time ticket for Harry Kerst, the time ticket for Mary Rosas, and the job cost sheet for Job ES34. 2. The costs for Job ES34 would have been recorded as follows: Materials requisition form: Quantity Unit Cost Total Cost Blanks 40 $8.00 $320 Nibs 960 $0.60 576 $896 Time ticket for Harry Kerst Started Ended Time Completed Rate Amount Job Number 9:00 AM 12:15 PM 3.25 $12.00 $39.00 ES34 Time ticket for Mary Rosas Started Ended Time Completed Rate Amount Job Number 2:15 PM 4:30 PM 2.25 $14.00 $31.50 ES34 Job Cost Sheet for Job ES34 Direct materials ... $896.00 Direct labor: Harry Kerst ....... 39.00 Mary Rosas ...... 31.50 $966.50 Exercise 3-3 (10 minutes) The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead ....... $586,000 Estimated total direct labor hours (DLHs) .. 40,000 DLHs = Predetermined overhead rate ............$14.65 per DLH Exercise 3-4 (15 minutes) a. Raw Materials ....................... 86,000 Accounts Payable .......... 86,000 b. Work in Process ........72,000 Manufacturing Overhead ........ 12,000 Raw Materials ............... 84,000 c. Work in Process ..............105,000 Manufacturing Overhead ........ 3,000 Wages Payable ............. 108,000 d. Manufacturing Overhead ..197,000 Various Accounts .......... 197,000 Exercise 3-5 (10 minutes) Actual direct labor-hours ....12,600 Predetermined overhead rate .$23.10 = Manufacturing overhead applied ...$291,060 Exercise 3-6 (15 minutes) 1. Actual manufacturing overhead costs .....$ 48,000 Manufacturing overhead applied: 10,000 MH $5 per MH .............................. 50,000 Overapplied overhead cost ....................$ 2,000 2. Direct materials: Raw materials inventory, beginning ..........$ 8,000 Add purchases of raw materials ............... 32,000 Raw materials available for use ...............40,000 Deduct raw materials inventory, ending ........ 7,000 Raw materials used in production .............$ 33,000 Direct labor ...................................40,000 Manufacturing overhead cost applied to work in process ................................................50,000 Total manufacturing cost .......................123,000 Add: Work in process, beginning ................6,000 129,000 Deduct: Work in process, ending ...............7,500 Cost of goods manufactured ...................$121,500 Exercise 3-7 (20 minutes) Parts 1 and 2. Cash Raw Materials (a) 75,000 (a) 75,000 (b) 73,000 (c) 152,000 (d) 126,000 Work in Process Finished Goods (b) 67,000 (f) 379,000 (c) 134,000 379,000 (f) 379,000 (e) 178,000 379,000 (f) 379,000 Manufacturing Overhead Cost of Goods Sold (b) 6,000 (e) 178,000 (f) 379,000 (g) 28,000 (c) 18,000 351,000 (d) 126,000 (g) 28,000 28,000 Exercise 3-8 (10 minutes) 1. Actual direct labor-hours .....................8,250 Predetermined overhead rate ............... $21.40 = Manufacturing overhead applied ........... $176,550 Less: Manufacturing overhead incurred .... 172,500 $ 4,050 Manufacturing overhead overapplied ........ $4,050 2. Because manufacturing overhead is overapplied, the cost of goods sold would decrease by $4,050 and the gross margin would increase by $4,050. Exercise 3-9 (30 minutes) 1. Since $320,000 of studio overhead cost was applied to Work in Process on the basis of $200,000 of direct staff costs, the apparent predetermined overhead rate was 160%: Studio overhead applied$320,000=Total amount of the allocation base$200,000 direct staff costs=160% of direct staff costs 2. The Krimmer Corporation Headquarters project is the only job remaining in Work in Process at the end of the month; therefore, the entire $40,000 balance in the Work in Process account at that point must apply to it. Recognizing that the predetermined overhead rate is 160% of direct staff costs, the following computation can be made: Total cost added to the Krimmer Corporation Headquarters project .....$40,000 Less: Direct staff costs ............................$13,500 Studio overhead cost ($13,500 160%) ........................... 21,600 35,100 Costs of subcontracted work ............... $ 4,900 With this information, we can now complete the job cost sheet for the Krimmer Corporation Headquarters project: Costs of subcontracted work ........... $ 4,900 Direct staff costs ............................ 13,500 Studio overhead ..........................21,600 Total cost to January 31 .................$40,000 Exercise 3-10 (30 minutes) 1. a. Raw Materials Inventory .................210,000 Accounts Payable ........................210,000 b. Work in Process ......................152,000 Manufacturing Overhead ..................38,000 Raw Materials Inventory ................190,000 c. Work in Process .................................49,000 Manufacturing Overhead ..................21,000 Salaries and Wages Payable ..............70,000 d.Manufacturing Overhead ................105,000 Accumulated Depreciation ..................105,000 e. Manufacturing Overhead ................ 130,000 Accounts Payable ..........................130,000 f. Work in Process ........................300,000 Manufacturing Overhead ....................300,000 75,000 machine-hours $4 per machine-hour = $300,000. g. Finished Goods .............................510,000 Work in Process ...............................510,000 h. Cost of Goods Sold .........................450,000 Finished Goods ..............................450,000 Accounts Receivable .........................675,000 Sales .......................................675,000 $450,000 1.5 = $675,000 2. Manufacturing Overhead Work in Process (b) 38,000 (f) 300,000 Bal. 35,000 (g) 510,000 (c) 21,000 (b) 152,000 (d) 105,000 (c) 49,000 (e)130,000 (f) 300,000 6,000 Bal. 26,000 (Overapplied overhead) Exercise 3-11 (30 minutes) 1. Williams Chandler Nguyen Designer-hours ..........200 80 120 Predetermined overhead rate .. $45 $45 $45 Overhead applied ....................$9,000 $3,600 $5,400 2. Williams Chandler Direct materials cost$ 4,800 $1,800 Direct labor cost ............2,400 1,000 Overhead applied ...........9,000 3,600 Total cost .................$16,200 $6,400 Completed Projects ..........22,600* Work in Process ...........22,600* * $16,200 + $6,400 3. The balance in the Work in Process account consists entirely of the costs associated with the Nguyen project: Direct materials cost ..........$ 3,600 Direct labor cost ................1,500 Overhead applied .................5,400 Total cost in work in process ....$10,500 4. The balance in the Overhead account is determined as follows: Overhead Actual overhead costs 16,000 18,000 Applied overhead costs 2,000 Overapplied overhead As indicated above, the credit balance in the Overhead account is called overapplied overhead. Exercise 3-12 (30 minutes) Note to the instructor: This exercise is a good vehicle for introducing the concept of predetermined overhead rates. This exercise can also be used as a launching pad for a discussion of the appendix to the chapter. 