COST_ACCTG_A_MANAGERIAL_PERSP_HORNGREN_SOL_MAN

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Unformatted text preview: CHAPTER 1 THE ACCOUNTANT’S ROLE IN THE ORGANIZATION ACCOUNTANT’ See the front matter of this Solutions Manual for suggestions regarding your choices of assignment material for each chapter. 1-1 Management accounting measures, analyzes and reports financial and nonfinancial information that helps managers make decisions to fulfill the goals of an organization. It focuses on internal reporting and is not restricted by generally accepted accounting principles (GAAP). Financial accounting focuses on reporting to external parties such as investors, government agencies, and banks. It measures and records business transactions and provides financial statements that are based on generally accepted accounting principles (GAAP). Other differences include (1) management accounting emphasizes the future (not the past), and (2) management accounting influences the behavior of managers and other employees (rather than primarily reporting economic events). 1-2 Financial accounting is constrained by generally accepted accounting principles. Management accounting is not restricted to these principles. The result is that management accounting allows managers to charge interest on owners’ capital to help judge a division’s performance, even though such a charge is not allowed under GAAP, management accounting can include assets or liabilities (such as “brand names” developed internally) not recognized under GAAP, and management accounting can use asset or liability measurement rules (such as present values or resale prices) not permitted under GAAP. 1-3 Management accountants can help to formulate strategy by providing information about the sources of competitive advantage—for example, the cost, productivity, or efficiency advantage of their company relative to competitors or the premium prices a company can charge relative to the costs of adding features that make its products or services distinctive. 1-4 The business functions in the value chain are Research and development development—generating and experimenting with ideas related to new products, services, or processes. Design of products, services, and processes processes—the detailed planning and engineering of products, services, or processes. Production Production—acquiring, coordinating, and assembling resources to produce a product or deliver a service. Marketing Marketing—promoting and selling products or services to customers or prospective customers. Distribution Distribution—delivering products or services to customers. Customer service service—providing after-sale support to customers. 1- 1-5 Supply chain describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers, regardless of whether those activities occur in the same organization or in other organizations. Cost management is most effective when it integrates and coordinates activities across all companies in the supply chain as well as across each business function in an individual company’s value chain. Attempts are made to restructure all cost areas to be more cost-effective. 1-6 “Management accounting deals only with costs.” This statement is misleading at best, and wrong at worst. Management accounting measures, analyzes, and reports financial and nonfinancial information that helps managers define the organization’s goals, and make decisions to fulfill them. Management accounting also analyzes revenues from products and customers in order to assess product and customer profitability. Therefore, while management accounting does use cost information, it is only a part of the organization’s information recorded and analyzed by management accountants. 1-7 Management accountants can help improve quality and achieve timely product deliveries by recording and reporting an organization’s current quality and timeliness levels and by analyzing and evaluating the costs and benefits—both financial and non-financial—of new quality initiatives such as TQM, relieving bottleneck constraints or providing faster customer service. 1-8 The five-step decision-making process is (1) identify the problem and uncertainties (2) obtain information (3) make predictions about the future (4) make decisions by choosing among alternatives and (5) implement the decision, evaluate performance and learn. 1-9 Planning decisions focus on (a) selecting organization goals, predicting results under various alternative ways of achieving those goals, deciding how to attain the desired goals, and (b) communicating the goals and how to attain them to the entire organization. Control decisions focus on (a) taking actions that implement the planning decisions, and (b) deciding how to evaluate performance and providing feedback and learning to help future decision making. 1-10 The three guidelines for management accountants are 1. Employ a cost-benefit approach. 2. Recognize behavioral and technical considerations. 3. Apply the notion of “different costs for different purposes”. 1-11 Agree. A successful management accountant requires general business skills (such as understanding the strategy of an organization) and people skills (such as motivating other team members) as well as technical skills (such as computer knowledge, calculating costs of products, and supporting planning and control decisions). 1- 1-12 The new controller could reply in one or more of the following ways: (a) Demonstrate to the plant manager how he or she could make better decisions if the plant controller was viewed as a resource rather than a deadweight. In a related way, the plant controller could show how the plant manager’s time and resources could be saved by viewing the new plant controller as a team member. (b) Demonstrate to the plant manager a good knowledge of the technical aspects of the plant. This approach may involve doing background reading. It certainly will involve spending much time on the plant floor speaking to plant personnel. (c) Show the plant manager examples of the new plant controller’s past successes in working with line managers in other plants. Examples could include assistance in preparing the budget, assistance in analyzing problem situations and evaluating financial and nonfinancial aspects of different alternatives, and assistance in submitting capital budget requests. (d) Seek assistance from the corporate controller to highlight to the plant manager the importance of many tasks undertaken by the new plant controller. This approach is a last resort but may be necessary in some cases. 1-13 IMA stands for the Institute of Management Accountants. It is the largest association of management accountants in the United States. The CMA (Certified Management Accountant) is the professional designation for management accountants and financial executives. It demonstrates that the holder has met the admission criteria and demonstrated the competency of management accounting knowledge required by the IMA. 1-14 The Institute of Management Accountants (IMA) sets standards of ethical conduct for management accountants in the following areas: Competence Confidentiality Integrity Credibility 1-15 Steps to take when established written policies provide insufficient guidance are (a) Discuss the problem with the immediate superior (except when it appears that the superior is involved). (b) Clarify relevant ethical issues by confidential discussion with an IMA Ethics Counselor or other impartial advisor. (c) Consult your own attorney as to legal obligations and rights concerning the ethical conflicts. 1- 1-16 (15 min.) Value chain and classification of costs, computer company. Cost Item a. b. c. d. e. f. g. h. 1-17 Value Chain Business Function Production Distribution Design of products, services or processes Research and Development Customer Service or Marketing Design of products, services or processes (or Research and Development) Marketing Production (15 min.) Value chain and classification of costs, pharmaceutical company. Cost Item a. b. c. d. e. f. g. h. Value Chain Business Function Design of products, services or processes Marketing Customer Service Research and Development Marketing Production Marketing Distribution 1-18 (15 min.) Value chain and classification of costs, fast food restaurant. Cost Item a. b. c. d. e. f. g. h. 1-19 Value Chain Business Function Production Distribution Marketing Marketing Marketing Production Design of products, services or processes Customer service (15 min.) Value chain, supply chain, and key success factors. Change in Management Accounting a. b. c. d. e. Key Theme Value-chain analysis Key success factors (cost and quality) Key success factors (cost) Supply-chain analysis Key success factors (time) 1- 1-20 (10-15 min.) Planning and control decisions. Action a. b. c. d. e. 1-21 (15 min.) Five-step decision-making process, manufacturing. Action a. b. c. d. e. f. g. 1-22 Decision Planning Control Control Planning Planning Step in Decision-Making Process Obtain information Make predictions about the future Identify the problem and uncertainties Implement the decision, evaluate performance, and learn Make predictions about the future Make decisions by choosing among alternatives Obtain information (15 min.) Five-step decision-making process, service firm. Action a. b. c. d. e. f. g. Step in Decision-Making Process Obtain information Identify the problem and uncertainties Make predictions about the future Implement the decision, evaluate performance, and learn Make predictions about the future Obtain information Make decisions by choosing among alternatives . 1- 1-23 (10–15 min.) Professional ethics and reporting division performance. 1. Miller’s ethical responsibilities are well summarized in the IMA’s “Standards of Ethical Conduct for Management Accountants” (Exhibit 1-7 of text). Areas of ethical responsibility include the following: competence confidentiality integrity credibility The ethical standards related to Miller’s current dilemma are integrity, competence and credibility. Using the integrity standard, Miller should carry out duties ethically and communicate unfavorable as well as favorable information and professional judgments or opinions. Competence demands that Miller perform her professional duties in accordance with relevant laws, regulations, and technical standards. Credibility requires that Miller report information fairly and objectively. Miller should refuse to book the $200,000 of sales until the goods are shipped. Both financial accounting and management accounting principles maintain that sales are not complete until the title is transferred to the buyer. 2. Miller should refuse to follow Maloney's orders. If Maloney persists, the incident should be reported to the corporate controller. Support for line management should be wholehearted, but it should not require unethical conduct. 1-24 (15 min.) Planning and control decisions, Internet company. 1. Planning decisions a. Decision to raise monthly subscription fee c. Decision to upgrade content of online services (later decision to inform subscribers and upgrade online services is an implementation part of control) e. Decision to decrease monthly subscription fee Control decisions b. Decision to inform existing subscribers about the rate of increase—an implementation part of control decisions d. Dismissal of VP of Marketing—performance evaluation and feedback aspect of control decisions 2. Other planning decisions that may be made at WebNews.com: decision to raise or lower advertising fees; decision to charge a fee from on-line retailers when customers click-through from WebNews.com to the retailers’ websites. Other control decisions that may be made at WebNews.com: evaluating how customers like the new format for the weather information, working with an outside vendor to redesign the website, and evaluating whether the waiting time for customers to access the website has been reduced. 1- 1-25 (20 min.) Strategic decisions and management accounting. 1. The strategies the companies are following in each case are: a. Low price strategy b. Differentiated product strategy c. Low price strategy d. Differentiated product strategy 2. Examples of information the management accountant can provide for each strategic decision follow. a. Cost to manufacture and sell the cell phone Productivity, efficiency and cost advantages relative to competition Prices of competitive cell phones Sensitivity of target customers to price and quality The production capacity of Roger Phones and its competitors b. Cost to develop, produce and sell new software Premium price that customers would be willing to pay due to product uniqueness Price of basic software Price of closest competitive software Cash needed to develop, produce and sell new software c. d. 1-26 1. 2. 3. 4. 5. 6. 7. 8. 9. Cost of producing the “store-brand” lip gloss Productivity, efficiency and cost advantages relative to competition Prices of competitive products Sensitivity of target customers to price and quality How the market for lip gloss is growing Cost to produce and sell new line of gourmet bologna Premium price that customers would be willing to pay due to product uniqueness Price of basic meat product Price of closest competitive product (15 min.) Management accounting guidelines. Cost-benefit approach Behavioral and technical considerations Different costs for different purposes Cost-benefit approach Behavioral and technical considerations Cost-benefit approach Behavioral and technical considerations Different costs for different purposes Behavioral and technical considerations 1- 1-27 1. (15 min.) Role of controller, role of chief financial officer. Activity Managing accounts payable Communicating with investors Strategic review of different lines of businesses Budgeting funds for a plant upgrade Managing the company’s short-term investments Negotiating fees with auditors Assessing profitability of various products Evaluating the costs and benefits of a new product design Controller X CFO X X X X X X X 2. As CFO, Perez will be interacting much more with the senior management of the company, the board of directors, and the external financial community. Any experience he can get with these aspects will help him in his new role as CFO. George Perez can be better positioned for his new role as CFO by participating in strategy discussions with senior management, by preparing the external investor communications and press releases under the guidance of the current CFO, by attending courses that focus on the interaction and negotiations between the various business functions and, either formally or on the job, getting training in issues related to investments and corporate finance. 1-28 (30 min.) Software procurement decisions, ethics. 1. Michael faces an ethical problem. The trip appears to be a gift which could influence his purchase decision. The ethical standard of integrity requires Michaels to refuse the gift. Companies with “codes of conduct” frequently have a “supplier clause” that prohibits their employees from accepting “material” (in some cases, any) gifts from suppliers. The motivations include (a) Integrity/conflict of interest. Suppose Michaels recommends that a Horizon 1-2-3 product should subsequently be purchased by Fiesta. This recommendation could be because he felt obligated to them as his trip to the Cancún conference was fully paid by Horizon. (b) The appearance of a conflict of interest. Even if the Horizon 1-2-3 product is the superior one at that time, other suppliers likely will have a different opinion. They may believe that the way to sell products to Fiesta is via “fully-paid junkets to resorts.” Those not wanting to do business this way may downplay future business activities with Fiesta even though Fiesta could gain much from such activities. Some executives view the meeting as “suspect” from the start given the Caribbean location and its “rest and recreation” tone. 2. Fiesta should not allow executives to attend user meetings while negotiating with other vendors about a purchase decision. The payment of expenses for the trip constitutes a gift that could appear to influence their purchase decision. 1- Pros of attending user meeting (a) Opportunity to learn more about Horizon’s software products. (b) Opportunity to interact with other possible purchasers and get their opinions. (c) Opportunity to influence the future product development plans of Horizon in a way that will benefit Fiesta. An example is Horizon subsequently developing software modules tailored to food product companies. (d) Saves Fiesta money. Visiting suppliers and their customers typically cost money, whereas Horizon is paying for the Cancún conference. Cons of Attending (a) The ethical issues raised in requirement 1. (b) Negative morale effects on other Fiesta employees who do not get to attend the Cancún conference. These employees may reduce their trust and respect for Michaels’s judgment, arguing he has been on a “supplier-paid vacation.” Conditions on Attending that Fiesta Might Impose (a) Sizable part of that time in Cancún has to be devoted to business rather than recreation. (b) Decision on which Fiesta executive attends is not made by the person who attends (this reduces the appearance of a conflict of interest). (c) Person attending (Michaels) does not have final say on purchase decision (this reduces the appearance of a conflict of interest). (d) Fiesta executives go only when a new major purchase is being contemplated (to avoid the conference becoming a regular “vacation”). A Conference Board publication on Corporate Ethics asked executives about a comparable situation. Following are the results: 76% said Fiesta and Michaels face an ethical consideration in deciding whether to attend. 71% said Michaels should not attend, as the payment of expenses is a “gift” within the meaning of a credible corporate ethics policy. 3. The company does not need its own code of ethics. They can use the code of ethics developed by the IMA. Pros of having a written code The Conference Board outlines the following reasons why companies adopt codes of ethics: (a) (b) (c) (d) Signals commitment of senior management to ethics. Promotes public trust in the credibility of the company and its employees. Signals the managerial professionalism of its employees. Provides guidance to employees as to how difficult problems are to be handled. If adhered to, employees will avoid many actions that are unethical or appear to be unethical. (e) Drafting of the policy (and its redrafting in the light of ambiguities) can assist management in anticipating and preparing for ethical issues not yet encountered. 1- Cons of having a written code (a) Can give appearance that all issues have been covered. Issues not covered may appear to be “acceptable” even when they are not (b)Can constrain the entrepreneurial activities of employees. Forces people to always “behave by the book.” (c) Cost of developing code can be “high” if it consumes a lot of employee time. 1-29 (30–40 min.) Professional ethics and end-of-year actions. 1. The possible motivations for the snack foods division wanting to take end-of-year actions include: (a) Management incentives. Gourmet Foods may have a division bonus scheme based on one-year reported division earnings. Efforts to front-end revenue into the current year or transfer costs into the next year can increase this bonus. (b) Promotion opportunities and job security. Top management of Gourmet Foods likely will view those division managers that deliver high reported earnings growth rates as being the best prospects for promotion. Division managers who deliver “unwelcome surprises” may be viewed as less capable. (c) Retain division autonomy. If top management of Gourmet Foods adopts a “management by exception” approach, divisions that report sharp reductions in their earnings growth rates may attract a sizable increase in top management supervision. 2. The “Standards of Ethical Conduct . . . ” require management accountants to Perform professional duties in accordance with relevant laws, regulations, and technical standards. Refrain from engaging in any conduct that would prejudice carrying out duties ethically. Communicate information fairly and objectively. Several of the “end-of-year actions” clearly are in conflict with these requirements and should be viewed as unacceptable by Taylor. (b) The fiscal year-end should be closed on midnight of December 31. “Extending” the close falsely reports next year’s sales as this year’s sales. (c) Altering shipping dates is falsification of the accounting reports. (f) Advertisements run in December should be charged to the current year. The advertising agency is facilitating falsification of the accounting records. The other “end-of-year actions” occur in many organizations and fall into the “gray” to “acceptable” area. However, much depends on the circumstances surrounding each one, such as the following: (a) If the independent contractor does not do maintenance work in December, there is no transaction regarding maintenance to record. The responsibility for ensuring that packaging equipment is well maintained is that of the plant manager. The division controller probably can do little more than observe the absence of a December maintenance charge. (d) In many organizations, sales are heavily concentrated in the final weeks of the fiscal year-end. If the double bonus is approved by the division marketing manager, the division controller can do little more than observe the extra bonus paid in December. 1- (e) If TV spots are reduced in December, the advertising cost in December will be reduced. There is no record falsification here. (g) Much depends on the means of “persuading” carriers to accept the merchandise. For example, if an under-the-table payment is involved, or if carriers are pressured to accept merchandise, it is clearly unethical. If, however, the carrier receives no extra consideration and willingly agrees to accept the assignment because it sees potential sales opportunities in December, the transaction appears ethical. Each of the (a), (d), (e), and (g) “end-of-year actions” may well disadvantage Gourmet Foods in the long run. For example, lack of routine maintenance may lead to subsequent equipment failure. The divisional controller is well advised to raise such issues in meetings with the division president. However, if Gourmet Foods has a rigid set of line/staff distinctions, the division president is the one who bears primary responsibility for justifying division actions to senior corporate officers. 3. If Taylor believes that Ryan wants her to engage in unethical behavior, she should first directly raise her concerns with Ryan. If Ryan is unwilling to change his request, Taylor should discuss her concerns with the Corporate Controller of Gourmet Foods. She could also initiate a confidential discussion with an IMA Ethics Counselor, other impartial adviser, or her own attorney. Taylor also may well ask for a transfer from the snack foods division if she perceives Ryan is unwilling to listen to pressure brought by the Corporate Controller, CFO, or even President of Gourmet Foods. In the extreme, she may want to resign if the corporate culture of Gourmet Foods is to reward division managers who take “end-of-year actions” that Taylor views as unethical and possibly illegal. It was precisely actions along the lines of (b), (c), and (f) that caused Betty Vinson, an accountant at WorldCom to be indicted for falsifying WorldCom’s books and misleading investors. 1-30 (30 min.) Professional ethics and earnings management. 1. The possible motivations for Harvest Day Corporation’s CEO to “manage” earnings include (a) Manage the stock price. Harvest Day’s CEO wants to meet the forecasted earnings number of $1.34 per share because the CEO believes that the stock price will drop if actual earnings fall short of the forecast . (b) Job security. The CEO may be concerned that the Board of Directors may have a poor view of him if he delivers “unwelcome surprises”. Depending on how much the stock falls, they may even consider dismissing him. (c) Management incentives. The bonuses of top management and the CEO may be based on earnings. If earnings decrease, smaller or no bonuses may be paid. If top management and the CEO have stock options, the value of these options will be adversely affected if the stock price falls. 2. The “Standards for Ethical Conduct…” requires management accountants to Perform professional duties in accordance with relevant laws, regulations, and technical standards. Refrain from engaging in any conduct that would prejudice carrying out duties ethically. Communicate information fairly and objectively. 1- Several of the “end of fiscal year actions” clearly are in conflict with these requirements and should be viewed as unacceptable. (a) Subscriptions cancelled in December should be recorded in December itself and not delayed until January. (c) Subscription revenue received in December in advance for magazines that will be sent out in January is a liability. Showing it as revenue falsely reports next year’s revenue as this year’s revenue. (d) Office supplies purchased in December should be recorded as an expense of the current year and not as an expense of the next year. (e) Booking advertising revenues that relate to January in December falsely reports next year’s revenue as this year’s revenue. The other “end of fiscal year actions” occur in many organizations and fall into the “gray” to “acceptable” area. Much depends on the circumstances surrounding each one, however, such as the following: (b) If the software on office computers is not updated until January, there is no transaction or expense to record in December. The responsibility for ensuring that the software is updated is that of the chief information technology officer. The controller can do little more than observe the absence of a December software update and question whether this will have an adverse long-term impact on Harvest Day. (f) If building repairs are not done in December, there is no transaction to record in December. There is no record falsification here. The decision regarding when to do building repairs is made by the operations manager. (g) Many companies switch their depreciation policy from one method to another. Harvest Day could argue that straight-line depreciation better represents the decrease in the economic value of the asset compared to the declining balance method. Straight-line depreciation may also be more in line with what its competitors do. If, however, Harvest Day changes to straight-line depreciation with the sole purpose of reducing expenses to meet its earnings goal, such behavior would be unacceptable. The Standards of Ethical Behavior require management accountants to communicate information fairly and objectively and to carry out duties ethically. 3. Harvest Day’s controller should directly raise his/her concerns with the CEO. If the CEO refuses to change his request, the Controller should raise these issues with the Audit Committee and the Board of Directors. The Controller could also initiate a confidential discussion with an IMA Ethics Counselor, other impartial adviser, or his/her own attorney. In the extreme, the Controller may want to resign if the corporate culture of Harvest Day is to reward executives who take “end of fiscal year actions” that the Controller views as unethical and possibly illegal. It was precisely actions along the lines of (a), (c), (d), and (e) that caused Betty Vinson, an accountant at WorldCom, to be indicted for falsifying WorldCom’s books and misleading investors. 1- 1-31 (40 min.) Global company, ethical challenges with bribery. 1. It is clear that bribes are illegal according to U.S. laws. It is not clear from the case whether bribes are illegal in Vartan. However, knowledgeable people in global business would attest to the fact that it is virtually impossible to find any country in the world that specifically sanctions bribery. The major point, however, that deserves discussion is: Should ZenTel engage in any unethical activities even if they are not illegal? It is difficult to make a generalization about all shareholders of the company. It is, however, safe to assume that not all shareholders would want to keep their investment in a company that is engaged in unethical and/or illegal activities. There is historical evidence to substantiate this point: When apartheid laws were in effect in South Africa, many investors divested shares of companies doing business in South Africa. 2. Apparently Hank thinks that local culture and common practice are one and the same. This, in fact, is not the case. There are many common practices in developing countries, which are against the native culture. Specifically, bribery often leads to decisions that are not made on the basis of the merits of the alternative selected. This results in misallocation of meager resources of the developing country. Misallocation of resources has adverse effects on the economy of a country and the living standard of its population. The negative impact is intensified in developing countries because they can least afford the misallocation of resources. As it applies to local common practice, multinational companies make some small allowances but draw a hard line against paying the $1 million “commission.” 3. ZenTel might have an articulated corporate policy against such payments to get the message across that regardless of laws, the top management would not tolerate any bribery payments made by its employees. A strong and consistent message from the top often has a noticeable effect on the corporate culture and employee behavior. U.S. laws specifically prohibit bribery payments. Such payments can result in heavy penalties to the corporation making the payments. 4. If this contract is of great importance to ZenTel’s global strategy, it is likely that this kind of issue will come up again as ZenTel expands into very diverse cultures and the company should tackle it head on and make a policy decision against offering bribes. Steve Cheng should discuss the situation with the top management at ZenTel and re-affirm his goal to get the Vartan contract by legal means. He could seek the help of the U.S. commercial attaché in Vartan to continue a dialogue with Vartan’s deputy minister of communications. He could propose other creative, legal changes to the ZenTel’s bid, even at the cost of reducing the profitability of the current project. Concessions such as training programs, schools and other public works projects may be legal, get the attention of the Vartan government and raise ZenTel’s profile both at home and abroad. In the worst case, if the Vartan government does not agree to any of the creative, legal “extras” that ZenTel can provide in order to win the contract, Cheng should report this to ZenTel’s management and be willing to walk away from the Vartan project. 1- CHAPTER 2 AN INTRODUCTION TO COST TERMS AND PURPOSES 2-1 A cost object is anything for which a separate measurement of costs is desired. Examples include a product, a service, a project, a customer, a brand category, an activity, and a department. 2-2 Direct costs of a cost object are related to the particular cost object and can be traced to that cost object in an economically feasible (cost-effective) way. Indirect costs of a cost object are related to the particular cost object but cannot be traced to that cost object in an economically feasible (cost-effective) way. Cost assignment is a general term that encompasses the assignment of both direct costs and indirect costs to a cost object. Direct costs are traced to a cost object while indirect costs are allocated to a cost object. 2-3 Managers believe that direct costs that are traced to a particular cost object are more accurately assigned to that cost object than are indirect allocated costs. When costs are allocated, managers are less certain whether the cost allocation base accurately measures the resources demanded by a cost object. Managers prefer to use more accurate costs in their decisions. 2-4 Factors affecting the classification of a cost as direct or indirect include the materiality of the cost in question, available information-gathering technology, design of operations 2-5 A variable cost changes in total in proportion to changes in the related level of total activity or volume. An example is a sales commission that is a percentage of each sales revenue dollar. A fixed cost remains unchanged in total for a given time period, despite wide changes in the related level of total activity or volume. An example is the leasing cost of a machine that is unchanged for a given time period (such as a year) regardless of the number of units of product produced on the machine. 2-6 A cost driver is a variable, such as the level of activity or volume, that causally affects total costs over a given time span. A change in the cost driver results in a change in the level of total costs. For example, the number of vehicles assembled is a driver of the costs of steering wheels on a motor-vehicle assembly line. 2-7 The relevant range is the band of normal activity level or volume in which there is a specific relationship between the level of activity or volume and the cost in question. Costs are described as variable or fixed with respect to a particular relevant range. 2-8 A unit cost is computed by dividing some amount of total costs (the numerator) by the related number of units (the denominator). In many cases, the numerator will include a fixed cost that will not change despite changes in the denominator. It is erroneous in those cases to multiply the unit cost by activity or volume change to predict changes in total costs at different activity or volume levels. 2-1 2-9 Manufacturing-sector companies purchase materials and components and convert them into various finished goods, for example automotive and textile companies. Merchandising-sector companies purchase and then sell tangible products without changing their basic form, for example retailing or distribution. Service-sector companies provide services or intangible products to their customers, for example, legal advice or audits. 2-10 Manufacturing companies typically have one or more of the following three types of inventory: 1. Direct materials inventory. Direct materials in stock and awaiting use in the manufacturing process. 2. Work-in-process inventory. Goods partially worked on but not yet completed. Also called work in progress. 3. Finished goods inventory. Goods completed but not yet sold. 2-11 Inventoriable costs are all costs of a product that are considered as assets in the balance sheet when they are incurred and that become cost of goods sold when the product is sold. These costs are included in work-in-process and finished goods inventory (they are “inventoried”) to accumulate the costs of creating these assets. Period costs are all costs in the income statement other than cost of goods sold. These costs are treated as expenses of the accounting period in which they are incurred because they are expected not to benefit future periods (because there is not sufficient evidence to conclude that such benefit exists). Expensing these costs immediately best matches expenses to revenues. 2-12 No. Service sector companies have no inventories and, hence, no inventoriable costs. 2-13 Direct material costs are the acquisition costs of all materials that eventually become part of the cost object (work in process and then finished goods), and can be traced to the cost object in an economically feasible way. Direct manufacturing labor costs include the compensation of all manufacturing labor that can be traced to the cost object (work in process and then finished goods) in an economically feasible way. Manufacturing overhead costs are all manufacturing costs that are related to the cost object (work in process and then finished goods), but cannot be traced to that cost object in an economically feasible way. Prime costs are all direct manufacturing costs (direct material and direct manufacturing labor). Conversion costs are all manufacturing costs other than direct material costs. 2-14 Overtime premium is the wage rate paid to workers (for both direct labor and indirect labor) in excess of their straight-time wage rates. Idle time is a subclassification of indirect labor that represents wages paid for unproductive time caused by lack of orders, machine breakdowns, material shortages, poor scheduling, and the like. 2-2 2-15 A product cost is the sum of the costs assigned to a product for a specific purpose. Purposes for computing a product cost include pricing and product mix decisions, contracting with government agencies, and preparing financial statements for external reporting under generally accepted accounting principles. 2-16 (15 min.) Computing and interpreting manufacturing unit costs costs. 1. 2. Based on total manuf. cost per unit ($1.75 120; $1.3833 160; $0.94 180) Correct total manuf. costs based on variable manuf. costs plus fixed costs equal Variable costs ($1.68 120; $1.29 160; $0.908 180) Fixed costs (in millions) Deluxe $ 54.00 28.00 84.00 $166.00 Regular $ 62.00 8.00 24.00 $ 94.00 Total $200.00 50.00 150.00 $400.00 5.60 $134.40 80 11.20 $154.80 120 3.20 $ 90.80 100 20.00 $380.00 $1.7500 $1.3833 $0.9400 $1.6800 $1.2900 $0.9080 Supreme Direct material cost Direct manuf. labor costs Indirect manuf. costs Total manuf. costs Fixed costs allocated at a rate of $20M $50M (direct mfg. labor) equal to $0.40 per dir. manuf. labor dollar (0.40 $14; 28; 8) Variable costs Units produced (millions) Cost per unit (Total manuf. costs ÷ units produced) Variable manuf. cost per unit (Variable manuf. costs Units produced) Supreme $ 84.00 14.00 42.00 $140.00 (in millions) Deluxe Regular Total $210.00 $221.33 $169.20 $600.53 $201.60 $206.40 $163.44 $571.44 20.00 Total costs $591.44 The total manufacturing cost per unit in requirement 1 includes $20 million of indirect manufacturing costs that are fixed irrespective of changes in the volume of output per month, while the remaining variable indirect manufacturing costs change with the production volume. Given the unit volume changes for August 2008, the use of total manufacturing cost per unit from the past month at a different unit volume level (both in aggregate and at the individual product level) will yield incorrect estimates of total costs of $600.53 million in August 2008 2-3 relative to the correct total manufacturing costs of $591.44 million calculated using variable manufacturing cost per unit times units produced plus the fixed costs of $20 million. 2-17 (15 min.) Direct, indirect, fixed and variable costs. 1. Clay – Direct, variable Paint- direct, variable Packaging materials –direct (or could be indirect if small and not traced to each unit), variable Depreciation on machinery and molds –indirect, fixed (unless “units of output” depreciation, which then would be variable) Rent on factory – indirect, fixed Insurance on factory –indirect, fixed Factory utilities – indirect, probably some variable and some fixed (e.g. electricity may be variable but heating costs may be fixed) Painters – direct, variable Painting Department manager –indirect, fixed Baking Department manager – indirect, fixed Materials handlers –depends on how they are paid. Most likely indirect fixed if salaried Custodian –indirect, fixed Night guard –indirect, fixed Machinist (running the baking machine) –depends on how they are paid. Most likely indirect fixed, if salaried Machine maintenance personnel – indirect, probably fixed, if salaried, but may be variable if paid only for time worked and maintenance increases with increased production Maintenance supplies – indirect, variable Cleaning supplies – indirect, most likely fixed since the custodians probably do the same amount of cleaning every night 2. If the cost object is Baking Department, then anything directly associated with the Baking Department will be a direct cost. This will include: depreciation on machinery and molds Baking Department manager Materials handlers (of the Baking Department) Machinist Machine Maintenance personnel (of the Baking Department) Maintenance supplies (of the Baking Department) Of course the clay will also be a direct cost of the Baking Department, but it is already a direct cost of each kind of figurine produced. 2-4 2-18 (15–20 min.) Classification of costs, service sector. Cost object: Each individual focus group Cost variability: With respect to the number of focus groups There may be some debate over classifications of individual items, especially with regard to cost variability. Cost Item A B C D E F G H D or I D I I I D I D I V or F V F Va F V F V Vb aSome students will note that phone call costs are variable when each call has a separate charge. It may be a fixed cost if Consumer Focus has a flat monthly charge for a line, irrespective of the amount of usage. bGasoline costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple purposes, and detailed records may be required to examine how costs vary with changes in one of the many purposes served. 2-19 (15–20 min.) Classification of costs, merchandising sector. Cost object: Videos sold in video section of store Cost variability: With respect to changes in the number of videos sold There may be some debate over classifications of individual items, especially with regard to cost variability. Cost Item A B C D E F G H D or I D I D D I I I D 2-5 V or F F F V F F V F V 2-20 (15–20 min.) Classification of costs, manufacturing sector. Cost object: Type of car assembled (Corolla or Geo Prism) Cost variability: With respect to changes in the number of cars assembled There may be some debate over classifications of individual items, especially with regard to cost variability. Cost Item A B C D E F G H 2-21 D or I D I D D D I D I V or F V F F F V V V F (20 min.) Variable costs, fixed costs, total costs. 1. Minutes/month 0 50 100 150 Plan A ($/month) 0 4 8 12 Plan B ($/month) 16 16 16 16 Plan C ($/month) 20 20 20 20 200 16 16 20 250 20 16 20 300 350 400 450 480 500 24 28 32 36 38.40 40 16 18.50 21 23.50 25 26 20 20 20 20 20 20.80 550 600 650 44 48 52 28.50 31 33.50 22.80 24.80 26.80 50 Total Cost 40 30 Plan A Plan B 20 Plan C 10 0 0 100 200 300 400 500 600 Number of long-distance minutes 2. In each region, Compo chooses the plan that has the lowest cost. From the graph (or from calculations), we can see that if Compo expects to use 0–200 minutes of long-distance each month, she should buy Plan A; for 200–380 minutes, Plan B; and for over 380 minutes, Plan C. If Compo plans to make 100 minutes of long-distance calls each month, she should choose Plan A; for 300 minutes, choose Plan B; for 500 minutes, choose Plan C. 2-6 2-22 1. (15–20 min.) Variable costs and fixed costs. Variable cost per ton of beach sand mined Subcontractor $ 80 per ton Government tax 50 per ton Total $130 per ton Fixed costs per month 0 to 100 tons of capacity per day 101 to 200 tons of capacity per day 201 to 300 tons of capacity per day = = = $150,000 $300,000 $450,000 2. $450,000 Costs $650,000 Tota l Fixed Tota l Va riable C osts $975,000 $325,000 2,500 5,000 $300,000 $150,000 100 7,500 Tons Mine d 200 300 Tons of Cap acity p er Day The concept of relevant range is potentially relevant for both graphs. However, the question does not place restrictions on the unit variable costs. The relevant range for the total fixed costs is from 0 to 100 tons; 101 to 200 tons; 201 to 300 tons, and so on. Within these ranges, the total fixed costs do not change in total. 3. Tons Mined per Day (1) (a) 180 (b) 220 Tons Mined per Month (2) = (1) × 25 4,500 Fixed Unit Cost per Ton (3) = FC ÷ (2) $300,000 ÷ 4,500 = $66.67 Variable Unit Cost per Ton (4) $130 Total Unit Cost per Ton (5) = (3) + (4) $196.67 5,500 $450,000 ÷ 5,500 = $81.82 $130 $211.82 The unit cost for 220 tons mined per day is $211.82, while for 180 tons it is only $196.67. This difference is caused by the fixed cost increment from 101 to 200 tons being spread over an increment of 80 tons, while the fixed cost increment from 201 to 300 tons is spread over an increment of only 20 tons. 2-7 2-23 (20 min.) Variable costs, fixed costs, relevant range. 1. Since the production capacity is 4,000 jaw breakers per month, the current annual relevant range of output is 0 to 4,000 jaw breakers × 12 months = 0 to 48,000 jaw breakers. 2. Current annual fixed manufacturing costs within the relevant range are $1,000 × 12 = $12,000 for rent and other overhead costs, plus $6,000 ÷ 10 = $600 for depreciation, totaling $12,600. The variable costs, the materials, are 10 cents per jaw breaker, or $3,600 ($0.10 per jaw breaker × 3,000 jaw breakers per month × 12 months) for the year. 3. If demand changes from 3,000 to 6,000 jaw breakers per month, or from 3,000 × 12 = 36,000 to 6,000 × 12 = 72,000 jaw breakers per year, Yumball will need a second machine. Assuming Yumball buys a second machine identical to the first machine, it will increase capacity from 4,000 jaw breakers per month to 8,000. The annual relevant range will be between 4,000 × 12 = 48,000 and 8,000 × 12 = 96,000 jaw breakers. Assume the second machine costs $6,000 and is depreciated using straight-line depreciation over 10 years and zero residual value, just like the first machine. This will add $600 of depreciation per year. Fixed costs for next year will increase to $13,200, $12,600 from the current year + $600 (because rent and other fixed overhead costs will remain the same at $12,000). That is, total fixed costs for next year equal $600 (depreciation on first machine) + $600 (depreciation on second machine) + $12,000 (rent and other fixed overhead costs). The variable cost per jaw breaker next year will be 90% × $0.10 = $0.09. Total variable costs equal $0.09 per jaw breaker × 72,000 jaw breakers = $6,480. 2-8 2-24 (20 min.) Cost drivers and value chain. 1. Identify the customer need (what do faculty and students want in a book?) – Product development Find an author – Product development Market the book to faculty – Marketing Author writes book – Product development Process orders from bookstores – Distribution Editor edits book – Product development Receive unsold copies of book from bookstore – Distribution Author rewrites book– Product development Provide on-line assistance to faculty and students (study guides, test banks, etc.) – Customer service Print and bind the books – Production Deliver the book to bookstores – Distribution 2. Value Chain Category Activity Product Identify the customer need Development Find an author Author writes book Editor edits book Production Author rewrites book Print and bind the books Marketing Market the book to faculty Distribution Process orders from bookstores Deliver the book to bookstores Customer service Receive unsold copies of book from bookstores Provide on-line assistance to faculty and students Cost driver Number of schools the marketing representative visits to discuss book ideas Number of potential authors interviewed Number of pages of text Amount paid to the author (direct labor cost as cost driver) Number of changes editor makes Number of pages of text Number of times author must do rewrites Machine hours for running the printing and binding equipment Number of schools the marketing representative visits to market the book Hours spent with prospective customers to sell the book Number of deliveries made to bookstores Number of schools that adopt the new book Number of books ordered by bookstores (Note: Number of purchase orders would be a better driver, but it is not on the list of activities.) Number of deliveries made to bookstores Number of unsold books sent back from bookstores Number of faculty that adopt the new book Number of books ordered by bookstores (probably net of number of unsold books sent back from bookstores) 2-9 2-25 (10–15 min.) Cost drivers and functions. 1. 1. 2. 3. 4. 5. 6. 7. Function Accounting Human Resources Data processing Research and development Purchasing Distribution Billing Representative Cost Driver Number of transactions processed Number of employees Hours of computer processing unit (CPU) Number of research scientists Number of purchase orders Number of deliveries made Number of invoices sent 1. 2. 3. 4. 5. 6. 7. Function Accounting Human Resources Data Processing Research and Development Purchasing Distribution Billing Representative Cost Driver Number of journal entries made Salaries and wages of employees Number of computer transactions Number of new products being developed Number of different types of materials purchased Distance traveled to make deliveries Number of credit sales transactions 2. 2-10 2-26 (20 min.) Total costs and unit costs 1. Number of attendees 0 Variable cost per person ($9 caterer charge – $5 student door fee) $4 Fixed Costs $1,600 Variable costs (number of attendees × variable cost per person) 0 Total costs (fixed + variable) $1,600 100 200 300 400 500 600 $4 $1,600 $4 $1,600 $4 $1,600 $4 $1,600 $4 $1,600 $4 $1,600 400 $2,000 800 $2,400 1,200 $2,800 1,600 $3,200 2,000 $3,600 2,400 $4,000 Fixed, Variable and Total Cost of Graduation Party 5000 Costs ($) 4000 3000 Fixed costs Variable costs Total cost 2000 1000 0 0 100 200 300 400 500 600 Number of attendees 2. Number of attendees Total costs (fixed + variable) Costs per attendee (total costs number of attendees) 0 $1,600 100 200 300 400 500 600 $2,000 $2,400 $2,800 $3,200 $3,600 $4,000 $20.00 $12.00 $9.33 $ 8.00 $ 7.20 $ 6.67 As shown in the table above, for 100 attendees the total cost will be $2,000 and the cost per attendee will be $20. 3. As shown in the table in requirement 2, for 500 attendees the total cost will be $3,600 and the cost per attendee will be $7.20. 2-11 4. Using the calculations shown in the table in requirement 2, we can construct the cost-perattendee graph shown below: 25 Cost per Attendee ($) 20 15 10 5 0 0 100 200 300 400 500 600 700 Number of Attendees As president of the student association requesting a grant for the party, you should not use the per unit calculations to make your case. The person making the grant may assume an attendance of 500 students and use a low number like $7.20 per attendee to calculate the size of your grant. Instead, you should emphasize the fixed cost of $1,600 that you will incur even if no students or very few students attend the party, and try to get a grant to cover as much of the fixed costs as possible as well as a variable portion to cover as much of the $5 variable cost to the student association for each person attending the party. 2-27 (25 min.) Total and unit cost, decision making. 1. Total Manufacturing Costs 60,000 Fixed Costs 50,000 40,000 Variable Costs 30,000 20,000 Total Manufacturing Costs 10,000 0 0 5,000 10,000 Number of Flanges Note that the production costs include the $20,000 of fixed manufacturing costs but not the $10,000 of period costs. The variable cost is $1 per flange for materials, and $2 per flange ($20 per hour divided by 10 flanges per hour) for direct manufacturing labor. 2-12 2. The inventoriable (manufacturing) cost per unit for 5,000 flanges is $3 × 5,000 + $20,000 = $35,000. Average (unit) cost = $35,000 ÷ 5,000 units = $7 per unit. This is below Fred’s selling price of $8.25 per flange. However, in order to make a profit, Graham’s Glassworks also needs to cover the period (non-manufacturing) costs of $10,000, or $10,000 ÷ 5,000 = $2 per unit. Thus total costs, both inventoriable (manufacturing) and period (non-manufacturing), for the flanges is $7 + $2 = $9. Graham’s Glassworks cannot sell below Fred’s price of $8.25 and still make a profit on the flanges. Alternatively, At Fred’s price of $8.25 per flange: Revenue $8.25 × 5,000 Variable costs $3.00 × 5,000 Fixed costs Operating Loss = = $41,250 15,000 30,000 $ (3,750) Graham’s Glassworks cannot sell below $8.25 per flange and make a profit. At Fred’s price of $8.25 per flange, the company has an operating loss of $3,750. 3. If Graham’s Glassworks produces 10,000 units, then total inventoriable cost will be: Variable cost ($3 × $10,000 ) + fixed manufacturing costs, $20,000 = total manufacturing costs, $50,000. Average (unit) inventoriable (manufacturing) cost will be $50,000 ? 10,000 units = $5 per flange Unit total cost including both inventoriable and period costs will be ($50,000 +$10,000) ÷ 10,000 = $6 per flange, and Graham’s Glassworks will be able to sell the flanges for less than Fred and still make a profit. Alternatively, At Fred’s price of $8.25 per flange: Revenue $8.25 × 10,000 Variable costs $3.00 × 10,000 Fixed costs Operating income = = $ 82,500 30,000 30,000 $ 22,500 Graham’s Glassworks can sell at a price below $8.25 per flange and still make a profit. The company earns operating income of $22,500 at a price of $8.25 per flange. The company will earn operating income as long as the price exceeds $6.00 per flange. The reason the unit cost decreases significantly is that inventoriable (manufacturing) fixed costs and fixed period (nonmanufacturing) costs remain the same regardless of the number of units produced. So, as Graham’s Glassworks produces more units, fixed costs are spread over more units, and cost per unit decreases. This means that if you use unit costs to make decisions about pricing, and which product to produce, you must be aware that the unit cost only applies to a particular level of output. 2-28 (20–30 min.) Inventoriable costs versus period costs. 2-13 1. Manufacturing-sector companies purchase materials and components and convert them into different finished goods. Merchandising-sector companies purchase and then sell tangible products without changing their basic form. Service-sector companies provide services or intangible products to their customers—for example, legal advice or audits. Only manufacturing and merchandising companies have inventories of goods for sale. 2. Inventoriable costs are all costs of a product that are regarded as an asset when they are incurred and then become cost of goods sold when the product is sold. These costs for a manufacturing company are included in work-in-process and finished goods inventory (they are “inventoried”) to build up the costs of creating these assets. Period costs are all costs in the income statement other than cost of goods sold. These costs are treated as expenses of the period in which they are incurred because they are presumed not to benefit future periods (or because there is not sufficient evidence to conclude that such benefit exists). Expensing these costs immediately best matches expenses to revenues. 3. (a) Mineral water purchased for resale by Safeway—inventoriable cost of a merchandising company. It becomes part of cost of goods sold when the mineral water is sold. (b) Electricity used at GE assembly plant—inventoriable cost of a manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a refrigerator finished good. (c) Depreciation on Google’s computer equipment—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. (d) Electricity for Safeway’s store aisles—period cost of a merchandising company. It is a cost that benefits the current period and it is not traceable to goods purchased for resale. (e) Depreciation on GE’s assembly testing equipment—inventoriable cost of a manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a refrigerator finished good. (f) Salaries of Safeway’s marketing personnel—period cost of a merchandising company. It is a cost that is not traceable to goods purchased for resale. It is presumed not to benefit future periods (or at least not to have sufficiently reliable evidence to estimate such future benefits). (g) Bottled water consumed by Google’s engineers—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. (h) Salaries of Google’s marketing personnel—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. 2-14 2-29 (20 min.) Flow of Inventoriable Costs. (All numbers below are in millions). 1. Direct materials inventory 8/1/2008 Direct materials purchased Direct materials available for production Direct materials used Direct materials inventory 8/31/2008 $ $ 2. Total manufacturing overhead costs Subtract: Variable manufacturing overhead costs Fixed manufacturing overhead costs for August 3. Total manufacturing costs Subtract: Direct materials used (from requirement 1) Total manufacturing overhead costs Direct manufacturing labor costs for August 4. Work-in-process inventory 8/1/2008 Total manufacturing costs Work-in-process available for production Subtract: Cost of goods manufactured (moved into FG) Work-in-process inventory 8/31/2008 5. Finished goods inventory 8/1/2008 Cost of goods manufactured (moved from WIP) Finished goods available for sale in August 6. Finished goods available for sale in August (from requirement 5) Subtract: Cost of goods sold Finished goods inventory 8/31/2008 2-15 $ $ 90 360 450 375 75 480 (250) 230 $ 1,600 (375) (480) $ 745 $ 200 1,600 1,800 (1,650) $ 150 $ 125 1,650 $ 1,775 $ 1,775 (1,700) $ 75 2-30 (20 min.) Computing cost of goods purchased and cost of goods sold. (1) Marvin Department Store Schedule of Cost of Goods Purchased For the Year Ended December 31, 2008 (in thousands) Purchases Add transportation-in $155,000 7,000 162,000 Deduct: Purchase return and allowances Purchase discounts Cost of goods purchased (2) $4,000 6,000 10,000 $152,000 Marvin Department Store Schedule of Cost of Goods Sold For the Year Ended December 31, 2008 (in thousands) Beginning merchandise inventory 1/1/2008 Cost of goods purchased (above) Cost of goods available for sale Ending merchandise inventory 12/31/2008 Cost of goods sold $ 27,000 152,000 179,000 34,000 $145,000 2-16 2-31 1. (30–40 min.) Cost of goods manufactured. Canseco Company Schedule of Cost of Goods Manufactured Year Ended December 31, 2009 (in thousands) Direct materials: Beginning inventory, January 1, 2009 $ 22,000 Purchases of direct materials 75,000 Cost of direct materials available for use 97,000 Ending inventory, December 31, 2009 26,000 Direct materials used Direct manufacturing labor Indirect manufacturing costs: Indirect manufacturing labor 15,000 Plant insurance 9,000 Depreciation—plant building & equipment 11,000 Repairs and maintenance—plant 4,000 Total indirect manufacturing costs Manufacturing costs incurred during 2009 Add beginning work-in-process inventory, January 1, 2009 Total manufacturing costs to account for Deduct ending work-in-process inventory, December 31, 2009 Cost of goods manufactured (to Income Statement) 2. $ 71,000 25,000 39,000 135,000 21,000 156,000 20,000 $136,000 Canseco Company Income Statement Year Ended December 31, 2009 (in thousands) Revenues Cost of goods sold: Beginning finished goods, January 1, 2009 Cost of goods manufactured Cost of goods available for sale Ending finished goods, December 31, 2009 Cost of goods sold Gross margin Operating costs: Marketing, distribution, and customer-service costs General and administrative costs Total operating costs Operating income 2-17 $300,000 $ 18,000 136,000 154,000 23,000 131,000 169,000 93,000 29,000 122,000 $ 47,000 2-32 (25–30 min.) Income statement and schedule of cost of goods manufactured. Howell Corporation Income Statement for the Year Ended December 31, 2009 (in millions) Revenues Cost of goods sold: Beginning finished goods, Jan. 1, 2009 Cost of goods manufactured (below) Cost of goods available for sale Ending finished goods, Dec. 31, 2009 Gross margin Marketing, distribution, and customer-service costs Operating income $950 $ 70 645 715 55 660 290 240 $ 50 Howell Corporation Schedule of Cost of Goods Manufactured for the Year Ended December 31, 2009 (in millions) Direct materials costs: Beginning inventory, Jan. 1, 2009 Purchases of direct materials Cost of direct materials available for use Ending inventory, Dec. 31, 2009 Direct materials used Direct manufacturing labor costs Indirect manufacturing costs: Indirect manufacturing labor Plant supplies used Plant utilities Depreciation––plant and equipment Plant supervisory salaries Miscellaneous plant overhead Manufacturing costs incurred during 2009 Add beginning work-in-process inventory, Jan. 1, 2009 Total manufacturing costs to account for Deduct ending work-in-process, Dec. 31, 2009 Cost of goods manufactured 2-18 $ 15 325 340 20 $320 100 60 10 30 80 5 35 220 640 10 650 5 $645 2-33 (15–20 min.) Interpretation of statements (continuation of 2-32). 1. The schedule in 2-32 can become a Schedule of Cost of Goods Manufactured and Sold simply by including the beginning and ending finished goods inventory figures in the supporting schedule, rather than directly in the body of the income statement. Note that the term cost of goods manufactured refers to the cost of goods brought to completion (finished) during the accounting period, whether they were started before or during the current accounting period. Some of the manufacturing costs incurred are held back as costs of the ending work in process; similarly, the costs of the beginning work in process inventory become a part of the cost of goods manufactured for 2009. 2. The sales manager’s salary would be charged as a marketing cost as incurred by both manufacturing and merchandising companies. It is basically an operating cost that appears below the gross margin line on an income statement. In contrast, an assembler’s wages would be assigned to the products worked on. Thus, the wages cost would be charged to Work-in-Process and would not be expensed until the product is transferred through Finished Goods Inventory to Cost of Goods Sold as the product is sold. 3. The direct-indirect distinction can be resolved only with respect to a particular cost object. For example, in defense contracting, the cost object may be defined as a contract. Then, a plant supervisor working only on that contract will have his or her salary charged directly and wholly to that single contract. 4. Direct materials used = $320,000,000 ÷ 1,000,000 units = $320 per unit Depreciation on plant equipment = $80,000,000 ÷ 1,000,000 units = $80 per unit 5. Direct materials unit cost would be unchanged at $320 per unit. Depreciation cost per unit would be $80,000,000 ÷ 1,200,000 = $66.67 per unit. Total direct materials costs would rise by 20% to $384,000,000 ($320 per unit × 1,200,000 units), whereas total depreciation would be unaffected at $80,000,000. 6. Unit costs are averages, and they must be interpreted with caution. The $320 direct materials unit cost is valid for predicting total costs because direct materials is a variable cost; total direct materials costs indeed change as output levels change. However, fixed costs like depreciation must be interpreted quite differently from variable costs. A common error in cost analysis is to regard all unit costs as one—as if all the total costs to which they are related are variable costs. Changes in output levels (the denominator) will affect total variable costs, but not total fixed costs. Graphs of the two costs may clarify this point; it is safer to think in terms of total costs rather than in terms of unit costs. 2-19 2-34 (25–30 min.) Income statement and schedule of cost of goods manufactured. Chan Corporation Income Statement for the Year Ended December 31, 2009 (in millions) Revenues Cost of goods sold: Beginning finished goods, Jan. 1, 2009 Cost of goods manufactured (below) Cost of goods available for sale Ending finished goods, Dec. 31, 2009 Gross margin Marketing, distribution, and customer-service costs Operating income $350 $ 40 204 244 12 232 118 90 $ 28 Chan Corporation Schedule of Cost of Goods Manufactured for the Year Ended December 31, 2009 (in millions) Direct material costs: Beginning inventory, Jan. 1, 2009 Direct materials purchased Cost of direct materials available for use Ending inventory, Dec. 31, 2009 Direct materials used Direct manufacturing labor costs Indirect manufacturing costs: Plant supplies used Property taxes on plant Plant utilities Indirect manufacturing labor costs Depreciation––plant and equipment Miscellaneous manufacturing overhead costs Manufacturing costs incurred during 2009 Add beginning work-in-process inventory, Jan. 1, 2009 Total manufacturing costs to account for Deduct ending work-in-process inventory, Dec. 31, 2009 Cost of goods manufactured (to income statement) 2-20 $ 30 80 110 5 $105 40 6 1 5 20 9 10 51 196 10 206 2 $204 2-35 1. Terminology, (15–20 min.)Terminology, interpretation of statements (continuation of 2-34) 2-34). $105 million 40 million $145 million Direct manufacturing labor costs Indirect manufacturing costs Conversion costs 2. Direct materials used Direct manufacturing labor costs Prime costs $ 40 million 51 million $ 91 million Inventoriable costs (in millions) for Year 2009 Plant utilities Indirect manufacturing labor Depreciation—plant and equipment Miscellaneous manufacturing overhead Direct materials used Direct manufacturing labor Plant supplies used Property tax on plant Total inventoriable costs Period costs (in millions) for Year 2009 Marketing, distribution, and customer-service costs $ 5 20 9 10 105 40 6 1 $196 $ 90 3. Design costs and R&D costs may be regarded as product costs in case of contracting with a governmental agency. For example, if the Air Force negotiated to contract with Lockheed to build a new type of supersonic fighter plane, design costs and R&D costs may be included in the contract as product costs. 4. Direct materials used = $105,000,000 ÷ 1,000,000 units = $105 per unit Depreciation on plant and equipment = $9,000,000 ÷ 1,000,000 units = $9 per unit 5. Direct materials unit cost would be unchanged at $105. Depreciation unit cost would be $9,000,000 ÷ 1,500,000 = $6 per unit. Total direct materials costs would rise by 50% to $157,500,000 ($105 per unit × 1,500,000 units). Total depreciation cost of $9,000,000 would remain unchanged. 6. In this case, equipment depreciation is a variable cost in relation to the unit output. The amount of equipment depreciation will change in direct proportion to the number of units produced. (a) Depreciation will be $4 million (1 million × $4) when 1 million units are produced. (b) Depreciation will be $6 million (1.5 million × $4) when 1.5 million units are produced. 2-21 2-36 (20 min.) Labor cost, overtime and idle time. 1.(a) Total cost of hours worked at regular rates 42 hours × 12 per hour 42 hours × 12 per hour 43 hours × 12 per hour 40 hours × 12 per hour Minus idle time (5.2 hours × $12 per hour) Direct manufacturing labor costs (b) Idle time = 5.2 hours × 12 per hour = (c) Overtime and holiday premium. Week 1: Overtime (42-40) hours × Premium, $6 per hour Week 2: Overtime (42-40) hours ×Premium, $6 per hour Week 3: Overtime (43-40) hours × Premium, $6 per hour Week 4: Holiday 8 hours × Premium, $12 per hour Total overtime and holiday premium (d) Total earnings in May Direct manufacturing labor costs Idle time Overtime and holiday premium Total earnings $ 504.00 504.00 516.00 480.00 2,004.00 62.40 $1,941.60 $62.40 $ 12.00 12.00 18.00 96.00 $138.00 $1,941.60 62.40 138.00 $2,142.00 2. Idle time caused by equipment breakdowns and scheduling mixups is an indirect cost of the job because it is not related to a specific job. Overtime premium caused by the heavy overall volume of work is also an indirect cost because it is not related to a particular job that happened to be worked on during the overtime hours. If, however, the overtime is the result of a demanding “rush job,” the overtime premium is a direct cost of that job. 2-22 2-37 (30–40 min.) Fire loss, computing inventory costs. 1. 2. 3. Finished goods inventory, 2/26/2009 = $50,000 Work-in-process inventory, 2/26/2009 = $28,000 Direct materials inventory, 2/26/2009 = $62,000 This problem is not as easy as it first appears. These answers are obtained by working from the known figures to the unknowns in the schedule below. The basic relationships between categories of costs are: Prime costs (given) = $294,000 Direct materials used = $294,000 – Direct manufacturing labor costs = $294,000 – $180,000 = $114,000 Conversion costs = Direct manufacturing labor costs ÷ 0.6 $180,000 ÷ 0.6 = $300,000 Indirect manuf. costs = $300,000 – $180,000 = $120,000 (or 0.40 $300,000) Schedule of Computations Direct materials, 1/1/2009 Direct materials purchased Direct materials available for use Direct materials, 2/26/2009 3= Direct materials used ($294,000 – $180,000) Direct manufacturing labor costs Prime costs Indirect manufacturing costs Manufacturing costs incurred during the current period Add work in process, 1/1/2009 Manufacturing costs to account for Deduct work in process, 2/26/2009 2= Cost of goods manufactured Add finished goods, 1/1/2009 Cost of goods available for sale (given) Deduct finished goods, 2/26/2009 1= Cost of goods sold (80% of $500,000) $ 16,000 160,000 176,000 62,000 114,000 180,000 294,000 120,000 414,000 34,000 448,000 28,000 420,000 30,000 450,000 50,000 $400,000 Some instructors may wish to place the key amounts in a Work in Process T-account. This problem can be used to introduce students to the flow of costs through the general ledger (amounts in thousands): Work in Process BI 34 DM used 114 COGM 420 DL 180 OH 120 To account for 448 EI 28 BI -------> Cost of Finished Goods Goods Sold 30 420 COGS 400 ---->400 Available for sale EI 2-23 450 50 2-38 (30 min.) Comprehensive problem on unit costs, product costs. 1. If 2 pounds of direct materials are used to make each unit of finished product, 100,000 units × 2 lbs., or 200,000 lbs. were used at $0.70 per pound of direct materials ($140,000 ÷ 200,000 lbs.). (The direct material costs of $140,000 are direct materials used, not purchased.) Therefore, the ending inventory of direct materials is 2,000 lbs. $0.70 = $1,400. 2. Direct materials costs Direct manufacturing labor costs Plant energy costs Indirect manufacturing labor costs Other indirect manufacturing costs Cost of goods manufactured Manufacturing Costs for 100,000 units Variable Fixed Total $140,000 $ – $140,000 30,000 – 30,000 5,000 – 5,000 10,000 16,000 26,000 8,000 24,000 32,000 $193,000 $40,000 $233,000 Average unit manufacturing cost: $233,000 ÷ 100,000 units = $2.33 per unit $20,970 (given) = $2.33 per unit = 9,000 units Finished goods inventory in units: 3. Units sold in 2009 = = Selling price in 2009 = = Beginning inventory + Production – Ending inventory 0 + 100,000 – 9,000 = 91,000 units $436,800 ÷ 91,000 $4.80 per unit 4. Revenues (91,000 units sold × $4.80) Cost of units sold: Beginning finished goods, Jan. 1, 2009 Cost of goods manufactured Cost of goods available for sale Ending finished goods, Dec. 31, 2009 Gross margin Operating costs: Marketing, distribution, and customer-service costs Administrative costs Operating income $436,800 $ 0 233,000 233,000 20,970 162,850 50,000 212,030 224,770 212,850 $ 11,920 Note: Although not required, the full set of unit variable costs is: Direct materials cost Direct manufacturing labor cost Plant energy cost Indirect manufacturing labor cost Other indirect manufacturing cost $1.40 0.30 0.05 0.10 0.08 = $1.93 per unit manufactured Marketing, distribution, and customer-service costs $1.35 per unit sold 2-24 2-39 (20-25 min.) Labor cost classification; ethics. 1. No. The direct manufacturing labor costs are not 20% or greater of total manufacturing costs. Direct manufacturing labor costs are $410,000 which are 16.4% of total manufacturing costs, $410,000 ÷ $2,500,000 = 16.4% 2. Bob Zixson can ask the controller to reclassify at least two of the costs that are currently reported as indirect manufacturing costs to direct manufacturing labor costs. The most logical are the fringe benefits and some of the overtime costs, particularly if it can be argued that some of the overtime was directly caused by jobs. The fringe benefits are logical because they are not only the largest, but can be argued to be a part of normal cost of manufacturing labor. Fringe benefits related to direct manufacturing labor costs together with some of the overtime premium could bring the total direct manufacturing labor cost over the minimum $500,000. Justification for reclassifying vacation and sick time is similar to that of fringe benefits—that it is a normal cost of labor since it is part of and can be traced to the direct manufacturing laborer’s payment. It is harder to justify reclassifying idle time, since it is difficult to identify a specific job that the idle time relates to. Idle time is also the smallest cost item. 3. The controller should not reclassify overhead costs as direct manufacturing labor costs just so the firm can reap tax benefits particularly if the changes would violate the company’s policy of computing direct manufacturing labor costs. The idea of cost classification is to allow internal (and external) decision making by clarifying what each cost item represents. Also, if costs in only the Costa Melon plant are reclassified, it will be harder for Zix to evaluate the Costa Melon plant, when compared to Zix’s other plants. Nevertheless, some of the arguments presented in requirement 2 can be justified and could prompt a reevaluation of Zix’s direct manufacturing labor classifications. 2-25 2-40 (20–25 min.) Finding unknown amounts. Let G = given, I = inferred Step 1: Use gross margin formula Revenues Cost of goods sold Gross margin Case 1 $ 32,000 G A 20,700 I $ 11,300 G Case 2 $31,800 G 20,000 G C $11,800 I Step 2: Use schedule of cost of goods manufactured formula Direct materials used Direct manufacturing labor costs Indirect manufacturing costs Manufacturing costs incurred Add beginning work in process, 1/1 Total manufacturing costs to account for Deduct ending work in process, 12/31 Cost of goods manufactured $ 8,000 G 3,000 G 7,000 G 18,000 I 0G 18,000 I 0G $ 18,000 I $ 12,000 G 5,000 G D 6,500 I 23,500 I 800 G 24,300 I 3,000 G $ 21,300 I $ 4,000 G 18,000 I 22,000 I B1,300 I $ 20,700 I $ 4,000 G 21,300 I 25,300 I 5,300 G $ 20,000 G Step 3: Use cost of goods sold formula Beginning finished goods inventory, 1/1 Cost of goods manufactured Cost of goods available for sale Ending finished goods inventory, 12/31 Cost of goods sold For case 1, do steps 1, 2, and 3 in order. For case 2, do steps 1, 3, and then 2. 2-26 CHAPTER 3 COST-VOLUME-PROFIT ANALYSIS NOTATION USED IN CHAPTER 3 SOLUTIONS SP: VCU: CMU: FC: TOI: Selling price Variable cost per unit Contribution margin per unit Fixed costs Target operating income 3-1 Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the units sold, selling price, variable cost per unit, or fixed costs of a product. 3-2 1. 2. 3. 4. The assumptions underlying the CVP analysis outlined in Chapter 3 are Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units sold. Total costs can be separated into a fixed component that does not vary with the units sold and a component that is variable with respect to the units sold. When represented graphically, the behavior of total revenues and total costs are linear (represented as a straight line) in relation to units sold within a relevant range and time period. The selling price, variable cost per unit, and fixed costs are known and constant. 3-3 Operating income is total revenues from operations for the accounting period minus cost of goods sold and operating costs (excluding income taxes): Operating income = Total revenues from operations – Costs of goods sold and operating costs (excluding income taxes Net income is operating income plus nonoperating revenues (such as interest revenue) minus nonoperating costs (such as interest cost) minus income taxes. Chapter 3 assumes nonoperating revenues and nonoperating costs are zero. Thus, Chapter 3 computes net income as: Net income = Operating income – Income taxes 3-4 Contribution margin is the difference between total revenues and total variable costs. Contribution margin per unit is the difference between selling price and variable cost per unit. Contribution-margin percentage is the contribution margin per unit divided by selling price. 3-5 Three methods to express CVP relationships are the equation method, the contribution margin method, and the graph method. The first two methods are most useful for analyzing operating income at a few specific levels of sales. The graph method is useful for visualizing the effect of sales on operating income over a wide range of quantities sold. 3- 3-6 Breakeven analysis denotes the study of the breakeven point, which is often only an incidental part of the relationship between cost, volume, and profit. Cost-volume-profit relationship is a more comprehensive term than breakeven analysis. 3-7 CVP certainly is simple, with its assumption of output as the only revenue and cost driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic depends on the decision context. In some cases, these assumptions may be sufficiently accurate for CVP to provide useful insights. The examples in Chapter 3 (the software package context in the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can provide such insights. In more complex cases, the basic ideas of simple CVP analysis can be expanded. 3-8 An increase in the income tax rate does not affect the breakeven point. Operating income at the breakeven point is zero, and no income taxes are paid at this point. 3-9 Sensitivity analysis is a “what-if” technique that managers use to examine how a result will change if the original predicted data are not achieved or if an underlying assumption changes. The advent of the electronic spreadsheet has greatly increased the ability to explore the effect of alternative assumptions at minimal cost. CVP is one of the most widely used software applications in the management accounting area. 3-10 Examples include: Manufacturing––substituting a robotic machine for hourly wage workers. Marketing––changing a sales force compensation plan from a percent of sales dollars to a fixed salary. Customer service––hiring a subcontractor to do customer repair visits on an annual retainer basis rather than a per-visit basis. 3-11 Examples include: Manufacturing––subcontracting a component to a supplier on a per-unit basis to avoid purchasing a machine with a high fixed depreciation cost. Marketing––changing a sales compensation plan from a fixed salary to percent of sales dollars basis. Customer service––hiring a subcontractor to do customer service on a per-visit basis rather than an annual retainer basis. 3-12 Operating leverage describes the effects that fixed costs have on changes in operating income as changes occur in units sold, and hence, in contribution margin. Knowing the degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes. 3-13 CVP analysis is always conducted for a specified time horizon. One extreme is a very short-time horizon. For example, some vacation cruises offer deep price discounts for people who offer to take any cruise on a day’s notice. One day prior to a cruise, most costs are fixed. The other extreme is several years. Here, a much higher percentage of total costs typically is variable. CVP itself is not made any less relevant when the time horizon lengthens. What happens is that many items classified as fixed in the short run may become variable costs with a longer time horizon. 3- 3-14 A company with multiple products can compute a breakeven point by assuming there is a constant sales mix of products at different levels of total revenue. 3-15 Yes, gross margin calculations emphasize the distinction between manufacturing and nonmanufacturing costs (gross margins are calculated after subtracting fixed manufacturing costs). Contribution margin calculations emphasize the distinction between fixed and variable costs. Hence, contribution margin is a more useful concept than gross margin in CVP analysis. 3-16 (10 min.) CVP computations. a. b. c. d. Variable Revenues Costs $2,000 $ 500 1,500 2,000 1,000 700 1,500 900 3-17 Fixed Costs 300 $300 300 300 300 Total Costs $ 800 1,800 1,000 1,200 Operating Income $1,200 200 0 300 Contribution Margin $1,500 500 300 600 Contribution Margin % 75.0% 25.0% 30.0% 40.0% (10–15 min.) CVP computations. 1a. Sales ($30 per unit × 200,000 units) Variable costs ($25 per unit × 200,000 units) Contribution margin $6,000,000 5,000,000 $1,000,000 1b. Contribution margin (from above) Fixed costs Operating income $1,000,000 800,000 $ 200,000 2a. Sales (from above) Variable costs ($16 per unit × 200,000 units) Contribution margin $6,000,000 3,200,000 $2,800,000 2b. Contribution margin Fixed costs Operating income $2,800,000 2,400,000 $ 400,000 3. Operating income is expected to increase by $200,000 if Ms. Schoenen’s proposal is accepted. The management would consider other factors before making the final decision. It is likely that product quality would improve as a result of using state of the art equipment. Due to increased automation, probably many workers will have to be laid off. Patel’s management will have to consider the impact of such an action on employee morale. In addition, the proposal increases the company’s fixed costs dramatically. This will increase the company’s operating leverage and risk. 3-18 (35–40 min.) CVP analysis, changing revenues and costs. 3- 1a. SP VCU CMU FC = 8% × $1,000 = $80 per ticket = $35 per ticket = $80 – $35 = $45 per ticket = $22,000 a month Q = $22,000 FC = $45 per ticket CMU = 489 tickets (rounded up) Q = FC TOI $22,000 $10,000 = CMU $45 per ticket = 1b. $32,000 $45 per ticket = 712 tickets (rounded up) 2a. SP VCU CMU FC = $80 per ticket = $29 per ticket = $80 – $29 = $51 per ticket = $22,000 a month Q = FC $22,000 = CMU $51 per ticket = 432 tickets (rounded up) 2b. Q = FC TOI $22,000 $10,000 = CMU $51 per ticket $32,000 $51 per ticket = 628 tickets (rounded up) = 3a. SP VCU CMU FC = $48 per ticket = $29 per ticket = $48 – $29 = $19 per ticket = $22,000 a month Q = FC $22,000 = CMU $19 per ticket = 1,158 tickets (rounded up) 3- Q = $22,000 $10,000 FC TOI = $19 per ticket CMU = 3b. $32,000 $19 per ticket = 1,685 tickets (rounded up) The reduced commission sizably increases the breakeven point and the number of tickets required to yield a target operating income of $10,000: Breakeven point Attain OI of $10,000 8% Commission (Requirement 2) 432 628 Fixed Commission of $48 1,158 1,685 4a. The $5 delivery fee can be treated as either an extra source of revenue (as done below) or as a cost offset. Either approach increases CMU $5: SP VCU CMU FC = $53 ($48 + $5) per ticket = $29 per ticket = $53 – $29 = $24 per ticket = $22,000 a month Q = $22,000 FC = $24 per ticket CMU = 917 tickets (rounded up) Q = FC TOI $22,000 $10,000 = CMU $24 per ticket = 4b. $32,000 $24 per ticket = 1,334 tickets (rounded up) The $5 delivery fee results in a higher contribution margin which reduces both the breakeven point and the tickets sold to attain operating income of $10,000. 3- 3-19 (20 min.) CVP exercises. Revenues $10,000,000G 10,000,000 10,000,000 10,000,000 10,000,000 10,800,000e 9,200,000g 11,000,000i 10,000,000 Orig. 1. 2. 3. 4. 5. 6. 7. 8. Gstands Variable Costs $8,000,000G 7,800,000 8,200,000 8,000,000 8,000,000 8,640,000f 7,360,000h 8,800,000j 7,600,000l Contribution Margin $2,000,000 2,200,000a 1,800,000b 2,000,000 2,000,000 2,160,000 1,840,000 2,200,000 2,400,000 Fixed Costs $1,800,000G 1,800,000 1,800,000 1,890,000c 1,710,000d 1,800,000 1,800,000 1,980,000k 1,890,000m Budgeted Operating Income $200,000 400,000 0 110,000 290,000 360,000 40,000 220,000 510,000 for given. a$2,000,000 × 1.10; b$2,000,000 × 0.90; c$1,800,000 × 1.05; d$1,800,000 × 0.95; e$10,000,000 × 1.08; f$8,000,000 × 1.08; g$10,000,000 × 0.92; h$8,000,000 × 0.92; i$10,000,000 × 1.10; j$8,000,000 × 1.10; k$1,800,000 × 1.10; l$8,000,000 × 0.95; m$1,800,000 × 1.05 3-20 (20 min.) CVP exercises. 1a. [Units sold (Selling price – Variable costs)] – Fixed costs = Operating income [5,000,000 ($0.50 – $0.30)] – $900,000 = $100,000 1b. Fixed costs ÷ Contribution margin per unit = Breakeven units $900,000 ÷ [($0.50 – $0.30)] = 4,500,000 units Breakeven units × Selling price = Breakeven revenues 4,500,000 units × $0.50 per unit = $2,250,000 or, Selling price -Variable costs Contribution margin ratio = Selling price $0.50 - $0.30 = = 0.40 $0.50 Fixed costs ÷ Contribution margin ratio = Breakeven revenues $900,000 ÷ 0.40 = $2,250,000 2. 5,000,000 ($0.50 – $0.34) – $900,000 = $ (100,000) 3. [5,000,000 (1.1) ($0.50 – $0.30)] – [$900,000 (1.1)] = $ 110,000 4. [5,000,000 (1.4) ($0.40 – $0.27)] – [$900,000 (0.8)] = $ 190,000 5. $900,000 (1.1) ÷ ($0.50 – $0.30) = 4,950,000 units 6. ($900,000 + $20,000) ÷ ($0.55 – $0.30) = 3,680,000 units 3- 3-21 (10 min.) CVP analysis, income taxes. 1. Monthly fixed costs = $60,000 + $70,000 + $10,000 = Contribution margin per unit = $26,000 – $22,000 – $500 = Breakeven units per month = 2. Tax rate Monthly fixed costs $140,000 = = Contribution margin per unit $3,500 per car $140,000 $ 3,500 40 cars 40% Target net income $63,000 Target net income $63, 000 $63, 000 $105,000 1 - tax rate (1 0.40) 0.60 Quantity of output units Fixed costs + Target operating income $140, 000 $105, 000 70 cars required to be sold = Contribution margin per unit $3,500 Target operating income = 3- 3-22 (20–25 min.) CVP analysis, income taxes. 1. Variable cost percentage is $3.20 $8.00 = 40% Let R = Revenues needed to obtain target net income $105,000 R – 0.40R – $450,000 = 1 0.30 0.60R = $450,000 + $150,000 R = $600,000 0.60 R = $1,000,000 or, $105,000 Target net income $450,000 + 1 0.30 = $1,000,000 1 Tax rate = Breakeven revenues = 0.60 Contribution margin percentage Proof: 2.a. b. 3. Revenues Variable costs (at 40%) Contribution margin Fixed costs Operating income Income taxes (at 30%) Net income $1,000,000 400,000 600,000 450,000 150,000 45,000 $ 105,000 Customers needed to earn net income of $105,000: Total revenues Sales check per customer $1,000,000 $8 = 125,000 customers Customers needed to break even: Contribution margin per customer = $8.00 – $3.20 = $4.80 Breakeven number of customers = Fixed costs Contribution margin per customer = $450,000 $4.80 per customer = 93,750 customers Using the shortcut approach: Change in net income = 错误!未指定开关参数。 错误!未指定开关参数。 (1 – Tax rate) New net income = (150,000 – 125,000) $4.80 (1 – 0.30) = $120,000 0.7 = $84,000 = $84,000 + $105,000 = $189,000 The alternative approach is: Revenues, 150,000 $8.00 $1,200,000 Variable costs at 40% 480,000 Contribution margin 720,000 Fixed costs 450,000 Operating income 270,000 Income tax at 30% 81,000 Net income $ 189,000 3-23 (30 min.) CVP analysis, sensitivity analysis analysis. 3- 1. SP = $30.00 (1 – 0.30 margin to bookstore) = $30.00 0.70 = $21.00 VCU = $ 4.00 variable production and marketing cost 3.15 variable author royalty cost (0.15 $21.00) $ 7.15 CMU = $21.00 – $7.15 = $13.85 per copy FC = $ 500,000 fixed production and marketing cost 3,000,000 up-front payment to Washington $3,500,000 Solution Exhibit 3-23A shows the PV graph. SOLUTION EXHIBIT 3-23A PV Graph for Media Publishers $4,000 FC = $3,500,000 CMU = $13.85 per book sold 3,000 Operating income (000’s) 2,000 1,000 0 U n its so ld 100,000 -1,000 200,000 -3,000 $3.5 million 3- 400,000 252,708 units -2,000 -4,000 300,000 500,000 2a. FC Breakeven = CMU number of units $3,500,000 = $13.85 = 252,708 copies sold (rounded up) 2b. Target OI = FC OI CMU $3,500,000 $2,000,000 $13.85 $5,500,000 = $13.85 = 397,112 copies sold (rounded up) = 3a. Decreasing the normal bookstore margin to 20% of the listed bookstore price of $30 has the following effects: SP $30.00 (1 – 0.20) = = $30.00 0.80 = $24.00 VCU = $ 4.00 variable production and marketing cost + 3.60 variable author royalty cost (0.15 $24.00) $ 7.60 CMU = $24.00 – $7.60 = $16.40 per copy FC Breakeven = CMU number of units $3,500,000 = $16.40 = 213,415 copies sold (rounded up) The breakeven point decreases from 252,708 copies in requirement 2 to 213,415 copies. 3b. Increasing the listed bookstore price to $40 while keeping the bookstore margin at 30% has the following effects: SP $40.00 (1 – 0.30) = = $40.00 0.70 = $28.00 3- VCU =$ 4.00 variable production and marketing cost + 4.20 variable author royalty cost (0.15 $28.00) $ 8.20 CMU= $28.00 – $8.20 = $19.80 per copy $3,500,000 Breakeven = $19.80 number of units = 176,768 copies sold (rounded up) The breakeven point decreases from 252,708 copies in requirement 2 to 176,768 copies. 3c. The answers to requirements 3a and 3b decrease the breakeven point relative to that in requirement 2 because in each case fixed costs remain the same at $3,500,000 while the contribution margin per unit increases. 3-24 (10 min.) CVP analysis, margin of safety. Fixed costs 1. Breakeven point revenues = Contribution margin percentage $600,000 Contribution margin percentage = = 0.40 or 40% $1,500,000 Selling price Variable cost per unit 2. Contribution margin percentage = Selling price SP $15 0.40 = SP 0.40 SP = SP – $15 0.60 SP = $15 SP = $25 3. Breakeven sales in units = Revenues ÷ Selling price = $1,500,000 ÷ $25 = 60,000 units Margin of safety in units = sales in units – Breakeven sales in units = 80,000 – 60,000 = 20,000 units Revenues, 80,000 units $25 Breakeven revenues Margin of safety 3- $2,000,000 1,500,000 $ 500,000 3-25 (25 min.) Operating leverage. 1a. Let Q denote the quantity of carpets sold Breakeven point under Option 1 $500Q $350Q = $5,000 $150Q = $5,000 Q = $5,000 $150 = 34 carpets (rounded up) 1b. 2. Breakeven point under Option 2 $500Q $350Q (0.10 $500Q) 100Q Q = = = 0 0 0 Operating income under Option 1 = $150Q $5,000 Operating income under Option 2 = $100Q Find Q such that $150Q $5,000 = $100Q $50Q = $5,000 Q = $5,000 $50 = 100 carpets Revenues = $500 × 100 carpets = $50,000 For Q = 100 carpets, operating income under both Option 1 and Option 2 = $10,000 For Q > 100, say, 101 carpets, Option 1 gives operating income = ($150 101) $5,000 = $10,150 Option 2 gives operating income = $100 101 = $10,100 So Color Rugs will prefer Option 1. For Q < 100, say, 99 carpets, Option 1 gives operating income = ($150 99) $5,000 = $9,850 Option 2 gives operating income = $100 99 = $9,900 So Color Rugs will prefer Option 2. 3. Contribution margin Operating income $150 100 Under Option 1, degree of operating leverage = = 1.5 $10,000 $100 100 Under Option 2, degree of operating leverage = = 1.0 $10,000 Degree of operating leverage = 4. The calculations in requirement 3 indicate that when sales are 100 units, a percentage change in sales and contribution margin will result in 1.5 times that percentage change in operating income for Option 1, but the same percentage change in operating income for Option 2. The degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes. 3- 3-26 (15 min.) CVP analysis, international cost structure differences. Variable Variable Sales price Annual Manufacturing Marketing & Contribution Country to retail Fixed Cost Distribution Cost Margin Breakeven Breakeven outlets Costs per Sweater per Sweater Per Unit Units Revenues (1) (2) (3) (4) (5)=(1)-(3)-(4) (6)=(2) (5) (6) (1) Singapore $32.00 $ 6,500,000 $ 8.00 $11.00 $13.00 500,000 $16,000,000 Thailand 32.00 4,500,000 5.50 11.50 15.00 300,000 9,600,000 United States 32.00 12,000,000 13.00 9.00 10.00 1,200,000 38,400,000 Requirement 1 Thailand has the lowest breakeven point since it has both the lowest fixed costs ($4,500,000) and the lowest variable cost per unit ($17.00). Hence, for a given selling price, Thailand will always have a higher operating income (or a lower operating loss) than Singapore or the U.S. The U.S. breakeven point is 1,200,000 units. Hence, with sales of only 800,000 units, it has an operating loss of $4,000,000. 3- Operating Income for Budgeted Sales of 800,000 Sweaters (7)=[800,000 (5)] – (2) $3,900,000 7,500,000 (4,000,000) Requirement 2 3-27 (30 min.) Sales mix, new and upgrade customers. 1. SP VCU CMU New Upgrade Customers Customers $210 $120 90 40 120 80 The 60%/40% sales mix implies that, in each bundle, 3 units are sold to new customers and 2 units are sold to upgrade customers. Contribution margin of the bundle = 3 × $120 + 2 × $80 = $360 + $160 = $520 $14,000,000 Breakeven point in bundles = = 26,923 bundles $520 Breakeven point in units is: Sales to new customers: 26,923 bundles × 3 units per bundle 80,769 units Sales to upgrade customers: 26,923 bundles × 2 units per bundle 53,846 units Total number of units to breakeven (rounded) 134,615 units Alternatively, Let S = Number of units sold to upgrade customers 1.5S = Number of units sold to new customers Revenues – Variable costs – Fixed costs = Operating income [$210 (1.5S) + $120S] – [$90 (1.5S) + $40S] – $14,000,000 = OI $435S – $175S – $14,000,000 = OI Breakeven point is 134,616 units when OI = 0 because $260S S 1.5S BEP = $14,000,000 = 53,846 units sold to upgrade customers (rounded) = 80,770 units sold to new customers (rounded) = 134,616 units Check Revenues ($210 80,770) + ($120 53,846) Variable costs ($90 80,770) + ($40 53,846) Contribution margin Fixed costs Operating income (caused by rounding) 3- $23,423,220 9,423,140 14,000,080 14,000,000 $ 80 2. When 200,000 units are sold, mix is: Units sold to new customers (60% 200,000) 120,000 Units sold to upgrade customers (40% 200,000) 80,000 Revenues ($210 120,000) + ($120 80,000) Variable costs ($90 120,000) + ($40 80,000) Contribution margin Fixed costs Operating income 3a. $34,800,000 14,000,000 20,800,000 14,000,000 $ 6,800,000 At New 50%/Upgrade 50% mix, each bundle contains 1 unit sold to new customer and 1 unit sold to upgrade customer. Contribution margin of the bundle = 1 $120 + 1 $80 = $120 + $80 = $200 $14,000,000 Breakeven point in bundles = = 70,000 bundles $200 Breakeven point in units is: Sales to new customers: 70,000 bundles × 1 unit per bundle 70,000 units Sales to upgrade customers: 70,000 bundles × 1 unit per bundle 70,000 units Total number of units to breakeven 140,000 units Alternatively, Let S = Number of units sold to upgrade customers then S = Number of units sold to new customers [$210S + $120S] – [$90S + $40S] – $14,000,000 = OI 330S – 130S = $14,000,000 200S = $14,000,000 S =70,000 units sold to upgrade customers S = 70,000 units sold to new customers BEP = 140,000 units Check Revenues ($210 70,000) + ($120 70,000) $23,100,000 Variable costs ($90 70,000) + ($40 70,000) 9,100,000 Contribution margin 14,000,000 Fixed costs 14,000,000 Operating income $ 0 3b. At New 90%/ Upgrade 10% mix, each bundle contains 9 units sold to new customers and 1 unit sold to upgrade customers. Contribution margin of the bundle = 9 $120 + 1 $80 = $1,080 + $80 = $1,160 $14,000,000 Breakeven point in bundles = = 12,069 bundles (rounded) $1,160 Breakeven point in units is: Sales to new customers: 12,069 bundles × 9 units per bundle 108,621 units Sales to upgrade customers: 12,069 bundles × 1 unit per bundle 12,069 units Total number of units to breakeven 120,690 units 3- Alternatively, Let S = Number of units sold to upgrade customers then 9S= Number of units sold to new customers [$210 (9S) + $120S] – [$90 (9S) + $40S] – $14,000,000 = OI 2,010S – 850S = $14,000,000 1,160S = $14,000,000 S =12,069 units sold to upgrade customers (rounded up) 9S =108,621 units sold to new customers (rounded up) 120,690 units Check Revenues ($210 108,621) + ($120 12,069) Variable costs ($90 108,621) + ($40 12,069) Contribution margin Fixed costs Operating income (caused by rounding) $24,258,690 10,258,650 14,000,040 14,000,000 $ 40 3c. As Zapo increases its percentage of new customers, which have a higher contribution margin per unit than upgrade customers, the number of units required to break even decreases: Requirement 3(a) Requirement 1 Requirement 3(b) 3-28 (20 min.) CVP analysis, multiple cost drivers. 1a. Operating income 1b. Operating income 2. New Upgrade Breakeven Customers Customers Point 50% 50% 140,000 60 40 134,616 90 10 120,690 Cost of picture Quantity of Cost of Number of Fixed = Revenues frames picture frames shipment shipments costs = ($45 40,000) ($30 40,000) ($60 1,000) $240,000 = $1,800,000 $1,200,000 $60,000 $240,000 = $300,000 = ($45 40,000) ($30 40,000) ($60 800) $240,000 = $312,000 Denote the number of picture frames sold by Q, then $45Q $30Q – (500 $60) $240,000 = 0 $15Q = $30,000 + $240,000 = $270,000 Q = $270,000 $15 = 18,000 picture frames 3. Suppose Susan had 1,000 shipments. $45Q $30Q (1,000 $60) $240,000 = 0 15Q = $300,000 Q = 20,000 picture frames The breakeven point is not unique because there are two cost drivers—quantity of picture frames and number of shipments. Various combinations of the two cost drivers can yield zero operating income. 3- 3-29 (25 mins) CVP, Not for profit. 1. Contributions Fixed costs Cash available to purchase land Divided by cost per acre to purchase land Acres of land SG can purchase $19,000,000 1,000,000 $18,000,000 ÷3,000 6,000 acres 2. Contributions ($19,000,000 – $5,000,000) Fixed costs Cash available to purchase land Divided by cost per acre to purchase land ($3,000 – $1,000) Acres of land SG can purchase $14,000,000 1,000,000 $13,000,000 ÷2,000 6,500 acres On financial considerations alone, SG should take the subsidy because it can purchase 500 more acres (6,500 acres – 6,000 acres). 3. Let the decrease in contributions be $ x . Cash available to purchase land = $19,000,000 – $ x – $1,000,000 Cost to purchase land = $3,000 – $1,000 = $2,000 To purchase 6,000 acres, we solve the following equation for x . 19,000,000 x 1,000,000 6,000 2,000 18,000,000 x 6,000 2,000 18,000,000 x 12,000,000 x $6,000,000 SG will be indifferent between taking the government subsidy or not if contributions decrease by $6,000,000. 3- 3-30 (15 min.) Contribution margin, decision making. 1. Revenues Deduct variable costs: Cost of goods sold Sales commissions Other operating costs Contribution margin $500,000 $200,000 50,000 40,000 290,000 $210,000 $210,000 = 42% $500,000 2. Contribution margin percentage = 3. Incremental revenue (20% × $500,000) = $100,000 Incremental contribution margin (42% × $100,000) Incremental fixed costs (advertising) Incremental operating income $42,000 10,000 $32,000 If Mr. Schmidt spends $10,000 more on advertising, the operating income will increase by $32,000, converting an operating loss of $10,000 to an operating income of $22,000. Proof (Optional): Revenues (120% × $500,000) Cost of goods sold (40% of sales) Gross margin Operating costs: Salaries and wages Sales commissions (10% of sales) Depreciation of equipment and fixtures Store rent Advertising Other operating costs: $40,000 Variable ( × $600,000) $500,000 Fixed Operating income 3- $600,000 240,000 360,000 $150,000 60,000 12,000 48,000 10,000 48,000 10,000 338,000 $ 22,000 3-31 (20 min.) Contribution margin, gross margin and margin of safety. 1. Mirabella Cosmetics Operating Income Statement, June 2008 Units sold Revenues Variable costs Variable manufacturing costs Variable marketing costs Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed marketing & administration costs Total fixed costs Operating income 2. 10,000 $100,000 $ 55,000 5,000 60,000 40,000 $ 20,000 10,000 30,000 $ 10,000 $40,000 $4 per unit 10,000 units Fixed costs $30, 000 Breakeven quantity = 7,500 units Contribution margin per unit $4 per unit Revenues $100, 000 Selling price = $10 per unit Units sold 10,000 units Breakeven revenues = 7,500 units $10 per unit = $75,000 Contribution margin per unit = Alternatively, Contribution margin percentage = Breakeven revenues = Contribution margin $40, 000 40% Revenues $100, 000 Fixed costs $30, 000 $75, 000 Contribution margin percentage 0.40 3. Margin of safety (in units) = Units sold – Breakeven quantity = 10,000 units – 7,500 units = 2,500 units 4. Units sold 8,000 Revenues (Units sold Selling price = 8,000 $10) Contribution margin (Revenues CM percentage = $80,000 40%) $32,000 Fixed costs 30,000 Operating income Taxes (30% $2,000) 3- $80,000 2,000 600 Net income $ 1,400 3- 3-32 (30 min.) Uncertainty and expected costs. 1. Monthly Number of Orders 300,000 400,000 500,000 600,000 700,000 Cost of Current System $1,000,000 + $40(300,000) = $13,000,000 $1,000,000 + $40(400,000) = $17,000,000 $1,000,000 + $40(500,000) = $21,000,000 $1,000,000 + $40(600,000) = $25,000,000 $1,000,000 + $40(700,000) = $29,000,000 Monthly Number of Orders 300,000 400,000 500,000 600,000 700,000 Cost of Partially Automated System $5,000,000 + $30(300,000) = $14,000,000 $5,000,000 + $30(400,000) = $17,000,000 $5,000,000 + $30(500,000) = $20,000,000 $5,000,000 + $30(600,000) = $23,000,000 $5,000,000 + $30(700,000) = $26,000,000 Monthly Number of Orders 300,000 400,000 500,000 600,000 700,000 Cost of Fully Automated System $10,000,000 + $20(300,000) = $16,000,000 $10,000,000 + $20(400,000) = $18,000,000 $10,000,000 + $20(500,000) = $20,000,000 $10,000,000 + $20(600,000) = $22,000,000 $10,000,000 + $20(700,000) = $24,000,000 2. Current System Expected Cost: $13,000,000 × 0.1 = $ 1,300,000 17,000,000 × 0.25 = 4,250,000 21,000,000 × 0.40 = 8,400,000 25,000,000 × 0.15 = 3,750,000 29,000,000 × 0.10 = 2,900,000 $ 20,600,000 Partially Automated System Expected Cost: $14,000,000 × 0.1 = $ 1 ,400,000 17,000,000 × 0.25 = 4,250,000 20,000,000 × 0.40 = 8,000,000 23,000,000 × 0.15 = 3,450,000 26,000,000 × 0.1 = 2,600,000 $19,700,000 Fully Automated System Expected Cost: $16,000,000 × 0.1 = $ 1,600,000 18,000,000 × 0.25 = 4,500,000 20,000,000 × 0.40 = 8,000,000 22,000,000 × 0.15 = 3,300,000 24,000,000 × 0.10 = 2,400,000 $19,800,000 3- 3. Dawmart should consider the impact of the different systems on its relationship with suppliers. The interface with Dawmart’s system may require that suppliers also update their systems. This could cause some suppliers to raise the cost of their merchandise. It could force other suppliers to drop out of Dawmart’s supply chain because the cost of the system change would be prohibitive. Dawmart may also want to consider other factors such as the reliability of different systems and the effect on employee morale if employees have to be laid off as it automates its systems. 3-33 (15–20 min.) CVP analysis, service firm firm. 1. Revenue per package Variable cost per package Contribution margin per package $4,000 3,600 $ 400 Breakeven (units) = Fixed costs ÷ Contribution margin per package $480,000 = = 1,200 tour packages $400 per package 2. Contribution margin ratio = Contribution margin per package $400 = = 10% Selling price $4,000 Revenue to achieve target income = (Fixed costs + target OI) ÷ Contribution margin ratio $480,000 $100,000 = = $5,800,000, or 0.10 $480,000 $100,000 Number of tour packages to earn $100,000 operating income: 1,450 tour packages $400 Revenues to earn $100,000 OI = 1,450 tour packages × $4,000 = $5,800,000. 3. Fixed costs = $480,000 + $24,000 = $504,000 Breakeven (units) = Fixed costs Contribution margin per unit Fixed costs Breakeven (units) $504,000 = = $420 per tour package 1,200 tour packages Contribution margin per unit = Desired variable cost per tour package = $4,000 – $420 = $3,580 Because the current variable cost per unit is $3,600, the unit variable cost will need to be reduced by $20 to achieve the breakeven point calculated in requirement 1. Alternate Method: If fixed cost increases by $24,000, then total variable costs must be reduced by $24,000 to keep the breakeven point of 1,200 tour packages. Therefore, the variable cost per unit reduction = $24,000 ÷ 1,200 = $20 per tour package 3- 3-34 (30 min.) CVP, target income, service firm. 1. Revenue per child Variable costs per child Contribution margin per child Breakeven quantity = = 2. Target quantity = = 3. $600 200 $400 Fixed costs Contribution margin per child $5,600 = 14 children $400 Fixed costs Target operating income Contribution margin per child $5,600 $10,400 = 40 children $400 Increase in rent ($3,000 – $2,000) Field trips Total increase in fixed costs Divide by the number of children enrolled Increase in fee per child $1,000 1,000 $2,000 ÷ 40 $ 50 Therefore, the fee per child will increase from $600 to $650. Alternatively, New contribution margin per child = $5,600 $2,000 $10,400 = $450 40 New fee per child = Variable costs per child + New contribution margin per child = $200 + $450 = $650 3- 3-35 (20–25 min.) CVP analysis. 1. Selling price Variable costs per unit: Purchase price $10.00 Shipping and handling 2.00 Contribution margin per unit (CMU) $16.00 12.00 $ 4.00 Fixed costs $600,000 = = 150,000 units Contr. margin per unit $4.00 Margin of safety (units) = 200,000 – 150,000 = 50,000 units Breakeven point in units = 2. Since Galaxy is operating above the breakeven point, any incremental contribution margin will increase operating income dollar for dollar. Increase in units sales = 10% × 200,000 = 20,000 Incremental contribution margin = $4 × 20,000 = $80,000 Therefore, the increase in operating income will be equal to $80,000. Galaxy’s operating income in 2008 would be $200,000 + $80,000 = $280,000. 3. Selling price Variable costs: Purchase price $10 × 130% Shipping and handling Contribution margin per unit Target sales in units = $16.00 $13.00 2.00 FC TOI $600,000 $200,000 = = 800,000 units CMU $1 Target sales in dollars = $16 × 800,000 = $12,800,000 3- 15.00 $ 1.00 3-36 (30–40 min.) CVP analysis, income taxes. 1. Revenues – Variable costs – Fixed costs = Target net income 1 Tax rate Let X = Net income for 2008 20,000($25.00) – 20,000($13.75) – $135,000 = $500,000 – $275,000 – $135,000 = X 1 0.40 X 0.60 $300,000 – $165,000 – $81,000 = X X = $54,000 Alternatively, Operating income = Revenues – Variable costs – Fixed costs = $500,000 – $275,000 – $135,000 = $90,000 Income taxes = 0.40 × $90,000 = $36,000 Net income = Operating income – Income taxes = $90,000 – $36,000 = $54,000 2. Let Q = Number of units to break even $25.00Q – $13.75Q – $135,000 = 0 Q = $135,000 $11.25 = 12,000 units 3. Let X = Net income for 2009 22,000($25.00) – 22,000($13.75) – ($135,000 + $11,250) = $550,000 – $302,500 – $146,250 = $101,250 = X 1 0.40 X 0.60 X 0.60 X = $60,750 4. Let Q = Number of units to break even with new fixed costs of $146,250 $25.00Q – $13.75Q – $146,250 Q = $146,250 $11.25 Breakeven revenues = 13,000 $25.00 5. = 0 = 13,000 units = $325,000 Let S = Required sales units to equal 2008 net income $25.00S – $13.75S – $146,250 = $54,000 0.60 $11.25S = $236,250 S = 21,000 units Revenues = 21,000 units $25 = $525,000 6. Let A = Amount spent for advertising in 2009 $550,000 – $302,500 – ($135,000 + A) = $60,000 0.60 $550,000 – $302,500 – $135,000 – A = $100,000 $550,000 – $537,500 = A A = $12,500 3- 3-37 (25 min.) CVP, sensitivity analysis analysis. Contribution margin per corkscrew = $4 – 3 = $1 Fixed costs = $6,000 Units sold = Total sales ÷ Selling price = $40,000 ÷ $4 per corkscrew = 10,000 corkscrews 1. Sales increase 10% Sales revenues 10,000 1.10 $4.00 Variable costs 10,000 1.10 $3.00 Contribution margin Fixed costs Operating income $44,000 33,000 11,000 6,000 $ 5,000 2. Increase fixed costs $2,000; Increase sales 50% Sales revenues 10,000 1.50 $4.00 $60,000 Variable costs 10,000 1.50 $3.00 45,000 Contribution margin 15,000 Fixed costs ($6,000 + $2,000) 8,000 Operating income $ 7,000 3. Increase selling price to $5.00; Sales decrease 20% Sales revenues 10,000 0.80 $5.00 $40,000 Variable costs 10,000 0.80 $3.00 24,000 Contribution margin 16,000 Fixed costs 6,000 Operating income $10,000 4. Increase selling price to $6.00; Variable costs increase $1 per corkscrew Sales revenues 10,000 $6.00 $60,000 Variable costs 10,000 $4.00 40,000 Contribution margin 20,000 Fixed costs 6,000 Operating income $14,000 Alternative 4 yields the highest operating income. If TOP is confident that unit sales will not decrease despite increasing the selling price, it should choose alternative 4. 3- 3-38 (20–30 min.) CVP analysis, shoe stores. 1. CMU (SP – VCU = $30 – $21) a. Breakeven units (FC CMU = $360,000 $9 per unit) b. Breakeven revenues (Breakeven units SP = 40,000 units $30 per unit) $ 2. Pairs sold Revenues, 35,000 $30 Total cost of shoes, 35,000 $19.50 Total sales commissions, 35,000 $1.50 Total variable costs Contribution margin Fixed costs Operating income (loss) 35,000 $1,050,000 682,500 52,500 735,000 315,000 360,000 $ (45,000) $1,200,000 3. Unit variable data (per pair of shoes) Selling price Cost of shoes Sales commissions Variable cost per unit Annual fixed costs Rent Salaries, $200,000 + $81,000 Advertising Other fixed costs Total fixed costs $ $ 60,000 281,000 80,000 20,000 $ 441,000 $ 10.50 42,000 $1,260,000 4. Unit variable data (per pair of shoes) Selling price Cost of shoes Sales commissions Variable cost per unit Total fixed costs $ 30.00 19.50 1.80 $ 21.30 $ 360,000 $ 8.70 41,380 (rounded up) $1,241,400 5. Pairs sold Revenues (50,000 pairs $30 per pair) Total cost of shoes (50,000 pairs $19.50 per pair) Sales commissions on first 40,000 pairs (40,000 pairs $1.50 per pair) Sales commissions on additional 10,000 pairs 3- 30.00 19.50 0 19.50 $ CMU, $30 – $19.50 a. Breakeven units, $441,000 $10.50 per unit b. Breakeven revenues, 42,000 units $30 per unit CMU, $30 – $21.30 a. Break even units = $360,000 $8.70 per unit b. Break even revenues = 41,380 units $30 per unit 9.00 40,000 50,000 $1,500,000 $ 975,000 60,000 [10,000 pairs ($1.50 + $0.30 per pair)] Total variable costs Contribution margin Fixed costs Operating income 18,000 $1,053,000 $ 447,000 360,000 $ 87,000 Alternative approach: Breakeven point in units = 40,000 pairs Store manager receives commission of $0.30 on 10,000 (50,000 – 40,000) pairs. Contribution margin per pair beyond breakeven point of 10,000 pairs = $8.70 ($30 – $21 – $0.30) per pair. Operating income = 10,000 pairs $8.70 contribution margin per pair = $87,000. 3- 3-39 (30 min.) CVP analysis, shoe stores (continuation of 3-38). Salaries + Commission Plan No. of CM units sold per Unit (1) (2) 40,000 $9.00 42,000 9.00 44,000 9.00 46,000 9.00 48,000 9.00 50,000 9.00 52,000 9.00 54,000 9.00 56,000 9.00 58,000 9.00 60,000 9.00 62,000 9.00 64,000 9.00 66,000 9.00 CM (3)=(1) (2) $360,000 378,000 396,000 414,000 432,000 450,000 468,000 486,000 504,000 522,000 540,000 558,000 576,000 594,000 Fixed Costs (4) $360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 360,000 Operating Income (5)=(3)– (5)=(3)–(4) 0 18,000 36,000 54,000 72,000 90,000 108,000 126,000 144,000 162,000 180,000 198,000 216,000 234,000 3- Higher Fixed Salaries Only CM per Unit (6) $10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 Operating CM Fixed Costs Income (7)=(1) (6) (8) (9)=(7)– (9)=(7)–(8) $420,000 $441,000 $ (21,000) 441,000 441,000 0 462,000 441,000 21,000 483,000 441,000 42,000 504,000 441,000 63,000 525,000 441,000 84,000 546,000 441,000 105,000 567,000 441,000 126,000 588,000 441,000 147,000 609,000 441,000 168,000 630,000 441,000 189,000 651,000 441,000 210,000 672,000 441,000 231,000 693,000 441,000 252,000 Difference in favor of higher-fixedsalary-only (10)=(9)– (10)=(9)–(5) $(21,000) (18,000) (15,000) (12,000) (9,000) (6,000) (3,000) 0 3,000 6,000 9,000 12,000 15,000 18,000 1. See preceding table. The new store will have the same operating income under either compensation plan when the volume of sales is 54,000 pairs of shoes. This can also be calculated as the unit sales level at which both compensation plans result in the same total costs: Let Q = unit sales level at which total costs are same forboth plans $19.50Q + $360,000 + $ $81,000 = $21Q + $360,000 $1.50 Q = $81,000 Q = 54,000 pairs 2. When sales volume is above 54,000 pairs, the higher-fixed-salaries plan results in lower costs and higher operating incomes than the salary-plus-commission plan. So, for an expected volume of 55,000 pairs, the owner would be inclined to choose the higher-fixed-salaries-only plan. But it is likely that sales volume itself is determined by the nature of the compensation plan. The salary-plus-commission plan provides a greater motivation to the salespeople, and it may well be that for the same amount of money paid to salespeople, the salary-plus-commission plan generates a higher volume of sales than the fixed-salary plan. 3. Let TQ = Target number of units For the salary-only plan, $30.00TQ – $19.50TQ – $441,000 $10.50TQ TQ TQ For the salary-plus-commission plan, $30.00TQ – $21.00TQ – $360,000 $9.00TQ TQ TQ = $168,000 = $609,000 = $609,000 ÷ $10.50 = 58,000 units = $168,000 = $528,000 = $528,000 ÷ $9.00 = 58,667 units (rounded up) The decision regarding the salary plan depends heavily on predictions of demand. For instance, the salary plan offers the same operating income at 58,000 units as the commission plan offers at 58,667 units. WalkRite Shoe Company Operating Income Statement, 2008 4. Revenues (48,000 pairs $30) + (2,000 pairs $18) Cost of shoes, 50,000 pairs $19.50 Commissions = Revenues 5% = $1,476,000 0.05 Contribution margin Fixed costs Operating income 3- $1,476,000 975,000 73,800 427,200 360,000 $ 67,200 3-40 (40 min.) Alternative cost structures, uncertainty, and sensitivity analysis. 