Feb 09 Midterm Solutions

Feb 09 Midterm Solutions - Question 1 (15 marks, suggested...

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Unformatted text preview: Question 1 (15 marks, suggested time 15 minutes) - (a) Compute the cost of raw materials purchased during 2008. (2 marks) BRMI + P - ERMI = RM used 500 + P - 1,000 = 2,000 P = 2,500 (b) The company applies manufacturing overhead to products on the basis of direct labour co_st.- Compute the predetermined overhead rate that was used during 2008. (3 marks) Total Mfg. cost = RM used +'DL + Applied MOH 8,000 = 2,000 + DL + 3,000 DL = $3,000 Applied at 100% of 01. cost (0) Compute/calculate the cost of goods manufactured for 2008. (3 marks) COGM = RM used + DL + Applied MOH + BWIP - EWIP '= Total mfg. cost + BWIP -' EWIP = 8,000 + (300 + 200 + 200) - (400 + 100 + 100) = 8,000 + 700 — 600 = 8,100 (d) Compute/calculate cost of goods sold for 2008. (2 marks) ' COGS = BFGl + COGM - EFGI 8,500 = 800 + 8,100 - 400' (e) Why do most companies use predetermined overhead rates and apply overhead .to products rather than use actual overhead rates? (2 marks) 1. Waiting until the period (month or year) is over to determine actual overhead costs would be too late. Managers need “timely information” for decision-making (e.g., setting price for “cost-plus contracts”, bidding for contracts, “request for proposal”, ' etc). _ 2. Overhead costs may be somewhat uniform from month to month, while activity may ' change substantially from month to month, and vice versa. Thus, need to “average”. (f) How would you deal with the over/under—applied overhead in this situation and why? Specificjournal entry is not required. (3 marks) o Sinceit is the end of the year, we need to close the underlover-applied overhead. _ o The amount is immaterial: (3,100 - 3,000)l3,100 is < 5% 0 Since immaterial, close to COGS. [If material, prorate to EWIP, F6 and 0068.] Question 2 (16 marks) _ Distribution Costs # of Shipments High $ 49,500 570 Low _ 25 500 278 $24,000 292 Variable cost $82.19 (24,000] 292] Total cost - high observation 49,500 Variable (570 x $82.19) 48,848 Fixed cost - $2,652 Total cost-low observation 25,500 Variable (278 x $82.19) 22,849 Fixed cost - $2,651 Estimated cost at 600 shipments: Variable cost (600 x $82.19) $49,314 Fixed cost 2,652 Total cost 51 966 However, 600 units is outside the relevant range and, thus, the estimate may not be "valid", Part B 1. High "Low only uses two points (regression uses all the points) 2. The two points are “extreme” and may not be representative of normal business operations (i.e., they may be outliers). Part C From High-Low: Estimated cost at 600 shipments: Variable cost $49,314 [600 x $82.19] Fixed cost 2,652 Total cost $51,966 It trucks are rented: Variable cost $43,314 [600 x ($82.19 - $10)] Fixed cost - 9,152 [2,652 + 6,500] Total cost $52,466 Thus, worse off by $500. i Cost = $6,500 vs. Benefit = 600 x $10 reduction = $6,000._ Thus, worse off $500. Point of indifference: $2,652 + 82.19(X) = 9,152 + 72.1900 x = 650 R it is worth it if the shipments are greater than 6,500 / 10 = 650. 3 Thus, it is worth it if expecting greater than 650 shipments. Although next month only 600 shipments are expected, the “the company is confident that the business will continue to grow”. Thus, the trucks should be purchased. QUESTION 3 (27 marks) PART A: Required: , (a). Calculate the “break—even" number of haircuts for Love Your Hair. (6 marks) Variable-costs per haircut = $1.00 + $0.30 +$0.20 = $1.50 Contribution margin = $15.00 - $1.50 = $13.50 Fixed costs = $250 + $2,000 + $200 + $40 + $8,333 (opportunity cost including 25% benefits of $80,000 x 1.25 I 12) = $10,823. Break-even haircuts = $10,823 / $13.50 = 801 (b). Based on your answer to (a), what advise do you have for Gordon and Grace. (2 marks) If the average number of haircuts a day is expected to be 30 (15 each x 2) then they will be able to perform only 720 haircuts a month (24 days x 30 per day) which won't allow them to make their "lost wages and benefits" at BC Ferries. PART B: Required: - (a) Should they expand into the women’s market? Show your computations. (8 marks) Since Gordon's chair has 15 men’s haircuts per day, and women’s haircuts take 1.5 times as long as men’s haircuts, Grace will have 10 women’s haircuts per day. Number of women’s haircuts / day = 15 /_1.5 = 10 Variable costs per woman’s haircut = $2.00 + $0.45 (1 .5 x $0.30) + $0.20 = $2.65 Contribution margin per woman’s haircut = $30 4 $2.65 = $27.35 Contribution margin per man's haircut = $13.50 Incremental contribution margin / day = (10 x $27.35 —_ 15 x $13.50) = $71 Incremental contribution margin / month = $71 x 24 days = $1,704 incremental fixed costs / month = $80 ($120 — $40) + $500 ($750 - $250) = $580 Thus, since the incremental contribution margin is greater than the incremental fixed costs, profits before tax will increase by $1,124. Thus, they should expand into the women's market. “INDIFFERENCE ANALYSIS APPROACH": Another way to "look at this” is to notice that there are two chairs to cut hair— one for men and one for women. The men's chair WILL NOT CHANGE. Thus, focusing on DIFFERENCES ONLY (men’s chair will change to women’s chair): fixed costs increase by $580 and the women’s chair can only do 10 haircuts a day (whereas the men‘s chair can do 15 haircuts a day). 360 haircuts (men) x $13.50 = $4,860 240 haircuts (women) X $27.35 = $5,984 Thus, expand into women's market because profits before tax will increase by $1,124. Approach One: Let X = number of women’s cuts a month (1 .5)(_13.50)X = 27.35X — 580 X = 81.6901 cuts (82 cuts) Thus, as long as the chair can do 81.6901 cuts it will generate the same profit as the men’s chair. Since the chair can do 240 haircuts a month, the women's chair will generate an extra $1,124 in profits [(240 — 81 .69)(27.35 — 20.25)]. ' 3 Approach Two: (b) _ (C) - Calculate the sales dollars (men’s haircuts) and the sales dollars (women's haircuts) they would have to generate to break-even. (9 marks) Gordon's CM per day = $13.50 x 15 = $202.50 Grace's CM per day = $27.35 [ women’s haircut x 10 cuts [ day = $273.50 Total CM per day = $202.50 + $273.50 = $476 I day Fixed costs per month = $10,823 (from Part A) + $80 (magazines) + $500 (advertising) = $11,403 $11,403 per month [$476 per day = 23.96 days Thus, the number ofmen's haircuts = 23.96 x 15 = 360 Thus, the number of women’s haircuts = 23.96 x 10 = 240 g Mix of menzwomen = 1.5:1 Weighted average contribution margin [“unit” = (1.5 [ 2.5) ($13.50) + (1 [2.5) ($27.35) = $19.04 - Break-even in “units” = $11,403 [$19.04 = 598.90 "units" Men's haircuts = 598.90 x (1.5 / 2.5) = 360 Women’s haircuts = 598.90 x (1 [2.5) = 240 E One “unit” = 1.5 men’s cuts and 1 women’s cut CM [ “unit” = (1.5) ($13.50) + (1) ($27.35) = $20.25 + $27.35 = $47.60 Break-even in "units" = $11,403 [$47.60 = 239.56 Thus, men’s haircuts = 239.56 x 1.5 = 360 Thus, women’s haircuts = 239.56 x 1 = 240 Sales dollars (men's haircuts) = 360 x $15 =_ $5,400 Sales dollars (women‘s haircuts) = 240 x $30 = $7,200 Briefly discuss TWO “other” (qualitative) factors that Gordon and Grace should consider before they embark on their “adventure in the nature of trade”. (2 marks) 1. Based on the fact that they will have to work 23 [ 24 days a month to make their wages at BCFerries, they will not have time for any vacation. Additionally, they will only get a One—day weekend. 2. Can they increase their “capacity utilization" to more than 75%? 3. What about the loss of the insurance and pension benefits? 4. Would it be feasible to rent out one chair to an employed hairdresser and have either Gordon or Grace continue working at BC Ferries. This option would offer some “security”. 5. Going into business is “risky”: How certain are they that they will be able to perform 15 haircuts a day each? Is there “competition” in the area? - 6. Likelihood of being laid off due to privatization/outsourcing (seniority in union?) 7. Accuracy of estimates (sensitivity analysis). Question 4 (a) (5 marks) (32 marks) Totali DL hours = (90,000 x .02) + (9,500 x .02) = 1,800 + 190 = 1,990 POH Rate = 42,000 / 1,990 = 21.11 BLUE RED DM per unit (45,000/ 90,000) $0.5 (6,650/9,500) $0.7 DL per unit (18,000 /90,000) $0.2 (1 ,900 I 9,500) $0.2 MOH per unit (.02 DLH x 21.11) §0.42 (.02 DLH x 21.11) . $0.42 7 $1.12 $1.32 (b) (13 marks) OVERHEAD COSTS BLUE PEN —EEEEE_ Indirect labour $28,000 50% = 14,000 Cost driver is number of setups (batches) 90,000/1,000 = 90 batches 9,500 [1,000 = 9.5 = 10 batches 90 l (90 + 10) x 14,000 = 12,600 101 (90 + 10) x 14000 = 1,400 9,500 l1,000 = 9.5 = 10 batches However, “twice as long" is the same as 20 "normal batches” = 20 inspections 40% = 11,200 Cost driver is number of inspections 90,000 / 1,000 = 90 batches = 90 inspections (1 inspection per batch) 90 / (90 + 20) x 11,200 = 9,164 20 l (90 + 20) x 11,200 = 2,036 10% = 2,800 Cost driver is number of products 1 /2x2,800=1,400 1/2x2,800=1,400 Total machinery- related costs = 8,000 + 4,000 + 2,000 = $14,000 Cost driver is machine hours 90,000 x .1 = 9,000 hours 9,500 x .2 = 1,900 hours 9,000 / (9,000 + 1,900) x 14,000 = 11,560 MOH er unit 