1. As suggested, the costing problem does indeed lie with manufacturing overhead cost. Since manufacturing overhead is mostly fixed, the cost per unit increases as the level of production decreases. The problem can be solved by using a predetermined overhead rate, which should be based on expected activity for the entire year. Many students will use units of product in computing the predetermined overhead rate, as follows: Estimated total manufacturing overhead cost Predetermined=overhead rateEstimated total amount of the allocation base$840,000=200,000 units=$4.20 per unit. The predetermined overhead rate could also be set on the basis of direct labor cost or direct materials cost. The computations are: Estimated total manufacturing overhead cost Predetermined=overhead rate Estimated total amount of the allocation base$840,000=$240,000 direct labor cost=350% of direct labor cost. Estimated total manufacturing overhead cost Predetermined=overhead rate Estimated total amount of the allocation base$840,000=$600,000 direct materials cost=140% of direct materials cost. Exercise 3-12 (continued) 2. Using a predetermined overhead rate, the unit costs would be: Quarter First Second Third Fourth Direct materials ..........$240,000 $120,000 $ 60,000 $180,000 Direct labor .............96,000 48,000 24,000 72,000 Manufacturing overhead: Applied at $4.20 per unit, 350% of direct labor cost, or 140% of direct materials cost 336,000 168,000 84,000 252,000 Total cost ..$672,000 $336,000 $168,000 $504,000 Number of units produced . 80,000 40,000 20,000 60,000 Estimated unit product cost .$8.40 $8.40 $8.40 $8.40 Exercise 3-13 (15 minutes) 1. Item (a): Actual manufacturing overhead costs for the year. Item (b): Overhead cost applied to work in process for the year. Item (c): Cost of goods manufactured for the year. Item (d): Cost of goods sold for the year. 2.Manufacturing Overhead .............................30,000 Cost of Goods Sold ................................ 30,000 3. The overapplied overhead will be allocated to the other accounts on the basis of the amount of overhead applied during the year in the ending balance of each account: Work in process ...............................$ 32,800 8% Finished goods .................................41,000 10 Cost of goods sold ............................ 336,200 82 Total cost .......................................$410,000 100 % Using these percentages, the journal entry would be as follows: Manufacturing Overhead .................30,000 Work in Process (8% $30,000) .........2,400 Finished Goods (10% $30,000) .........3,000 Cost of Goods Sold (82% $30,000) .... 24,600 Exercise 3-14 (30 minutes) 1. The overhead applied to Ms. Miyamis account would be computed as follows: 2005 2006 Estimated overhead cost (a) .......................$144,000 $144,000 Estimated professional staff hours (b) .............2,400 2,250 Predetermined overhead rate (a) (b) .............. $60 $64 Professional staff hours charged to Ms. Miyamis account .... 5 5 Overhead applied to Ms. Miyamis account ...$300 $320 2. If the actual overhead cost and the actual professional hours charged turn out to be exactly as estimated there would be no underapplied or overapplied overhead. 2005 2006 Predetermined overhead rate (see above) ......... $60 $64 Actual professional staff hours charged to clients accounts (by assumption) ... 2,400 2,250 Overhead applied .....$144,000 $144,000 Actual overhead cost incurred (by assumption) .. 144,000 144,000 Under- or overapplied overhead ..... $ 0 $ 0 3. If the predetermined overhead rate is based on the professional staff hours available, the computations would be: Estimated overhead cost (a) .....$144,000 $144,000 Professional staff hours available (b) .....3,000 3,000 Predetermined overhead rate (a) (b) ... $48 $48 Professional staff hours charged to Ms. Miyamis account ....... 5 5 Overhead applied to Ms. Miyamis account .......... $240 $240 Problem 3-14 (continued) 4. If the actual overhead cost and the actual professional staff hours charged to clients accounts turn out to be exactly as estimated over- head would be underapplied as shown below. 2005 2006 Predetermined overhead rate (see 3 above) (a) ... $48 Actual professional staff hours charged to clients accounts (by assumption) (b) ........... 2,400 2,250 Overhead applied (a) (b) .............. $115,200 $108,000 Actual overhead cost incurred (by assumption) ...144,000 144,000 Underapplied overhead .... $ 28,800 $ 36,000 The underapplied overhead is best interpreted in this situation as the cost of idle capacity. Proponents of this method of computing predetermined overhead rates suggest that the underapplied overhead be treated as a period expense that would be separately disclosed on the income statement as Cost of Unused Capacity. Exercise 3-15 (15 minutes) 1. Milling Department: Estimated total manufacturing overhead cost Predetermined=overhead rate Estimated total amount of the allocation base$510,000==$8.50 per machine-hour60,000 machine-hours Assembly Department: Estimated total manufacturing overhead cost Predetermined=overhead rate Estimated total amount of the allocation base$800,000==125% of direct labor cost$640,000 direct labor cost 2. Overhead Applied Milling Department: 90 MHs $8.50 per MH .. $765 Assembly Department: $160 125% ............. 200 Total overhead cost applied ........................... $965 3. Yes; if some jobs require a large amount of machine time and little labor cost, they would be charged substantially less overhead cost if a plant-wide rate based on direct labor cost were used. It appears, for example, that this would be true of Job 407 which required considerable machine time to complete, but required only a small amount of labor cost. Exercise 3-16 (30 minutes) 1. The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead cost Predetermined=overhead rate Estimated total amount of the allocation base$170,000==$2.00 per machine-hour85,000 machine-hours 2. The amount of overhead cost applied to Work in Process for the year would be: 80,000 machine-hours $2.00 per machine-hour = $160,000. This amount is shown in entry (a) below: Manufacturing Overhead (Utilities) 14,000 (a) 160,000 (Insurance) 9,000 (Maintenance) 33,000 (Indirect materials) 7,000 (Indirect labor) 65,000 (Depreciation) 40,000 Balance 8,000 Work in Process (Direct materials) 530,000 (Direct labor) 85,000 (Overhead) (a) 160,000 3. Overhead is underapplied by $8,000 for the year, as shown in the Manufacturing Overhead account above. The entry to close out this balance to Cost of Goods Sold would be: Cost of Goods Sold ................................8,000 Manufacturing Overhead ........................... 