1. Contribution margin assuming fixed rental arrangement = $50 – $30 = $20 per bouquet Fixed costs = $5,000 Breakeven point = $5,000 ÷ $20 per bouquet = 250 bouquets Contribution margin assuming $10 per arrangement rental agreement = $50 – $30 – $10 = $10 per bouquet Fixed costs = $0 Breakeven point = $0 ÷ $10 per bouquet = 0 (i.e. EB makes a profit no matter how few bouquets it sells) 2. Let x denote the number of bouquets EB must sell for it to be indifferent between the fixed rent and royalty agreement. To calculate x we solve the following equation. $50 x – $30 x – $5,000 = $50 x – $40 x $20 x – $5,000 = $10 x $10 x = $5,000 x = $5,000 ÷ $10 = 500 bouquets For sales between 0 to 500 bouquets, EB prefers the royalty agreement because in this range, $10 x > $20 x – $5,000. For sales greater than 500 bouquets, EB prefers the fixed rent agreement because in this range, $20 x – $5,000 > $10 x . 3. If we assume the $5 savings in variable costs applies to both options, we solve the following equation for x . $50 x – $25 x – $5,000 = $50 x – $35 x $25 x – $5,000 = $15 x $10 x = $5,000 x = $5,000 ÷ $10 per bouquet = 500 bouquets The answer is the same as in Requirement 2, that is, for sales between 0 to 500 bouquets, EB prefers the royalty agreement because in this range, $15 x > $25 x – $5,000. For sales greater than 500 bouquets, EB prefers the fixed rent agreement because in this range, $25 x – $5,000 > $15 x . 4. Fixed rent agreement: Bouquets Sold Revenue (1) (2) 200 200 $50=$10,000 400 400 $50=$20,000 600 600 $50=$30,000 800 800 $50=$40,000 1,000 1,000 $50=$50,000 Expected value of rent agreement 3- Fixed Costs (3) $5,000 $5,000 $5,000 $5,000 $5,000 Variable Costs (4) 200 $30=$ 6,000 400 $30=$12,000 600 $30=$18,000 800 $30=$24,000 1,000 $30=$30,000 Operating Income (Loss) (5)=(2)–(3)– (5)=(2)–(3)–(4) $ (1,000) $ 3,000 $ 7,000 $11,000 $15,000 Probability (6) 0.20 0.20 0.20 0.20 0.20 Expected Operating Income (7)=(5) (6) $ ( 200) 600 1,400 2,200 3,000 $7,000 Royalty agreement: Bouquets Variable Revenue Sold Costs (1) (2) (3) 200 200 $50=$10,000 200 $40=$ 8,000 400 400 $50=$20,000 400 $40=$16,000 600 600 $50=$30,000 600 $40=$24,000 800 800 $50=$40,000 800 $40=$32,000 1,000 1,000 $50=$50,000 1,000 $40=$40,000 Expected value of royalty agreement Operating Income (4)=(2)– (4)=(2)–(3) $2,000 $4,000 $6,000 $8,000 $10,000 Probability (5) 0.20 0.20 0.20 0.20 0.20 Expected Operating Income (6)=(4) (5) $ 400 800 1,200 1,600 2,000 $6,000 EB should choose the fixed rent agreement because the expected value is higher than the royalty agreement. EB will lose money under the fixed rent agreement if EB sells only 200 bouquets but this loss is more than made up for by high operating incomes when sales are high. 3-41 (20-30 min.) CVP, alternative cost structures. 1. Variable cost per glass of lemonade = $0.15 + ($0.10 ÷ 2) = $0.20 Contribution margin per glass = Selling price –Variable cost per glass = $0.50 – $0.20 = $0.30 Breakeven point = Fixed costs ÷ Contribution margin per glass = $6.00 ÷ $0.30 = 20 glasses (per day) Fixed costs + Target operating income Contribution margin per glass $6 + $3 = 30 glasses $0.30 3. Contribution margin per glass = Selling price – Variable cost per glass = $0.50 – $0.15 = $0.35 Fixed costs = $6 + $1.70 = $7.70 Fixed costs $7.70 Breakeven point = 22 glasses Contribution margin per glass $0.35 2. Target number of glasses = 4. Let x be the number of glasses for which Sarah is indifferent between hiring Jessica or hiring David. Sarah will be indifferent when the profits under the two alternatives are equal. $0.30 x – $6 = $0.35 x – $7.70 1.70 = 0.05 x x = $1.70 ÷ $0.05 = 34 glasses For sales between 0 and 34 glasses, Sarah prefers Jessica to squeeze the lemons because in this range, $0.30 x – $6 > $0.35 x – $7.70. For sales greater than 34 glasses, Sarah prefers David to squeeze the lemons because in this range, $0.35 x – $7.70 > $0.30 x – $6. 3- 3-42 (30 min.) CVP analysis, income taxes, sensitivity. 1a. To break even, Almo Company must sell 500 units. This amount represents the point where revenues equal total costs. Let Q denote the quantity of canopies sold. Revenue = Variable costs + Fixed costs $400Q = $200Q + $100,000 $200Q = $100,000 Q = 500 units Breakeven can also be calculated using contribution margin per unit. Contribution margin per unit = Selling price – Variable cost per unit = $400 – $200 = $200 Breakeven = Fixed Costs Contribution margin per unit = $100,000 $200 = 500 units 1b. To achieve its net income objective, Almo Company must sell 2,500 units. This amount represents the point where revenues equal total costs plus the corresponding operating income objective to achieve net income of $240,000. Revenue = Variable costs + Fixed costs + [Net income ÷ (1 – Tax rate)] $400Q = $200Q + $100,000 + [$240,000 (1 0.4)] $400 Q = $200Q + $100,000 + $400,000 Q = 2,500 units 2. To achieve its net income objective, Almo Company should select the first alternative where the sales price is reduced by $40, and 2,700 units are sold during the remainder of the year. This alternative results in the highest net income and is the only alternative that equals or exceeds the company’s net income objective. Calculations for the three alternatives are shown below. Alternative 1 Revenues Variable costs Operating income Net income = = = = ($400 350) + ($360a 2,700) = $1,112,000 $200 3,050b = $610,000 $1,112,000 $610,000 $100,000 = $402,000 $402,000 (1 0.40) = $241,200 a$400 – $40; b350 units + 2,700 units. Alternative 2 Revenues Variable costs Operating income Net income c$400 – $30; d$200 – $10. 3- = = = = ($400 350) + ($370c 2,200) = $954,000 ($200 350) + ($190d 2,200) = $488,000 $954,000 $488,000 $100,000 = $366,000 $366,000 (1 0.40) = $219,600 Alternative 3 Revenues Variable costs Operating income Net income = = = = ($400 350) + ($380e 2,000) = $900,000 $200 2,350f = $470,000 $900,000 $470,000 $90,000g = $340,000 $340,000 (1 0.40) = $204,000 e$400 – (0.05 $400) = $400 – $20; f350 units + 2,000 units; g$100,000 – $10,000 3-43 (30 min.) Choosing between compensation plans, operating leverage. 1. We can recast Marston’s income statement to emphasize contribution margin, and then use it to compute the required CVP parameters. Marston Corporation Income Statement For the Year Ended December 31, 2008 Revenues Variable Costs Cost of goods sold—variable Marketing commissions Contribution margin Fixed Costs Cost of goods sold—fixed Marketing—fixed Operating income Contribution margin percentage ($9,620,000 26,000,000; $11,700,000 $26,000,000) Breakeven revenues ($6,290,000 0.37; $8,370,000 0.45) Degree of operating leverage ($9,620,000 $3,330,000; $11,700,000 $3,330,000) Using Sales Agents $26,000,000 $11,700,000 4,680,000 2,870,000 3,420,000 Using Own Sales Force $26,000,000 $11,700,000 16,380,000 2,600,000 14,300,000 $9,620,000 $11,700,000 6,290,000 $3,330,000 2,870,000 5,500,000 8,370,000 $ 3,330,000 37% 45% $17,000,000 $18,600,000 2.89 3.51 The calculations indicate that at sales of $26,000,000, a percentage change in sales and contribution margin will result in 2.89 times that percentage change in operating income if Marston continues to use sales agents and 3.51 times that percentage change in operating income if Marston employs its own sales staff. The higher contribution margin per dollar of sales and higher fixed costs gives Marston more operating leverage, that is, greater benefits (increases in operating income) if revenues increase but greater risks (decreases in operating income) if revenues decrease. Marston also needs to consider the skill levels and incentives under the two alternatives. Sales agents have more incentive compensation and hence may be more motivated to increase sales. On the other hand, Marston’s own sales force may be more knowledgeable and skilled in selling the company’s products. That is, the sales volume itself will be affected by who sells and by the nature of the compensation plan. 2. 3- 3. Variable costs of marketing Fixed marketing costs Operating income = Revenues = 15% of Revenues = $5,500,000 Variable Fixed Variable Fixed marketing marketing manuf. costs manuf. costs costs costs Denote the revenues required to earn $3,330,000 of operating income by R, then R 0.45R $2,870,000 0.15R $5,500,000 = $3,330,000 R 0.45R 0.15R = $3,330,000 + $2,870,000 + $5,500,000 0.40R = $11,700,000 R = $11,700,000 0.40 = $29,250,000 3-44 (15–25 min.) Sales mix, three products. 1. Sales of A, B, and C are in ratio 20,000 : 100,000 : 80,000. So for every 1 unit of A, 5 (100,000 ÷ 20,000) units of B are sold, and 4 (80,000 ÷ 20,000) units of C are sold. Contribution margin of the bundle = 1 $3 + 5 $2 + 4 $1 = $3 + $10 + $4 = $17 $255,000 Breakeven point in bundles = = 15,000 bundles $17 Breakeven point in units is: Product A: 15,000 bundles × 1 unit per bundle 15,000 units Product B: 15,000 bundles × 5 units per bundle 75,000 units Product C: 15,000 bundles × 4 units per bundle 60,000 units Total number of units to breakeven 150,000 units Alternatively, Let Q = Number of units of A to break even 5Q = Number of units of B to break even 4Q = Number of units of C to break even Contribution margin – Fixed costs = Zero operating income $3Q + $2(5Q) + $1(4Q) – $255,000 $17Q Q 5Q 4Q Total 3- = 0 = $255,000 = 15,000 ($255,000 ÷ $17) units of A = 75,000 units of B = 60,000 units of C = 150,000 units 2. 3. Contribution margin: A:20,000 $3 $ 60,000 B:100,000 $2 C:80,000 $1 80,000 Contribution margin Fixed costs Operating income 200,000 $340,000 255,000 $ 85,000 Contribution margin A: 20,000 $3 B: 80,000 $2 C: 100,000 $1 Contribution margin Fixed costs Operating income $ 60,000 160,000 100,000 $320,000 255,000 $ 65,000 Sales of A, B, and C are in ratio 20,000 : 80,000 : 100,000. So for every 1 unit of A, 4 (80,000 ÷ 20,000) units of B and 5 (100,000 ÷ 20,000) units of C are sold. Contribution margin of the bundle = 1 $3 + 4 $2 + 5 $1 = $3 + $8 + $5 = $16 $255,000 Breakeven point in bundles = = 15,938 bundles (rounded up) $16 Breakeven point in units is: Product A: 15,938 bundles × 1 unit per bundle 15,938 units Product B: 15,938 bundles × 4 units per bundle 63,752 units Product C: 15,938 bundles × 5 units per bundle 79,690 units Total number of units to breakeven 159,380 units Alternatively, Let Q = Number of units of A to break even 4Q = Number of units of B to break even 5Q = Number of units of C to break even Contribution margin – Fixed costs = Breakeven point $3Q + $2(4Q) + $1(5Q) – $255,000 $16Q Q 4Q 5Q Total = = = = = = 0 $255,000 15,938 ($255,000 ÷ $16) units of A (rounded up) 63,752 units of B 79,690 units of C 159,380 units Breakeven point increases because the new mix contains less of the higher contribution margin per unit, product B, and more of the lower contribution margin per unit, product C. 3- 3-45 (40 min.) Multi-product CVP and decision making. 1. Faucet filter: Selling price Variable cost per unit Contribution margin per unit $80 20 $60 Pitcher-cum-filter: Selling price Variable cost per unit Contribution margin per unit $90 25 $65 Each bundle contains 2 faucet models and 3 pitcher models. So contribution margin of a bundle = 2 $60 + 3 $65 = $315 Breakeven Fixed costs $945,000 point in = 3,000 bundles Contribution margin per bundle $315 bundles Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,000 bundles 2 units per bundle = 6,000 units Pitcher models: 3,000 bundles 3 units per bundle = 9,000 units Total number of units to breakeven 15,000 units Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 6,000 units $80 per unit = $ 480,000 Pitcher models: 9,000 units $90 per unit = 810,000 Breakeven revenues $ 1,290,000 Alternatively, weighted average contribution margin per unit = Breakeven point = $945,000 15,000 units $63 2 15,000 units = 6,000 units 5 3 Pitcher-cum-filter: 15,000 units 9,000 units 5 Breakeven point in dollars Faucet filter: 6,000 units $80 per unit = $480,000 Pitcher-cum-filter: 9,000 units $90 per unit = $810,000 Faucet filter: 2. Faucet filter: Selling price Variable cost per unit Contribution margin per unit 3- $80 15 $65 (2 $60) + (3 $65) = $63 5 Pitcher-cum-filter: Selling price Variable cost per unit Contribution margin per unit $90 16 $74 Each bundle contains 2 faucet models and 3 pitcher models. So contribution margin of a bundle = 2 $65 + 3 $74 = $352 Breakeven Fixed costs $945,000 $181, 400 point in = 3, 200 bundles Contribution margin per bundle $352 bundles Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,200 bundles 2 units per bundle = 6,400 units Pitcher models: 3,200 bundles 3 units per bundle = 9,600 units Total number of units to breakeven 16,000 units Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 6,400 bundles $80 per unit = $ 512,000 Pitcher models: 9,600 bundles $90 per unit = 864,000 Breakeven revenues $1,376,000 Alternatively, weighted average contribution margin per unit = Breakeven point = $945,000+181,400 16, 000 units $70.40 (2 $65) + (3 $74) = $70.40 5 2 16,000 units = 6,400 units 5 3 Pitcher-cum-filter: 16, 000 units 9, 600 units 5 Breakeven point in dollars: Faucet filter: 6,400 units $80 per unit = $512,000 Pitcher-cum-filter: 9,600 units $90 per unit = $864,000 Faucet filter: 3. Let x be the number of bundles for Pure Water Products to be indifferent between the old and new production equipment. Operating income using old equipment = $315 x – $945,000 Operating income using new equipment = $352 x – $945,000 – $181,400 At point of indifference: $315 x – $945,000 = $352 x – $1,126,400 $352 x – $315 x = $1,126,400 – $945,000 $37 x = $181,400 x = $181,400 ÷ $37 = 4,902.7 bundles = 4,903 bundles (rounded) 3- Faucet models = 4,903 bundles 2 units per bundle = 9,806 units Pitcher models = 4,903 bundles 3 units per bundle = 14,709 units Total number of units 24,515 units Let x be the number of bundles, When total sales are less than 24,515 units (4,903 bundles), $315x $945,000 > $352x $1,126,400, so Pure Water Products is better off with the old equipment. When total sales are greater than 24,515 units (4,903 bundles), $352x $1,126,400 > $315x $945,000, so Pure Water Products is better off buying the new equipment. At total sales of 30,000 units (6,000 bundles), Pure Water Products should buy the new production equipment. Check $352 6,000 – $1,126,400 = $985,600 is greater than $315 6,000 –$945,000 = $945,000. 3-46 (20–25 min.) Sales mix, two products. 1. Sales of standard and deluxe carriers are in the ratio of 150,000 : 50,000. So for every 1 unit of deluxe, 3 (150,000 ÷ 50,000) units of standard are sold. Contribution margin of the bundle = 3 $6 + 1 $12 = $18 + $12 = $30 $1, 200,000 Breakeven point in bundles = = 40,000 bundles $30 Breakeven point in units is: Standard carrier: 40,000 bundles × 3 units per bundle 120,000 units Deluxe carrier: 40,000 bundles × 1 unit per bundle 40,000 units Total number of units to breakeven 160,000 units Alternatively, Let Q = Number of units of Deluxe carrier to break even 3Q = Number of units of Standard carrier to break even Revenues – Variable costs – Fixed costs = Zero operating income $20(3Q) + $30Q – $14(3Q) – $18Q – $1,200,000 $60Q + $30Q – $42Q – $18Q $30Q Q 3Q = = = = = 0 $1,200,000 $1,200,000 40,000 units of Deluxe 120,000 units of Standard The breakeven point is 120,000 Standard units plus 40,000 Deluxe units, a total of 160,000 units. 3- 2a. 2b. Unit contribution margins are: Standard: $20 – $14 = $6; Deluxe: $30 – $18 = $12 If only Standard carriers were sold, the breakeven point would be: $1,200,000 $6 = 200,000 units. If only Deluxe carriers were sold, the breakeven point would be: $1,200,000 $12 = 100,000 units 3. Operating income = Contribution margin of Standard + Contribution margin of Deluxe - Fixed costs = 180,000($6) + 20,000($12) – $1,200,000 = $1,080,000 + $240,000 – $1,200,000 = $120,000 Sales of standard and deluxe carriers are in the ratio of 180,000 : 20,000. So for every 1 unit of deluxe, 9 (180,000 ÷ 20,000) units of standard are sold. Contribution margin of the bundle = 9 $6 + 1 $12 = $54 + $12 = $66 $1, 200,000 Breakeven point in bundles = = 18,182 bundles (rounded up) $66 Breakeven point in units is: Standard carrier: 18,182 bundles × 9 units per bundle 163,638 units Deluxe carrier: 18,182 bundles × 1 unit per bundle 18,182 units Total number of units to breakeven 181,820 units Alternatively, Let Q = Number of units of Deluxe product to break even 9Q = Number of units of Standard product to break even $20(9Q) + $30Q – $14(9Q) – $18Q – $1,200,000 $180Q + $30Q – $126Q – $18Q $66Q Q 9Q = = = = = 0 $1,200,000 $1,200,000 18,182 units of Deluxe (rounded up) 163,638 units of Standard The breakeven point is 163,638 Standard + 18,182 Deluxe, a total of 181,820 units. The major lesson of this problem is that changes in the sales mix change breakeven points and operating incomes. In this example, the budgeted and actual total sales in number of units were identical, but the propor tion of the product having the higher contribution margin declined. Operating income suffered, falling from $300,000 to $120,000. Moreover, the breakeven point rose from 160,000 to 181,820 units. 3- 3-47 1. (20 min.) Gross margin and contribution margin margin. Ticket sales ($20 500 attendees) Variable cost of dinner ($10a 500 attendees) Variable invitations and paperwork ($1b 500) Contribution margin Fixed cost of dinner Fixed cost of invitations and paperwork Operating profit (loss) $10,000 $5,000 500 6,000 2,500 5,500 4,500 8,500 $ (4,000) a $5,000/500 b $500/500 2. attendees = $10/attendee attendees = $1/attendee Ticket sales ($20 1,000 attendees) Variable cost of dinner ($10 1,000 attendees) Variable invitations and paperwork ($1 1,000) Contribution margin Fixed cost of dinner Fixed cost of invitations and paperwork Operating profit (loss) 3-48 (30 min.) 1. Contribution margin percentage = = Breakeven revenues = = 6,000 2,500 11,000 9,000 8,500 $ 500 Revenues Variable costs Revenues $5,000,000 $3,000,000 $5,000,000 $2,000,000 = 40% $5,000,000 Fixed costs Contribution margin percentage $2,160,000 = $5,400,000 0.40 If variable costs are 52% of revenues, contribution margin percentage equals 48% (100% 52%) Breakeven revenues = = 3. $10,000 1,000 Ethics, CVP analysis. = 2. $20,000 Revenues Variable costs (0.52 $5,000,000) Fixed costs Operating income 3- Fixed costs Contribution margin percentage $2,160,000 = $4,500,000 0.48 $5,000,000 2,600,000 2,160,000 $ 240,000 4. Incorrect reporting of environmental costs with the goal of continuing operations is unethical. In assessing the situation, the specific “Standards of Ethical Conduct for Management Accountants” (described in Exhibit 1-7) that the management accountant should consider are listed below. Competence Clear reports using relevant and reliable information should be prepared. Preparing reports on the basis of incorrect environmental costs to make the company’s performance look better than it is violates competence standards. It is unethical for Bush not to report environmental costs to make the plant’s performance look good. Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. Bush may be tempted to report lower environmental costs to please Lemond and Woodall and save the jobs of his colleagues. This action, however, violates the responsibility for integrity. The Standards of Ethical Conduct require the management accountant to communicate favorable as well as unfavorable information. Credibility The management accountant’s Standards of Ethical Conduct require that information should be fairly and objectively communicated and that all relevant information should be disclosed. From a management accountant’s standpoint, underreporting environmental costs to make performance look good would violate the standard of objectivity. Bush should indicate to Lemond that estimates of environmental costs and liabilities should be included in the analysis. If Lemond still insists on modifying the numbers and reporting lower environmental costs, Bush should raise the matter with one of Lemond’s superiors. If after taking all these steps, there is continued pressure to understate environmental costs, Bush should consider resigning from the company and not engage in unethical behavior. 3-49 (35 min.) Deciding where to produce. Peoria Selling price Variable cost per unit Manufacturing Marketing and distribution Contribution margin per unit (CMU) Fixed costs per unit Manufacturing Marketing and distribution Operating income per unit CMU of normal production (as shown above) CMU of overtime production ($64 – $3; $48 – $8) 3- Moline $150.00 $72.00 14.00 30.00 19.00 86.00 64.00 49.00 $ 15.00 $150.00 $88.00 14.00 15.00 14.50 102.00 48.00 29.50 $ 18.50 $64 $48 61 40 1. Annual fixed costs = Fixed cost per unit Daily production rate Normal annual capacity ($49 400 units 240 days; $29.50 320 units 240 days) Breakeven volume = FC CMU of normal production ($4,704,000 $64; $2,265,600 48) 2. Units produced and sold Normal annual volume (units) (400 × 240; 320 × 240) Units over normal volume (needing overtime) CM from normal production units (normal annual volume CMU normal production) (96,000 × $64; 76,800 × 48) CM from overtime production units (0; 19,200 $40) Total contribution margin Total fixed costs Operating income Total operating income $4,704,000 $2,265,600 73,500units 47,200Units 96,000 96,000 96,000 0 76,800 19,200 $6,144,000 $3,686,400 0 6,144,000 4,704,000 $1,440,000 768,000 4,454,400 2,265,600 $2,188,800 $3,628,800 3. The optimal production plan is to produce 120,000 units at the Peoria plant and 72,000 units at the Moline plant. The full capacity of the Peoria plant, 120,000 units (400 units × 300 days), should be used because the contribution from these units is higher at all levels of production than is the contribution from units produced at the Moline plant. Contribution margin per plant: Peoria, 96,000 × $64 Peoria 24,000 × ($64 – $3) Moline, 72,000 × $48 Total contribution margin Deduct total fixed costs Operating income $ 6,144,000 1,464,000 3,456,000 11,064,000 6,969,600 $ 4,094,400 The contribution margin is higher when 120,000 units are produced at the Peoria plant and 72,000 units at the Moline plant. As a result, operating income will also be higher in this case since total fixed costs for the division remain unchanged regardless of the quantity produced at each plant. 3- CHAPTER 4 JOB COSTING 4-1 Cost pool––a grouping of individual cost items. Cost tracing––the assigning of direct costs to the chosen cost object. Cost allocation––the assigning of indirect costs to the chosen cost object. Cost-allocation base––a factor that links in a systematic way an indirect cost or group of indirect costs to a cost object. 4-2 In a job-costing system, costs are assigned to a distinct unit, batch, or lot of a product or service. In a process-costing system, the cost of a product or service is obtained by using broad averages to assign costs to masses of identical or similar units. 4-3 An advertising campaign for Pepsi is likely to be very specific to that individual client. Job costing enables all the specific aspects of each job to be identified. In contrast, the processing of checking account withdrawals is similar for many customers. Here, process costing can be used to compute the cost of each checking account withdrawal. 4-4 The seven steps in job costing are: (1) identify the job that is the chosen cost object, (2) identify the direct costs of the job, (3) select the cost-allocation bases to use for allocating indirect costs to the job, (4) identify the indirect costs associated with each cost-allocation base, (5) compute the rate per unit of each cost-allocation base used to allocate indirect costs to the job, (6) compute the indirect costs allocated to the job, and (7) compute the total cost of the job by adding all direct and indirect costs assigned to the job. 4-5 Two major cost objects that managers focus on in companies using job costing are (1) products or jobs, and (2) responsibility centers or departments. 4-6 Three major source documents used in job-costing systems are (1) job cost record or job cost sheet, a document that records and accumulates all costs assigned to a specific job, starting when work begins (2) materials requisition record, a document that contains information about the cost of direct materials used on a specific job and in a specific department; and (3) labor-time record, a document that contains information about the labor time used on a specific job and in a specific department. 4-7 The main concern with the source documents of job cost records is the accuracy of the records. Problems occurring in this area include incorrect recording of quantity or dollar amounts, materials recorded on one job being “borrowed” and used on other jobs, and erroneous job numbers being assigned to materials or labor inputs. 4-8 a. b. Two reasons for using an annual budget period are The numerator reason––the longer the time period, the less the influence of seasonal patterns, and The denominator reason––the longer the time period, the less the effect of variations in output levels on the allocation of fixed costs. 4-1 4-9 Actual costing and normal costing differ in their use of actual or budgeted indirect cost rates: Actual Normal Costing Costing Direct-cost rates Actual rates Actual rates Indirect-cost rates Actual rates Budgeted rates Each costing method uses the actual quantity of the direct-cost input and the actual quantity of the cost-allocation base. 4-10 A house construction firm can use job cost information (a) to determine the profitability of individual jobs, (b) to assist in bidding on future jobs, and (c) to evaluate professionals who are in charge of managing individual jobs. 4-11 The statement is false. In a normal costing system, the Manufacturing Overhead Control account will not, in general, equal the amounts in the Manufacturing Overhead Allocated account. The Manufacturing Overhead Control account aggregates the actual overhead costs incurred while Manufacturing Overhead Allocated allocates overhead costs to jobs on the basis of a budgeted rate times the actual quantity of the cost-allocation base. Underallocation or overallocation of indirect (overhead) costs can arise because of (a) the Numerator reason––the actual overhead costs differ from the budgeted overhead costs, and (b) the Denominator reason––the actual quantity used of the allocation base differs from the budgeted quantity. 4-12 Debit entries to Work-in-Process Control represent increases in work in process. Examples of debit entries under normal costing are (a) direct materials used (credit to Materials Control), (b) direct manufacturing labor billed to job (credit to Wages Payable Control), and (c) manufacturing overhead allocated to job (credit to Manufacturing Overhead Allocated). 4-13 Alternative ways to make end-of-period adjustments for underallocated or overallocated overhead are as follows: (i) Proration based on the total amount of indirect costs allocated (before proration) in the ending balances of work in process, finished goods, and cost of goods sold. (ii) Proration based on total ending balances (before proration) in work in process, finished goods, and cost of goods sold. (iii) Year-end write-off to Cost of Goods Sold. (iv) Restatement of all overhead entries using actual indirect cost rates rather than budgeted indirect cost rates. 4-14 A company might use budgeted costs rather than actual costs to compute direct labor rates because it may be difficult to trace direct labor costs to jobs as they are completed (for example, because bonuses are only known at the end of the year). 4-15 Modern technology such as electronic data interchange (EDI) is helpful to managers because it provides them with quick and accurate product-cost information that facilitates the management and control of jobs. 4-2 4-16 a. b. c. d. e. f. g. h. i. j. k. (10 min) Job order costing, process costing. Job costing Process costing Job costing Process costing Job costing Process costing Job costing Job costing (but some process costing) Process costing Process costing Job costing 4-17 l. m. n. o. p. q. r. s. t. u. Job costing Process costing Job costing Job costing Job costing Job costing Process costing Job costing Process costing Job costing (20 min.) Actual costing, normal costing, accounting for manufacturing overhead. Actual manufacturing overhead rate = Budgeted manufacturing overhead costs Budgeted direct manufacturing labor costs = 1. Budgeted manufacturing overhead rate $2, 700, 000 = 1.80 or 185% $1,500, 000 = Actual manufacturing overhead costs Actual direct manufacturing labor costs $2, 755, 000 = 1.9 or 190% $1, 450, 000 Costs of Job 626 under actual and normal costing follow: = 2. Actual Costing $ 40,000 30,000 4-3 $ 40,000 30,000 57,000 $127,000 Direct materials Direct manufacturing labor costs Manufacturing overhead costs $30,000 1.90; $30,000 1.80 Total manufacturing costs of Job 626 Normal Costing 54,000 $124,000 3. Total manufacturing overhead allocated under normal costing = Actual manufacturing Budgeted labor costs overhead rate = $1,450,000 1.80 = $2,610,000 Underallocated manufacturing = overhead Actual manufacturing – Manufacturing overhead costs overhead allocated = $2,755,000 $2,610,000 = $145,000 There is no under- or overallocated overhead under actual costing because overhead is allocated under actual costing by multiplying actual manufacturing labor costs and the actual manufacturing overhead rate. This, of course equals the actual manufacturing overhead costs. All actual overhead costs are allocated to products. Hence, there is no under- or overallocatead overhead. 4-18 1. (20 -30 min.) Job costing, normal and actual costing. Budgeted indirectcost rate = Budgeted indirect costs $8,000,000 = Budgeted direct labor-hours 160,000 hours = $50 per direct labor-hour Actual indirectcost rate = Actual indirect costs $6,888,000 = Actual direct labor-hours 164,000 hours = $42 per direct labor-hour These rates differ because both the numerator and the denominator in the two calculations are different—one based on budgeted numbers and the other based on actual numbers. Laguna Model Normal costing Direct costs Direct materials Direct labor Indirect costs Assembly support ($50 900; $50 1,010) Total costs 4-4 Mission Model $106,450 36,276 142,726 2a. $127,604 41,410 169,014 45,000 $187,726 50,500 $219,514 2b. Actual costing Direct costs Direct materials Direct labor $106,450 36,276 142,726 Indirect costs Assembly support ($42 900; $42 1,010) Total costs $127,604 41,410 169,014 37,800 $180,526 42,420 $211,434 3. Normal costing enables Anderson to report a job cost as soon as the job is completed, assuming that both the direct materials and direct labor costs are known at the time of use. Once the 900 direct labor-hours are known for the Laguna Model (June 2007), Anderson can compute the $187,726 cost figure using normal costing. Anderson can use this information to manage the costs of the Laguna Model job as well as to bid on similar jobs later in the year. In contrast, Anderson has to wait until the December 2007 year-end to compute the $180,526 cost of the Laguna Model using actual costing. Although not required, the following overview diagram summarizes Anderson Construction’s job-costing system. INDIRECT COST POOL Assembly Support COST ALLOCATION BASE Direct Labor-Hours COST OBJECT: RESIDENTIAL HOME Indirect Costs DIRECT COSTS Direct Costs Direct Materials 4-5 Direct Manufacturing Labor 4-19 (10 min.) Budgeted manufacturing overhead rate, allocated manufacturing overhead. 1. Budgeted manufacturing overhead rate = = 2. Budgeted manufacturing overhead Budgeted machine hours $4, 000, 000 = $20 per machine-hour 200, 000 machine-hours Manufacturing overhead allocated = Actual machine-hours ? Budgeted manufacturing overhead rate = 195,000 × $20 = $3,900,000 3. Since manufacturing overhead allocated is greater than the actual manufacturing overhead costs, Waheed overallocated manufacturing overhead: Manufacturing overhead allocated Actual manufacturing overhead costs Overallocated manufacturing overhead 4-6 $3,900,000 3,860,000 $ 40,000 4-20 (20-30 min.) Job costing, accounting for manufacturing overhead, budgeted rates. 1. An overview of the product costing system is INDIRECT COST POOL COST ALLOCATION BASE Machining Department Manufacturing Overhead Assembly Department Manufacturing Overhead Machine-Hours Indirect Costs COST OBJECT: PRODUCT DIRECT COST Direct Manuf. Labor Cost Direct Costs Direct Materials Direct Manufacturing Labor Budgeted manufacturing overhead divided by allocation base: Machining overhead Assembly overhead: 2. $1,800,000 = $36 per machine-hour 50,000 $3,600,000 = 180% of direct manuf. labor costs $2,000,000 Machining department, 2,000 hours $36 Assembly department, 180% $15,000 Total manufacturing overhead allocated to Job 494 $72,000 27,000 $99,000 Machining $2,100,000 Actual manufacturing overhead Manufacturing overhead allocated, 55,000 $36 180% $2,200,000 Underallocated (Overallocated) 4-7 Assembly $ 3,700,000 1,980,000 — $ 120,000 3. — 3,960,000 $ (260,000) 4-21 (2025 min.) Job costing, consulting firm. 1. Budgeted indirect-cost rate = $13,000,000 ÷ $5,000,000 = 260% of professional labor costs INDIRECT COST POOL Client Consulting Consulting Support Support COST ALLOCATION BASE Professional Professional Labor Costs Labor Costs COST OBJECT: JOB FOR CONSULTING CLIENT DIRECT COSTS 2. Indirect Costs Direct Costs Professional Labor At the budgeted revenues of $20,000,000, Taylor’s operating income of $2,000,000 equals 10% of revenues. Markup rate = $20,000,000 ÷ $5,000,000 = 400% of direct professional labor costs 4-8 3. Budgeted costs Direct costs: Director, $200 3 $ 600 Partner, $100 16 1,600 Associate, $50 40 2,000 Assistant, $30 160 4,800 Indirect costs: Consulting support, 260% $9,000 Total costs $ 9,000 23,400 $32,400 As calculated in requirement 2, the bid price to earn a 10% income-to-revenue margin is 400% of direct professional costs. Therefore, Taylor should bid 4 $9,000 = $36,000 for the Red Rooster job. Bid price to earn target operating income-to-revenue margin of 10% can also be calculated as follows: or, Let R = revenue to earn target income R – 0.10R = $32,400 0.90R = $32,400 R = $32,400 ÷ 0.90 = $36,000 Direct costs $ 9,000 Indirect costs 23,400 Operating income 3,600 Bid price $36,000 4-9 4-22 (15–20 min.) Service industry, time period used to compute indirect cost rates. 1. Direct labor costs Variable overhead costs as a percentage of direct labor costs Variable overhead costs (Percentage direct labor costs) Fixed overhead costs Total overhead costs Total overhead costs as a percentage of direct labor costs Jan– Jan–March $400,000 April– April–June $280,000 90% 60% $360,000 300,000 $660,000 165% Job 332 Direct materials Direct labor costs Overhead allocated (variable + fixed) (165%; 180%; 170% of $6,000) Full cost of Job 332 July– July–Sept $250,000 60% $168,000 300,000 $468,000 $150,000 300,000 $450,000 167% 180% Oct– Oct–Dec $270,000 Total $1,200,000 60% $162,000 300,000 $462,000 $ 840,000 1,200,000 $2,040,000 171% 170% Budgeted Overhead Rate Used Jan– Jan–March July– July–Sept Average Rate Rate Yearly Rate $10,000 $10,000 $10,000 6,000 6,000 6,000 9,900 $25,900 10,800 $26,800 10,200 $26,200 (a) The full cost of Job 332, using the budgeted overhead rate of 165% for January–March, is $25,900. (b) The full cost of Job 332, using the budgeted overhead rate of 180% for July–September, is $26,800. (c) The full cost of Job 332, using the annual budgeted overhead rate of 170%, is $26,200. 2. Budgeted fixed overhead rate based on annual fixed overhead costs and annual direct labor costs = $1,200,000 $1,200,000 = 100% Job 332 Direct materials Direct labor costs Variable overhead allocated (90%; 60%; of $6,000) Fixed overhead allocated (100% of $6,000) Full cost of Job 332 Budgeted Variable Overhead Rate Used January– January–March July– July–Sept rate rate $10,000 $10,000 6,000 6,000 5,400 6,000 $27,400 4-10 3,600 6,000 $25,600 (a) The full cost of Job 332, using the budgeted variable overhead rate of 90% for January–March and an annual fixed overhead rate of 100%, is $27,400. (b) The full cost of Job 332, using the budgeted variable overhead rate of 60% for July–September and an annual fixed overhead rate of 100%, is $25,600. 3. If Printers, Inc. sets prices at a markup of costs, then prices based on costs calculated as in Requirement 2 (rather than as in Requirement 1) would be more effective in deterring clients from sending in last-minute, congestion-causing orders in the January–March time frame. In this calculation, more variable manufacturing overhead costs are allocated to jobs in the first quarter, reflecting the larger costs of that quarter caused by higher overtime and facility and machine maintenance. This method better captures the cost of congestion during the first quarter. 4-23 1. (10–15 min.) Accounting for manufacturing overhead. Budgeted manufacturing overhead rate = $7,500, 000 250,000 = $30 per machine-hour 2. Work-in-Process Control 7,350,000 Manufacturing Overhead Allocated 7,350,000 (245,000 machine-hours $30 per machine-hour = $7,350,000) 3. $7,350,000– $7,300,000 = $50,000 overallocated, an insignificant amount of actual manufacturing overhead costs $50,000 ÷ $7,300,000 = 0.66%. Manufacturing Overhead Allocated 7,350,000 Manufacturing Department Overhead Control Cost of Goods Sold 4-11 7,300,000 50,000 4-24 (3545 min.) Job costing, journal entries. Some instructors may also want to assign Exercise 4-25. It demonstrates the relationships of the general ledger to the underlying subsidiary ledgers and source documents. 1. An overview of the product costing system is: INDIRECT COST POOL COST ALLOCATION BASE Manufacturing Overhead Direct Manufacturing Labor Costs Indirect Costs COST OBJECT: PRINT JOB DIRECT COST Direct Costs Direct Materials 4-12 Direct Manuf . Labor 2. & 3. This answer assumes COGS given of $4,020 does not include the writeoff of overallocated manufacturing overhead. 2. (1) Materials Control Accounts Payable Control (2) Work-in-Process Control Materials Control (3) Manufacturing Overhead Control Materials Control (4) Work-in-Process Control Manufacturing Overhead Control Wages Payable Control (5) Manufacturing Overhead Control Accumulated Depreciation––buildings and manufacturing equipment (6) Manufacturing Overhead Control Miscellaneous accounts (7) Work-in-Process Control Manufacturing Overhead Allocated (1.60 $1,300 = $2,080) (8) Finished Goods Control Work-in-Process Control (9) Accounts Receivable Control (or Cash) Revenues (10) Cost of Goods Sold Finished Goods Control (11) Manufacturing Overhead Allocated Manufacturing Overhead Control Cost of Goods Sold 4-13 800 800 710 710 100 100 1,300 900 2,200 400 400 550 550 2,080 2,080 4,120 4,120 8,000 8,000 4,020 4,020 2,080 1,950 130 3. Bal. 12/31/2008 (1) Purchases Bal. 12/31/2009 Bal. 12/31/2008 (2) Direct materials (4) Direct manuf. labor (7) Manuf. overhead allocated Bal. 12/31/2009 100 800 90 Materials Control (2) Issues (3) Issues Work-in-Process Control 60 (8)Goods completed 710 1,300 710 100 4,120 2,080 30 Bal. 12/31/2008 (8) Goods completed Bal. 12/31/2009 Finished Goods Control 500 (10) Goods sold 4,120 600 (10) Goods sold 4,020 Bal. 12/31/2009 3,890 (3) (4) (5) (6) Bal. Indirect materials Indirect manuf. labor Depreciation Miscellaneous (11) To close Cost of Goods Sold (11) Adjust for overallocation Manufacturing Overhead Control 100 (11) To close 900 400 550 0 Manufacturing Overhead Allocated 2,080 (7) Manuf. overhead allocated Bal. 4-14 4,020 130 1,950 2,080 0 4-25 (35 minutes) Journal entries, T-accounts, and source documents documents. 1. i. Direct Materials Control 124,000 Accounts Payable Control 124,000 Source Document: Purchase Invoice, Receiving Report Subsidiary Ledger: Direct Materials Record, Accounts Payable ii. Work in Process Control a 122,000 Direct Materials Control 122,000 Source Document: Material Requisition Records, Job Cost Record Subsidiary Ledger: Direct Materials Record, Work-in-Process Inventory, Records by Jobs iii. Work in Process Control 80,000 Manufacturing Overhead Control 54,500 Wages Payable Control 134,500 Source Document: Labor Time Records, Job Cost Records Subsidiary Ledger:, Manufacturing Overhead Records, Employee Labor Records, Work-inProcess Inventory Records by Jobs iv. Manufacturing Overhead Control 129,500 Salaries Payable Control 20,000 Accounts Payable Control 9,500 Accumulated Depreciation Control 30,000 Rent Payable Control 70,000 Source Document: Depreciation Schedule, Rent Schedule, Maintenance wages due, Invoices for miscellaneous factory overhead items Subsidiary Ledger: Manufacturing Overhead Records v. Work in Process Control 200,000 Manufacturing Overhead Allocated ($80,000 $2.50) Source Document: Labor Time Records, Job Cost Record Subsidiary Ledger: Work-in-Process Inventory Records by Jobs 200,000 vi. Finished Goods Control b 387,000 Work in Process Control 387,000 Source Document: Job Cost Record, Completed Job Cost Record Subsidiary Ledger: Work-in-Process Inventory Records by Jobs, Finished Goods Inventory Records by Jobs vii. Cost of Goods Sold c 432,000 Finished Goods Control Source Document: Sales Invoice, Completed Job Cost Record Subsidiary Ledger: Finished Goods Inventory Records by Jobs viii. Manufacturing Overhead Allocated Manufacturing Overhead Control Cost of Goods Sold 4-15 432,000 200,000 184,000 16,000 Source Document: Prior Journal Entries ix. Administrative Expenses 7,000 Marketing Expenses 120,000 Salaries Payable Control 30,000 Accounts Payable Control 90,000 Accumulated Depreciation, Office Equipment 7,000 Source Document: Depreciation Schedule, Marketing Payroll Request, Invoice for Advertising, Sales Commission Schedule. Subsidiary Ledger: Employee Salary Records, Administration Cost Records, Marketing Cost Records. a Materials used = Beginning direct materials inventory + Purchases Ending direct materials inventory = $9,000 + $124,000 $11,000 = $122,000 b Cost of goods manufactured = Beginning WIP inventory + Manufacturing cost Ending WIP inventory = $6,000 + ($122,000 + $80,000 + $200,000) $21,000 = 387,000 c Cost of Goods Sold = Beginning fin. goods inventory + Cost of goods manuf. Ending fin. goods inventory = $69,000 + $387,0000 $24,000 = $432,000 4-16 2. T-accounts Direct Materials Control 9,000 (2) Materials used 124,000 11,000 Bal. 1/1/2008 (1) Purchases Bal. 12/31/2008 122,000 Issues Work-in-Process Control Bal. 1/1/2008 6,000 (6) Cost of goods manufactured 387,000 (2) Direct materials used 122,000 (3) Direct manuf. labor 80,000 (5) Manuf. overhead allocated 200,000 Bal. 12/31/2008 21,000 Bal. 1/1/2008 (6) Cost of goods manuf. Bal. 12/31/2008 Finished Goods Control 69,000 (7) Cost of goods sold 387,000 24,000 (7) Cost of Goods Sold 432,000 (8) Adjust for overallocation Goods sold (3)Indirect labor (4) Supplies (4) Miscellaneous (4 Depreciation (4) Rent Bal. (8) To close Manufacturing Overhead Control 54,500 (8) To close 20,000 9,500 30,000 70,000 0 Manufacturing Overhead Allocated 200,000 (5) Manuf. overhead allocated Bal. 4-17 432,000 16,000 184,000 200,000 0 4-26 (45 min.) Job costing, journal entries. Some instructors may wish to assign Problem 4-24. It demonstrates the relationships of journal entries, general ledger, subsidiary ledgers, and source documents. 1. An overview of the product-costing system is INDIRECT COST POOL (3) (4) (5) (6) (7) (8) (9) (10a) (10b) Machine-Hours DIRECT COSTS (2) COST OBJECT PRODUCT (1) Manufacturing Overhead COST ALLOCATION BASE 2. Indirect Costs Direct Costs Direct Materials Direct Manuf. Labor Amounts in millions. Materials Control Accounts Payable Control Work-in-Process Control Materials Control Manufacturing Department Overhead Control Materials Control Work-in-Process Control Wages Payable Control Manufacturing Department Overhead Control Wages Payable Control Manufacturing Department Overhead Control Accumulated Depreciation Manufacturing Department Overhead Control Various liabilities Work-in-Process Control Manufacturing Overhead Allocated Finished Goods Control Work-in-Process Control Cost of Goods Sold Finished Goods Control Accounts Receivable Control (or Cash ) Revenues 4-18 150 150 145 145 10 10 90 90 30 30 19 19 9 9 63 63 294 294 292 292 400 400 The posting of entries to T-accounts is as follows: Bal. (1) Materials Control 12 (2) 150 (3) Bal. (9) Finished Goods Control 6 (10a) 294 (3) (5) (6) (7) Manufacturing Department Overhead Control 10 (11) 30 19 9 145 10 Bal. (2) (4) (8) Bal. Work-in-Process Control 2 (9) 145 90 63 6 292 (10a) (11) Cost of Goods Sold 292 5 150 Accumulated Depreciation (6) (10b) Manufacturing Overhead Allocated (11) 63 (8) 63 68 Accounts Payable Control (1) Wages Payable Control (4) (5) 19 Various Liabilities (7) Accounts Receivable Control 400 90 30 9 Revenues (10b) 400 The ending balance of Work-in-Process Control is $6. 3. 294 (11) Manufacturing Overhead Allocated Cost of Goods Sold Manufacturing Department Overhead Control Entry posted to T-accounts in Requirement 2. 4-19 63 5 68 4-27 (15 min.) Job costing, unit cost, ending work in progress. 1. Direct manufacturing labor rate per hour Manufacturing overhead cost allocated per manufacturing labor-hour $25 $20 Job M1 $275,000 11,000 2. Number of pipes produced for Job M1 Cost per pipe ($570,000 1,500) $160,000 Job M1 $ 75,000 275,000 220,000 $570,000 Job Costs May 2009 Direct materials Direct manufacturing labor Manufacturing overhead allocated Total costs 8,000 $220,000 Direct manufacturing labor costs Direct manufacturing labor hours ($275,000 $25; $200,000 $25) Manufacturing overhead cost allocated (11,000 $20; 8,000 $20) Job M2 $200,000 Job M2 $ 50,000 200,000 160,000 $410,000 1,500 $380 3. Finished Goods Control Work-in-Process Control 570,000 570,000 4. Raymond Company began May 2009 with no work-in-process inventory. During May, it started and finished M1. It also started M2, which is still in work-in-process inventory at the end of May. M2’s manufacturing costs up to this point, $410,000, remain as a debit balance in the Work-in-Process Inventory account at the end of May 2009. 4-20 4-28 1. (2030 min.) Job costing; actual, normal, and variation from normal costing. Actual direct cost rate for professional labor = $58 per professional labor-hour Actual indirect cost rate = $744,000 15,500 hours = $48 per professional labor-hour Budgeted direct cost rate for professional labor = $960,000 16,000 hours = $60 per professional labor-hour Budgeted indirect cost rate = $720,000 16,000 hours = $45 per professional labor-hour Direct-Cost Rate Indirect-Cost Rate 2. Direct Costs Indirect Costs Total Job Costs (a) (b) Actual Normal Costing Costing $58 $58 (Actual rate) (Actual rate) $48 $45 (Actual rate) (Budgeted rate) (c) Variation of Normal Costing $60 (Budgeted rate) $45 (Budgeted rate) (a) (b) (c) Actual Normal Variation of Costing Costing Normal Costing $58 120 = $ 6,960 $58 120 = $ 6,960 $60 120 = $ 7,200 48 120 = 5,760 45 120 = 5,400 45 120 = 5,400 $12,720 $12,360 $12,600 All three costing systems use the actual professional labor time of 120 hours. The budgeted 110 hours for the Pierre Enterprises audit job is not used in job costing. However, Chirac may have used the 110 hour number in bidding for the audit. The actual costing figure of $12,720 exceeds the normal costing figure of $12,360 because the actual indirect-cost rate ($48) exceeds the budgeted indirect-cost rate ($45). The normal costing figure of $12,360 is less than the variation of normal costing (based on budgeted rates for direct costs) figure of $12,600, because the actual direct-cost rate ($58) is less than the budgeted direct-cost rate ($60). 4-21 Although not required, the following overview diagram summarizes Chirac’s job-costing system. INDIRECT COST POOL COST ALLOCATION BASE Audit Support Professional Labor-Hours COST OBJECT: JOB FOR AUDITING PIERRE & CO. Indirect Costs Direct Costs DIRECT COST Professional Labor 4-22 4-29 (30 min.) Job order costing: actual, normal, and variation from normal costing. 1a. Actual costing Direct cost rate = Actual professional labor costs ÷ Actual professional labor-hours = $1,320,000 ÷ 22,000 hours = $60 per professional-hour Indirect cost rate = Actual support costs ÷ Actual professional labor-hours = $2,400,000 ÷ 22,000 hours = $109.09 per professional-hour 1b. Normal costing Budgeted professional hours = Budgeted hours per lawyer Number of lawyers = 2500 8 = 20,000 hours Direct cost rate = Actual professional labor costs ÷ Actual professional labor-hours = $1,320,000 ÷ 22,000 hours = $60 per professional-hour Indirect cost rate = Budgeted support costs ÷ Budgeted professional labor-hours = $2,000,000 ÷ 20,000 hours = $100 per professional-hour 1c. Variation from normal costing that uses budgeted rates for direct costs Direct cost rate Budgeted professional labor costs Budgeted professional labor-hours = $1,100,000 ÷ 20,000 hours = $55 per professional-hour Indirect cost rate = Budgeted support costs ÷ Budgeted professional labor-hours = $2,000,000 ÷ 20,000 hours = $100 per professional-hour 2. The costs of Ari Apostolus’ will under each method follow: a. Actual Costing Direct costs 4,000 hours $60 per hour $240,000 Indirect costs 4,000 hours $109.09 per hour 436,360 Total costs $676,360 b. Normal Costing Direct costs 4,000 hours $60 per hour Indirect costs 4,000 hours $100 per hour Total costs $240,000 400,000 $640,000 c. Variation from normal costing Direct costs 4,000 hours $55 per hour Indirect costs 4,000 hours $100 per hour Total costs $220,000 400,000 $620,000 4-23 4-30 (30 min.) Proration of overhead overhead. 1. Budgeted manufacturing overhead rate = Budgeted manufacturing overhead cost Budgeted direct manufacturing labor cost $100,000 50% of direct manufacturing labor cost $200,000 2. Overhead allocated = 50% Actual direct manufacturing labor cost = 50% $220,000 =$110,000 Overallocated plant overhead = Actual plant overhead costs – Allocated plant overhead costs = $106,000 – $110,000 = –$4,000 Overallocated plant overhead = $4,000 3a. All overallocated plant overhead is written off to cost of goods sold. Both work in process (WIP) and finished goods inventory remain unchanged. Proration of $4,000 Dec. 31, 2009 Balance Overallocated (Before Proration) Manuf. Overhead Account (1) (2) WIP $ 50,000 $ 0 Finished Goods 240,000 0 Cost of Goods Sold 560,000 4,000 Total $850,000 $4,000 Dec. 31, 2009 Balance (After Proration) (3) = (1) – (2) $ 50,000 240,000 556,000 $846,000 3b. Overallocated plant overhead prorated based on ending balances: Account WIP Finished Goods Cost of Goods Sold Total Dec. 31, 2009 Balance (Before Proration) (1) $ 50,000 240,000 560,000 $850,000 Balance as a Percent of Total (2) = (1) ÷ $850,000 0.0588 0.2824 0.6588 1.0000 Proration of $4,000 Overallocated Manuf. Overhead (3) = (2) $4,000 0.0588 $4,000 =$ 235 0.2824 $4,000 = 1,130 0.6588 $4,000 = 2,635 $4,000 Dec. 31, 2009 Balance (After Proration) (4) = (1) – (3) $ 49,765 238,870 557,365 $846,000 3c. Overallocated plant overhead prorated based on 2009 overhead in ending balances: Account WIP Finished Goods Cost of Goods Sold Total Dec. 31, 2009 Balance (Before Proration) (1) $ 50,000 240,000 560,000 $850,000 Allocated Manuf. Overhead in Dec. 31, 2009 Balance (2) $ 10,000a 30,000b 70,000c $110,000 4-24 Allocated Manuf. Overhead in Dec. 31, 31, 2009 Balance as a Percent of Total (3) = (2) ÷ $110,000 0.0909 0.2727 0.6364 1.0000 Proration of $4,000 Overallocated Manuf. Overhead (4) = (3) $4,000 0.0909 $4,000=$ 364 0.2727 $4,000= 1,091 0.6364 $4,000=$2,545 $4,000 Dec. 31, 2009 Balance (After Proration) (5) = (1) – (4) $ 49,636 238,909 557,455 $846,000 a,b,c Overhead allocated = Direct manuf. labor cost 50% = $20,000; 60,000; 140,000 50% 4. Writing off all of the overallocated plant overhead to Cost of Goods Sold (CGS) is usually warranted when CGS is large relative to Work-in-Process and Finished Goods Inventory and the overallocated plant overhead is immaterial. Both these conditions apply in this case. ROW should write off the $4,000 overallocated plant overhead to Cost of Goods Sold Account. 4-31 (2030 min) 1. Job costing, accounting for manufacturing overhead, budgeted rates. An overview of the job-costing system is: INDIRECT COST POOL COST ALLOCATION BASE Machining Department Manufacturing Overhead Finishing Department Manufacturing Overhead Machine-Hours in Machining Dept. Direct Manufacturing Labor Costs in Finishing Dept. Indirect Costs COST OBJECT: COST OBJECT: PRODUCT JOB DIRECT COST 2. Direct Costs Direct Materials Direct Manufacturing Labor Budgeted manufacturing overhead divided by allocation base: a. Machining Department: $10,000,000 = $50 per machine-hour 200,000 b. Finishing Department: $8,000,000 $4,000,000 = 200% of direct manufacturing labor costs 4-25 3. Machining Department overhead, $50 130 hours Finishing Department overhead, 200% of $1,250 Total manufacturing overhead allocated 4. Total costs of Job 431: Direct costs: Direct materials––Machining Department ––Finishing Department Direct manufacturing labor —Machining Department —Finishing Department Indirect costs: Machining Department overhead, $50 130 Finishing Department overhead, 200% of $1,250 Total costs $6,500 2,500 $9,000 $14,000 3,000 600 1,250 $6,500 2,500 $18,850 9,000 $27,850 The per-unit product cost of Job 431 is $27,850 ÷ 200 units = $139.25 per unit The point of this part is (a) to get the definitions straight and (b) to underscore that overhead is allocated by multiplying the actual amount of the allocation base by the budgeted rate. 5. Machining $11,200,000 Manufacturing overhead incurred (actual) Manufacturing overhead allocated 220,000 hours $50 11,000,000 200% of $4,100,000 Underallocated manufacturing overhead $ 200,000 Overallocated manufacturing overhead Total overallocated overhead = $300,000 – $200,000 = $100,000 Finishing $7,900,000 8,200,000 $ 300,000 6. A homogeneous cost pool is one where all costs have the same or a similar cause-andeffect or benefits-received relationship with the cost-allocation base. Solomon likely assumes that all its manufacturing overhead cost items are not homogeneous. Specifically, those in the Machining Department have a cause-and-effect relationship with machine-hours, while those in the Finishing Department have a cause-and-effect relationship with direct manufacturing labor costs. Solomon believes that the benefits of using two cost pools (more accurate product costs and better ability to manage costs) exceeds the costs of implementing a more complex system. 4-26 4-32 (1520 min.) Service industry, job costing, law firm. 1. INDIRECT COST POOL Legal Support COST ALLOCATION BASE Professional Labor-Hours COST OBJECT: JOB FOR CLIENT DIRECT COST Indirect Costs Direct Costs } Professional Labor 2. Budgeted professional = Budgeted direct labor compensation per professional labor-hour direct cost rate Budgeted direct labor-hours per professional $104,000 = 1,600 hours = $65 per professional labor-hour Note that the budgeted professional labor-hour direct-cost rate can also be calculated by dividing total budgeted professional labor costs of $2,600,000 ($104,000 per professional 25 professionals) by total budgeted professional labor-hours of 40,000 (1,600 hours per professional 25 professionals), $2,600,000 40,000 = $65 per professional labor-hour. 3. Budgeted total costs in indirect cost pool Budgeted total professional labor-hours $2,200,000 = 1,600 hours 25 $2,200,000 = 40,000 hours = $55 per professional labor-hour Budgeted indirect = cost rate 4. Direct costs: Professional labor, $65 100; $65 150 Indirect costs: Legal support, $55 100; $55 150 4-27 Richardson Punch $ 6,500 $ 9,750 5,500 $12,000 8,250 $18,000 4-33 (25–30 min.) Service industry, job costing, two direct- and indirect-cost categories, law firm (continuation of 4-32). Although not required, the following overview diagram is helpful to understand Keating’s jobcosting system. INDIRECT COST POOL General Support Secretarial Support COST ALLOCATION BASE Professional Labor-Hours Partner Labor-Hours COST OBJECT: JOB FOR CLIENT DIRECT COST } Indirect Costs Direct Costs Professional Associate Labor Professional Partner Labor 1. Budgeted compensation per professional Divided by budgeted hours of billable time per professional Budgeted direct-cost rate *Can also be calculated as †Can also be calculated as Professional Professional Partner Labor Associate Labor $ 200,000 $80,000 ÷1,600 $125 per hour* ÷1,600 $50 per hour† $200,000 5 $1,000,000 = 1,600 5 8,000 = $125 Total budgeted associate labor costs $80,000 20 $1,600,000 = = Total budgeted associate labor - hours 1,600 20 32,000 = $ 50 Total budgeted partner labor costs Total budgeted partner labor - hours 2. Budgeted total costs Divided by budgeted quantity of allocation base Budgeted indirect cost rate 4-28 = General Secretarial Support Support $1,800,000 $400,000 ÷ 40,000 hours ÷ 8,000 hours $45 per hour $50 per hour Richardson 3. Punch Direct costs: Professional partners, $125 60; $125 30 Professional associates, $50 40; $50 120 Direct costs Indirect costs: General support, $45 100; $45 150 Secretarial support, $50 60; $50 30 Indirect costs Total costs $7,500 2,000 $3,750 6,000 $ 9,500 $ 9,750 4,500 3,000 6,750 1,500 7,500 $17,000 8,250 $18,000 Richardson 4. Single direct - Single indirect (from Problem 4-32) Multiple direct – Multiple indirect (from requirement 3 of Problem 4-33) Difference Punch $12,000 $18,000 17,000 18,000 $ 5,000 undercosted $ 0 no change The Richardson and Punch jobs differ in their use of resources. The Richardson job has a mix of 60% partners and 40% associates, while Punch has a mix of 20% partners and 80% associates. Thus, the Richardson job is a relatively high user of the more costly partner-related resources (both direct partner costs and indirect partner secretarial support). The refined-costing system in Problem 4-32 increases the reported cost in Problem 4-32 for the Richardson job by 41.7% (from $12,000 to $17,000). 4-29 4-34 (2025 min.) Proration of overhead. 1. Budgeted manufacturing overhead rate is $4,800,000 ? 80,000 hours = $60 per machine-hour. 2. Manufacturing overhead = Manufacturing overhead – Manufacturing overhead underallocated incurred allocated = $4,900,000 – $4,500,000* = $400,000 *$60 75,000 actual machine-hours = $4,500,000 a. Write-off to Cost of Goods Sold Write-off of $400,000 Underallocated Manufacturing Overhead (3) Account Balance (Before Proration) (2) Account (1) Work in Process Finished Goods Cost of Goods Sold Total $ 750,000 1,250,000 8,000,000 $10,000,000 $ 0 0 Account Balance (After Proration) (4) = (2) + (3) $ 750,000 1,250,000 8,400,000 $10,400,000 400,000 $400,000 b. Proration based on ending balances (before proration) in Work in Process, Finished Goods and Cost of Goods Sold. Proration of $400,000 Underallocated Manufacturing Overhead (3) Account Balance Account (Before Proration) (1) (2) Work in Process $ 750,000 ( 7.5%) 0.075 $400,000 = $ 30,000 Finished Goods 1,250,000 (12.5%) 0.125 $400,000 = 50,000 Cost of Goods Sold 8,000,000 (80.0%) 0.800 $400,000 = 320,000 Total $10,000,000 100.0% $400,000 Account Balance (After Proration) (4) = (2) + (3) $ 780,000 1,300,000 8,320,000 $10,400,000 c. Proration based on the allocated overhead amount (before proration) in the ending balances of Work in Process, Finished Goods, and Cost of Goods Sold. Account Allocated Overhead Account Balance Included in Proration of $400,000 Balance (Before the Account Balance Underallocated (After Account Proration) (Before Proration) Manufacturing Overhead Proration) (1) (2) (3) (4) (5) (6) = (2) + (5) 0.0533 $400,000 = $ Work in Process $ a 750,000 $ 240,000 b Finished Goods 1,250,000 660,000 Cost of Goods Sold 8,000,000 3,600,000 Total c $10,000,000 $4,500,000 ( 5.33%) 21,320 (14.67%) 0.1467 $400,000 = 58,680 0.8000 $400,000 = (80.00%) 320,000 100.00% 4-30 $400,000 $ 771,320 1,308,680 8,320,000 $10,400,000 a b c $60 4,000 machine-hours; $60 11,000 machine-hours; $60 60,000 machine-hours 4-31 3. Alternative (c) is theoretically preferred over (a) and (b). Alternative (c) yields the same ending balances in work in process, finished goods, and cost of goods sold that would have been reported had actual indirect cost rates been used. Chapter 4 also discusses an adjusted allocation rate approach that results in the same ending balances as does alternative (c). This approach operates via a restatement of the indirect costs allocated to all the individual jobs worked on during the year using the actual indirect cost rate. 4-35 1a. (15 min.) Normal costing, overhead allocation, working backward. Manufacturing overhead allocated = 200% × Direct manufacturing labor cost $3,600,000 = 2 × Direct manufacturing labor cost Direct manufacturing labor cost = b. Total manufacturing = Direct material + Direct manufacturing + Manufacturing cost used labor cost overhead allocated $8,000,000 Direct material used 2. $3,600,000 = $1,800,000 2 = Direct material used + $1,800,000 + $3,600,000 = $2,600,000 Work in Process + Total manufacturing cost = Cost of goods manufactured + Work in Process 12/31/2009 1/1/2009 Denote Work-in-process on 12/31/2009 by X $320,000 + $8,000,000 = $7,920,000 + X X = $400,000 Work-in-process inventory, 12/31/09 = $400,000. 4-32 4-36 (40 min.) Proration of overhead with two indirect cost pools. 1.a. C & A department: Overhead allocated = $40 4,000 Machine hours = $160,000 Underallocated overhead = Actual overhead costs – Overhead allocated = $163,000 – 160,000 = $3,000 underallocated 1.b. Finishing department: Overhead allocated = $50 per direct labor-hour 2,000 direct labor-hours = $100,000 Overallocated overhead = Actual overhead costs – Overhead allocated = $87,000 – 100,000 = $13,000 overallocated 2a. All overallocated overhead is written off to cost of goods sold. Both Work in Process and Finished goods inventory remain unchanged. Account WIP Finished Goods Cost of Goods Sold Total Dec. 31, 2008 Balance (Before Proration) (1) $ 150,000 250,000 1,600,000 $2,000,000 Proration of $10,000 Overallocated Overhead (2) 0 0 +$3,000 –$13,000 $ 10,000 Dec. 31, 2008 Balance (After Proration) (3) = (1) + (2) $ 150,000 250,000 1,590,000 $1,990,000 2b. Overallocated overhead prorated based on ending balances Account WIP Finished Goods Cost of Goods Sold Total Dec. 31, 2008 Balance (Before Proration) (1) $ 150,000 250,000 1,600,000 $2,000,000 Balance as a Percent of Total (2) = (1) ÷ $2,000,000 0.075 0.125 0.800 1.000 Proration of $10,000 Overallocated Overhead (3) = (2) 10,000 0.075 × $10,000 = $ 750 0.125 × $10,000 = 1,250 0.800 × $10,000 = 8,000 $10,000 Dec. 31, 2008 Balanc (After Proration) (4) = (1) – (3) $ 149,250 248,750 1,592,000 $1,990,000 2c. Overallocated overhead prorated based on overhead in ending balances. (Note: overhead must be allocated separately from each department. This can be done using the number of machine hours/direct labor hours as a surrogate for overhead in ending balances.) 4-33 For C & A department: Account WIP Finished Goods Cost of Goods Sold Total Allocated Overhead in Dec. 31, 2008 Balance (1) 200 $40 = $ 8,000 600 $40 = 24,000 3,200 $40 = 128,000 $160,000 Allocated Overhead in Dec. 31, 2008 Balance as a Percent of Total (2) = (1) ÷ $160,000 0.05 0.15 0.80 1.00 Proration of $3,000 Underallocated Overhead (3) = (2) $3000 0.05 $3,000 = $ 150 0.15 $3,000 = 450 0.80 $3,000 = 2,400 $3,000 For finishing department: Account WIP Finished Goods Cost of Goods Sold Total Account WIP Finished Goods Cost of Goods Sold Total Allocated Overhead in Dec. 31, 2008 Balance (4) 100 $50 = $ 5,000 400 $50 = 20,000 1,500 $50 = 75,000 $100,000 Dec. 31, 2008 Balance (Before Proration) (7) $ 150,000 250,000 1,600,000 $2,000,000 Allocated Overhead in Dec. 31, 2008 Balance as a Percent of Total (5) = (4) ÷ $100,000 0.05 0.20 0.75 1.00 Proration of $13,000 Underallocated Overhead (6) = (5) $13,000 Underallocated/ Overallocated Overhead (8) = (3) – (6) $150 – $650 = $ (500) $450 – $2,600 = (2,150) $2,400 – $9,750 = (7,350) $(10,000) 0.05 $13,000 = $ 650 0.20 $13,000 = 2,600 0.75 $13,000 = 9,750 $13,000 Dec. 31, 2009 Balance (After Proration) (9) = (7) + (8) $ 149,500 247,850 1,592,650 $1,990,000 3. The first method is simple and Cost of Goods Sold accounts for 80% of the three account amounts. The amount of overallocated and underallocated overhead is also immaterial. Allocation to the other two accounts is minimal. Therefore, write-off to cost of goods sold is the most cost effective alternative. 4-34 4-37 (35 min.) General ledger relationships, under- and overallocation. The solution assumes all materials used are direct materials. A summary of the T-accounts for Needham Company before adjusting for under- or overallocation of overhead follows: Direct Materials Control 1-1-2008 Purchases 12-31-2008 Work-in-Process Control 30,000 Material used for 1-1-2008 400,000 manufacturing 380,000 Direct materials 50,000 Direct manuf. Labor Manuf. overhead allocated 12-31-2008 Finished Goods Control 1-1-2008 10,000 Cost of goods Transferred in sold from WIP 940,000 12-31-2008 50,000 20,000 Transferred to 380,000 finished goods 940,000 360,000 480,000 300,000 Cost of Goods Sold Finished goods 900,000 sold Manufacturing Overhead Control 900,000 Manufacturing Overhead Allocated Manufacturing overhead costs 540,000 Manufacturing overhead allocated to work in process 1. From Direct Materials Control T-account, Direct materials issued to production = $380,000 that appears as a credit. 2. Direct manufacturing labor-hours 480,000 Manufacturing overhead allocated Direct manufacturing labor costs Direct manufacturing wage rate per hour $360,000 = = 24,000 hours $15 per hour Manufacturing = Direct manufacturing overhead rate labor hours = 24,000 hours $20 per hour = $480,000 = 3. From the debit entry to Finished Goods T-account, Cost of jobs completed and transferred from WIP = $940,000 4. From Work-in-Process T-account, Work in process inventory = $20,000 + $380,000 + $360,000 + $480,000 – $940,000 on 12/31/2008 = $300,000 5. From the credit entry to Finished Goods Control T-account, Cost of goods sold (before proration) = $900,000 4-35 6. Manufacturing overhead underallocated 7. a. b. Debits to Manufacturing Credit to Manufacturing – Overhead Allocated Overhead Control = $540,000 – $480,000 = $60,000 underallocated = Write-off to Cost of Goods Sold will increase (debit) Cost of Goods Sold by $60,000. Hence, Cost of Goods Sold = $900,000 + $60,000 = $960,000. Proration based on ending balances (before proration) in Work in Process, Finished Goods, and Cost of Goods Sold. Account balances in each account after proration follows: Account (1) Work in Process Finished Goods Cost of Goods Sold Proration of $60,000 Account Balance Underallocated (Before Proration) Manufacturing Overhead (2) (3) $ 300,000 (24%) 0.24 $60,000 = $14,400 50,000 ( 4%) 0.04 $60,000 = 2,400 900,000 (72%) 0.72 $60,000 = 43,200 $1,250,000 100% $60,000 Account Balance (After Proration) (4)=(2)+(3) $ 314,400 52,400 943,200 $1,310,000 8. Needham’s operating income using write-off to Cost of Goods Sold and Proration based on ending balances (before proration) follows: Write-off to Cost of Goods Sold Revenues Cost of goods sold Gross margin Marketing and distribution costs Operating income/(loss) $1,090,000 960,000 130,000 140,000 $ (10,000) Proration Based on Ending Balances $1,090,000 943,200 146,800 140,000 $ 6,800 9. If the purpose is to report the most accurate inventory and cost of goods sold figures, the preferred method is to prorate based on the manufacturing overhead allocated component in the inventory and cost of goods sold accounts. Proration based on the balances in Work in Process, Finished Goods, and Cost of Goods Sold will equal the proration based on the manufacturing overhead allocated component if the proportions of direct costs to manufacturing overhead costs are constant in the Work in Process, Finished Goods and Cost of Goods Sold accounts. Even if this is not the case, the prorations based on Work in Process, Finished Goods, and Cost of Goods Sold will better approximate the results if actual cost rates had been used rather than the write-off to Cost of Goods Sold method. Another consideration in Needham’s decision about how to dispose of underallocated manufacturing overhead is the effects on operating income. The write-off to Cost of Goods Sold will lead to an operating loss. Proration based on the balances in Work in Process, Finished Goods, and Cost of Goods Sold will help Needham avoid the loss and show an operating income. The main merit of the write-off to Cost of Goods Sold method is its simplicity. However, accuracy and the effect on operating income favor the preferred and recommended proration approach. 4-36 4-38 (4055 min.) Overview of general ledger relationships. 1. & 3. An effective approach to this problem is to draw T-accounts and insert all the known figures. Then, working with T-account relationships, solve for the unknown figures (here coded by the letter X for beginning inventory figures and Y for ending inventory figures). Materials Control 15,000 (1) 85,000 100,000 30,000 X Purchases Y X (1) DM (2) DL (3) Overhead (a) (c) Y Work-in-Process Control 10,000 (4) 70,000 150,000 90,000 310,000 320,000 5,000 3,000 23,000 Y (5) Cost of Goods Sold 300,000 (d) (a) (b) (d) 70,000 305,000 305,000 Finished Goods Control 20,000 (5) 305,000 325,000 25,000 X (4) 70,000 Manufacturing Department Overhead Control 85,000 (d) 1,000 1,000 Manufacturing Overhead Allocated 93,000 (3) (c) 300,000 300,000 6,000 87,000 90,000 3,000 Manufacturing overhead cost rate = $90,000 ÷ $150,000 = 60% Wages Payable Control (a) 6,000 Various Accounts (b) 1,000 4-37 2. Adjusting and closing entries: (a) Work-in-Process Control Manufacturing Department Overhead Control Wages Payable Control To recognize payroll costs 5,000 1,000 (b) Manufacturing Department Overhead Control Various accounts To recognize miscellaneous manufacturing overhead 1,000 (c) Work-in-Process Control Manufacturing Overhead Allocated To allocate manufacturing overhead 3,000 6,000 1,000 3,000 Note: Students tend to forget entry (c) entirely. Stress that a budgeted overhead allocation rate is used consistently throughout the year. This point is a major feature of this problem. (d) Manufacturing Overhead Allocated 93,000 Manufacturing Department Overhead Control 87,000 Cost of Goods Sold 6,000 To close manufacturing overhead accounts and overallocated overhead to cost of goods sold An overview of the product-costing system is INDIRECT COST POOL COST ALLOCATION BASE Manufacturing Overhead Direct Manufacturing Labor Costs Indirect Costs Direct Costs COST OBJECT: JOB DIRECT COST 3. Direct Materials See the answer to 1. 4-38 Direct Manufacturing Labor 4-39 (30 min.) Allocation and proration of overhead overhead. 1. Budgeted overhead rate = Budgeted overhead costs ÷ Budgeted labor costs = £1,500 ÷ £2,000 = 75% of labor cost 2. Ending work in process Direct material costs Direct labor costs Overhead (0.75 × Direct labor costs) Total costs Job 1 £25 20 15 £60 Job 2 £15 32 Total £ 40 52 24 £71 39 £131 Cost of goods sold = Beginning WIP + Manufacturing costs – Ending WIP = £0 + (£900 + £1,800 + £1,800 × 0.75) – £131 = £3,919 3. Overhead allocated = 0.75 × £1,800 = £1,350 Overallocated overhead = Actual overhead – Allocated overhead = £1,250 – £1,350 = £100 overallocated 4.a. All overallocated overhead is written off to cost of goods sold. WIP inventory remains unchanged. Dec. 31, 1762 Account Balance Account (Before Proration) (1) (2) Work-in-Process £ 131 Cost of goods sold 3,919 £4,050 4b. Write-off of £100 Overallocated overhead (3) £ 0 (100) £(100) Dec. 31, 1762 Account Balance (After Proration) (4) = (2) + (3) £ 131 3,819 £3,950 Overallocated overhead prorated based on ending balances Account (1) Work-in-Process Cost of Goods Sold Dec. 31, 1762 Balance (Before Proration) (2) £ 131 3,919 £4,050 Balance as a Percent of Total (3) = (2) ÷ £4,050 0.03 0.97 1.00 Proration of £100 Overallocated Overhead (4) = (3) £100 £ (3) (97) £(100) Dec. 31, 1762 Balance (After Proration) (5) = (2) + (4) £ 128 3,822 £3,950 5. Writing off all of the overallocated overhead to Cost of Goods Sold (CGS) is warranted when CGS is large relative to Work-in-Process Inventory and Finished Goods Inventory and the overallocated overhead is immaterial. Both these conditions apply in this case. Franklin & Son Printing should write off the £100 overallocated overhead to Cost of Goods Sold account. 4-39 4-40 1. (20 min.) Job costing, contracting, ethics. Direct manufacturing costs: Direct materials Direct manufacturing labor Indirect manufacturing costs, 150% $6,000 Total manufacturing costs $25,000 6,000 $31,000 9,000 $40,000 Aerospace bills the Navy $52,000 ($40,000 130%) for 100 X7 seats or $520 ($52,000 100) per X7 seat. 2. a Direct manufacturing costs: Direct materials Direct manufacturing labora Indirect manufacturing costs, 150% $5,000 Total manufacturing costs $25,000 5,000 $30,000 7,500 $37,500 $6,000 – $400 ($25 16) setup – $600 ($50 12) design Aerospace should have billed the Navy $48,750 ($37,500 130%) for 100 X7 seats or $487.50 ($48,750 100) per X7 seat. 3. The problems the letter highlights (assuming it is correct) include the following: a. Costs included that should be excluded (design costs) b. Costs double-counted (setup included as both a direct cost and in an indirect cost pool) c. Possible conflict of interest in Aerospace Comfort purchasing materials from a family-related company Steps the Navy could undertake include the following: (i) Use only contractors with a reputation for ethical behavior as well as quality products or services. (ii) Issue guidelines detailing acceptable and unacceptable billing practices by contractors. For example, prohibiting the use of double-counting cost allocation methods by contractors. (iii) Issue guidelines detailing acceptable and unacceptable procurement practices by contractors. For example, if a contractor purchases from a family-related company, require that the contractor obtain quotes from at least two other bidders. (iv)Employ auditors who aggressively monitor the bills submitted by contractors. (v) Ask contractors for details regarding determination of costs. 4-40 4-41 (35 min.) Job costing-service industry industry. 1. Tours in Process (TIP) June 30, 2009 2. Complete (CCT) in 2009 Band As I Lay Dieing Ask Me Later Total Band Grunge Express Different Strokes Maybe Tomorrow Total Cost of Materials Labor Overhead Total d Tours (1) (2) (3) = 150% × (2) (4) June $250 $400 $600 $1,250 350 200 300 850 $600 $600 $900 $2,100 Materials Labor Overhead Total (1) (2) (3) = 150% × (2) (4) $ 400 $ 700 $1,050 $2,150 475 700 1,050 2,225 275 400 600 1,275 $1,150 $1,800 $2,700 $5,650 3. Overhead allocated = 1.50 × 1,400a = $2,100 Underallocated overhead = Actual overhead – Allocated overhead = $2,500 – 2,100 = $400 underallocated a Total labor in June = $100+$300+$400+$200+$400 = $1,400 4a. Underallocated overhead is written off to CCT CIP inventory remains unchanged. Account CIP CCT 4b. June 30, 2009 Balance (After Proration) (3) = (1) + (2) $2,100 6,050 $8,150 Underallocated overhead prorated based on ending balances Account TIP CCT 4c. June 30, 2009 Balance (Before Proration) (1) $2,100 5,650 $7,750 Proration of $400 Underallocated Overhead (2) $ 0 400 $400 June 30, 2009 Balance (Before Proration) (1) $2,100 5,650 $7,750 Balance as a Percent of Total (2) = (1) ÷ $7,750 0.271 0.729 1.000 Proration of $400 Underallocated Overhead (3) = (2) $400 0.271 $400 =$108 0.729 $400 = 292 $400 June 30, 2009 Balance (After Proration) (4) = (1) + (3) $2,208 5,942 $8,150 Underallocated overhead prorated based on June overhead in ending balances Account June 30, 2009 Balance Overhead allocated in June Included in 4-41 Overhead allocated in June Included in Proration of $400 Underallocated June 30, 2009 Balance TIP CCT a (Before Proration) (1) $2,100 5,650 $7,750 June 30, 2009 Balance (2) $ 900a 1,200b $2,100 June 30, 2009 as a Percent of Total (3) = (2) ÷ $2,100 0.43 0.57 1.00 Overhead (4) = (3) $400 0.43 $400 =$172 0.57 $400 = 228 $400 (After Proration) (5) = (1) + (4) $2,272 5,878 $8,150 June labor for As I Lay Dieing and Ask Me Later × 150% = ($400 + $200) × 150% = $600 × 150% = $900 June labor for Grunge Express, Different Strokes and Maybe Tomorrow × 150% = ($100 + $300 + $400) × 150% = $800 × $150 = $1,200 b 5. I would choose the method in 4c because this method results in account balances based on actual overhead allocation rates. The account balances before proration in TIP and CCT are significant and underallocated overhead is material. Furthermore, the ratio of ending balances in TIP and CCT is different from the ratio of overhead allocated to each of these accounts in June. 4-42 CHAPTER 5 ACTIVITY-BASED COSTING AND ACTIVITY-BASED MANAGEMENT 5-1 Broad averaging (or “peanut-butter costing”) describes a costing approach that uses broad averages for assigning (or spreading, as in spreading peanut butter) the cost of resources uniformly to cost objects when the individual products or services, in fact, use those resources in non-uniform ways. Broad averaging, by ignoring the variation in the consumption of resources by different cost objects, can lead to inaccurate and misleading cost data, which in turn can negatively impact the marketing and operating decisions made based on that information. 5-2 Overcosting may result in competitors entering a market and taking market share for products that a company erroneously believes are low-margin or even unprofitable. Undercosting may result in companies selling products on which they are in fact losing money, when they erroneously believe them to be profitable. 5-3 Costing system refinement means making changes to a simple costing system that reduces the use of broad averages for assigning the cost of resources to cost objects and provides better measurement of the costs of overhead resources used by different cost objects. Three guidelines for refinement are 1. Classify as many of the total costs as direct costs as is economically feasible. 2. Expand the number of indirect cost pools until each of these pools is more homogenous. 3. Use the cause-and-effect criterion, when possible, to identify the cost-allocation base for each indirect-cost pool. 5-4 An activity-based approach refines a costing system by focusing on individual activities as the fundamental cost objects. It uses the cost of these activities as the basis for assigning costs to other cost objects such as products or services. 5-5 Four levels of a cost hierarchy are (i) Output unit-level costs: costs of activities performed on each individual unit of a product or service. (ii) Batch-level costs: costs of activities related to a group of units of products or services rather than to each individual unit of product or service. (iii) Product-sustaining costs or service-sustaining costs: costs of activities undertaken to support individual products or services regardless of the number of units or batches in which the units are produced. (iv)Facility-sustaining costs: costs of activities that cannot be traced to individual products or services but support the organization as a whole. 5-6 It is important to classify costs into a cost hierarchy because costs in different cost pools relate to different cost-allocation bases and not all cost-allocation bases are unit-level. For example, an allocation base like setup hours is a batch-level allocation base, and design hours is a product-sustaining base, both insensitive to the number of units in a batch or the number of units of product produced. If costs were not classified into a cost hierarchy, the alternative would be to consider all costs as unit-level costs, leading to misallocation of those costs that are not unit-level costs. 5-1 5-7 An ABC approach focuses on activities as the fundamental cost objects. The costs of these activities are built up to compute the costs of products, and services, and so on. Simple costing systems have one or a few indirect cost pools, irrespective of the heterogeneity in the facility while ABC systems have multiple indirect cost pools. An ABC approach attempts to use cost drivers as the allocation base for indirect costs, whereas a simple costing system generally does not. The ABC approach classifies as many indirect costs as direct costs as possible. A simple costing system has more indirect costs. 5-8 Four decisions for which ABC information is useful are 1. pricing and product mix decisions, 2. cost reduction and process improvement decisions, 3. product design decisions, and 4. decisions for planning and managing activities. 5-9 No. Department indirect-cost rates are similar to activity-cost rates if (1) a single activity accounts for a sizable fraction of the department’s costs, or (2) significant costs are incurred on different activities within a department but each activity has the same cost-allocation base, or (3) significant costs are incurred on different activities with different cost-allocation bases within a department but different products use resources from the different activity areas in the same proportions. 5-10 “Tell-tale” signs that indicate when ABC systems are likely to provide the most benefits are as follows: 1. Significant amounts of indirect costs are allocated using only one or two cost pools. 2. All or most indirect costs are identified as output-unit-level costs (i.e., few indirect costs are described as batch-level, product-sustaining, or facility-sustaining costs). 3. Products make diverse demands on resources because of differences in volume, process steps, batch size, or complexity. 4. Products that a company is well suited to make and sell show small profits, whereas products that a company is less suited to produce and sell show large profits. 5. Operations staff has significant disagreements with the accounting staff about the costs of manufacturing and marketing products and services. 5-11 The main costs and limitations of ABC are the measurements necessary to implement the systems. Even basic ABC systems require many calculations to determine costs of products and services. Activity-cost rates often need to be updated regularly. Very detailed ABC systems are costly to operate and difficult to understand. Sometimes the allocations necessary to calculate activity costs often result in activity-cost pools and quantities of cost-allocation bases being measured with error. When measurement errors are large, activity-cost information can be misleading. 5-12 No, ABC systems apply equally well to service companies such as banks, railroads, hospitals, and accounting firms, as well merchandising companies such as retailers and distributors. 5-13 No. An activity-based approach should be adopted only if its expected benefits exceed its expected costs. It is not always a wise investment. If the jobs, products or services are alike in the way they consume indirect costs of a company, then a simple costing system will suffice. 5-2 5-14 Increasing the number of indirect-cost pools does NOT guarantee increased accuracy of product or service costs. If the existing cost pool is already homogeneous, increasing the number of cost pools will not increase accuracy. If the existing cost pool is not homogeneous, accuracy will increase only if the increased cost pools themselves increase in homogeneity vis-a-vis the single cost pool. 5-15 The controller faces a difficult challenge. The benefits of a better accounting system show up in improved decisions by managers. It is important that the controller have the support of these managers when seeking increased investments in accounting systems. Statements by these managers showing how their decisions will be improved by a better accounting system are the controller’s best arguments when seeking increased funding. For example, the new system will result in more accurate product costs which will influence pricing and product mix decisions. The new system can also be used to reduce product costs which will lower selling prices. As a result, the customer will benefit from the new system. 5-16 (20 min.) 1. Cost hierarchy. a. Indirect manufacturing labor costs of $1,200,000 support direct manufacturing labor and are output unit-level costs. Direct manufacturing labor generally increases with output units, and so will the indirect costs to support it. b. Batch-level costs are costs of activities that are related to a group of units of a product rather than each individual unit of a product. Purchase order-related costs (including costs of receiving materials and paying suppliers) of $600,000 relate to a group of units of product and are batch-level costs. c. Cost of indirect materials of $350,000 generally changes with labor hours or machine hours which are unit-level costs. Therefore, indirect material costs are output unitlevel costs. d. Setup costs of $700,000 are batch-level costs because they relate to a group of units of product produced after the machines are set up. e. Costs of designing processes, drawing process charts, and making engineering changes for individual products, $900,000, are product-sustaining because they relate to the costs of activities undertaken to support individual products regardless of the number of units or batches in which the product is produced. f. Machine-related overhead costs (depreciation and maintenance) of $1,200,000 are output unit-level costs because they change with the number of units produced. g. Plant management, plant rent, and insurance costs of $950,000 are facility-sustaining costs because the costs of these activities cannot be traced to individual products or services but support the organization as a whole. 5-3 2. The complex boom box made in many batches will use significantly more batch-level overhead resources compared to the simple boom box that is made in a few batches. In addition, the complex boom box will use more product-sustaining overhead resources because it is complex. Because each boom box requires the same amount of machine-hours, both the simple and the complex boom box will be allocated the same amount of overhead costs per boom box if Teledor uses only machine-hours to allocate overhead costs to boom boxes. As a result, the complex boom box will be undercosted (it consumes a relatively high level of resources but is reported to have a relatively low cost) and the simple boom box will be overcosted (it consumes a relatively low level of resources but is reported to have a relatively high cost). 3. Using the cost hierarchy to calculate activity-based costs can help Teledor to identify both the costs of individual activities and the cost of activities demanded by individual products. Teledor can use this information to manage its business in several ways: a. Pricing and product mix decisions. Knowing the resources needed to manufacture and sell different types of boom boxes can help Teledor to price the different boom boxes and also identify which boom boxes are more profitable. It can then emphasize its more profitable products. b. Teledor can use information about the costs of different activities to improve processes and reduce costs of the different activities. Teledor could have a target of reducing costs of activities (setups, order processing, etc.) by, say, 3% and constantly seek to eliminate activities and costs (such as engineering changes) that its customers perceive as not adding value. c. Teledor management can identify and evaluate new designs to improve performance by analyzing how product and process designs affect activities and costs. d. Teledor can use its ABC systems and cost hierarchy information to plan and manage activities. What activities should be performed in the period and at what cost? 5-17 (25 min.) ABC, cost hierarchy, service. 1. Output unit-level costs a. Direct-labor costs, $243,000 b. Equipment-related costs (rent, maintenance, energy, and so on), $400,000 These costs are output unit-level costs because they are incurred on each unit of materials tested, that is, for every hour of testing. Batch-level costs c. Setup costs, $385,000 These costs are batch-level costs because they are incurred each time a batch of materials is set up for either HT or ST, regardless of the number of hours for which the tests are subsequently run. Service-sustaining costs d. Costs of designing tests, $252,000. These costs are service-sustaining costs because they are incurred to design the HT and ST tests, regardless of the number of batches tested or the number of hours of test time. 5-4 2. Heat Testing (HT) Per Hour Total (2) = (1) (1) 50,000 Direct labor costs (given) Equipment-related costs $5 per hour* 50,000 hours $5 per hour* 30,000 hours Setup costs $22 per setup-hour† 13,500 setup-hours $22 per setup-hour† 4,000 setup-hours Costs of designing tests $60 per hour** 2,800 hours $60 per hour** 1,400 hours Total costs $183,000 $ 3.66 250,000 Stress Testing (ST) Per Hour Total (4) = (3) (3) 30,000 $ 60,000 $ 2.00 5.00 150,000 88,000 297,000 168,000 5.00 2.93 5.94 3.36 84,000 $898,000 $17.96 $382,000 2.80 $12.73 *$400,000 (50,000 + 30,000) hours = $5 per test-hour †$385,000 (13,500 + 4,000) setup hours = $22 per setup-hour **$252,000 (2,800 + 1,400) hours = $60 per hour At a cost per test-hour of $16, the simple costing system undercosts heat testing ($17.96) and overcosts stress testing ($12.73). The reason is that heat testing uses direct labor, setup, and design resources per hour more intensively than stress testing. Heat tests are more complex, take longer to set up, and are more difficult to design. The simple costing system assumes that testing costs per hour are the same for heat testing and stress testing. 3. The ABC system better captures the resources needed for heat testing and stress testing because it identifies all the various activities undertaken when performing the tests and recognizes the levels of the cost hierarchy at which costs vary. Hence, the ABC system generates more accurate product costs. Plymouth’s management can use the information from the ABC system to make better pricing and product mix decisions. For example, it might decide to increase the prices charged for the more costly heat testing and consider reducing prices on the less costly stress testing. Plymouth should watch if competitors are underbidding Plymouth in stress testing, and causing it to lose business. Plymouth can also use ABC information to reduce costs by eliminating processes and activities that do not add value, identifying and evaluating new methods to do testing that reduce the activities needed to do the tests, reducing the costs of doing various activities, and planning and managing activities. 5-5 5-18 (15 min.) Alternative allocation bases for a professional services firm. 1. Direct Professional Time Rate per Number Hour of Hours Total (2) (3) (4) = (2) (3) Support Services Rate (5) Amount Billed to Total Client (7) = (4) + (6) (6) = (4) (5) Client (1) SEATTLE DOMINION Wolfson Brown Anderson $500 120 80 15 3 22 $7,500 360 1,760 30% 30 30 $2,250 108 528 $ 9,750 468 2,288 $12,506 TOKYO ENTERPRISES Wolfson Brown Anderson $500 120 80 2 8 30 $1,000 960 2,400 30% 30 30 $300 288 720 $1,300 1,248 3,120 $5,668 2. Client (1) SEATTLE DOMINION Wolfson Brown Anderson Direct Professional Time Support Services Rate Number Rate per per of Hours Total Hour Total Hour (2) (3) (5) (4) = (2) (3) (6) = (3) (5) Amount Billed to Client (7) = (4) + (6) $500 120 80 15 3 22 $7,500 360 1,760 $50 50 50 $ 750 150 1,100 $ 8,250 510 2,860 $11,620 TOKYO ENTERPRISES Wolfson $500 Brown 120 Anderson 80 2 8 30 $1,000 960 2,400 $50 50 50 $ 100 400 1,500 $1,100 1,360 3,900 $6,360 Seattle Dominion Tokyo Enterprises Requirement 1 $12,506 5,668 $18,174 5-6 Requirement 2 $11,620 6,360 $17,980 Both clients use 40 hours of professional labor time. However, Seattle Dominion uses a higher proportion of Wolfson’s time (15 hours), which is more costly. This attracts the highest supportservices charge when allocated on the basis of direct professional labor costs. 3. Assume that the Wolfson Group uses a cause-and-effect criterion when choosing the allocation base for support services. You could use several pieces of evidence to determine whether professional labor costs or hours is the driver of support-service costs: a. Interviews with personnel. For example, staff in the major cost categories in support services could be interviewed to determine whether Wolfson requires more support per hour than, say, Anderson. The professional labor costs allocation base implies that an hour of Wolfson’s time requires 6.25 ($500 ÷ $80) times more support-service dollars than does an hour of Anderson’s time. b. Analysis of tasks undertaken for selected clients. For example, if computer-related costs are a sizable part of support costs, you could determine if there was a systematic relationship between the percentage involvement of professionals with high billing rates on cases and the computer resources consumed for those cases. 5-19 (20 min.) Plantwide, department and ABC indirect cost rates. 1. Actual plant-wide variable MOH rate based on machine hours, $308,600 4,000 $77.15 per machine hour United Motors Variable manufacturing overhead, allocated based on machine hours ($77.15 120; $77.15 2,800; $77.15 1,080) $9,258 Holden Motors Leland Vehicle Total $216,020 $83,322 $308,600 2. Department Design Production Engineering Variable MOH in 2007 $39,000 29,600 240,000 Total Driver Units 390 370 4,000 Rate $100 $ 80 $ 60 per CAD-design hour per engineering hour per machine hour United Motors Design-related overhead, allocated on CAD-design hours (110 $100; 200 $100; 80 $100) Production-related overhead, allocated on engineering hours (70 $80; 60 $80; 240 $80) Engineering-related overhead, allocated on machine hours (120 $60; 2,800 $60; 1,080 $60) Total 5-7 Holden Motors Leland Vehicle Total $11,000 $ 20,000 $ 8,000 $ 39,000 5,600 4,800 19,200 29,600 7,200 $23,800 168,000 $192,800 64,800 $92,000 240,000 $308,600 3. United Motors a. Department rates (Requirement 2) $23,800 b. Plantwide rate (Requirement 1) $ 9,258 Ratio of (a) ÷ (b) 2.57 Holden Motors Leland Vehicle $192,800 $92,000 $216,020 0.89 $83,322 1.10 The variable manufacturing overhead allocated to United Motors increases by 157% under the department rates, the overhead allocated to Holden decreases by about 11% and the overhead allocated to Leland increases by about 10%. The three contracts differ sizably in the way they use the resources of the three departments. The percentage of total driver units in each department used by the companies is: Cost Department Driver Design CAD-design hours Engineering Engineering hours Production Machine hours United Motors 28% 19 3 Holden Motors 51% 16 70 Leland Vehicle 21% 65 27 The United Motors contract uses only 3% of total machines hours in 2004, yet uses 28% of CAD design-hours and 19% of engineering hours. The result is that the plantwide rate, based on machine hours, will greatly underestimate the cost of resources used on the United Motors contract. This explains the 157% increase in indirect costs assigned to the United Motors contract when department rates are used. In contrast, the Holden Motors contract uses less of design (51%) and engineering (16%) than of machine-hours (70%). Hence, the use of department rates will report lower indirect costs for Holden Motors than does a plantwide rate. Holden Motors was probably complaining under the use of the simple system because its contract was being overcosted relative to its consumption of MOH resources. United, on the other hand was having its contract undercosted and underpriced by the simple system. Assuming that AP is an efficient and competitive supplier, if the new department-based rates are used to price contracts, United will be unhappy. AP should explain to United how the calculation was done, and point out United’s high use of design and engineering resources relative to production machine hours. Discuss ways of reducing the consumption of those resources, if possible, and show willingness to partner with them to do so. If the price rise is going to be steep, perhaps offer to phase in the new prices. 4. Other than for pricing, AP can also use the information from the department-based system to examine and streamline its own operations so that there is maximum value-added from all indirect resources. It might set targets over time to reduce both the consumption of each 5-8 indirect resource and the unit costs of the resources. The department-based system gives AP more opportunities for targeted cost management. 5. It would not be worthwhile to further refine the cost system into an ABC system if there wasn’t much variation among contracts in the consumption of activities within a department. If, for example, most activities within the design department were, in fact, driven by CAD-design hours, then the more refined system would be more costly and no more accurate than the department-based cost system. Even if there was sufficient variation, considering the relative sizes of the 3 department cost pools, it may only be cost-effective to further analyze the engineering cost pool, which consumes 78% ($240,000 $308,600) of the manufacturing overhead. 5-20 (10–15 min.) ABC, process costing. Note to instructors: The “number of production runs” for the financial calculator should be runs” 50 and not 0. Please announce this change to your students before assigning this problem. Rates per unit cost driver. Activity Cost Driver Machining Machine-hours Rate $375,000 ÷ (25,000 + 50,000) = $5 per machine-hour Set up Production runs $120,000 ÷ (50 + 50) = $1,200 per production run Inspection Inspection-hours $105,000 ÷ (1,000 + 500) = $70 per inspection-hour Overhead cost per unit: Machining: $5 × 25,000; 50,000 Set up: $1,200 × 50; $1,200 × 50 Inspection: $70 × 1,000; $70 × 500 Total manufacturing overhead costs Divide by number of units Manufacturing overhead cost per unit Mathematical $125,000 60,000 70,000 $255,000 ÷ 50,000 $ 5.10 Financial $250,000 60,000 35,000 $345,000 ÷100,000 $ 3.45 2. Mathematical Financial Manufacturing cost per unit: Direct materials $150,000 ÷ 50,000 $300,000 ÷ 100,000 Direct manufacturing labor $50,000 ÷ 50,000 $100,000 ÷ 100,000 Manufacturing overhead (from requirement 1) Manufacturing cost per unit 5-9 $3.00 $3.00 1.00 5.10 $9.10 1.00 3.45 $7.45 5-10 5-21 1. (30 min.) Activity-based costing, service company. Total indirect costs = $150,000 + $90,000 + $36,000 + $40,000 + $39,000 + $48,000 = $403,000 Total machine-hours = (400 10) + (200 10) = 6,000 Indirect cost rate per machine-hour = $403,000 6,000 = $67.17 per machine-hour Simple Costing System Cost of supplies per job Direct manufacturing labor cost per job Indirect cost allocated to each job (10 machine hours $67.17 per machine hour) Total costs 2. Standard Job $ 200.00 180.00 Special Job $ 250.00 200.00 671.70 $1,051.70 671.70 $1,121.70 Activity-based Costing System Quantity of Cost Driver Consumed during 2007 (see column (1)) Activity (1) Machine operations (400 jobs 10 mach. hrs. per job; 200 jobs 10 mach. hrs. per job) Setups (4 400; 7 200) Purchase orders (given) Design Marketing Administration ($180 400; $200 200) Cost Driver (2) machine hours setup hours no. of purchase orders selling price dir. mfg. labor costs Standard Job (3) 4,000 Special Job (4) 2,000 1,600 400 1,400 500 $72,000 $40,000 Cost of supplies ($200 400; $250 200) Direct manuf. labor costs ($180 400; $200 200) Indirect costs allocated: Machine operations ($25 per mach. hr. 4,000; 2,000) Setups ($30 per setup hr. 1,600; 1,400) Purchase orders ($40 per order 400; 500) Design Marketing (0.05 $1,200 400; 0.05 $1,500 200) Administration ($0.42857 72,000; 40,000) Total costs Cost of each job ($378,857 400; $266,143 200) 5-11 Total Cost of Activity (given) (5) $150,000 $ $ $ $ $ 90,000 36,000 40,000 39,000 48,000 Allocation Rate (6) = (5) ((3) + (4)), or given $ 25.00 per machine hour $ $ 30.00 40.00 per setup hour per purchase order $ 0.05 $0.42857 per dollar of sales per dollar of direct manuf. labor cost Total Costs Standard Special Job Job $ 80,000 $ 50,000 72,000 40,000 100,000 48,000 16,000 8,000 24,000 30,857 $378,857 $ 947.14 50,000 42,000 20,000 32,000 15,000 17,143 $266,143 $1,330.72 3. Cost per job Simple Costing System Activity-based Costing System Difference (Simple – ABC) Standard Job $1,051.70 $ 947.14 $ 104.56 Special Job $1,121.70 $1,330.72 $ (209.02) Relative to the ABC system, the simple costing system overcosts standard jobs and undercosts special jobs. Both types of jobs need 10 machine hours per job, so in the simple system, they are each allocated $671.70 in indirect costs. But, the ABC study reveals that each standard job consumes less of the indirect resources such as setups, purchase orders, and design costs than a special job, and this is reflected in the higher indirect costs allocated to special jobs in the ABC system. 4. Quikprint can use the information revealed by the ABC system to change its pricing based on the ABC costs. Under the simple system, Quikprint was making a gross margin of 12% on each standard job (($1,200 – $1,051.70) $1,200) and 25% on each special job (($1,500 – $1,121.70) $1,500). But, the ABC system reveals that it is actually making a gross margin of about 21% (($1,200 – $947) $1,200) on each standard job and about 11% (($1,500 – $1,331) $1,500) on each special job. Depending on the market competitiveness, Quikprint may either want to reprice the different types of jobs, or, it may choose to market standard jobs more aggressively than before. Quikprint can also use the ABC information to improve its own operations. It could examine each of the indirect cost categories and analyze whether it would be possible to deliver the same level of service, but consume fewer indirect resources, or find a way to reduce the perunit-cost-driver cost of some of those indirect resources. 5-12 5-22 (25 min.) Allocation of costs to activities, unused capacity. 1. Indirect Resources Teachers’ salaries and benefits Principals’ salaries and benefits Facilities cost Office staff salaries and benefits Sports program staff salaries and benefits Percentage of Costs Used by Each Activity Academic Sports Community Administration Instruction Training Relationships 60% 20% 8% 12% 10% 60% 5% 25% 35% 15% 45% 5% 5% 60% 10% 25% 35% 10% 45% 10% 2009 Expenditures $4,000,000 400,000 2,600,000 300,000 500,000 $7,800,000 Actual Resource Cost Used by Each Activity Indirect Resources Teachers’ salaries and benefits Principals’ salaries and benefits Facilities cost Office staff salaries and benefits Sports program staff salaries and benefits Total No. of students Cost per student Percent of total cost by activity Academic Instruction $2,400,000 40,000 910,000 15,000 175,000 $3,540,000 Administration $ 800,000 240,000 390,000 180,000 50,000 $1,660,000 Sports Training $ 320,000 20,000 1,170,000 30,000 225,000 $1,765,000 Community Relationships $480,000 100,000 130,000 75,000 50,000 $835,000 2006 Expenditures $4,000,000 400,000 2,600,000 300,000 500,000 $7,800,000 500 $7,080 45% 500 $ 3,320 21% 500 $3,530 23% 500 $1,670 11% 500 $15,600 100% The overall cost of educating each student is $15,600. Of this, $7,080 (or 45%) is spent on academic instruction and $3,320 (or 21%) is spent on administration. 2. Cost of ice hockey program $ 300,000 Total cost of activities without ice hockey program = $7,800,000 – $300,000 = $7,500,000 Per student cost of educational program without hockey = $7,500,000 500 = $ 15,000 3. Net cost of ice hockey program with $1,000 fee = $300,000 – (30 $1,000) = $ 270,000 Total cost of activities with ice hockey program fee = $7,500,000 + $270,000 = $7,770,000 Per student cost of educational program with hockey fee = $7,770,000 500 = $ 15,540 Charging a fee helps a bit but the net cost of the ice hockey program is still high and significantly increases the cost of educating each student 5-13 4. Academic instruction capacity Cost of academic instruction activity (from requirement 1 calculations) Cost of academic instruction per student at full utilization = $3,540,000 600 Academic instruction resource costs used by current student population = 500 $5,900 Cost of excess academic instruction capacity = $3,540,000 – $2,950,000 600 students $3,540,000 $ 5,900 $2,950,000 $ 590,000 Most of the costs at Harmon school are fixed in the short-run. So, Smith must try to recruit more students to the school. If, in the long run, it seems like the student population is going to be stable at around 500, he should plan how some of the excess capacity can be cut back so that the fixed school capacity is better utilized, that is, he should work to reduce the cost of excess capacity. One problem with that plan is that “cutting excess academic instruction capacity” may eventually mean reducing the number of sections in each grade and letting teachers go, and if this involves the loss of experienced teachers, that could cause long-term damage to the school. Unrelated to the excess capacity issue, but with the aim of improving the school’s economics, he should consider doing away with expensive activities like the ice hockey program which raises the cost per student substantially, even after a large fee is charged from students who choose to play the sport. 5-14 5-23 (30 min.) ABC, retail product-line profitability. 1. The simple costing system (Panel A of Solution Exhibit 5-23) reports the following: Baked Milk & Frozen Goods Fruit Juice Products Total Revenues $57,000 $63,000 $52,000 $172,000 Costs Cost of goods sold 38,000 47,000 35,000 120,000 Store support (30% of COGS) 11,400 14,100 10,500 36,000 Total costs 49,400 61,100 45,500 156,000 Operating income $ 7,600 $ 1,900 $ 6,500 $ 16,000 Operating income ÷ Revenues 2. 13.33% 3.02% 12.50% 9.30% The ABC system (Panel B of Solution Exhibit 5-23) reports the following: Baked Milk & Frozen Goods Fruit Juice Products Total Revenues $57,000 $63,000 $52,000 $172,000 Costs Cost of goods sold 38,000 47,000 35,000 120,000 Ordering ($100 × 30; 25; 13) 3,000 2,500 1,300 6,800 Delivery ($80 × 98; 36; 28) 7,840 2,880 2,240 12,960 Shelf-stocking ($20 × 183; 166; 24) 3,660 3,320 480 7,460 Customer support ($0.20 × 15,500; 20,500; 7,900) 3,100 4,100 1,580 8,780 Total costs 55,600 59,800 40,600 156,000 Operating income $ 1,400 $ 3,200 $11,400 $ 16,000 Operating income ÷ Revenues 2.46% 5.08% 21.92% 9.30% These activity costs are based on the following: Activity Ordering Delivery Shelf-stocking Customer support 3. Cost Allocation Rate $100 per purchase order $80 per delivery $20 per hour $0.20 per item sold Baked Goods 30 98 183 15,500 Milk & Fruit Juice 25 36 166 20,500 The rankings of products in terms of relative profitability are: Simple Costing System ABC System 1. Baked goods 13.33% Frozen products 2. Frozen products 12.50 Milk & fruit juice 3. Milk & fruit juice 3.02 Baked goods 5-15 Frozen Products 13 28 24 7,900 21.92% 5.08 2.46 The percentage revenue, COGS, and activity costs for each product line are: Revenues COGS Activity areas: Ordering Delivery Shelf-stocking Customer support Baked Goods 33.14 31.67 Milk & Frozen Fruit Juice Products Total 36.63 30.23 100.00 39.17 29.16 100.00 44.12 60.49 49.06 35.31 36.76 22.22 44.50 46.70 19.12 17.29 6.44 17.99 100.00 100.00 100.00 100.00 The baked goods line drops sizably in profitability when ABC is used. Although it constitutes 31.67% of COGS, it uses a higher percentage of total resources in each activity area, especially the high cost delivery activity area. In contrast, frozen products draws a much lower percentage of total resources used in each activity area than its percentage of total COGS. Hence, under ABC, frozen products is much more profitable. Family Supermarkets may want to explore ways to increase sales of frozen products. It may also want to explore price increases on baked goods. 5-16 SOLUTION EXHIBIT 5-23 Product-Costing Overviews of Family Supermarkets PANEL A: SIMPLE COSTING SYSTEM INDIRECT COST POOL COST Store Support BASE COST OBJECT: PRODUCT LINE DIRECT COST COGS ALLOCATION Indirect Costs Direct Costs COGS PANEL B: ABC SYSTEM INDIRECT COST POOL COST ALLOCATION BASE COST OBJECT: PRODUCT LINE DIRECT COST Ordering Number of Purchase Order Delivery ShelfStocking Customer Support Number of Deliveries Hours of Shelf-Stocking Number of Items Sold Indirect Costs Direct Costs COGS 5-17 5-24 (15–20 min.) ABC, wholesale, customer profitability. Chain 1 Gross sales $50,000 Sales returns 10,000 Net sales 40,000 Cost of goods sold (80%) 32,000 Gross margin 8,000 Customer-related costs: Regular orders $20 × 40; 150; 50; 70 800 Rush orders $100 × 10; 50; 10; 30 1,000 Returned items $10 × 100; 26; 60; 40 1,000 Catalogs and customer support 1,000 Customer related costs 3,800 Contribution (loss) margin $ 4,200 Contribution (loss) margin as percentage of gross sales 8.4% 2 $30,000 5,000 25,000 20,000 5,000 3,000 5,000 260 1,000 9,260 $ (4,260) (14.2%) 3 $100,000 7,000 93,000 74,400 18,600 1,000 4 $70,000 6,000 64,000 51,200 12,800 1,400 1,000 3,000 600 1,000 3,600 $ 15,000 400 1,000 5,800 $ 7,000 15.0% 10.0% The analysis indicates that customers’ profitability (loss) contribution varies widely from (14.2%) to 15.0%. Immediate attention to Chain 2 is required which is currently showing a loss contribution. The chain has a disproportionate number of both regular orders and rush orders. Villeagas should work with the management of Chain 2 to find ways to reduce the number of orders, while maintaining or increasing the sales volume. If this is not possible, Villeagas should consider dropping Chain 2, if it can save the customer-related costs. Chain 1 has a disproportionate number of the items returned as well as sale returns. The causes of these should be investigated so that the profitability contribution of Chain 1 could be improved. 5-18 5-25 (50 min.) ABC, activity area cost-driver rates, product cross-subsidization. 