34,724 / 90,000 = .39 7,276/9,500 = .77 _ Total cost per unit DM $0.5 DM $0.7 DL $0.2 DL $0.2 MOH $.39 MOH §.77 $1.09 $1.67 1,900 I (9,000 + 1,900)x14,000 = 2,440 (c) 1. Based on ABC, the company’s profitability per pen is as follows: (d) _ BLUE RED Selling price (135,000 I 90,000) $1.50 (17,100 I 9,500) $1.80 Total cost I unit $1.09 $1.67 $0.41 $0.13 Thus, the company has got to either_reduce the costs (without compromising "high quality") of the RED pen and/or increase its price. Before considering a price increase, "competition" must be taken into consideration. [To earn 2 marks, you didn’t have to show all this detail. If you showed all the detail above, you would have been awarded the full 4 marks for part (c).] . Re—deSign or re-engineer the RED pen so it uses less inspection time. inspection time is a non-value added activity. Also, the company can produce the RED pen in bigger batch sizes. ABC changes a manager’s perception of many overhead cests in that costs that were formerly thought to be indirect (power, inspection and machine setups) are identified with specific activities and thereby are recognized as being "traceable" to individual products. Selling and distribution and other non—manufacturing costs can be used in the determination of “Product Cost". Reflects the demand for the selling and distribution activities placed by different products sold to different types of customers through different distribution channels. More realistic costs help indicate what products should be “outsourced” (purchased rather than produced). More realistic costs provide better indication of marginal costs and marginal revenues leading to better decisions. ‘ Cost reduction efforts on non-value added activities are facilitated to create higher profits. More realistic costs help in evaluating true profitability of products orservices for decisions such as elimination or expansion of products, product lines, or services. Higher awareness of causes of costs is created. Thus, better able to control costs. More realistic bid prices can be generated because of knowledge of more realistic costs. More realistic costs help to plan marketing strategies for product promotion- i.e., “push” sales of most profitable products. (e) Since there is excess capacity (99,500 pens are being produced and the capacity is 150,000 pens), the minimum selling price would be the marginal (incremental) cost of _ producing the pen- i.e., variable costs. [2 marks for making this point] The important point to note with this particular set of facts is that the pens are produced in batches of 1,000 units. Thus, since only 1,500 units (9,500 — 8,000) of RED are scheduled to be produced in December, by accepting the special order NO additional batch-related activities need to be incurred re: 500 of the 2,500 units. The extra 500 units will be incorporated in the production of the final batch of 500 units of RED that would have had to be produced anyways. Accordingly, only TWO additional batches will have to be produced (since batches are 1,000 units each). [2 marks for making this point] Furthermore, amortization expense is a fixed cost and, thus, would not increase. Also, Indirect labour re: production templates won’t increase. The only incremental overhead costs would be as follows: Indirect labour re: setups (cost driver is batches) indirect labour re: inspections (cost driver is inspections) Maintenance (cost driver is machine hours) Electricity (cost driver is machine hours) [Simply noting the above would have earned you the full 8 marks. 10 marks were allocated for making all the above points.] Indirect labour re: setups l batch = 14,000 I 100 batches = 140 Indirect labour re: inspections / "normal" batch = 11,200 I 110 inspections = 101.82 Electricity and Maintenance / machine hour = (2,000 + 4,000) / 10,900 = 0.55 Incremental overhead = (2 batches x 140) + (4 "regular inSpections'? since "twice as long” x 101.82) + [(2,500 x .2 hours) x .55] = 280 + 407.28 + 275 = 962.28 Incremental costs: DM $0.70 DL $0.20 IVIOH $0.38 (962.28l2,500) $1.28 Thus, the minimum selling price should be $1.20. THERE WERE 14 MARKS AVAILABLE FOR THIS QUESTION. THUS, TO GET THE FULL 8 MARKS YOUR ANSWER WOULD NOT HAVE TO BE AS DETAILED AS THE SOLUTION PRESENTED ABOVE. Please note, that only a maximum of 8 marks can be avoided. Thus, if a student provided the answer above, slhe would only receive 8 marks. ...
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Feb 09 Midterm Solutions - Question 1 (15 marks, suggested...

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