8,000 Exercise 3-16 (continued) 4. When overhead is applied using a predetermined rate based on machine-hours, it is assumed that overhead cost is proportional to machine-hours. When the actual level of activity turns out to be 80,000 machine-hours, the costing system assumes that the overhead will be 80,000 machine-hours $2.00 per machine-hour, or $160,000. This is a drop of $10,000 from the initial estimated total manufacturing overhead cost of $170,000. However, the actual total manufacturing overhead did not drop by this much. The actual total manufacturing overhead was $168,000a drop of only $2,000 from the estimate. The manufacturing overhead did not decline by the full $10,000 because of the existence of fixed costs and/or because overhead spending was not under control. These issues will be covered in more detail in later chapters. Ch 4: Chapter 4 Systems Design: Process Costing Solutions to Questions 4-1 A process costing system should be used in situations where a homogeneous product is produced on a continuous basis. 4-2 1. Job-order costing and process costing have the same basic purposesto assign materials, labor, and overhead cost to products and to provide a mechanism for computing unit product costs. 2. Both systems use the same basic manufacturing accounts. 3. Costs flow through the accounts in basically the same way in both systems. 4-3 Cost accumulation is simpler under process costing because costs only need to be assigned to departmentsnot separate jobs. A company usually has a small number of processing departments, whereas a job-order costing system often must keep track of the costs of hundreds or even thousands of jobs. 4-4 In a process costing system, a Work in Process account is maintained for each separate processing department. 4-5 The journal entry would be: Work in Process, Firing ....................................XXXX Work in Process, Mixing .............................. XXXX 4-6 The costs that might be added in the Firing Department include: (1) costs transferred in from the Mixing Department; (2) materials costs added in the Firing Department; (3) labor costs added in the Firing Department; and (4) overhead costs added in the Firing Department. 4-7 Under the weighted-average method, equivalent units of production consist of units transferred to the next department (or to finished goods) during the period plus the equivalent units in the departments ending work in process inventory. 4-8 The company will want to distinguish between the costs of the metals used to make the medallions, but the medals are otherwise identical and go through the same production processes. Thus, operation costing is ideally suited for the companys needs. 4-9 Under the weighted-average method, each unit transferred out of the department is counted as one equivalent unitregardless of in what period the work was done to complete the units. Under the FIFO method, only the work done in the current period is counted. Units transferred out are divided into two parts. One part consists of the units in the beginning inventory. Only the work needed to complete these units is shown as part of the equivalent units for the current period. The other part of the units transferred out consists of the units started and completed during the current period. 4-10 The weighted-average method mixes costs from the current period with costs from the prior period. Thus, under the weighted-average method, the departments apparent performance in the current period is influenced to some extent by what happened in a prior period. In contrast, the FIFO method cleanly separates the costs and work of the current period from those of the prior period. This makes the FIFO method superior to the weighted-average method for cost control because current performance should be measured in relation to costs of the current period only. 4-11 Operating departments are the units in an organization within which the central purposes of the organization are carried out; these departments usually generate revenue. By contrast, service departments provide support or assistance to the operating departments. Examples of service departments include laundry services in a hotel or hospital, internal auditing, airport maintenance services (ground crews), cafeteria, personnel, cost accounting, and so on. 4-12 Service department costs are allocated to products and services in two stages. Service department costs are first allocated to the operating departments. These allocated costs are then included in the operating departments overhead rates, which are used to cost products and services. 4-13 Interdepartmental services exist whenever two service departments provide services to each other. 4-14 Under the direct method, interdepartmental services are ignored; service department costs are allocated directly to operating departments. 4-15 Under the step-down method, the costs of the service department performing the greatest amount of service for the other service departments are allocated first, the costs of the service department performing the next greatest amount of service are allocated next, and so forth through all the service departments. Once a service departments costs have been allocated, costs are not reallocated back to it under the step-down method. Exercise 4-1 (20 minutes) a. To record issuing raw materials for use in production: Work in ProcessMolding Department ......... 28,000 Work in ProcessFiring Department ............. 5,000 Raw Materials ....................................... 33,000 b. To record direct labor costs incurred: Work in ProcessMolding Department ......... 18,000 Work in ProcessFiring Department ............. 5,000 Wages Payable ..................................... 23,000 c. To record applying manufacturing overhead: Work in ProcessMolding Department ......... 24,000 Work in ProcessFiring Department ............. 37,000 Manufacturing Overhead ....................... 61,000 d. To record transfer of unfired, molded bricks from the Molding Department to the Firing Department: Work in ProcessFiring Department ............. 67,000 Work in ProcessMolding Department ... 67,000 e. To record transfer of finished bricks from the Firing Department to the finished goods warehouse: Finished Goods............................................ 108,000 Work in ProcessFiring Department ...... 108,000 f. To record Cost of Goods Sold: Cost of Goods Sold ...................................... 106,000 Finished Goods ..................................... 