1. Direct costs Direct materials Indirect costs Product support Total costs $ 150,000 983,000 $1,133,000 Cost per pound of potato cuts 2. Cost Pool Cleaning Cutting Packaging Costs in Pool $120,000 $231,000 $444,000 = $1,133,000 = $1.133 1,000,000 Number of Driver Units 1,200,000 raw pounds 3,850 hours* 37,000 hours** Costs per Driver Unit $ 0.10 $60.00 $12.00 *(900,000 ÷ 250) + (100,000 ÷ 400) = 3,600 + 250 = 3,850 **(900,000 ÷ 25) + (100,000 ÷ 100) = 36,000 + 1,000 = 37,000 3. Retail Potato Cuts Direct costs Direct materials $135,000 Packaging 180,000 Indirect costs Cleaning $0.10 × 90% × 1,200,000 108,000 $0.10 × 10% × 1,200,000 Cutting $60 × 3,600 hours 216,000 $60 × 250 hours Packaging $12 × 36,000; $12 × 1,000 432,000 Total costs Pounds produced Costs per pound Institutional Potato Cuts $ 315,000 $15,000 8,000 $23,000 12,000 15,000 756,000 $1,071,000 900,000 $ 1.19 12,000 39,000 $62,000 100,000 $ 0.62 Note: The total costs of $1,133,000 ($1,071,000 + $62,000) are the same as those in Requirement 1. 5-19 4. There is much evidence of product-cost cross-subsidization. Cost per Pound Retail Institutional Simple costing system $1.133 $1.133 ABC system $1.190 $0.620 Assuming the ABC numbers are more accurate, potato cuts sold to the retail market are undercosted while potato cuts sold to the institutional market are overcosted. The simple costing system assumes each product uses all the activity areas in a homogeneous way. This is not the case. Institutional sales use sizably less resources in the cutting area and the packaging area. The percentages of total costs for each cost category are as follows: Retail Institutional Total Direct costs Direct materials 90.0% 10.0% 100.0% Packaging 95.7 4.3 100.0 Indirect costs Cleaning 90.0 10.0 100.0 Cutting 93.5 6.5 100.0 Packaging 97.3 2.7 100.0 Units produced 90.0% 10.0% 100.0% Idaho can use the revised cost information for a variety of purposes: a. Pricing/product emphasis decisions. The sizable drop in the reported cost of potatoes sold in the institutional market makes it possible that Idaho was overpricing potato products in this market. It lost the bid for a large institutional contract with a bid 30% above the winning bid. With its revised product cost dropping from $1.133 to $0.620, Idaho could have bid much lower and still made a profit. An increased emphasis on the institutional market appears warranted. b. Product design decisions. ABC provides a road map as to how to reduce the costs of individual products. The relative components of costs are: Retail Direct costs Direct materials Packaging Indirect costs Cleaning Cutting Packaging Total costs Institutional 12.6% 16.8 24.20% 12.90 10.1 20.2 40.3 100.0% 19.35 24.20 19.35 100.00% Packaging-related costs constitute 57.1% (16.8% + 40.3%) of total costs of the retail product line. Design efforts that reduce packaging costs can have a big impact on reducing total unit costs for retail. c. Process improvements. Each activity area is now highlighted as a separate cost. The three indirect cost areas comprise over 60% of total costs for each product, indicating the upside from improvements in the efficiency of processes in these activity areas. 5-20 5-26 1. (2025 min.) Activity-based costing, job-costing system. An overview of the activity-based job-costing system is: INDIRECT COST POOL COST ALLOCATION BASE COST OBJECT: PC BOARD Dip Insertion Manual Insertion Wave Solder Backload Test Defect Analysis Number of Axial Insertions Number of Dip Insertions Number of Manual Insertions Number of Boards Soldered Number of Backload Insertions Budgeted Time in Test Budgeted Time in Analysis Indirect Costs DIRECT DIRECT COSTS COST 2. Axial Insertion Direct Costs Direct Direct Manufacturing Manufacturing Labor Labor Direct Materials Activity Area 1. Axial insertion 2. Dip insertion 3. Manual insertion 4. Wave solder 5. Backload 6. Test 7. Defect analysis Total Indirect Manufacturing Costs Allocated 45 $ 0.08 = $ 3.60 24 0.25 = 6.00 11 0.50 = 5.50 1 3.50 = 3.50 6 0.70 = 4.20 .25 90.00 = 22.50 .10 80.00 = 8.00 $53.30 Direct manufacturing costs: Direct materials Direct manufacturing labor Indirect manufacturing costs: Manufacturing overhead (see above) Total manufacturing costs $75.00 15.00 $ 90.00 53.30 $143.30 3. The manufacturing manager likely would find the ABC job-costing system useful in cost management. Unlike direct manufacturing labor costs, the seven indirect cost pools are systematically linked to the activity areas at the plant. The result is more accurate product costing. Productivity measures can be developed that directly link to the management accounting system. Marketing managers can use ABC information to price jobs as well as to advise customers about how selecting different product features will affect price. 5-21 5-27 (30 min.) ABC, product-costing at banks, cross-subsidization. 1. Robinson Revenues Spread revenue on annual basis (3% ; $1,100, $800, $25,000) Monthly fee charges ($20 ; 0, 12, 0) Total revenues Costs Deposit/withdrawal with teller $2.50 40; 50; 5 Deposit/withdrawal with ATM $0.80 10; 20; 16 Deposit/withdrawal on prearranged basis $0.50 0; 12; 60 Bank checks written $8.00 9; 3; 2 Foreign currency drafts $12.00 4; 1; 6 Inquiries $1.50 10; 18; 9 Total costs Operating income (loss) Skerrett Farrel Total $ 33 $ 24 $750.00 $ 807.00 0 33 240 264 0.00 750.00 240.00 1,047.00 100 125 12.50 237.50 8 16 12.80 36.80 0 6 30.00 36.00 72 24 16.00 112.00 48 12 72.00 132.00 15 243 $(210) 27 210 $ 54 13.50 156.80 $593.20 55.50 609.80 $ 437.20 The assumption that the Robinson and Farrel accounts exceed $1,000 every month and the Skerrett account is less than $1,000 each month means the monthly charges apply only to Skerrett. One student with a banking background noted that in this solution 100% of the spread is attributed to the “depositor side of the bank.” He noted that often the spread is divided between the “depositor side” and the “lending side” of the bank. 2. Cross-subsidization across individual Premier Accounts occurs when profits made on some accounts are offset by losses on other accounts. The aggregate profitability on the three customers is $437.20. The Farrel account is highly profitable ($593.20), while the Robinson account is sizably unprofitable. The Skerrett account shows a small profit but only because of the $240 monthly fees. It is unlikely that Skerrett will keep paying these high fees and that FIB would want Skerret to pay such high fees from a customer relationship standpoint. The facts also suggest that the customers do not use the bank services uniformly. For example, Robinson and Skerret have a lot of transactions with the teller or ATM, and also inquire about their account balances more often than Farrell. This suggests cross-subsidization. FIB should be very concerned about the cross-subsidization. Competition likely would “understand” that high-balance low-activity type accounts (such as Farrel) are highly profitable. Offering free services to these customers is not likely to retain these accounts if other banks offer higher interest rates. Competition likely will reduce the interest rate spread FIB can earn on the high-balance low-activity accounts they are able to retain. 5-22 3. Possible changes FIB could make are: a. Offer higher interest rates on high-balance accounts to increase FIB’s competitiveness in attracting and retaining these accounts. b. Introduce charges for individual services. The ABC study reports the cost of each service. FIB has to decide if it wants to price each service at cost, below cost, or above cost. If it prices above cost, it may use advertising and other means to encourage additional use of those services by customers. Of course, in determining its pricing strategy, FIB would need to consider how other competing banks are pricing their products and services. 5-28 (15 min.) Job costing with single direct-cost category, single indirect-cost pool, law firm. 1. Pricing decisions at Wigan Associates are heavily influenced by reported cost numbers. Suppose Wigan is bidding against another firm for a client with a job similar to that of Widnes Coal. If the costing system overstates the costs of these jobs, Wigan may bid too high and fail to land the client. If the costing system understates the costs of these jobs, Wigan may bid low, land the client, and then lose money in handling the case. Widnes Coal 2. Direct professional labor, $70 × 104; $70 × 96 Indirect costs allocated, $105 × 104; $105 × 96 Total costs to be billed St. Helen’s Helen’ Glass Total $ 7,280 $ 6,720 $14,000 10,920 $18,200 10,080 $16,800 21,000 $35,000 5-23 5-29 1. (20–25 min.) Job costing with multiple direct-cost categories, single indirect-cost pool, law firm (continuation of 5-28). Indirect costs = $7,000 Total professional labor-hours = 200 hours (104 hours on Widnes Coal + 96 hours on St. Helen’s Glass) Indirect cost allocated per professional labor-hour (revised) = $7,000 ÷ 200 = $35 per hour Widnes Coal Direct costs: Direct professional labor, $70 × 104; $70 × 96 Research support labor Computer time Travel and allowances Telephones/faxes Photocopying Total direct costs Indirect costs allocated, $35 × 104; $35 × 96 Total costs to be billed St. Helen’s Helen’ Glass Total $ 7,280 1,600 500 600 200 250 10,430 $ 6,720 3,400 1,300 4,400 1,000 750 17,570 $14,000 5,000 1,800 5,000 1,200 1,000 28,000 3,640 $14,070 3,360 $20,930 7,000 $35,000 Widnes Coal 2. St. Helen’s Helen’ Glass Total $18,200 14,070 $16,800 20,930 $35,000 35,000 3. Problem 5-28 Problem 5-29 The Problem 5-29 approach directly traces $14,000 of general support costs to the individual jobs. In Problem 5-28, these costs are allocated on the basis of direct professional labor-hours. The averaging assumption implicit in the Problem 5-28 approach appears incorrect—for example, the St. Helen’s Glass job has travel costs over seven times higher than the Widnes Coal case despite having lower direct professional labor-hours. 5-24 5-30 (30 min.) Job costing with multiple direct-cost categories, multiple indirect-cost pools, law firm (continuation of 5-28 and 5-29). Widnes Coal 1. St. Helen’s Helen’ Glass Total $ 5,600 $ 8,000 2,000 3,400 1,300 4,400 1,000 750 18,450 6,000 5,000 1,800 5,000 1,200 1,000 28,000 3,220 4,600 800 4,020 $22,470 2,400 7,000 $35,000 St. Helen’s Helen’ Glass Total $16,800 $35,000 $20,930 $35,000 $22,470 $35,000 Direct costs: Partner professional labor, $100 × 24; $100 × 56 $ 2,400 Associate professional labor, $50 × 80; $50 × 40 4,000 Research support labor 1,600 Computer time 500 Travel and allowances 600 Telephones/faxes 200 Photocopying 250 Total direct costs 9,550 Indirect costs allocated: Indirect costs for partners, $57.50 × 24; $57.50 × 56 1,380 Indirect costs for associates, $20 × 80; $20 × 40 1,600 Total indirect costs 2,980 Total costs to be billed $12,530 Widnes Comparison Coal Single direct cost/ Single indirect cost pool $18,200 Multiple direct costs/ Single indirect cost pool $14,070 Multiple direct costs/ Multiple indirect cost pools $12,530 The higher the percentage of costs directly traced to each case, and the greater the number of homogeneous indirect cost pools linked to the cost drivers of indirect costs, the more accurate the product cost of each individual case. The Widnes and St. Helen’s cases differ in how they use “resource areas” of Wigan Associates: Partner professional labor Associate professional labor Research support labor Computer time Travel and allowances Telephones/faxes Photocopying Widnes Coal 30.0% 66.7 32.0 27.8 12.0 16.7 25.0 5-25 St. Helen’s Helen’ Glass 70.0% 33.3 68.0 72.2 88.0 83.3 75.0 The Widnes Coal case makes relatively low use of the higher-cost partners but relatively higher use of the lower-cost associates than does St. Helen’s Glass. As a result, it also uses less of the higher indirect costs required to support partners compared to associates. The Widnes Coal case also makes relatively lower use of the support labor, computer time, travel, phones/faxes, and photocopying resource areas than does the St. Helen’s Glass case. 2. The specific areas where the multiple direct/multiple indirect (MD/MI) approach can provide better information for decisions at Wigan Associates include: Pricing and product (case) emphasis decisions. In a bidding situation using single direct/single indirect (SD/SI) or multiple direct/single indirect (MD/SI) data, Wigan may win bids for legal cases on which it will subsequently lose money. It may also not win bids on which it would make money with a lower-priced bid. From a strategic viewpoint, SD/SI or MD/SI exposes Wigan Associates to cherry-picking by competitors. Other law firms may focus exclusively on Widnes Coal-type cases and take sizable amounts of “profitable” business from Wigan Associates. MD/MI reduces the likelihood of Wigan Associates losing cases on which it would have made money. Client relationships. MD/MI provides a better “road map” for clients to understand how costs are accumulated at Wigan Associates. Wigan can use this road map when meeting with clients to plan the work to be done on a case before it commences. Clients can negotiate ways to get a lower-cost case from Wigan, given the information in MD/MI—for example, (a) use a higher proportion of associate labor time and a lower proportion of a partner time, and (b) use fax machines more and air travel less. If clients are informed in advance how costs will be accumulated, there is less likelihood of disputes about bills submitted to them after the work is done. Cost control. The MD/MI approach better highlights the individual cost areas at Wigan Associates than does the SD/SI or MD/SI approaches: MD/MI 7 2 9 Number of direct cost categories Number of indirect cost categories Total SD/SI 1 1 2 MD/SI 7 1 8 MD/MI is likely to promote better cost-control practices than SD/SI or MD/SI, as the nine cost categories in MD/MI give Wigan a better handle on how to effectively manage different categories of both direct and indirect costs. 5-26 5-31 (50 min.) Plantwide, department, and activity-cost rates. 1. Trophies Direct materials Forming Assembly Packaging Total Direct Labor Forming Assembly Plaques Medallions $2.50 0.50 0.75 $3.75 $1.50 1.25 0.50 $3.25 $0.50 0.25 0.10 $0.85 $3.00 1.50 $1.20 1.50 $0.60 0.50 Packaging 0.75 0.25 0.10 Total $5.25 $2.95 $1.20 Trophies Plaques Medallions Direct materials ($3.75 × 5,200; $3.25 × 7,500; $0.85 × 16,700) Direct labor ($5.25 × 5,200; $2.95 × 7,500; $1.20 × 16,700) Total $19,500 $24,375 $14,195 $ 58,070 27,300 $46,800 22,125 $46,500 20,040 $34,235 69,465 $127,535 $0.77296 Budgeted = ($22,386 $33,960 $42, 234) $98,580 = overhead rate $127,535 $127,535 per dollar of direct cost Direct materials Direct labor Total direct cost Allocated overhead* Total costs (1) $19,500 27,300 46,800 36,175 $82,975 Trophies (2)=(1)÷ (2)=(1)÷5200 $ 3.75 5.25 9.00 6.96 $15.96 (3) $24,375 22,125 46,500 35,943 $82,443 Plaques (4)=(3)÷ (4)=(3)÷7,500 $ 3.25 2.95 6.20 4.79 $10.99 (5) $14,195 20,040 34,235 26,462 $60,697 *Allocated overhead = Total direct cost ×Budgeted overhead rate (0.77296) 5-27 Medallions (6)=(5)÷ (6)=(5)÷16,700 $0.85 1.20 2.05 1.58 $3.63 Total (7) $ 58,070 69,465 127,535 98,580 $226,115 Budgeted Budgeted Forming Dept. overhead costs 2. overhead rate — = Budgeted Forming Dept. direct-labor costs Forming Dept. $22,386 = ($3 5, 200) ($1.20 7,500) ($0.60 16,700) $22,386 = $15,600 $9,000 $10,020 $22,386 = $0.64662 per Forming Dept. direct-labor $ $34,620 Budgeted Budgeted Assembly Dept. overhead costs overhead rate — = Budgeted Assembly Dept. direct costs Assembly Dept. $33,960 = ($2 5, 200) ($2.75 7,500) ($0.75 16,700) $33,960 = $10, 400 $20,625 $12,525 $33,960 = $0.77979 per Assembly Dept. direct cost $ $43,550 Budgeted Budgeted Packaging Dept. overhead costs overhead rate — = Packaging Dept. Budgeted Packaging Dept. direct material costs $42, 234 = ($0.75 5, 200) ($0.50 7,500) ($0.10 16,700) $42, 234 = $3,900 $3,750 $1,670 $42, 234 = $4.53155 per Packaging Dept. direct material $ $9,320 5-28 Direct materials _______Trophies______ (1) (2)=(1)÷ (2)=(1)÷5200 $19,500 $ 3.75 _______Plaques________ _______Medallions______ (3) (4)=(3)÷ (4)=(3)÷7,500 (5) (6)=(5)÷ (6)=(5)÷16,700 $24,375 $ 3.25 $14,195 $0.85 Total (7) $ 58,070 Direct labor Total direct cost 27,300 46,800 5.25 9.00 22,125 46,500 2.95 6.20 20,040 34,235 1.20 2.05 69,465 127,535 Allocated overhead Forming Dept.a Assembly Dept.b 10,087 8,110 1.94 1.56 5,820 16,083 0.78 2.14 6,479 9,767 0.39 0.59 22,386 33,960 Packaging Dept.c 17,673 3.40 16,993 2.27 7,568 0.45 42,234 $82,670 $15.90 $85,396 $11.39 $58,049 $3.48 $226,115 Total costs Trophies Plaques Medallions $15,600 $9,000 $10,020 $10,087 $5,820 $ 6,479 $10,400 $20,625 $12,525 (0.77979 × $10,400; $20,625 $12,525) $ 8,110 $16,083 $ 9,767 $ 3,900 $ 3,750 $ 1,670 $17,673 $16,993 $ 7,568 a Forming Dept. Direct labor costs Allocated overhead (0.64662 × $15,600; $9,000; $10,020) b Assembly Dept. Total direct costs Allocated overhead c Packaging Dept. Direct material costs Allocated overhead (4.53155 × $3,900; $3,750 $1,670) 3. Forming Total batches Trophies Plaques Medallions Total Total direct labor costs Trophies 5,200 × $3; $1.50; $0.75 Plaques 7,500 × $1.20; $1.50; $0.25 Medallions 16,700 × $0.60; $0.50; $0.10 Total Assembly Packaging Total 116 40 44 200 63 83 84 230 80 100 190 370 259 223 318 800 $15,600 $ 7,800 $3,900 $27,300 9,000 11,250 1,875 22,125 10,020 $34,620 8,350 $27,400 1,670 $7,445 20,040 $69,465 5-29 Forming Dept. Budgeted materials – handling rate = $5,700 = $28.50 per batch 200 batches Budgeted quality inspection rate = $6,300 = $31.50 per batch 200 batches Budgeted utilities rate = $10,386 $34,620 = $0.30 per direct-labor $ Assembly Dept. $9, 200 Budgeted materials – = = $40 per batch handling rate 230 batches Budgeted quality inspection rate = $13,800 = $60 per batch 230 batches Budgeted utilities rate = $10,960 $27, 400 = $0.40 per direct-labor $ Packaging Dept. $18,315 Budgeted materials – = = $49.50 per batch handling rate 370 batches Budgeted quality inspection rate = $14,985 = $40.50 per batch 370 batches Budgeted utilities rate = $8,934 $7, 445 = $1.20 per direct-labor $ 5-30 Trophies Direct material costs Direct labor costs Total direct costs Forming Dept. overhead Materials handling $28.50 116; 40; 44 Quality inspection $31.50 116; 40, 44 Utilities 0.30 $15,600;$9,000; $10,020 Assembly Dept. overhead Materials handling $40 63; 83; 84 Quality inspection $60 63; 83; 84 Utilities 0.40 $7,800; $11,250; $8,350 Packaging Dept. overhead Materials handling $49.50 80; 100; 190 Quality inspection $40.50 80; 100; 190 Utilities 1.20 $3,900; $1,875; $1,670 Total costs Plaques (1) (2) = (1) ÷ 5,200 $19,500 $ 3.75 27,300 5.25 46,800 9.00 Medallions Total (3) (4) = (3) ÷ $7,500 (5) $24,375 $ 3.25 $14,195 22,125 2.95 20,040 46,500 6.20 34,235 (6) = (5) ÷ 16,700 $0.85 1.20 2.05 3,306 0.64 1,140 0.15 1,254 0.08 3,654 0.70 1,260 0.17 1,386 0.08 4,680 0.90 3,000 0.40 3,006 0.18 2,520 0.48 3,320 0.44 3,360 0.20 3,780 0.73 4,980 0.67 5,040 0.30 3,120 0.60 4,500 0.60 3,340 0.20 3,960 0.76 4,950 0.66 9,405 0.56 3,240 0.62 4,050 0.54 7,695 0.46 4,680 $79,740 0.90 $15.33 2,250 $75,950 0.30 $10.13 2,004 $70,725 0.12 $4.23 5-31 4. Disaggregated information can improve decisions by allowing managers to see the details which helps them understand how different aspects of cost influence total cost per unit. Managers can also understand the drivers of different cost categories and use this information for pricing and product-mix decisions, cost reduction and process-improvement decisions, design decisions, and to plan and manage activities. However, too much detail can overload managers who don’t understand the data or what it means. Also, managers looking at per unit data may be misled when considering costs that aren’t unit-level costs. 5-32 5-32 (30-40 min.) Department and activity-cost rates service sector. 1. Overhead costs = $20,610 + $247,320 + $196,180 + $134,350 = $598,460 Budgeted overhead = $598, 460 $1.626 per DL $ rate $368,040 Technician labor Depreciation Materials Allocated overhead* Total budgeted costs Budgeted number of procedures Budgeted cost per service X-rays $ 61,440 32,240 22,080 99,901 $215,661 ÷3,840 $ 56.16 Ultrasound $105,600 268,000 16,500 171,706 $561,806 ÷4,400 $ 127.68 CT scan $ 96,000 439,000 24,000 156,096 $715,096 ÷3,000 $ 238.37 MRI $ 105,000 897,500 31,250 170,730 $1,204,480 ÷2,500 $ 481.79 Total $ 368,040 1,636,740 93,830 598,433 $2,697,043 * Allocated overhead = Budgeted overhead rate × Technician labor costs 2. Budgeted Information Number of procedures Cleaning minutes per procedure Total cleaning minutes X-rays 3,840 ×5 19,200 Number of procedures Minutes for each procedure Total procedure minutes 3,840 ×5 19,200 Ultrasound 4,400 ×5 22,000 X-rays $ 61,440 32,240 22,080 5,760 5-33 MRI 2,500 ×35 87,500 3,000 ×20 60,000 4,400 ×15 66,000 Units of Budgeted Cost Cost Driver Cost Driver Activity (1) (2) (3) Administration $ 20,610 Total number 13,740 of procedures Maintenance $247,320 Total dollars $1,636,740 of depreciation Sanitation $196,180 Total cleaning 173,700 minutes Utilities $134,350 Total procedure 257,700 minutes Technician labor Depreciation Materials Allocated activity costs: Administration ($1.50×3,840; 4,400; 3,000; 2,500) CT scan 3,000 ×15 45,000 Total 13,740 2,500 ×45 112,500 173,700 13,740 257,700 Activity Rate (4) = (1) ÷ (3) $1.50 per procedure $0.151105 per dollar of depreciation $1.12942 per cleaning minute $0.52134 per procedure minute Ultrasound $105,600 268,000 16,500 6,600 Total CT scan $ 96,000 439,000 24,000 MRI $ 105,000 897,500 31,250 $ 368,040 1,636,740 93,830 4,500 3,750 20,610 Maintenance ($0.151105×$32,240; $268,000; $439,000; $897,500) Sanitation ($1.12942×19,200; 22,000; 45,000; 87,500) Utilities ($0.52134×19,200; 66,000; 60,000; 112,500) Total budgeted cost Budgeted number of procedures Budgeted cost per service 4,872 40,496 66,335 135,617 247,320 21,685 24,847 50,824 98,824 196,180 10,010 $158,087 ÷3,840 $ 41.17 34,409 $496,452 ÷4,400 $ 112.83 31,280 $711,939 ÷3,000 $ 237.31 58,651 $1,330,592 ÷2,500 $ 532.24 134,350 $2,697,070 3. Using the disaggregated activity-based costing data, managers can see that the MRI actually costs substantially more and x-rays and ultrasounds substantially less than the traditional system indicated. In particular, the MRI activity generates a lot of maintenance activity and sanitation activity. Managers should examine the use of these two activities to search for ways to reduce the activity consumption and ultimately its cost. 5-34 5-33 (30 min.) Choosing cost drivers, activity-based costing, activity-based management management. 1. Direct costs = Dance teacher salaries, Child care teacher salaries, Fitness instructor salaries Indirect costs = Supplies; Rent, maintenance, and utilities; Administration salaries; Marketing expenses 2. Indirect Cost Cost Driver Supplies Number of participants Rent, maintenance, and utilities Square footage Administration salaries Number of participants Marketing expenses Number of advertisements Budgeted Cost Driver Rate $21,984 ÷ 2,205 = $9.97 per participant $97,511÷ 11,650 = $8.37 per square foot $50,075 ÷ 2,205 = $22.71 per participant $21,000 ÷ 70 = $300 per advertisement Supplies – Larger programs with more participants will require more supplies. For example, as the number of dance participants increases, so will the cost of dance accessories. Rent, maintenance and utilities are all building-related costs. Square-footage is the only spaceoriented cost driver available. Administration salaries – Larger programs require more time to enroll students and collect fees. Consequently, the number of participants appears to be a reasonable cost driver. Marketing expenses – Marketing expenses include the cost of advertising the studio. As the number of ads increases so do total marketing costs. 3. Salaries Allocated costs: Supplies ($9.97×1,485; 450; 270) Rent, maintenance, and utilities ($8.37×6,000; 3,150; 2,500) Administration salaries ($22.71×1,485; 450; 270) Marketing expenses ($300×26; 24; 20) Budgeted total costs ÷ Number of participants Budgeted cost per participant Dance $ 62,100 Childcare $ 24,300 Fitness $ 39,060 Total $ 125,460 14,805 4,487 2,692 21,984 50,220 26,366 20,925 97,511 33,724 10,219 6,132 50,075 7,800 $ 168,649 ÷ 1,485 $ 113.57 7,200 $ 72,572 ÷450 $ 161.27 6,000 $ 74,809 ÷270 $ 277.07 21,000 $ 316,030 4. By dividing the full cost of each service line by the number of participants, Annie can see that fitness classes should be charged a higher price. Most of the higher unit cost is attributable to the cost of Aerobic instructors. Besides cost data, Annie should also consider a variety of other factors before setting the price for each service. Examples of other issues she should consider include the actions of competitors in her market, and the quality of her facilities and instructors. 5-35 5-34 (30–40 min.) 1. Revenues Cost of goods sold Gross margin Other operating costs Operating income Gross margin % Activity-based costing, merchandising. General Supermarket Chains $3,708,000 3,600,000 $ 108,000 Drugstore Chains $3,150,000 3,000,000 $ 150,000 Mom-and-Pop Single Stores $1,980,000 1,800,000 $ 180,000 2.91% 4.76% 9.09% Total $8,838,000 8,400,000 $ 438,000 301,080 $ 136,920 The gross margin of Pharmacare, Inc., was 4.96% ($438,000 ÷ $8,838,000). The operating income margin of Pharmacare, Inc., was 1.55% ($136,920 ÷ $8,838,000). 2. The per-unit cost driver rates are: 1. Customer purchase order processing, $80,000 ÷ 2,000 (140 + 360 + 1,500) orders 2. Line item ordering, $63,840 ÷ 21,280 (1,960 + 4,320 + 15,000) line items 3. Store delivery, $71,000 ÷ 1,480 (120 + 360 + 1,000) deliveries 4. Cartons shipped, $76,000 ÷ 76,000 (36,000 + 24,000 + 16,000) cartons 5. Shelf-stocking, $10,240 ÷ 640 (360 + 180 + 100) hours 3. = $40 per order = $ 3 per line item = $47.973 per delivery = $ 1 per carton = $16 per hour The activity-based costing of each distribution market for August 2008 is: General Supermarket Chains 1. Customer purchase order processing ($40 140; 360; 1,500) 2. Line item ordering ($3 1,960; 4,320; 15,000) 3. Store delivery, ($47.973 120; 360; 1,000) 4. Cartons shipped ($1 36,000; 24,000; 16,000) 5. Shelf-stocking ($16 360; 180; 100) Drugstore Chains Mom-andPop Single Stores Total $ 5,600 $14,400 $ 60,000 $ 80,000 5,880 12,960 45,000 63 ,840 5,757 17,270 47,973 71,000 36,000 24,000 16,000 76,000 5,760 $58,997 2,880 $71,510 1,600 $170,573 10,240 $301,080 5-36 The revised operating income statement is: General Supermarket Drugstore Chains Chains Revenues $3,708,000 $3,150,000 Cost of goods sold 3,600,000 3,000,000 Gross margin 108,000 150,000 Operating costs 58,997 71,510 Operating income $ 49,003 $ 78,490 Operating income margin 1.32% 4. 2.49% Mom-and-Pop Single Stores $1,980,000 1,800,000 180,000 170,573 $ 9,427 0.48% Total $8,838,000 8,400,000 438,000 301,080 $ 136,920 1.55% The ranking of the three markets are: Using Gross Margin 1. Mom-and-Pop 9.09% 2. Drugstore Chains 1.32% 3. General 2.91% Using Operating Income Single Drugstore Chains 2. General 1. 4.76% 3. Supermarket Supermarket Mom-and-Pop Single Stores Stores 2.49% Chains Chains 0.48% The activity-based analysis of costs highlights how the Mom-and-Pop Single Stores use a larger amount of Pharmacare’s resources per revenue dollar than do the other two markets. The ratio of the operating costs to revenues across the three markets is: General Supermarket Chains Drugstore Chains Mom-and-Pop Single Stores 1.59% 2.27% 8.61% ($58,997 ÷ $3,708,000) ($71,510 ÷ $3,150,000) ($170,573 ÷ $1,980,000) This is a classic illustration of the maxim that “all revenue dollars are not created equal.” The analysis indicates that the Mom-and-Pop Single Stores are the least profitable market. Pharmacare should work to increase profits in this market through: (1) a possible surcharge, (2) decreasing the number of orders, (3) offering discounts for quantity purchases, etc. Other issues for Pharmacare to consider include a. Choosing the appropriate cost drivers for each area. The problem gives a cost driver for each chosen activity area. However, it is likely that over time further refinements in cost drivers would occur. For example, not all store deliveries are equally easy to make, depending on parking availability, accessibility of the storage/shelf space to the delivery point, etc. Similarly, not all cartons are equally easy to deliver––their weight, size, or likely breakage component are factors that can vary across carton types. b. Developing a reliable data base on the chosen cost drivers. For some items, such as the number of orders and the number of line items, this information likely would be available in machine readable form at a high level of accuracy. Unless the delivery personnel have hand-held computers that they use in a systematic way, estimates of 5-37 shelf-stocking time are likely to be unreliable. Advances in information technology likely will reduce problems in this area over time. c. Deciding how to handle costs that may be common across several activities. For example, (3) store delivery and (4) cartons shipped to stores have the common cost of the same trip. Some organizations may treat (3) as the primary activity and attribute only incremental costs to (4). Similarly, (1) order processing and (2) line item ordering may have common costs. d. Behavioral factors are likely to be a challenge to Flair. He must now tell those salespeople who specialize in Mom-and-Pop accounts that they have been less profitable than previously thought. 5-38 5-35 (30-40 min.) Choosing cost drivers, activity-based costing, activity-based management. management 1. Direct materials—purses Direct materials—backpacks Direct manufacturing labor—purses Direct manufacturing labor—backpacks Setup Shipping Design Plant utilities and administration Output unit-level costs Output unit-level costs Output unit-level costs Output unit-level costs Batch-level costs Batch-level costs Product-sustaining costs Facility-sustaining costs 2. Direct materials—purses Direct materials—backpacks Direct manufacturing labor—purses Direct manufacturing labor—backpacks Setup Shipping Design Plant utilities and administration Number of bags Number of bags Number of bags Number of bags Number of batches Number of batches Number of designs Hours of production Direct material and direct manufacturing labor are costs that can be easily traced to output, which in this case is the number of bags produced. Setup and shipping are both a function of the number of batches produced. Design is related to the number of designs created for each product. Plant utilities and administration result from general activity level in the plant. Thus, hours of production seems to be an appropriate cost driver. 3. Direct materials—purses $362,000 ÷ 3,150 purses = $114.92 per purse Direct materials—backpacks $427,000 ÷ 6,000 backpacks = $71.17 per backpack Direct manufacturing labor—purses $98,000 ÷ 3,150 purses = $31.11 per purse Direct manufacturing labor—backpacks $115,597 ÷ 6,000 backpacks = $19.27 per backpack Setup $64,960 ÷ 203 = $320 per batch Shipping $72,065 ÷ 203 = $355 per batch Design $167,000 ÷ 5 = $33,400 per design Plant utilities and administration $225,000 ÷ 4,160 hours = $54.0865 per hour 5-39 4. Direct materials Direct manufacturing labor Setup ($320×133; 70) Shipping ($355×133; 70) Design ($33,400×3; 2) Plant utilities and administration ($54.0865×1,560; 2,600) Budgeted total costs ÷ Number of bags Budgeted cost per bag Backpacks $427,000 115,597 Purses $362,000 98,000 Total $ 789,000 213,597 42,560 22,400 64,960 47,215 24,850 72,065 100,200, 66,800 167,000 84,375 $816,947 ÷ 6,000 $ 136.16 140,625 $714,675 ÷ 3,150 $ 226.88 225,000 $1,531,622 5. Based on this analysis, over 50% of product cost relates to direct material. Managers should determine whether the material costs can be reduced. Producing in small lots increases the setup and shipping costs. While both are relatively small components of product cost, management may want to evaluate ways to reduce the number of setups and the cost per setup. Of the indirect costs, the product- and facility-sustaining costs are the highest. Management should review the design process for cost savings and examine why it takes so long to produce purses relative to backpacks. 5-40 5-36 (40 min.) ABC, health care. 1a. Medical supplies rate = = Rent and clinic maintenance rate = = Admin. cost rate for patient-charts food and laundry = = Laboratory services rate = = Medical supplies costs $300,000 = Total number of patient - years 150 $2,000/patient-year Rent and clinic maint. costs $180,000 = Total amount of square feet of space 30,000 $6 per square foot Admin. costs to manage patient charts, food, laundry $600,000 = Total number of patient - years 150 $4,000/patient-year Laboratory services costs $100,000 = Total number of laboratory tests 2,500 $40 per test These cost drivers are chosen as the ones that best match the descriptions of why the costs arise. Other answers are acceptable, provided that clear explanations are given. 1b. Activity-based costs for each program and cost per patient-year of the alcohol and drug program follow: Alcohol Direct labor Physicians at $150,000 × 0; 4; 0 — Psychologists at $75,000 × 6; 4; 8 $450,000 Nurses at $30,000 × 4; 6; 10 120,000 Direct labor costs 570,000 Medical supplies1 $2,000 × 40; 50; 60 80,000 Rent and clinic maintenance2 $6 × 9,000; 9,000; 12,000 54,000 Administrative costs to manage patient charts, food, and laundry3 $4,000 × 40; 50; 60 160,000 Laboratory services 4 $40 × 400; 1,400; 700 16,000 Total costs $880,000 Cost per patient-year $880,000 40 = $22,000 1Allocated using patient-years using square feet of space 3Allocated using patient-years 4Allocated using number of laboratory tests 2Allocated 5-41 Drug After-Care Total $ 600,000 300,000 180,000 1,080,000 100,000 — $ 600,000 300,000 900,000 120,000 54,000 72,000 180,000 200,000 56,000 $1,490,000 240,000 28,000 $1,360,000 600,000 100,000 $3,730,000 $1,490,000 50 = $29,800 $ 600,000 1,350,000 600,000 2,550,000 300,000 1c. The ABC system more accurately allocates costs because it identifies better cost drivers. The ABC system chooses cost drivers for overhead costs that have a cause-and-effect relationship between the cost drivers and the costs. Of course, Clayton should continue to evaluate if better cost drivers can be found than the ones they have identified so far. By implementing the ABC system, Clayton can gain a more detailed understanding of costs and cost drivers. This is valuable information from a cost management perspective. The system can yield insight into the efficiencies with which various activities are performed. Clayton can then examine if redundant activities can be eliminated. Clayton can study trends and work toward improving the efficiency of the activities. In addition, the ABC system will help Clayton determine which programs are the most costly to operate. This will be useful in making long-run decisions as to which programs to offer or emphasize. The ABC system will also assist Clayton in setting prices for the programs that more accurately reflect the costs of each program. 2. The concern with using costs per patient-year as the rule to allocate resources among its programs is that it emphasizes “input” to the exclusion of “outputs” or effectiveness of the programs. After-all, Clayton’s goal is to cure patients while controlling costs, not minimize costs per-patient year. The problem, of course, is measuring outputs. Unlike many manufacturing companies, where the outputs are obvious because they are tangible and measurable, the outputs of service organizations are more difficult to measure. Examples are “cured” patients as distinguished from “processed” or “discharged” patients, “educated” as distinguished from “partially educated” students, and so on. 5-42 5-37 (25 min.) Unused capacity, activity-based costing, activity-based management management. 1. Number of batches Machine-hours Basketballs 300 11,000 Volleyballs 400 12,500 Total 700 23,500 Setup cost per batch = $143,500 ÷ 700 batches = $205 per batch. Equipment and maintenance = $109,900 ? 23,500 machine-hours = $4.6766 per machine-hour. Lease rent, insurance, utilities = $216,000 ÷ 12,000 sq. ft. of capacity = $18 per sq. ft. Capacity used for Capacity used for 2. Unused capacity Total capacity basketball production volleyball production 12,000 3,360 5,040 3,600 sq. ft. Cost of unused capacity = $18 per sq. ft × 3,600 sq. ft. = $64,800 3. Basketballs Volleyballs Total Direct materials $209,750 $358,290 $ 568,040 Direct manufacturing labor 107,333 102,969 210,302 Setup ($205 × 300; 400) 61,500 82,000 143,500 Equipment and maintenance ($4.6766 × 11,000; 12,500) 51,442 58,458 109,900 Lease rent, etc. ($18 × 3,360; 5,040) 60,480 90,720 151,200 $490,505 Budgeted total costs $692,437 $1,182,942 ÷ 66,000 ÷ Number of units ÷100,000 $ 7.43 Budgeted cost per unit $ 6.92 4. Currently, Nivag only utilizes 70% of its available capacity. Managers should consider whether the excess capacity is sufficient to produce footballs. Other issues to consider include demand for the proposed product, the competition, capital investment needed to start and support this product line, and the availability of skilled and unskilled labor needed to manufacture footballs. 5-43 5-38 (4050 min.) Activity-based job costing, unit-cost comparisons. An overview of the product-costing system is: INDIRECT COST POOL COST ALLOCATION BASE Materials Handling Lathe Work Milling Number of Parts Number of Turns Number of Machine-Hours Testing Number of Parts Number of Units Tested Indirect Costs COST OBJECT: COMPONENTS DIRECT COST Grinding Direct Costs Direct Manufacturing Labor Direct Materials 1. Job Order 410 Direct manufacturing cost Direct materials Direct manufacturing labor $30 25; $30 375 Indirect manufacturing cost $115 25; $115 375 Total manufacturing cost Number of units Manufacturing cost per unit $9,700 Job Order 411 $59,900 750 $10,450 11,250 $ 71,150 2,875 $13,325 ÷ 10 $ 1,332.50 43,125 $114,275 ÷ 200 $ 571.375 5-44 Job Order 410 2. Direct manufacturing cost Direct materials Direct manufacturing labor $30 25; $30 375 Indirect manufacturing cost Materials handling $0.40 500; $0.40 2,000 Lathe work $0.20 20,000; $0.20 60,000 Milling $20.00 150; $20.00 1,050 Grinding $0.80 500; $0.80 2,000 Testing $15.00 10; $15.00 200 Total manufacturing cost Number of units Manufacturing cost per unit 3. $9,700 750 Job Order 411 $59,900 $10,450 11,250 200 800 4,000 12,000 3,000 21,000 400 $ 71,150 1,600 150 7,750 $18,200 ÷ 10 $ 1,820 3,000 38,400 $109,550 ÷ 200 $ 547.75 Job Order 410 Number of units in job Costs per unit with prior costing system Costs per unit with activity-based costing 10 $1,332.50 1,820.00 Job Order 411 200 $571.375 547.750 Job order 410 has an increase in reported unit cost of 36.6% [($1,820 – $1,332.50) ÷ $1,332.50], while job order 411 has a decrease in reported unit cost of 4.1% [($547.75 – $571.375) ÷ $571.375]. A common finding when activity-based costing is implemented is that low-volume products have increases in their reported costs while high-volume products have decreases in their reported cost. This result is also found in requirements 1 and 2 of this problem. Costs such as materials-handling costs vary with the number of parts handled (a function of batches and complexity of products) rather than with direct manufacturing labor-hours, an output-unit level cost driver, which was the only cost driver in the previous job-costing system. The product cost figures computed in requirements 1 and 2 differ because a. the job orders differ in the way they use each of five activity areas, and b. the activity areas differ in their indirect cost allocation bases (specifically, each area does not use the direct manufacturing labor-hours indirect cost allocation base). 5-45 The following table documents how the two job orders differ in the way they use each of the five activity areas included in indirect manufacturing costs: Activity Area Materials handling Lathe work Milling Grinding Testing Usage Based on Analysis of Activity Area Cost Drivers Job Order Job Order 410 411 20.0% 80.0% 25.0 75.0 12.5 87.5 20.0 80.0 4.8 95.2 Usage Assumed with Direct Manuf. Labor-Hours as Application Base Job Order Job Order 410 411 6.25% 93.75% 6.25 93.75 6.25 93.75 6.25 93.75 6.25 93.75 The differences in product cost figures might be important to Tracy Corporation for product pricing and product emphasis decisions. The activity-based accounting approach indicates that job order 410 is being undercosted while job order 411 is being overcosted. Tracy Corporation may erroneously push job order 410 and deemphasize job order 411. Moreover, by its actions, Tracy Corporation may encourage a competitor to enter the market for job order 411 and take market share away from it. 4. Information from the ABC system can also help Tracy manage its business better in several ways. a. Product design. Product designers at Tracy Corporation likely will find the numbers in the activity-based costing approach more believable and credible than those in the simple system. In a machine-paced manufacturing environment, it is unlikely that direct labor-hours would be the major cost driver. Activity-based costing provides more credible signals to product designers about the ways the costs of a product can be reduced––for example, use fewer parts, require fewer turns on the lathe, and reduce the number of machine-hours in the milling area. b. Cost management. Tracy can reduce the cost of jobs both by making process improvements that reduce the activities that need to be done to complete jobs and by reducing the costs of doing the activities. c. Cost planning. ABC provides a more refined model to forecast costs and to explain why actual costs differ from budgeted costs. 5-46 5-39 (50 min.) ABC, implementation, ethics. 1. Applewood Electronics should not emphasize the Regal model and should not phase out the Monarch model. Under activity-based costing, the Regal model has an operating income percentage of less than 3%, while the Monarch model has an operating income percentage of nearly 43%. Cost driver rates for the various activities identified in the activity-based costing (ABC) system are as follows: Soldering $ 942,000 1,570,000 = $ 0.60 per solder point Shipments 860,000 20,000 = 43.00 per shipment Quality control 1,240,000 77,500 = 16.00 per inspection Purchase orders 950,400 190,080 = 5.00 per order Machine power 57,600 192,000 = 0.30 per machine-hour Machine setups 750,000 30,000 = 25.00 per setup Applewood Electronics Calculation of Costs of Each Model under Activity-Based Costing Monarch Direct costs Direct materials ($208 22,000; $584 4,000) $ 4,576,000 Direct manufacturing labor ($18 22,000; $42 4,000) 396,000 Machine costs ($144 22,000; $72 4,000) 3,168,000 Total direct costs 8,140,000 Indirect costs Soldering ($0.60 1,185,000; $0.60 385,000) 711,000 Shipments ($43 16,200; $43 3,800) 696,600 Quality control ($16 56,200; $16 21,300) 899,200 Purchase orders ($5 80,100; $5 109,980) 400,500 Machine power ($0.30 176,000; $0.30 16,000) 52,800 Machine setups ($25 16,000; $25 14,000) 400,000 Total indirect costs 3,160,100 Total costs $11,300,100 5-47 Regal $2,336,000 168,000 288,000 2,792,000 231,000 163,400 340,800 549,900 4,800 350,000 1,639,900 $4,431,900 Profitability analysis Revenues Cost of goods sold Gross margin Per-unit calculations: Units sold 22,000 Selling price ($19,800,000 22,000; $4,560,000 4,000) Cost of goods sold ($11,300,100 22,000; $4,431,900 4,000) Gross margin Gross margin percentage Monarch $19,800,000 11,300,100 $ 8,499,900 Regal $4,560,000 4,431,900 $ 128,100 Total $24,360,000 15,732,000 $ 8,628,000 4,000 $900.00 $1,140.00 513.64 $386.36 42.9% 1,107.98 $ 32.02 2.8% 2. Applewood’s simple costing system allocates all manufacturing overhead other than machine costs on the basis of machine-hours, an output unit-level cost driver. Consequently, the more machine-hours per unit that a product needs, the greater the manufacturing overhead allocated to it. Because Monarch uses twice the number of machine-hours per unit compared to Regal, a large amount of manufacturing overhead is allocated to Monarch. The ABC analysis recognizes several batch-level cost drivers such as purchase orders, shipments, and setups. Regal uses these resources much more intensively than Monarch. The ABC system recognizes Regal’s use of these overhead resources. Consider, for example, purchase order costs. The simple system allocates these costs on the basis of machine-hours. As a result, each unit of Monarch is allocated twice the purchase order costs of each unit of Regal. The ABC system allocates $400,500 of purchase order costs to Monarch (equal to $18.20 ($400,500 22,000) per unit) and $549,900 of purchase order costs to Regal (equal to $137.48 ($549,900 4,000) per unit). Each unit of Regal uses 7.55 ($137.48 $18.20) times the purchases order costs of each unit of Monarch. Recognizing Regal’s more intensive use of manufacturing overhead results in Regal showing a much lower profitability under the ABC system. By the same token, the ABC analysis shows that Monarch is quite profitable. The simple costing system overcosted Monarch, and so made it appear less profitable. 3. Duval’s comments about ABC implementation are valid. When designing and implementing ABC systems, managers and management accountants need to trade off the costs of the system against its benefits. Adding more activities would make the system harder to understand and more costly to implement but it would probably improve the accuracy of cost information, which, in turn, would help Applewood make better decisions. Similarly, using inspection-hours and setup-hours as allocation bases would also probably lead to more accurate cost information, but it would increase measurement costs. 5-48 4. Activity-based management (ABM) is the use of information from activity-based costing to make improvements in a firm. For example, a firm could revise product prices on the basis of revised cost information. For the long term, activity-based costing can assist management in making decisions regarding the viability of product lines, distribution channels, marketing strategies, etc. ABM highlights possible improvements, including reduction or elimination of non-value-added activities, selecting lower cost activities, sharing activities with other products, and eliminating waste. ABM is an integrated approach that focuses management’s attention on activities with the ultimate aim of continuous improvement. As a whole-company philosophy, ABM focuses on strategic, as well as tactical and operational activities of the company. 5. Incorrect reporting of ABC costs with the goal of retaining both the Monarch and Regal product lines is unethical. In assessing the situation, the specific “Standards of Ethical Conduct for Management Accountants” (described in Exhibit 1-7) that the management accountant should consider are listed below. Competence Clear reports using relevant and reliable information should be prepared. Preparing reports on the basis of incorrect costs in order to retain product lines violates competence standards. It is unethical for Benzo to change the ABC system with the specific goal of reporting different product cost numbers that Duval favors. Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. Benzo may be tempted to change the product cost numbers to please Duval, the division president. This action, however, would violate the responsibility for integrity. The Standards of Ethical Conduct require the management accountant to communicate favorable as well as unfavorable information. Credibility The management accountant’s standards of ethical conduct require that information should be fairly and objectively communicated and that all relevant information should be disclosed. From a management accountant’s standpoint, adjusting the product cost numbers to make both the Monarch and Regal lines look profitable would violate the standard of objectivity. Benzo should indicate to Duval that the product cost calculations are, indeed, appropriate. If Duval still insists on modifying the product cost numbers, Benzo should raise the matter with one of Duval’s superiors. If, after taking all these steps, there is continued pressure to modify product cost numbers, Benzo should consider resigning from the company, rather than engage in unethical behavior. 5-49 5-40 (30-40 mins.) Activity-based costing, cost hierarchy hierarchy. 1. Revenues Cost of Merchandise Cost of Café Cleaning Allocated Selling, General and Administration Costsa (0.300986 × $2,656,727; $1,722,311; $556,685) Operating income aOverhead Super Bookstore Income Statement For the Year Ended 31 December, 2010 Book CDs Café Café Total $3,720,480 $2,315,360 $736,216 $6,772,056 2,656,727 1,722,311 556,685 4,935,723 18,250 18,250 799,638 $ 264,115 518,392 $ 74,657 167,554 $ (6,273) 1,485,584 $ 332,499 Rate = $1,485,584 ÷ $4,935,723 = 0.300986 per cost of merchandise $ 2. Selling, general and administration (S,G & A) is comprised of a variety of costs that are unlikely to be consumed uniformly across product lines based on the cost of merchandise. Super Bookstore should consider an activity-based costing system to clarify how each product line uses these S, G & A resources. Number of purchase orders Number of deliveries received Hours of shelf-stocking time Items sold Purchasing Receiving Stocking Customer support Books 2,800 1,400 15,000 124,016 CDs 2,500 1,700 14,000 115,768 Café Café 2,000 1,600 10,000 368,108 Total 7,300 4,700 39,000 607,892 $474,500 ÷ 7,300 orders placed = $65 per purchase order $432,400 ÷ 4,700 deliveries = $92 per delivery $487,500 ÷ 39,000 hours = $12.50 per stocking hour $91, 184 ÷ 607,892 items sold = $0.15 per item sold Revenues Cost of Merchandise Gross margin Cost of Café Cleaning Purchasing ($65 × 2,800; 2,500; 2,000) Receiving ($92 × 1,400; 1,700; 1,600) Shelf-stocking ($12.50 × 15,000; 14,000; 10,000) Customer support ($0.15 × 124,016; 115,768; 368,108 Total S, G & A costs Operating income Books $3,720,480 2,656,727 1,063,753 CDs $2,315,360 1,722,311 593,049 Café Café $ 736,216 556,685 179,531 18,250 Total $6,772,056 4,935,723 1,836,333 18,250 182,000 162,500 130,000 474,500 128,800 156,400 147,200 432,400 187,500 175,000 125,000 487,500 18,603 516,903 $ 546,850 17,365 511,265 $ 81,784 55,216 475,666 $(296,135) 91,184 1,503,834 $ 332,499 5-50 Comparing product line income statements in requirements 1 and 2, it appears that books are much more profitable and café loses a lot more money under the ABC system compared to the simple system. The reason is that books use far fewer S,G & A resources relative to its merchandise costs and café uses far greater S, G & A resources relative to its merchandise costs. 3. To: Super Bookstore Management Team From: Cost Analyst Re: Costing System The current accounting system allocates indirect costs (S,G & A) to product lines based on the Cost of Merchandise sold. Using this method, the S, G & A costs are assigned 54%, 35%, 11%, to the Books, CDs, and Café product lines, respectively. I recommend that the organization switch to an activity-based costing (ABC) method. With ABC, the product lines are assigned indirect costs based on their consumption of the activities that give rise to the costs. An ABC analysis reveals that the Café consumes considerably more than 11% of indirect costs. Instead, the café generally requires 25-35% of the purchasing, receiving and stocking activity and 60% of the customer support. The current accounting technique masks the losses being produced by the café because it assumes all indirect costs are driven by the dollar amount of merchandise sold. By adopting ABC, management can evaluate the costs of operating the three product lines and make more informed pricing and product mix decisions. For example, management may want to consider increasing prices of the food and drinks served in the café. Before deciding whether to increase prices or to close the café, management must consider the beneficial effect that having a cafe has on the other product lines. An ABC analysis can also help Super Bookstore manage its costs by reducing the number of activities that each product line demands and by reducing the cost of each activity. These actions will improve the profitability of each product line. ABC analysis can also be used to plan and manage the various activities. 5-51 CHAPTER 6 MASTER BUDGET AND RESPONSIBILITY ACCOUNTING 6-1 a. b. c. d. The budgeting cycle includes the following elements: Planning the performance of the company as a whole as well as planning the performance of its subunits. Management agrees on what is expected. Providing a frame of reference, a set of specific expectations against which actual results can be compared. Investigating variations from plans. If necessary, corrective action follows investigation. Planning again, in light of feedback and changed conditions. 6-2 The master budget expresses management’s operating and financial plans for a specified period (usually a fiscal year) and includes a set of budgeted financial statements. It is the initial plan of what the company intends to accomplish in the period. 6-3 Strategy, plans, and budgets are interrelated and affect one another. Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives. Strategic analysis underlies both long-run and short-run planning. In turn, these plans lead to the formulation of budgets. Budgets provide feedback to managers about the likely effects of their strategic plans. Managers use this feedback to revise their strategic plans. 6-4 We agree that budgeted performance is a better criterion than past performance for judging managers, because inefficiencies included in past results can be detected and eliminated in budgeting. Also, future conditions may be expected to differ from the past, and these can also be factored into budgets. 6-5 Production and marketing traditionally have operated as relatively independent business functions. Budgets can assist in reducing conflicts between these two functions in two ways. Consider a beverage company such as Coca-Cola or Pepsi-Cola: Communication. Marketing could share information about seasonal demand with production. Coordination. Production could ensure that output is sufficient to meet, for example, high seasonal demand in the summer. 6-6 In many organizations, budgets impel managers to plan. Without budgets, managers drift from crisis to crisis. Research also shows that budgets can motivate managers to meet targets and improve their performance. Thus, many top managers believe that budgets meet the cost-benefit test. 6-7 A rolling budget, also called a continuous budget, is a budget or plan that is always available for a specified future period, by continually adding a period (month, quarter, or year) to the period that just ended. A four-quarter rolling budget for 2009 is superseded by a four-quarter rolling budget for April 2009 to March 2010, and so on. 6-1 6-8 The steps in preparing an operating budget are as follows: 1. Prepare the revenues budget 2. Prepare the production budget (in units) 3. Prepare the direct material usage budget and direct material purchases budget 4. Prepare the direct manufacturing labor budget 5. Prepare the manufacturing overhead budget 6. Prepare the ending inventories budget 7. Prepare the cost of goods sold budget 8. Prepare the nonmanufacturing costs budget 9. Prepare the budgeted income statement 6-9 The sales forecast is typically the cornerstone for budgeting, because production (and, hence, costs) and inventory levels generally depend on the forecasted level of sales. 6-10 Sensitivity analysis adds an extra dimension to budgeting. It enables managers to examine how budgeted amounts change with changes in the underlying assumptions. This assists managers in monitoring those assumptions that are most critical to a company in attaining its budget and allows them to make timely adjustments to plans when appropriate. 6-11 Kaizen budgeting explicitly incorporates continuous improvement anticipated during the budget period into the budget numbers. 6-12 Nonoutput-based cost drivers can be incorporated into budgeting by the use of activitybased budgeting (ABB). ABB focuses on the budgeted cost of activities necessary to produce and sell products and services. Nonoutput-based cost drivers, such as the number of part numbers, number of batches, and number of new products can be used with ABB. 6-13 The choice of the type of responsibility center determines what the manager is accountable for and thereby affects the manager’s behavior. For example, if a revenue center is chosen, the manager will focus on revenues, not on costs or investments. The choice of a responsibility center type guides the variables to be included in the budgeting exercise. 6-14 Budgeting in multinational companies may involve budgeting in several different foreign currencies. Further, management accountants must translate operating performance into a single currency for reporting to shareholders, by budgeting for exchange rates. Managers and accountants must understand the factors that impact exchange rates, and where possible, plan financial strategies to limit the downside of unexpected unfavorable moves in currency valuations. In developing budgets for operations in different countries, they must also have good understanding of political, legal and economic issues in those countries. 6-15 No. Cash budgets and operating income budgets must be prepared simultaneously. In preparing their operating income budgets, companies want to avoid unnecessary idle cash and unexpected cash deficiencies. The cash budget, unlike the operating income budget, highlights periods of idle cash and periods of cash shortage, and it allows the accountant to plan cost effective ways of either using excess cash or raising cash from outside to achieve the company’s operating income goals. 6-2 6-16 (15 min.) Sales budget, service setting. 1. McGrath & Sons Radon Tests Lead Tests 2009 Volume 11,000 15,200 At 2009 Selling Prices $250 $200 Expected 2010 Change in Volume +5% -10% Expected 2010 Volume 11,550 13,680 McGrath & Sons Sales Budget For the Year Ended December 31, 2010 Radon Tests Lead Tests Selling Price $250 $200 Units Sold 11,550 13,680 Total Revenues $2,887,500 2,736,000 $5,623,500 2. McGrath & Sons Radon Tests Lead Tests 2009 Volume 11,000 15,200 Planned 2010 Selling Prices $250 $190 Expected 2010 Expected Change in 2010 Volume Volume +5% 11,550 -5% 14,440 McGrath & Sons Sales Budget For the Year Ended December 31, 2010 Radon Tests Lead Tests Selling Price $250 $190 Units Sold 11,550 14,440 Total Revenues $2,887,500 2,743,600 $5,631,100 Expected revenues at the new 2010 prices are $5,631,100, which are greater than the expected 2010 revenues of $5,623,500 if the prices are unchanged. So, if the goal is to maximize sales revenue and if Jim McGrath’s forecasts are reliable, the company should lower its price for a lead test in 2010. 6-3 6-17 (5 min.) Sales and production budget. Budgeted sales in units Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced 6-18 (5 min.) Direct materials purchases budget. Direct materials to be used in production (bottles) Add target ending direct materials inventory (bottles) Total requirements (bottles) Deduct beginning direct materials inventory (bottles) Direct materials to be purchased (bottles) 6-19 200,000 25,000 225,000 15,000 210,000 2,500,000 80,000 2,580,000 50,000 2,530,000 (10 min.) Budgeting material purchases. Production Budget: Budgeted sales Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced Finished Goods (units) 45,000 18,000 63,000 16,000 47,000 Direct Materials Purchases Budget: Direct materials needed for production (47,000 3) Add target ending direct materials inventory Total requirements Deduct beginning direct materials inventory Direct materials to be purchased 6-4 Direct Materials (in gallons) 141,000 50,000 191,000 60,000 131,000 6-20 (30 min.) Revenues and production budget budget. 1. 12-ounce bottles 4-gallon units a b Selling Price $0.25 1.50 Units Sold 4,800,000a 1,200,000b Total Revenues $1,200,000 1,800,000 $3,000,000 400,000 × 12 months = 4,800,000 100,000 × 12 months = 1,200,000 2. Budgeted unit sales (12-ounce bottles) Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced 4,800,000 600,000 5,400,000 900,000 4,500,000 3. Beginning = Budgeted + Target Budgeted inventory sales ending inventory production = 1,200,000 + 200,000 1,300,000 = 100,000 4-gallon units 6-21 (30 min.) Budgeting: direct material usage, manufacturing cost and gross margin margin. 1. Direct Material Usage Budget in Quantity and Dollars Material Wool Physical Units Budget Direct materials required for Blue Rugs (100,000 rugs × 30 skeins and 0.5 gal.) 3,000,0000 skeins Cost Budget Available from beginning direct materials inventory (under a FIFO cost-flow assumption) Wool: 349,000 skeins $ 715,450 Dye: 5,000 gallons To be purchased this period Wool: (3,000,000 - 349,000) skeins × $2 per skein 5,302,000 _ Dye: (50,000 – 5,000) gal. × $5 per gal. ________ Direct materials to be used this period: (a) + (b) $6,017,450 6-5 Dye Total 50,000 gal. $ 24,850 225,000 $ 249,850 $6,267,300 2. $18,852,000 Weaving budgeted = = $3.3664 per DMLH overhead rate 5,600,000 DMLH Dyeing budgeted = $12,809,000 = $28.4644 per MH overhead rate 450,000 MH 3. Budgeted Unit Cost of Blue Rug Wool Dye Direct manufacturing labor Dyeing overhead Weaving overhead Total 10.15 Input per Unit of Output 30 skeins 0.5 gal. 56 hrs. 1 mach-hrs. 4.5 56 DMLH Cost per Unit of Input $2 5 15 28.4644 3.3664 Total 60.00 2.50 840.00 128.09 188.52 $1219.11 $ machine hour per skein 30 skeins per rug = 4.5 machine-hrs. per rug. 4. Revenue Budget Blue Rugs Blue Rugs Selling Units Price Total Revenues 100,000 $2,000 $200,000,000 95,000 $2,000 $190,000,000 5a. Sales = 100,000 rugs Cost of Goods Sold Budget From Schedule Beginning finished goods inventory Direct materials used Direct manufacturing labor ($840 × 100,000) Dyeing overhead ($128.09 × 100,000) Weaving overhead ($188.52 × 100,000) Cost of goods available for sale Deduct ending finished goods inventory Cost of goods sold 6-6 Total $ $ 6,267,300 84,000,000 12,809,000 18,852,000 0 121,928,300 121,928,300 0 $121,928,300 5b. Sales = 95,000 rugs Cost of Goods Sold Budget From Schedule Beginning finished goods inventory Direct materials used Direct manufacturing labor ($840 × 100,000) Dyeing overhead ($128.09 × 100,000) Weaving overhead ($188.52 × 100,000) Cost of goods available for sale Deduct ending finished goods inventory ($1,219.11 × 5,000) Cost of goods sold Total $ 0 $ 6,267,300 84,000,000 12,809,000 18,852,000 121,928,300 121,928,300 6,095,550 $115,832,750 6. Revenue Less: Cost of goods sold Gross margin 100,000 rugs sold $200,000,000 121,928,300 $ 78,071,700 95,000 rugs sold $190,000,000 115,832,750 $ 74,167,250 6-22 (15–20 min.) Revenues, production, and purchases budget. 1. 900,000 motorcycles 400,000 yen = 360,000,000,000 yen 2. Budgeted sales (motorcycles) Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced 3. Direct materials to be used in production, 880,000 × 2 (wheels) Add target ending direct materials inventory Total requirements Deduct beginning direct materials inventory Direct materials to be purchased (wheels) Cost per wheel in yen Direct materials purchase cost in yen 6-7 900,000 80,000 980,000 100,000 880,000 1,760,000 60,000 1,820,000 50,000 1,770,000 16,000 28,320,000,000 Note the relatively small inventory of wheels. In Japan, suppliers tend to be located very close to the major manufacturer. Inventories are controlled by just-in-time and similar systems. Indeed, some direct materials inventories are almost nonexistent. 6-23 (15-25 min.) Budgets for production and direct manufacturing labor. Roletter Company Budget for Production and Direct Manufacturing Labor for the Quarter Ended March 31, 2010 Budgeted sales (units) Add target ending finished goods inventorya (units) Total requirements (units) Deduct beginning finished goods inventory (units) Units to be produced Direct manufacturing labor-hours (DMLH) per unit Total hours of direct manufacturing labor time needed Direct manufacturing labor costs: Wages ($10.00 per DMLH) Pension contributions ($0.50 per DMLH) Workers’ compensation insurance ($0.15 per DMLH) Employee medical insurance ($0.40 per DMLH) Social Security tax (employer’s share) ($10.00 0.075 = $0.75 per DMLH) Total direct manufacturing labor costs January 10,000 February 12,000 March 8,000 Quarter 30,000 16,000 26,000 12,500 24,500 13,500 21,500 13,500 43,500 16,000 10,000 16,000 8,500 12,500 9,000 16,000 27,500 × 2.0 × 2.0 1.5 20,000 17,000 13,500 50,500 $200,000 $170,000 $135,000 $505,000 10,000 8,500 6,750 25,250 3,000 2,550 2,025 7,575 8,000 6,800 5,400 20,200 15,000 12,750 10,125 37,875 $236,000 $200,600 $159,300 $595,900 a100% of the first following month’s sales plus 50% of the second following month’s sales. Note that the employee Social Security tax of 7.5% is irrelevant. Such taxes are withheld from employees’ wages and paid to the government by the employer on behalf of the employees; therefore, the 7.5% amounts are not additional costs to the employer. 6-8 6-24 (20–30 min.) Activity-based budgeting. 1. This question links to the ABC example used in the Problem for Self-Study in Chapter 5 and to Question 5-23 (ABC, retail product-line profitability). Cost Hierarchy Activity Ordering $90 14; 24; 14 Delivery $82 12; 62; 19 Shelf-stocking $21 16; 172; 94 Customer support $0.18 4,600; 34,200; 10,750 Total budgeted indirect costs Soft Drinks Fresh Produce Packaged Food Total Batch-level $1,260 $ 2,160 $1,260 $ 4,680 Batch-level Output-unitlevel Output-unitlevel 984 5,084 1,558 7,626 336 3,612 1,974 5,922 828 $3,408 6,156 $17,012 1,935 $6,727 8,919 $27,147 13% 63% Percentage of total indirect costs (subject to rounding) 25% 2. Refer to the last row of the table in requirement 1. Fresh produce, which probably represents the smallest portion of COGS, is the product category that consumes the largest share (63%) of the indirect resources. Fresh produce demands the highest level of ordering, delivery, shelf-stocking and customer support resources of all three product categories—it has to be ordered, delivered and stocked in small, perishable batches, and supermarket customers often ask for a lot of guidance on fresh produce items. 3. An ABB approach recognizes how different products require different mixes of support activities. The relative percentage of how each product area uses the cost driver at each activity area is: Activity Ordering Delivery Shelf-stocking Customer support Cost Hierarchy Batch-level Batch-level Output-unit-level Output-unit-level Soft Drinks 27% 13 6 9 Fresh Produce 46% 67 61 69 Packaged Food 27% 20 33 22 Total 100% 100 100 100 By recognizing these differences, FS managers are better able to budget for different unit sales levels and different mixes of individual product-line items sold. Using a single cost driver (such as COGS) assumes homogeneity in the use of indirect costs (support activities) across product lines which does not occur at FS. Other benefits cited by managers include: (1) better identification of resource needs, (2) clearer linking of costs with staff responsibilities, and (3) identification of budgetary slack. 6-9 6-25 (20–30 min.) Kaizen approach to activity-based budgeting (continuation of 6-24). 1. Activity Ordering Delivery Shelf-stocking Customer support Cost Hierarchy Batch-level Batch-level Output-unit-level Output-unit-level Budgeted Cost-Driver Rates January February March $90.00 $89.82000 $89.64 82.00 81.83600 81.67 21.00 20.95800 20.92 0.18 0.17964 0.179 The March 2008 rates can be used to compute the total budgeted cost for each activity area in March 2008: Activity Ordering $89.64 14; 24; 14 Delivery $81.67 12; 62; 19 Shelf-stocking $20.92 16; 172; 94 Customer support $0.179 4,600; 34,200; 10,750 Total Cost Hierarchy Soft Drinks Fresh Produce Packaged Food Total Batch-level $1,255 $ 2,151 $1,255 $ 4,661 Batch-level 980 5,064 1,552 7,596 Output-unit-level 335 3,598 1,966 5,899 Output-unit-level 823 $3,393 6,122 $16,935 1,924 $6,697 8,869 $27,025 2. A kaizen budgeting approach signals management’s commitment to systematic cost reduction. Compare the budgeted costs from Question 6-24 and 6-25. Question 6-24 Question 6-25 (Kaizen) Ordering $4,680 4,661 Delivery $7,626 7,596 ShelfStocking $5,922 5,899 Customer Support $8,919 8,869 The kaizen budget number will show unfavorable variances for managers whose activities do not meet the required monthly cost reductions. This likely will put more pressure on managers to creatively seek out cost reductions by working “smarter” within FS or by having “better” interactions with suppliers or customers. One limitation of kaizen budgeting, as illustrated in this question, is that it assumes small incremental improvements each month. It is possible that some cost improvements arise from large discontinuous changes in operating processes, supplier networks, or customer interactions. Companies need to highlight the importance of seeking these large discontinuous improvements as well as the small incremental improvements. 6-10 6-26 (15 min.) Responsibility and controllability. 1. (a) Salesman (b) VP of Sales Permit the salesman to offer a reasonable discount to customers, but require that he clear bigger discounts with the VP. Also, base his bonus/performance evaluation not just on revenues generated, but also on margins (or, ability to meet budget). 2. (a) VP of Sales (b) VP of Sales VP of Sales should compare budgeted sales with actuals, and ask for an analysis of all the sales during the quarter. Discuss with salespeople why so many discounts are being offered—are they really needed to close each sale. Are our prices too high (i.e., uncompetitive)? 3. (a) Manager, Shipping department (b) Manager or Director of Operations (including shipping) Shipping department manager must report delays more regularly and request additional capacity in a timely manner. Operations manager should ask for a review of shipping capacity utilization, and consider expanding the department. 4. (a) HR department (b) Production supervisor The production supervisor should devise his or her own educational standards that all new plant employees are held to before they are allowed to work on the plant floor. Offer remedial in-plant training to those workers who show promise. Be very specific about the types of skills required when using the HR department to hire plant workers. Test the workers periodically for required skills. 5. (a) Production supervisor (b) Production supervisor Get feedback from the workers, analyze it, and act on it. Get extra coaching and training from experienced mentors. 6. (a) Maintenance department (b) Production supervisor First, get the requisite maintenance done on the machines. Make sure that the maintenance department head clearly understands the repercussions of poor maintenance. Discuss and establish maintenance standards that must be met (frequency of maintenance and tolerance limits, for example). Test and keep a log of the maintenance work. 6-11 6-27 (30 min.) Cash flow analysis, chapter appendix. 1. The cash that TabComp, Inc., can expect to collect during April 2006 is calculated below. April cash receipts: April cash sales ($400,000 .25) April credit card sales ($400,000 .30 .96) Collections on account: March ($480,000 .45 .70) February ($500,000 .45 .28) January (uncollectible-not relevant) Total collections $100,000 115,200 151,200 63,000 0 $429,400 2. (a) The projected number of the MZB-33 computer hardware units that TabComp, Inc., will order on January 25, 2006, is calculated as follows. March sales Plus: Ending inventorya Total needed Less: Beginning inventoryb Projected purchases in units a0.30 90 unit sales in April b0.30 MZB-33 Units 110 27 137 33 104 110 unit sales in March (b) Selling price = $2,025,000 675 units, or for March, $330,000 110 units = $3,000 per unit $ 1,800 Purchase price per unit, 60% $3,000 Projected unit purchases x 104 $187,200 Total MZB-33 purchases, $1,800 104 3. Monthly cash budgets are prepared by companies such as TabComp, Inc., in order to plan for their cash needs. This means identifying when both excess cash and cash shortages may occur. A company needs to know when cash shortages will occur so that prior arrangements can be made with lending institutions in order to have cash available for borrowing when the company needs it. At the same time, a company should be aware of when there is excess cash available for investment or for repaying loans. 6-12 6-28 (40 min.) Budget schedules for a manufacturer. 1a. Revenues Budget Units sold Selling price Budgeted revenues b. Executive Line 740 $ 1,020 $754,800 Chairman Line 390 $ 1,600 $624,000 $1,378,800 Production Budget in Units Executive Line 740 30 770 20 750 Budgeted unit sales Add budgeted ending fin. goods inventory Total requirements Deduct beginning fin. goods. inventory Budgeted production c. Total Chairman Line 390 15 405 5 400 Direct Materials Usage Budget (units) Red Oak Oak Executive Line: 1. Budgeted input per f.g. unit 2. Budgeted production 3. Budgeted usage (1 × 2) Chairman Line: 4. Budgeted input per f.g. unit 5. Budgeted production 6. Budgeted usage (4 × 5) 7. Total direct materials usage (3 + 6) Direct Materials Cost Budget 8. Beginning inventory 9. Unit price (FIFO) 10. Cost of DM used from beginning inventory (8 × 9) 11. Materials to be used from purchases (7 – 8) 12. Cost of DM in March 13. Cost of DM purchased and used in March (11 × 12) 14. Direct materials to be used (10 + 13) Oak Legs Red Oak Legs Total 16 750 12,000 – – – 4 750 3,000 – – – – – – 25 400 10,000 – – – 4 400 1,600 12,000 10,000 3,000 1,600 320 150 100 40 $18 $23 $11 $17 $5,760 $3,450 $1,100 $680 11,680 $20 9,850 $25 2,900 $12 1,560 $18 $233,600 $246,250 $34,800 $28,080 $542,730 $239,360 $249,700 $35,900 $28,760 $553,720 6-13 $10,990 Direct Materials Purchases Budget Oak Budgeted usage (from line 7) Add target ending inventory Total requirements Deduct beginning inventory Total DM purchases Purchase price (March) Total purchases d. 10,000 200 10,200 150 10,050 $25 $251,250 3,000 80 3,080 100 2,980 $12 $35,760 Output Units Produced 750 400 Direct Manuf. LaborHours per Output Unit 3 5 Total Hours 2,250 2,000 4,250 1,600 44 1,644 40 1,604 $18 $28,872 Total ________ $553,322 Hourly Rate $30 $30 Total $ 67,500 60,000 $127,500 Manufacturing Overhead Budget Variable manufacturing overhead costs (4,250 × $35) Fixed manufacturing overhead costs Total manufacturing overhead costs $191,250 Total manuf. overhead cost per hour = = 4,250 $42,500 Fixed manuf. overhead cost per hour = = 4,250 f. Red Oak Legs Direct Manufacturing Labor Budget Executive Line Chairman Line e. 12,000 192 12,192 320 11,872 $20 $237,440 Oak Legs Red Oak $148,750 42,500 $191,250 $45 per direct manufacturing labor-hour $10 per direct manufacturing labor-hour Computation of unit costs of ending inventory of finished goods Executive Chairman Line Line Direct materials Oak top ($20 × 16, 0) $320 $ 0 Red oak ($25 × 0, 25) 0 625 Oak legs ($12 × 4, 0) 48 0 Red oak legs ($18 × 0, 4) 0 72 Direct manufacturing labor ($30 × 3, 5) 90 150 Manufacturing overhead Variable ($35 × 3, 5) 105 175 Fixed ($10 × 3, 5) 30 50 Total manufacturing cost $593 $1,072 6-14 Ending Inventories Budget Cost per Unit Units Total Direct Materials Oak top Red oak top Oak legs Red oak legs $ 20 25 12 18 192 200 80 44 $ 3,840 5,000 960 792 10,592 Finished Goods Executive Chairman 593 1,072 30 15 17,790 16,080 33,870 $44,462 Total g. 2. Cost of goods sold budget Budgeted fin. goods inventory, March 1, 2009 ($10,480 + $4,850) 15,330 Direct materials used (from Dir. materials purch. budget) $553,720 Direct manufacturing labor (Dir. manuf. labor budget) 127,500 Manufacturing overhead (Manuf. overhead budget) 191,250 Cost of goods manufactured Cost of goods available for sale Deduct ending fin. goods inventory, March 31, 2009 (Inventories budget) Cost of goods sold $853,930 $ 872,470 887,800 33,870 Areas where continuous improvement might be incorporated into the budgeting process: (a) Direct materials. Either an improvement in usage or price could be budgeted. For example, the budgeted usage amounts could be related to the maximum improvement (current usage – minimum possible usage) of 1 square foot for either desk: • Executive: 16 square feet – 15 square feet minimum = 1 square foot • Chairman: 25 square feet – 24 square feet minimum = 1 square foot Thus, a 1% reduction target per month could be: • Executive: 15 square feet + (0.99 × 1) = 15.99 • Chairman: 24 square feet + (0.99 × 1) = 24.99 Some students suggested the 1% be applied to the 16 and 25 square-foot amounts. This can be done so long as after several improvement cycles, the budgeted amount is not less than the minimum desk requirements. (b) Direct manufacturing labor. The budgeted usage of 3 hours/5 hours could be continuously revised on a monthly basis. Similarly, the manufacturing labor cost per hour of $30 could be continuously revised down. The former appears more feasible than the latter. (c) Variable manufacturing overhead. By budgeting more efficient use of the allocation base, a signal is given for continuous improvement. A second approach is to budget continuous improvement in the budgeted variable overhead cost per unit of the allocation base. (d) Fixed manufacturing overhead. The approach here is to budget for reductions in the year-to-year amounts of fixed overhead. If these costs are appropriately classified as fixed, then they are more difficult to adjust down on a monthly basis. 6-15 6-29 (45 min.) Activity-based budget: kaizen improvements. 1. Revenue Budget For the Quarter Ending March 31, 20xx Units 20,000 Selling price $120 Total revenues $2,400,000 2. Direct Material Usage Budget in Quantity and Dollars For the Quarter Ending March 31, 20xx Physical units budget Direct materials required (20,000 units 10 oz.) 200,000 oz. Cost budget To be purchased this period (200,000 oz. $4 per oz.) $8,000,000 Direct materials to be used this period $8,000,000 3. Direct Manufacturing Labor Costs Budget For the Quarter Ending March 31, 20xx Output units produced 20,000 Direct manufacturing labor-hours per unit 2 Total direct manufacturing labor-hours 40,000 Hourly wage rate $15 Total direct manufacturing labor costs $600,000 4. Manufacturing Overhead Costs Budget For the Quarter Ending March 31, 20xx Machine setup overhead (400 setup-hours $80 per hour) $32,000 Operations overhead (40,000 hours $1.60 per hour) 64,000 Total manufacturing overhead costs $96,000 20,000 units = 200 batches. Each batch requires 2 setup hours, so 100 units per batch 200 batches 2 setup-hours per batch = 400 setup-hours 6-16 5. Budgeted Unit Cost For the Quarter Ending March 31, 20xx Cost per Unit of Input per Input Unit of Output Direct material $ 4 10 oz. Direct manufacturing labor 15 2 DMLH Machine setup overhead 80 0.02 setup-hours1 Operations overhead 1.60 2 DMLH Total cost per gizmo 1Setup-hours Total $40.00 30.00 1.60 3.20 $74.80 per gizmo = 400 setup-hours ÷ 20,000 gizmos = 0.02 setup-hours per gizmo. Alternatively, Budgeted Unit Cost For the Quarter Ending March 31, 20xx Total Per unit (1) (2) = (1) ÷ 20,000 Direct material costs (requirement 2) $ 800,000 $40.00 Direct manufacturing labor costs (requirement 3) 600,000 30.00 Machine setup overhead costs (requirement 4) 32,000 1.60 Operations overhead costs (requirement 4) 64,000 3.20 Total costs $1,496,000 $74.80 6. Cost of Goods Sold Budget For the Quarter Ending March 31, 20xx Total Beginning finished goods inventory, Jan. 1 Direct materials used Direct manufacturing labor Manufacturing overhead Cost of goods manufactured Cost of goods available for sale Deduct: Ending finished goods inventory, Mar. 311 Cost of goods sold 1Under $ 72,000 $800,000 600,000 96,000 1,496,000 1,568,000 72,000 $1,496,000 LIFO cost flow assumption, the 1,000 gizmos in beginning finished goods inventory that remain in inventory on March 31 continue to be valued at $72,000. 6-17 7. Budgeted Gross Margin For the Quarter Ending March 31, 20xx Revenues $2,400,000 Cost of goods sold 1,496,000 Gross margin $ 904,000 8. Direct material Direct manufacturing labor Machine setup overhead Operations overhead 1st Quarter Quantity (1) 10 oz 2 DMLH 0.02 setup-hours 2 DMLH Proposed Decrease (2) 1% 1% 3% 1% 2d Quarter Revised Quantity (3) = (1)×(100% ─ (2)) (1)× 9.9 oz. 1.98 DMLH 0.0194 setup-hours 1.98 DMLH 3rd Quarter Revised Quantity (4) = (3)×(100% ─ (2)) (3)× 9.8 oz. 1.96 DMLH 0.01882 setup-hours 1.96 DMLH Budgeted Unit Cost For the Quarters Ending June 30 and Sept. 30, 20xx Direct material Direct manufacturing labor Machine setup overhead Operations overhead Total Cost per Unit of Input $ 4 15 80 1.60 2d Quarter Input per Unit of Output 9.9 oz. 1.98 DMLH 0.0194 setup hrs. 1.98 DMLH Budgeted Unit Cost June 30 $39.60 29.70 1.55 3.17 $74.02 Budgeted Gross Margin For the Quarters Ending June 30, 20xx $2,400,000 Revenues Cost of goods sold ($74.02; $73.24 × 20,000) Gross margin 1,480,400 $ 919,600 3rd Quarter Input per Unit of Output 9.80 oz 1.96 DMLH 0.0188 setup-hr 1.96 DMLH Budgeted Unit Cost Sept. 30 $39.20 29.40 1.50 3.14 $73.24 Sept. 30, 20xx $2,400,000 1,464,800 $ 935,200 9. Reduction in materials can be accomplished by reducing waste and scrap. Reduction in direct labor and setup time can be accomplished by improving the efficiency of operations and decreasing down time. Employees who make the gizmos may have suggestions for ways to do their jobs more efficiently. For instance, employees may recommend process changes that reduce idle time, setup time, and scrap. To motivate workers to improve efficiency, many companies have set up programs that share productivity gains with the workers. Korna must be careful that productivity improvements and cost reductions do not in any way compromise product quality. 6-18 6-30 (30–40 min.) Revenue and production budgets. This is a routine budgeting problem. The key to its solution is to compute the correct quantities of finished goods and direct materials. Use the following general formula: 错误!未指定开关参数。= 错误!未指定开关参数。+ 错误!未指定开关参数。– 错误!未指定开关参数 。 Scarborough Corporation Revenue Budget for 2010 1. Thingone Thingtwo Budgeted revenues 2. Units 60,000 40,000 Total $ 9,900,000 10,000,000 $19,900,000 Scarborough Corporation Production Budget (in units) for 2010 Budgeted sales in units Add target finished goods inventories, December 31, 2010 Total requirements Deduct finished goods inventories, January 1, 2010 Units to be produced 3. Price $165 250 Thingone 60,000 Thingtwo 40,000 25,000 85,000 9,000 49,000 20,000 65,000 8,000 41,000 Scarborough Corporation Direct Materials Purchases Budget (in quantities) for 2007 Direct Materials A B Direct materials to be used in production • Thingone (budgeted production of 65,000 units times 4 lbs. of A, 2 lbs. of B) • Thingtwo (budgeted production of 41,000 units times 5 lbs. of A, 3 lbs. of B, 1 lb. of C) Total Add target ending inventories, December 31, 2010 Total requirements in units Deduct beginning inventories, January 1, 2010 Direct materials to be purchased (units) 6-19 C 260,000 130,000 -- 205,000 465,000 36,000 501,000 32,000 469,000 123,000 253,000 32,000 285,000 29,000 256,000 41,000 41,000 7,000 48,000 6,000 42,000 Scarborough Corporation Direct Materials Purchases Budget (in dollars) for 2010 4. Budgeted Purchases (Units) 469,000 256,000 42,000 Direct material A Direct material B Direct material C Budgeted purchases Total $5,628,000 1,280,000 126,000 $7,034,000 Scarborough Corporation Direct Manufacturing Labor Budget (in dollars) for 2010 5. Thingone Thingtwo Total 6. Expected Purchase Price per unit $12 5 3 Budgeted Production (Units) 65,000 41,000 Direct Manufacturing Labor-Hours per Unit 2 3 Rate Total per Hours Hour 130,000 $12 123,000 16 Total $1,560,000 1,968,000 $3,528,000 Scarborough Corporation Budgeted Finished Goods Inventory at December 31, 2010 Thingone: Direct materials costs: A, 4 pounds × $12 $48 B, 2 pounds × $5 10 Direct manufacturing labor costs, 2 hours × $12 Manufacturing overhead costs at $20 per direct manufacturing labor-hour (2 hours × $20) Budgeted manufacturing costs per unit Finished goods inventory of Thingone $122 × 25,000 units Thingtwo: Direct materials costs: A, 5 pounds × $12 $60 B, 3 pounds × $5 15 C, 1 each × $3 3 Direct manufacturing labor costs, 3 hours × $16 Manufacturing overhead costs at $20 per direct manufacturing labor-hour (3 hours × $20) Budgeted manufacturing costs per unit Finished goods inventory of Thingtwo $186 × 9,000 units Budgeted finished goods inventory, December 31, 2010 6-20 $ 58 24 40 $122 $3,050,000 $ 78 48 60 $186 1,674,000 $4,724,000 6-31 (30 min.) Budgeted income statement. Easecom Company Budgeted Income Statement for 2008 (in thousands) Revenues Equipment ($6,000 × 1.06 × 1.10) Maintenance contracts ($1,800 × 1.06) Total revenues Cost of goods sold ($4,600 × 1.03 × 1.06) Gross margin Operating costs: Marketing costs ($600 + $250) Distribution costs ($150 × 1.06) Customer maintenance costs ($1,000 + $130) Administrative costs Total operating costs Operating income 6-32 $6,996 1,908 $8,904 5,022 3,882 850 159 1,130 900 3,039 $ 843 (15 min.) Responsibility of purchasing agent. The time lost in the plant should be charged to the purchasing department. The plant manager probably should not be asked to underwrite a loss due to failure of delivery over which he had no supervision. Although the purchasing agent may feel that he has done everything he possibly could, he must realize that, in the whole organization, he is the one who is in the best position to evaluate the situation. He receives an assignment. He may accept it or reject it. But if he accepts, he must perform. If he fails, the damage is evaluated. Everybody makes mistakes. The important point is to avoid making too many mistakes and also to understand fully that the extensive control reflected in responsibility accounting is the necessary balance to the great freedom of action that individual executives are given. Discussions of this problem have again and again revealed a tendency among students (and among accountants and managers) to “fix the blame”––as if the variances arising from a responsibility accounting system should pinpoint misbehavior and provide answers. The point is that no accounting system or variances can provide answers. However, variances can lead to questions. In this case, in deciding where the penalty should be assigned, the student might inquire who should be asked––not who should be blamed. Classroom discussions have also raised the following diverse points: (a) Is the railroad company liable? (b) Costs of idle time are usually routinely charged to the production department. Should the information system be fine-tuned to reallocate such costs to the purchasing department? (c) How will the purchasing managers behave in the future regarding willingness to take risks? The text emphasizes the following: Beware of overemphasis on controllability. For example, a time-honored theme of management is that responsibility should not be given without accompanying authority. Such a guide is a useful first step, but responsibility accounting is more far-reaching. The basic focus should be on information or knowledge, not on control. The key 6-21 question is: Who is the best informed? Put another way, “Who is the person who can tell us the most about the specific item, regardless of ability to exert personal control?” 6-33 (60 min.) Comprehensive problem with ABC costing 1. Revenue Budget For the Month of April Cat-allac Dog-eriffic Total Units Selling Price Total Revenues 500 $160 $ 80,000 300 250 75,000 $155,000 2. Production Budget For the Month of April Budgeted unit sales Add target ending finished goods inventory Total required units Deduct beginning finished goods inventory Units of finished goods to be produced Product Cat-allac Dog-eriffic 500 300 35 15 535 315 15 30 520 285 3a. Direct Material Usage Budget in Quantity and Dollars For the Month of April Material Plastic Metal Physical Units Budget Direct materials required for Cat-allac (520 units × 4 lbs. and 0.5 lb.) Dog-errific (285 units × 6 lbs. and 1 lb.) Total quantity of direct material to be used 2,080 lbs. 1,710 lbs. 3,790 lbs. Cost Budget Available from beginning direct materials inventory (under a FIFO cost-flow assumption) Plastic: 250 lbs. × $3.80 per lb. $ 950 Metal: 60 lbs. × $3 per lb. To be purchased this period . Plastic: (3,790 – 250) lbs. $4 per lb. 14,160 Metal: (545 – 60) lbs. $3 per lb. __ ____ Direct materials to be used this period $15,110 6-22 Total 260 lbs. 285 lbs. 545 lbs. $ 180 1,455 $ 1,635 $16,745 Direct Material Purchases Budget For the Month of April Material Plastic Metal Physical Units Budget To be used in production (requirement 3) Add target ending inventory Total requirements Deduct beginning inventory Purchases to be made Cost Budget Plastic: 3,920 lbs. $4 Metal: 540 lbs. $3 Purchases 3,790 lbs. 380 lbs. 4,170 lbs. 250 lbs. 3,920 lbs. $15,680 ______ $15,680 Total 545 lbs. 55 lbs. 600 lbs. 60 lbs. 540 lbs. $ 1,620 $ 1,620 $ 17,300 4. Direct Manufacturing Labor Costs Budget For the Month of April Cat-allac Dog-errific Total Output Units Produced (requirement 2) 520 285 DMLH per Unit 3 5 Total Hours 1,560 1,425 Hourly Wage Rate $10 10 Total $15,600 14,250 $29,850 5. Machine Setup Overhead Units to be produced Units per batch Number of batches Setup time per batch Total setup time Cat-allac 520 ÷ 20 26 1.5 hrs. 39 hrs. Dog-errific 285 ÷15 19 1.75 hrs. 33.25 hrs. Total 72.25 hrs. Budgeted machine setup costs = $100 per setup hour 72.25 hours = $7,225 Processing Overhead Budgeted machine-hours (MH) = (10 MH per unit × 520 units) + (18 MH per unit × 285 units) = 5,200 MH + 5,130 MH = 10,330 MH Budgeted processing costs = $5 per MH × 10,330 MH = $51,650 Inspection Overhead Budgeted inspection-hours = (0.5 26 batches) + (0.6 19 batches) = 13 + 11.4 = 24.4 inspection hrs. Budgeted inspection costs = $16 per inspection hr. 24.4 inspection hours = $390.40 6-23 Manufacturing Overhead Budget For the Month of April Machine setup costs $ 7,225 Processing costs 51,650 Inspection costs 390 Total costs $59,265 6. Unit Costs of Ending Finished Goods Inventory April 30, 20xx Product Cat-allac Dog-errific Cost per Input per Input per Unit of Unit of Unit of Input Output Total Output Total Plastic $ 4 4 lbs. $ 16.00 6 lbs. $ 24.00 Metal 3 0.5 lbs. 1.50 1 lb. 3.00 Direct manufacturing labor 10 3 hrs. 30.00 5 hrs. 50.00 Machine setup 100 0.075 hrs. 1 7.50 0.1167 hr1 11.67 Processing 5 10 MH 50.00 18 MH 90.00 2 2 Inspection 16 0.025 hr 0.40 0.04 hr. 0.64 Total $105.40 $179.31 1 2 39 setup-hours ÷ 520 units = 0.075 hours per unit; 33.25 setup-hours ÷ 285 units = 0.1167 hours per unit 13 inspection hours ÷ 520 units = 0.025 hours per unit; 11.4 inspection hours ÷ 285 units = 0.04 hours per unit Ending Inventories Budget April 30, 20xx Quantity Direct Materials Plastic Metals Finished goods Cat-allac Dog-errific Total ending inventory Cost per unit Total 380 55 $4 3 $1,520 165 35 15 $105.40 179.31 $3,689 2,690 6-24 $1,685 6,379 $8,064 7. Cost of Goods Sold Budget For the Month of April, 20xx Beginning finished goods inventory, April, 1 ($1,500 + $5,580) Direct materials used (requirement 3) Direct manufacturing labor (requirement 4) Manufacturing overhead (requirement 5) Cost of goods manufactured Cost of goods available for sale Deduct: Ending finished goods inventory, April 30 (reqmt. 6) Cost of goods sold $ $16,745 29,850 59,265 8. Nonmanufacturing Costs Budget For the Month of April, 20xx Salaries ($36,000 ÷ 2 1.05) $18,900 Other fixed costs ($36,000 ÷ 2) 18,000 Sales commissions ($155,000 1%) 1,550 Total nonmanufacturing costs $38,450 9. Budgeted Income Statement For the Month of April, 20xx Revenues $155,000 Cost of goods sold 106,561 Gross margin 48,439 Operating (nonmanufacturing) costs 38,450 Operating income $ 9,989 6-25 7,080 105,860 112,940 6,379 $106,561 6-34 (25 min.) (Continuation of 6-33) Cash budget (Appendix) Cash Budget April 30, 20xx Cash balance, April 1, 20xx Add receipts Cash sales ($155,000 × 10%) Credit card sales ($155,000 × 90% × 97%) Total cash available for needs (x) Deduct cash disbursements Direct materials ($8,500 + $17,300 × 50%) Direct manufacturing labor Manufacturing overhead ($59,265 ─ $20,000 depreciation) Nonmanufacturing salaries Sales commissions Other nonmanufacturing fixed costs ($18,000 ─ $10,000 deprn) Machinery purchase Income taxes Total disbursements (y) Financing Repayment of loan 1 Interest at 12% ($2,000 12% ) 12 Total effects of financing (z) Ending cash balance, April 30 (x) ─ (y) ─ (z) 6-26 $ 5,360 15,500 135,315 $156,175 $ 17,150 29,850 39,265 18,900 1,550 8,000 13,700 5,000 $133,415 $ 2,000 20 $ 2,020 $ 20,740 6-35 (60 min.) Comprehensive operating budget, budgeted balance sheet. 1. Schedule 1: Revenues Budget for the Year Ended December 31, 2010 Units Selling Price Total Revenues Snowboards 1,000 $450 $450,000 2. Schedule 2: Production Budget (in Units) for the Year Ended December 31, 2010 Snowboards Budgeted unit sales (Schedule 1) 1,000 Add target ending finished goods inventory 200 Total requirements 1,200 Deduct beginning finished goods inventory 100 Units to be produced 1,100 3. Schedule 3A: Direct Materials Usage Budget for the Year Ended December 31, 2010 Wood Fiberglass Total Physical Units Budget Wood: 1,100 × 5.00 b.f. Fiberglass: 1,100 × 6.00 yards To be used in production Cost Budget Available from beginning inventory Wood: 2,000 b.f. × $28.00 Fiberglass: 1,000 b.f. × $4.80 To be used from purchases this period Wood: (5,500 – 2,000) × $30.00 Fiberglass: (6,600 – 1,000) × $5.00 Total cost of direct materials to be used 5,500 5,500 6,600 6,600 $ 56,000 $ 4,800 105,000 $161,000 28,000 $32,800 $193,800 Schedule 3B: Direct Materials Purchases Budget for the Year Ended December 31, 2010 Wood Physical Units Budget Production usage (from Schedule 3A) Add target ending inventory Total requirements Deduct beginning inventory Purchases Cost Budget Wood: 5,000 × $30.00 Fiberglass: 7,600 × $5.00) Purchases 5,500 1,500 7,000 2,000 5,000 Fiberglass Total 6,600 2,000 8,600 1,000 7,600 $150,000 $150,000 6-27 $38,000 $38,000 $188,000 4. Schedule 4: Direct Manufacturing Labor Budget for the Year Ended December 31, 2010 Labor Category Manufacturing labor 5. Cost Driver Units 1,100 DML Hours per Driver Unit 5.00 Total Hours 5,500 Wage Rate $25.00 Total $137,500 Schedule 5: Manufacturing Overhead Budget for the Year Ended December 31, 2010 At Budgeted Level of 5,500 Direct Manufacturing Labor-Hours Variable manufacturing overhead costs ($7.00 × 5,500) Fixed manufacturing overhead costs Total manufacturing overhead costs 6. 7. 8. $ 38,500 66,000 $104,500 $104,500 = $19.00 per hour 5,500 $104,500 Budgeted manufacturing overhead cost per output unit: = $95.00 per output unit 1,100 Schedule 6A: Computation of Unit Costs of Manufacturing Finished Goods in 2010 Budgeted manufacturing overhead rate: Cost per Unit of Inputa Direct materials Wood Fiberglass Direct manufacturing labor Total manufacturing overhead acost Inputsb $30.00 5.00 25.00 5.00 6.00 5.00 Total $150.00 30.00 125.00 95.00 $400.00 is per board foot, yard or per hour is the amount of each input per board binputs 9. Schedule 6B: Ending Inventories Budget, December 31, 2010 Cost per Units Unit Total Direct materials Wood 1,500 $ 30.00 $ 45,000 Fiberglass 2,000 5.00 10,000 Finished goods Snowboards 200 400.00 80,000 Total Ending Inventory $135,000 6-28 10. Schedule 7: Cost of Goods Sold Budget for the Year Ended December 31, 2010 From Schedule Total Beginning finished goods inventory January 1, 2010, $374.80 × 100 Given $ 37,480 Direct materials used 3A $193,800 Direct manufacturing labor 4 137,500 Manufacturing overhead 5 104,500 Cost of goods manufactured 435,800 Cost of goods available for sale 473,280 Deduct ending finished goods inventory, December 31, 2010 6B 80,000 Cost of goods sold $393,280 11. Budgeted Income Statement for Slopes for the Year Ended December 31, 2010 Revenues Schedule 1 $450,000 Cost of goods sold Schedule 7 393,280 Gross margin 56,720 Operating costs Variable marketing costs ($250 × 30) $ 7,500 Fixed nonmanufacturing costs 30,000 37,500 Operating income $ 19,220 12. Budgeted Balance Sheet for Slopes as of December 31, 2010 Cash Inventory Schedule 6B Property, plant, and equipment (net) Total assets Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity 6-29 $ 10,000 135,000 850,000 $995,000 $ 17,000 178,000 800,000 $995,000 6-36 (30 min.) Cash budgeting, chapter appendix. 1. Projected Sales May Sales in units June July August September 120 200 100 60 $36,000 $54,000 $90,000 $45,000 $27,000 May Revenues (Sales in units × $450) 80 June July August September October 40 Collections of Receivables From sales in: May (30% $36,000) June (50%; 30% $54,000) July (20%; 50%; 30% $90,000) August (20%; 50% $45,000) September (20% $27,000) Total $10,800 27,000 18,000 $16,200 45,000 9,000 $55,800 $70,200 $ 27,000 22,500 5,400 $54,900 July August September October Calculation of Payables May Material and Labor Use, Units Budgeted production Direct materials Wood (board feet) Fiberglass (yards) Direct manuf. labor (hours) June 200 100 60 40 1,000 1,200 1,000 500 600 500 300 360 300 200 240 200 $30,000 $15,000 $9,000 6,000 3,000 1,800 12,500 7,500 5,000 150 150 150 Disbursement of Payments Direct materials Wood (1,000; 500; 300 $30) Fiberglass (1,200; 600; 360 $5) Direct manuf. labor (500; 300; 200 $25) Interest payment (6% $30,000 ÷12) Variable Overhead Calculation Variable overhead rate Overhead driver (direct manuf. labor-hours) Variable overhead expense $ 7 500 $ 3,500 6-30 $ 7 300 $ 2,100 $ 7 200 $1,400 October Cash Budget for the months of July, August, September 2007 July August Beginning cash balance $10,000 $ 5,650 September $40,100 Add receipts: Collection of receivables Total cash available 55,800 $65,800 70,200 $75,850 54,900 $95,000 Deduct disbursements: Material purchases Direct manufacturing labor Variable costs Fixed costs Interest payments Total disbursements Ending cash balance $36,000 12,500 3,500 8,000 150 60,150 $ 5,650 $18,000 7,500 2,100 8,000 150 35,750 $40,100 $10,800 5,000 1,400 8,000 150 25,350 $69,650 2. Yes. Slopes has a budgeted cash balance of $69,650 on 10/1/2010 and so it will be in a position to pay off the $30,000 1-year note on October 1, 2010. 3. No. Slopes does not maintain a $10,000 minimum cash balance in July. To maintain a $10,000 cash balance in each of the three months, it could perhaps encourage its customers to pay earlier by offering a discount. Alternatively, Slopes could seek short-term credit from a bank. 6-31 6-37 (40–50 min.) Cash budgeting, chapter appendix. Itami Wholesale Co. Statement of Budgeted Cash Receipts and Disbursements For the Months of December 2009 and January 2010 Cash balance, beginning Add receipts: Collections of receivables (Schedule 1) (a) Total cash available for needs Deduct disbursements: For merchandise purchases (Schedule 2) For variable costs (Schedule 3) For fixed costs (Schedule 3) (b) Total disbursements Cash balance, end of month (a – b) December 2009 $ 10,000 January 2010 $ 2,025 235,900 245,900 285,800 287,825 $183,875 50,000 10,000 243,875 $ 2,025 $141,750 25,000 10,000 176,750 $111,075 Enough cash should be available for repayment of the note on January 31, 2010. Schedule 1: Collections of Receivables Collections in December October $14,400a November $50,000b} 171,500c 20,000d January December $235,900 $ 60,000e} 205,800f a0.08 b0.20 c0.70 × $180,000 × $250,000 × $250,000 × .98 d0.08 × $250,000 e0.20 × $300,000 f0.70 × $300,000 × .98 6-32 Total $285,800 Schedule 2: Payments for Merchandise December 875a 3,000 3,875 1,250b 2,625 $183,750 December Cash disbursements: For December, accounts payable; For January, December’s purchases at 50% For current month’s purchases at 50% January $ 92,000 91,875 $183,875 Target ending inventory (in units) Add units sold (sales ÷ $100) Total requirements Deduct beginning inventory (in units) Purchases (in units) Purchases in dollars (units × $70) January 800c 1,500 2,300 875 1,425 $99,750 $ 91,875 49,875 $141,750 a500 units + 0.25 ($150,000 ÷ $100) ÷ $70 c500 units + 0.25($120,000 ÷ $100) b$87,500 Schedule 3: Marketing, Distribution, and Customer-Service Costs Total annual fixed costs, $150,000, minus $30,000 depreciation Monthly fixed cost requiring cash outlay $400,000 $150,000 Variable cost ratio to sales = = 1/6 $1,500,000 December variable costs: 1/6 × $300,000 sales $50,000 January variable costs: 1/6 × $150,000 sales $25,000 6-33 $120,000 $ 10,000 6-38 (60 min.) Comprehensive problem; ABC manufacturing, two products. 1. Revenues Budget For the Year Ending December 31, 2009 Chairs Tables Total Units 172,000 45,000 Selling Price Total Revenues $ 80 $13,760,000 $900 $40,500,000 $54,260,000 2a. Total budgeted marketing costs = Budgeted variable marketing costs + Budgeted fixed marketing costs = $2,011,200 + $4,500,000 = $6,511,200 $6,511, 200 Marketing allocation rate = = $0.12 per sales dollar $54, 260,000 2b. Total budgeted distribution costs = Budgeted variable distribution costs + Budgeted fixed distribution costs = $54,000 + $380,000 = $434,000 Chairs: Tables: Total 172,000 units ÷ 500 units per delivery 45,000 units ÷ 500 units per delivery Delivery allocation rate = 344 deliveries 90 deliveries 434 deliveries $434,000 = $1,000 per delivery 434 deliveries 3. Production Budget (in Units) For the Year Ending December 31, 2009 Product Chairs Tables Budgeted unit sales 172,000 45,000 Add target ending finished goods inventory 8,500 2,250 Total required units 180,500 47,250 Deduct beginning finished goods inventory 8,000 2,100 Units of finished goods to be produced 172,500 45,150 6-34 4a. Chairs Machine setup overhead Units to be produced Units per batch Number of setups Hours to setup per batch Total setup hours Tables Total 172,500 ÷500 345 ×3 1,035 45,150 ÷50 903 ×2 1,806 2,841 Total budgeted setup costs = Budgeted variable setup costs + Budgeted fixed setup costs = $97,000 + $300,740 = $397,740 $397,740 Machine setup = = $140 per setup hour allocation rate 2,841 setup-hours b. Chairs: Tables: Total 172,500 units × 3 MH per unit 45,150 units × 5 MH per unit 517,500 MH 225,750 MH 743,250 MH Total budgeted processing costs = Budgeted variable processing costs + Budgeted fixed processing costs = $789,250 + $5,900,000 = $6,689,250 $6,689, 250 Processing allocation rate = $9 per MH 743, 250 MH 5. Direct Material Usage Budget in Quantity and Dollars For the Year Ending December 31, 2009 Wood Physical Units Budget Direct materials required for Chairs (172,500 units × 5 b.f. and 0 sheets) Tables (45,150 units × 7 b.f. and 2 sheets) Total quantity of direct materials to be used Material Glass 862,500 b.f. 316,050 b.f. 1,178,550 b.f. Cost Budget Available from beginning direct materials inventory (under a FIFO cost-flow assumption) $ 170,352 To be purchased this period Wood: (1,178,550 b.f. ─ 109,200 b.f.) × $1.60 per b.f. 1,710,960 Glass: (90,300 sheets ─ 8,750 sheets) × $12 per sheet _________ Direct materials to be used this period $1,881,312 Direct Materials Purchases Budget 6-35 Total 90,300 sheets 90,300 sheets $ 109,375 978,600 $ 1,087,975 $2,969,287 For the Year Ending December 31, 2009 Material Wood 1,178,550 b.f. 117,500 b.f. 1,296,050 b.f. 109,200 b.f. 1,186,850 Physical Units Budget To be used in production (requirement 5) Add: Target ending direct material inventory Total requirements Deduct: Beginning direct material inventory Purchases to be made Cost Budget Wood: 1,186,850 b.f. $1.60 per b.f. Glass: 90,550 sheets $12 per sheet Purchases Glass 90,300 sheets 9,000 sheets 99,300 sheets 8,750 sheets 90,550 sheets $ 1,898,960 __________ $ 1,898,960 $ 1,086,600 $ 1,086,600 Total $2,985,560 Total budgeted materials-handling costs = Budgeted variable materials-handling costs + Budgeted fixed materials-handling costs = $342,840 + $600,000 = $942,840 Materials handling = $942,840 = $0.80 per b.f. allocation rate 1,178,550 b.f. 7. Direct Manufacturing Labor Costs Budget For the Year Ending December 31, 2009 Chairs Tables Total Output Units Produced 172,500 45,150 Direct Manufacturing Total Hourly Wage Total Labor-Hours per Unit Hours Rate 4 690,000 $15 $10,350,000 8 361,200 15 5,418,000 $15,768,000 8. Manufacturing Overhead Cost Budget For the Year Ending December 31, 2009 Materials handling Machine setup Processing Total Variable $ 342,840 97,000 789,250 $1,229,090 Fixed $ 600,000 300,740 5,900,000 $6,800,740 6-36 Total $ 942,840 397,740 6,689,250 $8,029,830 9. Unit Costs of Ending Finished Goods Inventory For the Year Ending December 31, 2009 Wood Glass Direct manufacturing labor Materials handling Machine setup Processing Total 1 Cost per Unit of Input $1.60 12 15 0.80 140 9 Chair Input per Unit of Output 5 b.f. ─ 4 hrs. 5 b.f. 0.006 hrs. 1 3 MH Table Total $ 8.00 ─ 60.00 4.00 0.84 27.00 $ 99.84 Input per Unit of Output 7 b.f. 2 sheets 8 hrs. 7 b.f. 0.04 setup-hr1 5 MH Total $ 11.20 24.00 120.00 5.60 5.60 45.00 $211.40 1,035 setup-hours ÷ 172,500 units = 0.006 hours per unit; 1,806 setup hours ÷ 45,150 units = 0.04 hours per unit Ending Inventories Budget December 31, 2009 Quantity Direct Materials Wood Glass Finished goods Chairs Tables Total ending inventory Cost per unit Total 117,500 b.f. 9,000 sheets $1.60 12.00 $188,000 108,000 8,500 2,250 $99.84 211.40 $848,640 475,650 $ 296,000 1,324,290 $1,620,290 10. Cost of Goods Sold Budget For the Year Ending December 31, 2009 Beginning finished goods inventory, Jan. 1 ($760,000 + $477,000) Direct materials used (requirement 5) $ 2,969,287 Direct manufacturing labor (requirement 7) 15,768,000 Manufacturing overhead (requirement 8) 8,029,830 Cost of goods manufactured Cost of goods available for sale Deduct: Ending finished goods inventory, December 31 (reqmt. 9) Cost of goods sold 11. Nonmanufacturing Costs Budget For the Year Ending December 31, 2009 Marketing Distribution Total Variable $2,011,200 54,000 $2,065,200 Fixed $4,500,000 380,000 $4,880,000 6-37 Total $6,511,200 434,000 $6,945,200 $ 1,237,000 26,767,117 28,004,117 1,324,290 $26,679,827 12. Revenue Cost of goods sold Gross margin Operating (nonmanufacturing) costs Operating income Budgeted Income Statement For the Year Ending December 31, 2009 $54,260,000 26,679,827 27,580,173 6,945,200 $20,634,973 13. The budgeted unit cost of the chair is $99.84, which is $20 more than the selling price of $80 per chair. The company is willing to accept the loss on chairs because of the high markup on tables ($900 $688.60 ─ $211.40) = $688.60 ( 76.5% ). Customers who purchase a table will likely want $900 matching chairs. Thus the markup on tables more than recoups the loss on four chairs. Dinette could, of course, reduce the price on tables and increase the price on chairs. If, however, customers care less about the price of the table and more about the price of chairs and buy 4 chairs for every 1 table, Dinette’s pricing strategy may well be optimal. 6-38 6-39 (15 min.) Budgeting and ethics. 1. The standards proposed by Wert are not challenging. In fact, he set the target at the level his department currently achieves. DM 2.95 lbs. 100 units = 295 lbs. DL 19.2 min. 100 units = 1,920 min ÷ 60 = 32 hrs. MT 9.9 min. 100 units = 990 min. ÷ 60 = 16.5 hrs. 2. Wert probably chose these standards so that his department would be able to make the goal and receive any resulting reward. With a little effort, his department can likely beat these goals. 3. As discussed in the chapter, benchmarking might be used to highlight the easy targets set by Wert. Perhaps the organization has multiple plant locations that could be used as comparisons. Alternatively, management could use industry averages. Also, management should work with Wert to better understand his department and encourage him to set more realistic targets. Finally, the reward structure should be designed to encourage increasing productivity, not beating the budget. 6-40 (60 min.) Comprehensive budgeting problem; activity-based costing, operating and financial budgets. 1a. Revenues Budget For the Month of June, 20xx Large Giant Total Units Selling Price Total Revenues 3,000 $3 $ 9,000 1,800 4 7,200 $16,200 b. Production Budget For the Month of June, 20xx Budgeted unit sales Add: target ending finished goods inventory Total required units Deduct: beginning finished goods inventory Units of finished goods to be produced 6-39 Product Large Giant 3,000 1,800 300 180 3,300 1,980 200 150 3,100 1,830 c. Direct Material Usage Budget in Quantity and Dollars For the Month of June, 20xx Material Sugar Sticks Physical Units Budget Direct materials required for Large (3,100 units × 0.25 lb.; 1 stick) Giant (1,830 units × 0.50 lb.; 1 stick) Total quantity of direct materials to be used 775 lbs. 915 lbs. 1,690 lbs. Cost Budget Available from beginning direct materials inventory (under a FIFO cost-flow assumption) $ 64 To be purchased this period Sugar: (1,690 lbs. – 125 lbs.) × $0.50 per lb. 783 Sticks: (4,930 – 350) × $0.30 per stick ____ Direct materials to be used this period $847 Total 3,100 1,830 4,930 $ 105 1,374 $1,479 $2,326 Direct Materials Purchases Budget For the Month of June, 20xx Material Sugar Sticks Physical Units Budget To be used in production Add: Target ending direct material inventory Total requirements Deduct: beginning direct material inventory Purchases to be made 1,690 lbs. 240 lbs. 1,930 lbs. 125 lbs. 1,805 lbs. Cost Budget Sugar: (1,805 lbs. × $0.50 per lb.) Sticks: (5,060 × $0.30 per stick) Total $903 ____ $903 Total 4,930 480 5,410 350 5,060 $1,518 $1,518 $2,421 d. Direct Manufacturing Labor Costs Budget For the Month of June, 20xx Large Giant Total Output Units Produced 3,100 1,830 Direct Manufacturing Labor-Hours per Unit 0.20 0.25 6-40 Total Hourly Wage Hours Rate 620 $8 457.5 8 1,077.5 Total $4,960 3,660 $8,620 e. Manufacturing Overhead Costs Budget For the Month of June 20xx Total Machine setup (Large 310 batches1 0.08 hrs./batch + Giant 183 batches2 0.09 hrs./batch) $20/hour Processing (1,077.5 DMLH $1.70) Total 1Large: $ 825 1,832 $2,657 3,100 units ÷ 10 units per batch = 310; 2Giant: 1,830 units ÷ 10 units per batch = 183 f. Sugar Sticks Direct manufacturing labor Machine setup Processing Total 1 Unit Costs of Ending Finished Goods Inventory For the Month of June, 20xx Large Giant Cost per Input per Input per Unit of Input Unit of Output Total Unit of Output $ 0.50 0.25 lb $0.125 0.50 lb. 0.30 1 0.30 1 8.00 0.2 hr. 1.60 0.25 hr. 20.00 0.008 hr. 1 0.16 0.009 hr1 1.70 0.2 hr 0.34 0.25 hr $2.525 0.08 hour per setup ÷ 10 units per batch = 0.008 hr. per unit; 0.09 hour per setup ÷ 10 units per batch = 0.009 hr. per unit. Ending Inventories Budget June, 20xx Quantity Direct Materials Sugar Sticks Finished goods Large Giant Total ending inventory Cost per unit 240 lbs. 480 sticks $0.50 0.30 $120 144 300 180 $2.525 3.155 $757 568 6-41 Total $ 264 1,325 $1,589 Total $ 0.25 0.30 2.00 0.18 0.425 $3.155 g. Cost of Goods Sold Budget For the Month of June, 20xx Beginning finished goods inventory, June 1 ($500 + $474) Direct materials used (requirement c) Direct manufacturing labor (requirement d) Manufacturing overhead (requirement e) Cost of goods manufactured Cost of goods available for sale Deduct ending finished goods inventory, June 30 (requirement f) Cost of goods sold $ $2,326 8,620 2,657 13,603 14,577 1,325 $13,252 h. Nonmanufacturing Costs Budget For the Month of June, 20xx Total Marketing and general administration 10% 16,200 $1,620 2. Cash Budget June 30, 20xx Cash balance, June 30, 20xx Add receipts Collections from May accounts receivable Collections from June accounts receivable ($16,200 80% 50%) Collections from June cash sales ($16,200 20%) Total collection from customers Total cash available for needs (x) Deduct cash disbursements Direct material purchases in May Direct material purchases in June ( $2,421 70%) Direct manufacturing labor Manufacturing overhead ( $2,657 60% because 40% is depreciation) Nonmanufacturing costs ( $1,620 70% because 30% is depreciation) Taxes Total disbursements (y) Financing Interest at 12% ($20,000 12% 1 ÷ 12) (z) Ending cash balance, June 30 (x) ─ (y) ─ (z) 6-42 974 $ 587 4,704 6,480 3,240 14,424 $15,011 $ 696 1,695 8,620 1,594 1,134 500 $14,239 $ $ 200 572 3. Budgeted Income Statement For the Month of June, 20xx Revenues Cost of goods sold Gross margin Operating (nonmanufacturing) costs Bad debt expense ($16,200 80% 1%) Interest expense (for June) Net income $16,200 13,252 2,948 $1,620 130 200 $ 1,950 998 Budgeted Balance Sheet June 30, 20xx Assets Cash Accounts receivable ($16,200 80% 50%)) Less: allowance for doubtful accounts Inventories Direct materials Finished goods Fixed assets Less: accumulated depreciation ($55,759 + 2,657 40% + 1,620 30%) Total assets $ $ $ 6,480 130 6,350 264 1,325 1,589 $190,000 Liabilities and Equity Accounts payable ($2,421 30%) Interest payable Long-term debt Common stock Retained earnings ($109,279 + $998) Total liabilities and equity 6-43 572 57,308 132,692 $141,203 $ 726 200 20,000 10,000 110,277 $141,203 CHAPTER 7 FLEXIBLE BUDGETS, DIRECT-COST VARIANCES, AND MANAGEMENT CONTROL 7-1 Management by exception is the practice of concentrating on areas not operating as expected and giving less attention to areas operating as expected. Variance analysis helps managers identify areas not operating as expected. The larger the variance, the more likely an area is not operating as expected. 