106,000 Exercise 4-2 (10 minutes) Weighted-Average Method Equivalent Units Materials Conversion Units transferred to the next department ......410,000 410,000 Ending work in process: Materials: 30,000 units 70% complete ....21,000 Conversion: 30,000 units 50% complete .. 15,000 Equivalent units of production .............431,000 425,000 Exercise 4-3 (10 minutes) Weighted-Average Method Materials Labor Overhead Total Work in process, May 1 ..$ 14,550 $23,620 $118,100 Cost added during May .... 88,350 14,330 71,650 Total cost (a) ......$102,900 $37,950 $189,750 Equivalent units of production (b) ..1,200 1,100 1,100 Cost per equivalent unit (a) (b) ..$85.7 $34.50 $172.50 $292.75 Exercise 4-4 (10 minutes) Weighted-Average Method Materials Conversion Total Ending work in process inventory: Equivalent units of production ..300 100 Cost per equivalent unit .$31.56 $9.32 Cost of ending work in process inventory . $9,468 $932 $10,400 Units completed and transferred out: Units transferred to the next department .1,300 1,300 Cost per equivalent unit ..$31.56 $9.32 Cost of units completed and transferred out .$41,028 $12,116 $53,144 Exercise 4-5 (10 minutes) FIFO Method Materials Conversion To complete beginning work in process Materials: 400 units x (100% 75%) .........100 Conversion: 400 units x (100% 25%) ........300 Units started and completed during the period(42,600 units started 500 units in ending inventory) ........42,100 42,100 Ending work in process Materials: 500 units x 80% complete .400 Conversion: 500 units x 30% complete .150 Equivalent units of production ...42,600 42,550 Exercise 4-6 (10 minutes) FIFO method Materials Labor Overhead Total Cost added during May (a) .$82,560 $52,920 $132,300 Equivalent units of production (b) .16,000 14,000 14,000 Cost per equivalent unit (a) (b) .$5.16 $3.78 $9.45 $18.39 Exercise 4-7 (15 minutes) FIFO Method Materials Conversion Total Ending work in process inventory: Equivalent units of production .800 200 Cost per equivalent unit .$4.40 $1.30 Cost of ending work in process inventory $3,520 $260 $3,780 Units transferred out: Cost in beginning work in process inventory ..$2,700 $380 $3,080 Cost to complete the units in beginning work in process inventory: Equivalent units of production required to complete the beginning inventory 400 700 Cost per equivalent unit .$4.40 $1.30 Cost to complete the units in beginning inventory .$1,760 $910 $2,670 Cost of units started and completed this period: Units started and completed this period (8,000 units completed and transferred to the next department 1,000 units in beginning work in process inventory) .7,000 7,000 Cost per equivalent unit ....$4.40 $1.30 Cost of units started and completed this period ...$30,800 $9,100 $39,900 Total cost of units transferred out .$45,650 Exercise 4-8 (15 minutes) Service Departments Operating Departments Administration Physical Plant Services Undergraduate Programs Graduate Programs Total Departmental costs before allocations ..$2,070,000 $720,000 $23,650,000 $2,980,000 $29,420,000 Allocations: Administration costs (40/45, 5/45) .(2,070,000) 1,840,000 230,000 Physical Plant costs (250/300, 50/300)* .(720,000) 600,000 120,000 Total costs after allocation ..$ 0 $ 0 $26,090,000 $3,330,000 $29,420,000 *Based on the space occupied by the two operating departments, which is 300,000 square feet. Exercise 4-9 (15 minutes) Service Departments Operating Departments Administration Building Services Groceries Coffee Shop Total Departmental costs before allocations .$200,000 $60,000 $3,860,000 $340,000 $4,460,000 Allocations: Administration costs (320/3,200,2,720/3,200, 160/3,200)* .(200,000) 20,000 170,000 10,000 Building Services costs (9,500/10,000, 500/10,000) .(80,000) 76,000 4,000 Total costs after allocation $ 0 $ 0 $4,106,000 $354,000 $4,460,000 *Based on employee hours in the other three departments, 320 + 2,720 + 160 = 3,200. Based on space occupied by the two operating departments, 9,500 + 500 = 10,000. Both the Building Services Department costs of $60,000 and the Administration costs of $20,000 that have been allocated to the Building Services Department are allocated to the two operating departments. Exercise 4-10 (10 minutes) Work in ProcessMixing ....330,000 Raw Materials Inventory ...330,000 Work in ProcessMixing ....260,000 Work in ProcessBaking ....120,000 Wages Payable ............380,000 Work in ProcessMixing ...190,000 Work in ProcessBaking ..90,000 Manufacturing Overhead ...280,000 Work in ProcessBaking ..760,000 Work in ProcessMixing ...760,000 Finished Goods..980,000 Work in ProcessBaking ...980,000 Exercise 4-11 (20 minutes) Weighted-Average Method 1. Materials Labor Overhead Units transferred to the next department ...790,000 790,000 790,000 Ending work in process: Materials: 50,000 units 60% complete..... 30,000 Labor: 50,000 units 20% complete ....10,000 Overhead: 50,000 units 20% complete...10,000 Equivalent units of production ..820,000 800,000 800,000 2. Materials Labor Overhead Cost of beginning work in process ....... $ 68,600 $ 30,000 $ 48,000 Costs added during the period .. 907,200 370,000 592,000 Total cost (a) ..$975,800 $400,000 $640,000 Equivalent units of production (b) .820,000 800,000 800,000 Cost per equivalent unit (a) (b)..$1.19 $0.50 $0.80 Exercise 4-12 (20 minutes) FIFO Method 1. Materials Labor Overhead To complete beginning work in process Materials: 80,000 gallons (100% - 80%) .....16,000 Labor: 80,000 gallons (100% - 75%) ...20,000 Overhead: 80,000 gallons (100% - 75%) .20,000 Units started and completed during the period...710,000 710,000 710,000 Ending work in process: Materials: 50,000 gallons 60%..30,000 Labor: 50,000 gallons 20% ..10,000 Overhead: 50,000 gallons 20% .10,000 Equivalent units of production ..756,000 740,000 740,000 2. Materials Labor Overhead Cost added during the period (a) .$907,200 $370,000 $592,000 Equivalent units of production (b) ...756,000 740,000 740,000 Cost per equivalent unit (a) (b) ..$1.20 $0.50 $0.80 Exercise 4-13 (45 minutes) FIFO method 1. Computation of the total cost per equivalent unit of production: Cost per equivalent unit of production for material ..$18.20 Cost per equivalent unit of production for conversion .23.25 Total cost per equivalent unit of production .........$41.45 2. Computation of equivalent units in ending inventory: Materials Conversion Units in ending inventory .300 300 Percentage completed ....80 % 40 % Equivalent units of production ..240 120 3. Computation of equivalent units required to complete the beginning inventory: Materials Conversion Units in beginning inventory .400 400 Percentage uncompleted ....30 % 70 % Equivalent units of production .. 120 280 4. Units transferred to the next department .....4,400 Less units from the beginning inventory .......400 Units started and completed during the period .4,000 Exercise 4-13 (continued) 5. Materials Conversion Total Ending work in process inventory: Equivalent units of production .240 120 Cost per equivalent unit .$18.20 $23.25 Cost of ending work in process inventory .$4,368 $2,790 $7,158 Units transferred out: Cost from the beginning work in process inventory .$4,897 $2,989 $7,886 Cost to complete the units in beginning work in process inventory: Equivalent units of production required to complete the units in beginning inventory ...120 280 Cost per equivalent unit ...........................$18.20 $23.25 Cost to complete the units in beginning inventory .$2,184 $6,510 $8,694 Cost of units started and completed this period: Units started and completed this period ..4,000 4,000 Cost per equivalent unit ......$18.20 $23.25 Cost of units started and completed this period.$72,800 $93,000 $165,800 Total cost of units transferred out ..............$182,380 Exercise 4-14 (10 minutes) Weighted-Average Method Materials Labor & Overhead Pounds transferred to the Packing Department during May 490,000 490,000 Work in process, May 31: Materials: 20,000 pounds 100% complete ...20,000 Labor and overhead: 20,000 pounds 90% complete .. 18,000 Equivalent units of production .510,000 508,000 Exercise 4-15 (15 minutes) FIFO Method Materials Labor &Overhead To complete the beginning work in process: Materials: 30,000 pounds (100% - 100%) ..0 Labor and overhead:30,000 pounds (100% - 55%) ....13,500 Pounds started and completed during May (480,000 pounds started - 20,000 pounds in ending inventory) ...460,000 460,000 Ending work in process: Materials: 20,000 pounds 100% complete .......20,000 Labor and overhead: 20,000 pounds 90% complete ...18,000 Equivalent units of production .480,000 491,500 Exercise 14-16 (20 minutes) Service Departments Operating Departments Administrative Janitorial Maintenance Prep Finishing Total Costs before allocation .$84,000 $67,800 $36,000 $256,100 $498,600 $942,500 Allocation: Administrative: (60/1,200; 240/1,200; 600/1,200; 300/1,200) (84,000) 4,200 16,800 42,000 21,000 Janitorial: (10,000/100,000; 20,000/100,000; 70,000/100,000) .... (72,000) 7,200 14,400 50,400 Maintenance: (10,000/40,000; 30,000/40,000) .(60,000) 15,000 45,000 Total cost after allocations ....$ 0 $ 0 $ 0 $327,500 $615,000 $942,500 Exercise 14-17 (20 minutes) Service Departments Operating Departments Administrative Janitorial Equipment Maintenance Prep FinishingTotal Costs before allocation ..$84,000 $67,800 $36,000 $256,100 $498,600 $942,500 Allocation: Administrative: (600/900; 300/900) (84,000) 56,000 28,000 Janitorial: (20,000/90,000; 70,000/90,000) . (67,800) 15,067 52,733 Equipment Maintenance: (10,000/40,000; 30,000/40,000) . (36,000) 9,000 27,000 Total cost after allocations ..$ 0 $ 0 $ 0 $336,167 $606,333 $942,500 EXERCISE 4-18 (30 MINUTES) WEIGHTED-AVERAGE METHOD 1. MATERIALS CONVERSION UNITS TRANSFERRED TO THE NEXT PROCESS .300,000 300,000 ENDING WORK IN PROCESS: MATERIALS: 40,000 UNITS 50% COMPLETE .. 20,000 CONVERSION: 40,000 UNITS 25% COMPLETE 10,000 EQUIVALENT UNITS OF PRODUCTION ..320,000 310,000 2. MATERIALS CONVERSION COST OF BEGINNING WORK IN PROCESS .$ 56,600 $ 14,900 COST ADDED DURING THE PERIOD .385,000 214,500 TOTAL COST (A) ...$441,600 $229,400 EQUIVALENT UNITS OF PRODUCTION (B) ...320,000 310,000 COST PER EQUIVALENT UNIT (A) (B) ...$1.38 $0.74 3. MATERIALS CONVERSION TOTAL ENDING WORK IN PROCESS INVENTORY: EQUIVALENT UNITS OF PRODUCTION (SEE ABOVE) ..20,000 10,000 COST PER EQUIVALENT UNIT (SEE ABOVE) ..$1.38 $0.74 COST OF ENDING WORK IN PROCESS INVENTORY .....$27,600 $7,400 $35,000 UNITS COMPLETED AND TRANSFERRED OUT: UNITS TRANSFERRED TO THE NEXT DEPARTMENT .....300,000 300,000 COST PER EQUIVALENT UNIT (SEE PREVIOUS EXERCISE) ..$1.38 $0.74 COST OF UNITS COMPLETED AND TRANSFERRED OUT ....$414,000 $222,000 $636,000 Chapter 5 Cost Behavior: Analysis and Use Solutions to Questions 5-1 a. Variable cost: A variable cost remains constant on a per unit basis, but changes in total in direct relation to changes in volume. b. Fixed cost: A fixed cost remains constant in total amount. The average fixed cost per unit varies inversely with changes in volume. c. Mixed cost: A mixed cost contains both variable and fixed cost elements. 5-2 a. Unit fixed costs decrease as volume increases. b. Unit variable costs remain constant as volume increases. c. Total fixed costs remain constant as volume increases. d. Total variable costs increase as volume increases. 5-3 a. Cost behavior: Cost behavior 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. b. Relevant range: The relevant range is the range of activity within which assumptions about variable and fixed cost behavior are valid. 5-4 An activity base is a measure of whatever causes the incurrence of a variable cost. Examples of activity bases include units produced, units sold, letters typed, beds in a hospital, meals served in a cafe, service calls made, etc. 5-5 a. Variable cost: A variable cost remains constant on a per unit basis, but increases or decreases in total in direct relation to changes in activity. b. Mixed cost: A mixed cost is a cost that contains both variable and fixed cost elements. c. Step-variable cost: A step-variable cost is a cost that is incurred in large chunks, and which increases or decreases only in response to fairly wide changes in activity. 5-6 The linear assumption is reasonably valid providing that the cost formula is used only within the relevant range. Cost Activity Mixed Cost Variable Cost Step-Variable Cost 5-7 A discretionary fixed cost has a fairly short planning horizonusually a year. Such costs arise from annual decisions by management to spend on certain fixed cost items, such as advertising, research, and management development. A committed fixed cost has a long planning horizongenerally many years. Such costs relate to a companys investment in facilities, equipment, and basic organization. Once such costs have been incurred, they are locked in for many years. 5-8 a. Committed d. Committed b. Discretionary e. Committed c. Discretionary f. Discretionary 5-9 Yes. As the anticipated level of activity changes, the level of fixed costs needed to support operations may also change. Most fixed costs are adjusted upward and downward in large steps, rather than being absolutely fixed at one level for all ranges of activity. 5-10 The high-low method uses only two points to determine a cost formula. These two points are likely to be less than typical since they represent extremes of activity. 5-11 The formula for a mixed cost is Y = a + bX. In cost analysis, the a term represents the fixed cost, and the b term represents the vari- able cost per unit of activity. 