7-2 Two sources of information about budgeted amounts are (a) past amounts and (b) detailed engineering studies. 7-3 A favorable variance––denoted F––is a variance that has the effect of increasing operating income relative to the budgeted amount. An unfavorable variance––denoted U––is a variance that has the effect of decreasing operating income relative to the budgeted amount. 7-4 The key difference is the output level used to set the budget. A static budget is based on the level of output planned at the start of the budget period. A flexible budget is developed using budgeted revenues or cost amounts based on the actual output level in the budget period. The actual level of output is not known until the end of the budget period. 7-5 A flexible-budget analysis enables a manager to distinguish how much of the difference between an actual result and a budgeted amount is due to (a) the difference between actual and budgeted output levels, and (b) the difference between actual and budgeted selling prices, variable costs, and fixed costs. 7-6 The steps in developing a flexible budget are: Step 1: Identify the actual quantity of output. Step 2: Calculate the flexible budget for revenues based on budgeted selling price and actual quantity of output. Step 3: Calculate the flexible budget for costs based on budgeted variable cost per output unit, actual quantity of output, and budgeted fixed costs. 7-7 Four reasons for using standard costs are: (i) cost management, (ii) pricing decisions, (iii) budgetary planning and control, and (iv) financial statement preparation. 7-8 A manager should subdivide the flexible-budget variance for direct materials into a price variance (that reflects the difference between actual and budgeted prices of direct materials) and an efficiency variance (that reflects the difference between the actual and budgeted quantities of direct materials used to produce actual output). The individual causes of these variances can then be investigated, recognizing possible interdependencies across these individual causes. 7-1 7-9 Possible causes of a favorable direct materials price variance are: purchasing officer negotiated more skillfully than was planned in the budget, purchasing manager bought in larger lot sizes than budgeted, thus obtaining quantity discounts, materials prices decreased unexpectedly due to, say, industry oversupply, budgeted purchase prices were set without careful analysis of the market, and purchasing manager received unfavorable terms on nonpurchase price factors (such as lower quality materials). 7-10 Some possible reasons for an unfavorable direct manufacturing labor efficiency variance are the hiring and use of underskilled workers; inefficient scheduling of work so that the workforce was not optimally occupied; poor maintenance of machines resulting in a high proportion of non-value-added labor; unrealistic time standards. Each of these factors would result in actual direct manufacturing labor-hours being higher than indicated by the standard work rate. 7-11 Variance analysis, by providing information about actual performance relative to standards, can form the basis of continuous operational improvement. The underlying causes of unfavorable variances are identified, and corrective action taken where possible. Favorable variances can also provide information if the organization can identify why a favorable variance occurred. Steps can often be taken to replicate those conditions more often. As the easier changes are made, and perhaps some standards tightened, the harder issues will be revealed for the organization to act on—this is continuous improvement. 7-12 An individual business function, such as production, is interdependent with other business functions. Factors outside of production can explain why variances arise in the production area. For example: poor design of products or processes can lead to a sizable number of defects, marketing personnel making promises for delivery times that require a large number of rush orders can create production-scheduling difficulties, and purchase of poor-quality materials by the purchasing manager can result in defects and waste. 7-13 The plant supervisor likely has good grounds for complaint if the plant accountant puts excessive emphasis on using variances to pin blame. The key value of variances is to help understand why actual results differ from budgeted amounts and then to use that knowledge to promote learning and continuous improvement. 7-14 Variances can be calculated at the activity level as well as at the company level. For example, a price variance and an efficiency variance can be computed for an activity area. 7-15 Evidence on the costs of other companies is one input managers can use in setting the performance measure for next year. However, caution should be taken before choosing such an amount as next year's performance measure. It is important to understand why cost differences across companies exist and whether these differences can be eliminated. It is also important to examine when planned changes (in, say, technology) next year make even the current low-cost producer not a demanding enough hurdle. 7-2 7-16 (20–30 min.) Flexible budget. Variance Analysis for Brabham Enterprises for August 2009 FlexibleBudget Variances (2) = (1) – (3) Actual Results (1) g Flexible Budget (3) Sales-Volume Variances (4) = (3) – (5) Static Budget (5) g Units (tires) sold Revenues Variable costs Contribution margin Fixed costs 2,800 a $313,600 d 229,600 84,000 g 50,000 0 $ 5,600 F 22,400 U 16,800 U 4,000 F 2,800 b $308,000 e 207,200 100,800 g 54,000 200 U $22,000 U 14,800 F 7,200 U 0 3,000 c $330,000 f 222,000 108,000 g 54,000 Operating income $ 34,000 $12,800 U $ 46,800 $ 7,200 U $ 54,000 $12,800 U $ 7,200 U Total flexible-budget variance Total sales-volume variance $20,000 U Total static-budget variance a $112 × 2,800 = $313,600 $110 × 2,800 = $308,000 c $110 × 3,000 = $330,000 d Given. Unit variable cost = $229,600 ÷ 2,800 = $82 per tire e $74 × 2,800 = $207,200 f $74 × 3,000 = $222,000 g Given b 2. The key information items are: Actual Units Unit selling price Unit variable cost Fixed costs 2,800 $ 112 $ 82 $50,000 Budgeted 3,000 $ 110 $ 74 $54,000 The total static-budget variance in operating income is $20,000 U. There is both an unfavorable total flexible-budget variance ($12,800) and an unfavorable sales-volume variance ($7,200). The unfavorable sales-volume variance arises solely because actual units manufactured and sold were 200 less than the budgeted 3,000 units. The unfavorable flexible-budget variance of $12,800 in operating income is due primarily to the $8 increase in unit variable costs. This increase in unit variable costs is only partially offset by the $2 increase in unit selling price and the $4,000 decrease in fixed costs. 7-3 7-17 (15 min.) Flexible budget. The existing performance report is a Level 1 analysis, based on a static budget. It makes no adjustment for changes in output levels. The budgeted output level is 10,000 units––direct materials of $400,000 in the static budget ÷ budgeted direct materials cost per attaché case of $40. The following is a Level 2 analysis that presents a flexible-budget variance and a salesvolume variance of each direct cost category. Variance Analysis for Connor Company Output units Direct materials Direct manufacturing labor Direct marketing labor Total direct costs Actual Results (1) 8,800 $364,000 78,000 110,000 $552,000 FlexibleSalesBudget Flexible Volume Static Variances Budget Variances Budget (2) = (1) – (3) (3) (4) = (3) – (5) (5) 0 8,800 1,200 U 10,000 $12,000 U $352,000 $48,000 F $400,000 7,600 U 70,400 9,600 F 80,000 4,400 U 105,600 14,400 F 120,000 $24,000 U $528,000 $72,000 F $600,000 $24,000 U $72,000 F Flexible-budget variance Sales-volume variance $48,000 F Static-budget variance The Level 1 analysis shows total direct costs have a $48,000 favorable variance. However, the Level 2 analysis reveals that this favorable variance is due to the reduction in output of 1,200 units from the budgeted 10,000 units. Once this reduction in output is taken into account (via a flexible budget), the flexible-budget variance shows each direct cost category to have an unfavorable variance indicating less efficient use of each direct cost item than was budgeted, or the use of more costly direct cost items than was budgeted, or both. Each direct cost category has an actual unit variable cost that exceeds its budgeted unit cost: Actual Budgeted Units 8,800 10,000 Direct materials $ 41.36 $ 40.00 Direct manufacturing labor $ 8.86 $ 8.00 Direct marketing labor $ 12.50 $ 12.00 Analysis of price and efficiency variances for each cost category could assist in further the identifying causes of these more aggregated (Level 2) variances. 7-4 7-18 1. (25–30 min.) Flexible-budget preparation and analysis. Variance Analysis for Bank Management Printers for September 2009 Level 1 Analysis Actual Results (1) 12,000 a $252,000 d 84,000 168,000 150,000 $ 18,000 Units sold Revenue Variable costs Contribution margin Fixed costs Operating income Static-Budget Static Variances Budget (2) = (1) – (3) (3) 15,000 3,000 U c $ 48,000 U $300,000 f 36,000 F 120,000 12,000 U 180,000 5,000 U 145,000 $ 17,000 U $ 35,000 $17,000 U Total static-budget variance 2. Level 2 Analysis Units sold Revenue Variable costs Contribution margin Fixed costs Actual Results (1) 12,000 a $252,000 d 84,000 168,000 150,000 FlexibleBudget Flexible Variances Budget (2) = (1) – (3) (3) 0 12,000 b $12,000 F $240,000 e 12,000 F 96,000 24,000 F 144,000 5,000 U 145,000 Sales Volume Static Variances Budget (4) = (3) – (5) (5) 3,000 U 15,000 c $60,000 U $300,000 f 24,000 F 120,000 36,000 U 180,000 0 145,000 Operating income $ 18,000 $19,000 F $36,000 U $ (1,000) $ 35,000 $19,000 F $36,000 U Total flexible-budget Total sales-volume variance variance $17,000 U Total static-budget variance a d b e 12,000 × $21 = $252,000 12,000 × $20 = $240,000 c 15,000 × $20 = $300,000 12,000 × $7 = $ 84,000 12,000 × $8 = $ 96,000 f 15,000 × $8 = $120,000 3. Level 2 analysis breaks down the static-budget variance into a flexible-budget variance and a sales-volume variance. The primary reason for the static-budget variance being unfavorable ($17,000 U) is the reduction in unit volume from the budgeted 15,000 to an actual 12,000. One explanation for this reduction is the increase in selling price from a budgeted $20 to an actual $21. Operating management was able to reduce variable costs by $12,000 relative to the flexible budget. This reduction could be a sign of efficient management. Alternatively, it could be due to using lower quality materials (which in turn adversely affected unit volume). 7-5 7-19 (30 min.) Flexible budget, working backward. 1. Variance Analysis for The Clarkson Company for the year ended December 31, 2009 Units sold Revenues Variable costs Contribution margin Fixed costs Operating income FlexibleActual Budget Results Variances (1) (2)=(1) (2)=(1)(3) 130,000 0 $715,000 $260,000 F 515,000 255,000 U 200,000 5,000 F 140,000 20,000 U $ 60,000 $ 15,000 U Flexible Budget (3) 130,000 $455,000a 260,000b 195,000 120,000 $ 75,000 $15,000 U Total flexible-budget variance Sales-Volume Variances (4)=(3) (4)=(3)(5) 10,000 F $35,000 F 20,000 U 15,000 F 0 $15,000 F Static Budget (5) 120,000 $420,000 240,000 180,000 120,000 $ 60,000 $15,000 F Total sales volume variance $0 Total static-budget variance a b 130,000 × $3.50 = $455,000; $420,000 130,000 × $2.00 = $260,000; $240,000 2. 120,000 = $3.50 120,000 = $2.00 Actual selling price: Budgeted selling price: Actual variable cost per unit: Budgeted variable cost per unit: $715,000 420,000 515,000 240,000 ÷ ÷ ÷ 130,000 120,000 130,000 120,000 = = = = $5.50 $3.50 $3.96 $2.00 3. A zero total static-budget variance may be due to offsetting total flexible-budget and total sales-volume variances. In this case, these two variances exactly offset each other: Total flexible-budget variance Total sales-volume variance $15,000 Unfavorable $15,000 Favorable A closer look at the variance components reveals some major deviations from plan. Actual variable costs increased from $2.00 to $3.96, causing an unfavorable flexible-budget variable cost variance of $255,000. Such an increase could be a result of, for example, a jump in direct material prices. Clarkson was able to pass most of the increase in costs onto their customers—actual selling price increased by 57% [($5.50 – $3.50) $3.50], bringing about an offsetting favorable flexible-budget revenue variance in the amount of $260,000. An increase in the actual number of units sold also contributed to more favorable results. The company should examine why the units sold increased despite an increase in direct material prices. For example, Clarkson’s customers may have stocked up, anticipating future increases in direct material prices. Alternatively, Clarkson’s selling price increases may have been lower than competitors’ price increases. Understanding the reasons why actual results differ from budgeted amounts can help Clarkson better manage its costs and pricing decisions in the future. The important lesson learned here is that a superficial examination of summary level data (Levels 0 and 1) may be insufficient. It is imperative to scrutinize data at a more detailed level (Level 2). Had Clarkson not been able to pass costs on to customers, losses would have been considerable. 7-6 7-20 (30-40 min.) Flexible budget and sales volume variances. 1. and 2. Performance Report for Marron, Inc., June 2009 Units (pounds) Revenues Variable mfg. costs Contribution margin Actual (1) 525,000 $3,360,000 1,890,000 $1,470,000 Flexible Budget Variances (2) = (1) – (3) $ 52,500 U 52,500 U $105,000 U Flexible Budget (3) 525,000 $3,412,500a 1,837,500b $1,575,000 $105,000 U Flexible-budget variance Sales Volume Variances (4) = (3) – (5) 25,000 F $162,500 F 87,500 U $ 75,000 F $ 75,000 F Sales-volume variance $30,000 U Static-budget variance selling price = $3,250,000 500,000 lbs = $6.50 per lb. Flexible-budget revenues = $6.50 per lb. 525,000 lbs. = $3,412,500 a Budgeted b Budgeted variable mfg. cost per unit = $1,750,000 Flexible-budget variable mfg. costs = $3.50 per lb. Static Budget (5) 500,000 $3,250,000 1,750,000 $1,500,000 500,000 lbs. = $3.50 525,000 lbs. = $1,837,500 7-7 Static Budget Variance (6) = (1) – (5) 25,000 F $110,000 F 140,000 U $ 30,000 U Static Budget Variance as % of Static Budget (7) = (6) (5) 5.0% 3.4% 8.0% 2.0% 3. The selling price variance, caused solely by the difference in actual and budgeted selling price, is the flexible-budget variance in revenues = $52,500 U. 4. The flexible-budget variances show that for the actual sales volume of 525,000 pounds, selling prices were lower and costs per pound were higher. The favorable sales volume variance in revenues (because more pounds of ice cream were sold than budgeted) helped offset the unfavorable variable cost variance and shored up the results in June 2009. Levine should be more concerned because the small static-budget variance in contribution margin of $30,000 U is actually made up of a favorable sales-volume variance in contribution margin of $75,000, an unfavorable selling-price variance of $52,500 and an unfavorable variable manufacturing costs variance of $52,500. Levine should analyze why each of these variances occurred and the relationships among them. Could the efficiency of variable manufacturing costs be improved? Did the sales volume increase because of a decrease in selling price or because of growth in the overall market? Analysis of these questions would help Levine decide what actions he should take. 7-8 7-21 (20–30 min.) Price and efficiency variances. 1. The key information items are: Output units (scones) Input units (pounds of pumpkin) Cost per input unit Actual 60,800 16,000 $ 0.82 Budgeted 60,000 15,000 $ 0.89 Peterson budgets to obtain 4 pumpkin scones from each pound of pumpkin. The flexible-budget variance is $408 F. Pumpkin costs Actual Results (1) a $13,120 FlexibleBudget Variance (2) = (1) – (3) $408 F Flexible Budget (3) b $13,528 Sales-Volume Static Variance Budget (4) = (3) – (5) (5) c $178 U $13,350 a 16,000 × $0.82 = $13,120 × 0.25 × $0.89 = $13,528 c 60,000 × 0.25 × $0.89 = $13,350 b 60,800 2. Actual Costs Incurred (Actual Input Qty. × Actual Price) a $13,120 Actual Input Qty. × Budgeted Price b $14,240 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) c $13,528 $1,120 F $712 U Price variance Efficiency variance $408 F Flexible-budget variance a 16,000 × $0.82 = $13,120 × $0.89 = $14,240 c 60,800 × 0.25 × $0.89 = $13,528 b16,000 3. The favorable flexible-budget variance of $408 has two offsetting components: (a) favorable price variance of $1,120––reflects the $0.82 actual purchase cost being lower than the $0.89 budgeted purchase cost per pound. (b) unfavorable efficiency variance of $712––reflects the actual materials yield of 3.80 scones per pound of pumpkin (60,800 ÷ 16,000 = 3.80) being less than the budgeted yield of 4.00 (60,000 ÷ 15,000 = 4.00). The company used more pumpkins (materials) to make the scones than was budgeted. One explanation may be that Peterson purchased lower quality pumpkins at a lower cost per pound. 7-9 7-22 (15 min.) Materials and manufacturing labor variances. Direct Materials Actual Costs Incurred (Actual Input Qty. × Actual Price) $200,000 Actual Input Qty. × Budgeted Price $214,000 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) $225,000 $14,000 F $11,000 F Price variance Efficiency variance $25,000 F Flexible-budget variance Direct Mfg. Labor 7-23 $90,000 $86,000 $80,000 $4,000 U $6,000 U Price variance Efficiency variance $10,000 U Flexible-budget variance (30 min.) Direct materials and direct manufacturing labor variances. 1. May 2009 Units Direct materials Direct labor Total price variance Total efficiency variance Actual Results (1) 550 $12,705.00 $ 8,464.50 Price Variance (2) = (1)–(3) (1)– $1,815.00 U $ 104.50 U $1,919.50 U Actual Quantity Budgeted Price (3) $10,890.00a $ 8,360.00c Efficiency Variance (4) = (3) – (5) $990.00 U $440.00 F Flexible Budget (5) 550 $9,900.00b $8,800.00d $550.00 U a 7,260 meters $1.50 per meter = $10,890 lots 12 meters per lot $1.50 per meter = $9,900 c 1,045 hours $8.00 per hour = $8,360 d 550 lots 2 hours per lot $8 per hour = $8,800 b550 Total flexible-budget variance for both inputs = $1,919.50U + $550U = $2,469.50U Total flexible-budget cost of direct materials and direct labor = $9,900 + $8,800 = $18,700 Total flexible-budget variance as % of total flexible-budget costs = $2,469.50 $18,700 = 13.21% 7-10 2. May 2010 Units Direct materials Direct manuf. labor Total price variance Total efficiency variance Actual Results (1) 550 $11,828.36a $ 8,295.21d Price Variance (2) = (1) – (3) $1,156.16 U $ 102.41 U $1,258.57 U Actual Quantity Budgeted Price (3) Efficiency Variance (4) = (3) – (5) $10,672.20b $ 8,192.80e $772.20 U $607.20 F Flexible Budget (5) 550 $9,900.00c $8,800.00c $165.00 U Actual dir. mat. cost, May 2010 = Actual dir. mat. cost, May 2009 0.98 0.95 = $12,705 0.98 0.95 = $11.828.36 Alternatively, actual dir. mat. cost, May 2010 = (Actual dir. mat. quantity used in May 2009 0.98) (Actual dir. mat. price in May 2009 0.95) = (7,260 meters 0.98) ($1.75/meter 0.95) = 7,114.80 $1.6625 = $11,828.36 b (7,260 meters 0.98) $1.50 per meter = $10,672.20 c Unchanged from 2009. d Actual dir. labor cost, May 2010 = Actual dir. manuf. cost May 2009 0.98 = $8,464.50 0.98 = $8,295.21 Alternatively, actual dir. labor cost, May 2010 = (Actual dir. manuf. labor quantity used in May 2009 0.98) Actual dir. labor price in 2009 = (1,045 hours 0.98) $8.10 per hour = 1,024.10 hours $8.10 per hour = $8,295.21 e (1,045 hours 0.98) $8.00 per hour = $8,192.80 a Total flexible-budget variance for both inputs = $1,258.57U + $165U = $1,423.57U Total flexible-budget cost of direct materials and direct labor = $9,900 + $8,800 = $18,700 Total flexible-budget variance as % of total flexible-budget costs = $1,423.57 $18,700 = 7.61% 3. Efficiencies have improved in the direction indicated by the production manager—but, it is unclear whether they are a trend or a one-time occurrence. Also, overall, variances are still 7.6% of flexible input budget. GloriaDee should continue to use the new material, especially in light of its superior quality and feel, but it may want to keep the following points in mind: The new material costs substantially more than the old ($1.75 in 2009 and $1.6625 in 2010 vs. $1.50 per meter). Its price is unlikely to come down even more within the coming year. Standard material price should be re-examined and possibly changed. GloriaDee should continue to work to reduce direct materials and direct manufacturing labor content. The reductions from May 2009 to May 2010 are a good development and should be encouraged. 7-11 7-24 (30 min.) Price and efficiency variances, journal entries. 1. Direct materials and direct manufacturing labor are analyzed in turn: Actual Costs Incurred (Actual Input Qty. × Actual Price) Direct Materials (100,000 × $4.65a) $465,000 Actual Input Qty. × Budgeted Price Purchases Usage (100,000 × $4.50) $450,000 (98,055 × $4.50) $441,248 $15,000 U Price variance Direct Manufacturing Labor (4,900 × $31.5b) $154,350 b (9,850 × 10 × $4.50) $443,250 $2,002 F Efficiency variance (4,900 × $30) $147,000 $7,350 U Price variance a Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (9,850 × 0.5 × $30) or (4,925 × $30) $147,750 $750 F Efficiency variance $465,000 ÷ 100,000 = $4.65 $154,350 ÷ 4,900 = $31.5 2. Direct Materials Control Direct Materials Price Variance Accounts Payable or Cash Control 450,000 15,000 Work-in-Process Control Direct Materials Control Direct Materials Efficiency Variance 443,250 Work-in-Process Control Direct Manuf. Labor Price Variance Wages Payable Control Direct Manuf. Labor Efficiency Variance 147,750 7,350 465,000 441,248 2,002 154,350 750 3. Some students’ comments will be immersed in conjecture about higher prices for materials, better quality materials, higher grade labor, better efficiency in use of materials, and so forth. A possibility is that approximately the same labor force, paid somewhat more, is taking slightly less time with better materials and causing less waste and spoilage. A key point in this problem is that all of these efficiency variances are likely to be insignificant. They are so small as to be nearly meaningless. Fluctuations about standards are bound to occur in a random fashion. Practically, from a control viewpoint, a standard is a band or range of acceptable performance rather than a single-figure measure. 4. The purchasing point is where responsibility for price variances is found most often. The production point is where responsibility for efficiency variances is found most often. The Monroe Corporation may calculate variances at different points in time to tie in with these different responsibility areas. 7-12 7-25 (20 min.) Continuous improvement (continuation of 7-24). 1. Standard quantity input amounts per output unit are: Direct Direct Materials Manufacturing Labor (pounds) (hours) January 10.000 0.500 February (Jan. × 0.988) 9.880 0.494 March (Feb. × 0.988) 9.761 0.488 2. The answer is the same as that for requirement 1 of Question 7-24, except for the flexible-budget amount. Actual Costs Incurred (Actual Input Qty. × Actual Price) Direct Materials (100,000 × $4.65a) $465,000 Actual Input Qty. × Budgeted Price Purchases Usage (100,000 × $4.50) (98,055 × $4.50) $450,000 $441,248 $15,000 U Price variance Direct Manuf. Labor (4,900 × $31.5b) $154,350 b (9,850 × 9.761 × $4.50) $432,656 $8,592 U Efficiency variance (4,900 × $30) $147,000 $7,350 U Price variance a Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (9,850 × 0.488 × $30) $144,204 $2,796 U Efficiency variance $465,000 ÷ 100,000 = $4.65 $154,350 ÷ 4,900 = $31.5 Using continuous improvement standards sets a tougher benchmark. The efficiency variances for January (from Exercise 7-24) and March (from Exercise 7-25) are: Direct materials Direct manufacturing labor January $2,002 F $ 750 F March $8,592 U $2,796 U Note that the question assumes the continuous improvement applies only to quantity inputs. An alternative approach is to have continuous improvement apply to the total budgeted input cost per output unit ($45 for direct materials in January and $15 for direct manufacturing labor in January). 7-13 7-26 (2030 min.) Materials and manufacturing labor variances, standard costs. 1. Direct Materials Actual Costs Incurred (Actual Input Qty. × Actual Price) Actual Input Qty. × Budgeted Price (3,700 sq. yds. × $5.10) $18,870 (3,700 sq. yds. × $5.00) $18,500 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (2,000 × 2 × $5.00) (4,000 sq. yds. × $5.00) $20,000 $370 U Price variance $1,500 F Efficiency variance $1,130 F Flexible-budget variance The unfavorable materials price variance may be unrelated to the favorable materials efficiency variance. For example, (a) the purchasing officer may be less skillful than assumed in the budget, or (b) there was an unexpected increase in materials price per square yard due to reduced competition. Similarly, the favorable materials efficiency variance may be unrelated to the unfavorable materials price variance. For example, (a) the production manager may have been able to employ higher-skilled workers, or (b) the budgeted materials standards were set too loosely. It is also possible that the two variances are interrelated. The higher materials input price may be due to higher quality materials being purchased. Less material was used than budgeted due to the high quality of the materials. Direct Manufacturing Labor Actual Costs Incurred (Actual Input Qty. × Actual Price) Actual Input Qty. × Budgeted Price (900 hrs. × $9.80) $8,820 (900 hrs. × $10.00) $9,000 $180 F Price variance Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (2000 × 0.5 × $10.00) (1,000 hrs. × $10.00) $10,000 $1,000 F Efficiency variance $1,180 F Flexible-budget variance The favorable labor price variance may be due to, say, (a) a reduction in labor rates due to a recession, or (b) the standard being set without detailed analysis of labor compensation. The favorable labor efficiency variance may be due to, say, (a) more efficient workers being employed, (b) a redesign in the plant enabling labor to be more productive, or (c) the use of higher quality materials. 7-14 2. Control Point Purchasing Actual Costs Incurred (Actual Input Qty. × Actual Price) (6,000 sq. yds.× $5.10) $30,600 Actual Input Qty. × Budgeted Price (6,000 sq. yds. × $5.00) $30,000 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) Price) $600 U Price variance Production (3,700 sq. yds.× $5.00) $18,500 (2,000 × 2 × $5.00) $20,000 $1,500 F Efficiency variance Direct manufacturing labor variances are the same as in requirement 1. 7-15 7-27 (1525 min.) Journal entries and T-accounts (continuation of 7-26). For requirement 1 from Exercise 7-26: a. Direct Materials Price Variance Accounts Payable Control To record purchase of direct materials. Direct Materials Control 18,500 370 18,870 b. Work-in-Process Control Direct Materials Efficiency Variance Direct Materials Control To record direct materials used. 20,000 1,500 18,500 c. Work-in-Process Control 10,000 Direct Manufacturing Labor Price Variance Direct Manufacturing Labor Efficiency Variance Wages Payable Control To record liability for and allocation of direct labor costs. Direct Materials Control (a) 18,500 (b) 18,500 Work-in-Process Control (b) 20,000 (c) 10,000 Wages Payable Control (c) 8,820 Direct Materials Price Variance (a) 370 Direct Manufacturing Labor Price Variance (c) 180 180 1,000 8,820 Direct Materials Efficiency Variance (b) 1,500 Direct Manuf. Labor Efficiency Variance (c) 1,000 Accounts Payable Control (a) 18,870 For requirement 2 from Exercise 7-26: The following journal entries pertain to the measurement of price and efficiency variances when 6,000 sq. yds. of direct materials are purchased: a1. Direct Materials Control Direct Materials Price Variance Accounts Payable Control To record direct materials purchased. 30,000 600 a2. Work-in-Process Control Direct Materials Control Direct Materials Efficiency Variance To record direct materials used. 20,000 30,600 7-16 18,500 1,500 Direct Materials Control (a1) 30,000 (a2) 18,500 Direct Materials Price Variance (a1) 600 Accounts Payable Control (a1) 30,600 Work-in-Process Control (a2) 20,000 Direct Materials Efficiency Variance (a2) 1,500 The T-account entries related to direct manufacturing labor are the same as in requirement 1. The difference between standard costing and normal costing for direct cost items is: Direct Costs Standard Costs Standard price(s) × Standard input allowed for actual outputs achieved Normal Costs Actual price(s) × Actual input These journal entries differ from the normal costing entries because Work-in-Process Control is no longer carried at “actual” costs. Furthermore, Direct Materials Control is carried at standard unit prices rather than actual unit prices. Finally, variances appear for direct materials and direct manufacturing labor under standard costing but not under normal costing. 7-17 7-28 (25 min.) Flexible budget (Refer to data in Exercise 7-26). A more detailed analysis underscores the fact that the world of variances may be divided into three general parts: price, efficiency, and what is labeled here as a sales-volume variance. Failure to pinpoint these three categories muddies the analytical task. The clearer analysis follows (in dollars): Actual Costs Incurred (Actual Input Qty. × Actual Actual Input Qty. Price) × Budgeted Price Direct Materials $18,870 $8,820 Static Budget $20,000 $25,000 $18,500 (a) $370 U Direct Manuf. Labor Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (b) $1,500 F $9,000 (a) $180 F (c) $5,000 F $10,000 (b) $1,000 F $12,500 (c) $2,500 F (a) Price variance (b) Efficiency variance (c) Sales-volume variance The sales-volume variances are favorable here in the sense that less cost would be expected solely because the output level is less than budgeted. However, this is an example of how variances must be interpreted cautiously. Managers may be incensed at the failure to reach scheduled production (it may mean fewer sales) even though the 2,000 units were turned out with supreme efficiency. Sometimes this phenomenon is called being efficient but ineffective, where effectiveness is defined as the ability to reach original targets and efficiency is the optimal relationship of inputs to any given outputs. Note that a target can be reached in an efficient or inefficient way; similarly, as this problem illustrates, a target can be missed but the given output can be attained efficiently. 7-18 7-29 1. (45–50 min.) Activity-based costing, flexible-budget variances for finance-function activities. Receivables Receivables is an output unit level activity. Its flexible-budget variance can be calculated as follows: Flexible-budget = Actual – Flexible-budget variance costs costs = ($0.80 × 945,000) – ($0.639 × 945,000) = $756,000 – $603,855 = $152,145 U Payables Payables is a batch level activity. a. b. c. d. e. Number of deliveries Batch size (units per batch) Number of batches (a ÷ b) Cost per batch Total payables activity cost (c × d) Static-budget Amounts 1,000,000 5 200,000 $2.90 $580,000 Actual Amounts 945,000 4.468 211,504 $2.85 $602,786 Step 1: The number of batches in which payables should have been processed = 945,000 actual units ÷ 5 budgeted units per batch = 189,000 batches Step 2: The flexible-budget amount for payables = 189,000 batches × $2.90 budgeted cost per batch = $548,100 The flexible-budget variance can be computed as follows: Flexible-budget variance = Actual costs – Flexible-budget costs = (211,504 × $2.85) – (189,000 × $2.90) = $602,786 – $548,100 = $54,686 U Travel expenses Travel expenses is a batch level activity. a. b. c. d. e. Static-Budget Amounts Number of deliveries 1,000,000 Batch size (units per batch) 500 Number of batches (a ÷ b) 2,000 Cost per batch $7.60 Total travel expenses activity cost (c × d) $15,200 7-19 Actual Amounts 945,000 501.587 1,884 $7.45 $14,036 Step 1: The number of batches in which the travel expense should have been processed = 945,000 actual units ÷ 500 budgeted units per batch = 1,890 batches Step 2: The flexible-budget amount for travel expenses = 1,890 batches × $7.60 budgeted cost per batch = $14,364 The flexible budget variance can be calculated as follows: Flexible budget variance = Actual costs – Flexible-budget costs = (1,884 × $7.45) – (1,890 × $7.60) = $14,036 – $14,364 = $328 F 2. The flexible budget variances can be subdivided into price and efficiency variances. Price variance = Actual price –Budgeted price of input of input Efficiency variance = Receivables Price Variance = = Efficiency variance= = Payables Price variance = = Efficiency variance= = Travel expenses Price variance = = Efficiency variance= = Actual quantity – of input used × Actual quantity of input Budgeted quantity of input allowed for × Budgeted price of input actual output ($0.800 – $0.639) × 945,000 $152,145 U (945,000 – 945,000) × $0.639 $0 ($2.85 – $2.90 ) × 211,504 $10,575 F (211,504 – 189,000) × $2.90 $65,262 U ($7.45 – $7.60) × 1,884 $283 F (1,884-1,890) × $7.60 $46 F 7-20 7-30 (30 min.) Flexible budget, direct materials and direct manufacturing labor variances. 1. Variance Analysis for Tuscany Statuary for 2009 FlexibleBudget Variances Actual Results Flexible Budget SalesVolume Variances Static Budget (1) (2) = (1) – (3) (3) (4) = (3) – (5) (5) a Units sold 6,000 0 6,000 1,000 F 5,000a Direct materials $ 594,000 $ 6,000 F $ 600,000 b $100,000 U $ 500,000c Direct manufacturing labor 950,000a 10,000 F 960,000d 160,000 U 800,000e a a Fixed costs 1,005,000 5,000 U 1,000,000 0 1,000,000a Total costs $2,549,000 $11,000 F $2,560,000 $260,000 U $2,300,000 $11,000 F $260,000 U Flexible-budget variance Sales-volume variance $249,000 U Static-budget variance a Given b $100 × 6,000 = $600,000 × 5,000 = $500,000 d $160 × 6,000 = $960,000 e $160 × 5,000 = $800,000 c $100 Actual Incurred (Actual Input Qty. × Actual Price) Actual Input Qty. × Budgeted Price Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) $594,000a $540,000b $600,000c 2. Direct materials $54,000 U Price variance $60,000 F Efficiency variance $6,000 F Flexible-budget variance Direct manufacturing labor $950,000a $1,000,000e $960,000f $50,000 F $40,000 U Price variance Efficiency variance $10,000 F Flexible-budget variance a 54,000 pounds × $11/pound = $594,000 pounds × $10/pound = $540,000 c 6,000 statues × 10 pounds/statue × $10/pound = 60,000 pounds × $10/pound = $600,000 d 25,000 pounds × $38/pound = $950,000 e 25,000 pounds × $40/pound = $1,000,000 b 54,000 7-21 f 6,000 statues × 4 hours/statue × $40/hour = 24,000 hours × $40/hour = $960,000 7-22 7-31 (30 min.) Variance analysis, nonmanufacturing setting 1. Lightning C ar Detailing Income Statement Variances For the month ended June 30, 2011 Cars Detailed Revenue $ 30,000 $ 39,375 $ 9,375 F Variable Costs Costs of supplies Labor 1,500 5,600 2,250 6,000 750 U 400 U Total Variable Costs 7,100 8,250 1,150 U Contribution Margin 22,900 31,125 8,225 F 9,500 9,500 $ 13,400 $ 21,625 Fixed Costs Operating Income Actual 225 Static Budget Variance 25 F Budget 200 $ 8,225 F 2. To compute flexible budget variances for revenues and the variable costs, first calculate the budgeted cost or revenue per car, and then multiply that by the actual number of cars detailed. Subtract the actual revenue or cost, and the result is the flexible budget variance. FBV(Revenue) = = = = Actual Revenue - Actual number of cars (Budgeted revenue/budgeted # cars) $39,375 - 225 ($30,000/200) $39,375 - $33,750 $5,625 Favorable FBV(Supplies) = Actual Supplies expense - Actual number of cars (Budgeted cost of supplies/budgeted # cars) = $2,250 - 225 ($1,500/200) = $2,250 - $1,687.50 = $562.50 Unfavorable FBV(Labor) = Actual Labor expense - Actual number of cars (Budgeted cost of labor/budgeted # cars) = $6,000 - 225 ($5,600/200) = $6,000 - $6,300 = $300 Favorable 7-23 The flexible budget variance for fixed costs is the same as the static budget variance, and equals $0 in this case. Therefore, the overall flexible budget variance in income is given by aggregating the variances computed earlier, adjusting for whether they are favorable or unfavorable. This yields: FBV(Operating Income) = $5,625F (-) $562.50U (+) $300F = $5,362.50. 3. In addition to understanding the variances computed above, Stevie should attempt to keep track of the number of cars worked on by each employee, as well as the number of hours actually spent on each car. In addition, Stevie should look at the prices charged for detailing, in relation to the hours spent on each job. 4. This is just a simple problem of two equations & two unknowns. The two equations relate to the number of cars detailed and the labor costs (the wages paid to the employees). X = number of cars detailed by long-term employee Y = number of cars detailed by both short-term employees (combined) Budget: X + Y = 200 40X + 20Y = 5600 Actual: X + Y = 225 40X + 20Y = 6000 Substitution: 40X + 20(200-X) = 5600 20X = 1600 X=80 Y=120 Substitution: 40X + 20(225-X) = 6000 20X = 1500 X = 75 Y=150 Therefore the long term employee is budgeted to detail 80 cars, and the new employees are budgeted to detail 60 cars each. Actually the long term employee details 75 cars (and grosses $3,000 for the month), and the other two wash 75 each and gross $1,500 apiece. 5. The two short-term employees are budgeted to earn gross wages of $14,400 per year (if June is typical, and less if it is a high volume month). If this is a part-time job for them, then that is fine. If it is full-time, and they only get paid for what they wash, the excess capacity may be causing motivation problems. Stevie needs to determine a better way to compensate employees to encourage retention. This should increase customer satisfaction, and potentially revenue, because longer-term employees do a more thorough job. In addition, rather than paying the same wage per car, Stevie might consider setting quality standards and improvement goals for all of the employees. 7-24 7-32 (60 min.) Comprehensive variance analysis, responsibility issues. 1a. Actual selling price = $82.00 Budgeted selling price = $80.00 Actual sales volume = 7,275 units Selling price variance = (Actual sales price Budgeted sales price) × Actual sales volume = ($82 $80) × 7,275 = $14,550 Favorable 1b. Development of Flexible Budget Revenues Variable costs DMFrames $2.20/oz. × 3.00 oz. DMLenses $3.10/oz. × 6.00 oz. Direct manuf. labor $15.00/hr. × 1.20 hrs. Total variable manufacturing costs Fixed manufacturing costs Total manufacturing costs Budgeted Unit Amounts $80.00 Actual Volume 7,275 a 6.60 b 18.60 c 18.00 Flexible Budget Amount $582,000 7,275 7,275 7,275 Gross margin a 48,015 135,315 130,950 314,280 112,500 426,780 $155,220 b c $49,500 ÷ 7,500 units ; $139,500 ÷ 7,500 units; $135,000 ÷ 7,500 units Units sold Revenues Variable costs DMFrames DMLenses Direct manuf. labor Total variable costs Fixed manuf. costs Total costs Gross margin Level 2 Actual Results (1) 7,275 FlexibleBudget Variances (2)=(1)-(3) Flexible Budget (3) 7,275 Sales Volume Variance (4)=(3)-(5) Static Budget (5) 7,500 $596,550 $ 14,550 F $582,000 $ 18,000 U $600,000 55,872 150,738 145,355 351,965 108,398 460,363 $ 136,187 7,857 U 15,423 U 14,405 U 37,685 U 4,102 F 33,583 U $19,033 U 48,015 135,315 130,950 314,280 112,500 426,780 $155,220 1,485 F 4,185 F 4,050F 9,720 F 0 9,720 F $ 8,280 U 49,500 139,500 135,000 324,000 112,500 436,500 $163,500 $19,033 U Flexible-budget variance Level 1 $ 8,280 U Sales-volume variance $27,313 U Static-budget variance 7-25 1c. Price and Efficiency Variances DMFramesActual ounces used = 3.20 per unit × 7,275 units = 23,280 oz. Price per oz. = $55,872 23,280 = $2.40 DMLensesActual ounces used = 7.00 per unit × 7,275 units = 50,925 oz. Price per oz. = $150,738 50,925 = $2.96 Direct LaborActual labor hours = $145,355 14.80 = 9,821.3 hours Labor hours per unit = 9,821.3 7,275 units = 1.35 hours per unit Direct Materials: Frames Actual Costs Incurred (Actual Input Qty. × Actual Price) (1) (7,275 × 3.2 × $2.40) $55,872 Actual Input Qty. × Budgeted Price (2) (7,275 × 3.2 × $2.20) $51,216 $4,656 U Price variance Direct Materials: Lenses (7,275 × 7.0 × $2.96) $150,738 $3,201 U Efficiency variance (7,275 × 7.0 × $3.10) $157,868 $7,130 F Price variance Direct Manuf. Labor (7,275 × 1.35 × $14.80) $145,355 (7,275 × 6.00 × $3.10) $135,315 $22,553 U Efficiency variance (7,275 × 1.35 × $15.00) $147,319 $1,964 F Price variance 2. Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (3) (7,275 × 3.00 × $2.20) $48,015 (7,275 × 1.20 × $15.00) $130,950 $16,369 U Efficiency variance Possible explanations for the price variances are: (a) Unexpected outcomes from purchasing and labor negotiations during the year. (b) Higher quality of frames and/or lower quality of lenses purchased. (c) Standards set incorrectly at the start of the year. Possible explanations for the uniformly unfavorable efficiency variances are: (a) Substantially higher usage of lenses due to poor quality lenses purchased at lower price. (b) Lesser trained workers hired at lower rates result in higher materials usage (for both frames and lenses), as well as lower levels of labor efficiency. (c) Standards set incorrectly at the start of the year. 7-26 7-33 (20 min.) Possible causes for price and efficiency variances 1. Actual Costs Incurred (Actual Input Qty. × Actual Price) (1) Direct Materials: Bottles Pesos 2,125,000 Actual Input Qty. × Budgeted Price (2) (6,000,000 × Peso 0.35) $2,100,000 Pesos 25,000 U Price variance Direct Manufacturing Labor Pesos 664,940 Pesos 210,000 U Efficiency variance (22,040 × Peso 29.30) $645,772 Pesos 19,168 U Price variance 2. Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (3) (360,000 × 15 × Peso 0.35) $1,890,000 (360,000 × (2/60) × Peso 29.30) $351,600 Pesos 294,172 U Efficiency variance If union organizers are targeting our plant, it could suggest employee dissatisfaction with our wage and benefits policies. During this time of targeting, we might expect employees to work more slowly and they may be less careful with the materials that they are using. These tactics might be seen as helpful in either organizing the union or in receiving increases in wages and/or benefits. We should expect unfavorable efficiency variances for both wages and materials. We may see an unfavorable wage variance, if we need to pay overtime due to work slowdowns. We do, in fact, see a substantial unfavorable materials quantity variance, representing a serious overuse of materials. While we may not expect each bottle to use exactly 15 oz. of glass, we do expect the shrinkage to be much less than this. Similarly, we see over 80% more hours used than we expect to make this number of bottles. They are able to make just over 16 bottles per hour, instead of the standard 30 bottles per hour. It is plausible that this waste & inefficiency are either caused by, or are reflective of the reasons behind the attempt to organize the union at this plant. 7-27 7-34 (35 min.) Material cost variances, use of variances for performance evaluation 1. Materials Variances Actual Costs Incurred (Actual Input Qty. × Actual Price) Direct Materials (6,000 × $18a) $108,000 Actual Input Qty. × Budgeted Price Purchases Usage (6,000 × $20) (5,000 × $20) $120,000 $100,000 $12,000 F Price variance a Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (500 × 8 × $20) (4,000 × $20) $80,000 $20,000 U Efficiency variance $108,000 ÷ 6,000 = $18 2. The favorable price variance is due to the $2 difference ($20 - $18) between the standard price based on the previous suppliers and the actual price paid through the on-line marketplace. The unfavorable efficiency variance could be due to several factors including inexperienced workers and machine malfunctions. But the likely cause here is that the lower-priced titanium was lower quality or less refined, which led to more waste. The labor efficiency variance could be affected if the lower quality titanium caused the workers to use more time. 3. Switching suppliers was not a good idea. The $12,000 savings in the cost of titanium was outweighed by the $20,000 extra material usage. In addition, the $20,000U efficiency variance does not recognize the total impact of the lower quality titanium because, of the 6,000 pounds purchased, only 5,000 pounds were used. If the quantity of materials used in production is relatively the same, Better Bikes could expect the remaining 1,000 lbs to produce 100 more units. At standard, 100 more units should take 100 × 8 = 800 lbs. There could be an additional unfavorable efficiency variance of (1000 $20) $20,000 (100 × 8 × $20) $16,000 $4,000U 4. The purchasing manager’s performance evaluation should not be based solely on the price variance. The short-run reduction in purchase costs was more than offset by higher usage rates. His evaluation should be based on the total costs of the company as a whole. In addition, the production manager’s performance evaluation should not be based solely on the efficiency variances. In this case, the production manager was not responsible for the purchase of the lower-quality titanium, which led to the unfavorable efficiency scores. In general, it is important for Stanley to understand that not all favorable material price variances are “good news,” because of the negative effects that can arise in the production process from the purchase of inferior inputs. They can lead to unfavorable 7-28 efficiency variances for both materials and labor. Stanley should also that understand efficiency variances may arise for many different reasons and she needs to know these reasons before evaluating performance. 5. Variances should be used to help Better Bikes understand what led to the current set of financial results, as well as how to perform better in the future. They are a way to facilitate the continuous improvement efforts of the company. Rather than focusing solely on the price of titanium, Scott can balance price and quality in future purchase decisions. 6. Future problems can arise in the supply chain. Scott may need to go back to the previous suppliers. But Better Bikes’ relationship with them may have been damaged and they may now be selling all their available titanium to other manufacturers. Lower quality bicycles could also affect Better Bikes’ reputation with the distributors, the bike shops and customers, leading to higher warranty claims and customer dissatisfaction, and decreased sales in the future. 7-29 7-35 (30 min.) Direct manufacturing labor and direct materials variances, missing data. 1. Direct mfg. labor Actual Costs Incurred (Actual Input Qty.× Actual Price) Qty.× $368,000a Flexible Budget (Budgeted Input Qty. Allowed for Actual Input Qty. Actual Output × Budgeted Price × Budgeted Price) $384,000b $360,000c $16,000 F Price variance $24,000 U Efficiency variance $8,000 U Flexible-budget variance a Given (or 32,000 hours × $11.50/hour) 32,000 hours × $12/hour = $384,000 c 6,000 units × 5 hours/unit × $12/hour = $360,000 b 2. Unfavorable direct materials efficiency variance of $12,500 indicates that more pounds of direct materials were actually used than the budgeted quantity allowed for actual output. = $12,500 efficiency variance $2 per pound budgeted price = 6,250 pounds Budgeted pounds allowed for the output achieved = 6,000 × 20 = 120,000 pounds Actual pounds of direct materials used = 120,000 + 6,250 = 126,250 pounds $292,500 150,000 = $1.95 per pound 3. Actual price paid per pound = Actual Costs Incurred (Actual Input × Actual Price) $292,500a 4. $7,500 F Price variance a b Given 150,000 pounds × $2/pound = $300,000 7-30 Actual Input × Budgeted Price $300,000b 7-36 (20–30 min.) Direct materials and manufacturing labor variances, solving unknowns. All given items are designated by an asterisk. Actual Costs Incurred (Actual Input Qty. × Actual Price) Direct Manufacturing Labor Actual Input Qty. × Budgeted Price Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (1,900 × $21) $39,900 (1,900 × $20*) $38,000 (4,000* × 0.5* × $20*) $40,000 $1,900 U* Price variance Direct Materials (13,000 × $5.25) $68,250* $2,000 F* Efficiency variance Purchases (13,000 × $5*) $65,000 $3,250 U* Price variance Usage (12,500 × $5*) $62,500 (4,000* × 3* × $5*) $60,000 $2,500 U* Efficiency variance 1. 4,000 units × 0.5 hours/unit = 2,000 hours 2. Flexible budget – Efficiency variance = $40,000 – $2,000 = $38,000 Actual dir. manuf. labor hours = $38,000 ÷ Budgeted price of $20/hour = 1,900 hours 3. $38,000 + Price variance, $1,900 = $39,900, the actual direct manuf. labor cost Actual rate = Actual cost ÷ Actual hours = $39,000 ÷ 1,900 hours = $21/hour (rounded) 4. Standard qty. of direct materials = 4,000 units × 3 pounds/unit = 12,000 pounds 5. Flexible budget + Dir. matls. effcy. var. = $60,000 + $2,500 = $62,500 Actual quantity of dir. matls. used = $62,500 ÷ Budgeted price per lb = $62,500 ÷ $5/lb = 12,500 lbs 6. Actual cost of direct materials, $68,250 – Price variance, $3,250 = $65,000 Actual qty. of direct materials purchased = $65,000 ÷ Budgeted price, $5/lb = 13,000 lbs. 7. Actual direct materials price = $68,250 ÷ 13,000 lbs = $5.25 per lb. 7-31 7-37 Direct materials and manufacturing labor variances, journal entries. (20 min.) 1. Direct Materials: Actual Costs Incurred (Actual Input Qty. × Actual Price) Wool (given) $8,295.50 Actual Input Qty. × Budgeted Price 2,633.50 $3.00 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) 230 12 $3.00 $7,900.50 $8,280.00 $395 U $379.50 F Price variance Efficiency variance $15.50 U Flexible-budget variance Direct Manufacturing Labor: Actual Costs Incurred (Actual Input Qty. × Actual Price) (given) Actual Input Qty. × Budgeted Price 836 $10.50 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) 230 3.5 $10.50 $7,814.50 $8,778.00 $8,452.50 $963.50 F $325.50 U Price variance Efficiency variance $638 F Flexible-budget variance 2. Direct Materials Price Variance (time of purchase = time of use) Direct Materials Control 7,900.50 Direct Materials Price Variance 395.00 Accounts Payable Control or Cash 8,295.50 Direct Materials Efficiency Variance Work in Process Control Direct Materials Efficiency Variance Direct Materials Control 8,280.00 379.50 7,900.50 7-32 Direct Manufacturing Labor Variances Work in Process Control Direct Mfg. Labor Efficiency Variance Direct Mfg. Labor Price Variance Wages Payable or Cash 8,452.50 325.50 963.50 7,814.50 3. Plausible explanations for the above variances include: Shayna paid a little bit extra for the wool, but the wool was thicker and allowed the workers to use less of it. Shayna used more inexperienced workers in April than she usually does. This resulted in payment of lower wages per hour, but the new workers were more inefficient and took more hours than normal. Overall though, the lower wage rates resulted in Shayna’s total wage bill being significantly lower than expected. 7-33 7-38 (30 min.) Use of materials and manufacturing labor variances for benchmarking benchmarking. 1. Unit variable cost (dollars) and component percentages for each firm: Firm A DM DL VOH Total 2. Firm B $10.00 35.7% 11.25 40.2% 6.75 24.1% $28.00 100.0% Firm C $10.73 25.2% 17.05 40.0% 14.85 34.8% $42.63 100.0% Firm D $10.75 36.4% 12.80 43.3% 6.00 20.3% $29.55 100.0% $11.25 32.3% 14.03 40.3% 9.56 27.4% $34.84 100.0% Variances and percentage over/under standard for each firm relative to Firm A: Firm B % over Variance standard Firm C % over Variance standard Firm D % over Variance standard DM Price Variance 0.98 U 10.0% - - 0.0% 1.25 F -10.0% DM Efficiency Variance 0.25 F -2.5% 0.75 U 7.5% 2.50 U 25.0% DL Price Variance 0.55 U 3.3% 0.80 U 6.7% 1.28 U 10.0% DL Efficiency Variance 5.25 U 46.7% 0.75 U 6.7% 1.50 U 13.3% To illustrate these calculations, consider the DM Price Variance for Firm B. This is computed as: = = Actual Input Quantity × (Actual Input Price – Price paid by Firm A) 1.95 oz. × ($5.50 - $5.00) $0.98 U The % over standard is just the percentage difference in prices relative to Firm A. Again using the DM Price Variance calculation for Firm B, the % over standard is given by: = = (Actual Input Price – Price paid by Firm A)/Price paid by Firm A ($5.50 - $5.00)/$5.00 10% over standard. 3. 7-34 To: Boss From: Junior Accountant Re: Benchmarking & productivity improvements Date: October 15, 2010 Benchmarking advantages - we can see how productive we are relative to our competition - we can see the specific areas in which there may be opportunities for us to reduce costs Benchmarking disadvantages - some of our competitors are targeting the market for high-end and custom-made lenses. I'm not sure that looking at their costs helps with understanding ours better - we may focus too much on cost differentials and not enough on differentiating ourselves, maintaining our competitive advantages, and growing our margins Areas to discuss - we may want to find out whether we can get the same lower price for glass as Firm D - can we use Firm B’s materials efficiency and Firm C’s variable overhead consumption levels as our standards for the coming year? 7-35 7-39 (60 min.) Comprehensive variance analysis review review. Actual Results Units sold (90% × 2,000,000) Selling price per unit Revenues (1,800,000 × $4.80) Direct materials purchased and used: Direct materials per unit Total direct materials cost (1,800,000 × $0.80) Direct manufacturing labor: Actual manufacturing rate per hour Labor productivity per hour in units Manufacturing labor-hours of input (1,800,000 ÷ 250) Total direct manufacturing labor costs (7,200 × $15) Direct marketing costs: Direct marketing cost per unit Total direct marketing costs (1,800,000 × $0.30) Fixed costs ($850,000 $30,000) Static Budgeted Amounts Units sold Selling price per unit Revenues (2,000,000 × $5.00) Direct materials purchased and used: Direct materials per unit Total direct materials costs (2,000,000 × $0.85) Direct manufacturing labor: Direct manufacturing rate per hour Labor productivity per hour in units Manufacturing labor-hours of input (2,000,000 ÷ 300) Total direct manufacturing labor cost (6,667 × $15.00) Direct marketing costs: Direct marketing cost per unit Total direct marketing cost (2,000,000 × $0.30) Fixed costs Actual Results $8,640,000 1. Revenues Variable costs Direct materials Direct manufacturing labor Direct marketing costs Total variable costs Contribution margin Fixed costs Operating income 2. Actual operating income Static-budget operating income Total static-budget variance 1,440,000 108,000 540,000 2,088,000 6,552,000 820,000 $5,732,000 $5,732,000 6,750,000 $1,018,000 U 7-36 1,800,000 $4.80 $8,640,000 $0.80 $1,440,000 $15 250 7,200 $108,000 $0.30 $540,000 $820,000 2,000,000 $5.00 $10,000,000 $0.85 $1,700,000 $15.00 300 6,667 $100,000 $0.30 $600,000 $850,000 Static-Budget Amounts $10,000,000 1,700,000 100,000 600,000 2,400,000 7,600,000 850,000 $6,750,000 Flexible-budget-based variance analysis for Sonnet, Inc. for March 2010 Units (diskettes) sold 1,800,000 0 Flexible Budget SalesVolume Variances 1,800,000 Flexible-Budget Variances Actual Results 200,000 Static Budget 2,000,000 Revenues Variable costs Direct materials Direct manuf. labor Direct marketing costs Total variable costs Contribution margin Fixed costs $8,640,000 $360,000 U $9,000,000 $1,000,000 U $10,000,000 1,440,000 108,000 540,000 2,088,000 6,552,000 820,000 90,000 F 18,000 U 0 72,000 F 288,000 U 30,000 F 1,530,000 90,000 540,000 2,160,000 6,840,000 850,000 170,000 F 10,000 F 60,000 F 240,000 F 760,000 U 0 1,700,000 100,000 600,000 2,400,000 7,600,000 850,000 Operating income $5,732,000 $258,000 U $5,990,000 $ 760,000 U $6,750,000 $1,018,000 U Total static-budget variance $258,000 U $760,000 U Total flexible-budget variance Total sales-volume variance 3. Flexible-budget operating income = $5,990,000. 4. Flexible-budget variance for operating income = $258,000U. 5. Sales-volume variance for operating income = $760,000U. Analysis of direct mfg. labor flexible-budget variance for Sonnet, Inc. for March 2010 Direct. Mfg. Labor Actual Costs Incurred (Actual Input Qty. × Actual Price) (7,200 × $15.00) $108,000 Actual Input Qty. × Budgeted Price (7,200 × $15.00) $108,000 $0 Price variance Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (*6,000 × $15.00) $90,000 $18,000 U Efficiency variance $18,000 U Flexible-budget variance * 1,800,000 units ÷ 300 direct manufacturing labor standard productivity rate per hour. 6. DML price variance = $0; DML efficiency variance = $18,000U 7-37 7. DML flexible-budget variance = $18,000U 7-38 7-40 (25 min.) Comprehensive variance analysis. 1. Variance Analysis for Sol Electronics for the second quarter of 2009 Units Selling price Sales Variable costs Direct materials Direct manuf. labor Other variable costs Total variable costs Contribution margin Fixed costs Operating income SecondSecondQuarter 2009 Actuals (1) 4,800 $ 71.50 $343,200 57,600 30,240 47,280 135,120 208,080 68,400 $139,680 $7,200 F Flexible Budget for Second Quarter (3) 4,800 $ 70.00 $336,000 2,592 1,440 720 1,872 9,072 400 $8,672 F U F F F U F 60,192 a 28,800 b 48,000 c 136,992 199,008 68,000 $131,008 Flexible Budget Variance (2) = (1) – (3) 0 Sales Volume Variance (4) = (3) – (5) 800 F $56,000 F 10,032 4,800 8,000 22,832 33,168 0 $33,168 U U U U F F Static Budget (5) 4,000 $ 70.00 $280,000 50,160 24,000 40,000 114,160 165,840 68,000 $97,840 a 4,800 units 2.2 lbs. per unit $5.70 per lb. = $60,192 units 0.5 hrs. per unit $12 per hr. = $28,800 c 4,800 units $10 per unit = $48,000 b 4,800 Direct materials Direct manuf. labor (DML) a b SecondSecondQuarter 2009 Actuals $57,600 30,240 Actual Input Qty. Price Variance $2,880 U 4,320 U Budgeted Price $54,720 a 25,920 b 4,800 units 2 lbs. per unit $5.70 per lb. = $54,720 4,800 units 0.45 DML hours per unit $12 per DML hour = $25,920 7-39 Efficiency Variance $5,472 F 2,880 F Flexible Budget for Second Quarter $60,192 28,800 2. The following details, revealed in the variance analysis, should be used to rebut the union if it focuses on the favorable operating income variance: Most of the static budget operating income variance of $41,840F ($139,680 – $97,840) comes from a favorable sales volume variance, which only arose because Sol sold more units than planned. Of the $8,672 F flexible-budget variance in operating income, most of it comes from the $7,200F flexible-budget variance in sales. The net flexible-budget variance in total variable costs of $1,872 F is small, and it arises from direct materials and other variable costs, not from labor. Direct manufacturing labor flexible-budget variance is $1,440 U. The direct manufacturing labor price variance, $4,320U, which is large and unfavorable, is indeed offset by direct manufacturing labor’s favorable efficiency variance—but the efficiency variance is driven by the fact that Sol is using new, more expensive materials. Shaw may have to “prove” this to the union which will insist that it’s because workers are working smarter. Even if workers are working smarter, the favorable direct manufacturing labor efficiency variance of $2,880 does not offset the unfavorable direct manufacturing labor price variance of $4,320. 3. Changing the standards may make them more realistic, making it easier to negotiate with the union. But the union will resist any tightening of labor standards, and it may be too early (is one quarter’s experience enough to change on?); a change of standards at this point may be viewed as opportunistic by the union. Perhaps a continuous improvement program to change the standards will be more palatable to the union and will achieve the same result over a somewhat longer period of time. 7-40 7-41 (30 min.) Comprehensive variance analysis. 1. Computing unit selling prices and unit costs of inputs: Actual selling price = $1,777,500 ÷ 225,000 = $7.90 Budgeting selling price = $1,600,000 ÷ 200,000 = $8.00 Selling-price = 错误!未指定开关参数。× Actual variance units sold = ($7.90/unit – $8.00/unit) × 225,000 units = $22,500 U 2., 3., and 4. The actual and budgeted unit costs are: Actual Direct materials Cream Vanilla Extract Cherry Direct manufacturing labor Preparing Stirring Budgeted $0.02 ($46,500 ÷ 2,325,000) 0.20 ($266,000 ÷ 1,330,000) 0.50 ($120,000 ÷ 240,000) $0.02 0.15 0.50 14.40 ($54,000 ÷ 225,000) × 60 18.00 ($120,000 ÷ 400,000) × 60 14.40 18.00 The actual output achieved is 225,000 pounds of Cherry Star. 7-41 The direct cost price and efficiency variances are: Actual Costs Incurred (Actual Input Qty. × Actual Price) (1) Direct materials Cream Vanilla Extract Cherry $ 46,500 266,000 120,000 $432,500 Direct manuf. labor costs Preparing $ 54,000 Stirring 120,000 $174,000 Actual Input Qty. × Budgeted Price (3) Price Variance (2)=(1)– (2)=(1)–(3) a $ 0 66,500 U 0 $ 66,500 U $ $ $ 46,500 b 199,500 c 120,000 $366,000 d 0 0 0 a $ 54,000 e 120,000 $174,000 Efficiency Variance (4)=(3)– (4)=(3)–(5) Flex. Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (5) f $ 1,500 U 30,750 U 7,500 U $39,750 U $ 45,000 g 168,750 h 112,500 $326,250 $ 0 15,000 F $15,000 F $ 54,000 j 135,000 $189,000 i f $0.02 × 2,325,000 = $46,500 b $0.15 × 1,330,000 = $199,500 c $0.50 × 240,000 = $120,000 d $14.40/hr. × (225,000 min. ÷ 60 min./hr.) = $54,000 e $18.00/hr. × (400,000 min. ÷ 60 min./hr.) = $120,000 $0.02 × 10 × 225,000 = $45,000 $0.15 × 5 × 225,000 = $168,750 h $0.50 × 1 × 225,000 = $112,500 i $14.40 × (225,000 60) = $54,000 j $18.00 × (225,000 30) = $135,000 g Comments on the variances include Selling price variance. This may arise from a proactive decision to reduce price to expand market share or from a reaction to a price reduction by a competitor. It could also arise from unplanned price discounting by salespeople. Material price variance. The $0.05 increase in the price per ounce of vanilla extract could arise from uncontrollable market factors or from poor contract negotiations by Iceland. Material efficiency variance. For all three material inputs, usage is greater than budgeted. Possible reasons include lower quality inputs, use of lower quality workers, and the preparing and stirring equipment not being maintained in a fully operational mode. The higher price per ounce of vanilla extract (and perhaps higher quality of vanilla extract) did not reduce the quantity of vanilla extract used to produce actual output. Labor efficiency variance. The favorable efficiency variance for stirring could be due to workers eliminating nonvalue-added steps in production. 7-42 7-42 (20 min.) Variance analysis with activity-based costing and batch-level direct costs 1. Flexible budget variances for batch activities Setup Actual Costs Incurred (Actual Input Qty. × Actual Price) 15, 000 75 $ $16,800 Actual Input Qty. × Budgeted Price 15, 000 75 $ $15,050 $1,750 U Price variance Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) 15, 000 $ 100 $12,900 $2,150 U Efficiency variance $3,900 U Flexible-budget variance Quality Inspection Actual Costs Incurred (Actual Input Qty. × Actual Price) 15, 000 $ 100 $20,925 Actual Input Qty. × Budgeted Price 15, 000 $ 100 $23,625 $2,700 F Price variance Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) 15, 000 $ 120 $21,875 $1,750 U Efficiency variance $950 F Flexible-budget variance 7-43 2. Re: Explanation of Variances Below I explain the implications of the variances that I calculated. I would enjoy meeting with you to discuss whether we are following the most efficient policies, given these calculations. Please let me know if there is any way to improve my work or my presentation to you. 1. Our batch sizes for both setups and quality inspection were smaller than planned. Even though we were able to reduce the setup and quality inspection time needed for each batch (because of the smaller batch sizes), these gains were more than offset by the increased number of batches. Overall, we ended up substantially below the level of efficiency at which we wished to operate. 2. The hourly wage for the setup workers went over budget due to the tight labor market in our area for such employees. However, we saved a considerable amount of money because we were able to negotiate reduced wage rates for the quality inspection labor after the expiration of their previous contract. Overall, given our output level of 15,000 eels, we had a moderately favorable variance for quality inspection costs, and a significant unfavorable variance on setups, for the reasons outlined above. Thank you. 7-43 (30 min.) Price and efficiency variances, problems in standard-setting, benchmarking. 1. Budgeted direct materials input per shirt = 600 rolls ÷ 6,000 shirts= 0.10 roll of cloth Budgeted direct manufacturing. labor-hours per shirt (1,500 hours ÷ 6,000 shirts) = 0.25 hours Budgeted direct materials cost ($30,000 ÷ 600) = $50 per roll Budgeted direct manufacturing labor cost per hour ($27,000 ÷ 1,500) = $18 per hour Actual output achieved = 6,732 shirts Actual Costs Incurred (Actual Input Qty. × Actual Price) Direct Materials $30,294 Actual Input Qty. × Budgeted Price (612 × $50) $30,600 $306 F Price variance Direct Manufacturing Labor $3,060 F Efficiency variance (1,530 × $18) $27,540 $27,693 Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (6,732 × 0.10 × $50) $33,660 $153 U Price variance (6,732 × 0.25 × $18) $30,294 $2,754 F Efficiency variance 7-44 2. Actions employees may have taken include: (a) Adding steps that are not necessary in working on a shirt. (b) Taking more time on each step than is necessary. (c) Creating problem situations so that the budgeted amount of average downtime will be overstated. (d) Creating defects in shirts so that the budgeted amount of average rework will be overstated. Employees may take these actions for several possible reasons. (a) They may be paid on a piece-rate basis with incentives for production levels above budget. (b) They may want to create a relaxed work atmosphere, and a less demanding standard can reduce stress. (c) They have a “them vs. us” mentality rather than a partnership perspective. (d) They may want to gain all the benefits that ensue from superior performance (job security, wage rate increases) without putting in the extra effort required. This behavior is unethical if it is deliberately designed to undermine the credibility of the standards used at New Fashions. 3. If Jorgenson does nothing about standard costs, his behavior will violate the “Standards of Ethical Conduct for Practitioners of Management Accounting.” In particular, he would violate the (a) standards of competence, by not performing professional duties in accordance with relevant standards; (b) standards of integrity, by passively subverting the attainment of the organization’s objective to control costs; and (c) standards of credibility, by not communicating information fairly and not disclosing all relevant cost information. 4. Jorgenson should discuss the situation with Fenton and point out that the standards are lax and that this practice is unethical. If Fenton does not agree to change, Jorgenson should escalate the issue up the hierarchy in order to effect change. If organizational change is not forthcoming, Jorgenson should be prepared to resign rather than compromise his professional ethics. 5. Main pros of using Benchmarking Clearing House information to compute variances are: (a) Highlights to New Fashions in a direct way how it may or may not be costcompetitive. (b) Provides a “reality check” to many internal positions about efficiency or effectiveness. Main cons are: (a) New Fashions may not be comparable to companies in the database. (b) Cost data about other companies may not be reliable. (c) Cost of Benchmarking Clearing House reports. 7-45 CHAPTER 8 FLEXIBLE BUDGETS, OVERHEAD COST VARIANCES, AND MANAGEMENT CONTROL 8-1 Effective planning of variable overhead costs involves: 1. Planning to undertake only those variable overhead activities that add value for customers using the product or service, and 2. Planning to use the drivers of costs in those activities in the most efficient way. 8-2 At the start of an accounting period, a larger percentage of fixed overhead costs are locked-in than is the case with variable overhead costs. When planning fixed overhead costs, a company must choose the appropriate level of capacity or investment that will benefit the company over a long time. This is a strategic decision. 8-3 The key differences are how direct costs are traced to a cost object and how indirect costs are allocated to a cost object: Direct costs Indirect costs Actual Costing Actual prices × Actual inputs used Actual indirect rate × Actual inputs used Standard Costing Standard prices × Standard inputs allowed for actual output Standard indirect cost-allocation rate × Standard quantity of cost-allocation base allowed for actual output 8-4 Steps in developing a budgeted variable-overhead cost rate are: 1. Choose the period to be used for the budget, 2. Select the cost-allocation bases to use in allocating variable overhead costs to the output produced, 3. Identify the variable overhead costs associated with each cost-allocation base, and 4. Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to output produced. 8-5 Two factors affecting the spending variance for variable manufacturing overhead are: a. Price changes of individual inputs (such as energy and indirect materials) included in variable overhead relative to budgeted prices. b. Percentage change in the actual quantity used of individual items included in variable overhead cost pool, relative to the percentage change in the quantity of the cost driver of the variable overhead cost pool. 8-6 Possible reasons for a favorable variable-overhead efficiency variance are: Workers more skillful in using machines than budgeted, Production scheduler was able to schedule jobs better than budgeted, resulting in lower-than-budgeted machine-hours, Machines operated with fewer slowdowns than budgeted, and Machine time standards were overly lenient. 8- 8-7 A direct materials efficiency variance indicates whether more or less direct materials were used than was budgeted for the actual output achieved. A variable manufacturing overhead efficiency variance indicates whether more or less of the chosen allocation base was used than was budgeted for the actual output achieved. 8-8 Steps in developing a budgeted fixed-overhead rate are 1. Choose the period to use for the budget, 2. Select the cost-allocation base to use in allocating fixed overhead costs to output produced, 3. Identify the fixed-overhead costs associated with each cost-allocation base, and 4. Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to output produced. 8-9 The relationship for fixed-manufacturing overhead variances is: Flexible-budget variance Efficiency variance (never a variance) Spending variance There is never an efficiency variance for fixed overhead because managers cannot be more or less efficient in dealing with an amount that is fixed regardless of the output level. The result is that the flexible-budget variance amount is the same as the spending variance for fixedmanufacturing overhead. 8-10 For planning and control purposes, fixed overhead costs are a lump sum amount that is not controlled on a per-unit basis. In contrast, for inventory costing purposes, fixed overhead costs are allocated to products on a per-unit basis. 8-11 An important caveat is what change in selling price might have been necessary to attain the level of sales assumed in the denominator of the fixed manufacturing overhead rate. For example, the entry of a new low-price competitor may have reduced demand below the denominator level if the budgeted selling price was maintained. An unfavorable productionvolume variance may be small relative to the selling-price variance had prices been dropped to attain the denominator level of unit sales. 8- 8-12 A strong case can be made for writing off an unfavorable production-volume variance to cost of goods sold. The alternative is prorating it among inventories and cost of goods sold, but this would “penalize” the units produced (and in inventory) for the cost of unused capacity, i.e., for the units not produced. But, if we take the view that the denominator level is a “soft” number—i.e., it is only an estimate, and it is never expected to be reached exactly, then it makes more sense to prorate the production volume variance—whether favorable or not—among the inventory stock and cost of goods sold. Prorating a favorable variance is also more conservative: it results in a lower operating income than if the favorable variance had all been written off to cost of goods sold. Finally, prorating also dampens the efficacy of any steps taken by company management to manage operating income through manipulation of the production volume variance. In sum, a production-volume variance need not always be written off to cost of goods sold. 8-13 The four variances are: Variable manufacturing overhead costs spending variance efficiency variance Fixed manufacturing overhead costs spending variance production-volume variance 8-14 Interdependencies among the variances could arise for the spending and efficiency variances. For example, if the chosen allocation base for the variable overhead efficiency variance is only one of several cost drivers, the variable overhead spending variance will include the effect of the other cost drivers. As a second example, interdependencies can be induced when there are misclassifications of costs as fixed when they are variable, and vice versa. 8-15 Flexible-budget variance analysis can be used in the control of costs in an activity area by isolating spending and efficiency variances at different levels in the cost hierarchy. For example, an analysis of batch costs can show the price and efficiency variances from being able to use longer production runs in each batch relative to the batch size assumed in the flexible budget. 8- 8-16 (20 min.) Variable manufacturing overhead, variance analysis. 1. Variable Manufacturing Overhead Variance Analysis for Esquire Clothing for June 2009 Actual Costs Incurred Actual Input Qty. × Actual Rate (1) (4,536 × $11.50) $52,164 Actual Input Qty. × Budgeted Rate (2) (4,536 × $12) $54,432 $2,268 F Spending variance Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (4 × 1,080 × $12) $51,840 $2,592 U Efficiency variance $324 U Flexible-budget variance Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (4 × 1,080 × $12) $51,840 Never a variance Never a variance 2. Esquire had a favorable spending variance of $2,268 because the actual variable overhead rate was $11.50 per direct manufacturing labor-hour versus $12 budgeted. It had an unfavorable efficiency variance of $2,592 U because each suit averaged 4.2 labor-hours (4,536 hours ÷ 1,080 suits) versus 4.0 budgeted labor-hours. 8- 8-17 (20 min.) Fixed-manufacturing overhead, variance analysis (continuation of 8-16). 1 & 2. Budgeted fixed overhead rate per unit of allocation base $62,400 1,040 4 $62,400 = 4,160 = $15 per hour = Fixed Manufacturing Overhead Variance Analysis for Esquire Clothing for June 2009 Actual Costs Incurred (1) Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) $63,916 $62,400 $62,400 $1,516 U Spending variance Never a variance $1,516 U Flexible-budget variance Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (4 × 1,080 × $15) $64,800 $2,400 F Production-volume variance $2,400 F Production-volume variance The fixed manufacturing overhead spending variance and the fixed manufacturing flexible budget variance are the same––$1,516 U. Esquire spent $1,516 above the $62,400 budgeted amount for June 2009. The production-volume variance is $2,400 F. This arises because Esquire utilized its capacity more intensively than budgeted (the actual production of 1,080 suits exceeds the budgeted 1,040 suits). This results in overallocated fixed manufacturing overhead of $2,400 (4 × 40 × $15). Esquire would want to understand the reasons for a favorable production-volume variance. Is the market growing? Is Esquire gaining market share? Will Esquire need to add capacity? 8- 8-18 (30 min.) Variable manufacturing overhead variance analysis. 1. Denominator level = (3,200,000 × 0.02 hours) = 64,000 hours Actual Results 2,800,000 50,400 0.018 $680,400 $13.50 $0.243 2. 1. 2. 3. 4. 5. 6. Output units (baguettes) Direct manufacturing labor-hours Labor-hours per output unit (2 1) Variable manuf. overhead (MOH) costs Variable MOH per labor-hour (4 2) Variable MOH per output unit (4 1) a2,800,000 Flexible Budget Amounts 2,800,000 56,000a 0.020 $560,000 $10 $0.200 0.020= 56,000 hours Variable Manufacturing Overhead Variance Analysis for French Bread Company for 2009 Flexible Budget: Allocated: Actual Costs Budgeted Input Qty. Budgeted Input Qty. Incurred Allowed for Allowed for Actual Input Qty. Actual Input Qty. Actual Output Actual Output × Actual Rate × Budgeted Rate × Budgeted Rate × Budgeted Rate (1) (2) (3) (4) (50,400 × $13.50) (50,400 × $10) (56,000 × $10) (56,000 × $10) $680,400 $504,000 $560,000 $560,000 $176,400 U Spending variance $56,000 F Efficiency variance $120,400 U Flexible-budget variance Never a variance Never a variance 3. Spending variance of $176,400U. It is unfavorable because variable manufacturing overhead was 35% higher than planned. A possible explanation could be an increase in energy rates relative to the rate per standard labor-hour assumed in the flexible budget. Efficiency variance of $56,000F. It is favorable because the actual number of direct manufacturing labor-hours required was lower than the number of hours in the flexible budget. Labor was more efficient in producing the baguettes than management had anticipated in the budget. This could occur because of improved morale in the company, which could result from an increase in wages or an improvement in the compensation scheme. Flexible-budget variance of $120,400U. It is unfavorable because the favorable efficiency variance was not large enough to compensate for the large unfavorable spending variance. 8- 8-19 (30 min.) Fixed manufacturing overhead variance analysis (continuation of 8-18). 1. Budgeted standard direct manufacturing labor used = 0.02 per baguette Budgeted output = 3,200,000 baguettes Budgeted standard direct manufacturing labor-hours = 3,200,000 × 0.02 = 64,000 hours Budgeted fixed manufacturing overhead costs = 64,000 × $4.00 per hour = $256,000 Actual output = 2,800,000 baguettes Allocated fixed manufacturing overhead = 2,800,000 × 0.02 × $4 = $224,000 Fixed Manufacturing Overhead Variance Analysis for French Bread Company for 2009 Flexible Budget: Same Budgeted Same Budgeted Allocated: Lump Sum Lump Sum Budgeted Input Qty. (as in Static Budget) (as in Static Budget) Allowed for Actual Costs Regardless of Regardless of Actual Output Incurred Output Level Output Level × Budgeted Rate (1) (2) (3) (4) (2,800,000 × 0.02 × $4) $272,000 $256,000 $256,000 $224,000 $16,000 U Spending variance Never a variance $16,000 U Flexible-budget variance $32,000 U Production-volume variance $32,000 U Production-volume variance $48,000 U Underallocated fixed overhead (Total fixed overhead variance) 2. The fixed manufacturing overhead is underallocated by $48,000. 3. The production-volume variance of $32,000U captures the difference between the budgeted 3,200,0000 baguettes and the lower actual 2,800,000 baguettes produced—the fixed cost capacity not used. The spending variance of $16,000 unfavorable means that the actual aggregate of fixed costs ($272,000) exceeds the budget amount ($256,000). For example, monthly leasing rates for baguette-making machines may have increased above those in the budget for 2009. 8- 8-20 (30–40 min.) Manufacturing overhead, variance analysis. 1. The summary information is: The Solutions Corporation (June 2009) June Outputs units (number of assembled units) Hours of assembly time Assembly hours per unit Variable mfg. overhead cost per hour of assembly time Variable mfg. overhead costs Fixed mfg. overhead costs Fixed mfg. overhead costs per hour of assembly time a 200 units 2 assembly hours per unit = 400 hours 216 units = 1.90 assembly hours per unit b 411 hours c 216 units 2 assembly hours per unit = 432 hours d $12,420 411 assembly hours = $30.22 per assembly hour e 432 assembly hours $30 per assembly hour = $12,960 f 400 assembly hours $30 per assembly hour = $12,000 411 assembly hours = $50 per assembly hour h $19,200 400 assembly hours = $48 per assembly hour g $20,560 8- Actual 216 411 1.90b $ 30.20d $12,420 $20,560 $ 50.02g Flexible Budget 216 432c 2.00 $ 30.00 $12,960e $19,200 Static Budget 200 400a 2.00 $ 30.00 $12,000f $19,200 $ 48.00h Actual Input Qty. Actual Costs Incurred Variable Manufacturing Overhead $12,420 Flexible Budget: Budgeted Input Qty. Allowed Budgeted for Actual Output Rate Budgeted Rate 411 $30.00 assy. hrs. per assy. hr. $12,330 432 assy. hrs. Allocated: Budgeted Input Qty. Allowed Budgeted for Actual Output Rate $30.00 per assy. hr. $12,960 $90 U $30.00 per assy. hr. $12,960 $630 F Spending variance 432 assy. hrs. Efficiency variance Never a variance $540 F Flexible-budget variance Never a variance $540 F Overallocated variable overhead Flexible Budget: Actual Costs Incurred Fixed Manufacturing Overhead Static Budget Lump Sum Regardless of Output Level Static Budget Lump Sum Regardless of Output Level $20,560 $19,200 $19,200 $1,360 U Allocated: Budgeted Input Allowed Budgeted for Actual Output Rate $48.00 432 assy. hrs. per assy. hr. $20,736 $1,536 F Spending Variance Never a Variance $1,360 U $1,536 F Flexible-budget variance Production-volume variance $176 F Overallocated fixed overhead 8- Production-volume variance The summary analysis is: Spending Variance Variable Manufacturing Overhead Fixed Manufacturing Overhead 2. Efficiency Variance Production-Volume Variance $90 U $630 F Never a variance $1,360 U Never a variance $1,536 F Variable Manufacturing Costs and Variances a. Variable Manufacturing Overhead Control Accounts Payable Control and various other accounts To record actual variable manufacturing overhead costs incurred. 12,420 b. Work-in-Process Control Variable Manufacturing Overhead Allocated To record variable manufacturing overhead allocated. 12,960 c. Variable Manufacturing Overhead Allocated Variable Manufacturing Overhead Spending Variance Variable Manufacturing Overhead Control Variable Manufacturing Overhead Efficiency Variance To isolate variances for the accounting period. 12,960 90 12,420 12,960 12,420 630 d. Variable Manufacturing Overhead Efficiency Variance 630 Variable Manufacturing Overhead Spending Variance 90 Cost of Goods Sold 540 To write off variable manufacturing overhead variances to cost of goods sold. 8- Fixed Manufacturing Costs and Variances a. Fixed Manufacturing Overhead Control Salaries Payable, Acc. Depreciation, various other accounts To record actual fixed manufacturing overhead costs incurred. 20,560 b. Work-in-Process Control Fixed Manufacturing Overhead Allocated To record fixed manufacturing overhead allocated. 20,736 c. Fixed Manufacturing Overhead Allocated Fixed Manufacturing Overhead Spending Variance Fixed Manufacturing Overhead Production-Volume Variance Fixed Manufacturing Overhead Control To isolate variances for the accounting period. 20,736 1,360 20,560 20,736 d. Fixed Manufacturing Overhead Production-Volume Variance 1,536 Fixed Manufacturing Overhead Spending Variance Cost of Goods Sold To write off fixed manufacturing overhead variances to cost of goods sold. 1,536 20,560 1,360 176 3. Planning and control of variable manufacturing overhead costs has both a long-run and a short-run focus. It involves Solutions planning to undertake only value-added overhead activities (a long-run view) and then managing the cost drivers of those activities in the most efficient way (a short-run view). Planning and control of fixed manufacturing overhead costs at Solutions have primarily a long-run focus. It involves undertaking only value-added fixed-overhead activities for a budgeted level of output. Solutions makes most of the key decisions that determine the level of fixed-overhead costs at the start of the accounting period. 8- 8-21 1. 2. 3. 4. 5. (1015 min.) 4-variance analysis, fill in the blanks. Variable $4,200 U 4,500 U NEVER 8,700 U 8,700 U Spending variance Efficiency variance Production-volume variance Flexible-budget variance Underallocated (overallocated) MOH Fixed $3,000 U NEVER 600 U 3,000 U 3,600 U These relationships could be presented in the same way as in Exhibit 8-4. Variable MOH Actual Costs Incurred (1) $35,700 Actual Input Qty. × Budgeted Rate (2) $31,500 $4,200 U Spending variance Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) $27,000 $4,500 U Efficiency variance Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) $27,000 Never a variance $8,700 U Flexible-budget variance Never a variance $8,700 U Underallocated variable overhead (Total variable overhead variance) Fixed MOH Actual Costs Incurred (1) $18,000 Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) $15,000 $3,000 U Spending variance Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) $15,000 Never a variance $3,000 U Flexible-budget variance $600 U Production-volume variance $600 U Production-volume variance $3,600 U Underallocated fixed overhead (Total fixed overhead variance) 8- Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) $14,400 An overview of the 4 overhead variances is: 4-Variance Analysis Variable Overhead Fixed Overhead 8-22 Spending Variance Efficiency Variance ProductionVolume Variance $4,200 U $4,500 U Never a variance $3,000 U Never a variance $600 U (20–30 min.) Straightforward 4-variance overhead analysis. 1. The budget for fixed manufacturing overhead is 4,000 units × 6 machine-hours × $15 machine-hours/unit = $360,000. An overview of the 4-variance analysis is: 4-Variance Analysis Variable Manufacturing Overhead Fixed Manufacturing Overhead Spending Variance $17,800 U Efficiency Variance $16,000 U $13,000 U ProductionVolume Variance Never a Variance Never a Variance $36,000 F Solution Exhibit 8-22 has details of these variances. A detailed comparison of actual and flexible budgeted amounts is: Actual 4,400 28,400 b 6.45 $245,000 d $8.63 $373,000 f $13.13 Output units (auto parts) Allocation base (machine-hours) Allocation base per output unit Variable MOH Variable MOH per hour Fixed MOH Fixed MOH per hour a4,400 units × 6.00 machine-hours/unit = 26,400 machine-hours ÷ 4,400 = 6.45 machine-hours per unit c 4,400 units × 6.00 machine-hours per unit × $8.00 per machine-hour = $211,200 d $245,000 ÷ 28,400 = $8.63 e 4,000 units × 6.00 machine-hours per unit × $15 per machine-hour = $360,000 f $373,000 ÷ 28,400 = $13.13 b28,400 8- Flexible Budget 4,400 a 26,400 6.00 c $211,200 $8.00 e $360,000 – 2. Variable Manufacturing Overhead Control Accounts Payable Control and other accounts 245,000 Work-in-Process Control Variable Manufacturing Overhead Allocated 211,200 Variable Manufacturing Overhead Allocated Variable Manufacturing Overhead Spending Variance Variable Manufacturing Overhead Efficiency Variance Variable Manufacturing Overhead Control 211,200 17,800 16,000 Fixed Manufacturing Overhead Control Wages Payable Control, Accumulated Depreciation Control, etc. 373,000 Work-in-Process Control Fixed Manufacturing Overhead Allocated 396,000 245,000 211,200 245,000 373,000 Fixed Manufacturing Overhead Allocated 396,000 Fixed Manufacturing Overhead Spending Variance 13,000 Fixed Manufacturing Overhead Production-Volume Variance Fixed Manufacturing Overhead Control 396,000 36,000 373,000 3. Individual fixed manufacturing overhead items are not usually affected very much by day-to-day control. Instead, they are controlled periodically through planning decisions and budgeting procedures that may sometimes have horizons covering six months or a year (for example, management salaries) and sometimes covering many years (for example, long-term leases and depreciation on plant and equipment). 4. The fixed overhead spending variance is caused by the actual realization of fixed costs differing from the budgeted amounts. Some fixed costs are known because they are contractually specified, such as rent or insurance, although if the rental or insurance contract expires during the year, the fixed amount can change. Other fixed costs are estimated, such as the cost of managerial salaries which may depend on bonuses and other payments not known at the beginning of the period. In this example, the spending variance is unfavorable, so actual FOH is greater than the budgeted amount of FOH. The fixed overhead production volume variance is caused by production being over or under expected capacity. You may be under capacity when demand drops from expected levels, or if there are problems with production. Over capacity is usually driven by favorable demand shocks or a desire to increase inventories. The fact that there is a favorable volume variance indicates that production exceeded the expected level of output (4,400 units actual relative to a denominator level of 4,000 output units). 8- SOLUTION EXHIBIT 8-22 Actual Costs Incurred (1) Variable MOH $245,000 Actual Input × Budgeted Rate (2) (28,400 × $8) $227,200 $17,800 U Spending variance Flexible Budget: Budgeted Input Allowed for Actual Output × Budgeted Rate (3) (4,400 × 6 × $8) $211,200 $16,000 U Efficiency variance $33,800 U Flexible-budget variance Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (4,400 × 6 × $8) $211,200 Never a variance Never a variance $33,800 U Underallocated variable overhead (Total variable overhead variance) Actual Costs Incurred (1) Fixed MOH $373,000 Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) (4,000 × 6 × $15) $360,000 $13,000 U Spending variance Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) (4,000 × 6 × $15) $360,000 Never a variance Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (4,400 × 6 × $15) $396,000 $36,000 F Production-volume variance $13,000 U $36,000 F Production-volume Flexible-budget variance variance $23,000 F Overallocated fixed overhead (Total fixed overhead variance) 8- 8-23 (3040 min.) 1. Straightforward coverage of manufacturing overhead, standardcosting system. Solution Exhibit 8-23 shows the computations. Summary details are: Actual 41,000 13,300 0.32b $155,100 Output units Allocation base (machine-hours) Allocation base per output unit Variable MOH Variable MOH per hour Fixed MOH Fixed MOH per hour a b c 41,000 × 0.30 = 12,300 13,300 ÷ 41,000 = 0.32 41,000 × 0.30 × $12 = $147,600 d e d $11.66 $401,000 e $30.15 Flexible Budget 41,000 a 12,300 0.30 c $147,600 $12.00 $390,000 – $155,100 ÷ 13,300 = $11.66 $401,000 ÷ 13,300 = $30.15 An overview of the 4-variance analysis is: 4-Variance Analysis Variable Manufacturing Overhead Fixed Manufacturing Overhead Spending Variance Efficiency Variance Production Production Volume Variance $4,500 F $12,000 U $11,000 U Never a variance $21,000 U 8- Never a variance 2. Variable Manufacturing Overhead Control Accounts Payable Control and other accounts 155,100 Work-in-Process Control Variable Manufacturing Overhead Allocated 147,600 155,100 147,600 Variable Manufacturing Overhead Allocated 147,600 Variable Manufacturing Overhead Efficiency Variance 12,000 Variable Manufacturing Overhead Spending Variance Variable Manufacturing Overhead Control 4,500 155,100 Fixed Manufacturing Overhead Control Wages Payable Control, Accumulated Depreciation Control, etc. 401,000 401,000 Work-in-Process Control Fixed Manufacturing Overhead Allocated 369,000 Fixed Manufacturing Overhead Allocated Fixed Manufacturing Overhead Spending Variance Fixed Manufacturing Overhead Production-Volume Variance Fixed Manufacturing Overhead Control 369,000 11,000 369,000 21,000 401,000 3. The control of variable manufacturing overhead requires the identification of the cost drivers for such items as energy, supplies, and repairs. Control often entails monitoring nonfinancial measures that affect each cost item, one by one. Examples are kilowatt-hours used, quantities of lubricants used, and repair parts and hours used. The most convincing way to discover why overhead performance did not agree with a budget is to investigate possible causes, line item by line item. 4. The variable overhead spending variance is favorable. This means the actual rate applied to the manufacturing costs is lower than the budgeted rate. Since variable overhead consists of several different costs, this could be for a variety of reasons, such as the utility rates being lower than estimated or the indirect materials costs per unit of denominator activity being less than estimated. The variable overhead efficiency variance is unfavorable, which implies that the estimated denominator activity was too low. Since the denominator activity is machine hours, this could be the result of inefficient use of machines, poorly scheduled production runs, or machines that need maintenance and thus are not working at the expected level of efficiency. 8- SOLUTION EXHIBIT 8-23 Actual Costs Incurred (1) Variable Manufacturing Overhead $155,100 Flexible Budget: Budgeted Input Allowed for Actual Output × Budgeted Rate (3) (12,300 × $12) $147,600 Actual Input × Budgeted Rate (2) (13,300 × $12) $159,600 $4,500 F $12,000 U Spending variance Efficiency variance Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (12,300 × $12) $147,600 Never a variance $7,500 U Flexible-budget variance Never a variance $7,500 U Underallocated variable overhead (Total variable overhead variance) Actual Costs Incurred (1) Fixed Manufacturing Overhead Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) $401,000 $390,000 $390,000 $11,000 U Spending variance Never a variance $11,000 U Flexible-budget variance Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (12,300 × $30) $369,000 $21,000 U* Production-volume variance $21,000 U* Production-volume variance $32,000 U Underallocated fixed overhead (Total fixed overhead variance) $390,000 Fixed manufacturing overhead = = $30 per machine-hour. 13,000 machine - hours budgeted rate *Alternative computation: 13,000 denominator hours – 12,300 budgeted hours allowed = 700 hours; 700 hours × $30 per machine-hour = $21,000 U 8- 8-24 (20–25 min.) Overhead variances, service sector. 1. Meals on Wheels (May 2009) Output units (number of deliveries) Hours per delivery Hours of delivery time Variable overhead costs per delivery hour Variable overhead (VOH) costs Fixed overhead costs Fixed overhead cost per hour Actual Results 8,800 0.65a 5,720 $1.80c $10,296 $38,600 Flexible Budget 8,800 0.70 6,160b $1.50 $9,240d $35,000 Static Budget 10,000 0.70 7,000b $1.50 $10,500d $35,000 $5.00e 5,720 hours 8,800 deliveries = 0.65 hours per delivery hrs. per delivery number of deliveries = 0.70 10,000 = 7,000 hours c $10,296 VOH costs 5,720 delivery hours = $1.80 per delivery hour d Delivery hours VOH cost per delivery hour = 7,000 $1.50 = $10,500 e Static budget delivery hours = 10,000 units 0.70 hours/unit = 7,000 hours; Fixed overhead rate = Fixed overhead costs Static budget delivery hours = $35,000 7,000 hours = $5 per hour a b VARIABLE OVERHEAD Actual Input Qty. Budgeted Rate Actual Costs Incurred 5,720 hrs $1.50 per hr. $8,580 $10,296 $1,716 U Spending variance Flexible Budget: Budgeted Input Qty. Allowed for Actual Output Budgeted Rate 6,160 hrs $1.50 per hr. $9,240 $660 F Efficiency variance 2. Actual Costs Incurred $38,600 FIXED OVERHEAD Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level $35,000 $3,600 U Spending variance Allocated: Budgeted Input Qty. Allowed for Actual Output Budgeted Rate 8,800 units 0.70 hrs./unit $5/hr. 6,160 hrs. $5/hr. $30,800 $4,200 U Production-volume variance 8- 3. The spending variances for variable and fixed overhead are both unfavorable. This means that MOW had increases over budget in either or both the cost of individual items (such as telephone calls and gasoline) in the overhead cost pools, or the usage of these individual items per unit of the allocation base (delivery time). The favorable efficiency variance for variable overhead costs results from more efficient use of the cost allocation base––each delivery takes 0.65 hours versus a budgeted 0.70 hours. MOW can best manage its fixed overhead costs by long-term planning of capacity rather than day-to-day decisions. This involves planning to undertake only value-added fixed-overhead activities and then determining the appropriate level for those activities. Most fixed overhead costs are committed well before they are incurred. In contrast, for variable overhead, a mix of long-run planning and daily monitoring of the use of individual items is required to manage costs efficiently. MOW should plan to undertake only value-added variable-overhead activities (a long-run focus) and then manage the cost drivers of those activities in the most efficient way (a short-run focus). There is no production-volume variance for variable overhead costs. The unfavorable production-volume variance for fixed overhead costs arises because MOW has unused fixed overhead resources that it may seek to reduce in the long run. 8- 8-25 (4050 min.) Total overhead, 3-variance analysis. 1. This problem has two major purposes: (a) to give experience with data allocated on a total overhead basis instead of on separate variable and fixed bases and (b) to reinforce distinctions between actual hours of input, budgeted (standard) hours allowed for actual output, and denominator level. An analysis of direct manufacturing labor will provide the data for actual hours of input and standard hours allowed. One approach is to plug the known figures (designated by asterisks) into the analytical framework and solve for the unknowns. The direct manufacturing labor efficiency variance can be computed by subtracting $3,856 from $5,776. The complete picture is as follows: Actual Costs Incurred (4,820 hrs. × $16.80) $80,976* Actual Input × Budgeted Rate (4,820hrs. × $16.00*) $77,120 $3,856 U* Price variance Flexible Budget: Budgeted Input Allowed for Actual Output × Budgeted Rate (4,700 hrs. × $16.00*) $75,200 $1,920 U Efficiency variance $5,776 U* Flexible-budget variance * Given Direct Labor calculations Actual input × Budgeted rate = Actual costs – Price variance = $80,976 – $3,856 = $77,120 Actual input = $77,120 ÷ Budgeted rate = $77,120 ÷ $16 = 4,820 hours Budgeted input × Budgeted rate = $77,120 – Efficiency variance = $77,120 – $1,920 = $75,200 Budgeted input = $75,200 ÷ Budgeted rate = $75,200 ÷ 16 = 4,700 hours Production Overhead Variable overhead rate Budgeted fixed overhead costs = $25,600* ÷ 3,200* hrs. = $8.00 per standard labor-hour = $79,040* – 4,000* × ($8.00) = $47,040 If total overhead is allocated at 120% of direct labor-cost, the single overhead rate must be 120% of $16.00, or $19.20 per hour. Therefore, the fixed overhead component of the rate must be $19.20 – $8.00, or $11.20 per direct labor-hour. 8- Let D = denominator level in input units Budgeted fixed overhead rate per input unit $11.20 D = Budgeted fixed overhead costs Denominator level in input units = $47,040 ÷ D = 4,200 direct labor-hours A summary 3-variance analysis for October follows: Actual Costs Incurred Flexible Budget: Budgeted Input Allowed for Actual Output × Budgeted Rate $47,040 + ($8 × 4,700) $84,640 Actual Inputs × Budgeted Rate ($47,040 + (4,820 × $8.00) $85,600 $99,600* $14,000 U $960 U Spending variance Efficiency variance $5,600 F* $14,960 U Production-volume variance $5,600 F* Production-volume variance Flexible-budget variance * Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4,700 hrs. × $19.20) $90,240 Known figure An overview of the 3-variance analysis using the block format in the text is: 3-Variance Analysis Total Overhead Spending Variance Efficiency Variance $14,000 U $960U Production Production Volume Variance $5,600 F 2. The control of variable manufacturing overhead requires the identification of the cost drivers for such items as energy, supplies, equipment, and maintenance. Control often entails monitoring nonfinancial measures that affect each cost item, one by one. Examples are kilowatts used, quantities of lubricants used, and equipment parts and hours used. The most convincing way to discover why overhead performance did not agree with a budget is to investigate possible causes, line item by line item. Individual fixed manufacturing overhead items are not usually affected very much by dayto-day control. Instead, they are controlled periodically through planning decisions and budgeting that may sometimes have horizons covering six months or a year (for example, management salaries) and sometimes covering many years (for example, long-term leases and depreciation on plant and equipment). 8- 8-26 (30 min.) Overhead variances, missing information. 1. In the columnar presentation of variable overhead variance analysis, all numbers shown in bold are calculated from the given information, in the order (a) - (e). VARIABLE MANUFACTURING OVERHEAD Flexible Budget: Budgeted Input Qty. Actual Input Qty. Allowed for Budgeted Budgeted Rate Actual Output Rate (a) (c) Actual Costs Incurred (b) 15,000 mach. hrs. $89,625 $6.00 per mach. hr. $90,000 14,850 mach. hrs. $6.00 per mach. hr. $89,100 89,100 $900 U (d) Efficiency variance $375 F Spending variance $525 U (e) Flexible-budget variance a. 15,000 machine-hours $6 per machine-hour = $90,000 b. Actual VMOH $89,625 = $90,000 – $375F (VOH spending variance) = c. 14,850 machine-hours $6 per machine-hour = $89,100 d. VOH efficiency variance = $90,000 – $89,100 = $900U e. VOH flexible budget variance = $900U – $375F = $525U Allocated variable overhead will be the same as the flexible budget variable overhead of $89,100. The actual variable overhead cost is $89,625. Therefore, variable overhead is underallocated by $525. 8- 2. In the columnar presentation of fixed overhead variance analysis, all numbers shown in bold are calculated from the given information, in the order (a) – (e). Actual Costs Incurred (a) $30,375 FIXED MANUFACTURING OVERHEAD Flexible Budget: Allocated: Static Budget Lump Sum Budgeted Input Qty. Regardless of Output Allowed for Level Actual Output (b) 14,850 mach. hrs. $28,800 28,800 $23,760 23,760 $1,575 U Spending variance Budgeted Rate $1.60* (c) per mach. hr. $5,040 U (d) Production-volume variance $1,575 $1,575 U (e) Flexible-budget variance a. Actual FOH costs = $120,000 total overhead costs – $89,625 VOH costs = $30,375 b. Static budget FOH lump sum = $30,375 – $1,575 spending variance = $28,800 c. *FOH allocation rate = $28,800 FOH static-budget lump sum 18,000 static-budget machine-hours = $1.60 per machine-hour Allocated FOH = 14,850 machine-hours $1.60 per machine-hour = $23,760 d. PVV = $28,800 – $23,760 = $5,040U e. FOH flexible budget variance = FOH spending variance = $1,575 U Allocated fixed overhead is $23,760. The actual fixed overhead cost is $30,375. Therefore, fixed overhead is underallocated by $6,615. 8- 8-27 (15 min.) Identifying favorable and unfavorable variances. FOH ProductionVolume Variance Favorable: output is more than budgeted causing FOH costs to be overallocated VOH Spending Variance Cannot be determined: no information on actual versus budgeted VOH rates VOH Efficiency Variance Cannot be determined: no information on actual versus flexiblebudget machine-hours FOH Spending Variance Unfavorable: actual fixed costs are more than budgeted fixed costs Production output is 10% more than budgeted; actual machine hours are 5% less than budgeted Cannot be determined: no information on actual versus budgeted VOH rates Favorable: actual machine-hours less than flexiblebudget machine-hours Cannot be determined: no information on actual versus budgeted FOH costs Favorable: output is more than budgeted causing FOH costs to be overallocated Production output is 8% less than budgeted Cannot be determined: no information on actual versus budgeted VOH rates Cannot be determined: no information on actual versus budgeted FOH costs Unfavorable: output less than budgeted will cause FOH costs to be underallocate d Actual machine hours are 15% greater than flexible-budget machine hours Cannot be determined: no information on actual versus budgeted VOH rates Cannot be determined: no information on actual machine-hours versus flexiblebudget machine-hours Unfavorable: more machinehours used relative to flexible budget Cannot be determined: no information on actual versus budgeted FOH costs Relative to the flexible budget, actual machine hours are 10% greater and actual variable manufacturing o Unfavorable: actual VOH rate greater than budgeted VOH rate Unfavorable: actual machine-hours greater than flexiblebudget machine-hours Cannot be determined: no information on actual versus budgeted FO Cannot be determined: no information on flexiblebudget machine-hours relative to static-budget machine-hours Cannot be determined: no information on actual output relative to b Scenario Production output is 5% more than budgeted, and actual fixed manufacturing overhead costs are 6% more than budgeted 8- verhead costs are 15% greater H costs 8- udgeted output 8-28 (35 min.) Flexible-budget variances, review of Chapters 7 and 8. 1. Solution Exhibit 8-28 contains a columnar presentation of the variances for Doorknob Design Company (DDC) for April 2009. SOLUTION EXHIBIT 8-28 Direct Materials Actual Costs Incurred: Actual Input Qty. × Actual Rate (50,000 $22.0) $1,100,000 Actual Input Qty. Budgeted Price Purchases Usage (50,000 $20.0) (45,000 $20.0) $1,000,000 $900,000 $100,000 U $50,000 F a. Price variance Direct Manufacturing Labor Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Price (47,500 $20.0) $950,000 b. Efficiency variance (20,000 $30.0) $600,000 $650,000 (23,750 $30.0) $712,500 $50,000 U $112,500 F c. Price variance d. Efficiency variance Actual Costs Incurred Variable Manufacturing Overhead Actual Input Qty. Budgeted Rate Flexible Budget: Budgeted Input Qty. Allowed for Actual Output Budgeted Rate $400,000 (45,000 $10.0) $450,000 (47,500 $10.0) $475,000 $50,000 F $350,000 (47,500 $10.0) $475,000 $25,000 F e. Spending variance Fixed Manufacturing Overhead Allocated: (Budgeted Input Qty. Allowed for Actual Output Budgeted Rate) f. Efficiency variance $250,000* (47,500 $5.0) $237,500 $250,000 $100,000 U h. Spending variance Never a variance $12,500 U Never a variance *Denominator level in hours: 100,000 x .5 = 50,000 hours Budgeted Fixed Overhead: 50,000 x $5/hr = $250,000 8- g. Production volume variance 2. The direct materials price variance indicates that DDC paid more for brass than they had planned. If this is because they purchased a higher quality of brass, it may explain why they used less brass than expected (leading to a favorable material efficiency variance). In turn, since variable manufacturing overhead is assigned based on pounds of materials used, this directly led to the favorable variable overhead efficiency variance. The purchase of a better quality of brass may also explain why it took less labor time to produce the doorknobs than expected (the favorable direct labor efficiency variance). Finally, the unfavorable direct labor price variance could imply that the workers who were hired were more experienced than expected, which could also be related to the positive direct material and direct labor efficiency variances. 8-29 (30 min.) Comprehensive variance analysis. 1. Budgeted number of machine-hours planned can be calculated by multiplying the number of units planned (budgeted) by the number of machine-hours allocated per unit: 888 units 2 machine-hours per unit = 1,776 machine-hours. 2. Budgeted fixed MOH costs per machine-hour can be computed by dividing the flexible budget amount for fixed MOH (which is the same as the static budget) by the number of machine-hours planned (calculated in (a.)): $348,096 ÷ 1,776 machine-hours = $196.00 per machine-hour 3. Budgeted variable MOH costs per machine-hour are calculated as budgeted variable MOH costs divided by the budgeted number of machine-hours planned: $71,040 ÷ 1,776 machine-hours = $40.00 per machine-hour. 4. Budgeted number of machine-hours allowed for actual output achieved can be calculated by dividing the flexible-budget amount for variable MOH by budgeted variable MOH costs per machine-hour: $76,800 ÷ $40.00 per machine-hour= 1,920 machine-hours allowed 5. The actual number of output units is the budgeted number of machine-hours allowed for actual output achieved divided by the planned allocation rate of machine hours per unit: 1,920 machine-hours ÷ 2 machine-hours per unit = 960 units. 6. The actual number of machine-hours used per output unit is the actual number of machine hours used (given) divided by the actual number of units manufactured: 1,824 machine-hours ÷ 960 units = 1.9 machine-hours used per output unit. 8- 8-30 (60 min.) Journal entries (continuation of 8-29). 