5-12 The term least-squares regression means that the sum of the squares of the deviations from the plotted points on a graph to the regression line is smaller than could be obtained from any other line that could be fitted to the data. 5-13 Ordinary single least-squares regression analysis is used when a variable cost is a function of only a single factor. If a cost is a function of more than one factor, multiple regression analysis should be used to analyze the behavior of the cost. 5-14 The contribution approach income statement organizes costs by behavior, first deducting variable expenses to obtain contribution margin, and then deducting fixed expenses to obtain net operating income. The traditional approach organizes costs by function, such as production, selling, and administration. Within a functional area, fixed and variable costs are intermingled. 5-15 The contribution margin is total sales revenue less total variable expenses. Exercise 5-1 (15 minutes) 1. Cups of Coffee Served in a Week 1,800 1,900 2,000 Fixed cost ...$1,100 $1,100 $1,100 Variable cost . 468 494 520 Total cost .$1,568 $1,594 $1,620 Cost per cup of coffee served * ....$0.871 0.839 $0.810 * Total cost cups of coffee served in a week 2. The average cost of a cup of coffee declines as the number of cups of coffee served increases because the fixed cost is spread over more cups of coffee. Exercise 5-2 (30 minutes) 1. The completed scattergraph is presented below: 02,0004,0006,0008,00010,00012,00014,00016,00002,0004,0006,0008,00010,000Units Processed Total Cost Exercise 5-2 (continued) 2. (Students answers will vary considerably due to the inherent imprecision and subjectivity of the quick-and-dirty scattergraph method of estimating variable and fixed costs.) The approximate monthly fixed cost is $6,000the point where the straight line intersects the cost axis. The variable cost per unit processed can be estimated as follows using the 8,000-unit level of activity, which falls on the straight line: Total cost at the 8,000-unit level of activity ..$14,000 Less fixed costs .........................6,000 Variable costs at the 8,000-unit level of activity$ 8,000 $8,000 8,000 units = $1 per unit. Observe from the scattergraph that if the company used the high-low method to determine the slope of the line, the line would be too steep. This would result in underestimating the fixed cost and overestimating the variable cost per unit. Exercise 5-3 (20 minutes) 1. Month Occupancy-Days Electrical Costs High activity level (August) .. 3,608 $8,111 Low activity level (October) ..186 1,712 Change .3,422 $6,399 Variable cost = Change in cost Change in activity = $6,399 3,422 occupancy-days = $1.87 per occupancy-day Total cost (August) ..$8,111 Variable cost element ($1.87 per occupancy-day 3,608 occupancy-days) 6,747 Fixed cost element .....$1,364 2. Electrical costs may reflect seasonal factors other than just the variation in occupancy days. For example, common areas such as the reception area must be lighted for longer periods during the winter. This will result in seasonal effects on the fixed electrical costs. Additionally, fixed costs will be affected by how many days are in a month. In other words, costs like the costs of lighting common areas are variable with respect to the number of days in the month, but are fixed with respect to how many rooms are occupied during the month. Other, less systematic, factors may also affect electrical costs such as the frugality of individual guests. Some guests will turn off lights when they leave a room. Others will not. Exercise 5-4 (20 minutes) 1. The Haaki Shop, Inc. Income StatementSurfboard Department For the Quarter Ended May 31 Sales ...$800,000 Variable expenses: Cost of goods sold ($150 per surfboard 2,000 surfboards*) .......$300,000 Selling expenses ($50 per surfboard 2,000 surfboards) ........................100,000 Administrative expenses (25% $160,000) .40,000 440,000 Contribution margin .................360,000 Fixed expenses: Selling expenses ....150,000 Administrative expenses ......120,000 270,000 Net operating income ........$ 90,000 *$800,000 sales $400 per surfboard = 2,000 surfboards. 2. Since 2,000 surfboards were sold and the contribution margin totaled $360,000 for the quarter, the contribution of each surfboard toward fixed expenses and profits was $180 ($360,000 2,000 surfboards = $180 per surfboard). Another way to compute the $180 is: Selling price per surfboard ........$400 Less variable expenses: Cost per surfboard ..............$150 Selling expenses ..................50 Administrative expenses ($40,000 2,000 surfboards) ..20 220 Contribution margin per surfboard .....$180 Exercise 5-5 (20 minutes) The least-squares regression estimates of fixed and variable costs can be computed using any of a variety of statistical and mathematical software packages or even by hand. The solution below uses Microsoft Excel as illustrated in the text. The intercept provides the estimate of the fixed cost element, $2,296 per month, and the slope provides the estimate of the variable cost element, $3.74 per rental return. Expressed as an equation, the relation between car wash costs and rental returns is Y = $2,296 + $3.74X where X is the number of rental returns. Note that the R2 is 0.92, which is quite high, and indicates a strong linear relationship between car wash costs and rental returns. Exercise 5-5 (continued) While not a requirement of the exercise, it is always a good to plot the data on a scattergraph. The scattergraph can help spot nonlinearities or other problems with the data. In this case, the regression line (shown below) is a reasonably good approximation to the relationship between car wash costs and rental returns. $0$5,000$10,000$15,000$20,000$25,00001,0002,0003,0004,0005,0006,000Rental Returns Car Wash Costs Exercise 5-6 (20 minutes) 1. The companys variable cost per unit would be: $150,000=$2.50 per unit. 60,000 units Taking into account the difference in behavior between variable and fixed costs, the completed schedule would be: Units produced and sold 60,000 80,000 100,000 Total costs: Variable costs ..$150,000 * $200,000 $250,000 Fixed costs ..360,000 * 360,000 360,000 Total costs ...$510,000 * $560,000 $610,000 Cost per unit: Variable cost ..$2.50 $2.50 $2.50 Fixed cost ...6.00 4.50 3.60 Total cost per unit ..$8.50 $7.00 $6.10 2. The companys income statement in the contribution format would be: Sales (90,000 units $7.50 per unit) ................$675,000 Variable expenses (90,000 units $2.50 per unit) ....225,000 Contribution margin................................................450,000 Fixed expenses ......360,000 Net operating income ....$ 90,000 Exercise 5-7 (45 minutes) 1. Units Shipped Shipping Expense High activity level 8 $3,600 Low activity level ..2 1,500 Change ..............6 $2,100 Variable cost element: Change in cost$2,100==$350 per unit Change in activity6 units Fixed cost element: Shipping expense at the high activity level ......$3,600 Less variable cost element ($350 per unit 8 units)..2,800 Total fixed cost .....................$ 800 The cost formula is $800 per month plus $350 per unit shipped or Y = $800 + $350X, where X is the number of units shipped. 2. a. See the scattergraph on the following page. b. (Note: Students answers will vary due to the imprecision and subjetive nature of this method of estimating variable and fixed costs.) Total cost at 5 units shipped per month [a point falling on the line in (a)] ....$2,600 Less fixed cost element (intersection of the Y axis) ..1,100 Variable cost element.............................$1,500 $1,500 5 units = $300 per unit. The cost formula is $1,100 per month plus $300 per unit shipped or Y = $1,100 + 300X, where X is the number of units shipped. Exercise 5-7 (continued) 2. a. The scatter graph appears below: 05001,0001,5002,0002,5003,0003,5004,000012345678910 Units Shipped Total Shipping Expense 3. The cost of shipping units is likely to depend on the weight and volume of the units shipped and the distance traveled as well as on the number of units shipped. In addition, higher cost shipping might be necessary to meet a deadline. Exercise 5-8 (30 minutes) 1. Month Units Shipped(X) Shipping Expense (Y) January 4 $2,200 February 7 $3,100 March 5 $2,600 April 2 $1,500 May 3 $2,200 June 6 $3,000 July 8 $3,600 A spreadsheet application such as Excel or a statistical software package can be used to compute the slope and intercept of the least-squares regression line for the above data. The results are: Intercept (fixed cost) .....$1,011 Slope (variable cost per unit) .$318 R2 .......................0.96 Therefore, the cost formula is $1,011 per month plus $318 per unit shipped or Y = $1,011 + $318X. Note that the R2 is 0.96, which means that 96% of the variation in ship- ping costs is explained by the number of units shipped. This is a very high R2 and indicates a very good fit. 2. Variable Cost per Unit Fixed Cost per Month Quick-and-dirty scattergraph method .$300 $1,100 High-low method ......$350 $800 Least-squares regression method $318 $1,011 Note that the high-low method gives estimates that are quite different from the estimates provided by least-squares regression. Exercise 5-9 (20 minutes) 1. Miles Driven Total Annual Cost* High level of activity .120,000 $13,920 Low level of activity .80,000 10,880 Change ....40,000 $ 3,040 *120,000 miles $0.116 per mile = $13,920 80,000 miles $0.136 per mile = $10,880 Variable cost per mile: Change in cost$3,040==$0.076 per mileChange in activity40,000 miles Fixed cost per year: Total cost at 120,000 miles ....$13,920 Less variable cost element: 120,000 miles $0.076 per mile ....................... 9,120 Fixed cost per year ................................$ 4,800 2. Y = $4,800 + $0.076X 3. Fixed cost .....................$ 4,800 Variable cost: 100,000 miles $0.076 per mile ....7,600 Total annual cost .............................$12,400 Exercise 5-10 (20 minutes) 1. X-rays Taken X-ray Costs High activity level (February)..7,000 $29,000 Low activity level (June) ...3,000 17,000 Change ......4,000 $12,000 Variable cost per X-ray: Change in cost$12,000==$3.00 per X-rayChange in activity 4,000 X-rays Fixed cost per month: X-ray cost at the high activity level ...$29,000 Less variable cost element: 7,000 X-rays $3.00 per X-ray ....................21,000 Total fixed cost .....$ 8,000 The cost formula is $8,000 per month plus $3.00 per X-ray taken or, in terms of the equation for a straight line: Y = $8,000 + $3.00X where X is the number of X-rays taken. 2. Expected X-ray costs when 4,600 X-rays are taken: Variable cost: 4,600 X-rays $3.00 per X-ray ......$13,800 Fixed cost ...8,000 Total costs.......$21,800 Exercise 5-11 (30 minutes) 1. The scattergraph appears below. 02,0004,0006,0008,00010,00012,00014,00016,00018,00020,00022,00024,00026,00028,00030,00032,00001,0002,0003,0004,0005,0006,0007,008,000Number of X-Rays TakenCost of X-Rays Exercise 5-11 (continued) 2. (Note: Students answers will vary considerably due to the inherent lack of precision and subjectivity of the quick-and-dirty method.) Total costs at 5,000 X-rays per month [a point falling on the line in (1)] .........................$23,000 Less fixed cost element (intersection of the Y axis) ...6,500 Variable cost element...........................$16,500 $16,500 5,000 X-rays = $3.30 per X-ray. The cost formula is therefore $6,500 per month plus $3.30 per X-ray taken. Written in equation form, the cost formula is: Y = $6,500 + $3.30X, where X is the number of X-rays taken. 3. The high-low 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 flat. Consequently, the high-low method would over- estimate the fixed cost and underestimate the variable cost per unit. Exercise 5-12 (30 minutes) 1. Monthly operating costs at 70% occupancy: 2,000 rooms 70% = 1,400 rooms; 1,400 rooms $21 per room per day 30 days .. $882,000 Monthly operating costs at 45% occupancy (given) . 792,000 Change in cost ..................................$ 90,000 Difference in rooms occupied: 70% occupancy (2,000 rooms 70%)...1,400 45% occupancy (2,000 rooms 45%).............. 900 Difference in rooms (change in activity) ......500 Change in cost$90,000Variable cost===$180 per room. Change in activity500 rooms $180 per room 30 days = $6 per room per day. 2. Monthly operating costs at 70% occupancy (above) .. $882,000 Less variable costs: 1,400 rooms $6 per room per day 30 days ..252,000 Fixed operating costs per month .....$630,000 3. 2,000 rooms 60% = 1,200 rooms occupied. Fixed costs ....$630,000 Variable costs: 1,200 rooms $6 per room per day 30 days ...216,000 Total expected costs ...........................$846,000 Exercise 5-13 (30 minutes) 1. Units(X) Total Glazing Cost (Y) 8 $270 5 $200 10 $310 4 $190 6 $240 9 $290 A spreadsheet application such as Excel or a statistical software package can be used to compute the slope and intercept of the least-squares regression line for the above data. The results are: Intercept (fixed cost) ............$107.50 Slope (variable cost per unit) ....$20.36 R2 ....0.98 Therefore, the cost formula is $107.50 per week plus $20.36 per unit. Note that the R2 is 0.98, which means that 98% of the variation in glazing costs is explained by the number of units glazed. This is a very high R2 and indicates a very good fit. 2. Y = $107.50 + $20.36X, where X is the number of units glazed. 3. Total expected glazing cost if 7 units are processed: Variable cost: 7 units $20.36 per unit ..