1. Key information underlying the computation of variances is: Actual Flexible-Budget Results Amount 1. Output units (food processors) 960 960 2. Machine-hours 1,824 1,920 3. Machine-hours per output unit 1.90 2.00 Static-Budget Amount 888 1,776 2.00 4. Variable MOH costs 5. Variable MOH costs per machinehour (Row 4 ÷ Row 2) 6. Variable MOH costs per unit (Row 4 ÷ Row 1) $76,608 $76,800 $71,040 $42.00 $40.00 $40.00 $79.80 $80.00 $80.00 7. Fixed MOH costs 8. Fixed MOH costs per machinehour (Row 7 ÷ Row 2) 9. Fixed MOH costs per unit (7 ÷ 1) $350,208 $348,096 $348,096 $192.00 $364.80 $181.30 $362.60 $196.00 $392.00 Solution Exhibit 8-30 shows the computation of the variances. Journal entries for variable MOH, year ended December 31, 2010: Variable MOH Control Accounts Payable Control and Other Accounts 76,608 Work-in-Process Control Variable MOH Allocated 76,800 Variable MOH Allocated Variable MOH Spending Variance Variable MOH Control Variable MOH Efficiency Variance 76,800 3,648 76,608 76,800 76,608 3,840 Journal entries for fixed MOH, year ended December 31, 2010: Fixed MOH Control Wages Payable, Accumulated Depreciation, etc. 350,208 Work-in-Process Control Fixed MOH Allocated 376,320 Fixed MOH Allocated Fixed MOH Spending Variance Fixed MOH Control Fixed MOH Production-Volume Variance 376,320 2,112 350,208 376,320 8- 350,208 28,224 2. Adjustment of COGS Variable MOH Efficiency Variance Fixed MOH Production-Volume Variance Variable MOH Spending Variance Fixed MOH Spending Variance Cost of Goods Sold 3,840 28,224 3,648 2,112 26,304 SOLUTION EXHIBIT 8-30 Variable Manufacturing Overhead Actual Costs Incurred (1) (1,824 $42) $76,608 Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (1,920 $40) $76,800 Actual Input Qty. × Budgeted Rate (2) (1,824 $40) $72,960 $3,648 U Spending variance $3,840 F Efficiency variance Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (1,920 $40) $76,800 Never a variance Fixed Manufacturing Overhead Actual Costs Incurred (1) Same Budgeted Lump Sum (as in Static Budget) Regardless Of Output Level (2) Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) $350,208 $348,096 $348,096 $2,112U Spending variance Never a variance 8- Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (1,920 × $196) $376,320 $28,224 F Production-volume variance 8-31 1. (3040 min.) Graphs and overhead variances. Variable Manufacturing Overhead Costs Total Variable Manuf. Overhead Costs Graph for planning and control and inventory costing purposes at $9 per machine-hour $18,000,000 $9,000,000 1,000,000 Machine-Hours Fixed Manufacturing Overhead Costs Total Fixed Manuf. Overhead Costs Graph for planning and control purpose Graph for inventory costing purpose ($18 per machine-hour) $18,000,000 $9,000,000 1,000,000 Machine-Hours * Budgeted fixed manufacturing overhead rate per hour = Budgeted fixed manufacturing overhead Denominator level = $18,000,000/ 1,000,000 machine hours = $18 per machine-hour 8- 2. (a) Variable Manufacturing Overhead Variance Analysis for Fresh, Inc. for 2009 Actual Costs Incurred (1) $9,025,000 Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (875,000 $9) $7,875,000 Actual Input Qty. × Budgeted Rate (2) (950,000 $9) $8,550,000 $475,000 U Spending variance $675,000 U Efficiency variance Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (875,000 $9) $7,875,000 Never a variance $1,150,000 U Flexible-budget variance Never a variance $1,150000 U Underallocated variable overhead (Total variable overhead variance) (b) Fixed Manufacturing Overhead Variance Analysis for Fresh, Inc. for 2009 Actual Costs Incurred (1) Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) $18,050,000 $18,000,000 $18,000,000 $50,000 U Spending variance Never a variance $50,000 U Flexible-budget variance Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (875,000 × $18) $15,750,000 $2,250,000 U* Production-volume variance $2,250,000 U* Production-volume variance $2,300,000 U Underallocated fixed overhead (Total fixed overhead variance) *Alternative computation: 1,000,000 denominator hrs. – 875,000 budgeted hrs. allowed = 125,000 hrs. 125,000 $18 = $2,250,000 U 8- 3. The underallocated manufacturing overhead was: variable, $1,150,000 and fixed, $2,300,000. The flexible-budget variance and underallocated overhead are always the same amount for variable manufacturing overhead, because the flexible-budget amount of variable manufacturing overhead and the allocated amount of variable manufacturing overhead coincide. In contrast, the budgeted and allocated amounts for fixed manufacturing overhead only coincide when the budgeted input of the allocation base for the actual output level achieved exactly equals the denominator level. 4. The choice of the denominator level will affect inventory costs. The new fixed manufacturing overhead rate would be $18,000,000 ÷ 750,000 = $24 per machine-hour. In turn, the allocated amount of fixed manufacturing overhead and the production-volume variance would change as seen below: Actual Budget $18,050,000 $18,000,000 Allocated 875,000 × $24 = $21,000,000 $50,000 U $3,000,000 F* Flexible-budget variance Prodn. volume variance $2,950,000 F Total fixed overhead variance *Alternate computation: (750,000 – 875,000) × $24 = $3,000,000 F The major point of this requirement is that inventory costs (and, hence, income determination) can be heavily affected by the choice of the denominator level used for setting the fixed manufacturing overhead rate. 8- 8-32 (30 min.) 4-variance analysis, find the unknowns. Known figures denoted by an * Actual Costs Incurred Case A: Variable Manufacturing Overhead $15,000* Actual Input Qty. Qty. × Budgeted Rate (1,325 × $15) $19,875 $4,875* F Spending variance Fixed Manufacturing Overhead $26,500* Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (1,250* × $15) $18,750* (1,250* × $15) $18,750* $1,125 U Efficiency variance (Lump sum) $25,000* $1,500 U Spending variance Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate Never a variance (Lump sum) $25,000* Never a variance a (1,250 × $20 ) $25,000* $0 Production-volume variance Total budgeted manufacturing overhead = $18,750 + $25,000 = $43,750 Case B: Variable Manufacturing Overhead $13,813 (1,625 $8.50*) $13,813 (1,625* $8.50*) (1,625* $8.50*) $13,813 $13,813 $0* $0 Spending variance Efficiency variance Fixed Manufacturing Overhead $16,750 (Lump sum) b $17,500 $750 F* Spending variance Never a variance (Lump sum) b $17,500 Never a variance (1,625* $10) $16,250 $1,250 U* Production-volume variance Denominator level = Budgeted FMOH costs ÷ Budgeted FMOH rate = $17,500 ÷ $10 = 1,750 hours 8- Actual Costs Incurred Case C: Variable Manufacturing Overhead Actual Input Qty. Qty. × Budgeted Rate (2,925 $5.00*) $14,625 $15,500 Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (2,875 $5.00*) (2,875 $5.00*) c c $14,375 $14,375 $875 U* $250 U* Spending variance Efficiency variance Fixed Manufacturing Overhead $30,000* $27,500* $2,500 U Spending variance Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate Never a variance d $27,500* Never a variance $28,750 $1,250 F* Production-volume variance Total budgeted manufacturing overhead = $14,375 + $27,500 = $41,875 aBudgeted b FMOH rate = Budgeted FMOH costs ÷ Denominator level = $25,000 ÷ 1,250 = $20 Budgeted Budgeted Budgeted = + fixed manuf. overhead variable manuf. overhead total overhead $31,313* = BFMOH + (1,625 $8.50) BFMOH = $17,500 c Budgeted hours allowed for actual output achieved must be derived from the output level variance before this figure can be derived, or, since the fixed manufacturing overhead rate is $27,500 ÷ 2,750 = $10, and the allocated amount is $28,750, the budgeted hours allowed for the actual output achieved must be 2,875 ($28,750 $10). d 2,875 ($27,500* ÷ 2,750*) = $28,750 8- 8-33 (1525 min.) Flexible budgets, 4-variance analysis. Budgeted hours allowed per unit of output = Budgeted DLH Budgeted actual output = 1. 3,600,000 = 5 hours per unit 720,000 Budgeted DLH allowed for May output = 66,000 units 5 hrs./unit = 330,000 hrs. Allocated total MOH = 330,000 Total MOH rate per hour = 330,000 $1.20 = $396,000 2, 3, 4, 5. See Solution Exhibit 8-33 Variable manuf. overhead rate per DLH = $0.25 + $0.34 = $0.59 Fixed manuf. overhead rate per DLH = $0.18 + $0.15 + $0.28 = $0.61 Fixed manuf. overhead budget for May = ($648,000 + $540,000 + $1,008,000) ÷ 12 = $2,196,000 ÷ 12 = $183,000 or, Fixed manuf. overhead budget for May = $54,000 + $45,000 + $84,000 = $183,000 Using the format of Exhibit 8-5 for variable manufacturing overhead and then fixed manufacturing overhead: Actual variable manuf. overhead: $75,000 + $111,000 = $186,000 Actual fixed manuf. overhead: $51,000 + $54,000 + $84,000 = $189,000 An overview of the 4-variance analysis using the block format of the text is: 4-Variance Analysis Variable Manufacturing Overhead Fixed Manufacturing Overhead $6,000 U 8- Never a variance Never a variance $150 U Efficiency Variance $8,850 F Spending Variance ProductionVolume Variance $18,300 F SOLUTION EXHIBIT 8-33 Variable Manufacturing Overhead Actual Costs Incurred (1) $186,000 Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (330,000 $0.59) $194,700 Actual Input Qty. × Budgeted Rate (2) (315,000 $0.59) $185,850 $150 U Spending variance $8,850 F Efficiency variance Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (330,000 $0.59) $194,700 Never a variance Fixed Manufacturing Overhead Actual Costs Incurred (1) Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) $189,000 $183,000 $183,000 $6,000 U Spending variance Never a variance $18,300 F Production-volume variance Alternate computation of the production volume variance: = 错误!未指定开关参数。 错误!未指定开关参数。 3, 600, 000 = 330,000 × $ 0.61 12 = (330,000 – 300,000) × $0.61 = $18,300 F 8- Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (330,000 $0.61) $201,300 8-34 (20 min.) Variances 1. Direct Manufacturing Labor and Variable Manufacturing Overhead Direct Manufacturing Labor variance analysis for Sarah Beth’s Art Supply Company Actual Input Qty. Budgeted Rate Actual Costs Incurred 13,000 × 0.75 × 20.2 $196,950 13,000 × 0.75 × 20 $195,000 $1,950 U Price variance 2. Flexible Budget: Budgeted Input Qty. Allowed for Actual Output Budgeted Price 13,000 × 0.5 × 20.0 $130,000 $65,000 U Efficiency variance Variable Manufacturing Overhead variance analysis for Sarah Beth’s Art Supply Company Actual Input Qty. Budgeted Rate Actual Costs Incurred 13,000 × 0.75 × 9.75 $95,062.5 13,000 × 0.75 × 10.0 $97,500 $2,437.5 F Spending variance Flexible Budget: Budgeted Input Qty. Allowed for Actual Output Budgeted Rate 13,000 × 0.5 × 10.0 $65,000 $32,500 U Efficiency variance 3. The favorable spending variance for variable manufacturing overhead suggests that less costly items were used, which could have a negative impact on labor efficiency. But note that the workers were paid a higher rate than budgeted, which, if it indicates the hiring of more qualified employees, should lead to favorable labor efficiency variances. Moreover, the price variance and the spending variance are both very small, approximately 1% and 2.5% respectively, while the efficiency variances are very large, each equaling 50% of expected costs. It is clear therefore that the efficiency variances are related to factors other than the cost of the labor or overhead. 4. If the variable overhead consisted only of costs that were related to direct manufacturing labor, then Sarah is correct - both the labor efficiency variance and the variable overhead efficiency variance would reflect real cost overruns due to the inefficient use of labor. However, a portion of variable overhead may be a function of factors other than direct labor (e.g., the costs of energy or the usage of indirect materials). In this case, allocating variable overhead using direct labor as the only base will inflate the effect of inefficient labor usage on the variable overhead efficiency variance. The real effect on firm profitability will be lower, and will likely be captured in a favorable spending variance for variable overhead. 8- 8-35 1. (30 min.) Causes of Indirect Variances Variable Overhead Variance Analysis for Heather’s Horse Spa for August 2009 Actual Variable Overhead $7,500 Actual input x Budgeted rate (950 × 38 × $0.2) $7,220 $280 U Spending variance 2. Budgeted input allowed for Actual output x Budgeted rate (900 × 38 × $0.2) $6,840 $380 U Efficiency variance Fixed Overhead Variance Analysis for Heather’s Horse Spa for August 2009 Actual Fixed Overhead $50,000 Static Budget Fixed Overhead (900 x 40 x $1.5) $54,000 $4,000 F Spending variance Budgeted input allowed for Actual output x Budgeted Rate (900 × 38 × $1.5) 51,300 $2,700 U Production-volume variance 3. The variable overhead spending variance arises from the fact that the cost of horse feed, shampoo, ribbons and other supplies was higher, per weighted average horse-guest week, than expected ($7,500/(950×38)lbs = $0.208 per lb > $0.2 per lb). Unlike the material and labor price variances, which only reflect the prices paid, the spending variance could have both a cost and usage component. HHS would have a negative spending variance if they paid more for feed than expected or if the horses ate more feed than expected. 4. The $380 unfavorable variable overhead efficiency variance reflects the fact that the average weight of a horse was higher than expected. HHS expected horses to weigh an average of 900 lbs but during August, the horses weighed an average of 950 lbs. Larger horses are expected to consume more variable overhead, such as horse feed and shampoo, hence the unfavorable nature of the variance. 5. Fixed overhead is fixed with respect to horse weight. This does not mean that it can be forecasted with 100% accuracy. For example, salaries or actual costs for advertising may have been higher than expected, leading to the $4,000 unfavorable variance. 6. The production-volume variance of $2,700 exists because the fixed overhead rate was based on the forecasted number of horse guest-weeks, 40, while the fixed overhead was applied using the actual number of horse guest-weeks, 38. The overestimation of the number of horse guests in August would lead to an under-absorption of fixed overhead, resulting in the unfavorable production-volume variance. If the estimate was too far off from the actual number of horses, HHS might potentially not charge enough to cover their costs. 8- 8-36 (20 min.) Activity-based costing, batch-level variance analysis 1. Static budget number of crates = Budgeted pairs shipped / Budgeted pairs per crate = 240,000/12 = 20,000 crates 2. Flexible budget number of crates = Actual pairs shipped / Budgeted pairs per crate = 180,000/12 = 15,000 crates 3. Actual number of crates shipped = Actual pairs shipped / Actual pairs per box = 180,000/10 = 18,000 crates 4. Static budget number of hours = Static budget number of crates × budgeted hours per box = 20,000 × 1.2 = 24,000 hours Fixed overhead rate = Static budget fixed overhead / static budget number of hours = 60,000/24,000 = $2.50 per hour 5. Variable Overhead Variance Analysis for Rica’s Fleet Feet Inc. for 2008 Actual Variable Overhead (18,000 × 1.1 × $21) $415,800 Actual hours x Budgeted rate (18,000 × 1.1 × $20) $396,000 $19,800 U Spending variance 6. Budgeted hours allowed for Actual output x Budgeted rate (15,000 × 1.2 × $20) $360,000 $36,000 U Efficiency variance Fixed Overhead Variance Analysis for Rica’s Fleet Feet Inc. for 2008 Actual Fixed Overhead Static Budget Fixed Overhead $55,000 $60,000 $5,000 F Spending variance 8- Budgeted hours allowed for Actual output × Budgeted Rate (15,000 × 1.2 ×$2.5) $45,000 $15,000 U Production volume variance 8-37 (30 min.) Activity-based costing, batch-level variance analysis 1. Static budget number of setups = Budgeted books produced/ Budgeted books per setup = 200,000 ÷ 500 = 400 setups 2. Flexible budget number of setups = Actual books produced / Budgeted books per setup = 216,000 ÷ 500 = 432 setups 3. Actual number of setups = Actual books produced / Actual books per setup = 216,000/480 = 450 setups 4. Static budget number of hours = Static budget # of setups × Budgeted hours per setup = 400 × 6 = 2,400 hours Fixed overhead rate = Static budget fixed overhead / Static budget number of hours = 72,000/2,400 = $30 per hour 5. Budgeted variable overhead cost of a setup = Budgeted variable cost per setup-hour × Budgeted number of setup-hours = $100 × 6 = $600. Budgeted total overhead cost of a setup = Budgeted variable overhead cost + Fixed overhead rate ? Budgeted number of setup-hours = $600 + $30 × 6 = 780. So, the charge of $700 covers the budgeted incremental (i.e., variable overhead) cost of a setup, but not the budgeted full cost. 6. Variable Setup Overhead Variance Analysis for Jo Nathan Publishing Company for 2009 Actual Variable Overhead (450 × 6.5 × $90) $263,250 Actual hours x Budgeted rate (450 × 6.5 × $100) $292,500 $29,250F Spending variance Standard hours x Standard rate (432 × 6.0 × $100) $259,200 $33,300U Efficiency variance 8- 7. Fixed Setup Overhead Variance Analysis for Jo Nathan Publishing Company for 2009 Actual Fixed Overhead $79,000 Static Budget Fixed Overhead $72,000 $7,000 U Spending variance Standard hours x Budgeted Rate (432 × 6.0 × $30) $77,760 $5,760 F Production-volume variance 8. Rejecting an order may have implications for future orders (i.e., professors would be reluctant to order books from this publisher again). Jo Nathan should consider factors such as prior history with the customer and potential future sales. next If a book is relatively new, Jo Nathan might consider running a full batch and holding the extra books in case of a second special order or just hold the extra books until semester. If the special order comes at heavy volume times, Jo should look at the opportunity cost of filling it, i.e., accepting the order may interfere with or delay the printing of other books. 8- 8-38 (35 min.) Production-Volume Variance Analysis and Sales Volume Variance. 1. and 2. Fixed Overhead Variance Analysis for Dawn Floral Creations, Inc. for February Actual Fixed Overhead Static Budget Fixed Overhead $9,200 $9,000 $200 U Spending variance Standard Hours × Budgeted Rate (600 × 1.5 × $6*) $5,400 $3,600 U Production-volume variance * fixed overhead rate = (budgeted fixed overhead)/(budgeted DL hours at capacity) = $9,000/(1000 x 1.5 hours) = $9,000/1,500 hours = $6/hour 3. An unfavorable production-volume variance measures the cost of unused capacity. Production at capacity would result in a production-volume variance of 0 since the fixed overhead rate is based upon expected hours at capacity production. However, the existence of an unfavorable volume variance does not necessarily imply that management is doing a poor job or incurring unnecessary costs. Using the suggestions in the problem, two reasons can be identified. a. For most products, demand varies from month to month while commitment to the factors that determine capacity, e.g. size of workshop or supervisory staff, tends to remain relatively constant. If Dawn wants to meet demand in high demand months, it will have excess capacity in low demand months. In addition, forecasts of future demand contain uncertainty due to unknown future factors. Having some excess capacity would allow Dawn to produce enough to cover peak demand as well as slack to deal with unexpected demand surges in non-peak months. b. Basic economics provides a demand curve that shows a tradeoff between price charged and quantity demanded. Potentially, Dawn could have a lower net revenue if they produce at capacity and sell at a lower price than if they sell at a higher price at some level below capacity. In addition, the unfavorable production-volume variance may not represent a feasible cost savings associated with lower capacity. Even if Dawn could shift to lower fixed costs by lowering capacity, the fixed cost may behave as a step function. If so, fixed costs would decrease in fixed amounts associated with a range of production capacity, not a specific production volume. The production-volume variance would only accurately identify potential cost savings if the fixed cost function is continuous, not discrete. 8- 4. The static-budget operating income for February is: Revenues $55 × 1,000 Variable costs $25 × 1,000 Fixed overhead costs Static-budget operating income $55,000 25,000 9,000 $ 21,000 The flexible-budget operating income for February is: Revenues $55 × 600 Variable costs $25 × 600 Fixed overhead costs Flexible-budget operating income $33,000 15,000 9,000 $ 9,000 The sales-volume variance represents the difference between the static-budget operating income and the flexible-budget operating income: Static-budget operating income Flexible-budget operating income Sales-volume variance $21,000 9,000 $12,000 U Equivalently, the sales-volume variance captures the fact that when Dawn sells 600 units instead of the budgeted 1,000, only the revenue and the variable costs are affected. Fixed costs remain unchanged. Therefore, the shortfall in profit is equal to the budgeted contribution margin per unit times the shortfall in output relative to budget. Sales-volume = variance Budgeted Budgeted – variable cost selling price per unit × Difference in quantity of units sold relative to the static budget = ($55 – $25) × 400 = $30 × 400 = $12,000 U In contrast, we computed in requirement 2 that the production-volume variance was $3,600U. This captures only the portion of the budgeted fixed overhead expected to be unabsorbed because of the 400-unit shortfall. To compare it to the sales-volume variance, consider the following: Budgeted selling price Budgeted variable cost per unit Budgeted fixed cost per unit ($9,000 ÷ 1,000) Budgeted cost per unit Budgeted profit per unit Operating income based on budgeted profit per unit $21 per unit × 600 units 8- $55 $25 9 34 $ 21 $12,600 The $3,600 U production-volume variance explains the difference between operating income based on the budgeted profit per unit and the flexible-budget operating income: Operating income based on budgeted profit per unit Production-volume variance Flexible-budget operating income $12,600 3,600 U $ 9,000 Since the sales-volume variance represents the difference between the static- and flexible-budget operating incomes, the difference between the sales-volume and production-volume variances, which is referred to as the operating-income volume variance is: Operating-income volume variance = Sales-volume variance – Production-volume variance = Static-budget operating income - Operating income based on budgeted profit per unit = $21,000 U – $12,600 U = $8,400 U. The operating-income volume variance explains the difference between the static-budget operating income and the budgeted operating income for the units actually sold. The staticbudget operating income is $21,000 and the budgeted operating income for 600 units would have been $12,600 ($21 operating income per unit 600 units). The difference, $8,400 U, is the operating-income volume variance, i.e., the 400 unit drop in actual volume relative to budgeted volume would have caused an expected drop of $8,400 in operating income, at the budgeted operating income of $21 per unit. The operating-income volume variance assumes that $50,000 in fixed cost ($9 per unit 400 units) would be saved if production and sales volumes decreased by 400 units. 8- 8-39 (3040 min.) Comprehensive review of Chapters 7 and 8, working backward from given variances. 1. Solution Exhibit 8-39 outlines the Chapter 7 and 8 framework underlying this solution. a. Pounds of direct materials purchased = $176,000 ÷ $1.10 = 160,000 pounds b. Pounds of excess direct materials used = $69,000 ÷ $11.50 = 6,000 pounds c. Variable manufacturing overhead spending variance = $10,350 – $18,000 = $7,650 F d. Standard direct manufacturing labor rate = $800,000 ÷ 40,000 hours = $20 per hour Actual direct manufacturing labor rate = $20 + $0.50 = $20.50 Actual direct manufacturing labor-hours = $522,750 ÷ $20.50 = 25,500 hours e. Standard variable manufacturing overhead rate = $480,000 ÷ 40,000 = $12 per direct manuf. labor-hour Variable manuf. overhead efficiency variance of $18,000 ÷ $12 = 1,500 excess hours Actual hours – Excess hours = Standard hours allowed for units produced 25,500 – 1,500 = 24,000 hours f. Budgeted fixed manufacturing overhead rate = $640,000 ÷ 40,000 hours = $16 per direct manuf. labor-hour Fixed manufacturing overhead allocated = $16 24,000 hours = $384,000 Production-volume variance = $640,000 – $384,000 = $256,000 U 2. The control of variable manufacturing overhead requires the identification of the cost drivers for such items as energy, supplies, and repairs. Control often entails monitoring nonfinancial measures that affect each cost item, one by one. Examples are kilowatts used, quantities of lubricants used, and repair parts and hours used. The most convincing way to discover why overhead performance did not agree with a budget is to investigate possible causes, line item by line item. Individual fixed overhead items are not usually affected very much by day-to-day control. Instead, they are controlled periodically through planning decisions and budgeting procedures that may sometimes have planning horizons covering six months or a year (for example, management salaries) and sometimes covering many years (for example, long-term leases and depreciation on plant and equipment). SOLUTION EXHIBIT 8-39 8- Direct Materials Direct Manuf. Labor Flexible Budget: Budgeted Input Qty. Allowed for Actual Input Qty. Actual Output Budgeted Rate Budgeted Rate Purchases Usage 160,000 $11.50 96,000 $11.50 3 30,000 $11.50 $1,840,000 $1,104,000 $1,035,000 $69,000 U $176,000 F Efficiency variance Price variance Actual Costs Incurred (Actual Input Qty. Actual Rate) 160,000 $10.40 $1,664,000 0.85 30,000 $20.50 $522,750 0.85 30,000 $20 $510,000 $12,750 U Price variance 0.80 30,000 $20 $480,000 $30,000 U Efficiency variance $42,750 U Flexible-budget variance Variable MOH Actual Costs Incurred Actual Input Qty. Actual Rate 0.85 30,000 $11.70 $298,350 Actual Input Qty. Budgeted Rate 0.85 30,000 $12 $306,000 Flexible Budget: Budgeted Input Qty. Allowed for Actual Output Budgeted Rate 0.80 30,000 $12 $288,000 $7,650 F Spending variance $18,000 U Efficiency $10,350 U variance Flexible-budget variance Actual Costs Incurred (1) Fixed MOH $597,460 Never a variance Never a variance Flexible Budget: Same Budgeted Same Budgeted Lump Sum Lump Sum (as in Static Budget) (as in Static Budget) Regardless of Regardless of Output Level Output Level (2) (3) 0.80 × 50,000 × $16 $640,000 $640,000 $42,540 F Spending variance volume variance Never a variance $42,540 F Flexible-budget variance 8- Allocated: Budgeted Input Qty. Allowed for Actual Output Budgeted Rate 0.80 30,000 $12 $288,000 Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) 0.80 x 30,000 × $16 $384,000 $256,000 U $256,000 U Production volume variance 8-40 1. (3050 min.) Review of Chapters 7 and 8, 3-variance analysis. Total standard production costs are based on 7,800 units of output. Direct materials, 7,800 $15.00 7,800 3 lbs. $5.00 (or 23,400 lbs. $5.00) Direct manufacturing labor, 7,800 $75.00 7,800 5 hrs. $15.00 (or 39,000 hrs. $15.00) Manufacturing overhead: Variable, 7,800 $30.00 (or 39,000 hrs. $6.00) Fixed, 7,800 $40.00 (or 39,000 hrs. $8.00) Total The following is for later use: Fixed manufacturing overhead, a lump-sum budget *Fixed manufacturing overhead rate = $8.00 = $ 117,000 585,000 234,000 312,000 $1,248,000 $320,000* Budgeted fixed manufacturing overhead Denominator level Budget 40,000 hours Budget = 40,000 hours $8.00 = $320000 2. Solution Exhibit 8-40 presents a columnar presentation of the variances. An overview of the 3-variance analysis using the block format of the text is: 3-Variance Analysis Total Manufacturing Overhead Spending Variance Efficiency Variance Production Volume Variance $39,400 U $6,600 U $8,000 U 8- SOLUTION EXHIBIT 8-40 Flexible Budget: Actual Costs Budgeted Input Qty. Incurred: Actual Input Qty. Allowed for Actual Input Qty. Budgeted Price Actual Output × Actual Rate Purchases Usage × Budgeted Price Direct (25,000 $5.20) (25,000 $5.00) (23,100 $5.00) (23,400 $5.00) Materials $130,000 $125,000 $115,500 $117,000 $5,000 U $1,500 F a. Price variance Direct Manuf. Labor (40,100 $14.60) $585,460 b. Efficiency variance (40,100 $15.00) $601,500 $16,040 F c. Price variance (39,000 $15.00) $585,000 $16,500 U d. Efficiency variance Actual Costs Incurred Variable Manuf. Overhead Actual Input Qty. Budgeted Rate Flexible Budget: Budgeted Input Qty. Allowed for Actual Output Budgeted Rate (not given) (40,100 $6.00) $240,600 (39,000 $6.00) $234,000 $6,600 U Efficiency variance Fixed Manuf. Overhead (not given) $320,000 Total Manuf. Overhead (given) $600,000 ($240,600 + $320,000) $560,600 $39,400 U e. Spending variance *Denominator level in hours 40,000 Production volume in standard hours allowed 39,000 Production-volume variance 1,000 hours x $8.00 = $8,000 U 8- (39,000 $8.00) $312,000 $8,000 U* Prodn. volume variance ($234,000 + $320,000) $554,000 $6,600 U f. Efficiency variance (39,000 $6.00) $234,000 Never a variance $320,000 Never a variance Allocated: (Budgeted Input Qty. Allowed for Actual Output Budgeted Rate) ($234,000 + $312,000) $546,000 $8,000 U g. Prodn. volume variance 8-41 (20 minutes) Non-financial variances 1. Variance Analysis of Inspection Hours for Daisy Canine Products for May Actual Pounds Actual Hours For Inspections Inspected/Budgeted for Actual Output /Budgeted Pounds per hour Pounds per hour 200,000lbs/1,000 lbs per hour (2,250,000 x .1)/1,000 lbs per hour 200 hours 225 hours 210 hours 10 hours U 25 hours F Efficiency Variance 2. Standard Pounds Inspected Quantity Variance Variance Analysis of Pounds Failing Inspection for Daisy Canine Products for May Actual pounds Actual Pounds Failing Inspections 3,500 lbs Standard Pounds Inspected Inspected x Budgeted Inspection Failure Rate (200,000lbs x .02) 4,000 lbs 500 lbs F for Actual Output x Budgeted Inspection Failure Rate (2,250,000 x .1 x .02) 4,500 lbs 500 lbs F Efficiency Variance Quantity Variance 8- 8-42 (20 minutes) Non-financial performance measures 1. The cost of the ball bearings would be indirect materials if it is either not possible to trace the costs to individual products, or if the cost is so small relative to other costs that it is impractical to do so. Since Department B makes a fairly constant number of finished products (400 units) each day, it would be easy to trace the cost of bearings to the wheels completed daily. However, the fact that Rollie measures ball bearings by weight and discards leftover bearings at the end of each day suggests that they are a relatively inexpensive item and not worth the effort to restock or track in inventory. As such, it could be argued that ball bearings should be classified as overhead (e.g., indirect materials). 2. of Non-financial performance measures for Department B might include: Number or proportion of wheels sent back for rework and/or amount or proportion time spent on rework; Number of wheels thrown away, ratio of wheels thrown away to wheels reworked, and/or ratio of bad to good wheels; Amount of down time for broken machines during the day; Weight of ball bearings discarded, or ratio of weights used and discarded. 3. If the number of wheels thrown away is significant relative to the number of reworked wheels, then it is not efficient to rework them and so Rollie should re-examine the rework process or even just throw away all the bad wheels without rework. If the amount of rework is significant then the original process is not turning out quality goods in a timely manner. Rollie might slow down the process in Department B so it takes a little longer to make each good wheel, but the number of good wheels will be higher and may even save time overall if rework time drops considerably. They might also need to service the machines more often than just after the total daily production run, in which case they will trade off intentional down time for more efficient processing. If the amount of unintentional down time is significant they might bring in the mechanics during the day to fix a machine that goes down during a production run. Finally, Rollie might consider determining a better measure of ball bearings to requisition each day so that fewer are discarded, and might also keep any leftover ball bearings for use the next day. 8- Collaborative Learning Problem 8-43 1. (45 min.) Overhead variances, ethics. a. Total budgeted overhead Budgeted variable overhead ($10 budgeted rate per machine-hour × 2,500,000 budgeted machine-hours) Budgeted fixed overhead Budgeted fixed OH rate b. $31,250,000 25,000,000 $ 6,250,000 $6,250,000 budgeted amount = $2.50 per machine-hour 2,500,000 budgeted machine-hours Fixed overhead spending variance = Actual costs incurred – Budgeted amount. Because fixed overhead spending variance is unfavorable, the amount of actual costs is higher than the budgeted amount. Actual cost = $6,250,000 + $1,500,000 = $7,750,000 c. Production-volume variance = Budgeted fixed overhead = = = – Fixed overhead allocated using budgeted input allowed for actual output units produced $6,250,000 – ($2.50 per machine-hour × 2 machine-hours per unit* × 1,245,000 units) $6,250,000 – $6,225,000 $25,000 U * Budgeted variable overhead per unit = $20 Budgeted variable overhead rate = $10 per machine-hour Therefore, budgeted machine hours allowed per unit = $20/$10 = 2 machine-hours 2. Variable overhead spending variance: Actual variable Budgeted variable overhead cost – overhead cost per unit of cost per unit of allocation base cost-allocation base Actual quantity of variable overhead × cost-allocation base used for actual output $25,200,000 budget amount $10 per machine-hour 2, 400, 000 machine-hours 2,400,000 actual machine-hours = ($10.50 – $10) × 2,400,000 = $1,200,000 U 8- Variable overhead efficiency variance: Actual units of variable overhead cost-allocation base used for actual output = = = – Budgeted units of variable overhead cost-allocation base allowed for actual output Budgeted variable × overhead rate (2,400,000 – (2 × 1,245,000)) × $10 (2,400,000 – 2,490,000) × $10 $900,000 F 3. By manipulating, Remich has created a sizable unfavorable fixed overhead spending variance or, at least, has increased its magnitude. Jack Remich’s action is clearly unethical. Variances draw attention to the areas that need management attention. If the top management relies on Remich, due to his expertise, to interpret and explain the reasons for the unfavorable variance, it is likely that his report will be biased and misleading to the top management. The top management may erroneously conclude that Monroe is not able to manage his fixed overhead costs effectively. Another probable adverse outcome of Remich’s actions will be that Monroe will have even less confidence in the usefulness of accounting reports. This, of course, defeats the purpose of preparing the reports. In summary, Remich’s unethical actions will waste top management’s time and may lead to wrong decisions. 8- CHAPTER 9 INVENTORY COSTING AND CAPACITY ANALYSIS 9-1 No. Differences in operating income between variable costing and absorption costing are due to accounting for fixed manufacturing costs. Under variable costing only variable manufacturing costs are included as inventoriable costs. Under absorption costing both variable and fixed manufacturing costs are included as inventoriable costs. Fixed marketing and distribution costs are not accounted for differently under variable costing and absorption costing. 9-2 The term direct costing is a misnomer for variable costing for two reasons: a. Variable costing does not include all direct costs as inventoriable costs. Only variable direct manufacturing costs are included. Any fixed direct manufacturing costs, and any direct nonmanufacturing costs (either variable or fixed), are excluded from inventoriable costs. b. Variable costing includes as inventoriable costs not only direct manufacturing costs but also some indirect costs (variable indirect manufacturing costs). 9-3 No. The difference between absorption costing and variable costs is due to accounting for fixed manufacturing costs. As service or merchandising companies have no fixed manufacturing costs, these companies do not make choices between absorption costing and variable costing. 9-4 The main issue between variable costing and absorption costing is the proper timing of the release of fixed manufacturing costs as costs of the period: a. at the time of incurrence, or b. at the time the finished units to which the fixed overhead relates are sold. Variable costing uses (a) and absorption costing uses (b). 9-5 No. A company that makes a variable-cost/fixed-cost distinction is not forced to use any specific costing method. The Stassen Company example in the text of Chapter 9 makes a variable-cost/fixed-cost distinction. As illustrated, it can use variable costing, absorption costing, or throughput costing. A company that does not make a variable-cost/fixed-cost distinction cannot use variable costing or throughput costing. However, it is not forced to adopt absorption costing. For internal reporting, it could, for example, classify all costs as costs of the period in which they are incurred. 9-6 Variable costing does not view fixed costs as unimportant or irrelevant, but it maintains that the distinction between behaviors of different costs is crucial for certain decisions. The planning and management of fixed costs is critical, irrespective of what inventory costing method is used. 9-7 Under absorption costing, heavy reductions of inventory during the accounting period might combine with low production and a large production volume variance. This combination could result in lower operating income even if the unit sales level rises. 9-8 (a) The factors that affect the breakeven point under variable costing are: 1. Fixed (manufacturing and operating) costs. 2. Contribution margin per unit. 9-1 (b) The factors that affect the breakeven point under absorption costing are: 1. Fixed (manufacturing and operating) costs. 2. Contribution margin per unit. 3. Production level in units in excess of breakeven sales in units. 4. Denominator level chosen to set the fixed manufacturing cost rate. 9-9 Examples of dysfunctional decisions managers may make to increase reported operating income are: a. Plant managers may switch production to those orders that absorb the highest amount of fixed manufacturing overhead, irrespective of the demand by customers. b. Plant managers may accept a particular order to increase production even though another plant in the same company is better suited to handle that order. c. Plant managers may defer maintenance beyond the current period to free up more time for production. 9-10 Approaches used to reduce the negative aspects associated with using absorption costing include: a. Change the accounting system: Adopt either variable or throughput costing, both of which reduce the incentives of managers to produce for inventory. Adopt an inventory holding charge for managers who tie up funds in inventory. b. Extend the time period used to evaluate performance. By evaluating performance over a longer time period (say, 3 to 5 years), the incentive to take short-run actions that reduce long-term income is lessened. c. Include nonfinancial as well as financial variables in the measures used to evaluate performance. 9-11 The theoretical capacity and practical capacity denominator-level concepts emphasize what a plant can supply. The normal capacity utilization and master-budget capacity utilization concepts emphasize what customers demand for products produced by a plant. 9-12 The downward demand spiral is the continuing reduction in demand for a company’s product that occurs when the prices of competitors’ products are not met and (as demand drops further), higher and higher unit costs result in more and more reluctance to meet competitors’ prices. Pricing decisions need to consider competitors and customers as well as costs. 9-13 No. It depends on how a company handles the production-volume variance in the end-ofperiod financial statements. For example, if the adjusted allocation-rate approach is used, each denominator-level capacity concept will give the same financial statement numbers at year-end. 9-14 For tax reporting in the U.S., the IRS requires companies to use the practical capacity concept. At year-end, proration of any variances between inventories and cost of goods sold is required (unless the variance is immaterial in amount). 9-15 No. The costs of having too much capacity/too little capacity involve revenue opportunities potentially forgone as well as costs of money tied up in plant assets. 9-16 (30 min.) Variable and absorption costing, explaining operating-income differences. 9-2 1. Key inputs for income statement computations are April Beginning inventory Production Goods available for sale Units sold Ending inventory 0 500 500 350 150 May 150 400 550 520 30 The budgeted fixed cost per unit and budgeted total manufacturing cost per unit under absorption costing are (a) (b) (c)=(a)÷(b) (d) (e)=(c)+(d) (a) Budgeted fixed manufacturing costs Budgeted production Budgeted fixed manufacturing cost per unit Budgeted variable manufacturing cost per unit Budgeted total manufacturing cost per unit April $2,000,000 500 $4,000 $10,000 $14,000 May $2,000,000 500 $4,000 $10,000 $14,000 Variable costing April 2008 $8,400,000 a Revenues Variable costs Beginning inventory Variable manufacturing costsb Cost of goods available for sale Deduct ending inventoryc Variable cost of goods sold d Variable operating costs Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed operating costs Total fixed costs Operating income a $24,000 × 350; $24,000 × 520 b $10,000 × 500; $10,000 × 400 $ 0 5,000,000 5,000,000 (1,500,000) 3,500,000 1,050,000 May 2008 $12,480,000 $1,500,000 4,000,000 5,500,000 (300,000) 5,200,000 1,560,000 4,550,000 3,850,000 2,000,000 600,000 6,760,000 5,720,000 2,000,000 600,000 2,600,000 $1,250,000 c $10,000 × 150; $10,000 × 30 d $3,000 × 350; $3,000 × 520 9-3 2,600,000 $3,120,000 (b) Absorption costing Revenuesa Cost of goods sold Beginning inventory Variable manufacturing costsb Allocated fixed manufacturing costsc Cost of goods available for sale Deduct ending inventoryd Adjustment for prod.-vol. variancee Cost of goods sold Gross margin Operating costs Variable operating costsf Fixed operating costs Total operating costs Operating income a $ 0 5,000,000 2,000,000 7,000,000 (2,100,000) 0 May 2008 $12,480,000 $2,100,000 4,000,000 1,600,000 7,700,000 (420,000) 400,000 U 4,900,000 3,500,000 1,050,000 600,000 7,680,000 4,800,000 1,560,000 600,000 1,650,000 $1,850,000 2,160,000 $ 2,640,000 d b April 2008 $8,400,000 e $24,000 × 350; $24,000 × 520 $10,000 × 500; $10,000 × 400 c $4,000 × 500; $4,000 × 400 2. $14,000 × 150; $14,000 × 30 $2,000,000 – $2,000,000; $2,000,000 – $1,600,000 f $3,000 × 350; $3,000 × 520 Absorption-costing Variable-costing – operating income operating income = Fixed manufacturing costs Fixed manufacturing costs – in ending inventory in beginning inventory April: $1,850,000 – $1,250,000 $600,000 = ($4,000 × 150) – ($0) = $600,000 May: $2,640,000 – $3,120,000 = ($4,000 × 30) – ($4,000 × 150) – $480,000 = $120,000 – $600,000 – $480,000 = – $480,000 The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in April) and out of inventories as they decrease (as in May). 9-4 9-17 (20 min.) Throughput costing (continuation of Exercise 9-16). 1. April 2008 Revenuesa $8,400,000 Direct material cost of goods sold Beginning inventory $ 0 Direct materials in goods manufactured b 3,350,000 Cost of goods available for sale 3,350,000 Deduct ending inventoryc (1,005,000) Total direct material cost of goods sold 2,345,000 Throughput contribution 6,055,000 Other costs Manufacturing costs 3,650,000d Other operating costs 1,650,000f Total other costs 5,300,000 Operating income $ 755,000 a $1,005,000 2,680,000 3,685,000 (201,000) 3,484,000 8,996,000 3,320,000e 2,160,000g 5,480,000 $ 3,516,000 e b May 2008 $12,480,000 f $24,000 × 350; $24,000 × 520 $6,700 × 500; $6,700 × 400 c $6,700 × 150; $6,700 × 30 d ($3,300 × 500) + $2,000,000 2. ($3,300 × 400) + $2,000,000 ($3,000 × 350) + $600,000 g ($3,000 × 520) + $600,000 Operating income under: April $1,850,000 1,250,000 755,000 Absorption costing Variable costing Throughput costing May $2,640,000 3,120,000 3,516,000 In April, throughput costing has the lowest operating income, whereas in May throughput costing has the highest operating income. Throughput costing puts greater emphasis on sales as the source of operating income than does either absorption or variable costing. 3. Throughput costing puts a penalty on production without a corresponding sale in the same period. Costs other than direct materials that are variable with respect to production are expensed in the period of incurrence, whereas under variable costing they would be capitalized. As a result, throughput costing provides less incentive to produce for inventory than either variable costing or absorption costing. 9-5 9-18 (40 min.) Variable and absorption costing, explaining operating-income differences. 1. Key inputs for income statement computations are: January Beginning inventory Production Goods available for sale Units sold Ending inventory 0 1,000 1,000 700 300 February 300 800 1,100 800 300 March 300 1,250 1,550 1,500 50 The budgeted fixed manufacturing cost per unit and budgeted total manufacturing cost per unit under absorption costing are: (a) (b) (c)=(a)÷(b) (d) (e)=(c)+(d) Budgeted fixed manufacturing costs Budgeted production Budgeted fixed manufacturing cost per unit Budgeted variable manufacturing cost per unit Budgeted total manufacturing cost per unit 9-6 January $400,000 1,000 $400 $900 $1,300 February $400,000 1,000 $400 $900 $1,300 March $400,000 1,000 $400 $900 $1,300 (a) Variable Costing Revenues Variable costs Beginning inventoryb Variable manufacturing costsc Cost of goods available for sale Deduct ending inventoryd Variable cost of goods sold Variable operating costse Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed operating costs Total fixed costs Operating income January 2009 $1,750,000 a $ 0 900,000 900,000 (270,000) 630,000 420,000 February 2009 $2,000,000 $270,000 720,000 990,000 (270,000) 720,000 480,000 1,050,000 700,000 400,000 140,000 March 2009 $3,750,000 $ 270,000 1,125,000 1,395,000 (45,000) 1,350,000 900,000 1,200,000 800,000 400,000 140,000 540,000 $ 160,000 400,000 140,000 540,000 $ 260,000 a $2,500 × 700; $2,500 × 800; $2,500 × 1,500 b $? × 0; $900 × 300; $900 × 300 c $900 × 1,000; $900 × 800; $900 × 1,250 d $900 × 300; $900 × 300; $900 × 50 e $600 × 700; $600 × 800; $600 × 1,500 9-7 2,250,000 1,500,000 540,000 $ 960,000 (b) Absorption Costing Revenuesa Cost of goods sold Beginning inventoryb Variable manufacturing costsc Allocated fixed manufacturing costsd Cost of goods available for sale Deduct ending inventorye Adjustment for prod. vol. var.f Cost of goods sold Gross margin Operating costs Variable operating costsg Fixed operating costs Total operating costs Operating income January 2009 $1,750,000 February 2009 $2,000,000 March 2009 $3,750,000 $ 0 900,000 $ 390,000 720,000 $ 390,000 1,125,000 400,000 1,300,000 320,000 1,430,000 500,000 2,015,000 (390,000) 0 (390,000) 80,000 U 910,000 840,000 420,000 140,000 (65,000) (100,000) F 1,120,000 880,000 480,000 140,000 560,000 $ 280,000 900,000 140,000 620,000 $ 260,000 a $2,500 × 700; $2,500 × 800; $2,500 × 1,500 0; $1,300 × 300; $1,300 × 300 c $900 × 1,000; $900 × 800; $900 × 1,250 d $400 × 1,000; $400 × 800; $400 × 1,250 e $1,300 × 300; $1,300 × 300; $1,300 × 50 f $400,000 – $400,000; $400,000 – $320,000; $400,000 – $500,000 g $600 × 700; $600 × 800; $600 × 1,500 b $?× 9-8 1,850,000 1,900,000 1,040,000 $ 860,000 2. 错误!未指定开关参数。– 错误!未指定开关参数。= 错误!未指定开关参数。– 错误!未指定开 关参数。 January: $280,000 – $160,000 = ($400 × 300) – $0 $120,000 = $120,000 February: $260,000 – $260,000 = ($400 × 300) – ($400 × 300) $0 = $0 March: $860,000 – $960,000 = ($400 × 50) – ($400 × 300) – $100,000 = – $100,000 The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in January) and out of inventories as they decrease (as in March). 9-9 9-19 (20–30 min.) Throughput costing (continuation of Exercise 9-18). 1. January Revenues Direct material cost of goods sold $ 0 Beginning inventoryb Direct materials in goods manufacturedc 500,000 Cost of goods available for sale 500,000 Deduct ending inventoryd (150,000) Total direct material cost of goods sold Throughput contribution Other costs Manufacturinge 800,000 Operatingf 560,000 Total other costs Operating income February March a $1,750,000 $2,000,000 $3,750,000 $150,000 $ 150,000 400,000 625,000 550,000 (150,000) 350,000 1,400,000 775,000 (25,000) 400,000 1,600,000 720,000 620,000 1,360,000 40,000 $ 750,000 3,000,000 900,000 1,040,000 1,340,000 $ 260,000 1,940,000 $1,060,000 a $2,500 × 700; $2,500 × 800; $2,500 × 1,500 $? × 0; $500 × 300; $500 × 300 c $500 × 1,000; $500 × 800; $500 × 1,250 d $500 × 300; $500 × 300; $500 ×50 e ($400 × 1,000) + $400,000; ($400 × 800) + $400,000; ($400 × 1,250) + $400,000 f ($600 × 700) + $140,000; ($600 × 800) + $140,000; ($600 × 1,500) + $140,000 b 2. Operating income under: Absorption costing Variable costing Throughput costing January $280,000 160,000 40,000 February $260,000 260,000 260,000 March $860,000 960,000 1,060,000 Throughput costing puts greater emphasis on sales as the source of operating income than does absorption or variable costing. 3. Throughput costing puts a penalty on producing without a corresponding sale in the same period. Costs other than direct materials that are variable with respect to production are expensed when incurred, whereas under variable costing they would be capitalized as an inventoriable cost. 9-10 9-20 (40 min) Variable versus absorption costing. 1. Income Statement for the Zwatch Company, Variable Costing for the Year Ended December 31, 2009 Revenues: $22 × 345,400 Variable costs Beginning inventory: $5.10 × 85,000 Variable manufacturing costs: $5.10 × 294,900 Cost of goods available for sale Deduct ending inventory: $5.10 × 34,500 Variable cost of goods sold Variable operating costs: $1.10 × 345,400 Adjustment for variances Total variable costs Contribution margin Fixed costs Fixed manufacturing overhead costs Fixed operating costs Total fixed costs Operating income $7,598,800 $ 433,500 1,503,990 1,937,490 (175,950) 1,761,540 379,940 0 2,141,480 5,457,320 1,440,000 1,080,000 2,520,000 $2,937,320 Absorption Costing Data Fixed manufacturing overhead allocation rate = Fixed manufacturing overhead/Denominator level machine-hours = $1,440,000 6,000 = $240 per machine-hour Fixed manufacturing overhead allocation rate per unit = Fixed manufacturing overhead allocation rate/standard production rate = $240 50 = $4.80 per unit 9-11 Income Statement for the Zwatch Company, Absorption Costing for the Year Ended December 31, 2009 Revenues: $22 × 345,400 Cost of goods sold Beginning inventory ($5.10 + $4.80) × 85,000 Variable manuf. costs: $5.10 × 294,900 Allocated fixed manuf. costs: $4.80 × 294,900 Cost of goods available for sale Deduct ending inventory: ($5.10 + $4.80) × 34,500 Adjust for manuf. variances ($4.80 × 5,100)a Cost of goods sold Gross margin Operating costs Variable operating costs: $1.10 × 345,400 Fixed operating costs Total operating costs Operating income a $7,598,800 $ 841,500 1,503,990 1,415,520 $3,761,010 (341,550) 24,480 U 3,443,940 4,154,860 $ 379,940 1,080,000 1,459,940 $2,694,920 Production volume variance = [(6,000 hours × 50) – 294,900] × $4.80 = (300,000 – 294,900) × $4.80 = $24,480 2. Zwatch’s operating margins as a percentage of revenues are Under variable costing: Revenues Operating income Operating income as percentage of revenues $7,598,800 2,937,320 38.7% Under absorption costing: Revenues Operating income Operating income as percentage of revenues $7,598,800 2,694,920 35.5% 3. Operating income using variable costing is about 9% higher than operating income calculated using absorption costing. Variable costing operating income – Absorption costing operating income = $2,937,320 – $2,694,920 = $242,400 Fixed manufacturing costs in beginning inventory under absorption costing – Fixed manufacturing costs in ending inventory under absorption costing = ($4.80 × 85,000) – ($4.80 × 34,500) = $242,400 9-12 4. The factors the CFO should consider include (a) Effect on managerial behavior. (b) Effect on external users of financial statements. I would recommend absorption costing because it considers all the manufacturing resources (whether variable or fixed) used to produce units of output. Absorption costing has many critics. However, the dysfunctional aspects associated with absorption costing can be reduced by Careful budgeting and inventory planning. Adding a capital charge to reduce the incentives to build up inventory. Monitoring nonfinancial performance measures. 9-21 (10 min.) Absorption and variable costing. The answers are 1(a) and 2(c). Computations: 1. Absorption Costing Costing: Revenuesa Cost of goods sold: Variable manufacturing costsb Allocated fixed manufacturing costsc Gross margin Operating costs: Variable operatingd Fixed operating Operating income $4,800,000 $2,400,000 360,000 1,200,000 400,000 2,760,000 2,040,000 1,600,000 $ 440,000 a $40 × 120,000 × 120,000 c Fixed manufacturing rate = $600,000 ÷ 200,000 = $3 per output unit Fixed manufacturing costs = $3 × 120,000 d $10 × 120,000 b $20 2. Variable Costing Costing: Revenuesa Variable costs: Variable manufacturing cost of goods soldb Variable operating costsc Contribution margin Fixed costs: Fixed manufacturing costs Fixed operating costs Operating income a $40 × 120,000 $20 × 120,000 c $10 × 120,000 b 9-13 $4,800,000 $2,400,000 1,200,000 600,000 400,000 3,600,000 1,200,000 1,000,000 $ 200,000 9-22 (40 min) Absorption versus variable costing. 1. The variable manufacturing cost per unit is $55 + $45 + $120 = $220. 2009 Variable-Costing Based Operating Income Statement Revenues (8,960 $1,200 per unit) Variable costs Beginning inventory Variable manufacturing costs (10,000 units $220 per unit) Cost of goods available for sale Deduct: Ending inventory (1,040a units $220 per unit) Variable cost of goods sold Variable marketing costs (8,960 units $75 per unit) Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed R&D Fixed marketing Total fixed costs Operating income a Beginning $10,752,000 $ 2,200,000 2,200,000 (228,800) 1,971,200 672,000 2,643,200 8,108,800 1,471,680 981,120 3,124,480 5,577,280 $2,531,520 Inventory 0 + Production 10,000 – Sales 8,960 = Ending Inventory 1,040 units 2. 2009 Absorption-Costing Based Operating Income Statement Revenues (8,960 units $1,200 per unit) Cost of goods sold Beginning inventory Variable manufacturing costs (10,000 units $220 per unit) Allocated fixed manufacturing costs (10,000 units $165 per unit) Cost of goods available for sale Deduct ending inventory (1,040 units ($220 + $165) per unit) Deduct favorable production volume variance Cost of goods sold Gross margin Operating costs Variable marketing costs (8,960 units $75 per unit) Fixed R&D Fixed marketing Total operating costs Operating income a 0 PVV = Allocated $1,650,000 ($165 10,000) – Actual $1,471,680 = $178,320 9-14 $10,752,000 $ 0 2,200,000 1,650,000 3,850,000 (400,400) (178,320)a F 3,271,280 7,480,720 672,000 981,120 3,124,480 4,777,600 $2,703,120 3. 2009 operating income under absorption costing is greater than the operating income under variable costing because in 2009 inventories increased by 1,040 units, and under absorption costing fixed overhead remained in the ending inventory, and resulted in a lower cost of goods sold (relative to variable costing). As shown below, the difference in the two operating incomes is exactly the same as the difference in the fixed manufacturing costs included in ending vs. beginning inventory (under absorption costing). Operating income under absorption costing Operating income under variable costing Difference in operating income under absorption vs. variable costing $2,703,120 2,531,520 $ 171,600 Under absorption costing: Fixed mfg. costs in ending inventory (1,040 units $165 per unit) Fixed mfg. costs in beginning inventory (0 units $165 per unit) Change in fixed mfg. costs between ending and beginning inventory $ 171,600 0 $ 171,600 4. Relative to the obvious alternative of using contribution margin (from variable costing), the absorption-costing based gross margin has some pros and cons as a performance measure for Electron’s supervisors. It takes into account both variable costs and fixed costs—costs that the supervisors should be able to control in the long-run—and therefore it is a more complete measure than contribution margin which ignores fixed costs (and may cause the supervisors to pay less attention to fixed costs). The downside of using absorption-costing-based gross margin is the supervisor’s temptation to use inventory levels to control the gross margin—in particular, to shore up a sagging gross margin by building up inventories. This can be offset by specifying, or limiting, the inventory build-up that can occur, charging the supervisor a carrying cost for holding inventory, and using nonfinancial performance measures such as the ratio of ending to beginning inventory. 9-15 9-23 (20–30 min.) Comparison of actual-costing methods. The numbers are simplified to ease computations. This problem avoids standard costing and its complications. 1. Variable-costing income statements: 2008 Sales 1,000 units Production 1,400 units $3,000 Revenues ($3 per unit) Variable costs: Beginning inventory Variable cost of goods manufactured Cost of goods available for sale Deduct ending inventorya Variable cost of goods sold Variable operating costs Variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed operating costs Total fixed costs Operating income $ 0 700 700 (200) 500 1,000 2009 Sales 1,200 units Production 1,000 units $3,600 $ 200 500 700 (100) 600 1,200 1,500 1,500 1,800 1,800 700 400 700 400 1,100 $ 400 1,100 $ 700 a Unit inventoriable costs: Year 1: $700 ÷ 1,400 = $0.50 per unit; $0.50 × (1,400 – 1,000) Year 2: $500 ÷ 1,000 = $0.50 per unit; $0.50 × (400 + 1,000 – 1,200) 2. Absorption-costing income statements: Revenues ($3 per unit) Cost of goods sold: Beginning inventory Variable manufacturing costs Fixed manufacturing costsa Cost of goods available for sale Deduct ending inventoryb Cost of goods sold Gross margin Operating costs: Variable operating costs Fixed operating costs Total operating costs Operating income 2008 Sales 1,000 units Production 1,400 units $3,000 $ 0 700 700 1,400 (400) 2009 Sales 1,200 units Production 1,000 units $3,600 $ 400 500 700 1,600 (240) 1,000 2,000 1,360 2,240 1,200 400 1,000 400 1,400 $ 600 a Fixed manufacturing cost rate: Year 1: $700 ÷ 1,400 = $0.50 per unit Year 2: $700 ÷ 1,000 = $0.70 per unit b Unit inventoriable costs: Year 1: $1,400 ÷ 1,400 = $1.00 per unit; $1.00 × (1400 – 1000) Year 2: $1,200 ÷ 1,000 = $1.20 per unit $1.20 × (400 + 1,000 – 1,200) 9-16 1,600 $ 640 2008 错误!未指定开关参数。 Year 1: $600 – $400 $200 Year 2: $640 – $700 –$60 = = = = $640 240 0 200 = $700 100 $600 400 Variable Costing: Operating income Ending inventory Absorption Costing: Operating income Ending inventory Fixed manuf. overhead • in beginning inventory • in ending inventory 2009 $400 200 3. 200 140 错误!未指定开关参数。 $0.50 × 400 – $0 $200 ($0.70 × 200) – ($0.50 × 400) –$60 The difference in reported operating income is due to the amount of fixed manufacturing overhead in the beginning and ending inventories. In Year 1, absorption costing has a higher operating income of $200 due to ending inventory having $200 more in fixed manufacturing overhead than does beginning inventory. In Year 2, variable costing has a higher operating income of $60 due to ending inventory under absorption costing having $60 less in fixed manufacturing overhead than does beginning inventory. 4. a. Absorption costing is more likely to lead to inventory build-ups than variable costing. Under absorption costing, operating income in a given accounting period is increased by inventory buildup, because some fixed manufacturing costs are accounted for as an asset (inventory) instead of as a cost of the period of production. b. Although variable costing will counteract undesirable inventory build-ups, other measures can be used without abandoning absorption costing. Examples include: (1) careful budgeting and inventory planning, (2) incorporating a carrying charge for inventory, (3) changing the period used to evaluate performance to be long-term, (4) including nonfinancial variables that measure inventory levels in performance evaluations. 9-17 9-24 (40 min.) Variable and absorption costing, sales, and operating-income changes. 1. Headsmart’s annual fixed manufacturing costs are $1,200,000. It allocates $24 of fixed manufacturing costs to each unit produced. Therefore, it must be using $1,200,000 $24 = 50,000 units (annually) as the denominator level to allocate fixed manufacturing costs to the units produced. We can see from Headsmart’s income statements that it disposes off any production volume variance against cost of goods sold. In 2009, 60,000 units were produced instead of the budgeted 50,000 units. This resulted in a favorable production volume variance of $240,000 F ((60,000 – 50,000) units $24 per unit), which, when written off against cost of goods sold, increased gross margin by that amount. 2. The breakeven calculation, same for each year, is shown below: Calculation of breakeven volume Selling price ($2,100,000 50,000; $2,100,000 50,000; $2,520,000 60,000) Variable cost per unit (all manufacturing) Contribution margin per unit Total fixed costs (fixed mfg. costs + fixed selling & admin. costs) Breakeven quantity = Total fixed costs contribution margin per unit 2008 $42 14 $28 2009 $42 14 $28 2010 $42 14 $28 $1,400,000 $1,400,000 $1,400,000 50,000 50,000 50,000 3. Variable Costing Sales (units) Revenues Variable cost of goods sold Beginning inventory $14 0; 0; 10,000 Variable manuf. costs $14 50,000; 60,000; 50,000 Deduct ending inventory $14 0; 10,000; 0 Variable cost of goods sold Contribution margin Fixed manufacturing costs Fixed selling and administrative expenses Operating income Explaining variable costing operating income Contribution margin ($28 contribution margin per unit sales units) Total fixed costs Operating income 9-18 2008 2009 2010 50,000 50,000 60,000 $2,100,000 $2,100,000 $2,520,000 0 0 140,000 700,000 840,000 700,000 0 (140,000) 0 700,000 700,000 840,000 $1,400,000 $1,400,000 $1,680,000 $1,200,000 $1,200,000 $1,200,000 200,000 200,000 200,000 $ 0 $ 0 $ 280,000 $1,400,000 $1,400,000 $1,680,000 1,400,000 1,400,000 1,400,000 $ 0 $ 0 $ 280,000 4. Reconciliation of absorption/variable costing operating incomes (1) Absorption costing operating income (ACOI) (2) Variable costing operating income (VCOI) (3) Difference (ACOI – VCOI) 2008 $0 0 $0 2009 2010 $240,000 $ 40,000 0 280,000 $240,000 $(240,000) (4) Fixed mfg. costs in ending inventory under absorption costing (ending inventory in units $24 per unit) $0 $240,000 (5) Fixed mfg. costs in beginning inventory under absorption costing (beginning inventory in units $24 per unit) (6) Difference = (4) – (5) 0 $0 0 240,000 $240,000 $(240,000) $ 0 In the table above, row (3) shows the difference between the operating income under absorption costing and the operating income under variable costing, for each of the three years. In 2008, the difference is $0; in 2009, absorption costing income is greater by $240,000; and in 2010, it is less by $240,000. Row (6) above shows the difference between the fixed costs in ending inventory and the fixed costs in beginning inventory under absorption costing, which is $0 in 2008, $240,000 in 2009 and -$240,000 in 2010. Row (3) and row (6) explain and reconcile the operating income differences between absorption costing and variable costing. Stuart Weil is surprised at the non-zero, positive net income (reported under absorption costing) in 2009, when sales were at the ‘breakeven volume’ of 50,000; further, he is concerned about the drop in operating income in 2010, when, in fact, sales increased to 60,000 units. In 2009, starting with zero inventories, 60,000 units were produced, 50,000 were sold, i.e., at the end of the year, 10,000 units remained in inventory. These 10,000 units had each absorbed $24 of fixed costs (total of $240,000), which would remain as assets on Headsmart’s balance sheet until they were sold. Cost of goods sold, representing only the costs of the 50,000 units sold in 2009, was accordingly reduced by $240,000, the production volume variance, resulting in a positive operating income even though sales were at breakeven levels. The following year, in 2010, production was 50,000 units, sales were 60,000 units i.e., all of the fixed costs that were included in 2009 ending inventory, flowed through COGS in 2010. Contribution margin in 2010 was $1,680,000 (60,000 units $28), but, in absorption costing, COGS also contains the allocated fixed manufacturing costs of the units sold, which were $1,440,000 (60,000 units $24), resulting in an operating income of $40,000 = 1,680,000 – $1,440,000 – $200,000 (fixed sales and admin.) Hence the drop in operating income under absorption costing, even though sales were greater than the computed breakeven volume: inventory levels decreased sufficiently in 2010 to cause 2010’s operating income to be lower than 2009 operating income. Note that beginning and ending with zero inventories during the 2008–2010 period, under both costing methods, Headsmart’s total operating income was $280,000. 9-19 9-25 (10 min.) Capacity management, denominator-level capacity concepts. 1. a, b 2. a 3. d 4. c, d 5. c 6. d 7. a 8. b (or a) 9. b 10. c, d 11. a, b 9-26 (25 min.) Denominator-level problem. 1. Budgeted fixed manufacturing overhead costs rates: Denominator Level Capacity Concept Theoretical Practical Normal Master-budget Budgeted Fixed Manufacturing Overhead per Period $ 4,000,000 4,000,000 4,000,000 4,000,000 Budgeted Capacity Level 2,880 1,920 1,200 1,500 Budgeted Fixed Manufacturing Overhead Cost Rate $ 1,388.89 2,083.33 3,333.33 2,666,67 The rates are different because of varying denominator-level concepts. Theoretical and practical capacity levels are driven by supply-side concepts, i.e., “how much can I produce?” Normal and master-budget capacity levels are driven by demand-side concepts, i.e., “how much can I sell?” (or “how much should I produce?”) The variances that arise from use of the theoretical or practical level concepts will signal that there is a divergence between the supply of capacity and the demand for capacity. This is useful input to managers. As a general rule, however, it is important not to place undue reliance on the production volume variance as a measure of the economic costs of unused capacity. 2. 3. Under a cost-based pricing system, the choice of a master-budget level denominator will lead to high prices when demand is low (more fixed costs allocated to the individual product level), further eroding demand; conversely, it will lead to low prices when demand is high, forgoing profits. This has been referred to as the downward demand spiral—the continuing reduction in demand that occurs when the prices of competitors are not met and demand drops, resulting in even higher unit costs and even more reluctance to meet the prices of competitors. The positive aspects of the master-budget denominator level are that it is based on demand for the product and indicates the price at which all costs per unit would be recovered to enable the company to make a profit. Master-budget denominator level is also a good benchmark against which to evaluate performance. 9-20 9-27 (55 min.) Variable and absorption costing and breakeven points 1. a. 2009 Variable-Costing Based Operating Income Statement Revenues (800 cat trees x $300 per tree) Variable costs Beginning inventory Variable manufacturing costs (1,000 trees $75 per tree.) Cost of goods available for sale Deduct: Ending inventory (200 trees $75 per tree) Variable cost of goods sold Variable shipping costs (800 trees $25 per tree) Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed selling and administrative $240,000 $ 0 75,000 75,000 (15,000) 60,000 20,000 80,000 160,000 100,000 50,000 Total fixed costs Operating income 150,000 $ 10,000 1. b. 2009 Absorption-Costing Based Operating Income Statement Revenues (800 cat trees x $300 per tree) Cost of goods sold Beginning inventory Variable manufacturing costs (1,000 trees. $75 per tree) Allocated fixed manufacturing costs (1,000 trees $100* per tree) Cost of goods available for sale Deduct ending inventory (200 trees ($75 + $100) per tree) Cost of goods sold Gross margin Operating costs Variable marketing costs (800 trees Fixed selling and administrative $ 0 75,000 100,000 175,000 (35,000) 140,000 100,000 $25 per pkg.) 20,000 50,000 Total operating costs Operating income *Fixed manufacturing rate $240,000 70,000 $ 30,000 = Fixed manufacturing cost/production = $100,000/1000 trees = $100 per tree 9-21 2. Breakeven point in units: a. Variable Costing: QT = Total Fixed Costs Target Operating Income Contribution Margin Per Unit QT = ($100,000 $50,000) $0 $300 ($75 $25) QT = $150,000 $200 QT = 750 cat trees b. Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree QT = Total Fixed Target Fixed Manuf. Breakeven Units Cost Rate Cost OI Sales in Units Produced Contribution Margin Per Unit QT = $150,000 $100 (QT 1,000) $200 QT = $150, 000 $100 QT $100,000 $200 $200 QT $100 QT = $150,000 – $100,000 $100 QT = $50,000 QT = 500 cat trees 9-22 3. Breakeven point in units: a. Variable Costing: QT Total Fixed Costs Target Operating Income Contribution Margin Per Unit QT = ($100,000 $50,000) $0 $300 ($100 $25) QT = $150,000 $175 QT b. = = 857.14 cat trees Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree QT = Total Fixed Target Fixed Manuf. Breakeven Units Cost Rate Cost OI Sales in Units Produced Contribution Margin Per Unit QT = $150,000 $100 (QT 1,000) $175 QT = $150, 000 $100 QT $100,000 $175 $175 QT $100 QT = $150,000 – $100,000 $75 QT = $50,000 QT = 666.66 cat trees 9-23 4. Units needed to achieve target operating income: a. Variable Costing: QT = Total Fixed Costs Target Operating Income Contribution Margin Per Unit QT = ($100,000 $50,000) $10,000 $300 ($75 $25) QT = $160,000 $200 QT = 800 cat trees b. Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree QT = Total Fixed Target Fixed Manuf. Breakeven Units Cost Rate Cost OI Sales in Units Produced Contribution Margin Per Unit QT = $150,000 $30,000 $100 (QT 1,000) $200 QT = $180, 000 $100 QT $100,000 $200 $200 QT $100 QT = $180,000 – $100,000 $100 QT = $80,000 QT = 800 cat trees 9-24 9-28 1. (40 min.) Variable costing versus absorption costing. Absorption Costing: Mavis Company Income Statement For the Year Ended December 31, 2009 Revenues (540,000 × $5.00) Cost of goods sold: Beginning inventory (30,000 × $3.70a) Variable manufacturing costs (550,000 × $3.00) Allocated fixed manufacturing costs (550,000 × $0.70) Cost of goods available for sale Deduct ending inventory (40,000 × $3.70) Add adjustment for prod.-vol. variance (50,000b × $0.70) Cost of goods sold Gross margin Operating costs: Variable operating costs (540,000 × $1) Fixed operating costs Total operating costs Operating income $2,700,000 $ 111,000 1,650,000 385,000 2,146,000 (148,000) 35,000 U 2,033,,000 667,000 540,000 120,000 660,000 $ 7,000 a $3.00 + ($7.00 ÷ 10) = $3.00 + $0.70 = $3.70 b [(10 units per mach. hr. × 60,000 mach. hrs.) – 550,000 units)] = 50,000 units unfavorable 2. Variable Costing: Mavis Company Income Statement For the Year Ended December 31, 2009 Revenues Variable cost of goods sold: Beginning inventory (30,000 × $3.00) Variable manufacturing costs (550,000 × $3.00) Cost of goods available for sale Deduct ending inventory (40,000 × $3.00) Variable cost of goods sold Variable operating costs Contribution margin Fixed costs: Fixed manufacturing overhead costs Fixed operating costs Total fixed costs Operating income 9-25 $2,700,000 $ 90,000 1,650,000 1,740,000 (120,000) 1,620,000 540,000 540,000 420,000 120,000 $ 540,000 0 3. The difference in operating income between the two costing methods is: 错误!未指定开关参数。= 错误!未指定开关参数。 $7,000 – $0 $7,000 $7,000 = [(40,000 × $0.70) – (30,000 × $0.70)] = $28,000 – $21,000 = $7,000 The absorption-costing operating income exceeds the variable costing figure by $7,000 because of the increase of $7,000 during 2009 of the amount of fixed manufacturing costs in ending inventory vis-a-vis beginning inventory. 4. Total fixed manufacturing costs Actual and budget line $420,000 $385,000 Unfavorable production-volume variance volume variance } Favorable production- { 55,000 Allocated line @ $7.00 60,000 Machine-hours 5. Absorption costing is more likely to lead to buildups of inventory than does variable costing. Absorption costing enables managers to increase reported operating income by building up inventory which reduces the amount of fixed manufacturing overhead included in the current period’s cost of goods sold. Ways to reduce this incentive include (a) Careful budgeting and inventory planning. (b) Change the accounting system to variable costing or throughput costing. (c) Incorporate a carrying charge for carrying inventory. (d) Use a longer time period to evaluate performance than a quarter or a year. (e) Include nonfinancial as well as financial measures when evaluating management performance. 9-26 9-29 (40 min.) Variable costing and absorption costing, the All-Fixed Company. This problem always generates active classroom discussion. 1. The treatment of fixed manufacturing overhead in absorption costing is affected primarily by what denominator level is selected as a base for allocating fixed manufacturing costs to units produced. In this case, is 10,000 tons per year, 20,000 tons, or some other denominator level the most appropriate base? We usually place the following possibilities on the board or overhead projector and then ask the students to indicate by vote how many used one denominator level versus another. Incidentally, discussion tends to move more clearly if variable-costing income statements are discussed first, because there is little disagreement as to computations under variable costing. a. Variable-Costing Income Statement: Revenues (and contribution margin) Fixed costs: Manufacturing costs Operating costs Operating income 2008 $300,000 $280,000 40,000 2009 $300,000 Together $600,000 320,000 $ (20,000) 320,000 $ (20,000) 640,000 $ (40,000) 9-27 b. Absorption-Costing Income Statement: The ambiguity about the 10,000- or 20,000-unit denominator level is intentional. IF YOU WISH, THE AMBIGUITY MAY BE AVOIDED BY GIVING THE STUDENTS A SPECIFIC DENOMINATOR LEVEL IN ADVANCE. Alternative 1. Use 20,000 units as a denominator; fixed manufacturing overhead per unit is $280,000 20,000 = $14. 2008 2009 Together Revenues $300,000 $ 300,000 $600,000 Cost of goods sold Beginning inventory 0 140,000* 0 Allocated fixed manufacturing costs at $14 280,000 — 280,000 Deduct ending inventory (140,000) — — Adjustment for production-volume variance 0 280,000 U 280,000 U Cost of goods sold 140,000 420,000 560,000 Gross margin 160,000 (120,000) 40,000 Operating costs 40,000 40,000 80,000 Operating income $120,000 $(160,000) $ (40,000) * Inventory carried forward from 2008 and sold in 2009. Alternative 2. Use 10,000 units as a denominator; fixed manufacturing overhead per unit is $280,000 10,000 = $28. Revenues Cost of goods sold Beginning inventory Allocated fixed manufacturing costs at $28 Deduct ending inventory Adjustment for production-volume variance Cost of goods sold Gross margin Operating costs Operating income *Inventory 2008 $300,000 2009 $300,000 560,000 (280,000) (280,000) F 0 300,000 40,000 $260,000 280,000* — — 280,000 U 560,000 (260,000) 40,000 $(300,000) 0 Together $600,000 0 560,000 — 0 560,000 40,000 80,000 $ (40,000) carried forward from 2008 and sold in 2009. Note that operating income under variable costing follows sales and is not affected by inventory changes. Note also that students will understand the variable-costing presentation much more easily than the alternatives presented under absorption costing. 9-28 2. Breakeven point under variable = costing Fixed costs $320,000 = Contribution margin per ton $30 = 10,667 (rounded) tons per year or 21,334 for two years. If the company could sell 667 more tons per year at $30 each, it could get the extra $20,000 contribution margin needed to break even. Most students will say that the breakeven point is 10,667 tons per year under both absorption costing and variable costing. The logical question to ask a student who answers 10,667 tons for variable costing is: “What operating income do you show for 2008 under absorption costing?” If a student answers $120,000 (alternative 1 above), or $260,000 (alternative 2 above), ask: “But you say your breakeven point is 10,667 tons. How can you show an operating income on only 10,000 tons sold during 2008?” The answer to the above dilemma lies in the fact that operating income is affected by both sales and production under absorption costing. Given that sales would be 10,000 tons in 2008, solve for the production level that will provide a breakeven level of zero operating income. Using the formula in the chapter, sales of 10,000 units, and a fixed manufacturing overhead rate of $14 (based on $280,000 ÷ 20,000 units denominator level = $14): Let P = Production level Target Fixed manuf. Breakeven Units Total fixed costs operating overhead sales in produced income units rate Breakeven = sales Unit contribution margin in units $320‚000 $0 $14(10‚000 P) 10,000 tons = $30 $300,000 = $320,000 + $140,000 – $14P $14P = $160,000 P = 11,429 units (rounded) Proof: Gross margin, 10,000 × ($30 – $14) Production-volume variance, (20,000 – 11,429) × $14 Marketing and administrative costs Operating income (due to rounding) $160,000 $119,994 40,000 159,994 6 $ 9-29 Given that production would be 20,000 tons in 2008, solve for the breakeven unit sales level. Using the formula in the chapter and a fixed manufacturing overhead rate of $14 (based on a denominator level of 20,000 units): Let N = Breakeven sales in units Target Fixed manuf. Units Total fixed costs operating overhead N produced income rate N = Unit contribution margin $320,000 + $0 + $14(N 20,000) N = $30 $30N = $320,000 + $14N – $280,000 $16N = $40,000 N = 2,500 units Proof: Gross margin, 2,500 × ($30 – $14) $40,000 Production-volume variance $ 0 Marketing and administrative costs 40,000 40,000 Operating income $ 0 We find it helpful to put the following comparisons on the board: Variable costing breakeven Absorption costing breakeven = f(sales) = 10,667 tons = f(sales and production) = f(10,000 and 11,429) = f(2,500 and 20,000) 3. Absorption costing inventory cost: Either $140,000 or $280,000 at the end of 2008 and zero at the end of 2009. Variable costing: Zero at all times. This is a major criticism of variable costing and focuses on the issue of the definition of an asset. 4. Operating income is affected by both production and sales under absorption costing. Hence, most managers would prefer absorption costing because their performance in any given reporting period, at least in the short run, is influenced by how much production is scheduled near the end of a period. 9-30 9-30 (30–35 min.) Comparison of variable costing and absorption costing. 1. Since production volume variance is unfavorable, the budgeted fixed manufacturing overhead must be larger than the fixed manufacturing overhead allocated. Production - volume variance $400,000 = Budgeted fixed – Fixed manufacturing manufacturing overhead overhead allocated = $1,200,000 – Allocated Allocated = $800,000, which is 67% of $1,200,000 If 67% of the budgeted fixed costs were allocated, the plant must have been operating at 67% of denominator level in 2009. 2. The problem provides the beginning and ending inventory balances under both, variable and absorption costing. Under variable costing, all fixed costs are written off as period costs, i.e., they are not inventoried. Under absorption costing, inventories include variable and fixed costs. Therefore the difference between inventory under absorption costing and inventory under variable costing is the amount of fixed costs included in the inventory. Absorption Costing Inventories: December 31, 2008 December 31, 2009 Variable Costing Fixed Manuf. Overhead in Inventory $1,720,000 206,000 $1,200,000 66,000 $520,000 140,000 3. Note that the answer to (3) is independent of (1). The difference in operating income of $380,000 ($1,520,000 – $1,140,000) is explained by the release of $380,000 of fixed manufacturing costs when the inventories were decreased during 2009: Absorption Costing Inventories: December 31, 2008 December 31, 2009 Release of fixed manuf. costs $1,720,000 206,000 Variable Costing $1,200,000 66,000 Fixed Manuf. Overhead in Inventory $520,000 140,000 $380,000 The above schedule in this requirement is a formal presentation of the equation: 错误!未指定开关参数。 = 错误!未指定开关参数。 ($1,140,000 – $1,520,000) = ($140,000 – $520,000) – $380,000 = – $380,000 Alternatively, the presence of fixed manufacturing overhead costs in each income statement can be analyzed: 9-31 Absorption costing, Fixed manuf. costs in cost of goods sold ($5,860,000 − $4,680,000) Production-volume variance $1,180,000 400,000 1,580,000 Variable costing, fixed manuf. costs charged to expense (1,200,000) Difference in operating income explained $ 380,000 4. Under absorption costing, operating income is a function of both sales and production (i.e., change in inventory levels). During 2009, Hinkle experienced a severe decline in inventory levels: sales were probably higher than anticipated, production was probably lower than planned (at 67% of denominator level), resulting in much of the 2009 beginning inventory passing through cost of goods sold in 2009. This means that under absorption costing, large amounts of inventoried fixed costs have flowed through 2009 cost of goods sold, resulting in a smaller operating income than in 2008, despite an increase in sales volume. 9-31 (30 min.) Effects of differing production levels on absorption costing income: Metrics to minimize inventory buildups. 1. Revenues Cost of goods sold Production-volume variance ( 24,000)c Net cost of goods sold Gross Margin 10,000 12,000 books books $1,000,000 $1,000,000 720,000a 720,000 0b (72,000)d 720,000 696,000 $ 280,000 $ 304,000 a 16,000 books $1,000,000 720,000 648,000 $ 352,000 cost per unit = ($60 + $120,000/10,000 books) = $72 per book CGS = $72 10,000 = $720,000 b volume variance = Budgeted fixed cost – fixed overhead rate production $120,000 – $12 10,000 books = $0 c volume variance = Budgeted fixed cost – fixed overhead rate production $120,000 – $12 12,000 books = $24,000 d volume variance = Budgeted fixed cost – fixed overhead rate production $120,000 – $12 16,000 books = $72,000 9-32 2. Beginning inventory + Production ─ Books sold Ending inventory Cost per book Cost of Ending Inventory 10,000 books 0 10,000 books 10,000 10,000 0 books × $72 $0 12,000 books 0 12,000 books 12,000 10,000 2,000 books × $72 $144,000 16,000 books 0 16,000 books 16,000 10,000 6,000 books × $72 $432,000 3a. 10,000 books Gross margin $280,000 Less 10% Ending inventory 0 Adjusted gross margin $280,000 12,000 books $304,000 (14,400) $289,600 16,000 books $352,000 (43,200) $308,800 While adjusting for ending inventory does to some degree mitigate the increase in inventory associated with excess production, it may be difficult to mechanically compensate for all of the increased income. In addition, it does nothing to hold the manager responsible for the poor decisions from the organization’s standpoint. 3b. 10,000 books 1) Inventory change: End inventory ─ begin inventory 2) Excess production (%) Production ÷ sales 12,000 books 16,000 books 0 2,000 books 6,000 books 10000 ÷ 10,000 1.0 12000 ÷ 10000 1.2 16000 ÷10000 1.6 A ratio of ending inventory to beginning inventory, as suggested in the book, is not possible since beginning inventory was 0, so we substituted change in inventory level. For these non-financial measures to be useful they must be incorporated into the reward function of the manager. 9-33 9-32 (25–30 min.) Alternative denominator-level capacity concepts, effect on operating income. 1. Denominator-Level Capacity Concept Theoretical capacity Practical capacity Normal capacity utilization Master-budget utilization (a) January-June 2009 (b) July-December 2009 Budgeted Fixed Manuf. Overhead per Period (1) $28,000,000 28,000,000 28,000,000 Days of Hours of Production Production per Period per Day (2) (3) 360 24 350 20 350 20 14,000,000 14,000,000 175 175 Barrels per Hour (4) 540 500 400 Budgeted Denominator Level (Barrels) (5) = (2) (3) (4) 4,665,600 3,500,000 2,800,000 Budgeted Fixed Manufacturing Overhead Rate per Barrel (6) = (1) (5) $ 6.00 8.00 10.00 320 480 1,120,000 1,680,000 12.50 8.33 20 20 The differences arise for several reasons: a. The theoretical and practical capacity concepts emphasize supply factors, while normal capacity utilization and master-budget utilization emphasize demand factors. b. The two separate six-month rates for the master-budget utilization concept differ because of seasonal differences in budgeted production. 2. Using column (6) from above, Denominator-Level Capacity Concept Theoretical capacity Practical capacity Normal capacity utilization a Budgeted Fixed Mfg. Overhead Rate per Barrel (6) $6.00 8.00 10.00 Per Barrel Budgeted Budgeted Variable Total Mfg Mfg. Cost Rate Cost Rate (8) = (7) (6) + (7) $30.20a $36.20 30.20 38.20 30.20 40.20 $78,520,000 2,600,000 barrels 9-34 Fixed Mfg. Overhead Costs Allocated (9) = 2,600,000 (6) $15,600,000 20,800,000 26,000,000 Fixed Mfg. Overhead Variance (10) = $27,088,000 – (9) 27,088,000 $11,488,000 U 6,288,000 U 1,088,000 U Absorption-Costing Income Statement Revenues (2,400,000 bbls. $45 per bbl.) Cost of goods sold Beginning inventory Variable mfg. costs Fixed mfg. overhead costs allocated (2,600,000 units $6.00; $8.00; $10.00 per unit) Cost of goods available for sale Deduct ending inventory (200,000 units $36.20; $38.20; $40.20 per unit) Adjustment for variances (add: all unfavorable) Cost of goods sold Gross margin Other costs Operating income 9-33 (20 min.) Theoretical Capacity $108,000,000 0 78,520,000 Practical Capacity $108,000,000 Normal Capacity Utilization $108,000,000 0 78,520,000 0 78,520,000 15,600,000 94,120,000 20,800,000 99,320,000 26,000,000 104,520,000 (7,240,000) 11,488,000 U 98,368,000 9,632,000 0 $ 9,632,000 (7,640,000) 6,288,000 U 97,968,000 10,032,000 0 $ 10,032,000 (8,040,000) 1,088,000 U 97,568,000 10,432,000 0 $ 10,432,000 Motivational considerations in denominator-level capacity selection (continuation of 9-32). 1. If the plant manager gets a bonus based on operating income, he/she will prefer the denominator-level capacity to be based on normal capacity utilization (or master-budget utilization). In times of rising inventories, as in 2009, this denominator level will maximize the fixed overhead trapped in ending inventories and will minimize COGS and maximize operating income. Of course, the plant manager cannot always hope to increase inventories every period, but on the whole, he/she would still prefer to use normal capacity utilization because the smaller the denominator, the higher the amount of overhead costs capitalized for inventory units. Thus, if the plant manager wishes to be able to “adjust” plant operating income by building inventory, normal capacity utilization (or master-budget capacity utilization) would be preferred. 2. Given the data in this question, the theoretical capacity concept reports the lowest operating income and thus (other things being equal) the lowest tax bill for 2009. Lucky Lager benefits by having deductions as early as possible. The theoretical capacity denominator-level concept maximizes the deductions for manufacturing costs. 3. The IRS may restrict the flexibility of a company in several ways: a. Restrict the denominator-level concept choice (to say, practical capacity). b. Restrict the cost line items that can be expensed rather than inventoried. c. Restrict the ability of a company to use shorter write-off periods or more accelerated write-off periods for inventoriable costs. d. Require proration or allocation of variances to represent actual costs and actual capacity used. 9-35 9-34 (25 min.) Denominator-level choices, changes in inventory levels, effect on operating income. 1. Denominator level in units Budgeted fixed manuf. costs Budgeted fixed manuf. cost allocated per unit Production in units Allocated fixed manuf. costs (production in units budgeted fixed manuf. cost allocated per unit) Production volume variance (Budgeted fixed manuf. costs – allocated fixed manuf. costs)a aPVV Theoretical Capacity 144,000 $1,440,000 $ 10.00 104,000 Practical Capacity 120,000 $1,440,000 $ 12.00 104,000 Normal Utilization Capacity 96,000 $1,440,000 $ 15.00 104,000 $1,040,000 $1,248,000 $1,560,000 $ 400,000 U $ 192,000 U $ 120,000 F is unfavorable if budgeted fixed manuf. costs are greater than allocated fixed costs 2. Units sold Budgeted fixed mfg. cost allocated per unit Budgeted var. mfg. cost per unit Budgeted cost per unit of inventory or production ABSORPTION-COSTING BASED INCOME STATEMENTS Revenues ($3 selling price per unit units sold) Cost of goods sold Beginning inventory (10,000 units budgeted cost per unit of inventory) Variable manufacturing costs (104,000 units $3 per unit) Allocated fixed manufacturing overhead (104,000 units budgeted fixed mfg. cost allocated per unit) Cost of goods available for sale Deduct ending inventory (2,000b units budgeted cost per unit of inventory) Adjustment for production-volume variance Total cost of goods sold Gross margin Operating costs Operating income bEnding Theoretical Capacity 112,000 $10 $ 3 $13 Practical Capacity 112,000 $12 $ 3 $15 Normal Utilization Capacity 112,000 $15 $ 3 $18 $3,360,000 $3,360,000 $3,360,000 130,000 150,000 180,000 312,000 312,000 312,000 1,040,000 1,482,000 1,248,000 1,710,000 1,560,000 2,052,000 (26,000) 400,000 U 1,856,000 1,504,000 400,000 $1,104,000 (30,000) 192,000 U 1,872,000 1,488,000 400,000 $1,088,000 (36,000) (120,000) F 1,896,000 1,464,000 400,000 $1,064,000 inventory = Beginning inventory + production – sales = 10,000 + 104,000 – 112,000 = 2,000 units 2,000 x $13; 2,000 x $15; 2,000 x $18 9-36 3. Koshu’s 2009 beginning inventory was 10,000 units; its ending inventory was 2,000 units. So, during 2009, there was a drop of 8,000 units in inventory levels (matching the 8,000 more units sold than produced). The smaller the denominator level, the larger is the budgeted fixed cost allocated to each unit of production, and, when those units are sold (all the current production is sold, and then some), the larger is the cost of each unit sold, and the smaller is the operating income. Normal utilization capacity is the smallest capacity of the three, hence in this year, when production was less than sales, the absorption-costing based operating income is the smallest when normal capacity utilization is used as the denominator level. 4. Reconciliation Theoretical Capacity Operating Income – Practical Capacity Operating Income Decrease in inventory level during 2009 8,000 Fixed mfg cost allocated per unit under practical capacity – fixed mfg. cost allocated per unit under theoretical capacity ($12 – $10) $2 Additional allocated fixed cost included in COGS under practical capacity = 8,000 units $2 per unit = $16,000 $16,000 More fixed manufacturing costs are included in inventory under practical capacity, so, when inventory level decreases (as it did in 2009), more fixed manufacturing costs are included in COGS under practical capacity than under theoretical capacity, resulting in a lower operating income. 9-37 9-35 (30-35 min.) Effects of denominator-level choice. 1. Normal capacity utilization. Givens denoted* Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) Allocated: Budgeted Input Allowed for Actual Costs Actual Output Incurred × Budgeted Rate (1) (4) 28,000 hrs.* × $2.00a $52,000 $48,000* $48,000* = $56,000 $4,000 U* $8,000 F* Spending variance Never a variance Prodn. volume variance Production volume = 错误!未指定开关参数。 variance – $8,000 X a Budgeted fixed manufacturing = ($48,000 – X) = $56,000 = $56,000 ÷ 28,000 machine-hours overhead rate per unit = $2 per machine-hour Denominator level = $48,000 ÷ $2 per machine-hour = 24,000 machine-hours 9-38 2. Practical capacity. Givens denoted* Same Lump Sum (as in Static Budget) Regardless of Budgeted Output Level (2) Flexible Budget: Same Lump Sum (as in Static Budget) Regardless of Budgeted Output Level (3) Allocated: Budgeted Input Allowed for Actual Costs Actual Output Incurred × Budgeted Rate (1) (4) 28,000* × $1.20a $52,000 $48,000* $48,000* = $33,600 $4,000 U* $14,400 U* Spending variance Never a variance Prodn. volume variance Production-volume variance $14,400 = 错误!未指定开关参数。 = ($48,000 – X) X = $33,600 a Budgeted manufacturing = $33,600 ÷ 28,000 machine-hours overhead rate per unit = $1.20 per machine-hour Denominator level = $48,000 ÷ $1.20 per machine-hour = 40,000 machine-hours 3. To maximize operating income, the executive vice president would favor using normal capacity utilization rather than practical capacity. Why? Because normal capacity utilization is a smaller base than practical capacity, resulting in any year-end inventory having a higher unit cost. Thus, less fixed manufacturing overhead would become a 2009 expense as part of the production-volume variance if normal capacity utilization were used as the denominator level. 9-39 9-36 (20 min.) Downward demand spiral. 1. and 2. Original 7,500 7,500 $100 $2,250,000 100% Practical capacity (units) Budgeted capacity (units) Variable manufacturing cost per unit Fixed manufacturing costs Markup percentage Manufacturing cost per unit Variable Fixed (fixed mfg costs budgeted capacity) ($2,250,000 7,500; $2,250,000 6,000) Full manufacturing cost per unit Selling Price (200% of full manuf. cost per unit) Competitive Situation 7,500 6,000 $100 $2,250,000 100% $100 $100 300 $400 $800 375 $475 $950 3. We can see that when the budgeted production is used as the denominator level and this level changes with anticipated demand, then the full manufacturing cost per unit and therefore the selling price can be quite sensitive to the denominator level. In this case, the denominator level has fallen by 20% [(7,500 – 6,000) 7,500] and the allocated fixed cost has increased by 25% [($375 – $300) 300], resulting in an 18.75% [($950 – $800) $800] increase in selling price. If Network’s market is becoming more competitive because of foreign entrants, raising the selling price could further drive away customers, lower the budgeted capacity and raise the fixed cost per unit, that is, lead to a downward spiral. If Network’s production plant was built for a practical capacity of 7,500 units, a denominator level of 7,500 units should be used, and the cost of excess capacity should not be charged to the units produced and sold. This will focus managerial attention on the unused capacity. If the competitive trends continue, Network will need to cut back its installed capacity to stay competitive. 4. Suppose Network sells x units each year. Its total cost to manufacture the x units would be $100x + $2,250,000. Its total cost to purchase x units would be $400x + $450,000. Therefore, Network should manufacture in-house, if $100x + $2,250,000 < $400x + $450,000; i.e., if x > 6,000 units. In-house, the cost structure is a low variable cost, high fixed cost structure, and only worth pursuing for high volumes. The source-outside cost structure is a high variable cost, low fixed cost structure, and only worth pursuing for small volumes. Currently, demand is exactly at 6,000 units. Network should conduct some research to forecast future demand patterns. If it seems likely that demand is going to fall below 6,000, it may be better to shut down its production capacity and outsource all of its needed units. This may also allow the management to examine and pursue other business options, as its current business gets increasingly competitive. 9-40 9-37 (35 min.) Absorption costing and production volume variance -- alternative capacity bases 1. Inventoriable cost per unit = Variable production cost + Fixed manufacturing overhead/Capacity Capacity Type Theoretical Practical Normal Master Budget Capacity Level 800,000 500,000 250,000 200,000 Fixed Mfg. Overhead $1,000,000 $1,000,000 $1,000,000 $1,000,000 Fixed Mfg. Overhead Rate $1.25 $2.00 $4.00 $5.00 Variable Production Cost $2.50 $2.50 $2.50 $2.50 Inventoriable Cost Per Unit $3.75 $4.50 $6.50 $7.50 2. ELF’s actual production level is 220,000 bulbs. We can compute the production-volume variance as: Production Volume Variance = Budgeted Fixed Mfg. Overhead – (Fixed Mfg. Overhead Rate × Actual Production Level) Capacity Type Theoretical Practical Normal Master Budget Capacity Level 800,000 500,000 250,000 200,000 Fixed Mfg. Overhead $1,000,000 $1,000,000 $1,000,000 $1,000,000 Fixed Mfg. Overhead Rate $1.25 $2.00 $4.00 $5.00 Fixed Mfg. Overhead Rate × Actual Production $ 275,000 $ 440,000 $ 880,000 $1,100,000 Production Volume Variance $725,000 U $560,000 U $120,000 U $100,000 F 3. Operating Income for ELF given production of 220,000 bulbs and sales of 200,000 bulbs @ $9 apiece: Revenue Less: Cost of goods sold a Productionvolume variance Gross margin Variable selling b Fixed selling Operating income a200,000 b200,000 Theoretical $1,800,000 Practical $1,800,000 Normal $1,800,000 Master Budget $1,800,000 750,000 900,000 1,300,000 1,500,000 725,000 U 325,000 50,000 250,000 $ 25,000 560,000 U 340,000 50,000 250,000 $ 40,000 120,000 U 380,000 50,000 250,000 $ 80,000 (100,000)F 400,000 50,000 250,000 $ 100,000 × 3.75, × 4.50, × 6.50, × 7.50 × 0.25 9-41 9-38 (35 min.) Operating income effects of denominator-level choice and disposal of production-volume variance (continuation of 9-37) 9-37 1. Since no beginning inventories exist, if ELF sells all 220,000 bulbs manufactured, its operating income will be the same under all four capacity options. Calculations are provided below: Revenue Less: Cost of goods sold a Production volume variance Gross margin Variable selling b Fixed selling Operating income a220,000 b200,000 Theoretical $1,980,000 Practical $1,980,000 Normal $1,980,000 Master Budget $1,980,000 825,000 990,000 1,430,000 1,650,000 725,000 U 430,000 55,000 250,000 $ 125,000 560,000 U 430,000 55,000 250,000 $ 125,000 120,000 U 430,000 55,000 250,000 $ 125,000 (100,000) F 430,000 55,000 250,000 $ 125,000 × 3.75, × 4.50, × 6.50, × 7.50 × 0.25 2. If the manager of ELF produces and sells 220,000 bulbs, then all capacity levels will result in the same operating income of $125,000 (see requirement 1 above). If the manager of ELF is able to sell only 200,000 of the bulbs produced and if the production-volume variance is closed to cost of goods sold, then the operating income is given as in requirement 3 of 9-37. Both sets of numbers are reproduced below. Income with sales of 220,000 bulbs Income with sales of 200,000 bulbs Decrease in income when there is over production Theoretical $125,000 25,000 Practical $125,000 40,000 Normal $125,000 80,000 Master Budget $125,000 100,000 $100,000 $ 85,000 $ 45,000 $ 25,000 Comparing these results, it is clear that for a given level of overproduction relative to sales, the manager’s performance will appear better if he/she uses as the denominator a level that is lower. In this example, setting the denominator to equal the master budget (the lowest of the four capacity levels here), minimizes the loss to the manager from being unable to sell the entire production quantity of 220,000 bulbs. 9-42 3. In this scenario, the manager of ELF produces 220,000 bulbs and sells 200,000 of them, and the production volume variance is prorated. Given the absence of ending work in process inventory or beginning inventory of any kind, the fraction of the production volume variance that is absorbed into the cost of goods sold is given by 200,000/220,000 or 10/11. The operating income under various denominator levels is then given by the following modification of the solution to requirement 3 of 9-37: Revenue Less: Cost of goods sold Prorated productionvolume variance a Gross margin Variable selling b Fixed selling Operating income a (10/11) b200,000 Theoretical $1,800,000 Practical $1,800,000 Normal $1,800,000 Master Budget $1,800,000 750,000 900,000 1,300,000 1,500,000 659,091 U 390,909 50,000 250,000 $ 90,909 509,091 U 390,909 50,000 250,000 $ 90,909 109,091 U 390,909 50,000 250,000 $ 90,909 (90,909) F 390,909 50,000 250,000 $ 90,909 × 725,000, × 560,000, × 120,000, × 100,000 × 0.25 Under the proration approach, operating income is $90,909 regardless of the denominator initially used. Thus, in contrast to the case where the production volume variance is written off to cost of goods sold, there is no temptation under the proration approach for the manager to play games with the choice of denominator level. 9-43 9-39 (30 min.) Cost allocation, downward demand spiral. SOLUTION EXHIBIT 9-39 2009 2010 Master Practical Master Budget Capacity Budget (1) (2) (3) $1,533,000 $1,533,000 $1,533,000 1,022,000 1,460,000 876,000 Budgeted fixed costs Denominator level Budgeted fixed cost per meal Budgeted fixed costs Denominator level ($1,533,000 1,022,000; $1,533,000 1,460,000; $1,533,000 876,000) $ Budgeted variable cost per meal Total budgeted cost per meal $ 1.50 $ 4.50 6.00 $ 1.05 $ 4.50 5.55 $ 1.75 4.50 6.25 1. The 2009 budgeted fixed costs are $1,533,000. Deliman budgets for 1,022,000 meals in 2009, and this is used as the denominator level to calculate the fixed cost per meal. $1,533,000 1,022,000 = $1.50 fixed cost per meal. (see column (1) in Solution Exhibit 9-39). 2. In 2010, 3 hospitals have dropped out of the purchasing group and the master budget is 876,000 meals. If this is used as the denominator level, fixed cost per meal = $1,533,000 876,000 = $1.75 per meal, and the total budgeted cost per meal would be $6.25 (see column (3) in Solution Exhibit 9-39). If the hospitals have already been complaining about quality and cost and are allowed to purchase from outside, they will not accept this higher price. More hospitals may begin to purchase meals from outside the system, leading to a downward demand spiral, possibly putting Deliman out of business. 3. The basic problem is that Deliman has excess capacity and the associated excess fixed costs. If Smith uses the practical capacity of 1,460,000 meals as the denominator level, the fixed cost per meal will be $1.05 (see column (2) in Solution Exhibit 9-39), and the total budgeted cost per meal would be $5.55, probably a more acceptable price to the customers (it may even draw back the three hospitals that have chosen to buy outside). This denominator level will also isolate the cost of unused capacity and not allocate it to the meals produced. To make the $5.55 price per meal profitable in the long run, Smith will have to find ways to either use the extra capacity or reduce Deliman’s practical capacity and the related fixed costs. 9-44 9-40 (20 min.) Cost allocation, responsibility accounting, ethics (continuation of 9-39). 1. (See Solution Exhibit 9-39). If Deliman uses its master budget capacity utilization to allocate fixed costs in 2010, it would allocate 806,840 $1.75 = $1,411,970. Budgeted fixed costs are $1,533,000. Therefore, the production volume variance = $1,533,000 – $1,411,970 = $121,030 U. An unfavorable production volume variance will reduce operating income by this amount. (Note: in this business, there are no inventories. All variances are written off to cost of goods sold). 2. Hospitals are charged a budgeted variable cost rate and allocated budgeted fixed costs. By overestimating budgeted meal counts, the denominator-level is larger, hence the amount charged to individual hospitals is lower. Consider 2010 where the budgeted fixed cost rate is computed as follows: $1,533,000/876,000 meals = $1.75 per meal If in fact, the hospital administrators had better estimated and revealed their true demand (say, 806,800 meals), the allocated fixed cost per meal would have been $1,533,000/806,800 meals = $1.90 per meal, 8.6% higher than the $1.75 per meal. Hence, by deliberately overstating budgeted meal count, hospitals are able to reduce the price charged by Deliman for each meal. In this scheme, Deliman bears the downside risk of demand overestimates. 3. Evidence that could be collected include: (a) Budgeted meal-count estimates and actual meal-count figures each year for each hospital controller. Over an extended time period, there should be a sizable number of both underestimates and overestimates. Controllers could be ranked on both their percentage of overestimation and the frequency of their overestimation. (b) Look at the underlying demand estimates by patients at individual hospitals. Each hospital controller has other factors (such as hiring of nurses) that give insight into their expectations of future meal-count demands. If these factors are inconsistent with the meal-count demand figures provided to the central food-catering facility, explanations should be sought. 4. (a) Highlight the importance of a corporate culture of honesty and openness. Deli One could institute a Code of Ethics that highlights the upside of individual hospitals providing honest estimates of demand (and the penalties for those who do not). (b) Have individual hospitals contract in advance for their budgeted meal count. Unused amounts would be charged to each hospital at the end of the accounting period. This approach puts a penalty on hospital administrators who overestimate demand. (c) Use an incentive scheme that has an explicit component for meal-count forecasting accuracy. Each meal-count “forecasting error” would reduce the bonus by $0.05. Thus, if a hospital bids for 292,000 meals and actually uses 200,000 meals, its bonus would be reduced by $0.05 × (292,000 – 200,000) = $4,600. 9-45 Collaborative Learning Problem 9-41 (50 min.) Absorption, variable, and throughput costing (1) Variable Costing Revenuesa Variable costs Beginning inventoryb Variable manufacturing costsc Cost of goods available for sale Deduct ending inventoryd Variable cost of goods sold Variable selling costse Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed administrative costs Total fixed costs Operating income April 2008 $300,000 $ 0 77,500 77,500 0 77,500 7,500 May 2008 $300,000 $ 0 108,500 108,500 (31,000) 77,500 7,500 85,000 215,000 June 2008 $300,000 $ 31,000 46,500 77,500 0 77,500 7,500 85,000 85,000 215,000 215,000 105,000 35,000 105,000 35,000 140,000 $ 75,000 a $6 × 50,000 b ? × 0; $1.55 × 0; $1.55 × 20,000 c $1.55 × 50,000; $1.55 × 70,000; $1.55 × 30,000 d $1.55 × 0; $1.55 × 20,000; $1.55 × 0 e $.15 × 50,000 9-46 105,000 35,000 140,000 $ 75,000 140,000 $ 75,000 (2) Absorption Costing Revenuesa Cost of goods sold Beginning inventoryb Variable manufacturing costsc Allocated fixed manufacturing costsd Cost of goods available for sale Deduct ending inventorye Adjustment for prod. vol. var.f Cost of goods sold Gross margin Operating costs Variable selling costsg Fixed administrative costs Total operating costs Operating income April 2008 $300,000 $ 0 77,500 105,000 182,500 0 0 May 2008 $300,000 $ 0 108,500 105,000 213,500 (61,000) 30,000 U 182,500 117,500 7,500 $ 61,000 46,500 105,000 212,500 0 0 152,500 147,500 7,500 35,000 June 2008 $300,000 212,500 87,500 7,500 35,000 35,000 42,500 42,500 42,500 $ 75,000 $105,000 $ 45,000 a $6 × 50,000 0; $3.65× 0; $3.05 × 20,000 c $1.55 × 50,000; $1.55 × 70,000; $1.55 × 30,000 d ($105,000/50,000)×50,000; ($105,000/70,000) ×70,000; (105,000/30,000)×30,000 e $3.65 × 0; $3.05 × 20,000; $5.05 × 0 f $105,000 – $105,000; $105,000 – $105,000; $105,000 – $105,000 g $.15 × 50,000 b $?× 9-47 (3) Throughput costing Revenues Direct material cost of goods sold Beginning inventoryb Direct materials in goods manufacturedc Cost of goods available for sale Deduct ending inventoryd Total direct material cost of goods sold April 2008 $300,000 a Throughput contribution Other costs Manufacturinge Operatingf Total other costs Operating income $ May 2008 $300,000 0 $ June 2008 $300,000 40,000 $ 16,000 56,000 40,000 0 24,000 56,000 (16,000) 0 40,000 40,000 0 40,000 260,000 40,000 260,000 142,500 42,500 157,500 42,500 185,000 $ 75,000 a $6 × 50,000 0; $0.80× 0; $0.80 × 20,000 c $0.80 × 50,000; $0.80 × 70,000; $0.80 × 30,000 d $0.80 × 0; $0.80 × 20,000; $0.80 × 0 e ($0.75 × 50,000) + $105,000; ($0.75× 70,000) + $105,000; ($0.75 × 30,000) + $105,000 f ($0.15 × 50,000) + $35,000 b $?× 9-48 260,000 127,500 42,500 200,000 $ 60,000 170,000 $ 90,000 4. The benefit of using throughput costing is that net income is reduced if managers produce more units than they can sell. By treating all costs, except direct material costs, as period costs, the income statement expenses not only the cost of goods sold but also the direct labor and variable overhead costs associated with units in ending inventory. So reported income is reduced by the cost of unnecessary production. For performance evaluation purposes, variable costing is superior to absorption costing because it prevents managers from increasing income by just increasing production. In the same way, throughput costing may be considered superior to variable costing because not only is management not rewarded for producing more than can be sold, they are penalized for excess production. In this example, income is highest when management produced less than demand and therefore reduced inventory that already existed. 9-49 CHAPTER 10 DETERMINING HOW COSTS BEHAVE 10-1 1. 2. 10-2 1. 2. 3. The two assumptions are Variations in the level of a single activity (the cost driver) explain the variations in the related total costs. Cost behavior is approximated by a linear cost function within the relevant range. A linear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity forms a straight line. Three alternative linear cost functions are Variable cost function––a cost function in which total costs change in proportion to the changes in the level of activity in the relevant range. Fixed cost function––a cost function in which total costs do not change with changes in the level of activity in the relevant range. Mixed cost function––a cost function that has both variable and fixed elements. Total costs change but not in proportion to the changes in the level of activity in the relevant range. 10-3 A linear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity related to that cost is a straight line. An example of a linear cost function is a cost function for use of a telephone line where the terms are a fixed charge of $10,000 per year plus a $2 per minute charge for phone use. A nonlinear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity related to that cost is not a straight line. Examples include economies of scale in advertising where an agency can double the number of advertisements for less than twice the costs, step-cost functions, and learning-curve-based costs. 10-4 No. High correlation merely indicates that the two variables move together in the data examined. It is essential also to consider economic plausibility before making inferences about cause and effect. Without any economic plausibility for a relationship, it is less likely that a high level of correlation observed in one set of data will be similarly found in other sets of data. 10-5 1. 2. 3. 4. Four approaches to estimating a cost function are Industrial engineering method. Conference method. Account analysis method. Quantitative analysis of current or past cost relationships. 10-6 The conference method estimates cost functions on the basis of analysis and opinions about costs and their drivers gathered from various departments of a company (purchasing, process engineering, manufacturing, employee relations, etc.). Advantages of the conference method include 1. The speed with which cost estimates can be developed. 2. The pooling of knowledge from experts across functional areas. 3. The improved credibility of the cost function to all personnel. 10-1 10-7 The account analysis method estimates cost functions by classifying cost accounts in the subsidiary ledger as variable, fixed, or mixed with respect to the identified level of activity. Typically, managers use qualitative, rather than quantitative, analysis when making these costclassification decisions. 10-8 The six steps are 1. Choose the dependent variable (the variable to be predicted, which is some type of cost). 2. Identify the independent variable or cost driver. 3. Collect data on the dependent variable and the cost driver. 4. Plot the data. 5. Estimate the cost function. 6. Evaluate the cost driver of the estimated cost function. Step 3 typically is the most difficult for a cost analyst. 10-9 Causality in a cost function runs from the cost driver to the dependent variable. Thus, choosing the highest observation and the lowest observation of the cost driver is appropriate in the high-low method. 10-10 1. 2. 3. Three criteria important when choosing among alternative cost functions are Economic plausibility. Goodness of fit. Slope of the regression line. 10-11 A learning curve is a function that measures how labor-hours per unit decline as units of production increase because workers are learning and becoming better at their jobs. Two models used to capture different forms of learning are 1. Cumulative average-time learning model. The cumulative average time per unit declines by a constant percentage each time the cumulative quantity of units produced doubles. 2. Incremental unit-time learning model. The incremental time needed to produce the last unit declines by a constant percentage each time the cumulative quantity of units produced doubles. 10-12 Frequently encountered problems when collecting cost data on variables included in a cost function are 1. The time period used to measure the dependent variable is not properly matched with the time period used to measure the cost driver(s). 2. Fixed costs are allocated as if they are variable. 3. Data are either not available for all observations or are not uniformly reliable. 4. Extreme values of observations occur. 5. A homogeneous relationship between the individual cost items in the dependent variable cost pool and the cost driver(s) does not exist. 6. The relationship between the cost and the cost driver is not stationary. 7. Inflation has occurred in a dependent variable, a cost driver, or both. 10-2 10-13 Four key assumptions examined in specification analysis are 1. Linearity of relationship between the dependent variable and the independent variable within the relevant range. 2. Constant variance of residuals for all values of the independent variable. 3. Independence of residuals. 4. Normal distribution of residuals. 10-14 No. A cost driver is any factor whose change causes a change in the total cost of a related cost object. A cause-and-effect relationship underlies selection of a cost driver. Some users of regression analysis include numerous independent variables in a regression model in an attempt to maximize goodness of fit, irrespective of the economic plausibility of the independent variables included. Some of the independent variables included may not be cost drivers. 10-15 No. Multicollinearity exists when two or more independent variables are highly correlated with each other. 10-16 (10 min.) Estimating a cost function. 1. Difference in costs Slope coefficient = Difference in machine-hours = $5, 400 $4,000 10,000 6,000 = $1, 400 = $0.35 per machine-hour 4,000 Constant = Total cost – (Slope coefficient Quantity of cost driver) = $5,400 – ($0.35 10,000) = $1,900 = $4,000 – ($0.35 6,000) = $1,900 The cost function based on the two observations is Maintenance costs = $1,900 + $0.35 Machine-hours 2. The cost function in requirement 1 is an estimate of how costs behave within the relevant range, not at cost levels outside the relevant range. If there are no months with zero machinehours represented in the maintenance account, data in that account cannot be used to estimate the fixed costs at the zero machine-hours level. Rather, the constant component of the cost function provides the best available starting point for a straight line that approximates how a cost behaves within the relevant range. 10-3 10-17 (15 min.) Identifying variable-, fixed-, and mixed-cost functions. 1. See Solution Exhibit 10-17. 2. Contract 1: y = $50 Contract 2: y = $30 + $0.20X Contract 3: y = $1X where X is the number of miles traveled in the day. 3. Contract 1 2 3 Cost Function Fixed Mixed Variable SOLUTION EXHIBIT 10-17 Plots of Car Rental Contracts Offered by Pacific Corp. Contract 1: Fixed Costs Car Rental Co sts $160 140 120 100 80 60 40 20 0 0 50 100 Miles Travel ed per Day 150 Car Rent al Costs Contract 2: Mixed Costs $160 140 120 100 80 60 40 20 0 0 100 50 Miles Travel ed per Day 150 Car Rental Co sts Contract 3: Variable Costs $160 140 120 100 80 60 40 20 0 0 50 100 Miles Travel ed per Day 10-4 150 10-18 1. 2. 3. 4. 5. 6. 7. 8. 9. (20 min.) Various cost-behavior patterns. K B G J Note that A is incorrect because, although the cost per pound eventually equals a constant at $9.20, the total dollars of cost increases linearly from that point onward. I The total costs will be the same regardless of the volume level. L F This is a classic step-cost function. K C 10-19 (30 min.) Matching graphs with descriptions of cost and revenue behavior. a. b. c. d. e. f. (1) (6) (9) (2) (8) (10) g. h. (3) (8) A step-cost function. It is data plotted on a scatter diagram, showing a linear variable cost function with constant variance of residuals. The constant variance of residuals implies that there is a uniform dispersion of the data points about the regression line. 10-20 (15 min.) Account analysis method. 1. Variable costs: Car wash labor $260,000 Soap, cloth, and supplies 42,000 Water 38,000 Electric power to move conveyor belt 72,000 Total variable costs $412,000 Fixed costs: Depreciation $ 64,000 Salaries 46,000 Total fixed costs $110,000 Some costs are classified as variable because the total costs in these categories change in proportion to the number of cars washed in Lorenzo’s operation. Some costs are classified as fixed because the total costs in these categories do not vary with the number of cars washed. If the conveyor belt moves regardless of the number of cars on it, the electricity costs to power the conveyor belt would be a fixed cost. 2. $412,000 = $5.15 per car 80,000 Total costs estimated for 90,000 cars = $110,000 + ($5.15 × 90,000) = $573,500 Variable costs per car = 10-5 10-21 ( 15 min.) Account analysis 1. The electricity cost is clearly variable since it entirely depends on number of kilowatt hours used. The Waste Management contract is a fixed amount if the cost object is not number of quarters, since it does not depend on amount of activity or output during the quarter. The telephone cost is a mixed cost because there is a fixed component and a component that depends on number of calls made. 2. The electricity rate is $573 ÷ 3000 kw hour = $0.191 per kw hour The waste management fixed cost is $270 for three months, or $90 (270 ÷ 3) per month. The telephone cost is $20 + ($0.03 per call 1,200 calls) = $56 Adding them together we get: Fixed cost of utilities = $90 (waste management) + $20 (telephone) = $110 Utilities cost = $110 + ($0.191 per kw hour kw hours used) + ($0.03 per call number of calls) per month 3. Utilities cost = $146 + ($0.191 per kw hour 4000 hours) + ($0.03 per call 1,200 calls) for February = $146 + $764 + $36 = $910 10-6 10-22(30 min.) Account analysis method. 1. Manufacturing cost classification for 2009: Account Direct materials Direct manufacturing labor Power Supervision labor Materials-handling labor Maintenance labor Depreciation Rent, property taxes, admin Total Total Costs (1) $300,000 225,000 37,500 56,250 60,000 75,000 95,000 100,000 $948,750 % of Total Costs Fixed Variable That is Variable Costs Cost per Unit Variable Costs (2) (3) = (1) (2) (4) = (1) – (3) (5) = (3) ÷ 75,000 100% 100 100 20 50 40 0 0 $300,000 225,000 37,500 11,250 30,000 30,000 0 0 $633,750 $ 0 0 0 45,000 30,000 45,000 95,000 100,000 $315,000 $4.00 3.00 0.50 0.15 0.40 0.40 0 0 $8.45 Total manufacturing cost for 2009 = $948,750 Variable costs in 2010: Account Direct materials Direct manufacturing labor Power Supervision labor Materials-handling labor Maintenance labor Depreciation Rent, property taxes, admin. Total Unit Variable Increase in Cost per Variable Variable Cost per Unit Unit for Percentage Cost for 2010 2009 Increase per Unit (6) (7) (8) = (6) (7) (9) = (6) + (8) $4.00 3.00 0.50 0.15 0.40 0.40 0 0 $8.45 5% 10 0 0 0 0 0 0 10-7 $0.20 0.30 0 0 0 0 0 0 $0.50 $4.20 3.30 0.50 0.15 0.40 0.40 0 0 $8.95 Total Variable Costs for 2010 (10) = (9) 80,000 $336,000 264,000 40,000 12,000 32,000 32,000 0 0 $716,000 Fixed and total costs in 2010: Account Fixed Costs for 2009 (11) Direct materials $ 0 Direct manufacturing labor 0 0 Power Supervision labor 45,000 30,000 Materials-handling labor Maintenance labor 45,000 95,000 Depreciation Rent, property taxes, admin. 100,000 Total $315,000 Percentage Increase (12) 0% 0 0 0 0 0 5 7 Dollar Increase in Fixed Costs (13) = (11) (12) $ 0 0 0 0 0 0 4,750 7,000 $11,750 Fixed Costs for 2010 (14) = (11) + (13) $ 0 0 0 45,000 30,000 45,000 99,750 107,000 $326,750 Variable Costs for 2010 (15) Total Costs (16) = (14) + (15) $336,000 $ 336,000 264,000 264,000 40,000 40,000 12,000 57,000 62,000 32,000 32,000 77,000 99,750 0 0 107,000 $716,000 $1,042,750 Total manufacturing costs for 2010 = $1,042,750 2. Total cost per unit, 2009 Total cost per unit, 2010 $948,750 = $12.65 75,000 $1,042,750 = = $13.03 80,000 = 3. Cost classification into variable and fixed costs is based on qualitative, rather than quantitative, analysis. How good the classifications are depends on the knowledge of individual managers who classify the costs. Gower may want to undertake quantitative analysis of costs, using regression analysis on time-series or cross-sectional data to better estimate the fixed and variable components of costs. Better knowledge of fixed and variable costs will help Gower to better price his products, to know when he is getting a positive contribution margin, and to better manage costs. 10-8 10-23 (15–20 min.) Estimating a cost function, high-low method. 1. The key point to note is that the problem provides high-low values of X (annual round trips made by a helicopter) and Y X (the operating cost per round trip). We first need to calculate the annual operating cost Y (as in column (3) below), and then use those values to estimate the function using the high-low method. Highest observation of cost driver Lowest observation of cost driver Difference Cost Driver: Annual RoundTrips (X) (1) 2,000 1,000 1,000 Operating Cost per Round-Trip (2) $300 $350 Annual Operating Cost (Y) (3) = (1) (2) $600,000 $350,000 $250,000 Slope coefficient = $250,000 1,000 = $250 per round-trip Constant = $600,000 – ($250 2,000) = $100,000 The estimated relationship is Y = $100,000 + $250 X; where Y is the annual operating cost of a helicopter and X represents the number of round trips it makes annually. 2. The constant a (estimated as $100,000) represents the fixed costs of operating a helicopter, irrespective of the number of round trips it makes. This would include items such as insurance, registration, depreciation on the aircraft, and any fixed component of pilot and crew salaries. The coefficient b (estimated as $250 per round-trip) represents the variable cost of each round trip—costs that are incurred only when a helicopter actually flies a round trip. The coefficient b may include costs such as landing fees, fuel, refreshments, baggage handling, and any regulatory fees paid on a per-flight basis. 3. If each helicopter is, on average, expected to make 1,200 round trips a year, we can use the estimated relationship to calculate the expected annual operating cost per helicopter: Y = $100,000 + $250 X X = 1,200 Y = $100,000 + $250 1,200 = $100,000 + $300,000 = $400,000 With 10 helicopters in its fleet, Reisen’s estimated operating budget is 10 $400,000 = $4,000,000. 10-9 10-24 (20 min.) Estimating a cost function, high-low method. 1. See Solution Exhibit 10-24. There is a positive relationship between the number of service reports (a cost driver) and the customer-service department costs. This relationship is economically plausible. 2. Number of Customer-Service Service Reports Department Costs Highest observation of cost driver 436 $21,890 Lowest observation of cost driver 122 12,941 Difference 314 $ 8,949 Customer-service department costs = a + b (number of service reports) Slope coefficient (b) Constant (a) $8,949 = $28.50 per service report 314 = $21,890 – $28.50 436 = $9,464 = $12,941 – $28.50 122 = $9,464 = Customer-service = $9,464 + $28.50 (number of service reports) department costs 3. Other possible cost drivers of customer-service department costs are: a. Number of products replaced with a new product (and the dollar value of the new products charged to the customer-service department). b. Number of products repaired and the time and cost of repairs. Customer-Service Department Costs SOLUTION EXHIBIT 10-24 Plot of Number of Service Reports versus Customer-Service Dept. Costs for Capitol Products $25,000 20,000 15,000 10,000 5,000 $0 0 100 200 300 400 Number of Service Reports 10-10 500 10-25 (30–40 min.) Linear cost approximation. 1. Slope coefficient (b) Constant (a) Cost function Difference in cost = Difference in labor-hours = $529,000 $400,000 = $43.00 7,000 4,000 = $529,000 – ($43.00 × 7,000) = $228,000 = $228,000 + $43.00 professional labor-hours The linear cost function is plotted in Solution Exhibit 10-25. No, the constant component of the cost function does not represent the fixed overhead cost of the Memphis Group. The relevant range of professional labor-hours is from 3,000 to 8,000. The constant component provides the best available starting point for a straight line that approximates how a cost behaves within the 3,000 to 8,000 relevant range. 2. A comparison at various levels of professional labor-hours follows. The linear cost function is based on the formula of $228,000 per month plus $43.00 per professional labor-hour. Total overhead cost behavior: Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Professional labor-hours 3,000 4,000 5,000 6,000 7,000 8,000 Actual total overhead costs $340,000 $400,000 $435,000 $477,000 $529,000 $587,000 Linear approximation 357,000 400,000 443,000 486,000 529,000 572,000 Actual minus linear approximation $(17,000) $ 0 $ (8,000) $ (9,000) $ 0 $ 15,000 The data are shown in Solution Exhibit 10-25. The linear cost function overstates costs by $8,000 at the 5,000-hour level and understates costs by $15,000 at the 8,000-hour level. 3. Contribution before deducting incremental overhead Incremental overhead Contribution after incremental overhead The total contribution margin actually forgone is $3,000. 10-11 Based on Actual $38,000 35,000 $ 3,000 Based on Linear Cost Function $38,000 43,000 $ (5,000) SOLUTION EXHIBIT 10-25 Linear Cost Function Plot of Professional Labor-Hours on Total Overhead Costs for Memphis Consulting Group Total Overhead Costs $700,000 600,000 500,000 400,000 300,000 200,000 100,000 0 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 Professional Labor-Hours Billed 10-26 (20 min.) Cost-volume-profit and regression analysis. Average cost of manufacturing = Total manufacturing costs Number of bicycle frames = 1a. $900,000 = $30 per frame 30,000 This cost is greater than the $28.50 per frame that Ryan has quoted. 1b. Garvin cannot take the average manufacturing cost in 2009 of $30 per frame and multiply it by 36,000 bicycle frames to determine the total cost of manufacturing 36,000 bicycle frames. The reason is that some of the $900,000 (or equivalently the $30 cost per frame) are fixed costs and some are variable costs. Without distinguishing fixed from variable costs, Garvin cannot determine the cost of manufacturing 36,000 frames. For example, if all costs are fixed, the manufacturing costs of 36,000 frames will continue to be $900,000. If, however, all costs are variable, the cost of manufacturing 36,000 frames would be $30 36,000 = $1,080,000. If some costs are fixed and some are variable, the cost of manufacturing 36,000 frames will be somewhere between $900,000 and $1,080,000. Some students could argue that another reason for not being able to determine the cost of manufacturing 36,000 bicycle frames is that not all costs are output unit-level costs. If some costs are, for example, batch-level costs, more information would be needed on the number of 10-12 batches in which the 36,000 bicycle frames would be produced, in order to determine the cost of manufacturing 36,000 bicycle frames. 2. Expected cost to make = $432,000 + $15 36,000 36,000 bicycle frames = $432,000 + $540,000 = $972,000 Purchasing bicycle frames from Ryan will cost $28.50 36,000 = $1,026,000. Hence, it will cost Garvin $1,026,000 $972,000 = $54,000 more to purchase the frames from Ryan rather than manufacture them in-house. 3. Garvin would need to consider several factors before being confident that the equation in requirement 2 accurately predicts the cost of manufacturing bicycle frames. a. Is the relationship between total manufacturing costs and quantity of bicycle frames economically plausible? For example, is the quantity of bicycles made the only cost driver or are there other cost-drivers (for example batch-level costs of setups, production-orders or material handling) that affect manufacturing costs? b. How good is the goodness of fit? That is, how well does the estimated line fit the data? c. Is the relationship between the number of bicycle frames produced and total manufacturing costs linear? d. Does the slope of the regression line indicate that a strong relationship exists between manufacturing costs and the number of bicycle frames produced? e. Are there any data problems such as, for example, errors in measuring costs, trends in prices of materials, labor or overheads that might affect variable or fixed costs over time, extreme values of observations, or a nonstationary relationship over time between total manufacturing costs and the quantity of bicycles produced? f. How is inflation expected to affect costs? g. Will Ryan supply high-quality bicycle frames on time? 10-13 10-27 (25 min.) Regression analysis, service company. 1. Solution Exhibit 10-27 plots the relationship between labor-hours and overhead costs and shows the regression line. y = $48,271 + $3.93 X Economic plausibility. Labor-hours appears to be an economically plausible driver of overhead costs for a catering company. Overhead costs such as scheduling, hiring and training of workers, and managing the workforce are largely incurred to support labor. Goodness of fit The vertical differences between actual and predicted costs are extremely small, indicating a very good fit. The good fit indicates a strong relationship between the laborhour cost driver and overhead costs. Slope of regression line. The regression line has a reasonably steep slope from left to right. Given the small scatter of the observations around the line, the positive slope indicates that, on average, overhead costs increase as labor-hours increase. 2. The regression analysis indicates that, within the relevant range of 2,500 to 7,500 laborhours, the variable cost per person for a cocktail party equals: Food and beverages Labor (0.5 hrs. $10 per hour) Variable overhead (0.5 hrs $3.93 per labor-hour) Total variable cost per person $15.00 5.00 1.97 $21.97 3. To earn a positive contribution margin, the minimum bid for a 200-person cocktail party would be any amount greater than $4,394. This amount is calculated by multiplying the variable cost per person of $21.97 by the 200 people. At a price above the variable costs of $4,394, Bob Jones will be earning a contribution margin toward coverage of his fixed costs. Of course, Bob Jones will consider other factors in developing his bid including (a) an analysis of the competition––vigorous competition will limit Jones’s ability to obtain a higher price (b) a determination of whether or not his bid will set a precedent for lower prices––overall, the prices Bob Jones charges should generate enough contribution to cover fixed costs and earn a reasonable profit, and (c) a judgment of how representative past historical data (used in the regression analysis) is about future costs. SOLUTION EXHIBIT 10-27 Regression Line of Labor-Hours on Overhead Costs for Bob Jones’s Catering Company $90,000 80,000 Overhead Costs 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 Cost Driver: Labor-Hours 10-14 10-28 High-low, regression 1. Pat will pick the highest point of activity, 3400 parts (August) at $20,500 of cost, and the lowest point of activity, 1910 parts (March) at $11560. Highest observation of cost driver Lowest observation of cost driver Difference Cost driver: Quantity Purchased 3,400 1,910 1,490 Cost $20,500 11,560 $ 8,940 Purchase costs = a + b Quantity purchased $8,940 Slope coefficient (b) $6 per part 1, 490 Constant (a) = $20,500 ─ ($6 3,400) = $100 The equation Pat gets is: Purchase costs = $100 + ($6 Quantity purchased) 2. Using the equation above, the expected purchase costs for each month will be: Month October November December Purchase Quantity Expected 3,000 parts 3,200 2,500 Formula Expected cost y = $100 + ($6 3,000) $18,100 y = $100 + ($6 3,200) 19,300 y = $100 + ($6 2,500) 15,100 3. Economic Plausibility: Clearly, the cost of purchasing a part is associated with the quantity purchased. Goodness of Fit: As seen in Solution Exhibit 10-28, the regression line fits the data well. The vertical distance between the regression line and observations is small. Significance of the Independent Variable: The relatively steep slope of the regression line suggests that the quantity purchased is correlated with purchasing cost for part #4599. 10-15 SOLUTION EXHIBIT 10-28 Serth Manufacturing Purchase Costs for Part #4599 Cost of Purchase $25,000 $20,000 $15,000 $10,000 $5,000 $0 0 1,000 2,000 3,000 4,000 Quantity Purchased According to the regression, Pat’s original estimate of fixed cost is too low given all the data points. The original slope is too steep, but only by 16 cents. So, the variable rate is lower but the fixed cost is higher for the regression line than for the high-low cost equation. The regression is the more accurate estimate because it uses all available data (all nine data points) while the high-low method only relies on two data points and may therefore miss some important information contained in the other data. 4. Using the regression equation, the purchase costs for each month will be: Purchase Quantity Month Expected Formula Expected cost October 3,000 parts y = $501.54 + ($5.84 3,000) $18,022 November 3,200 y = $501.54 + ($5.84 3,200) 19,190 December 2,500 y = $501.54 + ($5.84 2,500) 15,102 Although the two equations are different in both fixed element and variable rate, within the relevant range they give similar expected costs. In fact the estimated costs for December vary by only $2. This implies that the high and low points of the data are a reasonable representation of the total set of points within the relevant range. 10-16 10-29 (20 min.) Learning curve, cumulative average-time learning model. The direct manufacturing labor-hours (DMLH) required to produce the first 2, 4, and 8 units given the assumption of a cumulative average-time learning curve of 90%, is as follows: 90% Learning Curve Cumulative Number of Units (X) (1) 1 2 3 4 5 6 7 8 Cumulative Average Time per Unit (y): Labor Hours (2) 3,000 2,700 = (3,000 0.90) 2,539 2,430 = (2,700 0.90) 2,349 2,285 2,232 2,187 = (2,430 0.90) Cumulative Total Time: Labor-Hours (3) = (1) (2) 3,000 5,400 7,616 9,720 11,745 13,710 15,624 17,496 Alternatively, to compute the values in column (2) we could use the formula y = aXb where a = 3,000, X = 2, 4, or 8, and b = – 0.152004, which gives when X = 2, y = 3,000 2– 0.152004 = 2,700 when X = 4, y = 3,000 4– 0.152004 = 2,430 when X = 8, y = 3,000 8– 0.152004 = 2,187 Direct materials $80,000 2; 4; 8 Direct manufacturing labor $25 5,400; 9,720; 17,496 Variable manufacturing overhead $15 5,400; 9,720; 17,496 Total variable costs Variable Costs of Producing 2 Units 4 Units 8 Units $160,000 $320,000 $ 640,000 135,000 243,000 437,400 81,000 $376,000 145,800 $708,800 262,440 $1,339,840 10-17 10-30 (20 min.) Learning curve, incremental unit-time learning model. 1. The direct manufacturing labor-hours (DMLH) required to produce the first 2, 3, and 4 units, given the assumption of an incremental unit-time learning curve of 90%, is as follows: 90% Learning Curve Cumulative Individual Unit Time for Xth Cumulative Total Time: Unit (y): Labor Hours Labor-Hours Number of Units (X) (1) (2) (3) 1 3,000 3,000 2 2,700 = (3,000 0.90) 5,700 3 2,539 8,239 4 2,430 = (2,700 0.90) 10,669 Values in column (2) are calculated using the formula y = aXb where a = 3,000, X = 2, 3, or 4, and b = – 0.152004, which gives when X = 2, y = 3,000 2– 0.152004 = 2,700 when X = 3, y = 3,000 3– 0.152004 = 2,539 when X = 4, y = 3,000 4– 0.152004 = 2,430 Direct materials $80,000 2; 3; 4 Direct manufacturing labor $25 5,700; 8,239; 10,669 Variable manufacturing overhead $15 5,700; 8,239; 10,669 Total variable costs Variable Costs of Producing 2 Units 3 Units 4 Units $160,000 $240,000 $ 320,000 142,500 205,975 266,725 85,500 $388,000 123,585 $569,560 160,035 $746,760 2. Incremental unit-time learning model (from requirement 1) Cumulative average-time learning model (from Exercise 10-28) Difference Variable Costs of Producing 2 Units 4 Units $388,000 $746,760 376,000 708,800 $ 12,000 $ 37,960 Total variable costs for manufacturing 2 and 4 units are lower under the cumulative average-time learning curve relative to the incremental unit-time learning curve. Direct manufacturing labor-hours required to make additional units decline more slowly in the incremental unit-time learning curve relative to the cumulative average-time learning curve when the same 90% factor is used for both curves. The reason is that, in the incremental unit-time learning curve, as the number of units double only the last unit produced has a cost of 90% of the initial cost. In the cumulative average-time learning model, doubling the number of units causes the average cost of all the additional units produced (not just the last unit) to be 90% of the initial cost. 10-18 10-31 (25 min.) High-low method. 1. Machine-Hours Highest observation of cost driver Lowest observation of cost driver Difference Maintenance costs $250,000 170,000 $ 80,000 = a + b Machine-hours $80,000 = $2 per machine-hour 40,000 Slope coefficient (b) = Constant (a) 125,000 85,000 40,000 Maintenance Costs = $250,000 – ($2 × 125,000) = $250,000 – $250,000 = $0 or Constant (a) = $170,000 – ($2 × 85,000) = $170,000 – $170,000 = $0 Maintenance costs = $2 × Machine-hours 2. SOLUTION EXHIBIT 10-31 Plot and High-Low Line of Machine-Hours on Maintenance Costs $260,000 Maintenance Costs 240,000 220,000 200,000 180,000 160,000 140,000 120,000 100,000 80,000 90,000 100,000 110,000 Machine-Hours 10-19 120,000 130,000 Solution Exhibit 10-31 presents the high-low line. Economic plausibility.The cost function shows a positive economically plausible relationship between machine-hours and maintenance costs. There is a clear-cut engineering relationship of higher machine-hours and maintenance costs. Goodness of fit.The high-low line appears to “fit” the data well. The vertical differences between the actual and predicted costs appear to be quite small. Slope of high-low line.The slope of the line appears to be reasonably steep indicating that, on average, maintenance costs in a quarter vary with machine-hours used. 3. Using the cost function estimated in 1, predicted maintenance costs would be $2 × 90,000 = $180,000. Howard should budget $180,000 in quarter 13 because the relationship between machinehours and maintenance costs in Solution 10-31 is economically plausible, has an excellent goodness of fit, and indicates that an increase in machine-hours in a quarter causes maintenance costs to increase in the quarter. 10-32 (30min.) High-low method and regression analysis. 1. See Solution Exhibit 10-32. Weekly Total Costs SOLUTION EXHIBIT 10-32 Plot, High-low Line, and Regression Line for Number of Customers per Week versus Weekly Total Costs for Happy Business College Restaurant $25,000 $20,000 Regression line $15,000 $10,000 High-low line $5,000 $0 0 200 400 600 Number of Customers per Week 10-20 800 1000 2. Number of Customers per week Highest observation of cost driver (Week 9) 925 Lowest observation of cost driver (Week 2) 745 Difference 180 Weekly total costs = a + b (number of customers per week) Slope coefficient (b) Constant (a) Weekly total costs Weekly Total Costs $20,305 16,597 $ 3,708 $3,708 = $20.60 per customer 180 = $20,305 – ($20.60 925) = $1,250 = $16,597 – ($20.60 745) = $1,250 = = $1,250 + $20.60 (number of customers per week) See high-low line in Solution Exhibit 10-32. 3. Solution Exhibit 10-32 presents the regression line. Economic Plausibility. The cost function shows a positive economically plausible relationship between number of customers per week and weekly total restaurant costs. Number of customers is a plausible cost driver since both cost of food served and amount of time the waiters must work (and hence their wages) increase with the number of customers served. Goodness of fit. The regression line appears to fit the data well. The vertical differences between the actual costs and the regression line appear to be quite small. Significance of independent variable. The regression line has a steep positive slope and increases by more than $19 for each additional customer. Because the slope is not flat, there is a strong relationship between number of customers and total restaurant costs. The regression line is the more accurate estimate of the relationship between number of customers and total restaurant costs because it uses all available data points while the high-low method relies only on two data points and may therefore miss some information contained in the other data points. Nevertheless, the graphs of the two lines are fairly close to each other, so the cost function estimated using the high-low method appears to be a good approximation of the cost function estimated using the regression method. 4. The cost estimate by the two methods will be equal where the two lines intersect. You can find the number of customers by setting the two equations to be equal and solving for x. That is, $1,250 + $20.60x = $2,453 + $19.04x $20.60 x ─ $19.04 x = $2,453 ─ $1,250 1.56 x = 1,203 x = 771.15 or ≈ 771customers. 10-21 10-33 (3040 min.) High-low method, regression analysis. 1. Solution Exhibit 10-33 presents the plots of advertising costs on revenues. SOLUTION EXHIBIT 10-33 Plot and Regression Line of Advertising Costs on Revenues $90,000 80,000 70,000 Revenues 60,000 50,000 40,000 30,000 20,000 10,000 0 $0 $1,000 $2,000 $3,000 $4,000 $5,000 Advertising Costs 2. Solution Exhibit 10-33 also shows the regression line of advertising costs on revenues. We evaluate the estimated regression equation using the criteria of economic plausibility, goodness of fit, and slope of the regression line. Economic plausibility. Advertising costs appears to be a plausible cost driver of revenues. Restaurants frequently use newspaper advertising to promote their restaurants and increase their patronage. Goodness of fit. The vertical differences between actual and predicted revenues appears to be reasonably small. This indicates that advertising costs are related to restaurant revenues. Slope of regression line. The slope of the regression line appears to be relatively steep. Given the small scatter of the observations around the line, the steep slope indicates that, on average, restaurant revenues increase with newspaper advertising. 10-22 3. The high-low method would estimate the cost function as follows: Advertising Costs Highest observation of cost driver $4,000 Lowest observation of cost driver 1,000 Difference $3,000 Revenues = a + (b advertising costs) Slope coefficient (b) Constant (a) = Revenues $80,000 55,000 $25,000 $25,000 = 8.333 $3,000 = $80,000 ($4,000 8.333) = $80,000 $33,332 = $46,668 or Constant (a) = $55,000 ($1,000 8.333) = $55,000 $8,333 = $46,667 Revenues 4. = $46,667 + (8.333 Advertising costs) The increase in revenues for each $1,000 spent on advertising within the relevant range is a. Using the regression equation, 8.723 $1,000 = $8,723 b. Using the high-low equation, 8.333 $1,000 = $8,333 The high-low equation does fairly well in estimating the relationship between advertising costs and revenues. However, Martinez should use the regression equation because it uses information from all observations. The high-low method, on the other hand, relies only on the observations that have the highest and lowest values of the cost driver and these observations are generally not representative of all the data. 10-23 10-34 (30 min.) Regression, activity-based costing, choosing cost drivers. 1. Both number of units inspected and inspection labor-hours are plausible cost drivers for inspection costs. The number of units inspected is likely related to test-kit usage, which is a significant component of inspection costs. Inspection labor-hours are a plausible cost driver if labor hours vary per unit inspected, because costs would be a function of how much time the inspectors spend on each unit. This is particularly true if the inspectors are paid a wage, and if they use electric or electronic machinery to test the units of product (cost of operating equipment increases with time spent). 2. Solution Exhibit 10-34 presents (a) the plots and regression line for number of units inspected versus inspection costs and (b) the plots and regression line for inspection laborhours and inspection costs. SOLUTION EXHIBIT 10-34A Plot and Regression Line for Units Inspected versus Inspection Costs for Newroute Manufacturing Inspection Costs Newroute Manufacturing Inspection Costs and Units Inspected $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 0 500 1,000 1,500 2,000 2,500 3,000 Number of Units Inspected SOLUTION EXHIBIT 10-34B Plot and Regression Line for Inspection Labor-Hours and Inspection Costs for Newroute Manufacturing Inspection Costs Newroute Manufacturing Inspection Costs and Inspection Labor-Hours $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 0 50 100 150 200 250 300 Inspection Labor-Hours Goodness of Fit. As you can see from the two graphs, the regression line based on number of units inspected better fits the data (has smaller vertical distances from the points to the line) 10-24 than the regression line based on inspection labor-hours. The activity of inspection appears to be more closely linearly related to the number of units inspected than inspection laborhours. Hence number of units inspected is a better cost driver. This is probably because the number of units inspected is closely related to test-kit usage, which is a significant component of inspection costs. Significance of independent variable. It is hard to visually compare the slopes because the graphs are not the same size, but both graphs have steep positive slopes indicating a strong relationship between number of units inspected and inspection costs, and inspection laborhours and inspection costs. Indeed, if labor-hours per inspection do not vary much, number of units inspected and inspection labor-hours will be closely related. Overall, it is the significant cost of test-kits that is driven by the number of units inspected (not the inspection labor-hours spent on inspection) that makes units inspected the preferred cost driver. 3. At 150 inspection labor hours and 1200 units inspected, Inspection costs using units inspected = $1,004 + ($2.02 × 1200) = $3,428 Inspection costs using inspection labor-hours = $626 + ($19.51 × 150) = $3,552.50 If Neela uses inspection-labor-hours she will estimate inspection costs to be $3,552.50, $124.50 ($3,552.50 ─$3,428) higher than if she had used number of units inspected. If actual costs equaled, say, $3,500, Neela would conclude that Newroute has performed efficiently in its inspection activity because actual inspection costs would be lower than budgeted amounts. In fact, based on the more accurate cost function, actual costs of $3,500 exceeded the budgeted amount of $3,428. Neela should find ways to improve inspection efficiency rather than mistakenly conclude that the inspection activity has been performing well. 10-25 10-35 (15-20min.) Interpreting regression results, matching time periods. 1. The regression of 2 years of Brickman’s monthly data yields the following estimated relationships: Maintenance costs = $21,000 – ($2.20 per machine-hour Number of machine-hours); Sales revenue = $310,000 – ($1.80 advertising expenditure) Sascha Green is commenting about some surprising and economically-implausible regression results. In the first regression, the coefficient on machine-hours has a negative sign. This implies that the greater the number of machine-hours (i.e., the longer the machines are run), the smaller will be the maintenance costs; specifically, it suggests that each extra machine hour reduces maintenance costs by $2.20. Similarly, the second regression, with its negative coefficient on advertising expenditure, implies that each extra dollar spent on advertising will actually reduce sales revenue by $1.80! Clearly, these estimated relationships are not economically plausible. 2. The problem statement tells us that Brickman has four peak sales periods, each lasting two months and it schedules maintenance in the intervening months, when production volume is low. To correctly understand the relationship between machine-hours and maintenance costs, Brickman should estimate the regression equation of maintenance costs on lagged (i.e., previous months’) machine-hours. The greater the machine use in one month, the greater is the expected maintenance costs in later months. 3. The negative coefficient on advertising expenditure in the second regression can likely be explained by (1) the fact that advertising during a particular period increases sales revenues in subsequent periods (2) the possibility that Brickman may be increasing advertising outlays during periods of declining sales in an attempt to clear out its end-of-season merchandise. Brickman should therefore estimate the relationship between advertising costs in a particular period and sales in future periods. In fact, Brickman’s marketing and sales staff may be able to provide a good sense of what the time lag should be—how long before advertising has an effect on sales. 10-26 10-36 (30–40 min.) Cost estimation, cumulative average-time learning curve. 1. Cost to produce the 2nd through the 8th troop deployment boats: Direct materials, 7 $100,000 Direct manufacturing labor (DML), 39,1301 $30 Variable manufacturing overhead, 39,130 $20 Other manufacturing overhead, 25% of DML costs Total costs $ 700,000 1,173,900 782,600 293,475 $2,949,975 1 The direct manufacturing labor-hours to produce the second to eighth boats can be calculated in several ways, given the assumption of a cumulative average-time learning curve of 85%: Use of table format: Cumulative Number of Units (X) (1) 1 2 3 4 5 6 7 8 85% Learning Curve Cumulative Average Time per Unit (y): Labor Hours (2) 10,000.00 8,500.00 = (10,000 0.85) 7,729.00 7,225.00 = (8,500 0.85) 6,856.71 6,569.78 6,336.56 6,141.25 = (7,225 0.85) Cumulative Total Time: Labor-Hours (3) = (1) (2) 10,000 17,000 23,187 28,900 34,284 39,419 44,356 49,130 The direct labor-hours required to produce the second through the eighth boats is 49,130 – 10,000 = 39,130 hours. Use of formula: y = aXb where a = 10,000, X = 8, and b = – 0.234465 y = 10,000 8– 0.234465 = 6,141.25 hours The total direct labor-hours for 8 units is 6,141.25 8 = 49,130 hours The direct labor-hours required to produce the second through the eighth boats is 49,130 – 10,000 = 39,130 hours. Note: Some students will debate the exclusion of the tooling cost. The question specifies that the tooling “cost was assigned to the first boat.” Although Nautilus may well seek to ensure its total revenue covers the $725,000 cost of the first boat, the concern in this question is only with the cost of producing seven more PT109s. 10-27 2. Cost to produce the 2nd through the 8th boats assuming linear function for direct laborhours and units produced: $ 700,000 Direct materials, 7 $100,000 Direct manufacturing labor (DML), 7 10,000 hrs. $30 2,100,000 Variable manufacturing overhead, 7 10,000 hrs. $20 1,400,000 Other manufacturing overhead, 25% of DML costs 525,000 Total costs $4,725,000 The difference in predicted costs is: Predicted cost in requirement 2 (based on linear cost function) Predicted cost in requirement 1 (based on 85% learning curve) Difference in favor of learning-curve based costs $4,725,000 2,949,975 $1,775,025 Note that the linear cost function assumption leads to a total cost that is 60% higher than the cost predicted by the learning curve model. Learning curve effects are most prevalent in large manufacturing industries such as airplanes and boats where costs can run into the millions or hundreds of millions of dollars, resulting in very large and monetarily significant differences between the two models. 10-28 10-37 (20–30 min.) Cost estimation, incremental unit-time learning model. 1. Cost to produce the 2nd through the 8th boats: Direct materials, 7 $100,000 Direct manufacturing labor (DML), 49,3581 $30 Variable manufacturing overhead, 49,358 $20 Other manufacturing overhead, 25% of DML costs Total costs $ 700,000 1,480,740 987,160 370,185 $3,538,085 1The direct labor hours to produce the second through the eighth boats can be calculated via a table format, given the assumption of an incremental unit-time learning curve of 85%: 85% Learning Curve Cumulative Number of Units (X) (1) 1 2 3 4 5 6 7 8 Individual Unit Time for Xth Unit (y*): Labor Hours (2) 10,000 8,500 = (10,000 0.85) 7,729 7,225 = (8,500 0.85) 6,857 6,570 6,337 6,141 = (7,225 0.85) Cumulative Total Time: Labor-Hours (3) 10,000 18,500 26,229 33,454 40,311 46,881 53,217 59,358 *Calculated as y = pXq where p = 10,000, q = – 0.234465, and X = 1, 2, 3,. . .8. The direct manufacturing labor-hours to produce the second through the eighth boat is 59,358 – 10,000 = 49,358 hours. 10-29 2. Difference in total costs to manufacture the second through the eighth boat under the incremental unit-time learning model and the cumulative average-time learning model is $3,538,085 (calculated in requirement 1 of this problem) – $2,949,975 (from requirement 1 of Problem 10-36) = $588,110, i.e., the total costs are higher for the incremental unit-time model. The incremental unit-time learning curve has a slower rate of decline in the time required to produce successive units than does the cumulative average-time learning curve (see Problem 10-35, requirement 1). Assuming the same 85% factor is used for both curves: Cumulative Number of Units 1 2 4 8 Estimated Cumulative Direct Manufacturing Labor-Hours Cumulative AverageIncremental Unit-Time Time Learning Model Learning Model 10,000 10,000 17,000 18,500 28,900 33,454 49,130 59,358 The reason is that, in the incremental unit-time learning model, as the number of units double, only the last unit produced has a cost of 85% of the initial cost. In the cumulative average-time learning model, doubling the number of units causes the average cost of all the additional units produced (not just the last unit) to be 85% of the initial cost. Nautilus should examine its own internal records on past jobs and seek information from engineers, plant managers, and workers when deciding which learning curve better describes the behavior of direct manufacturing labor-hours on the production of the PT109 boats. 10-30 10-38 Regression; choosing among models. (chapter appendix) 1. Solution Exhibit 10-38A presents the regression output for (a) setup costs and number of setups and (b) setup costs and number of setup-hours. SOLUTION EXHIBIT 10-38A Regression Output for (a) Setup Costs and Number of Setups and (b) Setup Costs and Number of Setup-Hours SUMMARY OUTPUT Regression Statistics Multiple R 0.5807364 R Square 0.3372548 Adjusted R Square 0.2425769 Standard Error 28720.995 Observations 9 ANOVA df Regression Residual Total Intercept Number of Setups 1 7 8 SS 2938383589 5774269011 8712652600 MS 2938383589 824895573 F Significance F 3.562128 0.101066787 Coefficients Standard Error t Stat P-value 3905.3482 41439.10166 0.09424307 0.927557 410.09094 217.2828325 1.887360052 0.1010668 Multiple R R Square Adjusted R Square Standard Error Observations Lower 95% Upper 95% Lower 95.0% Upper 95.0% -94082.55656 101893.25 -94082.5566 101893.2529 -103.701317 923.88319 -103.701317 923.883193 0.923210231 0.85231713 0.831219577 13557.86298 9 ANOVA df Regression Residual Total Intercept Number of Setup Hours SS 7425943061 1286709539 8712652600 MS 7425943061 183815648.5 Coefficients Standard Error 3348.71803 12878.63428 56.2692934 8.85292724 t Stat 0.260021207 6.35600993 1 7 8 F Significance F 40.39886224 0.00038302 10-31 P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% 0.80232966 -27104.4129 33801.849 -27104.41289 33801.849 0.00038302 35.33544701 77.20314 35.33544701 77.2031399 2. Solution Exhibit 10-38B presents the plots and regression lines for (a) number of setups versus setup costs and (b) number of setup hours versus setup costs. SOLUTION EXHIBIT 10-38B Plots and Regression Lines for (a) Number of Setups versus Setup Costs and (b) Number of Setup-Hours versus Setup Costs $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0 0 50 100 150 200 250 300 Number of Setups Tilbert Toys Setup Costs and Number of Setup Hours Setup Costs Setup Costs Tilbert Toys Setup Costs and Number of Setups $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0 0 500 1,000 1,500 Number of Setup Hours 10-32 2,000 2,500 3. Number of Setups A positive relationship between setup costs and the number of setups is economically plausible. Number of Setup Hours A positive relationship between setup costs and the number of setuphours is also economically plausible, especially since setup time is not uniform, and the longer it takes to setup, the greater the setup costs, such as costs of setup labor and setup equipment. Goodness of fit r2 = 34% standard error of regression =$28,721 Poor goodness of fit. r2 = 85% standard error of regression =$13,558 Excellent goodness of fit. Significance of Independent Variables The t-value of 1.89 is not significant at the 0.05 level. The t-value of 6.36 is significant at the 0.05 level. Specification analysis of estimation assumptions Based on a plot of the data, the linearity assumption holds, but the constant variance assumption may be violated. The Durbin-Watson statistic of 1.12 suggests the residuals are independent. The normality of residuals assumption appears to hold. However, inferences drawn from only 9 observations are not reliable. Based on a plot of the data, the assumptions of linearity, constant variance, independence of residuals (Durbin-Watson = 1.50), and normality of residuals hold. However, inferences drawn from only 9 observations are not reliable. Economic plausibility 4. The regression model using number of setup-hours should be used to estimate set up costs because number of setup-hours is a more economically plausible cost driver of setup costs (compared to number of setups). The setup time is different for different products and the longer it takes to setup, the greater the setup costs such as costs of setup-labor and setup equipment. The regression of number of setup-hours and setup costs also has a better fit, a significant independent variable, and better satisfies the assumptions of the estimation technique. 10-33 10-39 (30min.) Multiple regression (continuation of 10-38). 1. Solution Exhibit 10-39 presents the regression output for setup costs using both number of setups and number of setup-hours as independent variables (cost drivers). SOLUTION EXHIBIT 10-39 Regression Output for Multiple Regression for Setup Costs Using Both Number of Setups and Number of Setup-Hours as Independent Variables (Cost Drivers) SUMMARY OUTPUT Regression Statistics Multiple R 0.925940474 R Square 0.857365762 Adjusted R Square 0.809821016 Standard Error 14391.67909 Observations 9 ANOVA df Regression Residual Total Intercept Number of Setups Number of Setup-Hours 2. Economic plausibility MS F 3734965019 18.032818 207120427 Significance F 0.002901826 Coefficients Standard Error t Stat P-value -3894.83189 20831.39503 -0.18696933 0.8578466 60.8402738 132.0202547 0.460840451 0.6611444 53.29936621 11.3948941 4.677477979 0.0034048 Lower 95% -54867.41916 -262.2016515 25.41706486 2 6 8 SS 7469930038 1242722562 8712652600 Upper 95% 47077.75538 383.8821991 81.18166757 Lower 95.0% -54867.41916 -262.2016515 25.41706486 A positive relationship between setup costs and each of the independent variables (number of setups and number of setup-hours) is economically plausible. Goodness of fit r2 = 86%, Adjusted r2 = 81% Standard error of regression =$14,392 Excellent goodness of fit. Significance of Independent Variables The t-value of 0.46 for number of setups is not significant at the 0.05 level. The t-value of 4.68 for number of setup-hours is significant at the 0.05 level. Specification analysis of estimation assumptions Assuming linearity, constant variance, and normality of residuals, the Durbin-Watson statistic of 1.36 suggests the residuals are independent. However, we must be cautious when drawing inferences from only 9 observations. 10-34 Upper 95.0% 47077.75538 383.8821991 81.18166757 3. Multicollinearity is an issue that can arise with multiple regression but not simple regression analysis. Multicollinearity means that the independent variables are highly correlated. The correlation feature in Excel’s Data Analysis reveals a coefficient of correlation of 0.56 between number of setups and number of setup-hours. Since the correlation is less than 0.70, the multiple regression does not suffer from multicollinearity problems. 4. The simple regression model using the number of setup-hours as the independent variable achieves a comparable r2 to the multiple regression model. However, the multiple regression model includes an insignificant independent variable, number of setups. Adding this variable does not improve Williams’ ability to better estimate setup costs. Bebe should use the simple regression model with number of setup-hours as the independent variable to estimate costs. 10-40 (40–50 min.) Purchasing Department cost drivers, activity-based costing, simple regression analysis. The problem reports the exact t-values from the computer runs of the data. Because the coefficients and standard errors given in the problem are rounded to three decimal places, dividing the coefficient by the standard error may yield slightly different t-values. 1. Plots of the data used in Regressions 1 to 3 are in Solution Exhibit 10-40A. See Solution Exhibit 10-40B for a comparison of the three regression models. 2. Both Regressions 2 and 3 are well-specified regression models. The slope coefficients on their respective independent variables are significantly different from zero. These results support the Couture Fabrics’ presentation in which the number of purchase orders and the number of suppliers were reported to be drivers of purchasing department costs. In designing an activity-based cost system, Fashion Flair should use number of purchase orders and number of suppliers as cost drivers of purchasing department costs. As the chapter appendix describes, Fashion Flair can either (a) estimate a multiple regression equation for purchasing department costs with number of purchase orders and number of suppliers as cost drivers, or (b) divide purchasing department costs into two separate cost pools, one for costs related to purchase orders and another for costs related to suppliers, and estimate a separate relationship for each cost pool. 3. Guidelines presented in the chapter could be used to gain additional evidence on cost drivers of purchasing department costs. 1. Use physical relationships or engineering relationships to establish cause-and-effect links. Lee could observe the purchasing department operations to gain insight into how costs are driven. 2. Use knowledge of operations. Lee could interview operating personnel in the purchasing department to obtain their insight on cost drivers. 10-35 SOLUTION EXHIBIT 10-40A Regression Lines of Various Cost Drivers on Purchasing Dept. Costs for Fashion Flair Purchasing D epartment Co sts $2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 100 50 0 150 Dol lar Valu e o f Merchan dise Purch ased (in mill io ns) Pu rchas ing Department Cos ts $2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 0 2,000 4,000 6,000 8,000 Number o f Pu rchase Orders Purchas ing Depart ment Cos ts $2,500,000 2,000,000 1,500,000 1,000,000 500,000 0 0 100 200 Number o f Su ppliers 10-36 300 SOLUTION EXHIBIT 10-40B Comparison of Alternative Cost Functions for Purchasing Department Costs Estimated with Simple Regression for Fashion Flair Criterion 1. Economic Plausibility Regression 1 PDC = a + (b MP$) Result presented at seminar by Couture Fabrics found little support for MP$ as a driver. Purchasing personnel at the Miami store believe MP$ is not a significant cost driver. 2. Goodness of fit r2 = 0.08. Poor goodness of fit. 3. Significance of Independent Variables 4. Specification Analysis A. Linearity within the relevant range t-value on MP$ of 0.84 is insignificant. Regression 2 PDC = a + (b # of POs) Economically plausible. The higher the number of purchase orders, the more tasks undertaken. Regression 3 PDC = a + (b # of Ss) Economically plausible. Increasing the number of suppliers increases the costs of certifying vendors and managing the Fashion Flairsupplier relationship. r2 = 0.42. Reasonable goodness of fit. r2 = 0.39. Reasonable goodness of fit. t-value on # of POs of 2.43 t-value on # of Ss of 2.28 is significant. is significant. Appears questionable Appears reasonable. but no strong evidence against linearity. Appears reasonable. B. Constant variance of residuals Appears questionable, Appears reasonable. but no strong evidence against constant variance. Appears reasonable. C. Independence of residuals Durbin-Watson Statistic = 2.41 Assumption of independence is not rejected. Durbin-Watson Statistic = 1.97 Assumption of independence is not rejected. D. Normality of residuals Data base too small to Data base too small to make reliable inferences. make reliable inferences. Durbin-Watson Statistic = 1.98 Assumption of independence is not rejected. 10-37 Data base too small to make reliable inferences. 10-41 (30–40 min.) Purchasing Department cost drivers, multiple regression analysis (continuation of 10-40) (chapter appendix). The problem reports the exact t-values from the computer runs of the data. Because the coefficients and standard errors given in the problem are rounded to three decimal places, dividing the coefficient by the standard error may yield slightly different t-values. 1. Regression 4 is a well-specified regression model: Economic plausibility: Both independent variables are plausible and are supported by the findings of the Couture Fabrics study. Goodness of fit: The r2 of 0.63 indicates an excellent goodness of fit. Significance of independent variables: The t-value on # of POs is 2.14 while the t-value on # of Ss is 2.00. These t-values are either significant or border on significance. Specification analysis: Results are available to examine the independence of residuals assumption. The Durbin-Watson statistic of 1.90 indicates that the assumption of independence is not rejected. Regression 4 is consistent with the findings in Problem 10-39 that both the number of purchase orders and the number of suppliers are drivers of purchasing department costs. Regressions 2, 3, and 4 all satisfy the four criteria outlined in the text. Regression 4 has the best goodness of fit (0.63 for Regression 4 compared to 0.42 and 0.39 for Regressions 2 and 3, respectively). Most importantly, it is economically plausible that both the number of purchase orders and the number of suppliers drive purchasing department costs. We would recommend that Lee use Regression 4 over Regressions 2 and 3. 2. Regression 5 adds an additional independent variable (MP$) to the two independent variables in Regression 4. This additional variable (MP$) has a t-value of –0.07, implying its slope coefficient is insignificantly different from zero. The r2 in Regression 5 (0.63) is the same as that in Regression 4 (0.63), implying the addition of this third independent variable adds close to zero explanatory power. In summary, Regression 5 adds very little to Regression 4. We would recommend that Lee use Regression 4 over Regression 5. 3. Budgeted purchasing department costs for the Baltimore store next year are $485,384 + ($123.22 3,900) + ($2,952 110) = $1,290,662 10-38 4. Multicollinearity is a frequently encountered problem in cost accounting; it does not arise in simple regression because there is only one independent variable in a simple regression. One consequence of multicollinearity is an increase in the standard errors of the coefficients of the individual variables. This frequently shows up in reduced t-values for the independent variables in the multiple regression relative to their t-values in the simple regression: Variables Regression 4: # of POs # of Ss Regression 5: # of POs # of Ss MP$ t-value in Multiple Regression t-value from Simple Regressions in Problem 10-39 2.14 2.00 2.43 2.28 1.95 1.84 –0.07 2.43 2.28 0.84 The decline in the t-values in the multiple regressions is consistent with some (but not very high) collinearity among the independent variables. Pairwise correlations between the independent variables are: # of POs # of Ss # of POs MP$ # of Ss MP$ Correlation 0.29 0.27 0.34 There is no evidence of difficulties due to multicollinearity in Regressions 4 and 5. 5. are Decisions in which the regression results in Problems 10-40 and 10-41 could be useful Cost management decisions: Fashion Flair could restructure relationships with the suppliers so that fewer separate purchase orders are made. Alternatively, it may aggressively reduce the number of existing suppliers. Purchasing policy decisions: Fashion Flair could set up an internal charge system for individual retail departments within each store. Separate charges to each department could be made for each purchase order and each new supplier added to the existing ones. These internal charges would signal to each department ways in which their own decisions affect the total costs of Fashion Flair. Accounting system design decisions: Fashion Flair may want to discontinue allocating purchasing department costs on the basis of the dollar value of merchandise purchased. Allocation bases better capturing cause-and-effect relations at Fashion Flair are the number of purchase orders and the number of suppliers. 10-39 10-42 (40 min.) High-low method, alternative regression functions, accrual accounting adjustments, ethics. 1. Solution Exhibit 10-42A presents the two data plots. The plot of engineering support reported costs and machine-hours shows two separate groups of data, each of which may be approximated by a separate cost function. The problem arises because the plant records materials and parts costs on an “as purchased” rather than an “as used” basis. The plot of engineering support restated costs and machine-hours shows a high positive correlation between the two variables (the coefficient of determination is 0.94); a single linear cost function provides a good fit to the data. Better estimates of the cost relation result because Kennedy adjusts the materials and parts costs to an accrual accounting basis. 2. Cost Driver Machine-Hours 73 19 54 Highest observation of cost driver (August) Lowest observation of cost driver (September) Difference Reported Engineering Support Costs $ 617 1,066 $ (449) Difference between costs associated with Slope coefficient, b = highest and lowest observations of the cost driver Difference between highest and lowest observations of the cost driver –$449 54 = –$8.31 per machine-hour Constant (at highest observation of cost driver) = $ 617 – (–$8.31 73) = $1,224 Constant (at lowest observation of cost driver) = $1,066 – (–$8.31 19) = $1,224 The estimated cost function is y = $1,224 – $8.31X = Cost Driver Restated Engineering Machine-Hours Support Costs Highest observation of cost driver (August) 73 $966 Lowest observation of cost driver (September) 19 370 Difference 54 $596 Difference between costs associated with highest and lowest observations of the cost driver Slope coefficient, b = Difference between highest and lowest observations of the cost driver = $596 = $11.04 per machine-hour 54 Constant (at highest observation of cost driver) Constant (at lowest observation of cost driver) The estimated cost function is y = $160 + $11.04 X 10-40 = = $ 966 – ($11.04 73) = $160 $ 370 – ($11.04 19) = $160 3. The cost function estimated with engineering support restated costs better approximates the regression analysis assumptions. See Solution Exhibit 10-42B for a comparison of the two regressions. 4. Of all the cost functions estimated in requirements 2 and 3, Kennedy should choose Regression 2 using engineering support restated costs as best representing the relationship between engineering support costs and machine-hours. The cost functions estimated using engineering support reported costs are mis-specified and not-economically plausible because materials and parts costs are reported on an “as-purchased” rather than on an “as-used” basis. With respect to engineering support restated costs, the high-low and regression approaches yield roughly similar estimates. The regression approach is technically superior because it determines the line that best fits all observations. In contrast, the high-low method considers only two points (observations with the highest and lowest cost drivers) when estimating the cost function. Solution Exhibit 10-42B shows that the cost function estimated using the regression approach has excellent goodness of fit (r2 = 0.94) and appears to be well specified. 5. Problems Kennedy might encounter include a. A perpetual inventory system may not be used in this case; the amounts requisitioned likely will not permit an accurate matching of costs with the independent variable on a month-by-month basis. b. Quality of the source records for usage by engineers may be relatively low; e.g., engineers may requisition materials and parts in batches, but not use them immediately. c. Records may not distinguish materials and parts for maintenance from materials and parts used for repairs and breakdowns; separate cost functions may be appropriate for the two categories of materials and parts. d. Year-end accounting adjustments to inventory may mask errors that gradually accumulate month-by-month. 6. Picking the correct cost function is important for cost prediction, cost management, and performance evaluation. For example, had United Packaging used Regression 1 (engineering support reported costs) to estimate the cost function, it would erroneously conclude that engineering support costs decrease with machine-hours. In a month with 60 machine-hours, Regression 1 would predict costs of $1,393.20 – ($14.23 60) = $539.40. If actual costs turn out to be $800, management would conclude that changes should be made to reduce costs. In fact, on the basis of the preferred Regression 2, support overhead costs are lower than the predicted amount of $176.38 + ($11.44 60) = $862.78––a performance that management should seek to replicate, not change. On the other hand, if machine-hours worked in a month were low, say 25 hours, Regression 1 would erroneously predict support overhead costs of $1,393.20 – ($14.23 25) = $1,037.45. If actual costs are $700, management would conclude that its performance has been very good. In fact, compared to the costs predicted by the preferred Regression 2 of $176.38 + ($11.44 25) = $462.38, the actual performance is rather poor. Using Regression 1, management may feel costs are being managed very well when in fact they are much higher than what they should be and need to be managed “down.” 10-41 7. Because Kennedy is confident that the restated numbers are correct, he cannot change them just to please Mason. If he does, he is violating the standards of integrity and objectivity for management accountants. Kennedy should establish the correctness of the numbers with Mason, point out that he cannot change them, and also reason that this is a problem that could crop up each year and they should take a firm, ethical stand right away. If Mason continues to apply pressure, Kennedy has no option but to escalate the problem to higher levels in the organization. He should be prepared to resign, if necessary, rather than compromise his professional ethics. $1,400 1,200 1,000 600 800 400 200 0 0 10 20 30 40 50 60 70 80 Machine-Hours Engineering Support Restated Costs Engineering Support Reported Costs SOLUTION EXHIBIT 10-42A Plots and Regression Lines for Engineering Support Reported Costs and Engineering Support Restated Costs $1,200 1,000 800 600 400 200 0 0 10 20 30 40 Machine-Hours 10-42 50 60 70 80 SOLUTION EXHIBIT 10-42B Comparison of Alternative Cost Functions for Engineering Support Costs at United Packaging Regression 1 Dependent Variable: Engineering Support Reported Costs Negative slope relationship is economically implausible over the long run. Regression 2 Dependent Variable: Engineering Support Restated Costs Positive slope relationship is economically plausible. 2. Goodness of Fit r2 = 0.43. Moderate goodness of fit. r2 = 0.94. Excellent goodness of fit. 3. Significance of Independent Variables t-statistic on machine-hours is statistically significant (t = –2.31), albeit economically implausible. t-statistic on machine-hours is highly statistically significant (t=10.59). Linearity does not describe data very well. Linearity describes data very well. B. Constant variance of residuals Appears questionable, although 12 observations do not facilitate the drawing of reliable inferences. Appears reasonable, although 12 observations do not facilitate the drawing of reliable inferences. C. Independence of residuals Durbin-Watson = 2.26. Residuals serially uncorrelated. Durbin-Watson = 1.31. Some evidence of serial correlation in the residuals. D. Normality of residuals Database too small to make reliable inferences. Database too small to make reliable inferences. Criterion 1. Economic Plausibility 4. Specification Analysis: A. Linearity 10-43 CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION 11-1 1. 2. 3. 4. 5. The five steps in the decision process outlined in Exhibit 11-1 of the text are Identify the problem and uncertainties Obtain information Make predictions about the future Make decisions by choosing among alternatives Implement the decision, evaluate performance, and learn 11-2 Relevant costs are expected future costs that differ among the alternative courses of action being considered. Historical costs are irrelevant because they are past costs and, therefore, cannot differ among alternative future courses of action. 11-3 No. Relevant costs are defined as those expected future costs that differ among alternative courses of action being considered. Thus, future costs that do not differ among the alternatives are irrelevant to deciding which alternative to choose. 11-4 Quantitative factors are outcomes that are measured in numerical terms. Some quantitative factors are financial––that is, they can be easily expressed in monetary terms. Direct materials is an example of a quantitative financial factor. Qualitative factors are outcomes that are difficult to measure accurately in numerical terms. An example is employee morale. 11-5 Two potential problems that should be avoided in relevant cost analysis are (i) Do not assume all variable costs are relevant and all fixed costs are irrelevant. (ii) Do not use unit-cost data directly. It can mislead decision makers because a. it may include irrelevant costs, and b. comparisons of unit costs computed at different output levels lead to erroneous conclusions 11-6 No. Some variable costs may not differ among the alternatives under consideration and, hence, will be irrelevant. Some fixed costs may differ among the alternatives and, hence, will be relevant. 11-7 No. Some of the total unit costs to manufacture a product may be fixed costs, and, hence, will not differ between the make and buy alternatives. These fixed costs are irrelevant to the make-or-buy decision. The key comparison is between purchase costs and the costs that will be saved if the company purchases the component parts from outside plus the additional benefits of using the resources freed up in the next best alternative use (opportunity cost). Furthermore, managers should consider nonfinancial factors such as quality and timely delivery when making outsourcing decisions. 11-8 Opportunity cost is the contribution to income that is forgone (rejected) by not using a limited resource in its next-best alternative use. 11-9 No. When deciding on the quantity of inventory to buy, managers must consider both the purchase cost per unit and the opportunity cost of funds invested in the inventory. For example, the purchase cost per unit may be low when the quantity of inventory purchased is large, but the 11- benefit of the lower cost may be more than offset by the high opportunity cost of the funds invested in acquiring and holding inventory. 11-10 No. Managers should aim to get the highest contribution margin per unit of the constraining (that is, scarce, limiting, or critical) factor. The constraining factor is what restricts or limits the production or sale of a given product (for example, availability of machine-hours). 11-11 No. For example, if the revenues that will be lost exceed the costs that will be saved, the branch or business segment should not be shut down. Shutting down will only increase the loss. Allocated costs are always irrelevant to the shut-down decision. 11-12 Cost written off as depreciation is irrelevant when it pertains to a past cost such as equipment already purchased. But the purchase cost of new equipment to be acquired in the future that will then be written off as depreciation is often relevant. 11-13 No. Managers tend to favor the alternative that makes their performance look best so they focus on the measures used in the performance-evaluation model. If the performance-evaluation model does not emphasize maximizing operating income or minimizing costs, managers will most likely not choose the alternative that maximizes operating income or minimizes costs. 11-14 The three steps in solving a linear programming problem are (i) Determine the objective function. (ii) Specify the constraints. (iii) Compute the optimal solution. 11-15 The text outlines two methods of determining the optimal solution to an LP problem: (i) Trial-and-error solution approach (ii) Graphical solution approach Most LP applications in practice use standard software packages that rely on the simplex method to compute the optimal solution. 11- 11-16 (20 min.) Disposal of assets. 1. This is an unfortunate situation, yet the $75,000 costs are irrelevant regarding the decision to remachine or scrap. The only relevant factors are the future revenues and future costs. By ignoring the accumulated costs and deciding on the basis of expected future costs, operating income will be maximized (or losses minimized). The difference in favor of remachining is $2,000: (a) (b) Remachine Scrap Future revenues Deduct future costs Operating income $30,000 25,000 $ 5,000 Difference in favor of remachining $3,000 – $3,000 $2,000 2. This, too, is an unfortunate situation. But the $100,000 original cost is irrelevant to this decision. The difference in relevant costs in favor of rebuilding is $5,000 as follows: (a) Replace $105,000 Difference in favor of rebuilding – 15,000 – $ 90,000 New truck Deduct current disposal price of existing truck Rebuild existing truck (b) Rebuild – $85,000 $85,000 $5,000 Note, here, that the current disposal price of $15,000 is relevant, but the original cost (or book value, if the truck were not brand new) is irrelevant. 11- 11-17 (20 min.) Relevant and irrelevant costs costs. 1. Make Relevant costs Variable costs Avoidable fixed costs Purchase price Unit relevant cost Buy $180 20 ____ $200 $210 $210 Dalton Computers should reject Peach’s offer. The $30 of fixed costs are irrelevant because they will be incurred regardless of this decision. When comparing relevant costs between the choices, Peach’s offer price is higher than the cost to continue to produce. 2. Cash operating costs (4 years) Current disposal value of old machine Cost of new machine Total relevant costs Keep $80,000 ______ $80,000 Replace $48,000 (2,500) 8,000 $53,500 Difference $32,000 2,500 (8,000) $26,500 AP Manufacturing should replace the old machine. The cost savings are far greater than the cost to purchase the new machine. 11-18 (15 min.) Multiple choice. 1. (b) Special order price per unit Variable manufacturing cost per unit Contribution margin per unit Effect on operating income $6.00 4.50 $1.50 = $1.50 20,000 units = $30,000 increase 2. (b) Costs of purchases, 20,000 units $60 Total relevant costs of making: Variable manufacturing costs, $64 – $16 Fixed costs eliminated Costs saved by not making Multiply by 20,000 units, so total costs saved are $57 20,000 Extra costs of purchasing outside Minimum overall savings for Reno Necessary relevant costs that would have to be saved in manufacturing Part No. 575 11- $1,200,000 $48 9 $57 1,140,000 60,000 25,000 $ 85,000 11-19 (30 min.) Special order, activity-based costing. 1. Award Plus’ operating income under the alternatives of accepting/rejecting the special order are: Without OneWith OneTime Only Time Only Special Order Special Order 7,500 Units 10,000 Units Revenues Variable costs: Direct materials Direct manufacturing labor Batch manufacturing costs Fixed costs: Fixed manufacturing costs Fixed marketing costs Total costs Operating income 1 $262,500 10,000 7,500 Difference 2,500 Units $1,125,000 $250,000 262,500 300,000 75,000 350,000 2 400,000 3 87,500 1 87,500 100,000 12,500 275,000 175,000 1,087,500 $ 37,500 2 $1,375,000 275,000 175,000 1,287,500 $ 87,500 –– –– 200,000 $ 50,000 $300,000 10,000 7,500 3 $75,000 + (25 $500) Alternatively, we could calculate the incremental revenue and the incremental costs of the additional 2,500 units as follows: Incremental revenue $100 2,500 $250,000 $262,500 2,500 7,500 $300,000 2,500 7,500 $500 25 Incremental direct manufacturing costs Incremental direct manufacturing costs Incremental batch manufacturing costs Total incremental costs Total incremental operating income from accepting the special order 87,500 100,000 12,500 200,000 $ 50,000 Award Plus should accept the one-time-only special order if it has no long-term implications because accepting the order increases Award Plus’ operating income by $50,000. If, however, accepting the special order would cause the regular customers to be dissatisfied or to demand lower prices, then Award Plus will have to trade off the $50,000 gain from accepting the special order against the operating income it might lose from regular customers. 11- 2. Award Plus has a capacity of 9,000 medals. Therefore, if it accepts the special one-time order of 2,500 medals, it can sell only 6,500 medals instead of the 7,500 medals that it currently sells to existing customers. That is, by accepting the special order, Award Plus must forgo sales of 1,000 medals to its regular customers. Alternatively, Award Plus can reject the special order and continue to sell 7,500 medals to its regular customers. Award Plus’ operating income from selling 6,500 medals to regular customers and 2,500 medals under one-time special order follow: Revenues (6,500 $150) + (2,500 $100) 1 1 Direct materials (6,500 $35 ) + (2,500 $35 ) 2 2 Direct manufacturing labor (6,500 $40 ) +(2,500 $40 ) 3 Batch manufacturing costs (130 $500) + (25 $500) Fixed manufacturing costs Fixed marketing costs Total costs Operating income 1 $35 = $262,500 7,500 2 $40 = $1,225,000 315,000 360,000 77,500 275,000 175,000 1,202,500 $ 22,500 $300,000 7,500 3 Award Plus makes regular medals in batch sizes of 50. To produce 6,500 medals requires 130 (6,500 ÷ 50) batches. Accepting the special order will result in a decrease in operating income of $15,000 ($37,500 – $22,500). The special order should, therefore, be rejected. A more direct approach would be to focus on the incremental effects––the benefits of accepting the special order of 2,500 units versus the costs of selling 1,000 fewer units to regular customers. Increase in operating income from the 2,500-unit special order equals $50,000 (requirement 1). The loss in operating income from selling 1,000 fewer units to regular customers equals: Lost revenue, $150 1,000 Savings in direct materials costs, $35 1,000 Savings in direct manufacturing labor costs, $40 1,000 Savings in batch manufacturing costs, $500 20 Operating income lost $(150,000) 35,000 40,000 10,000 $ (65,000) Accepting the special order will result in a decrease in operating income of $15,000 ($50,000 – $65,000). The special order should, therefore, be rejected. 3. Award Plus should not accept the special order. Increase in operating income by selling 2,500 units under the special order (requirement 1) Operating income lost from existing customers ($10 7,500) Net effect on operating income of accepting special order The special order should, therefore, be rejected. 11- $ 50,000 (75,000) $(25,000) 11-20 (30 min.) Make versus buy, activity-based costing. 1. The expected manufacturing cost per unit of CMCBs in 2009 is as follows: Direct materials, $170 10,000 Direct manufacturing labor, $45 10,000 Variable batch manufacturing costs, $1,500 80 Fixed manufacturing costs Avoidable fixed manufacturing costs Unavoidable fixed manufacturing costs Total manufacturing costs Total Manufacturing Manufacturing Costs of CMCB Cost per Unit (1) (2) = (1) ÷ 10,000 $1,700,000 $170 450,000 45 120,000 12 320,000 800,000 $3,390,000 32 80 $339 2. The following table identifies the incremental costs in 2009 if Svenson (a) made CMCBs and (b) purchased CMCBs from Minton. Incremental Items Cost of purchasing CMCBs from Minton Direct materials Direct manufacturing labor Variable batch manufacturing costs Avoidable fixed manufacturing costs Total incremental costs Total Incremental Costs Make Buy $3,000,000 $1,700,000 450,000 120,000 320,000 $2,590,000 $3,000,000 Difference in favor of making $410,000 Per-Unit Incremental Costs Make Buy $300 $170 45 12 32 $259 $300 $41 Note that the opportunity cost of using capacity to make CMCBs is zero since Svenson would keep this capacity idle if it purchases CMCBs from Minton. Svenson should continue to manufacture the CMCBs internally since the incremental costs to manufacture are $259 per unit compared to the $300 per unit that Minton has quoted. Note that the unavoidable fixed manufacturing costs of $800,000 ($80 per unit) will continue to be incurred whether Svenson makes or buys CMCBs. These are not incremental costs under either the make or the buy alternative and hence, are irrelevant. 11- 3. Svenson should continue to make CMCBs. The simplest way to analyze this problem is to recognize that Svenson would prefer to keep any excess capacity idle rather than use it to make CB3s. Why? Because expected incremental future revenues from CB3s, $2,000,000, are less than expected incremental future costs, $2,150,000. If Svenson keeps its capacity idle, we know from requirement 2 that it should make CMCBs rather than buy them. An important point to note is that, because Svenson forgoes no contribution by not being able to make and sell CB3s, the opportunity cost of using its facilities to make CMCBs is zero. It is, therefore, not forgoing any profits by using the capacity to manufacture CMCBs. If it does not manufacture CMCBs, rather than lose money on CB3s, Svenson will keep capacity idle. A longer and more detailed approach is to use the total alternatives or opportunity cost analyses shown in Exhibit 11-7 of the chapter. Choices for Svenson Make CMCBs Buy CMCBs Buy CMCBs and Do Not and Do Not and Make Relevant Items Make CB3s Make CB3s CB3s TOTAL-ALTERNATIVES APPROACH TO MAKE-OR-BUY DECISIONS Total incremental costs of making/buying CMCBs (from requirement 2) $2,590,000 $3,000,000 $3,000,000 Excess of future costs over future revenues from CB3s 0 0 150,000 $2,590,000 $3,000,000 $3,150,000 Total relevant costs Svenson will minimize manufacturing costs by making CMCBs. OPPORTUNITY-COST APPROACH TO MAKE-OR-BUY DECISIONS Total incremental costs of making/buying CMCBs (from requirement 2) $2,590,000 $3,000,000 Opportunity cost: profit contribution forgone because capacity will not be used to make CB3s 0* 0* Total relevant costs $2,590,000 $3,000,000 *Opportunity $3,000,000 0 $3,000,000 cost is 0 because Svenson does not give up anything by not making CB3s. Svenson is best off leaving the capacity idle (rather than manufacturing and selling CB3s). 11- 11-21 (10 min.) Inventory decision, opportunity costs. 1. Unit cost, orders of 20,000 Unit cost, order of 240,000 (0.96 $9.00) $9.00 $8.64 Alternatives under consideration: (a) Buy 240,000 units at start of year. (b) Buy 20,000 units at start of each month. Average investment in inventory: (a) (240,000 $8.64) ÷ 2 (b) ( 20,000 $9.00) ÷ 2 Difference in average investment $1, 036,800 90,000 $ 946,800 Opportunity cost of interest forgone from 240,000-unit purchase at start of year = $946,800 0.10 = $94,680 2. No. The $94,680 is an opportunity cost rather than an incremental or outlay cost. No actual transaction records the $94,680 as an entry in the accounting system. 3. The following table presents the two alternatives: Alternative A: Alternative B: Purchase Purchase 240,000 20,000 spark plugs at spark plugs beginning of at beginning year of each month Difference (1) (2) (3) = (1) – (2) Annual purchase-order costs $ 200 (1 $200; 12 $200) 2,073,600 Annual purchase (incremental) costs (240,000 $8.64; 240,000 $9) Annual interest income that could be earned if investment in inventory were invested (opportunity cost) 103,680 (10% $1,036,800; 10% $90,000) $2,177,480 Relevant costs $ 2,400 2,160,000 $ (2,200) (86,400) 9,000 $2,171,400 94,680 $ 6,080 Column (3) indicates that purchasing 20,000 spark plugs at the beginning of each month is preferred relative to purchasing 240,000 spark plugs at the beginning of the year because the opportunity cost of holding larger inventory exceeds the lower purchasing and ordering costs. If other incremental benefits of holding lower inventory such as lower insurance, materials handling, storage, obsolescence, and breakage costs were considered, the costs under Alternative A would have been higher, and Alternative B would be preferred even more. 11- 11-22 (20–25 min.) Relevant costs, contribution margin, product emphasis. 1. Cola $18.80 14.20 $ 4.60 Selling price Deduct variable cost per case Contribution margin per case Lemonade $20.00 16.10 $ 3.90 Punch $27.10 20.70 $ 6.40 Natural Orange Juice $39.20 30.20 $ 9.00 2. The argument fails to recognize that shelf space is the constraining factor. There are only 12 feet of front shelf space to be devoted to drinks. Sexton should aim to get the highest daily contribution margin per foot of front shelf space: Contribution margin per case Sales (number of cases) per foot of shelf space per day Daily contribution per foot of front shelf space 3. Cola $ 4.60 25 $115.00 Lemonade $ 3.90 24 $93.60 Punch $ 6.40 4 $25.60 Natural Orange Juice $ 9.00 5 $45.00 The allocation that maximizes the daily contribution from soft drink sales is: Daily Contribution per Foot of Total Contribution Front Shelf Space Margin per Day $115.00 $ 690.00 93.60 374.40 45.00 45.00 25.60 25.60 $1,135.00 Feet of Shelf Space Cola Lemonade Natural Orange Juice Punch 6 4 1 1 The maximum of six feet of front shelf space will be devoted to Cola because it has the highest contribution margin per unit of the constraining factor. Four feet of front shelf space will be devoted to Lemonade, which has the second highest contribution margin per unit of the constraining factor. No more shelf space can be devoted to Lemonade since each of the remaining two products, Natural Orange Juice and Punch (that have the second lowest and lowest contribution margins per unit of the constraining factor) must each be given at least one foot of front shelf space. 11- 11-23 (10 min.) Selection of most profitable product. Only Model 14 should be produced. The key to this problem is the relationship of manufacturing overhead to each product. Note that it takes twice as long to produce Model 9; machine-hours for Model 9 are twice that for Model 14. Management should choose the product mix that maximizes operating income for a given production capacity (the scarce resource in this situation). In this case, Model 14 will yield a $9.50 contribution to fixed costs per machine hour, and Model 9 will yield $9.00: Model 9 Selling price Variable costs per unit (total cost – FMOH) Contribution margin per unit Relative use of machine-hours per unit of product Contribution margin per machine hour $100.00 82.00 $ 18.00 ÷ 2 $ 9.00 Model 14 $70.00 60.50 $ 9.50 ÷ 1 $ 9.50 11-24 (20 min.) Which base to close, relevant-cost analysis, opportunity costs. The future outlay operating costs will be $400 million regardless of which base is closed, given the additional $100 million in costs at Everett if Alameda is closed. Further, one of the bases will permanently remain open while the other will be shut down. The only relevant revenue and cost comparisons are a. $500 million from sale of the Alameda base. Note that the historical cost of building the Alameda base ($100 million) is irrelevant. Note also that future increases in the value of the land at the Alameda base is also irrelevant. One of the bases must be kept open, so if it is decided to keep the Alameda base open, the Defense Department will not be able to sell this land at a future date. b. $60 million in savings in fixed income note if the Everett base is closed. Again, the historical cost of building the Everett base ($150 million) is irrelevant. The relevant costs and benefits analysis favors closing the Alameda base despite the objections raised by the California delegation in Congress. The net benefit equals $440 ($500 – $60) million. 11- 11-25 (2530 min.) Closing and opening stores. 1. Solution Exhibit 11-25, Column 1, presents the relevant loss in revenues and the relevant savings in costs from closing the Rhode Island store. Lopez is correct that Sanchez Corporation’s operating income would increase by $7,000 if it closes down the Rhode Island store. Closing down the Rhode Island store results in a loss of revenues of $860,000 but cost savings of $867,000 (from cost of goods sold, rent, labor, utilities, and corporate costs). Note that by closing down the Rhode Island store, Sanchez Corporation will save none of the equipmentrelated costs because this is a past cost. Also note that the relevant corporate overhead costs are the actual corporate overhead costs $44,000 that Sanchez expects to save by closing the Rhode Island store. The corporate overhead of $40,000 allocated to the Rhode Island store is irrelevant to the analysis. 2. Solution Exhibit 11-25, Column 2, presents the relevant revenues and relevant costs of opening another store like the Rhode Island store. Lopez is correct that opening such a store would increase Sanchez Corporation’s operating income by $11,000. Incremental revenues of $860,000 exceed the incremental costs of $849,000 (from higher cost of goods sold, rent, labor, utilities, and some additional corporate costs). Note that the cost of equipment written off as depreciation is relevant because it is an expected future cost that Sanchez will incur only if it opens the new store. Also note that the relevant corporate overhead costs are the $4,000 of actual corporate overhead costs that Sanchez expects to incur as a result of opening the new store. Sanchez may, in fact, allocate more than $4,000 of corporate overhead to the new store but this allocation is irrelevant to the analysis. The key reason that Sanchez’s operating income increases either if it closes down the Rhode Island store or if it opens another store like it is the behavior of corporate overhead costs. By closing down the Rhode Island store, Sanchez can significantly reduce corporate overhead costs presumably by reducing the corporate staff that oversees the Rhode Island operation. On the other hand, adding another store like Rhode Island does not increase actual corporate costs by much, presumably because the existing corporate staff will be able to oversee the new store as well. SOLUTION EXHIBIT 11-25 Relevant-Revenue and Relevant-Cost Analysis of Closing Rhode Island Store and Opening Another Store Like It. (Loss in Revenues) Loss and Savings in Costs from Closing Rhode Island Store (1) $(860,000) 660,000 75,000 42,000 0 46,000 44,000 867,000 $ 7,000 Revenues Cost of goods sold Lease rent Labor costs Depreciation of equipment Utilities (electricity, heating) Corporate overhead costs Total costs Effect on operating income (loss) 11- Incremental Revenues and (Incremental Costs) of Opening New Store Like Rhode Island Store (2) $ 860,000 (660,000) (75,000) (42,000) (22,000) (46,000) (4,000) (849,000) $ 11,000 11-26 (20 min.) Choosing customers. If Broadway accepts the additional business from Kelly, it would take an additional 500 machine-hours. If Broadway accepts all of Kelly’s and Taylor’s business for February, it would require 2,500 machine-hours (1,500 hours for Taylor and 1,000 hours for Kelly). Broadway has only 2,000 hours of machine capacity. It must, therefore, choose how much of the Taylor or Kelly business to accept. To maximize operating income, Broadway should maximize contribution margin per unit of the constrained resource. (Fixed costs will remain unchanged at $100,000 regardless of the business Broadway chooses to accept in February, and is, therefore, irrelevant.) The contribution margin per unit of the constrained resource for each customer in January is: Taylor Corporation $78,000 = $52 1,500 Contribution margin per machine-hour Kelly Corporation $32,000 = $64 500 Since the $80,000 of additional Kelly business in February is identical to jobs done in January, it will also have a contribution margin of $64 per machine-hour, which is greater than the contribution margin of $52 per machine-hour from Taylor. To maximize operating income, Broadway should first allocate all the capacity needed to take the Kelly Corporation business (1,000 machine-hours) and then allocate the remaining 1,000 (2,000 – 1,000) machine-hours to Taylor. Contribution margin per machine-hour Machine-hours to be worked Contribution margin Fixed costs Operating income Taylor Corporation $52 1,000 $52,000 11- Kelly Corporation $64 1,000 $64,000 Total $116,000 100,000 $ 16,000 11-27 (30–40 min.) Relevance of equipment costs. 1a. Statements of Cash Receipts and Disbursements Year 1 Receipts from operations: Revenues Deduct disbursements: Other operating costs Operation of machine Purchase of “old” machine Purchase of “new” equipment Cash inflow from sale of old equipment Net cash inflow Keep Each Year 2, 3, 4 $150,000 $150,000 $600,000 $150,000 $150,000 $600,000 (110,000) (15,000) (20,000)* (110,000) (15,000) (440,000) (60,000) (20,000) (110,000) (9,000) (20,000) (24,000) (110,000) (9,000) (440,000) (36,000) (20,000) (24,000) $ 5,000 $ 25,000 $ 80,000 Four Years Together Buy New Machine Each Four Year Years Year 1 2, 3, 4 Together 8,000 $ (5,000) $ 31,000 8,000 $ 88,000 *Some students ignore this item because it is the same for each alternative. However, note that a statement for the entire year has been requested. Obviously, the $20,000 would affect Year 1 only under both the “keep” and “buy” alternatives. The difference is $8,000 for four years taken together. In particular, note that the $20,000 book value can be omitted from the comparison. Merely cross out the entire line; although the column totals are affected, the net difference is still $8,000. 1b. Again, the difference is $8,000: Income Statements Revenues Costs (excluding disposal): Other operating costs Depreciation Operating costs of machine Total costs (excluding disposal) Loss on disposal: Book value (“cost”) Proceeds (“revenue”) Loss on disposal Total costs Operating income Keep Buy New Machine Each Four Each Four Years Year Years Year Together 1, 2, 3, 4 Together Year 1 2, 3, 4 $150,000 $600,000 $150,000 $150,000 $600,000 110,000 5,000 15,000 130,000 440,000 20,000 60,000 520,000 110,000 6,000 9,000 125,000 130,000 520,000 $ 20,000 $ 80,000 20,000 (8,000) 12,000 137,000 $ 13,000 *As 110,000 6,000 9,000 125,000 440,000 24,000 36,000 500,000 20,000* (8,000) 12,000 125,000 512,000 $ 25,000 $ 88,000 in part (1), the $20,000 book value may be omitted from the comparison without changing the $8,000 difference. This adjustment would mean excluding the depreciation item of $5,000 per year (a cumulative effect of $20,000) under the “keep” alternative and excluding the book value item of $20,000 in the loss on disposal computation under the “buy” alternative. 11- 1c. The $20,000 purchase cost of the old equipment, the revenues, and the other operating costs are irrelevant because their amounts are common to both alternatives. 2. The net difference would be unaffected. Any number may be substituted for the original $20,000 figure without changing the final answer. Of course, the net cash outflows under both alternatives would be high. The Auto Wash manager really blundered. However, keeping the old equipment will increase the cost of the blunder to the cumulative tune of $8,000 over the next four years. 3. Book value is irrelevant in decisions about the replacement of equipment, because it is a past (historical) cost. All past costs are down the drain. Nothing can change what has already been spent or what has already happened. The $20,000 has been spent. How it is subsequently accounted for is irrelevant. The analysis in requirement (1) clearly shows that we may completely ignore the $20,000 and still have a correct analysis. The only relevant items are those expected future items that will differ among alternatives. Despite the economic analysis shown here, many managers would keep the old machine rather than replace it. Why? Because, in many organizations, the income statements of part (2) would be a principal means of evaluating performance. Note that the first-year operating income would be higher under the “keep” alternative. The conventional accrual accounting model might motivate managers toward maximizing their first-year reported operating income at the expense of long-run cumulative betterment for the organization as a whole. This criticism is often made of the accrual accounting model. That is, the action favored by the “correct” or “best” economic decision model may not be taken because the performance-evaluation model is either inconsistent with the decision model or because the focus is on only the short-run part of the performance-evaluation model. There is yet another potential conflict between the decision model and the performance evaluation model. Replacing the machine so soon after it is purchased may reflect badly on the manager’s capabilities and performance. Why didn’t the manager search and find the new machine before buying the old machine? Replacing the old machine one day later at a loss may make the manager appear incompetent to his or her superiors. If the manager’s bosses have no knowledge of the better machine, the manager may prefer to keep the existing machine rather than alert his or her bosses about the better machine. 11- 11-28 (30 min.) Equipment upgrade versus replacement replacement. 1. Based on the analysis in the table below, TechMech will be better off by $180,000 over three years if it replaces the current equipment. Comparing Relevant Costs of Upgrade and Replace Alternatives Cash operating costs $140; $80 per desk 6,000 desks per yr. 3 yrs. Current disposal price One time capital costs, written off periodically as depreciation Total relevant costs Over 3 years Upgrade Replace (1) (2) Difference in favor of Replace (3) = (1) – (2) $2,520,000 $1,440,000 (600,000) $1,080,000 600,000 2,700,000 $5,220,000 4,200,000 $5,040,000 (1,500,000) $ 180,000 Note that the book value of the current machine ($900,000) would either be written off as depreciation over three years under the upgrade option, or, all at once in the current year under the replace option. Its net effect would be the same in both alternatives: to increase costs by $900,000 over three years, hence it is irrelevant in this analysis. 2. Suppose the capital expenditure to replace the equipment is $X. From requirement 1, column (2), substituting for the one-time capital cost of replacement, the relevant cost of replacing is $1,440,000 – $600,000 + $X. From column (1), the relevant cost of upgrading is $5,220,000. We want to find X such that $1,440,000 – $600,000 + $X < $5,220,000 (i.e., TechMech will favor replacing) Solving the above inequality gives us X < $5,220,000 – $840,000 = $4,380,000. TechMech would prefer to replace, rather than upgrade, if the replacement cost of the new equipment does not exceed $4,380,000. Note that this result can also be obtained by taking the original replacement cost of $4,200,000 and adding to it the $180,000 difference in favor of replacement calculated in requirement 1. 3. Suppose the units produced and sold over 3 years equal y. Using data from requirement 1, column (1), the relevant cost of upgrade would be $140y + $2,700,000, and from column (2), the relevant cost of replacing the equipment would be $80y – $600,000 + $4,200,000. TechMech would want to upgrade if $140y + $2,700,000 < $80y – $600,000 + $4,200,000 $60y < $900,000 y < $900,000 $60 = 15,000 units or upgrade when y < 15,000 units (or 5,000 per year for 3 years) and replace when y > 15,000 units over 3 years. When production and sales volume is low (less than 5,000 per year), the higher operating costs under the upgrade option are more than offset by the savings in capital costs from upgrading. When production and sales volume is high, the higher capital costs of replacement are more than offset by the savings in operating costs in the replace option. 11- 4. Operating income for the first year under the upgrade and replace alternatives are shown below: Year 1 Upgrade Replace (1) (2) Revenues (6,000 $500) $3,000,000 $3,000,000 Cash operating costs $140; $80 per desk 6,000 desks per year 840,000 480,000 a + $2,700,000) 3; $4,200,000 3 Depreciation ($900,000 1,200,000 1,400,000 Loss on disposal of old equipment (0; $900,000 – $600,000) 0 300,000 Total costs 2,040,000 2,180,000 Operating Income $ 960,000 $ 820,000 aThe book value of the current production equipment is $1,500,000 useful life of 3 years. 3 5 = $900,000; it has a remaining First-year operating income is higher by $140,000 under the upgrade alternative, and Dan Doria, with his one-year horizon and operating income-based bonus, will choose the upgrade alternative, even though, as seen in requirement 1, the replace alternative is better in the long run for TechMech. This exercise illustrates the possible conflict between the decision model and the performance evaluation model. 11- 11-29 (20 min.) Special Order Order. 1. Revenues from special order ($25 10,000 bats) Variable manufacturing costs ($161 10,000 bats) Increase in operating income if Ripkin order accepted 1 Direct $250,000 (160,000) $ 90,000 materials + Direct manufacturing labor + Variable manufacturing overhead = $12 $1 $3 $16 Louisville should accept Ripkin’s special order because it increases operating income by $90,000. Since no variable selling costs will be incurred on this order, this cost is irrelevant. Similarly, fixed costs are irrelevant because they will be incurred regardless of the decision. 2a. Revenues from special order ($25 10,000 bats) Variable manufacturing costs ($16 10,000 bats) Contribution margin foregone ([$32─$181] 10,000 bats) Decrease in operating income if Ripkin order accepted 1 Direct $250,000 (160,000) (140,000) $ (50,000) matls. + Direct manuf. labor + Variable manuf. overhead + Variable selling exp. = $12 $1 $3 $2 $18 Based strictly on financial considerations, Louisville should reject Ripkin’s special order because it results in a $50,000 reduction in operating income. 2b. Louisville will be indifferent between the special order and continuing to sell to regular customers if the special order price is $30. At this price, Louisville recoups the variable manufacturing costs of $160,000 and the contribution margin given up from regular customers of $140,000 ([$160,000 + $140,000] ÷ 10,000 units = $30). Looked at a different way, Louisville expects the full price of $32 less the $2 saved on variable selling costs. 2c. Louisville may be willing to accept a loss on this special order if the possibility of future long-term sales seem likely. However, Louisville should also consider the effect on customer relationships by refusing sales from existing customers. Also, Louisville cannot afford to adopt the special order price long-term or with other customers who may ask for price concessions. 11- 11-30 (30 min.) Contribution approach, relevant costs costs. 1. Average one-way fare per passenger Commission at 8% of $500 Net cash to Air Frisco per ticket Average number of passengers per flight Revenues per flight ($460 × 200) Food and beverage cost per flight ($20 × 200) Total contribution margin from passengers per flight 2. If fare is Commission at 8% of $480 Net cash per ticket Food and beverage cost per ticket Contribution margin per passenger Total contribution margin from passengers per flight ($421.60 × 212) All other costs are irrelevant. $ $ × $ $ $ $ 500 (40) 460 200 92,000 4,000 88,000 480.00 (38.40) 441.60 20.00 421.60 $89,379.20 On the basis of quantitative factors alone, Air Frisco should decrease its fare to $480 because reducing the fare gives Air Frisco a higher contribution margin from passengers ($89,379.20 versus $88,000). 3. In evaluating whether Air Frisco should charter its plane to Travel International, we compare the charter alternative to the solution in requirement 2 because requirement 2 is preferred to requirement 1. Under requirement 2, contribution from passengers Deduct fuel costs Total contribution per flight $89,379.20 14,000.00 $75,379.20 Air Frisco gets $74,500 per flight from chartering the plane to Travel International. On the basis of quantitative financial factors, Air Frisco is better off not chartering the plane and, instead, lowering its own fares. Other qualitative factors that Air Frisco should consider in coming to a decision are a. The lower risk from chartering its plane relative to the uncertainties regarding the number of passengers it might get on its scheduled flights. b. The stability of the relationship between Air Frisco and Travel International. If this is not a long-term arrangement, Air Frisco may lose current market share and not benefit from sustained charter revenues. 11- 11-31 (30 min.) Relevant costs, opportunity costs. 1. Easyspread 2.0 has a higher relevant operating income than Easyspread 1.0. Based on this analysis, Easyspread 2.0 should be introduced immediately: Easyspread 1.0 $160 Easyspread 2.0 $195 $ 0 Relevant revenues Relevant costs: Manuals, diskettes, compact discs Total relevant costs Relevant operating income $30 0 $160 30 $165 Reasons for other cost items being irrelevant are Easyspread 1.0 Manuals, diskettes—already incurred Development costs—already incurred Marketing and administrative—fixed costs of period Easyspread 2.0 Development costs—already incurred Marketing and administration—fixed costs of period Note that total marketing and administration costs will not change whether Easyspread 2.0 is introduced on July 1, 2009, or on October 1, 2009. 2. Other factors to be considered: a. Customer satisfaction. If 2.0 is significantly better than 1.0 for its customers, a customer driven organization would immediately introduce it unless other factors offset this bias towards “do what is best for the customer.” b. Quality level of Easyspread 2.0. It is critical for new software products to be fully debugged. Easyspread 2.0 must be error-free. Consider an immediate release only if 2.0 passes all quality tests and can be fully supported by the salesforce. c. Importance of being perceived to be a market leader. Being first in the market with a new product can give Basil Software a “first-mover advantage,” e.g., capturing an initial large share of the market that, in itself, causes future potential customers to lean towards purchasing Easyspread 2.0. Moreover, by introducing 2.0 earlier, Basil can get quick feedback from users about ways to further refine the software while its competitors are still working on their own first versions. Moreover, by locking in early customers, Basil may increase the likelihood of these customers also buying future upgrades of Easyspread 2.0. d. Morale of developers. These are key people at Basil Software. Delaying introduction of a new product can hurt their morale, especially if a competitor then preempts Basil from being viewed as a market leader. 11- 11-32 (20 min.) Opportunity costs. 1. The opportunity cost to Wolverine of producing the 2,000 units of Orangebo is the contribution margin lost on the 2,000 units of Rosebo that would have to be forgone, as computed below: Selling price Variable costs per unit: Direct materials Direct manufacturing labor Variable manufacturing overhead Variable marketing costs Contribution margin per unit $20 $2 3 2 4 Contribution margin for 2,000 units 11 $ 9 $ 18,000 The opportunity cost is $18,000. Opportunity cost is the maximum contribution to operating income that is forgone (rejected) by not using a lim ited resource in its next-best alternative use. 2. Contribution margin from manufacturing 2,000 units of Orangebo and purchasing 2,000 units of Rosebo from Buckeye is $16,000, as follows: Manufacture Orangebo Selling price Variable costs per unit: Purchase costs Direct materials Direct manufacturing labor Variable manufacturing costs Variable marketing overhead Variable costs per unit Contribution margin per unit Contribution margin from selling 2,000 units of Orangebo and 2,000 units of Rosebo Purchase Rosebo $15 $20 – 2 3 2 14 2 9 $ 6 4 18 $ 2 $12,000 $4,000 Total $16,000 As calculated in requirement 1, Wolverine’s contribution margin from continuing to manufacture 2,000 units of Rosebo is $18,000. Accepting the Miami Company and Buckeye offer will cost Wolverine $2,000 ($16,000 – $18,000). Hence, Wolverine should refuse the Miami Company and Buckeye Corporation’s offers. 3. The minimum price would be $9, the sum of the incremental costs as computed in requirement 2. This follows because, if Wolverine has surplus capacity, the opportunity cost = $0. For the short-run decision of whether to accept Orangebo’s offer, fixed costs of Wolverine are irrelevant. Only the incremental costs need to be covered for it to be worthwhile for Wolverine to accept the Orangebo offer. 11- 11-33 (30–40 min.) Product mix, relevant costs. 1. Selling price Variable manufacturing cost per unit Variable marketing cost per unit Total variable costs per unit Contribution margin per unit Contribution margin per hour of the constrained resource (the regular machine) Total contribution margin from selling only R3 or only HP6 R3: $25 50,000; HP6: $30 50,000 Less Lease costs of high-precision machine to produce and sell HP6 Net relevant benefit R3 $100 60 15 75 $ 25 $25 = $25 1 HP6 $150 100 35 135 $ 15 $15 = $30 0.5 $1,250,000 $1,500,000 $1,250,000 300,000 $1,200,000 Even though HP6 has the higher contribution margin per unit of the constrained resource, the fact that Pendleton must incur additional costs of $300,000 to achieve this higher contribution margin means that Pendleton is better off using its entire 50,000-hour capacity on the regular machine to produce and sell 50,000 units (50,000 hours 1 hour per unit) of R3. The additional contribution from selling HP6 rather than R3 is $250,000 ($1,500,000 $1,250,000), which is not enough to cover the additional costs of leasing the high-precision machine. Note that, because all other overhead costs are fixed and cannot be changed, they are irrelevant for the decision. 2. If capacity of the regular machines is increased by 15,000 machine-hours to 65,000 machine-hours (50,000 originally + 15,000 new), the net relevant benefit from producing R3 and HP6 is as follows: R3 HP6 Total contribution margin from selling only R3 or only HP6 R3: $25 65,000; HP6: $30 65,000 Less Lease costs of high-precision machine that would be incurred if HP6 is produced and sold Less Cost of increasing capacity by 15,000 hours on regular machine Net relevant benefit 11- $1,625,000 $1,950,000 300,000 150,000 $1,475,000 150,000 $1,500,000 Investing in the additional capacity increases Pendleton’s operating income by $250,000 ($1,500,000 calculated in requirement 2 minus $1,250,000 calculated in requirement 1), so Pendleton should add 15,000 hours to the regular machine. With the extra capacity available to it, Pendleton should use its entire capacity to produce HP6. Using all 65,000 hours of capacity to produce HP6 rather than to produce R3 generates additional contribution margin of $325,000 ($1,950,000 $1,625,000) which is more than the additional cost of $300,000 to lease the highprecision machine. Pendleton should therefore produce and sell 130,000 units of HP6 (65,000 hours 0.5 hours per unit of HP6) and zero units of R3. 