$142.52 Fixed cost .....107.50 Total expected cost .$250.02 7-1 Absorption and variable costing differ in how they handle fixed manufacturing overhead. Under absorption costing, fixed manufacturing overhead is treated as a product cost and hence is an asset until products are sold. Under variable costing, fixed manufacturing overhead is treated as a period cost and is expensed on the current periods income statement. 7-2 Selling and administrative expenses are treated as period costs under both variable costing and absorption costing. 7-3 Under absorption costing, fixed manufacturing overhead costs are included in product costs, along with direct materials, direct labor, and variable manufacturing overhead. If some of the units are not sold by the end of the period, then they are carried into the next period as inventory. The fixed manufacturing overhead cost attached to the units in ending inventory follow the units into the next period. When the units are finally sold, the fixed manufacturing overhead cost that has been carried over with the units is included as part of that periods cost of goods sold. 7-4 Absorption costing advocates believe that absorption costing does a better job of matching costs with revenues than variable costing. They argue that all manufacturing costs must be assigned to products to properly match the costs of producing units of product with the revenues from the units when they are sold. They believe that no distinction should be made between variable and fixed manufacturing costs for the purposes of matching costs and revenues. 7-5 Advocates of variable costing argue that fixed manufacturing costs are not really the cost of any particular unit of product. If a unit is made or not, the total fixed manufacturing costs will be exactly the same. Therefore, how can one say that these costs are part of the costs of the products? These costs are incurred to have the capacity to make products during a particular period and should be charged against that period as period costs according to the matching principle. 7-6 If production and sales are equal, net operating income should be the same under absorption and variable costing. When production equals sales, inventories do not increase or decrease and therefore under absorption costing fixed manufacturing overhead cost cannot be deferred in inventory or released from inventory. 7-7 If production exceeds sales, absorption costing will usually show higher net operating income than variable costing. When production exceeds sales, inventories increase and under absorption costing part of the fixed manufacturing overhead cost of the current period is deferred in inventory to the next period. In contrast, all of the fixed manufacturing overhead cost of the current period is immediately ex- pensed under variable costing. 7-8 If fixed manufacturing overhead cost is released from inventory, then inventory levels must have decreased and therefore production must have been less than sales. 7-9 Inventory decreased. The decrease resulted in fixed manufacturing overhead cost being released from inventory and expensed as part of cost of goods sold. This added fixed manufacturing overhead cost resulted in a loss even though the company operated at its breakeven. 7-10 Under absorption costing net operating income can be increased by simply increasing the level of production without any increase in sales. If production exceeds sales, units of product are added to inventory. These units carry a portion of the current periods fixed manufacturing overhead costs into the inventory account, thereby reducing the current periods reported expenses and causing net operating income to increase. 7-11 Generally speaking, variable costing cannot be used externally for financial reporting purposes nor can it be used for tax purposes. It can, however, be used in internal reports. 7-12 Differences in reported net operating income between absorption and variable costing arise because of changing levels of inventory. In lean production, goods are produced strictly to customers orders. With production geared to sales, inventories are largely (or entirely) eliminated. If inventories are completely eliminated, they cannot change from one period to another and absorption costing and variable costing will report the same net operating income. Exercise 7-1 (15 minutes) 1. Under absorption costing, all manufacturing costs (variable and fixed) are included in product costs. Direct materials .....................R120 Direct labor .........................140 Variable manufacturing overhead ......50 Fixed manufacturing overhead (R600,000 10,000 units) ...........60 Unit product cost ....................R370 2. Under variable costing, only the variable manufacturing costs are included in product costs. Direct materials ........................R120 Direct labor ............................140 Variable manufacturing overhead ........ 50 Unit product cost .......................R310 Note that selling and administrative expenses are not treated as product costs under either absorption or variable costing; that is, they are not included in the costs that are inventoried. These expenses are always treated as period costs and are charged against the current periods revenue. Exercise 7-2 (30 minutes) 1. 2,000 units R60 per unit fixed manufacturing overhead = R120,000 2. 2. The variable costing income statement appears below: Sales .................R4,000,000 Variable expenses: Variable cost of goods sold: Beginning inventory .............R 0 Add variable manufacturing costs (10,000 units. R310 per unit) .. 3,100,000 Goods available for sale ...........3,100,000 Less ending inventory (2,000 units R310 per unit) ...... 620,000 Variable cost of goods sold* ...2,480,000 Variable selling and administrative (8,000 units R20 per unit) .160,000 2,640,000 Contribution margin ..............1,360,000 Fixed expenses: Fixed manufacturing overhead .....600,000 Fixed selling and administrative .400,000 1,000,000 Net operating income ..................R 360,000 * The variable cost of goods sold could be computed more simply as: 8,000 units sold R310 per unit = R2,480,000. The difference in net operating income between variable and absorption costing can be explained by the deferral of fixed manufacturing overhead cost in inventory that has taken place under the absorption costing approach. Note from part (1) that R120,000 of fixed manufacturing overhead cost has been deferred in inventory to the next period. Thus, net operating income under the absorption costing approach is R120,000 higher than it is under variable costing. ...
View Full Document

{[ snackBarMessage ]}

Ask a homework question - tutors are online