3. R3 Contribution margin per hour of the constrained resource (the regular machine) S3 $100 60 15 75 $ 25 Selling price Variable manufacturing costs per unit Variable marketing costs per unit Total variable costs per unit Contribution margin per unit HP6 $150 100 35 135 $ 15 $120 70 15 85 $ 35 $25 = $25 1 $15 = $30 0.5 $35 = $35 1 The first step is to compare the operating profits that Pendleton could earn if it accepted the Carter Corporation offer for 20,000 units with the operating profits Pendleton is currently earning. S3 has the highest contribution margin per hour on the regular machine and requires no additional investment such as leasing a high-precision machine. To produce the 20,000 units of S3 requested by Carter Corporation, Pendleton would require 20,000 hours on the regular machine resulting in contribution margin of $35 20,000 = $700,000. Pendleton now has 45,000 hours available on the regular machine to produce R3 or HP6. R3 Total contribution margin from selling only R3 or only HP6 R3: $25 45,000; HP6: $30 45,000 Less Lease costs of high-precision machine to produce and sell HP 6 Net relevant benefit HP6 $1,125,000 $1,350,000 $1,125,000 300,000 $1,050,000 Pendleton should use all the 45,000 hours of available capacity to produce 45,000 units of R3. Thus, the product mix that maximizes operating income is 20,000 units of S3, 45,000 units of R3, and zero units of HP6. This optimal mix results in a contribution margin of $1,825,000 ($700,000 from S3 and $1,125,000 from R3). Relative to requirement 2, operating income increases by $325,000 ($1,825,000 minus $1,500,000 calculated in requirement 2). Hence, Pendleton should accept the Carter Corporation business and supply 20,000 units of S3. 11- 11-34 (35–40 min.) Dropping a product line, selling more units. 1. The incremental revenue losses and incremental savings in cost by discontinuing the Tables product line follows: Difference: Incremental (Loss in Revenues) and Savings in Costs from Dropping Tables Line Revenues Direct materials and direct manufacturing labor Depreciation on equipment Marketing and distribution General administration Corporate office costs Total costs Operating income (loss) $(500,000) 300,000 0 70,000 0 0 370,000 $(130,000) Dropping the Tables product line results in revenue losses of $500,000 and cost savings of $370,000. Hence, Grossman Corporation’s operating income will be $130,000 lower if it drops the Tables line. Note that, by dropping the Tables product line, Home Furnishings will save none of the depreciation on equipment, general administration costs, and corporate office costs, but it will save variable manufacturing costs and all marketing and distribution costs on the Tables product line. 2. Grossman’s will generate incremental operating income of $128,000 from selling 4,000 additional tables and, hence, should try to increase table sales. The calculations follow: Revenues Direct materials and direct manufacturing labor Cost of equipment written off as depreciation Marketing and distribution costs General administration costs Corporate office costs Operating income *Note Incremental Revenues (Costs) and Operating Income $500,000 (300,000) (42,000)* (30,000)† 0** 0** $128,000 that the additional costs of equipment are relevant future costs for the “selling more tables decision” because they represent incremental future costs that differ between the alternatives of selling and not selling additional tables. †Current marketing and distribution costs which varies with number of shipments = $70,000 – $40,000 = $30,000. As the sales of tables double, the number of shipments will double, resulting in incremental marketing and distribution costs of (2 $30,000) – $30,000 = $30,000. **General administration and corporate office costs will be unaffected if Grossman decides to sell more tables. Hence, these costs are irrelevant for the decision. 11- 3.Solution Exhibit 11-34, Column 1, presents the relevant loss of revenues and the relevant savings in costs from closing the Northern Division. As the calculations show, Grossman’s operating income would decrease by $140,000 if it shut down the Northern Division (loss in revenues of $1,500,000 versus savings in costs of $1,360,000). Grossman will save variable manufacturing costs, marketing and distribution costs, and division general administration costs by closing the Northern Division but equipment-related depreciation and corporate office allocations are irrelevant to the decision. Equipment-related costs are irrelevant because they are past costs (and the equipment has zero disposal price). Corporate office costs are irrelevant because Grossman will not save any actual corporate office costs by closing the Northern Division. The corporate office costs that used to be allocated to the Northern Division will be allocated to other divisions. 4. Solution Exhibit 11-34, Column 2, presents the relevant revenues and relevant costs of opening the Southern Division (a division whose revenues and costs are expected to be identical to the revenues and costs of the Northern Division). Grossman should open the Southern Division because it would increase operating income by $40,000 (increase in relevant revenues of $1,500,000 and increase in relevant costs of $1,460,000). The relevant costs include direct materials, direct manufacturing labor, marketing and distribution, equipment, and division general administration costs but not corporate office costs. Note, in particular, that the cost of equipment written off as depreciation is relevant because it is an expected future cost that Grossman will incur only if it opens the Southern Division. Corporate office costs are irrelevant because actual corporate office costs will not change if Grossman opens the Southern Division. The current corporate staff will be able to oversee the Southern Division’s operations. Grossman will allocate some corporate office costs to the Southern Division but this allocation represents corporate office costs that are already currently being allocated to some other division. Because actual total corporate office costs do not change, they are irrelevant to the division. SOLUTION EXHIBIT 11-34 Relevant-Revenue and Relevant-Cost Analysis for Closing Northern Division and Opening Southern Division Revenues Variable direct materials and direct manufacturing labor costs Equipment cost written off as depreciation Marketing and distribution costs Division general administration costs Corporate office costs Total costs Effect on operating income (loss) 11- Incremental (Loss in Revenues) Revenues and and Savings in (Incremental Costs) Costs from Closing from Opening Northern Division Southern Division (1) (2) $(1,500,000) $1,500,000 825,000 0 205,000 330,000 0 1,360,000 $ (140,000) (825,000) (100,000) (205,000) (330,000) 0 (1,460,000) $ 40,000 11-35 (30–40 min.) Make or buy, unknown level of volume. 1. The variable costs required to manufacture 150,000 starter assemblies are Direct materials Direct manufacturing labor Variable manufacturing overhead Total variable costs $200,000 150,000 100,000 $450,000 The variable costs per unit are $450,000 ÷ 150,000 = $3.00 per unit. Let X = number of starter assemblies required in the next 12 months. The data can be presented in both “all data” and “relevant data” formats: Variable manufacturing costs Fixed general manufacturing overhead Fixed overhead, avoidable Division 2 manager’s salary Division 3 manager’s salary Purchase cost, if bought from Tidnish Electronics Total All Data Relevant Data Alternative Alternative Alternative Alternative 1: 2: 1: 2: Buy Make Buy Make $ 3X – $ 3X – 150,000 $150,000 – – 100,000 – 100,000 – 40,000 50,000 40,000 $50,000 50,000 – 50,000 – – $340,000 + $ 3X 4X $200,000 + $ 4X – $190,000 + $ 3X 4X $50,000 + $ 4X The number of units at which the costs of make and buy are equivalent is All data analysis: or Relevant data analysis: $340,000 + $3X = $200,000 + $4X X = 140,000 $190,000 + $3X = $50,000 + $4X X = 140,000 Assuming cost minimization is the objective, then • If production is expected to be less than 140,000 units, it is preferable to buy units from Tidnish. • If production is expected to exceed 140,000 units, it is preferable to manufacture internally (make) the units. • If production is expected to be 140,000 units, Oxford should be indifferent between buying units from Tidnish and manufacturing (making) the units internally. 11- 2. The information on the storage cost, which is avoidable if self-manufacture is discontinued, is relevant; these storage charges represent current outlays that are avoidable if self-manufacture is discontinued. Assume these $50,000 charges are represented as an opportunity cost of the make alternative. The costs of internal manufacture that incorporate this $50,000 opportunity cost are All data analysis: Relevant data analysis: $390,000 + $3X $240,000 + $3X The number of units at which the costs of make and buy are equivalent is All data analysis: Relevant data analysis: $390,000 + $3X X $240,000 + $3X X = = = = $200,000 + $4X 190,000 $50,000 + $4X 190,000 If production is expected to be less than 190,000, it is preferable to buy units from Tidnish. If production is expected to exceed 190,000, it is preferable to manufacture the units internally. 11- 11-36 (30 min.) Make versus buy, activity-based costing, opportunity costs. 1. Relevant costs under buy alternative: Purchases, 10,000 $8.20 $82,000 Relevant costs under make alternative: Direct materials Direct manufacturing labor Variable manufacturing overhead Inspection, setup, materials handling Machine rent Total relevant costs under make alternative $40,000 20,000 15,000 2,000 3,000 $80,000 The allocated fixed plant administration, taxes, and insurance will not change if Ace makes or buys the chains. Hence, these costs are irrelevant to the make-or-buy decision. The analysis indicates that Ace should make and not buy the chains from the outside supplier. 2. Relevant costs under the make alternative: Relevant costs (as computed in requirement 1) Relevant costs under the buy alternative: Costs of purchases (10,000 $8.20) Additional fixed costs Additional contribution margin from using the space where the chains were made to upgrade the bicycles by adding mud flaps and reflector bars, 10,000 ($20 – $18) Total relevant costs under the buy alternative $80,000 $82,000 16,000 (20,000) $78,000 Ace should now buy the chains from an outside vendor and use its own capacity to upgrade its own bicycles. 3. In this requirement, the decision on mud flaps and reflectors is irrelevant to the analysis. Cost of manufacturing chains: Variable costs, ($4 + $2 + $1.50 = $7.50) 6,200 Batch costs, $200/batcha 8 batches Machine rent Cost of buying chains, $8.20 6,200 a$2,000 $46,500 1,600 3,000 $51,100 $50,840 10 batches In this case, Ace should buy the chains from the outside vendor. 11- 11-37 (60 min.) Multiple choice, comprehensive problem on relevant costs. You may wish to assign only some of the parts. Manufacturing costs: Direct materials Direct manufacturing labor Variable manufac. indirect costs Fixed manufac. indirect costs Marketing costs: Variable Fixed 1. (b) $3.50 2. (e) Total $1.00 1.20 0.80 0.50 Per Unit Fixed Variable $3.50 $3.00 2.40 $5.90 $1.50 0.90 $0.50 0.90 $1.40 1.50 $4.50 Manufacturing Costs Variable $3.00 Fixed 0.50 Total $3.50 None of the above. Decrease in operating income is $16,800. Revenues Variable costs Manufacturing Marketing and other Variable costs Contribution margin Fixed costs Manufacturing Marketing and other Fixed costs Operating income *Incremental revenue: $5.80 24,000 Deduct price reduction $0.20 240,000 Old 240,000 $6.00 $1,440,000 $0.50 20,000 12 mos. = $0.90 240,000 New 264,000 $5.80 $1,531,200 720,000 360,000 1,080,000 360,000 240,000 $3.00 240,000 $1.50 Differential + $ 91,200* + 72,000 + 36,000 + 108,000 – 16,800 264,000 $3.00 264,000 $1.50 120,000 216,000 336,000 $ 24,000 –– –– –– – $ 16,800 $139,200 48,000 $ 91,200 11- 792,000 396,000 1,188,000 343,200 120,000 216,000 336,000 $ 7,200 3. (c) $3,500 If this order were not landed, fixed manufacturing overhead would be underallocated by $2,500, $0.50 per unit 5,000 units. Therefore, taking the order increases operating income by $1,000 plus $2,500, or $3,500. Another way to present the same idea follows: Revenues will increase by (5,000 $3.50 = $17,500) + $1,000 Costs will increase by 5,000 $3.00 Fixed overhead will not change Change in operating income $18,500 (15,000) – $ 3,500 Note that this answer to (3) assumes that variable marketing costs are not influenced by this contract. These 5,000 units do not displace any regular sales. 4. (a) $4,000 less ($7,500 – $3,500) Government Contract As above $3,500 5. (b) Regular Channels Sales, 5,000 $6.00 Increase in costs: Variable costs only: Manufacturing, 5,000 $3.00 $15,000 Marketing, 5,000 $1.50 7,500 Fixed costs are not affected Change in operating income $30,000 22,500 $ 7,500 $4.15 Differential costs: Variable: Manufacturing Shipping Fixed: $4,000 ÷ 10,000 $3.00 0.75 $3.75 10,000 0.40 10,000 $4.15 10,000 $37,500 4,000 $41,500 Selling price to break even is $4.15 per unit. 6. (e) $1.50, the variable marketing costs. The other costs are past costs and therefore, are irrelevant. 11- 7. (e) None of these. The correct answer is $3.55. This part always gives students trouble. The short-cut solution below is followed by a longer solution that is helpful to students. Short-cut solution: The highest price to be paid would be measured by those costs that could be avoided by halting production and subcontracting: Variable manufacturing costs Fixed manufacturing costs saved $60,000 ÷ 240,000 Marketing costs (0.20 $1.50) Total costs $3.00 0.25 0.30 $3.55 Longer but clearer solution: Comparative Annual Income Statement Present Difference Proposed Revenues Variable costs: Manufacturing, 240,000 $3.00 Marketing and other, 240,000 $1.50 Variable costs Contribution margin Fixed costs: Manufacturing Marketing and other Total fixed costs Operating income $1,440,000 $ – $1,440,000 720,000 360,000 1,080,000 360,000 +132,000 – 72,000 852,000* 288,000 1,140,000 300,000 120,000 216,000 336,000 $ 24,000 – 60,000 60,000 216,000 276,000 $ 24,000 $ 0 *This solution is obtained by filling in the above schedule with all the known figures and working “from the bottom up” and “from the top down” to the unknown purchase figure. Maximum variable costs that can be incurred, $1,140,000 – $288,000 = maximum purchase costs, or $852,000. Divide $852,000 by 240,000 units, which yields a maximum purchase price of $3.55. 11-38 (25 min.) Closing down divisions divisions. 1. Division A $530,000 370,500 60,000 465,000 $ 65,000 11- $450,000 405,000 Sales Variable costs of goods sold ($450,000 0.90; $390,000 0.95) Variable S,G & A ($100,000 0.60; $120,000 0.80) Total variable costs Contribution margin Division D 96,000 466,500 $(16,500) 2. Division A Fixed costs of goods sold ($450,000 ─ $405,000; $390,000 ─ $370,500) Fixed S,G & A ($100,000 ─ $60,000; $120,000 ─ $96,000) Total fixed costs Fixed costs savings if shutdown ($85,000 0.60; $43,500 0.60) Division D $45,000 $19,500 40,000 $85,000 24,000 $43,500 $51,000 $26,100 Division A’s contribution margin of $65,000 more than covers its avoidable fixed costs of $51,000. The difference of $14,000 helps cover the company’s unavoidable fixed costs. Since $51,000 of Division A’s fixed costs are avoidable, the remaining $34,000 is unavoidable and will be incurred regardless of whether Division A continues to operate. Division A’s $20,000 loss is the rest of the unavoidable fixed costs ($34,000 ─ $14,000). If Division A is closed, the remaining divisions will need to generate sufficient profits to cover the entire $34,000 unavoidable fixed cost. Consequently, Division A should not be closed since it helps defray $14,000 of this cost. In contrast, Division D earns a negative contribution margin, which means its revenues are less than its variable costs. Division D also generates $26,100 of avoidable fixed costs. Based strictly on financial considerations, Division D should be closed because the company will save $42,600 ($26,100 + $16,500). An alternative set of calculations is as follows: Division A Total variable costs Avoidable fixed costs if shutdown Total cost savings if shutdown Loss of revenues if shutdown Cost savings minus loss of revenues $465,000 51,000 516,000 530,000 $ (14,000) Division D $466,500 26,100 492,600 450,000 $ 42,600 Division A should not be shut down because loss of revenues if Division A is shut down exceeds cost savings. Division D should be shut down because cost savings from shutting down Division D exceeds loss of revenues. 3. Before deciding to close Division D, management should consider the role that the Division’s product line plays relative to other product lines. For instance, if the product manufactured by Division D attracts customers to the company, then dropping Division D may have a detrimental effect on the revenues of the remaining divisions. Management may also want to consider the impact on the morale of the remaining employees if Division D is closed. Talented employees may become fearful of losing their jobs and seek employment elsewhere. 11- 11-39 (25 min.) Product mix, constrained resource resource. 1. Selling price Variable costs: Direct materials (DM) Labor and other costs Total variable costs Contribution margin Pounds of DM per unit1 Contribution margin per lb. 1A110: B382: C657: A110 $84 B382 $ 56 C657 $70 24 28 52 $32 ÷8 lbs. $ 4 per lb. 15 27 42 $ 14 ÷5 lbs. $2.80 per lb. 9 40 49 $21 ÷ 3 lbs. $ 7 per lb. Direct material cost per unit Cost per pound of Bistide Direct material cost per unit Cost per pound of Bistide Direct material cost per unit Cost per pound of Bistide = = = $24 $3 $15 $3 $9 $3 8 lb. per unit 5 lb. per unit 3 lb. per unit First, satisfy minimum requirements. Minimum units Times pounds per unit Pounds needed to produce minimum units A110 200 ×8 lb. per unit 1,600 lb. B382 200 ×5 lb. per unit 1,000 lb. C657 200 ×3 lb. per unit 600 lb. Total 3,200 lb. The remaining 1,800 pounds (5,000 ─ 3,200) should be devoted to C657 because it has the highest contribution margin per pound of direct material. Since each unit of C657 requires 3 pounds of Bistide, the remaining 1,800 pounds can be used to produce another 600 units of C657. The following combination yields the highest contribution margin given the 5,000 pounds constraint on availability of Bistide. A110: 200 units B382: 200 units C657: 800 units (200 minimum + 600 extra) 11- 2. The demand for Westford’s products exceeds the materials available. Assuming that fixed costs are covered by the original product mix, Westford should be willing to pay upto an additional $7 per pound (the contribution margin per pound of C657) for another 1,000 pounds of Bistide. That is, Westford should be willing to pay $3 + $7 = $10 per pound of Bistide1. This cost assumes that sufficient demand exists to sell another 333 units (1000 pounds ÷ 3 pounds per unit) of C657. If not, then the maximum price falls to an additional $4 per pound (the contribution margin per pound of A110) so that Westford can produce up to 125 more units of A110 (1,000 pounds ÷ 8 pounds per unit). In this case, Westford would be willing to pay $3 + $4 = $7 per pound. If there is insufficient demand to sell another 125 units of A110, then the maximum price Westford would be willing to pay falls to an additional $2.80 per pound (the contribution margin per pound of B382). Westford would be willing to pay $2.80 + $3 = $5.80 per pound of Bistide. 1An alternative calculation focuses on column 3 for C657 of the table in requirement 1. Selling price Variable labor and other costs (excluding direct materials) Contribution margin Divided by pounds of direct material per unit Direct material cost per pound that Westford can pay without contribution margin becoming negative 11- $70 40 $30 ÷3 lbs. $10 11-40 (30–40 min.) Optimal product mix. 1. Let D represent the batches of Della’s Delight made and sold. Let B represent the batches of Bonny’s Bourbon made and sold. The contribution margin per batch of Della’s Delight is $300. The contribution margin per batch of Bonny’s Bourbon is $250. The LP formulation for the decision is: Maximize Subject to $300D + $250 B 30D + 15B 660 (Mixing Department constraint) 15B 270 (Filling Department constraint) 10D + 15B 300 (Baking Department constraint) 2. Solution Exhibit 11-40 presents a graphical summary of the relationships. The optimal corner is the point (18, 8) i.e., 18 batches of Della’s Delights and 8 of Bonny’s Bourbons. SOLUTION EXHIBIT 11-40 Graphic Solution to Find Optimal Mix, Della Simpson, Inc. Della Simpson Production Model 50 45 0, 44 Mixing Dept. Constraint B (batches of Bonny's Bourbons) 40 35 Equal Contribution Margin Lines 30 Optimal Corner (18,8) 25 20 Filling Dept. Constraint 3, 18 0, 18 15 10 Feasible Region 5 Baking Dept. Constraint 0 0 5 10 15 20 22, 0 25 D (batches of Della's Delight) 11- 30 35 40 We next calculate the optimal production mix using the trial-and-error method. The corner point where the Mixing Dept. and Baking Dept. constraints intersect can be calculated as (18, 8) by solving: 30D + 15B = 660 (1) Mixing Dept. constraint 10D + 15B = 300 (2) Baking Dept. constraint Subtracting (2) from (1), we have 20D = 360 or D = 18 Substituting in (2) (10 18) + 15B = 300 that is, 15B = 300 180 = 120 or B = 8 The corner point where the Filling and Baking Department constraints intersect can be calculated as (3,18) by substituting B = 18 (Filling Department constraint) into the Baking Department constraint: 10 D + (15 18) = 300 10 D = 300 270 = 30 D= 3 The feasible region, defined by 5 corner points, is shaded in Solution Exhibit 11-40. We next use the trial-and-error method to check the contribution margins at each of the five corner points of the area of feasible solutions. Trial 1 2 3 4 5 Corner (D,B) (0,0) (22,0) (18,8) (3,18) (0,18) Total Contribution Margin ($300 0) + ($250 0) = $0 ($300 22) + ($250 0) = $6,600 ($300 18) + ($250 8) = $7,400 ($300 3) + ($250 18) = $5,400 ($300 0) + ($250 18) = $4,500 The optimal solution that maximizes contribution margin and operating income is 18 batches of Della’s Delights and 8 batches of Bonny’s Bourbons. 11- 11-41 (30 min.) Make versus buy, ethics. 1. Direct materials per unit = $195,000 30,000 = 6.50 Direct manufacturing labor per unit = $120,000 30,000 = $4 Variable manufacturing overhead for 30,000 units = 40% of $225,000 = $90,000 Variable manufacturing overhead as a percentage of direct manufacturing labor = $90,000 $120,000 = 75% Fixed manufacturing overhead = 60% of $225,000 = $135,000 SOLUTION EXHIBIT 11-41A Manufacturing Costs for Manufacturing 32,000 Units Costs for with Porter 30,000 Units Estimates (1) (2) Purchasing costs ($17.30/unit 32,000 units) Direct materials ($6.50/unit 30,000; 32,000 units) Direct manufacturing labor ($4/unit 30,000; 32,000 units) Plant space rental (or penalty to terminate) Equipment leasing (or penalty to terminate) Variable overhead (75% of direct manufacturing labor) Fixed manufacturing overhead Total manufacturing or purchasing costs $195,000 120,000 84,000 36,000 90,000 135,000 $660,000 Purchase Costs for 32,000 Units with Porter Estimates (3) $553,600 $208,000 128,000 84,000 36,000 96,000 135,000 $687,000 10,000 5,000 135,000 $703,600 On the basis of Porter’s estimates, Solution Exhibit 11-41A suggests that in 2009, the cost to purchase 32,000 units of MTR-2000 will be $703,600, which is greater than the estimated $687,000 costs to manufacture MTR-2000 in-house. Based solely on these financial results, the 32,000 units of MTR-2000 for 2009 should be manufactured in-house. 2. SOLUTION EXHIBIT 11-41B Manufacturing Costs for 32,000 Units with Hart Estimates (4) Purchasing costs ($17.30/unit 32,000 units) Direct materials ($208,000 1.08) Direct manufacturing labor ($128,000 1.05) Plant space rental (or penalty to terminate) Equipment leasing (or penalty to terminate) Variable overhead (75% of direct mfg. labor) Fixed manufacturing overhead Total manufacturing or purchasing costs 11- $224,640 134,400 84,000 36,000 100,800 135,000 $714,840 Purchase Costs for 32,000 Units with Hart Estimates (5) $553,600 10,000 3,000 135,000 $701,600 Based solely on the financial results shown in Solution Exhibit 11-41B, Hart’s estimates suggest that the 32,000 units of MTR-2000 should be purchased from Marley. The total cost from Marley would be $701,600, or $13,240 less than if the units were made by Paibec. 3. At least four other factors that Paibec Corporation should consider before agreeing to purchase MTR-2000 from Marley Company include the following: In future years, Paibec will not incur the rental and lease contract termination costs on its annual contacts that it will incur in 2009. This will make the purchase option even more attractive, in a financial sense. But then, Marley’s own longevity, its ability to provide the required units of MTR-2000, and its demanded price should be considered, since terminating the contracts may make the make-versus-buy decision a long-term one for Paibec. The quality of the Marley component should be equal to, or better than, the quality of the internally made component. Otherwise, the quality of the final product might be compromised and Paibec’s reputation affected. Marley’s reliability as an on-time supplier is important, since late deliveries could hamper Paibec’s production schedule and delivery dates for the final product. Layoffs may result if the component is outsourced to Marley. This could impact Paibec’s other employees and cause labor problems or affect the company’s position in the community. In addition, there may be labor termination costs, which have not been factored into the analysis. 4. Referring to “Standards of Ethical Conduct for Management Accountants,” in Exhibit 1-7, Lynn Hart would consider the request of John Porter to be unethical for the following reasons. Competence Prepare complete and clear reports and recommendations after appropriate analysis of relevant and reliable information. Adjusting cost numbers violates the competence standard. Integrity Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. Paibec has a legitimate objective of trying to obtain the component at the lowest cost possible, regardless of whether it is manufactured internally or outsourced to Marley. Communicate unfavorable as well as favorable information and professional judgments or opinions. Hart needs to communicate the proper and accurate results of the analysis, regardless of whether or not it favors internal production. Refrain from engaging in or supporting any activity that would discredit the profession. Falsifying the analysis would discredit Hart and the profession. 11- Credibility Communicate information fairly and objectively. Hart needs to perform an objective makeversus-buy analysis and communicate the results fairly. Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. Hart needs to fully disclose the analysis and the expected cost increases. Confidentiality Not affected by this decision. Hart should indicate to Porter that the costs she has derived under the make alternative are correct. If Porter still insists on making the changes to lower the costs of making MTR-2000 internally, Hart should raise the matter with Porter’s superior, after informing Porter of her plans. If, after taking all these steps, there is a continued pressure to understate the costs, Hart should consider resigning from the company, rather than engage in unethical conduct. 11- 11-42 (30 min.) Product mix, constrained resource. 1. Nealy Tersa Pelta Total Units (1) 1,800 4,500 39,000 Machine Hrs Per Unit (2) = Var. Mach. Cost/Unit ÷ $200/Hour $600 ÷ $200 = 3 $500 ÷ $200 = 2.5 $200 ÷ $200 = 1 Machine Hrs Demanded (3) = (1) × (2) 5,400 11,250 39,000 55,650 2. Selling price Variable costs: Direct materials Variable machining Sales commissions (5%, 5%, 10%) Total variable costs Contribution margin per unit Nealy $3,000 Tersa $2,100 Pelta $800 750 600 150 1,500 $1,500 500 500 105 1,105 $ 995 100 200 80 380 $420 3. Total machine hours needed to satisfy demand exceed the machine hours available (55,650 needed > 50,000 available). Consequently Marion Taylor needs to evaluate these products based on the contribution margin per machine hour. Unit contribution margin Machine-hours (MH) per unit Unit contribution margin per MH Nealy $1,500 ÷3 MH $ 500 Tersa $995 ÷2.5 MH $398 Pelta $420 ÷1 MH $420 Based on this analysis, Marion Taylor should produce to meet the demand for products with the highest unit contribution margin per machine hour, first Nealy, then Pelta, and finally Tersa. The optimal product mix will be as follows: Nealy Pelta Tersa Total 1,800 units = 5,400 MH 39,000 units = 39,000 MH 2,240 (5,600 MH ÷ 2.5 MH/unit) units = 5,600 MH (50,000 ─ 5,400 ─ 39,000) 50,000 MH 4. The optimal product mix in Part 3 satisfies the demand for Nealy and Pelta and leaves only 2,260 units (4,500 ─ 2,240) of Tersa unfilled. These remaining units of Tersa require 5,650 machine hours (2,260 units 2.5 MH per unit). The maximum price Marion Taylor is willing to pay for extra machine hours is $398, which is the unit contribution per machine hour for additional units of Tersa. That is, total cost per machine-hour for these units will be $398 + $200 (variable cost per machine-hour) = $598 per machine-hour. 11- CHAPTER 12 PRICING DECISIONS AND COST MANAGEMENT 12-1 The three major influences on pricing decisions are 1. Customers 2. Competitors 3. Costs 12-2 Not necessarily. For a one-time-only special order, the relevant costs are only those costs that will change as a result of accepting the order. In this case, full product costs will rarely be relevant. It is more likely that full product costs will be relevant costs for long-run pricing decisions. 12-3 1. 2. Two examples of pricing decisions with a short-run focus: Pricing for a one-time-only special order with no long-term implications. Adjusting product mix and volume in a competitive market. 12-4 Activity-based costing helps managers in pricing decisions in two ways. 1. It gives managers more accurate product-cost information for making pricing decisions. 2. It helps managers to manage costs during value engineering by identifying the cost impact of eliminating, reducing, or changing various activities. 12-5 Two alternative starting points for long-run pricing decisions are 1. Market-based pricing, an important form of which is target pricing. The market-based approach asks, “Given what our customers want and how our competitors will react to what we do, what price should we charge?” 2. Cost-based pricing which asks, “What does it cost us to make this product and, hence, what price should we charge that will recoup our costs and achieve a target return on investment?” 12-6 A target cost per unit is the estimated long-run cost per unit of a product (or service) that, when sold at the target price, enables the company to achieve the targeted operating income per unit. 12-7 Value engineering is a systematic evaluation of all aspects of the value-chain business functions, with the objective of reducing costs while satisfying customer needs. Value engineering via improvement in product and process designs is a principal technique that companies use to achieve target costs per unit. 12-8 A value-added cost is a cost that customers perceive as adding value, or utility, to a product or service. Examples are costs of materials, direct labor, tools, and machinery. A nonvalue-added cost is a cost that customers do not perceive as adding value, or utility, to a product or service. Examples of nonvalue-added costs are costs of rework, scrap, expediting, and breakdown maintenance. 12-9 No. It is important to distinguish between when costs are locked in and when costs are incurred, because it is difficult to alter or reduce costs that have already been locked in. 12- 12-10 Cost-plus pricing is a pricing approach in which managers add a markup to cost in order to determine price. 12-11 Cost-plus pricing methods vary depending on the bases used to calculate prices. Examples are (a) variable manufacturing costs; (b) manufacturing function costs; (c) variable product costs; and (d) full product costs. 12-12 Two examples where the difference in the costs of two products or services is much smaller than the differences in their prices follow: 1. The difference in prices charged for a telephone call, hotel room, or car rental during busy versus slack periods is often much greater than the difference in costs to provide these services. 2. The difference in costs for an airplane seat sold to a passenger traveling on business or a passenger traveling for pleasure is roughly the same. However, airline companies price discriminate. They routinely charge business travelers––those who are likely to start and complete their travel during the same week excluding the weekend––a much higher price than pleasure travelers who generally stay at their destinations over at least one weekend. 12-13 Life-cycle budgeting is an estimate of the revenues and costs attributable to each product from its initial R&D to its final customer servicing and support. 12-14 1. 2. in 3. Three benefits of using a product life-cycle reporting format are: The full set of revenues and costs associated with each product becomes more visible. Differences among products in the percentage of total costs committed at early stages the life cycle are highlighted. Interrelationships among business function cost categories are highlighted. 12-15 Predatory pricing occurs when a business deliberately prices below its costs in an effort to drive competitors out of the market and restrict supply, and then raises prices rather than enlarge demand. Under U.S. laws, dumping occurs when a non-U.S. company sells a product in the United States at a price below the market value in the country where it is produced, and this lower price materially injures or threatens to materially injure an industry in the United States. Collusive pricing occurs when companies in an industry conspire in their pricing and production decisions to achieve a price above the competitive price and so restrain trade. 12- 12-16 (20–30 min.) 1. Relevant-cost approach to pricing decisions, special order. Relevant revenues, $4.00 1,000 Relevant costs Direct materials, $1.60 1,000 Direct manufacturing labor, $0.90 1,000 Variable manufacturing overhead, $0.70 1,000 Variable selling costs, 0.05 $4,000 Total relevant costs Increase in operating income $4,000 $1,600 900 700 200 3,400 $ 600 This calculation assumes that: a. The monthly fixed manufacturing overhead of $150,000 and $65,000 of monthly fixed marketing costs will be unchanged by acceptance of the 1,000 unit order. b. The price charged and the volumes sold to other customers are not affected by the special order. Chapter 12 uses the phrase “one-time-only special order” to describe this special case. 2. The president’s reasoning is defective on at least two counts: a. The inclusion of irrelevant costs––assuming the monthly fixed manufacturing overhead of $150,000 will be unchanged; it is irrelevant to the decision. b. The exclusion of relevant costs––variable selling costs (5% of the selling price) are excluded. 3. Key issues are: a. Will the existing customer base demand price reductions? If this 1,000-tape order is not independent of other sales, cutting the price from $5.00 to $4.00 can have a large negative effect on total revenues. b. Is the 1,000-tape order a one-time-only order, or is there the possibility of sales in subsequent months? The fact that the customer is not in Dill Company’s “normal marketing channels” does not necessarily mean it is a one-time-only order. Indeed, the sale could well open a new marketing channel. Dill Company should be reluctant to consider only short-run variable costs for pricing long-run business. 12- 12-17 (20–30 min.) Relevant-cost approach to short-run pricing decisions. 1. Analysis of special order: Sales, 3,000 units $75 Variable costs: Direct materials, 3,000 units $35 Direct manufacturing labor, 3,000 units $10 Variable manufacturing overhead, 3,000 units $6 Other variable costs, 3,000 units $5 Sales commission Total variable costs Contribution margin $225,000 $105,000 30,000 18,000 15,000 8,000 176,000 $ 49,000 Note that the variable costs, except for commissions, are affected by production volume, not sales dollars. If the special order is accepted, operating income would be $1,000,000 + $49,000 = $1,049,000. 2. Whether McMahon’s decision to quote full price is correct depends on many factors. He is incorrect if the capacity would otherwise be idle and if his objective is to increase operating income in the short run. If the offer is rejected, San Carlos, in effect, is willing to invest $49,000 in immediate gains forgone (an opportunity cost) to preserve the long-run selling-price structure. McMahon is correct if he thinks future competition or future price concessions to customers will hurt San Carlos’s operating income by more than $49,000. There is also the possibility that Abrams could become a long-term customer. In this case, is a price that covers only short-run variable costs adequate? Would Holtz be willing to accept a $8,000 sales commission (as distinguished from her regular $33,750 = 15% $225,000) for every Abrams order of this size if Abrams becomes a long-term customer? 12- 12-18 (15-20 min.) Short-run pricing, capacity constraints. 1. Per kilogram of hard cheese: Milk (10 liters $1.50 per liter) Direct manufacturing labor Variable manufacturing overhead Fixed manufacturing cost allocated Total manufacturing cost $15 5 3 6 $29 If Vermont Hills can get all the Holstein milk it needs, and has sufficient production capacity, then, the minimum price per kilo it should charge for the hard cheese is the variable cost per kilo = $15+5+3 = $23 per kilo. 2. If milk is in short supply, then each kilo of hard cheese displaces 2.5 kilos of soft cheese (10 liters of milk per kilo of hard cheese versus 4 liters of milk per kilo of soft cheese). Then, for the hard cheese, the minimum price Vermont should charge is the variable cost per kilo of hard cheese plus the contribution margin from 2.5 kilos of soft cheese, or, $23 + (2.5 $8 per kilo) = $43 per kilo That is, if milk is in short supply, Vermont should not agree to produce any hard cheese unless the buyer is willing to pay at least $43 per kilo. 12-19 (25–30 min.) Value-added, nonvalue-added costs costs. 1. Category Value-added costs Nonvalue-added costs Gray area Examples a. Materials and labor for regular repairs b. Rework costs c. Expediting costs caused by work delays g. Breakdown maintenance of equipment Total d. Materials handling costs e. Materials procurement and inspection costs f. Preventive maintenance of equipment Total $ 800,000 $ 75,000 60,000 55,000 $190,000 $ 50,000 35,000 15,000 $100,000 Classifications of value-added, nonvalue-added, and gray area costs are often not clear-cut. Other classifications of some of the cost categories are also plausible. For example, some students may include materials handling, materials procurement, and inspection costs and preventive maintenance as value-added costs (costs that customers perceive as adding value and as being necessary for good repair service) rather than as in the gray area. Preventive maintenance, for instance, might be regarded as value-added because it helps prevent nonvalueadding breakdown maintenance. 12- 2. Total costs in the gray area are $100,000. Of this, we assume 65%, or $65,000, are value-added and 35%, or $35,000, are nonvalue-added. Total value-added costs: $800,000 + $65,000 $ 865,000 Total nonvalue-added costs: $190,000 + $35,000 225,000 Total costs $1,090,000 Nonvalue-added costs are $225,000 ÷ $1,090,000 = 20.64% of total costs. Value-added costs are $865,000 ÷ $1,090,000 = 79.36% of total costs. 3. Program (a) Quality improvement programs to • reduce rework costs by 75% (0.75 $75,000) • reduce expediting costs by 75% (0.75 $60,000) • reduce materials and labor costs by 5% (0.05 $800,000) Total effect (b) Working with suppliers to • reduce materials procurement and inspection costs by 20% (0.20 $35,000) • reduce materials handling costs by 25% (0.25 $50,000) Total effect Transferring 65% of gray area costs (0.65 $19,500 = $12,675) as value-added and 35% (0.35 $19,500 = $6,825) as nonvalue-added Effect on value-added and nonvalue-added costs (c) Maintenance programs to • increase preventive maintenance costs by 50% (0.50 $15,000) • decrease breakdown maintenance costs by 40% (0.40 $55,000) Total effect Transferring 65% of gray area costs (0.65 $7,500 = $4,875) as value-added and 35% (0.35 $7,500 = $2,625) as nonvalue-added Effect on value-added and nonvalue-added costs Total effect of all programs Value-added and nonvalue-added costs calculated in requirement 2 Expected value-added and nonvalue-added costs as a result of implementing these programs Effect on Costs Classified as ValueNonvalueGray Added Added Area –$56,250 – 45,000 –$ 40,000 –$ 40,000 –$101,250 –$7,000 –12,500 –19,500 –$ 12,675 –$ 12,675 – $ 6,825 – $6,825 + 19,500 $ 0 +$7,500 – $22,000 – 22,000 +$ 4,875 +$ 4,875 – $ 47,800 + 2,625 – $19,375 –$127,450 865,000 – 7,500 $ 0 225,000 $817,200 + $7,500 $ 97,550 If these programs are implemented in 2007, total costs would decrease from $1,090,000 (requirement 2) to $817,200 + $97,550 = $914,750, and the percentage of nonvalue-added costs would decrease from 20.64% (requirement 2) to $97,550 ÷ 914,750 = 10.66%. These are significant improvements in Marino’s performance. 12- 12-20 (2530 min.) Target operating income, value-added costs, service company. 1. The classification of total costs in 2009 into value-added, nonvalue-added, or in the gray area in between follows: Value Gray NonvalueTotal Added Area added (4) = (1) (2) (3) (1)+(2)+(3) Doing calculations and preparing drawings 75% × $400,000 $300,000 $300,000 Checking calculations and drawings 4% × $400,000 $16,000 16,000 Correcting errors found in drawings 7% × $400,000 $28,000 28,000 Making changes in response to client requests 6% × $400,000 24,000 24,000 Correcting errors to meet government building code, 8% × $400,000 32,000 32,000 Total professional labor costs 324,000 16,000 60,000 400,000 Administrative and support costs at 40% ($160,000 ÷ $400,000) of professional labor costs 129,600 6,400 24,000 160,000 Travel 18,000 — 18,000 Total $471,600 $22,400 $84,000 $578,000 Doing calculations and responding to client requests for changes are value-added costs because customers perceive these costs as necessary for the service of preparing architectural drawings. Costs incurred on correcting errors in drawings and making changes because they were inconsistent with building codes are nonvalue-added costs. Customers do not perceive these costs as necessary and would be unwilling to pay for them. Carasco should seek to eliminate these costs by making sure that all associates are well-informed regarding building code requirements and by training associates to improve the quality of their drawings. Checking calculations and drawings is in the gray area (some, but not all, checking may be needed). There is room for disagreement on these classifications. For example, checking calculations may be regarded as value added. 2. Reduction in professional labor-hours by a. Correcting errors in drawings (7% × 8,000) b. Correcting errors to conform to building code (8% × 8,000) Total Cost savings in professional labor costs (1,200 hours × $50) Cost savings in variable administrative and support costs (40% × $60,000) Total cost savings Current operating income in 2009 Add cost savings from eliminating errors Operating income in 2009 if errors eliminated 12- 560 hours 640 hours 1,200 hours $ 60,000 24,000 $ 84,000 $102,000 84,000 $186,000 3. Currently 85% × 8,000 hours = 6,800 hours are billed to clients generating revenues of $680,000. The remaining 15% of professional labor-hours (15% × 8,000 = 1,200 hours) is lost in making corrections. Carasco bills clients at the rate of $680,000 ÷ 6,800 = $100 per professional labor-hour. If the 1,200 professional labor-hours currently not being billed to clients were billed to clients, Carasco’s revenues would increase by 1,200 hours × $100 = $120,000 from $680,000 to $800,000. Costs remain unchanged Professional labor costs Administrative and support (40% × $400,000) Travel Total costs Carasco’s operating income would be Revenues Total costs Operating income 12- $400,000 160,000 18,000 $578,000 $800,000 578,000 $222,000 12-21 (25–30 min.) Target prices, target costs, activity-based costing. 1. Snappy’s operating income in 2008 is as follows: Revenues ($4 250,000) Purchase cost of tiles ($3 250,000) Ordering costs ($50 500) Receiving and storage ($30 4,000) Shipping ($40 1,500) Total costs Operating income Total for 250,000 Tiles (1) $1,000,000 750,000 25,000 120,000 60,000 955,000 $ 45,000 Per Unit (2) = (1) ÷ 250,000 $4.00 3.00 0.10 0.48 0.24 3.82 $0.18 2. Price to retailers in 2009 is 95% of 2008 price = 0.95 $4 = $3.80; cost per tile in 2009 is 96% of 2008 cost = 0.96 $3 = $2.88. Snappy’s operating income in 2009 is as follows: Revenues ($3.80 250,000) Purchase cost of tiles ($2.88 250,000) Ordering costs ($50 500) Receiving and storage ($30 4,000) Shipping ($40 1,500) Total costs Operating income Total for 250,000 Tiles (1) $ 950,000 720,000 25,000 120,000 60,000 925,000 $ 25,000 Per Unit (2) = (1) ÷ 250,000 $3.80 2.88 0.10 0.48 0.24 3.70 $0.10 3. Snappy’s operating income in 2009, if it makes changes in ordering and material handling, will be as follows: Total for 250,000 Tiles Per Unit (1) (2) = (1) ÷ 250,000 $950,000 $3.80 Revenues ($3.80 250,000) 720,000 2.88 Purchase cost of tiles ($2.88 250,000) 5,000 0.02 Ordering costs ($25 200) 87,500 0.35 Receiving and storage ($28 3,125) 60,000 0.24 Shipping ($40 1,500) 872,500 3.49 Total costs $ 77,500 $0.31 Operating income Through better cost management, Snappy will be able to achieve its target operating income of $0.30 per tile despite the fact that its revenue per tile has decreased by $0.20 ($4.00 – $3.80), while its purchase cost per tile has decreased by only $0.12 ($3.00 – $2.88). 12- 12-22 (20 min.) Target costs, effect of product-design changes on product costs costs. 1. and 2. Manufacturing costs of HJ6 in 2008 and 2009 are as follows: 2008 Total (1) Direct materials, $1,200 × 3,500; $1,100 × 4,000 $4,200,000 Batch-level costs, $8,000 × 70; $7,500 × 80 560,000 Manuf. operations costs, $55 × 21,000; $50 × 22,000 1,155,000 Engineering change costs, $12,000 × 14; $10,000 × 10 168,000 Total $6,083,000 3. Per Unit (2) = (1) ÷ 3,500 $1,200 160 2009 Per Unit Total (4) = (3) (3) ÷ 4,000 $4,400,000 $1,100 600,000 150 330 1,100,000 275 48 $1,738 100,000 $6,200,000 25 $1,550 Target manufacturing cost Manufacturing cost per unit of HJ6 in 2009 = per unit in 2008 × 90% = $1,738 × 0.90 = $1,564.20 Actual manufacturing cost per unit of HJ6 in 2009 was $1,550. Hence, Medical Instruments did achieve its target manufacturing cost per unit of $1,564.20 4. To reduce the manufacturing cost per unit in 2009, Medical Instruments reduced the cost per unit in each of the four cost categories—direct materials costs, batch-level costs, manufacturing operations costs, and engineering change costs. It also reduced machine-hours and number of engineering changes made—the quantities of the cost drivers. In 2008, Medical Instruments used 6 machine-hours per unit of HJ6 (21,000 machine-hours 3,500 units). In 2009, Medical Instruments used 5.5 machine-hours per unit of HJ6 (22,000 machine-hours 4,000 units). Medical Instruments reduced engineering changes from 14 in 2008 to 10 in 2009. Medical Instruments achieved these gains through value engineering activities that retained only those product features that customers wanted while eliminating nonvalue-added activities and costs. 12- 12-23 (20 min.) Cost-plus target return on investment pricing. 1. Target operating income = target return on investment invested capital Target operating income (25% of $1,000,000) $250,000 Total fixed costs 358,000 Target contribution margin $608,000 Target contribution per room-night, ($608,000 ÷ 16,000) Add variable costs per room-night Price to be charged per room-night Proof Total room revenues ($42 16,000 room-nights) Total costs: Variable costs ($4 16,000) Fixed costs Total costs Operating income $38 4 $42 $672,000 $ 64,000 358,000 422,000 $250,000 The full cost of a room = variable cost per room + fixed cost per room The full cost of a room = $4 + ($358,000 ÷ 16,000) = $4 + $22.375 = $26.375 Markup per room = Rental price per room – Full cost of a room = $42 – $26.375 = $15.625 Markup percentage as a fraction of full cost = $15.625 ÷ $26.375 = 59.24% 2. If price is reduced by 10%, the number of rooms Beck could rent would increase by 10%. The new price per room would be 90% of $42 $37.80 The number of rooms Beck expects to rent is 110% of 16,000 17,600 The contribution margin per room would be $37.80 – $4 $33.80 Contribution margin ($33.80 17,600) $594,880 Because the contribution margin of $594,880 at the reduced price of $37.80 is less than the contribution margin of $608,000 at a price of $42, Beck should not reduce the price of the rooms. Note that the fixed costs of $358,000 will be the same under the $42 and the $37.80 price alternatives and hence, are irrelevant to the analysis. 12- 12-24 (2025 min.) Cost-plus, target pricing, working backwards. 1. Investment Return on investment Operating income (20% $2,400,000) Operating income per unit of RF17 ($480,000 20,000) Full cost per unit of RF17 Selling price ($300 + $24) Markup percentage on full cost ($24 $300) $2,400,000 20% $480,000 $24 $300 $324 8% With a 50% markup on variable costs, Selling price of RF17 = Variable cost per unit of RF17 1.50, so: Variable costs per unit of RF17 = 2. Selling price of RF17 $324 = = $216 1.50 1.50 Fixed cost per unit = $300 – $216 = Total fixed costs = $84 per unit 20,000 units = At a price of $348, sales = 20,000 units 0.90 Revenues ($348 18,000) Variable costs ($216 18,000) Contribution margin ($132 18,000) Fixed costs Operating income $84 $1,680,000 18,000 $6,264,000 3,888,000 2,376,000 1,680,000 $ 696,000 If Waterbuy increases the selling price of RF17 to $348, its operating income will be $696,000. This would be more than the $480,000 operating income Waterbury earns by selling 20,000 units at a price of $324, so, if its forecast is accurate, and based on financial considerations alone, Waterbury should increase the selling price to $348. 3. Target investment in 2009 Target return on investment Target operating income in 2009, 20% $2,100,000 $2,100,000 20% $420,000 Anticipated revenues in 2009, $315 20,000 Less target operating income in 2009 Target full costs in 2009 Less: total target fixed costs Total target variable costs in 2009 $6,300,000 420,000 5,880,000 1,680,000 $4,200,000 Target variable cost per unit in 2009, $4,200,000 20,000 = $210 12- 12-25 Life-cycle product costing. 1. Variable cost per unit = Production cost per unit + Mktg and distribn. cost per unit = $50 + $10 = $60 Total fixed costs over life of Yew = $6,590,000 $1, 450,000 $19,560,000 5, 242,000 $2, 900,000 = $35,742,000 Fixed costs $35,742,000 BEP in units = = 714,840 units Selling price Variable cost per unit $110 $60 2a. Revenues ($110 1,500,000 units) Variable costs ($60 1,500,000 units) Fixed costs Operating income $165,000,000 90,000,000 35,742,000 $ 39,258,000 Revenues Year 2 ($240 100,000 units) Years 3 & 4 ($110 1,200,000 units) Total revenues Variable costs ($60 1,300,000 units) Fixed costs Operating income $ 24,000,000 132,000,000 156,000,000 78,000,000 35,742,000 $ 42,258,000 2b. Over the product’s life-cycle, Option B results in an overall higher operating income of $3,000,000. 3. Before selecting its pricing strategy, Intentical managers should evaluate whether the same pricing policy will be adopted globally. Different markets may need different pricing. For example, special taxes on imports may mean higher prices in foreign markets. Intentical’s pricing strategy must be sensitive to changing customer preferences and reactions of competitors. 12- 12-26 (30 min.) 1. Relevant-cost approach to pricing decisions. Revenues (1,000 crates at $100 per crate) Variable costs: Manufacturing Marketing Total variable costs Contribution margin Fixed costs: Manufacturing Marketing Total fixed costs Operating income $100,000 $40,000 14,000 54,000 46,000 $20,000 16,000 36,000 $ 10,000 Normal markup percentage: $46,000 ÷ $54,000 = 85.19% of total variable costs. 2. Only the manufacturing-cost category is relevant to considering this special order; no additional marketing costs will be incurred. The relevant manufacturing costs for the 200-crate special order are: Variable manufacturing cost per unit $40 200 crates Special packaging Relevant manufacturing costs $ 8,000 2,000 $10,000 Any price above $50 per crate ($10,000 ÷ 200) will make a positive contribution to operating income. Therefore, based on financial considerations, Stardom should accept the 200-crate special order at $55 per crate that will generate revenues of $11,000 ($55 200) and relevant (incremental) costs of $10,000. The reasoning based on a comparison of $55 per crate price with the $60 per crate absorption cost ignores monthly cost-volume-profit relationships. The $60 per crate absorption cost includes a $20 per crate cost component that is irrelevant to the special order. The relevant range for the fixed manufacturing costs is from 500 to 1,500 crates per month; the special order will increase production from 1,000 to 1,200 crates per month. Furthermore, the special order requires no incremental marketing costs. 3. If the new customer is likely to remain in business, Stardom should consider whether a strictly short-run focus is appropriate. For example, what is the likelihood of demand from other customers increasing over time? If Stardom accepts the 200-crate special offer for more than one month, it may preclude accepting other customers at prices exceeding $55 per crate. Moreover, the existing customers may learn about Stardom’s willingness to set a price based on variable cost plus a small contribution margin. The longer the time frame over which Stardom keeps selling 200 crates of canned peaches at $55 a crate, the more likely it is that existing customers will approach Stardom for their own special price reductions. If the new customer wants the contract to extend over a longer time period, Stardom should negotiate a higher price. 12- 12-27 (25–30 min.) Target rate of return on investment, activity-based costing. 1. Operating Income Statement, April 2009 Revenues (12,000 disks $22 per disk) Materials (12,000 disks $15 per disk) Gross margin Ordering (40 vendors $250 per vendor) Cataloging (20 new titles $100 per title) Delivery and support (400 deliveries $15 per delivery) Billing and collection (300 customers $50 per customer) Operating Income Rate of return on investment ($51,000 $300,000 ) $264,000 180,000 84,000 10,000 2,000 6,000 15,000 $ 51,000 17.00% 2. The table below shows that if the selling price of game disks falls to $18 and the cost of each disk falls to $12, monthly gross margin falls to $72,000 (from $84,000 in April), and this results in a return on investment of 13%, which is below EA’s target rate of return on investment of 15%. EA will have to cut costs to earn its target rate of return on investment. Operating Income Statement, May 2009 Revenues (12,000 disks $18 per disk) Materials (12,000 disks $12 per disk) Gross margin Ordering (40 vendors $250 per vendor) Cataloging (20 new titles $100 per title) Delivery and support (400 deliveries $15 per delivery) Billing and collection (300 customers $50 per customer) Operating Income Rate of return on investment ($39,000 $300,000 ) $216,000 144,000 72,000 10,000 2,000 6,000 15,000 $ 39,000 13.00% 3. After EA’s workforce has implemented process improvements, its monthly support costs are $31,500, as shown below. Monthly support costs after process improvements, May 2009 Ordering (30 vendors $200 per vendor) $ 6,000 Cataloging (15 new titles $100 per title) 1,500 Delivery and support (450 deliveries $20 per delivery) 9,000 Billing and collection (300 customers $50 per customer) 15,000 Total monthly support costs $31,500 EA now earns $6 ($18 – $12) gross margin per disk. Suppose it needs to sell X game disks to earn at least its 15% target rate of return on investment of $300,000. Then X needs to be such that: $6 X – $31,500 >= $300,000 15% = $45,000 $6 X >= $76,500 X >= $76,500 $6 = 12,750 game disks i.e., EA must now sell at least 12,750 game disks per month to earn its target rate of return on investment of 15%. 12- 12-28 (25 min.) Cost-plus, target pricing, working backward backward. 1. In the following table, work backwards from operating income to calculate the selling price Selling price $ 9.45 (plug) Less: Variable cost per unit 2.50 Unit contribution margin $ 6.95 Number of units produced and sold ×500,000 units Contribution margin $3,475,000 Less: Fixed costs 3,250,000 Operating income $ 225,000 a) Total sales revenue = $9.45 500,000 units = $4,725,000 b) Selling price = $9.45 (from above) Alternatively, Operating income $ 225,000 Add fixed costs 3,250,000 Contribution margin 3,475,000 Add variable costs ($2.50 × 500,000 units) 1,250,000 Sales revenue $4,725,000 Sales revenue $4,725,000 Selling price = $9.45 Units sold 500,000 Operating income $225,000 c) Rate of return on investment = = 9% Total investment in assets 2,500,000 d) Markup % on full cost Total cost = ($2.50 500,000 units) + $3,250,000 = $4,500,000 $4,500,000 Unit cost = = $9 500,000 units $9.45 $9 Markup % = = 5% $9 $4,725,000 $4,500,000 Or = 5% $4,500,000 2. 3. New fixed costs New variable costs New total costs New total sales (5% markup) New selling price Alternatively, New unit cost New selling price = $3,250,000 ─ $250,000 = $3,000,000 = $2.50 ─ $0.50 = $2 = ($2 500,000 units) + $3,000,000 = $4,000,000 = $4,000,000 1.05 = $4,200,000 = $4,200,000 ÷ 500,000 units = $8.40 = $4,000,000 ÷ 500,000 units = $8 = $8 1.05 = $8.40 New units sold = $500,000 × 90% = $450,000 units Budgeted Operating Income For the year ending December 31, 20xx Revenues ($8.40 450,000 units) Variable costs ($2.00 450,000 units) Contribution margin Fixed costs Operating income (loss) 12- $3,780,000 900,000 2,880,000 3,000,000 $ (120,000) 12-29 (40–45 min.) Target prices, target costs, value engineering, cost incurrence, lockedin cost, activity-based costing. 1. Old CE100 Direct materials costs $182,000 Direct manufacturing labor costs 28,000 Machining costs 31,500 Testing costs 35,000 Rework costs 14,000 Ordering costs 3,360 Engineering costs 21,140 Total manufacturing costs $315,000 Cost Change $2.20 7,000 = $15,400 less $0.50 7,000 = $3,500 less Unchanged because capacity same (20% 2.5 7,000) $2 = $7,000 (See Note 1) (See Note 2) Unchanged because capacity same New CE100 $166,600 24,500 31,500 28,000 5,600 2,100 21,140 $279,440 Note 1: 10% of old CE100s are reworked. That is, 700 (10% of 7,000) CE100s made are reworked. Rework costs = $20 per unit reworked 700 = $14,000. If rework falls to 4% of New CE100s manufactured, 280 (4% of 7,000) New CE100s manufactured will require rework. Rework costs = $20 per unit 280 = $5,600. Note 2 : Ordering costs for New CE100 = 2 orders/month 50 components $21/order = $2,100 Unit manufacturing costs of New CE100 = $279,440 ÷ 7,000 = $39.92 2. Total manufacturing cost reductions based on new design = $315,000 – $279,440 = $35,560 Reduction in unit manufacturing costs based on new design = $35,560 ÷ 7,000 = $5.08 per unit. The reduction in unit manufacturing costs based on the new design can also be calculated as Unit cost of old design, $45 ($315,000 ÷ 7,000 units) – Unit cost of new design, $39.92 = $5.08 Therefore, the target cost reduction of $6 per unit is not achieved by the redesign. 3. Changes in design have a considerably larger impact on costs per unit relative to improvements in manufacturing efficiency ($5.08 versus $1.50). One explanation is that many costs are locked in once the design of the radio-cassette is completed. Improvements in manufacturing efficiency cannot reduce many of these costs. Design choices can influence many direct and overhead cost categories, for example, by reducing direct materials requirements, by reducing defects requiring rework, and by designing in fewer components that translate into fewer orders placed and lower ordering costs. 12- 12-30 (25 min.) Cost-plus, target return on investment pricing. 1. Target operating income = Return on capital in dollars = $13,000,000 10% = $1,300,000 2. Revenues* Variable costs [($3.50 + $1.50) 500,000 cases Contribution margin Fixed costs ($1,000,000 + $700,000 + $500,000) Operating income (from requirement 1) * solve backwards for revenues $6,000,000 2,500,000 3,500,000 2,200,000 $1,300,000 $6,000,000 $12 per case. 500,000 cases Markup % on full cost Full cost = $2,500,000 + $2,200,000 = $4,700,000 Unit cost = $4,700,000 ÷ 500,000 cases = $9.40 per case $12 - $9.40 Markup % on full cost = 27.66% $9.40 Selling price = 3. Budgeted Operating Income For the year ending December 31, 20xx Revenues ($14 475,000 cases*) $6,650,000 Variable costs ($5 475,000 cases) 2,375,000 Contribution margin 4,275,000 Fixed costs 2,200,000 Operating income $2,075,000 * New units = 500,000 cases 95% = 475,000 cases Return on investment = $2,075,000 15.96% $13,000,000 Yes, increasing the selling price is a good idea because operating income increases without increasing invested capital, which results in a higher return on investment. The new return on investment exceeds the 10% target return on investment. 12- 12-31 (20 min.) Cost-plus, time and materials. 1. The different markup rates used by Mazzoli for direct materials and direct labor may represent the approximate overheads (plus a profit margin) associated with each: for example, direct materials would incur ordering and handling overhead, and direct labor would incur overheads such as benefits, insurance, etc., and these may be approximately 50% and 100% of costs. These markups could also be driven by industry practice and competitive factors. 2. As shown in the table below, Bariess will tell White that she will have to pay $270 get the clutch plate repaired and $390 to get it replaced. COST Repair option (3.5 hrs. $30 per hr.; $40) Replace option(1.5 hrs. $30 per hr.; $200) Labor Materials Total Cost $105 $ 40 $145 45 200 245 PRICE (100% markup on labor cost; 50% markup on materials) Repair option ($105 2; $40 1.5) Replace option ($45 2; $200 1.5) Labor Materials $210 $ 60 90 300 Total Price $270 390 3. If the repair and replace options are equally safe and effective, White will choose to get the clutch plate repaired for $270 (rather than spend $390 on a replacement plate). 4. Mazzoli Brothers will earn a greater contribution toward overhead in the replace option ($145 = $390 – $245) than in the repair option ($125 = $270 – $145). If we assume that Mazzoli Brothers earns a constant profit margin on each job, it will earn a larger profit by replacing the clutch plate on Johanna White’s car for $390 than by repairing it for $270. Therefore, Bariess will recommend the replace option to White, which is not the one she would prefer. Recognizing this conflict, Bariess may even present only the replace option to Johanna White, or suggest that the repair option will result in a less-than-safe car. Of course, he runs the risk of White walking away and thinking of other options (at which point, he could present the repair option as a compromise). The problem is that Bariess has superior information about the repairs needed but his incentives may cause him to not reveal his information and instead use it to his advantage. It is only the seller’s desire to build a reputation, to have a long-term relationship with the customer, and to have the customer recommend the seller to other potential buyers of the service that encourages an honest discussion of the options. 12- 12-32 (25 min.) Cost-plus and market-based pricing. 1. California Temps’ full cost per hour of supplying contract labor is Variable costs Fixed costs ($240,000 ÷ 80,000 hours) Full cost per hour $12 3 $15 Price per hour at full cost plus 20% = $15 1.20 = $18 per hour. 2. Contribution margins for different prices and demand realizations are as follows: Price per Hour (1) $16 17 18 19 20 Variable Cost per Hour (2) $12 12 12 12 12 Contribution Margin per Hour (3) = (1) – (2) $4 5 6 7 8 Demand in Hours (4) 120,000 100,000 80,000 70,000 60,000 Total Contribution (5) = (3) × (4) $480,000 500,000 480,000 490,000 480,000 Fixed costs will remain the same regardless of the demand realizations. Fixed costs are, therefore, irrelevant since they do not differ among the alternatives. The table above indicates that California Temps can maximize contribution margin ($500,000) and operating income by charging a price of $17 per hour. 3. The cost-plus approach to pricing in requirement 1 does not explicitly consider the effect of prices on demand. The approach in requirement 2 models the interaction between price and demand and determines the optimal level of profitability using concepts of relevant costs. The two different approaches lead to two different prices in requirements 1 and 2. As the chapter describes, pricing decisions should consider both demand or market considerations and supply or cost factors. The approach in requirement 2 is the more balanced approach. In most cases, of course, managers use the cost-plus method of requirement 1 as only a starting point. They then modify the cost-plus price on the basis of market considerations—anticipated customer reaction to alternative price levels and the prices charged by competitors for similar products. 12- 12-33 Cost-plus and market-based pricing. 1. Single rate = $1, 262, 460 $11.91 per testing hour 106,000 testing hours Billing rate = $11.91 1.45 = $17.27 2. Labor and supervision = $ 491,840 = $4.64 per test-hour 106,000 test-hours Setup and facility costs = Utilities = $402,620 = $503.275 per setup hour 800 setup hours $368,000 = $36.80 per MH 10,000 MH 3. Labor and supervision (60%, 40%) Setup and facility cost (25%, 75%) Utilities (50%, 50%) Total cost Number of testing hours (TH)1 Cost per testing hour Markup Billing rate per testing hour 1106,000 HTT $295,104 100,655 184,000 $579,759 ÷63,600 TH $ 9.12 per TH ×1.45 $ 13.22 per TH ACT $196,736 301,965 184,000 $682,701 ÷42,400 TH $ 16.10 per TH ×1.45 $ 23.35 per TH Total $ 491,840 402,620 368,000 $1,262,460 testing hours 60% = 63,600 TH; 106,000 testing hours 40% = 42,400 TH The billing rates based on the activity-based cost structure make more sense. These billing rates reflect the ways the testing procedures consume the firm’s resources. 4. To stay competitive, Best Test needs to be more efficient in arctic testing. Roughly 44% of 301,965 arctic testing’s total cost ( 44% ) occurs in setups and facility costs. Perhaps the setup 682,701 activity can be redesigned to achieve cost savings. 12- 12-34 (25–30 min.) Life-cycle costing. 1. Projected Life Cycle Income Statement Revenues [$500 (16,000 + 4,800)] Variable costs: Production [$225 (16,000 + 4,800)] Distribution [($20 16,000) + ($22 4,800)] Contribution margin Fixed costs: Design costs Production ($9,000 48 mos.) Marketing [($3,000 32 mos.) + ($1,000 16 mos.)] Distribution [($2,000 32 mos.) + ($1,000 16 mos.)] Life cycle operating income Average profit per desk = $10,400,000 4,680,000 425,600 5,294,400 700,000 432,000 112,000 80,000 $ 3,970,400 $3,970, 400 $190.88 (16,000 4,800) 2. Projected Life Cycle Income Statement Revenues ($400 16,000) Variable costs: Production ($225 16,000) Distribution ($20 16,000) Contribution margin Fixed costs: Design costs Production ($9,000 32 mos.) Marketing ($3,000 32 mos.) Distribution ($2,000 32 mos.) Life cycle operating income $6,400,000 3,600,000 320,000 2,480,000 700,000 288,000 96,000 64,000 $1,332,000 The new desk design is still profitable even if FFM drops the product after only 32 months of $1,332,000 production. However, the operating income per unit falls to only $83.25 per desk. 16,000 desks 3. Life cycle operating income (requirement 2) $1,332,000 Additional fixed production costs ($9,000 16 mos.) 144,000 Revised life cycle operating income $1,188,000 No, the answer does not change even if FFM continues to incur the fixed production costs for the full 48 months. The revised operating income for the new executive desk becomes $1,188,000, $1,188,000 which translates into $74.25 ( ) operating income per desk. 16,000 desks 12- 12-35 (30 min.) Airline pricing, considerations other than cost in pricing pricing. 1. If the fare is $500, a. Air Americo would expect to have 200 business and 100 pleasure travelers. b. Variable costs per passenger would be $80. c. Contribution margin per passenger = $500 – $80 = $420. If the fare is $2,000, a. Air Americo would expect to have 190 business and 20 pleasure travelers. b. Variable costs per passenger would be $180. c. Contribution margin per passenger = $2,000 – $180 = $1,820. Contribution margin from business travelers at prices of $500 and $2,000, respectively, follow: At a price of $500: $420 × 200 passengers At a price of $2,000: $1,820 × 190 passengers = $ 84,000 = $345,800 Air Americo would maximize contribution margin and operating income by charging business travelers a fare of $2,000. Contribution margin from pleasure travelers at prices of $500 and $2,000, respectively, follow: At a price of $500: $420 × 100 passengers At a price of $2,000: $1,820 × 20 passengers = $42,000 = $36,400 Air Americo would maximize contribution margin and operating income by charging pleasure travelers a fare of $500. Air Americo would maximize contribution margin and operating income by a price differentiation strategy, where business travelers are charged $2,000 and pleasure travelers $500. In deciding between the alternative prices, all other costs such as fuel costs, allocated annual lease costs, allocated ground services costs, and allocated flight crew salaries are irrelevant. Why? Because these costs will not change whatever price Air Americo chooses to charge. 2. The elasticity of demand of the two classes of passengers drives the different demands of the travelers. Business travelers are relatively price insensitive because they must get to their destination during the week (exclusive of weekends) and their fares are paid by their companies. A 300% increase in fares from $500 to $2,000 will deter only 5% of the business passengers from flying with Air Americo. In contrast, a similar fare increase will lead to an 80% drop in pleasure travelers who are paying for their own travels, unlike business travelers, and who may have alternative vacation plans they could pursue instead. 3. Since business travelers often want to return within the same week, while pleasure travelers often stay over weekends, a requirement that a Saturday night stay is needed to qualify for the $500 discount fare would discriminate between the passenger categories. This price discrimination is legal because airlines are service companies rather than manufacturing companies and because these practices do not, nor are they intended to, destroy competition. 12- 12-36 (25 min.) Ethics and pricing. 1. Baker prices at full product costs plus a mark-up of 10% = $80,000 + 10% of $80,000 = $80,000 + $8,000 = $88,000. 2. The incremental costs of the order are as follows: Direct materials $40,000 Direct manufacturing labor 10,000 30% of overhead costs (30% × $30,000) 9,000 Incremental costs $59,000 Any bid above $59,000 will generate a positive contribution margin for Baker. Baker may prefer to use full product costs because it regards the new ball-bearings order as a long-term business relationship rather than a special order. For long-run pricing decisions, managers prefer to use full product costs because it indicates the bare minimum costs they need to recover to continue in business rather than shut down. For a business to be profitable in the long run, it needs to recover both its variable and its fixed product costs. Using only variable costs may tempt the manager to engage in excessive long-run price cutting as long as prices give a positive contribution margin. Using full product costs for pricing thereby prompts price stability. 3. Not using full product costs (including an allocation of fixed overhead) to price the order, particularly if it is in direct contradiction of company policy, may be unethical. In assessing the situation, the specific “Standards of Ethical Conduct for Management Accountants,” described in Chapter 1 (p. 16), that the management accountant should consider are listed below. Competence Clear reports using relevant and reliable information should be prepared. Reports prepared on the basis of excluding certain fixed costs that should be included would violate the management accountant’s responsibility for competence. It is unethical for Lazarus to suggest that Decker change the cost numbers that were prepared for the bearings order and for Decker to change the numbers in order to make Lazarus’s performance look good. Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. Lazarus’s motivation for wanting Decker to reduce costs was precisely to earn a larger bonus. This action could be viewed as violating the standard for integrity. The Standards of Ethical Conduct require the management accountant to communicate favorable as well as unfavorable information. In this regard, both Lazarus’s and Decker’s behavior (if Decker agrees to reduce the cost of the order) could be viewed as unethical. Credibility The Standards of Ethical Conduct for Management Accountants require that information should be fairly and objectively communicated and that all relevant information should be disclosed. From a management accountant’s standpoint, reducing fixed overhead costs in deciding on the price to bid are clearly violating both of these precepts. For the reasons cited above, the behavior described by Lazarus and Decker (if he goes along with Lazarus’s wishes) is unethical. Decker should indicate to Lazarus that the costs were correctly computed and that determining prices on the basis of full product costs plus a mark-up of 10% are required by company policy. If Lazarus still insists on making the changes and reducing the costs of the order, Decker should raise the matter with Lazarus’s superior. If, after taking all these steps, there is continued pressure to understate the costs, Decker should consider resigning from the company, rather than engaging in unethical behavior. 12- 12-37 (30 min.) Target prices, target costs, value engineering. 1. Direct materials Direct manufacturing labor ($15 per hr. 0.5 hr.) $14 25,000 hrs. ) Engineering ( 50,000 units Testing ($12 per hr. 0.25 hr.) Full cost per unit of TX40 2. Markup % = $14.98 7.50 7.00 3.00 $32.48 $40.60 $32.48 = 25% $32.48 3. These new units will require direct costs and testing, but no additional engineering since there will be no incremental R&D and design costs to produce 10,000 more units. Incremental revenues Direct costs ($14.98 + $7.50) Testing costs Contribution margin Increase in units sold Increased contribution margin Less : Advertising costs Operating income (loss) $40.60 22.48 3.00 $15.12 ×10,000 units $151,200 (200,000) $ (48,800) No, the increase in units sold are insufficient to cover the extra advertising costs and incremental costs of production. Avery will incur an operating loss on these extra units and should not pursue this strategy. 4. Direct costs ($22.48 60,000 units) Engineering ($14 25,000 hrs.) Testing ($3 60,000 units) Advertising Full cost of TX40 Divide by number of units Full cost per unit of TX40 Markup New selling price $1,348,800 350,000 180,000 200,000 $2,078,800 ÷60,000 units $34.65 ×1.25 $43.31 12-25 CHAPTER 13 STRATEGY, BALANCED SCORECARD, AND STRATEGIC PROFITABILITY ANALYSIS 13-1 Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives. 13-2 The five key forces to consider in industry analysis are: (a) competitors, (b) potential entrants into the market, (c) equivalent products, (d) bargaining power of customers, and (e) bargaining power of input suppliers. 13-3 Two generic strategies are (1) product differentiation, an organization’s ability to offer products or services perceived by its customers to be superior and unique relative to the products or services of its competitors and (2) cost leadership, an organization’s ability to achieve lower costs relative to competitors through productivity and efficiency improvements, elimination of waste, and tight cost control. 13-4 A customer preference map describes how different competitors perform across various product attributes desired by customers, such as price, quality, customer service and product features. 13-5 Reengineering is the fundamental rethinking and redesign of business processes to achieve improvements in critical measures of performance such as cost, quality, service, speed, and customer satisfaction. 13-6 The four key perspectives in the balanced scorecard are: (1) Financial perspective—this perspective evaluates the profitability of the strategy, (2) Customer perspective—this perspective identifies the targeted customer and market segments and measures the company’s success in these segments, (3) Internal business process perspective—this perspective focuses on internal operations that further both the customer perspective by creating value for customers and the financial perspective by increasing shareholder value, and (4) Learning and growth perspective—this perspective identifies the capabilities the organization must excel at to achieve superior internal processes that create value for customers and shareholders. 13-7 A strategy map represents more detailed and specific cause-and-effect relationships across various scorecard measures. It describes specific links across the measures. 13-8 1. 2. 3. 4. A good balanced scorecard design has several features: It tells the story of a company’s strategy by articulating a sequence of cause-and-effect relationships. It helps to communicate the strategy to all members of the organization by translating the strategy into a coherent and linked set of understandable and measurable operational targets. It places strong emphasis on financial objectives and measures in for-profit companies. Nonfinancial measures are regarded as part of a program to achieve future financial performance. It limits the number of measures to only those that are critical to the implementation of strategy. 13-1 5. It highlights suboptimal tradeoffs that managers may make when they fail to consider operational and financial measures together. 13-9 1. Pitfalls to avoid when implementing a balanced scorecard are: Don’t assume the cause-and-effect linkages are precise; they are merely hypotheses. An organization must gather evidence of these linkages over time. Don’t seek improvements across all of the measures all of the time. Don’t use only objective measures in the balanced scorecard. Don’t fail to consider both costs and benefits of different initiatives before including these initiatives in the balanced scorecard. Don’t ignore nonfinancial measures when evaluating managers and employees. Don’t use too many measures. 2. 3. 4. 5. 6. 13-10 Three key components in doing a strategic analysis of operating income are: 1. The growth component which measures the change in operating income attributable solely to the change in quantity of output sold from one year to the next. 2. The price-recovery component which measures the change in operating income attributable solely to changes in the prices of inputs and outputs from one year to the next. 3. The productivity component which measures the change in costs attributable to a change in the quantity and mix of inputs used in the current year relative to the quantity and mix of inputs that would have been used in the previous year to produce current year output. 13-11 An analyst can incorporate other factors such as the growth in the overall market and reductions in selling prices resulting from productivity gains into a strategic analysis of operating income. By doing so, the analyst can attribute the sources of operating income changes to particular factors of interests. For example, the analyst will combine the operating income effects of strategic price reductions and any resulting growth with the productivity component to evaluate a company’s cost leadership strategy. 13-12 Engineered costs result from a cause-and-effect relationship between the cost driver, output, and the (direct or indirect) resources used to produce that output. Discretionary costs arise from periodic (usually annual) decisions regarding the maximum amount to be incurred. There is no measurable cause-and-effect relationship between output and resources used. 13-13 Downsizing (also called rightsizing) is an integrated approach configuring processes, products, and people to match costs to the activities that need to be performed for operating effectively and efficiently in the present and future. Downsizing is an attempt to eliminate unused capacity. 13-14 A partial productivity measure is the quantity of output produced divided by the quantity of an individual input used (e.g., direct materials or direct manufacturing labor). 13-15 No. Total factor productivity (TFP) and partial productivity measures work best together because the strengths of one offset weaknesses in the other. TFP measures are comprehensive, consider all inputs together, and explicitly consider economic substitution among inputs. Physical partial productivity measures are easier to calculate and understand and, as in the case of labor productivity, relate directly to employees’ tasks. Partial productivity measures are also easier to compare across different plants and different time periods. 13-2 13-16 (15 min.) Balanced scorecard. 1. La Quinta’s 2009 strategy is a cost leadership strategy. La Quinta plans to grow by producing high-quality boxes at a low cost delivered to customers in a timely manner. La Quinta’s boxes are not differentiated, and there are many other manufacturers who produce similar boxes. To succeed, La Quinta must produce high-quality boxes at lower costs relative to competitors through productivity and efficiency improvements. 2. Solution Exhibit 13-16A shows the customer preference map for corrugated boxes for La Quinta and Mesa on price, timeliness, quality and design. SOLUTION EXHIBIT 13-16A Customer Preference Map for Corrugated Boxes 3. Measures that we would expect to see on a La Quinta’s balanced scorecard for 2009 are Financial Perspective (1) Operating income from productivity gain, (2) operating income from growth, (3) cost reductions in key areas. These measures evaluate whether La Quinta has successfully reduced costs and generated growth through cost leadership. 13-3 Customer Perspective (1) Market share in corrugated boxes market, (2) new customers, (3) customer satisfaction index. The logic is that improvements in these customer measures are leading indicators of whether La Quinta’s cost leadership strategy is succeeding with its customers and helping it to achieve superior financial performance. Internal Business Process Perspective (1) Productivity, (2) order delivery time, (3) on-time delivery, (4) number of major process improvements. Improvements in these measures are key drivers of achieving cost leadership and are expected to lead to more satisfied customers and in turn to superior financial performance Learning and Growth Perspective (1) Percentage of employees trained in process and quality management, (2) employee satisfaction. Improvements in these measures aim to improve La Quinta’s ability to achieve cost leadership and have a cause-and-effect relationship with improvements in internal business processes, which in turn lead to customer satisfaction and financial performance. Solution Exhibit 13-16B presents the strategy for La Quinta for 2009. SOLUTION EXHIBIT 13-16B Strategy Map for La Quinta for 2009 FINANCIAL PERSPECTIVE CUSTOMER PERSEPCTIVE Operating income from productivity gain Cost reduction in key areas Number of new customers Customer satisfaction Productivity INTERNALBUSINESSPROCESS PERSEPCTIVE LEARNING-ANDGROWTH PERSEPCTIVE Quality Number of major improvements in manufacturing process On-time delivery Employeesatisfaction ratings Percentage of employees trained in process and quality management 13-4 Operating income from growth Market share in corrugated boxes market 13-17 (20 min.) Analysis of growth, price-recovery, and productivity components (continuation of 13-16). 1. La Quinta’s operating income gain is consistent with the cost leadership strategy identified in requirement 1 of Exercise 13-16. The increase in operating income in 2009 was driven by the $140,000 gain in productivity in 2009. La Quinta took advantage of its productivity gain to reduce the prices of its boxes and to fuel growth. It increased market share by growing even though the total market size was unchanged. 2. The productivity component measures the change in costs attributable to a change in the quantity and mix of inputs used in a year relative to the quantity and mix of inputs that would have been used in a previous year to produce the current year output. It measures the amount by which operating income increases and costs decrease through the productive use of input quantities. When comparing productivities across years, the productivity calculations use current year input prices in all calculations. Hence, the productivity component is unaffected by input price changes. The productivity component represents savings in both variable costs and fixed costs. With respect to variable costs, such as direct materials, productivity improvements immediately translate into cost savings. In the case of fixed costs, such as fixed manufacturing conversion costs, productivity gains result only if management takes actions to reduce unused capacity. For example, reengineering manufacturing processes will decrease the capacity needed to produce a given level of output, but it will lead to a productivity gain only if management reduces the unused capacity by, say, selling off the excess capacity. 13-5 13-18 (20 min.) Strategy, balanced scorecard, merchandising operation. 1. Oceano & Sons follows a product differentiation strategy. Oceano’s designs are “trendsetting,” its T-shirts are distinctive, and it aims to make its T-shirts a “must have” for each and every teenager. These are all clear signs of a product differentiation strategy, and, to succeed, Oceano must continue to innovate and be able to charge a premium price for its product. 2. Possible key elements of Oceano’s balance scorecard, given its product differentiation strategy: Financial Perspective (1) Increase in operating income from charging higher margins, (2) price premium earned on products. These measures will indicate whether Oceano has been able to charge premium prices and achieve operating income increases through product differentiation. Customer Perspective (1) Market share in distinctive, name-brand T-shirts, (2) customer satisfaction, (3) new customers, (4) number of mentions of Oceano’s T-shirts in the leading fashion magazines Oceano’s strategy should result in improvements in these customer measures that help evaluate whether Oceano’s product differentiation strategy is succeeding with its customers. These measures are, in turn, leading indicators of superior financial performance. Internal Business Process Perspective (1) Quality of silk-screening (number of colors, use of glitter, durability of the design), (2) frequency of new designs, (3) time between concept and delivery of design Improvements in these measures are expected to result in more distinctive and trendsetting designs delivered to its customers and in turn, superior financial performance. Learning and Growth Perspective (1) Ability to attract and retain talented designers (2) improvements in silk-screening processes, (3) continuous education and skill levels of marketing and sales staff, (4) employee satisfaction. Improvements in these measures are expected to improve Oceano’s capabilities to produce distinctive designs that have a cause-and-effect relationship with improvements in internal business processes, which in turn lead to customer satisfaction and financial performance. 13-6 13-19 (25–30 min.) Strategic analysis of operating income (continuation of 13-18). Operating Income Statement 1. 2008 $4,950,000 Administrative costs Design costs Total costs Operating income 2009 $6,414,200 2,000,000 1,200,000 250,000 3,450,000 $1,500,000 Revenues ($25 198,000; $26 246,700) Costs T-shirts purchased ($10 200,000; $8.50 250,000) 2,125,000 1,162,500 275,000 3,562,500 $2,851,700 Change in operating income 2. $1,351,700 F The Growth Component Selling price in 2008 = Actual units of Actual units of output sold output sold in 2009 in 2008 = Revenue effect of growth (246,700 198,000) $25 = $1,217,500 F × Units of input Actual units of Input required to input used × price produce to produce output in 2009 in 2008 2008 2008 ouput Actual units of capacity in 2008 if adequate to produce 2009 output in 2008 Actual units Cost effect of OR of capacity growth for = If 2008 capacity inadequate in 2008 × fixed costs to produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 Cost effect of growth for variable costs = Price per unit of capacity in 2008 Direct materials (purchased T-shirts) costs that would be required in 2009 to sell 246,700 Tshirts instead of the 198,000 sold in 2008, assuming the 2008 input-output relationship continued 246,700 into 2009, equal 249,192 purchased T-shirts ( 200,000). Administrative costs will not 198,000 change since adequate capacity exists in 2008 to support year 2009 output and customers. Design capacity is discretionary and adequate to support output in year 2009. The cost effects of growth component are Direct materials costs Administrative costs Design costs (249,192 200,000) (4,000 – 4,000) (5 – 5) $10 $300 $50,000 = = = $491,920 U 0 0 $491,920 U Cost effect of growth In summary, the net increase in operating income as a result of the growth component equals: 13-7 Revenue effect of growth $1,217,500 F Cost effect of growth Change in operating income due to growth 491,920 U $ 725,580 F The Price-Recovery Component Actual units Revenue effect of = Selling price Selling price of output price-recovery in 2009 in 2008 sold in 2009 = ($26 $25) 246,700 = $246,700 F Units of input Input Cost effect of Input required to price-recovery for = price in price in × 2009 produce 2009 output variable costs 2008 in 2008 Actual units of capacity in 2008, if adequate to produce 2009 output in 2008 Price per Price per Cost effect of OR unit of unit of × price-recovery for = If 2008 capacity inadequate to capacity capacity fixed costs in 2009 in 2008 produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 Direct materials costs ($8.50 $10) 249,192 =$373,788 F Administrative costs ($310 $300) 4,000 = 40,000 U Design costs ($55,000 $50,000) 5 = 25,000 U Total cost effect of price-recovery component $308,788 F In summary, the net increase in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery $246,700 F Cost effect of price-recovery 308,788 F Change in operating income due to price-recovery $555,488 F 13-8 The Productivity Component Actual units of Units of input Cost effect of Input input used required to productivity for = to produce produce 2009 price 2009 output ouput in 2008 variable costs in 2009 Actual units of capacity in 2008, if adequate to produce 2009 output in 2008 Price per Cost effect of Actual units of OR productivity for = capacity in If 2008 capacity inadequate unit of capacity fixed costs 2009 to produce 2009 output in 2008, in 2009 units of capacity required to produce 2009 output in 2008 The productivity component of cost changes are Direct materials costs (250,000 249,192) $8.50 = $ 6,868 U Administrative costs (4,000 3,750) $310 = 77,500 F Design costs (5 5) $55,000 = 0 Change in operating income due to productivity $70,632 F The change in operating income between 2008 and 2009 can be analyzed as follows: Revenues Costs Operating income Income Statement Amounts in 2008 (1) $4,950,000 Income Revenue and Revenue and Cost Effect Statement Amounts Cost Effects Cost Effects of of of Growth Price-Recovery Productivity in 2009 (5) = in 2009 in 2009 in 2009 (2) (3) (4) (1) + (2) + (3) + (4) $1,217,500 F $246,700 F $6,414,200 3,450,000 491,920 U 308,788 F $70,632 F 3,562,500 $1,500,000 $ 725,580 F $555,488 F $70,632 F $2,851,700 $1,351,700 F Change in operating income 3. The analysis of operating income indicates that growth, price-recovery, and productivity all resulted in favorable changes in operating income in 2009. Further, a significant amount of the increase in operating income resulted from Oceano’s product differentiation strategy. The company was able to continue to charge a premium price while growing sales. It was also able to earn additional operating income by improving its productivity. 13-9 13-20 (20 min.) Analysis of growth, price-recovery, and productivity components (continuation of 13-19). Effect of the industry-market-size factor on operating income Of the 48,700-unit (246,700 – 198,000) increase in sales between 2008 and 2009, 19,800 (10% 198,000) units are due to growth in market size, and 28,900 units are due to an increase in market share. The change in Oceano’s operating income from the industry-market size factor rather than from specific strategic actions is: 19,800 $725,580 (the growth component in Exercise 13-19) $295,000 F 48,700 Effect of product differentiation on operating income The change in operating income due to: Increase in the selling price (revenue effect of price recovery) $246,700 F Increase in price of inputs (cost effect of price recovery) 308,788 F Growth in market share due to product differentiation $725,580 (the growth component in Exercise 13-19) 28,900 48,700 430,580 F Change in operating income due to product differentiation $986,068 F Effect of cost leadership on operating income The change in operating income from cost leadership is: Productivity component $ 70,632 F The change in operating income between 2008 and 2009 can be summarized as follows: Change due to industry-market-size Change due to product differentiation Change due to cost leadership Change in operating income $ 295,000 F 986,068 F 70,632 F $1,351,700 F Oceano has been very successful in implementing its product differentiation strategy. Nearly 73% ($986,068 $1,351,700) of the increase in operating income during 2009 was due to product differentiation, i.e., the distinctiveness of its T-shirts. It was able to raise prices of its products despite a decline in the cost of the T-shirts purchased. Oceano’s operating income increase in 2009 was also helped by a growth in the overall market and a small productivity improvement, which it did not pass on to its customers in the form of lower prices. 13-10 13-21 (15 min.) Identifying and managing unused capacity (continuation of 13 18). 1. The amount and cost of unused capacity at the beginning of year 2009 based on year 2009 production follows: Amount of Cost of Unused Unused Capacity Capacity Administrative, 4,000 3,500; (4,000 – 3,500) $310 500 $155,000 Design Discretionary Discretionary cost, so cannot determine unused capacity* cost so cannot be calculated* *The absence of a cause-and-effect relationship makes identifying unused capacity for discretionary costs difficult. Management cannot determine the desgin resources used for the actual output produced against which to compare design capacity. 2. Oceano can at most reduce administrative capacity by another 200 customers (3,750 – 200 = 3,550 > 3,500 = actual customers; but 3,750 – 400 = 3,350 < 3,500 = actual customers). Oceano will save another 200 $310 = $62,000. This is the maximum amount of costs Oceano can save in 2009. 3. Before Oceano downsizes administrative capacity, it should consider whether sales increases in the future would lead to a greater demand for and utilization of capacity as new customers are drawn to Oceano’s distinctive products—at that point, customer service may be the key to new customer retention and further growth. Also, the market feedback often provided by customer service staff is probably key to Oceano’s cutting-edge fashion strategy; some of this may be lost if administrative capacity is cut back. Additionally, significant reductions in capacity usually means laying off people which can hurt employee morale. 13-11 13-22 (15 min.) Strategy, balanced scorecard. 1. Meredith Corporation follows a product differentiation strategy in 2009. Meredith’s D4H machine is distinct from its competitors and generally regarded as superior to competitors’ products. To succeed, Meredith must continue to differentiate its product and charge a premium price. 2. Balanced Scorecard measures for 2009 follow: Financial Perspective (1) Increase in operating income from charging higher margins, (2) price premium earned on products. These measures indicate whether Meredith has been able to charge premium prices and achieve operating income increases through product differentiation. Customer Perspective (1) Market share in high-end special-purpose textile machines, (2) customer satisfaction, (3) new customers. Meredith’s strategy should result in improvements in these customer measures that help evaluate whether Meredith’s product differentiation strategy is succeeding with its customers. These measures are leading indicators of superior financial performance. Internal Business Process Perspective (1) Manufacturing quality, (2) new product features added, (3) order delivery time. Improvements in these measures are expected to result in more distinctive products delivered to its customers and in turn superior financial performance. Learning and Growth Perspective (1) Development time for designing new machines, (2) improvements in manufacturing processes, (3) employee education and skill levels, (4) employee satisfaction. Improvements in these measures are likely to improve Meredith’s capabilities to produce distinctive products that have a cause-and-effect relationship with improvements in internal business processes, which in turn lead to customer satisfaction and financial performance. 13-12 13-23 1. (30 min.) Strategic analysis of operating income (continuation of 13-22) 13-22). Operating income for each year is as follows: Revenue ($40,000 200; $42,000 210) Costs Direct materials costs ($8 300,000; $8.50 310,000) Manufacturing conversion costs ($8,000 250; 8,100 250) Selling & customer service costs ($10,000 100; $9,900 95) Design costs ($100,000 12; $101,000 12) Total costs Operating income Change in operating income 2. 2008 $8,000,000 2009 $8,820,000 2,400,000 2,635,000 2,000,000 2,025,000 1,000,000 940,500 1,200,000 1,212,000 6,600,000 6,812,500 $1,400,000 $2,007,500 $607,500 F The Growth Component Selling Actual units of Actual units of Revenue effect = output sold output sold price of growth in 2009 in 2008 in 2008 = (210 200) $40,000 = $400,000 F Units of input Actual units of required Cost effect Input to produce inputs price of growth 2009 output used to produce for variable costs in 2008 in 2008 2008 output Cost effect of growth for = fixed costs Actual units of capacity in 2008 if adequate to produce 2009 output in 2008 Actual units OR of capacity If 2008 capacity inadequate in 2008 × to produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 Price per unit of capacity in 2008 Direct materials costs that would be required in 2009 to produce 210 units instead of the 200 units produced in 2008, assuming the 2008 input-output relationship continued into 2009, equal 300,000 315,000 kilograms ( 210). Manufacturing conversion costs and selling and customer200 service costs will not change since adequate capacity exists in 2008 to support year 2009 output and customers. R&D costs are discretionary costs and would not change in 2008 if Meredith had to produce and sell the higher 2009 volume in 2008. The cost effects of growth component are: 13-13 Direct materials costs Manufacturing conversion costs Selling & customer-service costs Design costs (315,000 300,000) $8 = $120,000 U (250 250) $8,000 = 0 (100 100) $25,000 = 0 (12-12) $100,000 = 0 Cost effect of growth $120,000 U In summary, the net increase in operating income as a result of the growth component equals: Revenue effect of growth $400,000 F Cost effect of growth 120,000 U Change in operating income due to growth $280,000 F The Price-Recovery Component Actual units of output sold in 2009 = ($42,000 $40,000) 210 = $420,000 F Revenue effect of = Selling price Selling price price-recovery in 2009 in 2008 Cost effect of price-recovery for = variable costs Cost effect of price-recovery for = fixed costs Units of input Input Input required to price in price in × produce 2009 output 2009 2008 in 2008 Price per Price per unit of unit of × capacity capacity in 2009 in 2008 Actual units of capacity in 2008, if adequate to produce 2009 output in 2008 OR If 2008 capacity inadequate to produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 Direct materials costs ($8.50 $8) 315,000 Manufacturing conversion costs ($8,100 $8,000) 250 Selling & customer-service costs ($9,900 $10,000) 100 Design costs ($101,000 $100,000) 12 Cost effect of price-recovery =$157,500 U = 25,000 U = 10,000 F = 12,000 U $184,500 U In summary, the net increase in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery $420,000 F Cost effect of price-recovery 184,500 U Change in operating income due to price-recovery $235,500 F 13-14 The Productivity Component Actual units of Units of input Input Cost effect of input used required to productivity for = to produce produce 2009 price 2009 output ouput in 2008 variable costs in 2009 Actual units of capacity in 2008, if adequate to produce 2009 output in 2008 Price per Cost effect of Actual units of OR productivity for = capacity in If 2008 capacity inadequate unit of capacity fixed costs 2009 to produce 2009 output in 2008, in 2009 units of capacity required to produce 2009 output in 2008 The productivity component of cost changes are Direct materials costs (310,000 315,000) Manufacturing conversion costs (250 250) Selling & customer-service costs (95 100) Design costs (12 12) Change in operating income due to productivity $8.50 $8,100 $9,900 $101,000 = = = = $42,500 F 0 49,500 F 0 $92,000 F The change in operating income between 2008 and 2009 can be analyzed as follows: Revenues Costs Operating income Income Statement Amounts in 2008 (1) $8,000,000 Revenue and Revenue and Cost Effect Cost Effects Cost Effects of of Income of Growth Price-Recovery Productivity Statement Component Component Component Amounts in 2009 in 2009 in 2009 in 2009 (2) (3) (4) (5) = (1) + (2) + (3) + (4) $400,000 F $420,000 F $8,820,000 6,600,000 120,000 U 184,500 U $92,000 F 6,812,500 $1,400,000 $280,000 F $235,500 F $92,000 F $2,007,500 $607,500 F Change in operating income 3. The analysis of operating income indicates that a significant amount of the increase in operating income resulted from Meredith’s product differentiation strategy. The company was able to continue to charge a premium price while growing sales. Meredith was also able to earn additional operating income by improving its productivity. 13-15 Analysis 13-24 (20 min.)Analysis of growth, price-recovery, (continuation of 13-23). and productivity components Effect of the industry-market-size factor on operating income If the 10-unit increase in sales from 200 to 210 units, 3% or 6 (3% 200) units are due to growth in market size, and 4 (10 6) units are due to an increase in market share. The change in Meredith’s operating income from the industry-market size factor rather than from specific strategic actions is: 6 $280,000 (the growth component in Exercise 13-23) $168,000 F 10 Effect of product differentiation on operating income The change in operating income due to: Increase in the selling price of D4H (revenue effect of price recovery) $420,000 F Increase in price of inputs (cost effect of price recovery) 184,500 U Growth in market share due to product differentiation $280,000 (the growth component in Exercise 13-23) 4 10 112,000 F Change in operating income due to product differentiation $347,500 F Effect of cost leadership on operating income The change in operating income from cost leadership is: Productivity component $ 92,000 F The change in operating income between 2008 and 2009 can be summarized as follows: Change due to industry-market-size Change due to product differentiation Change due to cost leadership Change in operating income $168,000 F 347,500 F 92,000 F $607,500 F Meredith has been successful in implementing its product differentiation strategy. More than 57% ($347,500 $607,500) of the increase in operating income during 2009 was due to product differentiation, i.e., the distinctiveness of its machines. It was able to raise the prices of its machines faster than the costs of its inputs and still grow market share. Meredith’s operating income increase in 2009 was also helped by a growth in the overall market and some productivity improvements. 13-16 13-25 (15 min.) Identifying and managing unused capacity (continuation of 13 22). 1. The amount and cost of unused capacity at the beginning of year 2009 based on year 2009 production follows: Manufacturing, 250 210; (250 – 210) $8,100 Selling and customer service, 100 – 80; (100 – 80) $9,900 Design Amount of Unused Capacity 40 20 Cost of Unused Capacity $324,000 198,000 Discretionary cost, so cannot determine unused capacity* Discretionary cost so cannot be calculated* *The absence of a cause-and-effect relationship makes identifying unused capacity for discretionary costs difficult. Management cannot determine the R&D resources used for the actual output produced to compare R&D capacity against. 2. Meredith can reduce manufacturing capacity from 250 units to 220 (250 30) units. Meredith will save 30 $8,100 = $243,000. This is the maximum amount of costs Meredith can save in 2009. It cannot reduce capacity further (by another 30 units to 190 units) because it would then not have enough capacity to manufacture 210 units in 2009 (units that contribute significantly to operating income). 3. Meredith may choose not to downsize because it projects sales increases that would lead to a greater demand for and utilization of capacity. Meredith may have also decided not to downsize because downsizing requires a significant reduction in capacity. For example, Meredith may have chosen to downsize some more manufacturing capacity if it could do so in increments of say, 10, rather than 30 units. Also, Meredith may be focused on product differentiation, which is key to its strategy, rather than on cost reduction. Not reducing significant capacity also helps to boost and maintain employee morale. 13-17 13-26 (15 min.) Strategy, balanced scorecard, service company. 1. Snyder Corporation’s strategy in 2009 is cost leadership. Snyder’s consulting services for implementing sales management software is not distinct from its competitors. The market for these services is very competitive. To succeed, Snyder must deliver quality service at low cost. Improving productivity while maintaining quality is key. 2. Balanced Scorecard measures for 2009 follow: Financial Perspective (1) Increase operating income from productivity gains and growth, (2) revenues per employee, (3) cost reductions in key areas, for example, software implementation and overhead costs. These measures indicate whether Snyder has been able to reduce costs and achieve operating income increases through cost leadership. Customer Perspective (1) Market share, (2) new customers, (3) customer responsiveness, (4) customer satisfaction. Snyder’s strategy should result in improvements in these customer measures that help evaluate whether Snyder’s cost leadership strategy is succeeding with its customers. These measures are leading indicators of superior financial performance. Internal Business Process Perspective (1) Time to complete customer jobs, (2) time lost due to errors, (3) quality of job (Is system running smoothly after job is completed?) Improvements in these measures are key drivers of achieving cost leadership and are expected to lead to more satisfied customers, lower costs, and superior financial performance. Learning and Growth Perspective (1) Time required to analyze and design implementation steps, (2) time taken to perform key steps implementing the software, (3) skill levels of employees, (4) hours of employee training, (5) employee satisfaction and motivation. Improvements in these measures are likely to improve Snyder’s ability to achieve cost leadership and have a cause-and-effect relationship with improvements in internal business processes, customer satisfaction, and financial performance. 13-18 13-27 1. (30 min.) Strategic analysis of operating income (continuation of 13-26). Operating income for each year is as follows: 2008 $3,000,000 1,800,000 2. 2,016,000 360,000 Revenues ($50,000 60; $48,000 70) Costs Software implementation labor costs ($60 30,000; $63 32,000) Software implementation support costs ($4,000 90; $4,100 90) Software development costs ($125,000 3; $130,000 3) Total costs Operating income Change in operating income 2009 $3,360,000 369,000 375,000 390,000 2,535,000 2,775,000 $ 465,000 $ 585,000 $120,000 F The Growth Component Cost effect of growth for variable costs = Actual units of Actual units of Selling output sold output sold price in 2008 in 2009 in 2008 = Revenue effect of growth (70 – 60) $50,000 = $500,000 F = Actual units Units of input Input of input required to produce price 2009 output used to produce in 2008 in 2008 2008 output Actual units of capacity in 2008 if adequate to produce 2009 output in 2008 Actual units Cost effect of Price per OR capacity growth for = If 2008 capacity inadequate ofin 2008 × unit of capacity fixed costs in 2008 to produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 Software implementation labor costs that would be required in 2009 to produce 70 units instead of the 60 units produced in 2008, assuming the 2008 input-output relationship continued 30,000 into 2009, equal 35,000 ( 70) labor-hours. Software implementation support costs 60 would not change since adequate capacity exists in 2008 to support year 2009 output and customers. Software development costs are discretionary costs not directly related to output and, hence, would not change in 2008 even if Snyder had to produce and sell the higher year 2009 output in 2008. 13-19 The cost effects of growth component are Software implementation labor costs (35,000 – 30,000) $60 =$300,000 U Software implementation support costs (90 – 90) $4,000 = 0 Software development costs (3 – 3) $125,000 = 0 Cost effect of growth $300,000 U In summary, the net increase in operating income as a result of the growth component equals: Revenue effect of growth $500,000 F Cost effect of growth 300,000 U Change in operating income due to growth $200,000 F The Price-Recovery Component Revenue effect of = price-recovery = Cost effect of price-recovery for = variable costs Cost effect of price-recovery for = fixed costs Actual units of Selling price Selling price soldoutput in 2009 in 2008 in 2009 ($48,000 – $50,000) 70 = $140,000 U Units of input Input Input price in price in required to produce 2009 2009 output in 2008 2008 Price per Price per unit of unit of × capacity capacity in 2009 in 2008 Actual units of capacity in 2008, if adequate to produce 2009 output in 2008 OR If 2008 capacity inadequate to produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 Software implementation labor costs ($63 – $60) 35,000 = $105,000 U Software implementation support costs ($4,100 – $4,000) 90 = 9,000 U Software development costs ($130,000 – $125,000) 3 = 15,000 U Cost effect of price recovery $129,000 U In summary, the net decrease in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery $140,000 U Cost effect of price-recovery 129,000 U Change in operating income due to price recovery $269,000 U 13-20 The Productivity Component Cost effect of Units of input Input Actual units of productivity for = input used to produce required to produce price in variable costs 2009 output 2009 output in 2008 2009 Actual units of capacity in 2008, if adequate to produce 2009 output in 2008 Price per Cost effect of Actual units of capacity in OR unit of productivity for = capacity 2009 If 2008 capacity inadequate fixed costs to produce 2009 output in 2008, in 2009 units of capacity required to produce 2009 output in 2008 The productivity component of cost changes are: Software implementation labor costs (32,000 – 35,000) $63 Software implementation support costs (90 – 90) $4,100 Software development costs (3 – 3) $130,000 Change in operating income due to productivity =$189,000 F = 0 = 0 $189,000 F The change in operating income between 2008 and 2009 can be analyzed as follows: Income Statement Amounts in 2008 (1) Revenues Revenue and Cost Effects of Growth Component in 2009 (2) Revenue and Income Cost Effects of Cost Effect of Statement Price-Recovery Productivity Amounts Component Component in 2009 in 2009 in 2009 (5) = (3) (4) (1) + (2) + (3) + (4) $3,000,000 $500,000 F $140,000 U 2,535,000 300,000 U 129,000 U $189,000 F 2,775,000 Operating income $ 465,000 $200,000 F $269,000 U $189,000 F $ 585,000 Costs $3,360,000 $120,000 F Change in operating income 3. The analysis of operating income indicates that a significant amount of the increase in operating income resulted from Snyder’s productivity improvements in 2009. The company had to reduce selling prices while labor costs were increasing but it was able to increase operating income by improving its productivity. The productivity gains also allowed Snyder to be competitive and grow the business. The unfavorable price recovery component indicates that Snyder could not pass on increases in labor-related wages via price increases to its customers, very likely because its product was not differentiated from competitors’ offerings. 13-21 13-28 (25 min.) Analysis of growth, price-recovery, and productivity components (continuation of 13-27). Effect of industry-market-size factor on operating income Of the 10-unit increase in sales from 60 to 70 units, 5% or 3 units (5% 60) are due to growth in market size, and 7 (10 3) units are due to an increase in market share. The change in Snyder’s operating income from the industry market-size factor rather than from specific strategic actions is: 3 $200,000 (the growth component in Exercise 13-27) $ 60,000 F 10 Effect of product differentiation on operating income Of the $2,000 decrease in selling price, 1% or $500 (1% $50,000) is due to a general decline in prices, and the remaining decrease of $1,500 ($2,000 $500) is due to a strategic decision by Snyder’s management to implement its cost leadership strategy of lowering prices to stimulate demand. The change in operating income due to a decline in selling price (other than the strategic reduction in price included in the cost leadership component) $500 70 units $ 35,000 U Increase in prices of inputs (cost effect of price recovery) 129,000 U Change in operating income due to product differentiation $164,000 U Effect of cost leadership on operating income Productivity component Effect of strategic decision to reduce selling price, $1,500 70 Growth in market share due to productivity improvement and strategic decision to reduce selling price 7 $200,000 (the growth component in Exercise 13-27) 10 Change in operating income due to cost leadership $189,000 F 105,000 U 140,000 F $224,000 F The change in operating income between 2008 and 2009 can then be summarized as Change due to industry-market-size Change due to product differentiation Change due to cost leadership Change in operating income $ 60,000 F 164,000 U 224,000 F $120,000 F Snyder has been very successful in implementing its cost leadership strategy. Due to a lack of product differentiation, Snyder was unable to pass along increases in labor costs by increasing the selling price—in fact, the selling price declined by $2,000 per work unit. However, Snyder was able to take advantage of its productivity gains to reduce price, gain market share, and increase operating income. 13-22 13-29 (20 min.) Identifying and managing unused capacity (continuation of 13-26). 1. The amount and cost of unused capacity at the beginning of year 2009 based on work performed in year 2009 follows: Software implementation support, 90 70; (90 70) $4,100 Software development Amount of Cost of Unused Unused Capacity Capacity 20 $82,000 Discretionary Discretionary cost, so cannot cost, so cannot determine be calculated* unused capacity* *The absence of a cause-and-effect relationship makes identifying unused capacity for discretionary costs difficult. Management cannot determine the software development resources used for the actual output produced to compare against software development capacity. 2. Snyder can reduce software implementation support capacity from 90 units to 75 (90 15) units. Snyder will save 15 $4,100 = $61,500. This is the maximum amount of costs Snyder can save by downsizing in 2009. It cannot reduce capacity further (by another 15 units to 60 units) because it would then not have enough capacity to perform 70 units of work in 2009 (work that contributes significantly to operating income). 3. Snyder may choose not to downsize because it projects sales increases that would lead to greater demand for and utilization of capacity. Snyder may have also decided not to downsize because downsizing requires significant reduction in capacity. For example, Snyder may have chosen to downsize additional software implementation support capacity if it could do so in, say, increments of 5, rather than 15 units. Not reducing significant capacity by laying off employees boosts employee morale and keeps employees more motivated and productive. 13-23 13-30 (30 min.) Balanced scorecard and strategy. 1. Solution Exhibit 13-30A shows the customer preference map for ZP98-type electronic components for Dransfield Company and Yorunt Manufacturing on price, delivery time, and quality. SOLUTION EXHIBIT 13-30A Customer Preference Map for ZP98-type Electronic Components 2. Dransfield currently follows a cost leadership strategy, which is reflected in its lower price compared to Yorunt Manufacturing. The electronic component ZP98 is similar to products offered by competitors. 3. In the internal-business-process perspective, Dransfield needs to set targets for decreasing the percentage of defective products sold and then identify measures that would be leading indicators of achieving this goal. For example, in the learning and growth perspective, Dransfield may want to measure the percentage of employees trained in quality management and the percentage of manufacturing processes with real-time feedback. The logic is that improvements in these measures will drive quality improvements and so reduce the percentage of defective products sold. To achieve its goals, items that Dransfield could include under each perspective of the balanced scorecard follows: 13-24 Financial Perspective Operating income from productivity and quality improvement Operating income from growth Revenue growth Customer Perspective Market share in electronic components Number of additional customers Customer-satisfaction ratings Internal-BusinessProcess Perspective Percentage of defective products sold Order delivery time On-time delivery Number of major improvements in manufacturing process Learning-and-Growth Perspective Employee-satisfaction ratings Percentage of employees trained in quality management Percentage of line workers empowered to manage processes Percentage of manufacturing processes with real-time feedback 4. Solution Exhibit 13-30B presents Dransfield’s strategy map explaining cause-and-effect relationships in its balanced scorecard. SOLUTION EXHIBIT 13-30B Strategy Map for Dransfield Company for 2009 FINANCIAL PERSPECTIVE CUSTOMER PERSEPCTIVE INTERNALBUSINESSPROCESS PERSEPCTIVE Operating income from productivity and quality improvement Revenue growth Number of additional customers Customer-satisfaction ratings Percentage of defective products sold Operating income from growth Orderdelivery time Market share in electronic components segment On-time delivery Number of major improvements in manufacturing processes LEARNING AND GROWTH PERSEPCTIVE Employeesatisfaction ratings Percentage of employees trained in quality management Percentage of line workers empowered to manage processes 13-25 Percentage of manufacturing processes with real-time feedback 13-31 (25-30 min.) Strategic analysis of operating income (continuation of 13-30) 1. Operating income for each year is as follows: Revenue ($44 5,000; $50 6,250) Less: Sales returns ($44 500; $50 225) Net revenue Costs Direct materials costs ($10 2,500; $10 3,125) Conversion costs Selling & customer service costs Advertising costs Total costs Operating income Change in operating income 2. 2008 $220,000 22,000 198,000 2009 $312,500 11,250 301,250 25,000 31,250 128,000 184,000 4,000 4,180 20,000 24,000 177,000 243,430 $ 21,000 $ 57,820 $36,820 F The Growth Component Selling Actual units of Actual units of Revenue effect = output sold output sold price of growth in 2009 in 2008 in 2008 = (6,025 4,500) $44 = $67,100 F Units of input Actual units of required Cost effect Input to produce inputs price of growth 2009 output used to produce for variable costs in 2008 in 2008 2008 output Actual units of capacity in 2008 if adequate to produce 2009 output in 2008 Actual units Cost effect of Price per unit OR capacity growth for = If 2008 capacity inadequate ofin 2008 × of capacity fixed costs in 2008 to produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 Direct materials costs that would be required in 2009 to produce 6,025 units instead of the 4,500 units produced in 2008, assuming the 2008 input-output relationship continued into 2009, equal 2,500 6,025 3,347.22 pounds ( ). Conversion costs and selling and customer-service costs will 4,500 not change since adequate capacity exists in 2008 to support year 2009 output and customers. Advertising costs are discretionary costs and would not change in 2008 if Dransfield had to produce and sell the higher 2009 volume in 2008. The cost effects of growth component are: 13-26 Direct materials costs Conversion costs Selling & cust.-serv. costs Advertising costs (3,374.22 2,500) (8,000 8,000) (60 60) (1-1) $10 $16 $66.67 $20,000 Cost effect of growth = = = = $ 8,472 U 0 0 0 $ 8,472 U In summary, the net increase in operating income as a result of the growth component equals: Revenue effect of growth $67,100 F Cost effect of growth 8,472 U Change in operating income due to growth $58,628 F The Price-Recovery Component Actual units Revenue effect of Selling price Selling price = of output price-recovery in 2009 in 2008 sold in 2009 = ($50 $44) 6,025 = $36,150 F Cost effect of price-recovery for = variable costs Cost effect of price-recovery for = fixed costs Units of input Input Input required to price in price in × produce 2009 output 2008 2009 in 2008 Price per Price per unit of unit of × capacity capacity in 2009 in 2008 Direct materials costs Conversion costs Selling & customer-service costs Advertising costs Cost effect of price-recovery Actual units of capacity in 2008, if adequate to produce 2009 output in 2008 OR If 2008 capacity inadequate to produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 ($10 $10) 3,347.22 = $ 0 ($23 $16) 8,000 = 56,000 U ($69.67 $66.67) 60 = 180 U ($24,000 $20,000) 1 = 4,000 U $60,180 U In summary, the net increase in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery $36,150 F Cost effect of price-recovery 60,180 U Change in operating income due to price-recovery $24,030 U 13-27 The Productivity Component Actual units of Units of input Input Cost effect of input used required to productivity for = to produce produce 2009 price 2009 output ouput in 2008 variable costs in 2009 Actual units of capacity in 2008, if adequate to produce 2009 output in 2008 Cost effect of Actual units of OR productivity for = capacity in If 2008 capacity inadequate 2009 fixed costs to produce 2009 output in 2008, units of capacity required to produce 2009 output in 2008 The productivity component of cost changes are Direct materials costs (3,125 3,347.22) $10 Conversion costs (8,000 8,000) $23 Selling & customer-service costs (60 60) $69.67 Advertising costs (1 1) $24,000 Change in operating income due to productivity Price per unit of capacity in 2009 = = = = $2,222 F 0 0 0 $2,222 F The change in operating income between 2008 and 2009 can be analyzed as follows: Revenues Costs Operating income Income Statement Amounts in 2008 (1) $198,000 Revenue and Revenue and Cost Effect Income Cost Effects Cost Effects of of Statement of Growth Price-Recovery Productivity Amounts Component Component Component in 2009 in 2009 in 2009 in 2009 (5) = (2) (3) (4) (1) + (2) + (3) + (4) $67,100 F $36,150 F $301,250 177,000 8,472 U 60,180 U $2,222 F $ 21,000 $58,628 F $24,030 U $2,222 F 243,430 $57,820 $36,820 F Change in operating income 3. The analysis of operating income indicates that a significant amount of the increase in operating income resulted from Dransfield’s cost leadership strategy. The company was able to improve quality and grow sales. The price recovery component indicates that selling prices increased in line with the market but Dransfield’s costs increased even faster, particularly the price of conversion cost capacity, as Dransfield focused on improving quality. The benefit of this improved quality came in the form of higher sales that more than offset the spending on quality. 13-28 13-32 (20 min.) Analysis of growth, price-recovery, and productivity components (continuation of 13-31) Effect of the industry-market-size factor on operating income Of the 1,525 increase in sales from 4,500 to 6,025 units, 8% or 360 (8% 4,500) units are due to growth in market size, and 1,165 (1,525 360) units are due to an increase in market share. The change in Dransfield’s operating income from the industry-market from specific strategic actions is: 360 $58,628 (the growth component in Exercise 13-31) 1,525 Effect of product differentiation on operating income The change in operating income due to: Increase in the selling price of ZP98 (revenue effect of price recovery) Increase in price of inputs (cost effect of price recovery) Change in operating income due to product differentiation Effect of cost leadership on operating income The change in operating income from cost leadership is: Productivity component Growth in market share due to cost leadership $58,628 (the growth component in Exercise 13-31) Change in operating income due to cost leadership size factor rather than $13,840 F $36,150 F 60,180 U $24,030 U $ 2,222 F 1,165 1,525 44,788 F $47,010 F The change in operating income between 2008 and 2009 can be summarized as follows: Change due to industry market-size Change due to product differentiation Change due to cost leadership Change in operating income $13,840 F 24,030 U 47,010 F $36,820 F A thoughtful student might argue that the $24,030 U price-recovery variance could also be thought of as part of the productivity variance. Why? Because a large component of this cost is from conversion costs incurred to improve quality which is more closely associated with productivity and process improvement rather than product development and product differentiation. Under this assumption, the change in operating income between 2008 and 2009 can be summarized as follows: Change due to market industry size Change due to product differentiation Change due to cost leadership ($47,010 ─ $24,030) Change in operating income $13,840 F 0 22,980 F $36,820 F Dransfield has been successful in implementing its cost leadership strategy. The increase in operating income during 2009 was due to quality improvements and sales growth. Dransfield’s operating income increase in 2009 was also helped by a growth in the overall market size. 13-29 13-33 (20 min.) Identifying and managing unused capacity (continuation of 13-31) 1. The amount and cost of unused capacity at the beginning of year 2009 based on year 2009 production follows: Amount of Cost of Unused Unused Capacity Capacity Manufacturing, 8,000 6,250; (8,000 – 6,250) $23 1,750 $40,250 0 Selling and customer service, 60 – 60; (60– 60) $4,180 $ 0 Discretionary cost, Discretionary cost, Advertising so cannot determine unused capacity* so cannot be calculated* *The absence of a cause-and-effect relationship makes identifying unused capacity for discretionary costs difficult. Management cannot determine the advertising resources used for the actual output produced to compare advertising capacity against. 2. Reasons for Downsizing: 1. Currently Dransfield only operates at 78% of capacity (6,250 units ÷ 8,000 units). Downsizing will allow the company to match resources available with resources consumed and eliminate management time and effort in managing unused capacity. 2. Downsizing should lead to cost savings and increased efficiency that result in higher operating income. Reasons against Downsizing: 1. Downsizing may require layoffs, which can hurt employee morale and loyalty. 2. Dransfield may want to maintain some unused capacity for future growth. 3a. Misclassification of the cost will not affect overall operating income because the cost will still be included in the calculation of operating income, only as advertising instead of sales and customer service. For financial accounting purposes, it will still be part of selling and administration (period) costs. 3b. This cost will not affect the growth component since the growth component is calculated using cost data from 2008. Misclassification of the cost will have no effect on the sales and customer service component of the cost effect of price recovery because adequate capacity exists in 2008 to produce 2009 output. It will increase the advertising component of the cost effect of price recovery. Misclassification of this cost will increase the productivity component because the capacity amount for selling and customer-service cost will be understated. There will be no effect on advertising because advertising capacity had not changed. The net effect of this misclassification is to decrease the price-recovery component by increasing the cost effect of price-recovery for advertising and to increase the productivity component by an equal amount by understating the selling and customer-service capacity. 3c. The misclassification will make the performance of the ZP98 manager look better than it is because selling and customer-service costs that the manager is evaluated on will appear lower. The higher advertising cost does not affect the manager’s performance evaluation because advertising costs are excluded from the manager’s performance evaluation measure. The manager’s cost classification actions are unethical because the sole purpose of the misclassification of customer-service costs as advertising costs is to make the manager’s performance look better than it is. Like many other corporations, Dransfields code of conduct, values and culture need to clearly proscribe such behavior. 13-30 13-34 (20–30 min.) Balanced scorecard. Perspectives ▪ Financial Strategic Objectives Performance Measures ▪ Increase shareholder value ▪ Increase profit generated by each salesperson ▪ ▪ ▪ ▪ ▪ ▪ ▪ ▪ Earnings per share Net income Return on assets Return on sales Return on equity Product cost per unit Customer cost per unit Profit per salesperson ▪ Customer ▪ Acquire new customers ▪ Retain customers ▪ Develop profitable customers ▪ Number of new customers ▪ Percentage of customers retained ▪ Customer profitability ▪ Internal Business Processs ▪ Improve manufacturing quality ▪ Introduce new products ▪ Percentage of defective product units ▪ Minimize invoice error rate ▪ On-time delivery by suppliers ▪ Percentage of error-free invoices ▪ Percentage of on-time deliveries by suppliers ▪ Number of patents ▪ Increase proprietary products ▪ Learning and Growth ▪ Increase information system capabilities ▪ Enhance employee skills ▪ Percentage of processes with real-time feedback ▪ Employee turnover rate ▪ Average job-related training hours per employee 13-35 (20 min.) Balanced scorecard. 1. Caltex’s strategy is to focus on “service-oriented customers” who are willing to pay a higher price for services. Even though gasoline is largely a commodity product, Caltex wants to differentiate itself through the service it provides at its retailing stations. Does the scorecard represent Caltex’s strategy? By and large it does. The focus of the scorecard is on measures of process improvement, quality, market share, and financial success from product differentiation and charging higher prices for customer service. There are some deficiencies that the subsequent assignment questions raise but, abstracting from these concerns for the moment, the scorecard does focus on implementing a product differentiation strategy. Having concluded that the scorecard has been reasonably well designed, how has Caltex performed relative to its strategy in 2009? It appears from the scorecard that Caltex was successful in implementing its strategy in 2009. It achieved all targets in the financial, internal business, and learning and growth perspectives. The only target it missed was the market 13-31 share target in the customer perspective. At this stage, students may raise some questions about whether this is a good scorecard measure. Requirement 3 gets at this issue in more detail. The bottom line is that measuring “market share in the overall gasoline market” rather than in the “service-oriented customer” market segment is not a good scorecard measure, so not achieving this target may not be as big an issue as it may seem at first. 2. Yes, Caltex should include some measure of employee satisfaction and employee training in the learning and growth perspective. Caltex’s differentiation strategy and ability to charge a premium price is based on customer service. The key to good, fast, and friendly customer service is well trained and satisfied employees. Untrained and dissatisfied employees will have poor interactions with customers and cause the strategy to fail. Hence, training and employee satisfaction are very important to Caltex for implementing its strategy. These measures are leading indicators of whether Caltex will be able to successfully implement its strategy and should be measured on the balanced scorecard. 3. Caltex’s strategy is to focus on the 60% of gasoline consumers who are service-oriented, not on the 40% price-shopper segment. To evaluate if it has been successful in implementing its strategy, Caltex needs to measure its market share in its targeted market segment, “serviceoriented customer,” not its market share in the overall market. Given Caltex’s strategy, it should not be concerned if its market share in the price-shopper segment declines. In fact, charging premium prices will probably cause its market share in this segment to decline. Caltex should replace “market share in overall gasoline market” with “market share in the service-oriented customer segment” in its balanced scorecard customer measure. Caltex may also want to consider putting a customer satisfaction measure on the scorecard. This measure should capture an overall evaluation of customer reactions to the facility, the convenience store, employee interactions, and quick turnaround. The customer satisfaction measure would serve as a leading indicator of market share in the service-oriented customer segment. 4. Although there is a cause-and-effect link between internal business process measures and customer measures on the current scorecard, Caltex should add more measures to tighten this linkage. In particular, the current scorecard measures focus exclusively on refinery operations and not on gas station operations. Caltex should add measures of gas station performance such as cleanliness of the facility, turnaround time at the gas pumps, the shopping experience at the convenience store, and the service provided by employees. Many companies do random audits of their facilities to evaluate how well their branches and retail outlets are performing. These measures would serve as leading indicators of customer satisfaction and market share in Caltex’s targeted segments. 5. Caltex is correct in not measuring changes in operating income from productivity improvements on its scorecard under the financial perspective. Caltex’s strategy is to grow by charging premium prices for customer service. The scorecard measures focus on Caltex’s success in implementing this strategy. Productivity gains per se are not critical to Caltex’s strategy and therefore, should not be measured on the scorecard. 13-32 13-36 (30 min.) Balanced scorecard scorecard. 1. The market for color laser printers is competitive. Lee’s strategy is to produce and sell high quality laser printers at a low cost. The key to achieving higher quality is reducing defects in its manufacturing operations. The key to managing costs is dealing with the high fixed costs of Lee’s automated manufacturing facility. To reduce costs per unit, Lee would have to either produce more units or eliminate excess capacity. The scorecard correctly measures and evaluates Lee’s broad strategy of growth through productivity gains and cost leadership. There are some deficiencies, of course, that subsequent assignment questions will consider. It appears from the scorecard that Lee was not successful in implementing its strategy in 2009. Although it achieved targeted performance in the learning and growth and internal business process perspectives, it significantly missed its targets in the customer and financial perspectives. Lee has not had the success it targeted in the market and has not been able to reduce fixed costs. 2. Lee’s scorecard does not provide any explanation of why the target market share was not met in 2009. Was it due to poor quality? Higher prices? Poor post-sales service? Inadequate supply of products? Poor distribution? Aggressive competitors? The scorecard is not helpful for understanding the reasons underlying the poor market share. Lee may want to include some measures in the customer perspective (and internal business process perspective) that get at these issues. These measures would then serve as leading indicators (based on cause-and-effect relationships) for lower market share. For example, Lee should measure customer satisfaction with its printers on various dimensions of product features, quality, price, service, and availability. It should measure how well its printers match up against other color laser printers on the market. This is critical information for Lee to successfully implement its strategy. 3. Lee should include a measure of employee satisfaction to the learning and growth perspective and a measure of new product development to the internal business process perspective. The focus of its current scorecard measures is on processes and not on people and innovation. Lee considers training and empowering workers as important for implementing its highquality, low-cost strategy. Therefore employee training and employee satisfaction should appear in the learning and growth perspective of the scorecard. Lee can then evaluate if improving employee-related measures results in improved internal-business process measures, market share and financial performance. Adding new product development measures to internal business processes is also important. As Lee reduces defects, Lee’s costs will not automatically decrease because many of Lee’s costs are fixed. Instead, Lee will have more capacity available to it. The key question is how Lee will obtain value from this capacity. One important way is to use the capacity to produce and sell new models of its products. Of course if this strategy is to work, Lee must develop new products at the same time that it is improving quality. Hence, the scorecard should contain some measure to monitor progress in new product development. Improving quality without developing and selling new products (or downsizing) will result in weak financial performance. 13-33 4. Improving quality and significantly downsizing to eliminate unused capacity is difficult. Recall that the key to improving quality at Lee Corporation is training and empowering workers. As quality improvements occur, capacity will be freed up, but because costs are fixed, quality improvements will not automatically lead to lower costs. To reduce costs, Lee’s management must take actions such as selling equipment and laying off employees. But how can management lay off the very employees whose hard work and skills led to improved quality? If it did lay off employees now, will the remaining employees ever work hard to improve quality in the future? For these reasons, Lee’s management should first focus on using the newly available capacity to sell more product. If it cannot do so and must downsize, management should try to downsize in a way that would not hurt employee morale, such as through retirements and voluntary severance. 13-37 (20 min.) Partial productivity measurement. 1. Guble Company’s partial productivity ratios in 2009 are as follows: Direct materials partial productivity Conversion costs partial productivity Quantity of output produced in 2009 = = Yards of direct materials used in 2009 Quantity of output produced in 2009 Units of manuf. capacity in 2009 = 2, 650, 000 1.59 wallets = per yard 1, 669,500 = 0.95 wallets 2, 650, 000 = per unit of 2,800, 000 capacity To compare partial productivities in 2009 with partial productivities in 2008, we first calculate the inputs that would have been used in 2008 to produce year 2009’s 2,650,000 units of output assuming the year 2008 relationship between inputs and outputs. Direct materials = = Manufacturing capacity = 1,875,000 yards (2008) 2,650,000 output units in 2009 2,500,000 output units in 2008 1,875,000 yards 1.06 = 1,987,500 yards 3,000,000 units of capacity, because manufacturing capacity is fixed, and adequate capacity existed in 2008 to produce year 2009 output. Partial productivity calculations for 2008 based on year 2009 output (to make the partial productivities comparable across the two years): Direct materials partial productivity = Conversion costs partial productivity = Quantity of output produced in 2009 Yards of direct materials that would have been used in 2008 to produce year 2009 output Quantity of output produced in 2009 Units of manuf. capacity that would have been used in 2008 to produce year 2009 output = = 2, 650, 000 = 1.33 units per yard 1,987,500 2, 650, 000 3, 000, 000 0.883 = unit ofunits per capacity The calculations indicate that Berkshire improved the partial productivity of direct materials and conversion costs between 2008 and 2009 via efficiency improvements and by reducing unused manufacturing capacity. 13-34 2. Guble Company management can use the partial productivity measures to set targets for the next year. Partial productivity measures can easily be compared over multiple periods. For example, they may specify bonus payments if partial productivity of direct materials increases to 1.75 units of output per yard and if partial productivity of conversion costs improves to 1 unit of output per unit of capacity. A major advantage of partial productivity measures is that they focus on a single input; hence, they are simple to calculate and easy to understand at the operations level. Managers and operators can also examine these numbers to understand the reasons underlying productivity changes from one period to the next—better training of workers, lower labor turnover, better incentives, or improved methods. Management can then implement and sustain these factors in the future. 13-38 (25 min.) Total factor productivity (continuation of 13-37) 1. Total factor productivity for 2009 using 2009 prices = = = = Quantity of output produced in 2009 Costs of inputs used in 2009 based on 2009 prices 2,650,000 (1,669,500 $4)+(8, 680, 000) 2, 650, 000 2,650,000 $6, 678, 000 $8,680,00 $15,358,000 0.1725 units of output per dollar of input 2. By itself, the 2009 TFP of 0.1725 units per dollar of input is not particularly helpful. We need something to compare the 2009 TFP against. We use, as a benchmark, TFP calculated using the inputs that Berkshire would have used in 2008 to produce 2,650,000 units of output calculated in requirement 1 at 2009 prices. Using the current year’s (2009) prices in both calculations controls for input price differences and focuses the analysis on the adjustments the manager made in the quantities of inputs in response to changes in prices. 2009 price of capacity = Benchmark TFP Cost of capacity in 2009 $8,680,000 $3.10 per unit of capacity Capacity in 2009 2,800,000 units = = = = = Quantity of output produced in 2009 Costs of inputs that would have been used in 2008 to produce 2009 output at year 2009 input prices 2,650,000 (1,987,500 $4)+(3,000,000 $3.10) 2,650,000 $7,950,000 + $9,300,000 2,650,000 $17,250,000 0.1536 units of output per dollar of input Using year 2009 prices, total factor productivity increased 12.3% [(0.1725 0.1536) 0.1536] from 2008 to 2009. 13-35 3. Total factor productivity increased because Guble produced more output per dollar of input in 2009 relative to 2008, measured in both years using 2009 prices. The change in partial productivity of direct materials and conversion costs tells us that Guble used less materials and capacity in 2009 relative to output, than in 2008. A major advantage of TFP over partial productivity measures is that TFP combines the productivity of all inputs and so measures gains from using fewer physical inputs and substitution among inputs. Partial productivities cannot be combined to indicate the overall effect on cost as a result of these individual improvements. The TFP measure allows managers to evaluate the change in overall productivity by simultaneously combining all inputs to measure gains from using fewer physical inputs as well as substitution among inputs. 13-39 (35 min.) Strategic analysis of operating income. 1. Halsey is following a product differentiation strategy. Halsey offers a wide selection of clothes and excellent customer service. Halsey’s strategy is to distinguish itself from its competitors and to charge a premium price. 2. Operating income for each year is as follows: Revenues ($60 40,000; $59 40,000) Costs Costs of goods sold ($40 40,000; $41 40,000) Selling & customer service costs ($7 51,000); $6.90 43,000) Purchasing & admin. costs ($250 980; $240 850) Total costs Operating income Change in operating income 3. 2009 $2,400,000 2010 $2,360,000 1,600,000 1,640,000 357,000 296,700 245,000 204,000 2,202,000 2,140,700 $ 198,000 $ 219,300 $21,300 F The Growth Component Revenue effect of growth Actual units of Actual units of Selling output sold output sold price in 2009 in 2010 in 2009 = (40,000 40,000) $60 = $0 = Actual units of Cost effect Input Units of input inputs used of growth for = required to produce × price to produce variable costs 2010 output in 2009 in 2009 2009 output Cost effect of growth for fixed costs = Actual units of capacity in 2009 if adequate to produce 2010 output in 2009 Actual units Price per OR of capacity If 2009 capacity inadequate in 2009 × unit of capacity in 2009 to produce 2010 output in 2009, units of capacity required to produce 2010 output in 2009 13- Pieces of clothing that would be required to be purchased in 2010 would be the same as that required in 2009 because output is the same between 2009 and 2010. Purchasing and administrative costs and selling and customer-service costs will not change since adequate capacity exists in 2009 to support year 2010 output and customers. The cost effects of growth component are: Costs of goods sold Selling & customer-service costs Purch. & admin. costs Cost effect of growth (40,000 40,000) (51,000 51,000) (980 980) $40 = $0 $7 = 0 $250 = 0 $0 In summary, the net effect on operating income as a result of the growth component equals: Revenue effect of growth Cost effect of growth Change in operating income due to growth $0 0 $0 The Price-Recovery Component Revenue effect of price-recovery = = Cost effect of price-recovery for variable costs = Cost effect of price-recovery for = fixed costs Actual units of output sold in 2010 ($59 $60) 40,000 = $40,000 U Selling price Selling price in 2010 in 2009 Units of input Input Input price in price in required to produce 2010 2010 output in 2009 2009 Actual units of capacity in 2009, if adequate to produce 2010 output in 2009 Price per Price per OR unit of unit of × If 2009 capacity inadequate to capacity capacity produce 2010 output in 2009, in 2010 in 2009 units of capacity required to produce 2010 output in 2009 Costs of goods sold Selling & cust.-serv. costs Purchas. & admin. costs Cost effect of price-recovery ($41 $40) 40,000 ($6.90 $7) 51,000 ($240 $250) 980 = = = $40,000 U 5,100 F 9,800 F $25,100 U In summary, the net decrease in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery Cost effect of price-recovery Change in operating income due to price-recovery 13- $40,000 U 25,100 U $65,100 U The Productivity Component Units of input Input Actual units of input used to produce requried to produce price in 2010 2010 output 2010 output in 2009 Actual units of capacity in 2009, if adequate to produce 2010 output in 2009 Price per Cost effect of Actual units of OR productivity for = capacity in If 2009 capacity inadequate unit of 2010 capacity fixed costs to produce 2010 output in 2009, in 2010 units of capacity required to produce 2010 output in 2009 The productivity component of cost changes are: Costs of goods sold (40,000 40,000) $41 = 0 Selling & customer-service costs (43,000 51,000) $6.90 = $55,200 F Purchasing & admin. costs (850 980) $240 = 31,200 F Change in operating income due to productivity $86,400 F Cost effect of productivity for variable costs The change in operating income between 2009 and 2010 can be analyzed as follows: Income Statement Amounts in 2009 (1) Revenues Revenue and Cost Effects of Growth Component in 2010 (2) Revenue and Cost Effect Income Cost Effects of of Statement Price-Recovery Productivity Amounts Component Component in 2010 in 2010 in 2010 (5) = (3) (4) (1) + (2) + (3) + (4) $2,400,000 $0 $40,000 U 2,202,000 0 25,100 U $ 86,400 F 2,140,700 Operating income $ 198,000 $0 $65,100 U $ 86,400 F $ 219,300 Costs $2,360,000 $21,300 F Change in operating income 4. The analysis of operating income indicates that a significant amount of the increase in operating income resulted from productivity gains rather than product differentiation. The company was unable to charge a premium price for its clothes. Thus, the strategic analysis of operating income indicates that Halsey has not been successful at implementing its premium price, product differentiation strategy, despite the fact that operating income increased by more than 10% between 2009 and 2010. Halsey could not pass on increases in purchase costs to its customers via higher prices. Halsey must either reconsider its product-differentiation strategy or focus managers on increasing margins and growing market share by offering better product variety and superb customer service. 13- CHAPTER 14 COST ALLOCATION, CUSTOMER-PROFITABILITY ANALYSIS, AND SALES-VARIANCE ANALYSIS 14-1 Disagree. Cost accounting data plays a key role in many management planning and control decisions. The division president will be able to make better operating and strategy decisions by being involved in key decisions about cost pools and cost allocation bases. Such an understanding, for example, can help the division president evaluate the profitability of different customers. 14-2 1. 2. 3. 4. Exhibit 14-1 outlines four purposes for allocating costs: To provide information for economic decisions. To motivate managers and other employees. To justify costs or compute reimbursement amounts. To measure income and assets. 14-3 Exhibit 14-2 lists four criteria used to guide cost allocation decisions: 1. Cause and effect. 2. Benefits received. 3. Fairness or equity. 4. Ability to bear. The cause-and-effect criterion and the benefits-received criterion are the dominant criteria when the purpose of the allocation is related to the economic decision purpose or the motivation purpose. 14-4 Disagree. In general, companies have three choices regarding the allocation of corporate costs to divisions: allocate all corporate costs, allocate some corporate costs (those “controllable” by the divisions), and allocate none of the corporate costs. Which one of these is appropriate depends on several factors: the composition of corporate costs, the purpose of the costing exercise, and the time horizon, to name a few. For example, one can easily justify allocating all corporate costs when they are closely related to the running of the divisions and when the purpose of costing is, say, pricing products or motivating managers to consume corporate resources judiciously. 14-5 Disagree. If corporate costs allocated to a division can be reallocated to the indirect cost pools of the division on the basis of a logical cause-and-effect relationship, then it is in fact preferable to do so—this will result in fewer division indirect cost pools and a more costeffective cost allocation system. This reallocation of allocated corporate costs should only be done if the allocation base used for each division indirect cost pool has the same cause-and-effect relationship with every cost in that indirect cost pool, including the reallocated corporate cost. Note that we observe such a situation with corporate human resource management (CHRM) costs in the case of CAI, Inc., described in the chapter—these allocated corporate costs are included in each division’s five indirect cost pools. (On the other hand, allocated corporate treasury cost pools are kept in a separate cost pool and are allocated on a different cost-allocation base than the other division cost pools.) 14-1 14 6 Customer profitability analysis highlights to managers how individual customers differentially contribute to total profitability. It helps managers to see whether customers who contribute sizably to total profitability are receiving a comparable level of attention from the organization. 14 7 Companies that separately record (a) the list price and (b) the discount have sufficient information to subsequently examine the level of discounting by each individual customer and by each individual salesperson. 14 8 No. A customer profitability profile highlights differences in current period's profitability across customers. Dropping customers should be the last resort. An unprofitable customer in one period may be highly profitable in subsequent future periods. Moreover, costs assigned to individual customers need not be purely variable with respect to short run elimination of sales to those customers. Thus, when customers are dropped, costs assigned to those customers may not disappear in the short run. 14 9 Five categories in a customer cost hierarchy are identified in the chapter. The examples given relate to the Spring Distribution Company used in the chapter: Customer output unit level costs—costs of activities to sell each unit (case) to a customer. An example is product handling costs of each case sold. Customer batch level costs—costs of activities that are related to a group of units (cases) sold to a customer. Examples are costs incurred to process orders or to make deliveries. Customer sustaining costs—costs of activities to support individual customers, regardless of the number of units or batches of product delivered to the customer. Examples are costs of visits to customers or costs of displays at customer sites. Distribution channel costs—costs of activities related to a particular distribution channel rather than to each unit of product, each batch of product, or specific customers. An example is the salary of the manager of Spring’s retail distribution channel. Corporate sustaining costs—costs of activities that cannot be traced to individual customers or distribution channels. Examples are top management and general administration costs. 14-10 Using the levels approach introduced in Chapter 7, the sales volume variance is a Level 2 variance. By sequencing through Level 3 (sales mix and sales quantity variances) and then Level 4 (market size and market share variances), managers can gain insight into the causes of a specific sales-volume variance caused by changes in the mix and quantity of the products sold as well as changes in market size and market share. 14 11 The total sales mix variance arises from differences in the budgeted contribution margin of the actual and budgeted sales mix. The composite unit concept enables the effect of individual product changes to be summarized in a single intuitive number by using weights based on the mix of individual units in the actual and budgeted mix of products sold. 14 12 favorable sales quantity variance arises because the actual units of all products sold 12A exceed the budgeted units of all products sold. 14-2 14 13 The sales quantity variance can be decomposed into (a) a market size variance (because the actual total market size in units is different from the budgeted market size in units), and (b) a market share variance (because the actual market share of a company is different from the budgeted market share of a company). Both variances use the budgeted average contribution margin per unit. 14 14 Some companies believe that reliable information on total market size is not available and therefore they choose not to compute market size and market share variances. 14 15 The direct materials efficiency variance is a Level 3 variance. Further insight into this variance can be gained by moving to a Level 4 analysis where the effect of mix and yield changes are quantified. The mix variance captures the effect of a change in the relative percentage use of each input relative to that budgeted. The yield variance captures the effect of a change in the total number of inputs required to obtain a given output relative to that budgeted. 14-16 (15-20 min.) Cost allocation in hospitals, alternative allocation criteria. 1. Direct costs = $2.40 Indirect costs ($11.52 – $2.40) = $9.12 Overhead rate 2. = $9.12 = 380% $2.40 The answers here are less than clear-cut in some cases. Overhead Cost Item Allocation Criteria Processing of paperwork for purchase Cause and effect Supplies room management fee Benefits received Operating-room and patient-room handling costs Cause and effect Administrative hospital costs Benefits received University teaching-related costs Ability to bear Malpractice insurance costs Ability to bear or benefits received Cost of treating uninsured patients Ability to bear Profit component None. This is not a cost. 3. Assuming that Meltzer’s insurance company is responsible for paying the $4,800 bill, Meltzer probably can only express outrage at the amount of the bill. The point of this question is to note that even if Meltzer objects strongly to one or more overhead items, it is his insurance company that likely has the greater incentive to challenge the bill. Individual patients have very little power in the medical arena. In contrast, insurance companies have considerable power and may decide that certain costs are not reimbursable––for example, the costs of treating uninsured patients. 14-3 14-17 (15 min.) Allocating costs to divisions. 1. Allocations based on square feet. 1. Square feet 2. % square feet (130,000; 90,000; 80,000; 10,000 ÷ 400,000) 3. Allocated headquarter cost (Row 2 × $14,255,000) Segment margin Less: Headquarter costs Division margin Division margin ÷ Revenues Refrigerator 130,000 Stove 90,000 32.5% $4,632,875 22.5% $3,207,375 Refrigerator Stove $5,200,000 $8,400,000 4,632,875 3,207,375 $ 567,125 $5,192,625 5.2% 27.6% Dishwasher 80,000 20% Microwave Oven 10,000 Total 400,000 25% 100% $2,851,000 $3,563,750 $14,255,000 Dishwasher $5,300,000 2,851,000 $2,449,000 21.3% Microwave oven $3,560,000 3,563,750 $ (3,750) (0.06)% Total $22,460,000 14,255,000 $ 8,205,000 17.1% Dishwasher $5,300,000 Microwave Oven $3,560,000 Total $22,460,000 Allocations based on segment margin. 1. Segment margin 2. % segment margin $5,200000; $8,400,000; $5,300,000; $3,560,000 ÷ $22,460,000 3. Allocated headquarter cost (Row 2 × $14,255,000) Segment margin Less: Headquarter costs Division margin Division margin ÷ Revenues Refrigerator Stove $5,200,000 $8,400,000 23.15% $3,300,033 37.40% $5,331,370 Refrigerator Stove $5,200,000 $8,400,000 3,300,033 5,331,370 $1,899,967 $3,068,630 17.4% 16.3% 23.60% 15.85% 100% $3,364,180 $2,259,417 $14,255,000 Dishwasher $5,300,000 3,364,180 $1,935,820 16.8% Microwave oven $3,560,000 2,259,417 $1,300,583 (19.2)% Total $22,460,000 14,225,000 $ 8,205,000 17.1% 2. I prefer the allocation based on segment margins because a cause-and-effect relationship may exist between headquarter costs and division segment margin – headquarter staff are likely to spend more time on divisions that have more revenues and segment margins. Segment margins can also be justified on the ability-to-bear principle – divisions with higher margins can bear more of the headquarter costs. The physical size of the divisions probably has no causeand-effect relationship with headquarter costs. 14-4 3. None of the divisions should be dropped, since all four have positive segment margins before considering the headquarter’s cost allocation. As seen by these two options, the allocation of headquarter costs is arbitrary and should not serve as the basis for closing a division. Dropping the microwave division would be worthwhile only if the $3,563,750 of allocated headquarter costs could be saved if the microwave division is closed – a very unlikely scenario. 14-18 (30 min.) Cost allocation to divisions. 1. Revenue Direct costs Segment margin Fixed overhead costs Income before taxes Segment margin % Hotel $16,425,000 9,819,260 $ 6,605,740 40.22% Restaurant $5,256,000 3,749,172 $1,506,828 Casino $12,340,000 4,248,768 $ 8,091,232 28.67% Rembrandt $34,021,000 17,817,200 16,203,800 14,550,000 $ 1,653,800 65.57% 2. Direct costs Direct cost % Square footage Square footage % Number of employees Number of employees % Hotel $9819260 55.11% 80,000 50.00% 200 40.00% Restaurant $3749172 21.04% 16,000 10.00% 50 10.00% Casino $4248768 23.85% 64,000 40.00% 250 50.00% Rembrandt $17817200 100.00% 160,000 100.00% 500 100.00% A: Cost allocation based on direct costs: Revenue Direct costs Segment margin Allocated fixed overhead costs Segment pre-tax income Segment pre-tax income % of rev. Hotel Restaurant $16,425,000 $ 5,256,000 9,819,260 3,749,172 6,605,740 1,506,828 8,018,505 3,061,320 $ (1,412,765) $ (1,554,492) -8.60% -29.58% Casino $12,340,000 4,248,768 8,091,232 3,470,175 $ 4,621,057 37.45% Rembrandt $34,021,000 17,817,200 16,203,800 14,550,000 $ 1,653,800 B: Cost allocation based on floor space: Hotel $7,275,000 $ (669,260) -4.07% Restaurant $1,455,000 $ 51,828 0.99% Casino $5,820,000 $2,271,232 18.41% Rembrandt $14,550,000 $ 1,653,800 C: Cost allocation based on number of employees Hotel Allocated fixed overhead costs $5,820,000 Segment pre-tax income $ 785,740 Segment pre-tax income % of rev. 4.78% Restaurant $1,455,000 $ 51,828 0.99% Casino $7,275,000 $ 816,232 6.61% Rembrandt $14,550,000 $ 1,653,800 Allocated fixed overhead costs Segment pre-tax income Segment pre-tax income % of rev. 14-5 3. Requirement 2 shows the dramatic effect of choice of cost allocation base on segment pre-tax income as a percentage of revenues: Allocation Base Direct costs Floor space Number of employees Pre-tax Income Percentage Hotel Restaurant Casino -8.60% -29.58% 37.45% -4.07 0.99 18.41 4.78 0.99 6.61 The decision context should guide (a) whether costs should be allocated, and (b) the preferred cost allocation base. Decisions about, say, performance measurement, may be made on a combination of financial and nonfinancial measures. It may well be that Rembrandt may prefer to exclude allocated costs from the financial measures to reduce areas of dispute. Where cost allocation is required, the cause-and-effect and benefits-received criteria are recommended in Chapter 14. The $14,550,000 is a fixed overhead cost. This means that on a short-run basis, the cause-and-effect criterion is not appropriate but Rembrandt could attempt to identify the cost drivers for these costs in the long run when these costs are likely to be more variable. Rembrandt should look at how the $14,550,000 cost benefits the three divisions. This will help guide the choice of an allocation base in the short run. 4. The analysis in requirement 2 should not guide the decision on whether to shut down any of the divisions. The overhead costs are fixed costs in the short run. It is not clear how these costs would be affected in the long run if Rembrandt shut down one of the divisions. Also, each division is not independent of the other two. A decision to shut down, say, the restaurant, likely would negatively affect the attendance at the casino and possibly the hotel. Rembrandt should examine the future revenue and future cost implications of different resource investments in the three divisions. This is a future-oriented exercise, whereas the analysis in requirement 2 is an analysis of past costs. 14-6 14-19 (25 min.) Cost allocation to divisions. Percentages for various allocation bases (old and new): Pulp (1) Division margin percentages $2,400,000; $7,100,000; $9,500,000 $19,000,000 (2) Share of employees $350; 250; 400 1,000 (3) Share of floor space 35,000; 24,000; 66,000 125,000 (4) Share of total division administrative costs $2,000,000; $1,800,000; $3,200,000 $7,000,000 Paper Fibers 12.63157% 37.36843% 35.0 25.0 40.0 100.0 28.0 19.2 52.8 100.0 28.57142 25.71428 45.71428 100.0 50.0% Total 100.0% 1. Pulp Paper Fibers Total $2,400,000 $ 7,100,000 $ 9,500,000 $19,000,000 (5) Division margin (6) Corporate overhead allocated on segment margins = (1) $9,000,000 1,136,842 3,363,158 4,500,000 9,000,000 (7) Operating margin with division-margin-based allocation = (5) – (6) $1,263,158 $ 3,736,842 $ 5,000,000 $10,000,000 (8) Revenues $8,500,000 $17,500,000 $24,000,000 $50,000,000 Operating margin as a percentage of revenues 14.9% 21.3% 20.8% 20.0% 2. (5) Division margin HRM costs (alloc. base: no. of employees) = (2) $1,800,000 Facility costs (alloc. base: floor space) = (3) $2,700,000 Corp. admin (alloc. base: div. admin costs) = (4) $4,500,000 Corp. overhead allocated to each division Operating margin with cause-and-effect allocation (8) Revenues Operating margin as a percentage of revenues Pulp Paper Fibers Total $2,400,000 $ 7,100,000 $ 9,500,000 $19,000,000 630 ,000 450,000 720,000 1,800,000 756,000 518,400 1,425,600 2,700,000 1,285,714 2,671,714 1,157,143 2,125,543 2,057,143 4,202,743 4,500,000 9,000,000 $ (271,714) $ 4,974,457 $ 5,297,257 $10,000,000 $8,500,000 $17,500,000 $24,000,000 $50,000,000 -3.2% 28.4% 22.1% 20.0 % 14-7 3. When corporate overhead is allocated to the divisions on the basis of division margins (requirement 1), each division is profitable (has positive operating margin) and the Paper division is the most profitable (has the highest operating margin percentage) by a slim margin, while the Pulp division is the least profitable. When Bardem’s suggested bases are used to allocate the different types of corporate overhead costs (requirement 2), we see that, in fact, the Pulp division is not profitable (it has a negative operating margin). Paper continues to be the most profitable and, in fact, it is significantly more profitable than the Fibers division. If division performance is linked to operating margin percentages, Pulp will resist this new way of allocating corporate costs, which causes its operating margin of nearly 15% (in the old scheme) to be transformed into a -3.2% operating margin. The new cost allocation methodology reveals that, if the allocation bases are reasonable, the Pulp division consumes a greater share of corporate resources than its share of segment margins would indicate. Pulp generates 12.6% of the segment margins, but consumes almost 29.7% ($2,671,714 $9,000,000) of corporate overhead resources. Paper will welcome the change—its operating margin percentage rises the most, and Fiber’s operating margin percentage remains practically the same. Note that in the old scheme, Paper was being penalized for its efficiency (smallest share of administrative costs), by being allocated a larger share of corporate overhead. In the new scheme, its efficiency in terms of administrative costs, employees, and square footage is being recognized. 4. The new approach is preferable because it is based on cause-and-effect relationships between costs and their respective cost drivers in the long run. Human resource management costs are allocated using the number of employees in each division because the costs for recruitment, training, etc., are mostly related to the number of employees in each division. Facility costs are mostly incurred on the basis of space occupied by each division. Corporate administration costs are allocated on the basis of divisional administrative costs because these costs are incurred to provide support to divisional administrations. To overcome objections from the divisions, Bardem may initially choose not to allocate corporate overhead to divisions when evaluating performance. He could start by sharing the results with the divisions, and giving them—particularly the Pulp division—adequate time to figure out how to reduce their share of cost drivers. He should also develop benchmarks by comparing the consumption of corporate resources to competitors and other industry standards. 14-8 14-20 (30 min.) Customer profitability, customer cost hierarchy. 1. All amounts in thousands of U.S. dollars Wholesale Retail North America South America Big Sam World Reven ues at list prices $420,000 Price discounts 30,000 Revenues (at actual prices) 390,000 Cost of goods sold 325,000 Gross margin 65,000 Customer-level operating costs Delivery 450 Order processing 800 Sales visit 5,600 Total cust.-level optg.costs 6,850 Customer-level operating income $ 58,150 $580,000 40,000 540,000 455,000 85,000 $130,000 7,000 123,000 118,000 5,000 $100,000 500 99,500 90,000 9,500 650 1,000 5,500 7,150 200 200 2,300 2,700 125 130 1,350 1,605 $ 77,850 14-9 $ 2,300 $ 7,895 2. Total (all customers) (1) = (2) + (5) Revenues (at actual prices) $1,152,500 Customer-level costs 1,006,305 Customer-level operating income 146,195 Distribution-channel costs 45,000 Distribution-channel-level oper. income 101,195 Corporate-sustaining costs 65,000 Operating income $ 36,195 aCost Customer Distribution Channels (all amounts in $000s) Wholesale Customers Retail Customers Total North America South America Total Big Sam World Wholesale Wholesaler Wholesaler Retail Stereo Market (2) = (3) + (4) (3) (4) (5) = (6) + (7) (6) (7) $930,000 $390,000 $540,000 $222,500 $123,000 $99,500 794,000 331,850 a 462,150 a 212,305 120,700 a 91,605 a 136,000 $ 58,150 $ 77,850 10,195 $ 2,300 $ 7,895 38,000 7,000 $ 98,000 $ 3,195 of goods sold + Total customer-level operating costs from Requirement 1 3. If corporate costs are allocated to the channels, the retail channel will show an operating loss of $10,805,000 ($3,195,000 – $14,000,000), and the wholesale channel will show an operating profit of $47,000,000 ($98,000,000 – $51,000,000). The overall operating profit, of course, is still $36,195,000, as in requirement 2. There is, however, no cause-and-effect or benefits-received relationship between corporate costs and any allocation base, i.e., the allocation of $51,000,000 to the wholesale channel and of $14,000,000 to the retail channel is arbitrary and not useful for decision-making. Therefore, the management of Ramish Electronics should not base any performance evaluations or investment/disinvestment decisions based on these channel-level operating income numbers. They may want to take corporate costs into account, however, when making pricing decisions. 14-10 14-21 (2030 min.) Customer profitability, service company. 1. Revenues Technician and equipment cost Gross margin Service call handling ($75 150; 240; 40; 120; 180) Web-based parts ordering ($80 120; 210; 60; 150; 150) Billing/Collection ($50 30; 90; 90; 60; 120) Database maintenance ($10 150; 240; 40; 120; 180) Customer-level operating income 2. Avery $260,000 182,000 78,000 Okie $200,000 175,000 25,000 Wizard $322,000 225,000 97,000 Grainger $122,000 107,000 15,000 Duran $212,000 178,000 34,000 11,250 18,000 3,000 9,000 13,500 9,600 16,800 4,800 12,000 12,000 1,500 4,500 4,500 3,000 6,000 1,500 $ 54,150 2,400 400 $ (16,700) $ 84,300 1,200 1,800 $(10,200) $ 700 Customers Ranked on Customer-Level Operating Income Customer Code Wizard Avery Duran Grainger Okie Customer-Level Operating Income (1) $ 84,300 54,150 700 (10,200) (16,700) $112,250 Customer Revenue (2) $ 322,000 260,000 212,000 122,000 200,000 $1,116,000 Customer-Level Cumulative Operating Income Customer-Level as a % of Revenue Operating Income (3) = (1) (2) (4) 26.18% $ 84,300 20.83% 138,450 0.33% 139,150 -8.36% 128,950 -8.35% 112,250 14-11 Cumulative Customer-Level Operating Income as a % of Total Customer-Level Operating Income (5) = (4) $112,250 75% 123% 124% 115% 100% Customer-Level Operating Income $100,000 $84,300 Customer-Level Operating Income $80,000 $60,000 $54,150 Wizard $40,000 Avery Duran $20,000 Grainger Okie $700 $0 $(10,200) -$20,000 $(16,700) -$40,000 Customers The above table and graph present the summary results. Wizard, the most profitable customer, provides 75% of total operating income. The three best customers provide 124% of IS’s operating income, and the other two, by incurring losses for IS, erode the extra 24% of operating income down to IS’s operating income. 3. The options that Instant Service should consider include: a. Increase the attention paid to Wizard and Avery. These are “key customers,” and every effort has to be made to ensure they retain IS. IS may well want to suggest a minor price reduction to signal how important it is in their view to provide a costeffective service to these customers. b. Seek ways of reducing the costs or increasing the revenues of the problem accounts––Okie and Grainger. For example, are the copying machines at those customer locations outdated and in need of repair? If yes, an increased charge may be appropriate. Can IS provide better on-site guidelines to users about ways to reduce breakdowns? c. As a last resort, IS may want to consider dropping particular accounts. For example, if Grainger (or Okie) will not agree to a fee increase but has machines continually breaking down, IS may well decide that it is time not to bid on any more work for that customer. But care must then be taken to otherwise use or get rid of the excess fixed capacity created by “firing” unprofitable customers. 14-12 14-22 (2025 min.) Customer profitability, distribution. 1. The activity-based costing for each customer is: Charleston Pharmacy 1. 2. 3. 4. 5. Order processing, $40 × 13; $40 × 10 Line-item ordering, $3 × (13 × 9; 10 × 18) Store deliveries, $50 × 7; $50 ×10 Carton deliveries, $1 × (7 × 22; 10 × 20) Shelf-stocking, $16 × (7 × 0; 10 × 0.5) Operating costs Chapel Hill Pharmacy $ 520 $ 400 351 540 350 500 154 200 0 $1,375 80 $1,720 The operating income of each customer is: Charleston Pharmacy Revenues, $2,400 × 7; $1,800 × 10 Cost of goods sold, $2,100 × 7; $1,650 × 10 Gross margin Operating costs Operating income Chapel Hill Pharmacy $16,800 $18,000 14,700 2,100 1,375 $ 725 16,500 1,500 1,720 $ (220) Chapel Hill Pharmacy has a lower gross margin percentage than Charleston (8.33% vs. 12.50%) and consumes more resources to obtain this lower margin. 2. a. b. c. Ways Figure Four could use this information include: Pay increased attention to the top 20% of the customers. This could entail asking them for ways to improve service. Alternatively, you may want to highlight to your own personnel the importance of these customers; e.g., it could entail stressing to delivery people the importance of never missing delivery dates for these customers. Work out ways internally at Figure Four to reduce the rate per cost driver; e.g., reduce the cost per order by having better order placement linkages with customers. This cost reduction by Figure Four will improve the profitability of all customers. Work with customers so that their behavior reduces the total “system-wide” costs. At a minimum, this approach could entail having customers make fewer orders and fewer line items. This latter point is controversial with students; the rationale is that a reduction in the number of line items (diversity of products) carried by Ma and Pa stores may reduce the diversity of products Figure Four carries. 14-13 There are several options here: Simple verbal persuasion by showing customers cost drivers at Figure Four. Explicitly pricing out activities like cartons delivered and shelf-stocking so that customers pay for the costs they cause. Restricting options available to certain customers, e.g., customers with low revenues could be restricted to one free delivery per week. An even more extreme example is working with customers so that deliveries are easier to make and shelf-stocking can be done faster. d. Offer salespeople bonuses based on the operating income of each customer rather than the gross margin of each customer. Some students will argue that the bottom 40% of the customers should be dropped. This action should be only a last resort after all other avenues have been explored. Moreover, an unprofitable customer today may well be a profitable customer tomorrow, and it is myopic to focus on only a 1-month customer-profitability analysis to classify a customer as unprofitable. 14-23 (30–40 min.) Variance analysis, multiple products. 1. Sales-volume = Actual sales Budgeted sales Budgeted contribution quantity in units quantity in units margin per ticket variance Lower-tier tickets Upper-tier tickets All tickets 2. = (3,300 – 4,000) $20 =$14,000 U = (7,700 – 6,000) $ 5 = 8,500 F $ 5,500 U Budgeted average contribution margin per unit = (4,000 $20) (6,000 $5) 10,000 = $80,000 $30,000 $110,000 = 10,000 10,000 = $11 per unit (seat sold) Sales-mix percentages: Lower-tier Upper-tier Budgeted 4,000 = 0.40 10,000 Actual 3,300 = 0.30 11,000 6,000 = 0.60 10,000 7,700 = 0.70 11,000 14-14 Solution Exhibit 14-23 presents the sales-volume, sales-quantity, and sales-mix variances for lower-tier tickets, upper-tier tickets, and in total for Detroit Penguins in 2010. The sales-quantity variances can also be computed as: Budgeted Budgeted Actual units Budgeted units Sales-quantity = of all tickets of all tickets sales - mix cont. margin percentage variance sold sold per ticket The sales-quantity variances are: Lower-tier tickets = (11,000 – 10,000) × 0.40 × $20 = $ 8,000 F Upper-tier tickets = (11,000 – 10,000) × 0.60 × $ 5 = 3,000 F All tickets $11,000 F The sales-mix variance can also be computed as: Actual units Sales-mix = of all tickets × variance sold Budgeted Budgeted Actual sales-mix sales-mix contribution margin percentage percentage per ticket The sales-mix variances are Lower-tier tickets Upper-tier tickets All tickets = 11,000 × (0.30 – 0.40) × $20 = 11,000 × (0.70 – 0.60) × $ 5 = $22,000 U = 5,500 F $16,500 U 3. The Detroit Penguins increased average attendance by 10% per game. However, there was a sizable shift from lower-tier seats (budgeted contribution margin of $20 per seat) to the upper-tier seats (budgeted contribution margin of $5 per seat). The net result: the actual contribution margin was $5,500 below the budgeted contribution margin. 14-15 SOLUTION EXHIBIT 14-23 Columnar Presentation of Sales-Volume, Sales-Quantity and Sales-Mix Variances for Detroit Penguins Flexible Budget: Actual Units of All Products Sold × Actual Sales Mix × Budgeted Contribution Margin per Unit (1) Panel A: Lower-tier a (11,000 × 0.30 ) × $20 3,300 × $20 $66,000 Actual Units of All Products Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Unit (2) b (11,000 × 0.40 ) × $20 4,400 × $20 $88,000 Static Budget: Budgeted Units of All Products Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Unit (3) b (10,000 × 0.40 ) × $20 4,000 × $20 $80,000 $22,000U Sales-mix variance $8,000 F Sales-quantity variance $14,000 U Sales-volume variance Panel B: Upper-tier c (11,000 × 0.70 ) × $5 7,700 × $5 $38,500 d (11,000 × 0.60 ) × $5 6,600 × $5 $33,000 $5,500 F Sales-mix variance d (10,000 × 0.60 ) × $5 6,000 × $5 $30,000 $3,000 F Sales-quantity variance $8,500 F Sales-volume variance Panel C: All Tickets (Sum of Lowertier and Uppertier tickets) e $104,500 f $121,000 g $110,000 $16,500 U $11,000 F Total sales-mix variance Total sales-quantity variance $5,500 U Total sales-volume variance F = favorable effect on operating income; U = unfavorable effect on operating income. Actual Sales Mix: a Lower-tier = 3,300 ÷ 11,000 c Upper-tier = 7,700 ÷ 11,000 e $66,000 + $38,500 = $104,500 = 30% = 70% Budgeted Sales Mix: b Lower-tier = 4,000 ÷ 10,000 = 40% d Upper-tier = 6,000 ÷ 10,000 = 60% f $88,000 + $33,000 = $121,000 g $80,000 + $30,000 = $110,000 14-16 14-24 (30 min.) Variance analysis, working backward backward. 1. and 2. Solution Exhibit 14-24 presents the sales-volume, sales-quantity, and sales-mix variances for the Plain and Chic wine glasses and in total for Jinwa Corporation in June 2009. The steps to fill in the numbers in Solution Exhibit 14-24 follow: Step 1 Consider the static budget column (Column 3): Static budget total contribution margin Budgeted units of all glasses to be sold Budgeted contribution margin per unit of Plain Budgeted contribution margin per unit of Chic $5,600 2,000 $2 $6 Suppose that the budgeted sales-mix percentage of Plain is y. Then the budgeted salesmix percentage of Chic is (1 – y). Therefore, (2,000y $2) + (2,000 (1 – y) $6) $4000y + $12,000 – $12,000y $8,000y y 1–y = = = = = $5,600 $5,600 $6,400 0.8 or 80% 20% Jinwa’s budgeted sales mix is 80% of Plain and 20% of Chic. We can then fill in all the numbers in Column 3. Step 2 Next, consider Column 2 of Solution Exhibit 14-24. The total of Column 2 in Panel C is $4,200 (the static budget total contribution margin of $5,600 – the total sales-quantity variance of $1,400 U which was given in the problem). We need to find the actual units sold of all glasses, which we denote by q. From Column 2, we know that (q 0.8 $2) + (q 0.2 $6) $1.6q + $1.2q $2.8q q = = = = $4,200 $4,200 $4,200 1,500 units So, the total quantity of all glasses sold is 1,500 units. This computation allows us to fill in all the numbers in Column 2. 14-17 Step 3 Next, consider Column 1 of Solution Exhibit 14-24. We know actual units sold of all glasses (1,500 units), the actual sales-mix percentage (given in the problem information as Plain, 60%; Chic, 40%), and the budgeted unit contribution margin of each product (Plain, $2; Chic, $6). We can therefore determine all the numbers in Column 1. Solution Exhibit 14-24 displays the following sales-quantity, sales-mix, and sales-volume variances: Sales-Volume Variance Plain $1,400 U Chic 1,200 F All Glasses $ 200 U Sales-Mix Variances Plain $ 600 U Chic 1,800 F All Glasses $1,200 F Sales-Quantity Variances Plain $ 800 U Chic 600 U All Glasses $1,400 U 3. Jinwa Corporation shows an unfavorable sales-quantity variance because it sold fewer wine glasses in total than was budgeted. This unfavorable sales-quantity variance is partially offset by a favorable sales-mix variance because the actual mix of wine glasses sold has shifted in favor of the higher contribution margin Chic wine glasses. The problem illustrates how failure to achieve the budgeted market penetration can have negative effects on operating income. 14-18 SOLUTION EXHIBIT 14-24 Columnar Presentation of Sales-Volume, Sales-Quantity and Sales-Mix Variances for Jinwa Corporation Flexible Budget: Actual Units of All Glasses Sold Actual Sales Mix Budgeted Contribution Margin per Unit Actual Units of All Glasses Sold Budgeted Sales Mix Budgeted Contribution Margin per Unit Static Budget: Budgeted Units of All Glasses Sold Budgeted Sales Mix Budgeted Contribution Margin per Unit Panel A: Plain (1,500 0.6) $2 (1,500 0.8) $2 (2,000 0.8) $2 900 $2 1,200 $2 1,600 $2 $1,800 $2,400 $3,200 $600 U $800 U Sales-mix variance Sales-quantity variance $1,400 U Sales-volume variance Panel B: Chic (1,500 0.4) $6 (1,500 0.2) $6 (2,000 0.2) $6 600 $6 300 $6 400 $6 $3,600 $1,800 $2,400 $1,800 F $600 U Sales-mix variance Sales-quantity variance $1,200 F Sales-volume variance Panel C: All Glasses $5,400 $4,200 $5,600 $1,200 F $1,400 U Total sales-mix variance Total sales-quantity variance $200 U Total sales-volume variance F = favorable effect on operating income; U = unfavorable effect on operating income. 14-19 14-25 (60 min.) Variance analysis, multiple products. 1. Budget for 2009 Kola Limor Orlem Total Selling Price (1) $6.00 4.00 7.00 Variable Contrib. Cost Margin Units Sales per Unit per Unit Sold Mix (2) (3) = (1) – (2) (4) (5) $4.00 $2.00 400,000 16% 2.80 1.20 600,000 24 4.50 2.50 1,500,000 60 2,500,000 100% Contribution Margin (6) = (3) × (4) $ 800,000 720,000 3,750,000 $5,270,000 Variable Contrib. Cost Margin Units per Unit per Unit Sold (2) (3) = (1) – (2) (4) $4.50 $1.70 480,000 2.75 1.50 900,000 4.60 2.20 1,620,000 3,000,000 Contribution Margin (6) = (3) × (4) $ 816,000 1,350,000 3,564,000 $5,730,000 Actual for 2009 Kola Limor Orlem Total Selling Price (1) $6.20 4.25 6.80 Sales Mix (5) 16% 30 54 100% Solution Exhibit 14-25 presents the sales-volume, sales-quantity, and sales-mix variances for each product and in total for 2009. Budgeted Budgeted Actual Sales-volume quantity of quantity of contribution margin variance units sold units sold per unit Kola Limor Orlem Total = ( 480,000 – 400,000) × $2.00 = = ( 900,000 – 600,000) × $1.20 = = (1,620,000 – 1,500,000) × $2.50 = $160,000 F 360,000 F 300,000 F $820,000 F Budgeted Budgeted Actual units Budgeted units Sales-quantity of all products of all products sales-mix contribution margin variance sold sold percentage per unit Kola Limor Orlem Total = (3,000,000 – 2,500,000) × 0.16 × $2.00 = (3,000,000 – 2,500,000) × 0.24 × $1.20 = (3,000,000 – 2,500,000) × 0.60 × $2.50 14-20 = $ 160,000 F = 144,000 F = 750,000 F $1,054,000 F Actual units Actual Sales-mix = of all products × sales-mix variance sold percentage Kola Limor Orlem Total = = = Budgeted Budgeted – sales-mix × contrib. margin percentage per unit 3,000,000 × (0.16 – 0.16) × $2.00 3,000,000 × (0.30– 0.24) × $1.20 3,000,000 × (0.54 – 0.60) × $2.50 = = = $ 0 216,000 F 450,000 U $234,000 U 2. The breakdown of the favorable sales-volume variance of $820,000 shows that the biggest contributor is the 500,000 unit increase in sales resulting in a favorable sales-quantity variance of $1,054,000. There is a partially offsetting unfavorable sales-mix variance of $234,000 in contribution margin. SOLUTION EXHIBIT 14-25 Sales-Mix and Sales-Quantity Variance Analysis of Soda King for 2009 Flexible Budget: Actual Units of All Products Sold Actual Sales Mix Budgeted Contribution Margin Per Unit Static Budget: Budgeted Units of All Products Sold Budgeted Sales Mix Budgeted Contribution Margin Per Unit Actual Units of All Products Sold Budgeted Sales Mix Budgeted Contribution Margin Per Unit Kola 3,000,000 0.16 $2 = $ 960,000 3,000,000 0.16 $2 =$ 960,000 2,500,000 0.16 $2 = $ 800,000 Limor 3,000,000 0.30 $1.20 = 1,080,000 3,000,000 0.24 $1.20 = 864,000 2,500,000 0.24 $1.20 = 720,000 Orlem 3,000,000 0.54 $2.50 = 4,050,000 3,000,000 0.60 $2.50 = 4,500,000 2,500,000 0.60 $2.50 = 3,750,000 $6,090,000 $6,324,000 $5,270,000 $234,000 U Sales-mix variance $1,054,000 F Sales-quantity variance $820,000 F Sales-volume variance F = favorable effect on operating income; U= unfavorable effect on operating income 14-21 14-26 (20 min.) Market-share and market-size variances (continuation of 14-25). Western region Soda King Market share Actual 24 million 3 million 12.5% Budgeted 25 million 2.5 million 10% Average budgeted contribution margin per unit = $2.108 ($5,270,000 ÷ 2,500,000) Solution Exhibit 14-26 presents the sales-quantity variance, market-size variance, and marketshare variance for 2006. Market-share variance Actual = market size in units × Actual market share – Budgeted market share Budgeted contribution × margin per composite unit for budgeted mix = 24,000,000 × (0.125 – 0.10) × $2.108 = 24,000,000 × .025 × $2.108 = $1,264,800 F Market-size variance = Actual market size – in units Budgeted market size in units × Budgeted market share × Budgeted contribution margin per composite unit for budgeted mix = (24,000,000 – 25,000,000) × 0.10 × $2.108 = – 1,000,000 × 0.10 × $2.108 = 210,800 U The market share variance is favorable because the actual 12.5% market share was higher than the budgeted 10% market share. The market size variance is unfavorable because the market size decreased 4% [(25,000,000 – 24,000,000) ÷ 25,000,000]. While the overall total market size declined (from 25 million to 24 million), the increase in market share meant a favorable sales-quantity variance. Sales-Quantity Variance $1,054,000 F Market-share variance $1,264,800 F Market-size variance $210,800 U 14-22 SOLUTION EXHIBIT 14-26 Market-Share and Market-Size Variance Analysis of Soda King for 2009 Actual Market Size Actual Market Share Budgeted Average Contribution Margin Per Unit 24,000,000 0.125a $2.108b $6,324,000 Actual Market Size Budgeted Market Share Budgeted Average Contribution Margin Per Unit 24,000,000 0.10c $2.108 b $5,059,200 Static Budget: Budgeted Market Size Budgeted Market Share Budgeted Average Contribution Margin Per Unit 25,000,000 0.10c $2.108b $5,270,000 $1,264,800 F $210,800 U Market-share variance Market-size variance $1,054,000 F Sales-quantity variance F = favorable effect on operating income; U = unfavorable effect on operating income aActual market share: 3,000,000 units ÷ 24,000,000 units = 0.125, or 12.5% bBudgeted average contribution margin per unit $5,270,000 ÷ 2,500,000 units = $2.108 per unit cBudgeted market share: 2,500,000 units ÷ 25,000,000 units = 0.10, or 10% 14-23 14-27 (40 min.) Allocation of corporate costs to divisions. 1. a. b. c. d. The purposes for allocating central corporate costs to each division include the following (students may pick and discuss any two): To provide information for economic decisions. Allocations can signal to division managers that decisions to expand (contract) activities will likely require increases (decreases) in corporate costs that should be considered in the initial decision about expansion (contraction). When top management is allocating resources to divi sions, analysis of relative divi sion profitability should consider differential use of corporate services by divisions. Some alloca tion schemes can encourage the use of central ser vices that would otherwise be underutilized. A common rationale related to this pur pose is “to remind profit center managers that central corporate costs exist and that division earnings must be adequate to cover some share of those costs.” Motivation. Allocations create incentives for division managers to control costs; for example, by reducing the number of employees at a divi sion, a manager will save direct labor costs as well as central personnel and payroll costs allocated on the basis of number of employees. Allocation also creates incentives for division managers to monitor the effectiveness and efficiency with which central corporate costs are spent. Cost justification or reimbursement. Some lines of business of Richfield Oil may be regulated with cost data used in determining “fair prices”; allocations of central corporate costs will result in higher prices being set by a regulator. Income measurement for external parties. Richfield Oil may in clude allocations of central corporate costs in its external line-of-busi ness reporting. 2. Revenues Percentage of revenues $8,000; $16,000; $4,800; $3,200 $32,000 (Dollar amounts in millions) Revenues Operating costs Operating income Corp. costs allocated on revenues (% of revs $3,228) Division operating income Oil & Gas Upstream $8,000 Oil & Gas Chemical Downstream Products $16,000 $4,800 25% Oil & Gas Upstream $8,000 3,000 5,000 807 $4,193 14-24 50% 15% Oil & Gas Chemical Downstream Products $16,000 $4,800 15,000 3,800 1,000 1,000 $ 1,614 (614) 484 $ 516 Copper Mining $3,200 Total $32,000 10% 100% Copper Mining $3,200 3,500 (300) Total $32,000 25,300 6,700 323 $ (623) 3,228 $ 3,472 3. First, calculate the share of each allocation base for each of the four corporate cost pools: Identifiable assets (1)Percentage of total identifiable assets $14,000; $6,000; $3,000; $2,000 $25,000 Oil & Gas Upstream $14,000 Oil & Gas Downstream $6,000 Chemical Products $3,000 Copper Mining $2,000 Total $25,000 56% 24% 12% 8% 100% Division revenues (2) Percentage of total division revenues $8,000; $16,000; $4,800; $3,200 $32,000 $8,000 $16,000 $4,800 $3,200 $32,000 25% 50% 15% 10% 100% Positive operating income (3) Percentage of total positive operating income $5,000; $1,000; $1,000; 0 $7,000 $5,000 $1,000 $1,000 NONE $7,000 71.4% 14.3% 14.3% 0% 100% 9,000 12,000 6,000 3,000 30,000 30% 40% 20% 10% 100% Number of employees (4) Percentage of total employees 9,000; 12,000; 6,000; 3,000 30,000 Using these allocation percentages and the allocation bases suggested by Rhodes, we can allocate the $3,228 M of corporate costs as shown below. Note that the costs in Cost Pool 2 total $800 M ($150 + $110 + $200 + $140 + $200). (Dollar amounts in millions) Revenues Operating Costs Operating Income Cost Pool 1 Allocation ((1) $2,000) Cost Pool 2 Allocation ((2) $800) Cost Pool 3 Allocation ((3) $203) Cost Pool 4 Allocation ((4) $225) Division Income Oil & Gas Oil & Gas Chemical Copper Upstream Downstream Products Mining $8,000.00 $16,000.00 $4,800.00 $3,200.00 3,000.00 15,000.00 3,800.00 3,500.00 5,000.00 1,000.00 1,000.00 (300.00) 1,120.00 480.00 240.00 160.00 200.00 400.00 120.00 80.00 145.00 29.00 29.00 0.00 67.50 90.00 45.00 22.50 $3,467.50 $ 1.00 $ 566.00 $ (562.50) Total $32,000 25,300 6,700 2,000 800 203 225 $ 3,472 4. The table below compares the reported income of each division under the original revenue-based allocation scheme and the new 4-pool-based allocation scheme. Oil & Gas Upstream seems 17% less profitable than before ($3,467.5 $4,193 = 83%), and may resist the new allocation, but each of the other divisions seem more profitable (or less loss-making) than before and they will probably welcome it. In this setting, corporate costs are relatively large (about 13% of total operating costs), and division incomes are sensitive to the corporate cost allocation method. (Dollar amounts in millions) Operating Income (before corp. cost allocation) Division income under revenue-based allocation of corporate costs Division income under 4-cost-pool allocation of corporate costs Oil & Gas Upstream Oil & Gas Chemical Downstream Products $5,000.00 $1,000.00 $1,000.00 $(300.00) $6,700 $4,193.00 $ (614.00) $ 516.00 $(623.00) $3,472 $3,467.50 $ $ 566.00 $(562.50) $3,472 1.00 Strengths of Rhodes’ proposal relative to existing single-cost pool method: 14-25 Copper Mining Total a. Better able to capture cause-and-effect relationships. Interest on debt is more likely caused by the financing of assets than by revenues. Personnel and payroll costs are more likely caused by the number of employ ees than by revenues. b. Relatively simple. No extra information need be collected beyond that already available. (Some students will list the extra costs of Rhodes' proposal as a weakness. However, for a company with $30 billion in revenues, those extra costs are minimal.) Weaknesses of Rhodes’ proposal relative to existing single-cost pool method: a. May promote dysfunctional decision making. May encour age division managers to lease or rent assets rather than to purchase assets, even where it is economical for Richfield Oil to purchase them. This off-balance sheet financing will re duce the “identifiable assets” of the division and thus will reduce the interest on debt costs allocated to the division. (Richfield Oil could counteract this problem by incorporating leased and rented assets in the "identifiable assets" base.) Note: Some students criticized Rhodes’ proposal, even though agreeing that it is preferable to the existing single-cost pool method. These criticisms include: a. The proposal does not adequately capture cause-and-effect relationships for the legal and research and development cost pools. For these cost pools, specific identification of individual projects with an individual division can better capture cause-and-effect relation ships. b. The proposal may give rise to disputes over the definition and valuation of “identifiable assets.” c. The use of actual rather than budgeted amounts in the allocation bases cre ates interdependencies between divisions. Moreover, use of ac tual amounts means that division managers do not know cost alloca tion consequences of their decisions until the end of each reporting period. d. A separate allocation of fixed and variable costs would result in more refined cost allocations. e. It is questionable that 100% of central corporate costs should be allo cated. Many students argue that public affairs should not be allocated to any division, based on the notion that division managers may not control many of the individual expenditures in this cost pool. 14-26 14-28 Cost allocation to divisions. 1. Segment margin Allocated headquarter costs ($5,100,000 ÷ 3) Operating income Bread $6,400,000 Cake $1,300,000 Doughnuts $6,150,000 Total $13,850,000 1,700,000 $4,700,000 1,700,000 $ (400,000) 1,700,000 $4,450,000 5,100,000 $ 8,750,000 2. Segment margin Allocated headquarter costs, Human resources1 (50%; 12.5%; 37.5% × $1,900,000) Accounting department2 (53.9%; 11.6%; 34.5% × $1,400,000) Rent and depreciation3 (50%; 20%; 30% × $1,200,000) 1 Other ( $600,000 ) 3 Total Operating income Bread $6,400,000 Cake $1,300,000 Doughnuts $6,150,000 Total $13,850,000 950,000 237,500 712,500 1,900,000 754,600 162,400 483,000 1,400,000 600,000 240,000 360,000 1,200,000 200,000 200,000 200,000 600,000 2,504,600 $3,895,400 839,900 $ 460,100 1,755,500 $4,394,500 5,100,000 $ 8,750,000 1HR costs: 400 ÷ 800 = 50%; 100 ÷ 800 = 12.5%; 300 ÷ 800 = 37.5% $20,900,000 ÷ $38,800,000 = 53.9%; $4,500,000 ÷ $38,800,000 = 11.6%; $13,400,000 ÷ $38,800,000 = 34.5% 3 Rent and depreciation: 10,000 ÷ 20,000 = 50%; 4,000 ÷ 20,000 = 20%; 6,000 ÷ 20,000 = 30% 2Accounting: A cause-and-effect relationship may exist between Human Resources costs and the number of employees at each division. Rent and depreciation costs may be related to square feet, except that very expensive machines may require little square footage, which is inconsistent with this choice of allocation base. The Accounting Department costs are probably related to the revenues earned by each division – higher revenues mean more transactions and more accounting. Other overhead costs are allocated arbitrarily. 3. The manager suggesting the new allocation bases probably works in the Cake Division. Under the old scheme, the Cake Division shows an operating loss after allocating headquarter costs because it is smaller, yet was charged an equal amount (a third) of headquarter costs. The new allocation scheme shows an operating profit in the Cake Division, even after allocating headquarter costs. The ABC method is a better way to allocate headquarter costs because it uses cost allocation bases that, by and large, represent cause-and-effect relationships between various categories of headquarter costs and the demands that different divisions place on these costs. 14-27 14-29 Customer-profitability. 1. 01 02 Customer 03 04 05 06 Customer-level costs Customer orders ($40 × 2; 7; 1; 5; 20; 3) $ 80 Customer fittings ($25 × 1; 2; 0; 0; 4; 1) 25 Rush order costs ($100 × 0; 0; 1; 1; 3; 0) 0 Returns for repair ($30 × 0; 1; 0; 1; 5; 1) 0 Total customer-level costs $105 $ 280 50 0 30 $ 360 $ 40 0 100 0 $140 $ 200 0 100 30 $ 330 $ 800 100 300 150 $1,350 $120 25 0 30 $175 Revenue Cost of product Gross profit Customer-level costs Customer-level operating income $4,200 2,940 1,260 360 $ 900 $300 210 90 140 $(50) $2,500 1,750 750 330 $ 420 $4,900 3,430 1,470 1,350 $ 120 $700 490 210 175 $ 35 $600 420 180 105 $ 75 The table indicates there are profitable and unprofitable customers. The ranking of customers from most to least profitable is: Customer-Level Cumulative CustomerOperating CustomerCumulative CustomerLevel Income Level Level Operating Income Operating Customer Divided by Operating as a % of Total Customer Customer Income Revenue Revenue Income Income Number (1) (2) (3) = (1) ÷ (2) (4) (5) = (4) ÷ $1,500 02 04 05 01 06 03 $ 900 420 120 75 35 (50) $1,500 $ 4,200 2,500 4,900 600 700 300 $13,200 21.4% 16.8% 2.4% 12.5% 5% -16.7% $ 900 $1,320 $1,440 $1,515 $1,550 $1,500 60.0% 88.0% 96.0% 101.0% 103.3% 100.0% 2. Customer 03 is unprofitable and of the rest, customer 06 has the lowest operating income. Customer 05 has a very low operating income to revenue percentage. Customer 3 is unprofitable because it has very low revenues and requires a rush order. Customer 5 has a low operating income percentage because it places many orders, several rush orders, and requires a large number of customer return visits for repairs in the 30-day period after the sale. Ring Delights could make these customers more profitable by charging extra for rush orders, charging a small fee for repairs, increasing the selling price, or requiring a minimum total revenue for free post-sales service. Whatever decision it takes, Ring Delights must also consider the effect the decision might have on sales. 14-28 14-30 (40 min.) Customer profitability, distribution. P Q $29,952 $126,000 0 2,100 29,952 123,900 24,960 105,000 4,992 18,900 Customer R S $875,520 $457,920 72,960 15,264 802,560 442,656 729,600 381,600 72,960 61,056 1,500 160 280 1,040 2,500 240 240 4,375 3,000 480 360 30,400 2,500 160 640 15,900 0 2,980 $ 2,012 0 7,355 $ 11,545 0 34,240 $ 38,720 0 19,200 $ 41,856 1. a Revenues at list prices b Discount Revenues (at actual prices) c Cost of goods sold Gross margin Customer-level operating costs d Order taking e Customer visits f Delivery vehicles g Product handling h Expedited runs Total Customer-level operating income T $56,160 5,616 50,544 46,800 3,744 3,000 240 1,600 1,950 300 7,090 $ (3,346) a $14.40 2,080; 8,750; 60,800; 31,800; 3,900 b ($14.40 – $14.40) 50,000; ($14.40 – $14.16) 8,750; ($14.40 – $13.20) 60,800; ($14.40 – $13.92) 31,800; ($14.40 – $12.96) 3,900 c $12 2,080; 8,750; 60,800, 31,800; 3,900 d $100 15; 25; 30; 25; 30 e $80 2; 3; 6; 2; 3 f $2 (10 14); (30 4); (60 3); (40 8); (20 40) g $0.50 2,080; 8,750; 60,800; 31,800; 3,900 h $300 0; 0; 0; 0; 1 Customer S is the most profitable customer, despite having only 52% (31,800 60,800) of the unit volume of Customer R. A major explanation is that Customer R receives a $1.20 discount per case while Customer S receives only a $0.48 discount per case. Customer T is unprofitable, while the smaller customer P is profitable. Customer T receives a $1.44 discount per case, makes more frequent orders, requires more customer visits, and requires more delivery miles than Customer P. 2. Separate reporting of both the list selling price and the actual selling price enables Spring Distribution to examine which customers receive different discounts and how salespeople may differ in the discounts they grant. There is a size pattern in the discounts across the five customers, except for Customer T, larger volume customers get larger discounts: Sales Volume R (60,800 cases) S (31,800 cases) Q (8,750 cases) T (3,900 cases) P (2,080 cases) Discount per case $1.20 $0.48 $0.24 $1.44 $0.00 The reasons for the $1.44 discount for T should be explored. 14-29 3. Dropping customers should be the last resort taken by Spring Distribution. Factors to consider include the following: a. What is the expected future profitability of each customer? Are the currently unprofitable (T) or low-profit (P) customers likely to be highly profitable in the future? b. Are there externalities from having some customers, even if they are unprofitable in the short run? For example, some customers have a marquee-value that is “in effect” advertising that benefits the business. c. What costs are avoidable if one or more customers are dropped? d. Can the relationship with the “problem” customers be restructured so that there is a “win-win” situation? For example, could Customer T get by with fewer deliveries per month? 14-30 14-31 Customer profitability in a manufacturing firm. 1. Calculation of customer profitability by customer: A Customer C B Revenues at list price D E $ (7,880) $100 × 5,000; 2,400; 1,200; 4,000; 8,000 Price discount 10% × $500,000; 0; 10% × $120,000; 0; 10% × $400,000 Revenues (actual price) Cost of goods sold $80 × 5,000; 2,400, 1,200; 4,000; 8,000 Gross margin Customer-level costs: Order taking $380 × 10; 12; 48; 16; 12 Product handling $10 × 500; 240; 144; 400; 812 Warehousing $55 × 13; 16; 0; 12; 120 Rush order processing $520 × 0; 2; 0; 0; 5 Exchange and repair $40 × 0; 30; 5; 20; 95 $500,000 $240,000 $120,000 $400,000 $800,000 50,000 450,000 0 240,000 12,000 108,000 0 400,000 40,000 760,000 400,000 50,000 192,000 48,000 96,000 12,000 320,000 80,000 640,000 120,000 3,800 4,560 18,240 6,080 4,560 5,000 2,400 1,440 4,000 8,120 715 880 0 660 6,600 0 1,040 0 0 2,600 0 1,200 200 800 3,800 9,515 10,080 19,880 11,540 25,680 $ 37,920 $ (7,880) $ 68,460 $ 94,320 Total customer-level costs Customer-level operating income $ 40,485 Customer ranking Customer-Level Operating Customer Income Code (1) Customer Revenue (2) Customer-Level Operating Cumulative Income Customer-Level Divided by Revenue Operating Income (3) = (1) ÷ (2) (4) E $ 94,320 $ 760,000 12.4% D 68,460 400,000 17.1% $162,780 69.8% A 40,485 450,000 9.0% $203,265 87.1% B 37,920 240,000 15.8% $241,185 103.4% C (7,880) 108,000 -7.3% $233,305 100.0% $233,305 $1,958,000 Total $ 94,320 Cumulative Customer-Level Operating Income as a % of Total Customer-Level Operating Income (5) = (4) ÷ $233,305 40.4% 2. Customer C is Bizzan’s only unprofitable customer. All other customers are profitable in line with revenue, except customer A which has more revenue than D but less operating income. 14-31 If Customer C were not being given price discounts, C would be profitable. The salesperson is giving discounts on orders, even though the size of the order is small. It is costing Bizzan money to process many small orders as opposed to a few large orders. To turn Customer C into a profitable customer, Bizzan needs to encourage Customer C to place fewer, larger orders and offer a price discount only if Customer C changes behavior, rather than as a reward for repeat business. Customer A has many rush orders in proportion to total number of orders. Bizzan should work with Customer A to find a production schedule that would meet its needs without having to rush the order. Customer E has high warehousing needs that are costly to Bizzan. Bizzan should work with Customer E to align its production schedule to Customer E’s needs. The exchange and repair rate for customers with rush orders is higher than for other customers. Bizzan should explore whether rushing an order reduces attention to quality. Either reducing the number of rush orders (which would also save Bizzan money) or working toward increasing the quality of rush orders would help to reduce these costs. The three most profitable customers (E, D, and A) generate 87% of the customer-level operating income. These customers are valued customers and should receive the highest level of customer service. 14-32 14-32 (60 min.) Variance analysis, sales-mix and sales-quantity variances. 1. Actual Contribution Margins Actual Actual Actual Variable Contribution Selling Cost per Margin per Product Price Unit Unit Palm Pro $349 $178 $171 Palm CE 285 92 193 PalmKid 102 73 29 Actual Sales Actual Actual Volume in Contribution Contribution Units Dollars Percent 11,000 $ 1,881,000 16% 44,000 8,492,000 71% 55,000 1,595,000 13% 110,000 $11,968,000 100% The actual average contribution margin per unit is $108.80 ($11,968,000 110,000 units). Budgeted Contribution Margins Budgeted Budgeted Variable Selling Cost per Product Price Unit Palm Pro $379 $182 Palm CE 269 98 Palm Kid 149 65 Budgeted Sales Budgeted Budgeted Volume in Contribution Contribution Units Dollars Percent 12,500 $ 2,462,500 19% 37,500 6,412,500 49% 50,000 4,200,000 32% 100,000 $13,075,000 100% The budgeted average contribution margin per unit is $130.75 ($13,075,000 100,000 units). 2. Budgeted Contribution Margin per Unit $197 171 84 Actual Sales Mix Actual Sales Volume in Units Actual Sales Mix 10.0% (11,000 ÷ 110,000) 40.0% (44,000 ÷ 110,000) 50.0% (55,000 ÷ 110,000) 100.0% Product Palm 11,000 Pro Palm CE Palm Kid 44,000 55,000 110,000 Budgeted Sales Mix Budgeted Sales Volume in Units Product Palm Pro 12,500 Palm CE Palm Kid 37,500 50,000 Budgeted Sales Mix 12.5% (12,500 ÷ 100,000) 37.5% (37,500 ÷ 100,000) 50.0% (50,000 ÷ 100,000) 14-33 100,000 100.0% 14-34 3. Sales-volume variance: Budgeted Actual = quantity of quantity of units sold units sold PalmPro (11,000 PalmCE (44,000 PalmKid (55,000 Total sales-volume variance Budgeted contribution margin per unit 12,500) 37,500) 50,000) × × × $197 $171 $ 84 $ 295,500 U 1,111,500 F 420,000 F $1,236,000 F Sales-mix variance: Budgeted Actual units Budgeted Actual = of all × sales mix sales mix × contrib. margin products sold percentage percentage per unit PalmPro = 110,000 PalmCE = 110,000 PalmKid = 110,000 Total sales-mix variance × (0.10 × (0.40 × (0.50 0.125) 0.375) 0.50) × × × $197 $171 $ 84 $541,750 U 470,250 F 0F $ 71,500 U Sales-quantity variance: Budgeted units Budgeted Budgeted Actual units × sales mix × contrib. margin = of all of all products sold products sold percentage per unit PalmPro (110,000 PalmCE (110,000 PalmKid (110,000 Total sales-quantity variance 100,000) 100,000) 100,000) × × × 14-35 0.125 0.375 0.50 × × × $197 $171 $ 84 $ 246,250 F 641,250 F 420,000 F $1,307,500 F Solution Exhibit 14-32 presents the sales-volume variance, the sales-mix variance, and the salesquantity variance for Palm Pro, Palm CE, and PalmKid and in total for the third quarter 2010. SOLUTION EXHIBIT 14-32 Sales-Mix and Sales-Quantity Variance Analysis of Aussie Infonautics for the Third Quarter 2010. Flexible Budget: Actual Units of All Products Sold Actual Sales Mix Budgeted Contribution Margin Per Unit Palm Pro 110,000 0.10 $197 =$ 2,167,000 PalmCE 110,000 0.40 $171 = 7,524,000 PalmKid 110,000 0.50 $ 84 = 4,620,000 $14,311,000 Static Budget: Budgeted Units of All Products Sold Budgeted Sales Mix Budgeted Contribution Margin Per Unit Actual Units of All Products Sold Budgeted Sales Mix Budgeted Contribution Margin Per Unit 110,000 0.125 $197 =$ 2,708,750 110,000 0.375 $171 = 7,053,750 110,000 0.50 $ 84 = 4,620,000 $14,382,500 100,000 0.125 $197 =$ 2,462,500 100,000 0.375 $171 = 6,412,500 100,000 0.50 $ 84 = 4,200,000 $13,075,000 $71,500 U $1,307,500 F Sales-mix variance Sales-quantity variance $1,236,000 F Sales-volume variance F = favorable effect on operating income; U= unfavorable effect on operating income 4. The following factors help us understand the differences between actual and budgeted amounts: The difference in actual versus budgeted contribution margins was $1,107,000 unfavorable ($11,968,000 $13,075,000). However, the contribution margin from the PalmCE exceeded budget by $2,079,500 ($8,492,000 $6,412,500) while the contributions from the PalmPro and the PalmKid were lower than expected and offset this gain. This is attributable to lower unit sales in the case of PalmPro and lower contribution margins in the case of PalmKid. In percentage terms, the PalmCE accounted for 71% of actual contribution margin versus a planned 49% contribution margin. However, the PalmPro accounted for 16% versus planned 19% and the PalmKid accounted for only 13% versus a planned 32%. In unit terms (rather than in contribution terms), the PalmKid accounted for 50% of the sales mix as planned. However, the PalmPro accounted for only 10% versus a budgeted 12.5% and the PalmCE accounted for 40% versus a planned 37.5%. Variance analysis for the PalmPro shows an unfavorable sales-mix variance outweighing a favorable sales-quantity variance and producing an unfavorable salesvolume variance. The drop in sales-mix share was far larger than the gain from an overall greater quantity sold. The PalmCE gained both from an increase in share of the sales mix as well as from the increase in the overall number of units sold. The PalmKid maintained sales-mix share at 50%––as a result, the sales-mix variance is zero. However, PalmKid sales gained from the overall increase in units sold. 14-36 Overall, there was a favorable total sales-volume variance. However, the large drop in PalmKid’s contribution margin per unit combined with a decrease in the actual number of PalmPro units sold as well as a drop in the actual contribution margin per unit below budget, led to the total contribution margin being much lower than budgeted. Other factors could be discussed here––for example, it seems that the PalmKid did not achieve much success with a three digit price point––selling price was budgeted at $149 but dropped to $102. At the same time, variable costs increased. This could have been due to a marketing push that did not succeed. 14-33 (20 min.) Market-share and market-size variances (continuation of 14-32). 1. Worldwide Aussie Info. Market share Actual Budgeted 500,000 400,000 110,000 100,000 22% 25% Average contribution margin per unit: Actual = $108.80 ($11,968,000 110,000) Budgeted = $130.75 ($13,075,000 100,000) Market-share variance = = = = Market-size variance = Budgeted Actual Budgeted contribution margin market market per composite unit share share for budgeted mix 500,000 (0.22 – 0.25) $130.75 500,000 (–0.03) $130.75 $1,961,250 U Actual market size in units Budgeted Actual market size market size in units in units = (500,000 – 400,000) 0.25 $130.75 = 100,000 0.25 $130.75 = $3,268,750 F 14-37 Budgeted Budgeted contribution margin market per composite unit share for budgeted mix Solution Exhibit 14-33 presents the market-share variance, the market-size variance, and the sales-quantity variance for the third quarter 2010. SOLUTION EXHIBIT 14-33 Market-Share and Market-Size Variance Analysis of Aussie Infonautics for the Third Quarter 2010. Actual Market Size Actual Market Share Budgeted Average Contribution Margin Per Unit 500,000 0.22a $130.75b $14,382,500 Actual Market Size Budgeted Market Share Budgeted Average Contribution Margin Per Unit 500,000 0.25c $130.75 b $16,343,750 Static Budget: Budgeted Market Size Budgeted Market Share Budgeted Average Contribution Margin Per Unit 400,000 0.25c $130.75b $13,075,000 $1,961,250 U $3,268,750 F Market-share variance Market-size variance $1,307,500 F Sales-quantity variance F = favorable effect on operating income; U = unfavorable effect on operating income aActual market share: 110,000 units ÷ 500,000 units = 0.22, or 22% bBudgeted average contribution margin per unit $13,075,000 ÷ 100,000 units = $130.75 per unit cBudgeted market share: 100,000 units ÷ 400,000 units = 0.25, or 25% 2. While the market share declined (from 25% to 22%), the overall increase in the total market size meant a favorable sales-quantity variance: Sales-Quantity Variance $1,307,500 F Market-Share Variance $1,961,250 U 14-38 Market Size Variance $3,268,750 F 3. The required actual market size is the budgeted market size, i.e., 400,000 units. This can easily be seen by setting up the following equation: Budgeted Budgeted Budgeted Actual Market - size market size market size market contribution margin variance per composite unit in units in units share for budgeted mix = (M – 400,000) × 0.25 × $130.75 When M = 400,000, the market-size variance is $0. Actual Market-Share Calculation Again, the answer is the budgeted market share, 25%. By definition, this will hold irrespective of the actual market size. This can be seen by setting up the appropriate equation: Market-share Budgeted Actual Actual Budgeted contribution margin variance market size market market = per composite unit in units share share for budgeted mix = Actual market size × (M – 25%) × $130.75 When M = 25%, the market-share variance is $0. 14-39 14-34 (40 min.) Variance analysis, multiple products. 1, 2, and 3. Solution Exhibit 14-34 presents the sales-volume, sales-quantity, and sales-mix variances for each type of cookie and in total for Debbie’s Delight, Inc., in August 2009. The sales-volume variances can also be computed as Sales-volume = Actual quantity Budgeted quantity × Budgeted contribution margin per pound of pounds sold of pounds sold variance The sales-volume variances are Chocolate chip = (57,600 – 45,000) $2.00 Oatmeal raisin = (18,000 – 25,000) $2.30 Coconut = (9,600 – 10,000) $2.60 White chocolate = (13,200 – 5,000) $3.00 Macadamia nut = (21,600 – 15,000) $3.10 All cookies = = = = = $25,200 F 16,100 U 1,040 U 24,600 F 20,460 F $53,120 F The sales-quantity variance can also be computed as Budgeted Budgeted Actual pounds Budgeted pounds Sales-volume = of all cookies of all cookies sales-mix contribution variance percentage margin per pound sold sold The sales-quantity variances are Chocolate chip = (120,000 – 100,000) 0.45 $2.00 Oatmeal raisin = (120,000 – 100,000) 0.25 $2.30 Coconut = (120,000 – 100,000) 0.10 $2.60 White chocolate = (120,000 – 100,000) 0.05 $3.00 Macadamia nut = (120,000 – 100,000) 0.15 $3.10 All cookies = = = = = $18,000 F 11,500 F 5,200 F 3,000 F 9,300 F $47,000 F The sales-mix variance can also be computed as: Sales-quantity = variance Actual pounds Budgeted Actual sales- Budgeted sales- of all cookies contribution mix percentage mix percentage sold margin per pound The sales-mix variances are: Chocolate chip = (0.48 – 0.45) 120,000 $2.00 Oatmeal raisin = (0.15 – 0.25) 120,000 $2.30 Coconut = (0.08 – 0.10) 120,000 $2.60 White chocolate = (0.11 – 0.05) 120,000 $3.00 Macadamia nut = (0.18 – 0.15) 120,000 $3.10 All cookies 14-40 = = = = = $ 7,200 F 27,600 U 6,240 U 21,600 F 11,160 F $ 6,120 F A summary of the variances is: Sales-Volume Variance Chocolate chip $25,200 F Oatmeal raisin 16,100 U Coconut 1,040 U White chocolate 24,600 F Macadamia nut 20,460 F All cookies $53,120 F Sales-Mix Variance Chocolate chip $ 7,200 F Oatmeal raisin 27,600 U Coconut 6,240 U White chocolate 21,600 F Macadamia nut 11,160 F All cookies $ 6,120 F Sales-Quantity Variance Chocolate chip $18,000 F Oatmeal raisin 11,500 F Coconut 5,200 F White chocolate 3,000 F Macadamia nut 9,300 F All cookies $47,000 F 4. Debbie’s Delight shows a favorable sales-quantity variance because it sold more cookies in total than was budgeted. Together with the higher quantities, Debbie’s also sold more of the high-contribution margin white chocolate and macadamia nut cookies relative to the budgeted mix––as a result, Debbie’s also showed a favorable total sales-mix variance. 14-41 SOLUTION EXHIBIT 14-34 Columnar Presentation of Sales-Volume, Sales-Quantity, and Sales-Mix Variances for Debbie’s Delight, Inc. Flexible Budget: Actual Pounds of All Cookies Sold × Actual Sales Mix × Budgeted Contribution Margin per Pound (1) Actual Pounds of All Cookies Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Pound (2) Static Budget: Budgeted Pounds of All Cookies Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Pound (3) (120,000 × 0.48a) × $2 57,600 × $2 $115,200 (120,000 × 0.45b) × $2 54,000 × $2 $108,000 (100,000 × 0.45b) × $2 45,000 × $2 $90,000 Panel A: Chocolate Chip $7,200 F Sales-mix variance $18,000 F Sales-quantity variance $25,200 F Sales-volume variance Panel B: Oatmeal Raisin (120,000 × 0.15c) × $2.30 18,000 × $2.30 $41,400 (120,000 × 0.25d) × $2.30 30,000 × $2.30 $69,000 $27,600 U Sales-mix variance (100,000 × 0.25d) × $2.30 25,000 × $2.30 $57,500 $11,500 F Sales-quantity variance $16,100 U Sales-volume variance Panel C: Coconut (120,000 × 0.08e) × $2.60 9,600 × $2.60 $24,960 (120,000 × 0.10f) × $2.60 12,000 × $2.60 $31,200 $6,240 U Sales-mix variance (100,000 × 0.10f) × $2.60 10,000 × $2.60 $26,000 $5,200 F Sales-quantity variance $1,040 U Sales-volume variance F = favorable effect on operating income; U = unfavorable effect on operating income. Actual Sales Mix: aChocolate Chip = 57,600 ÷ 120,000 = 48% cOatmeal Raisin = 18,000 ÷ 120,000 = 15% eCoconut = 9,600 ÷ 120,000 = Budgeted Sales Mix: bChocolate Chip dOatmeal Raisin f Coconut 8% 14-42 = = = 45,000 ÷ 100,000 = 45% 25,000 ÷ 100,000 = 25% 10,000 ÷ 100,000 = 10% SOLUTION EXHIBIT 14-34 (Cont’d.) Columnar Presentation of Sales-Volume, Sales-Quantity, and Sales-Mix Variances for Debbie’s Delight, Inc. Flexible Budget: Actual Pounds of All Cookies Sold × Actual Sales Mix × Budgeted Contribution Margin per Pound (1) Panel D: White Chocolate Actual Pounds of All Cookies Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Pound (2) Static Budget: Budgeted Pounds of All Cookies Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Pound (3) (120,000 × 0.11g) × $3.00 13,200 × $3.00 $39,600 (120,000 × 0.05h) × $3.00 6,000 × $3.00 $18,000 (100,000 × 0.05h) × $3.00 5,000 × $3.00 $15,000 $21,600 F Sales-mix variance $3,000 F Sales-quantity variance $24,600 F Sales-volume variance Panel E: Macadamia Nut (120,000 × 0.18j) × $3.10 21,600 × $3.10 $66,960 (120,000 × 0.15k) × $3.10 18,000 × $3.10 $55,800 (100,000 × 0.15k) × $3.10 15,000 × $3.10 $46,500 $9,300 F Sales-quantity variance $11,160 F Sales-mix variance $20,460 F Sales-volume variance Panel F: All Cookies $288,120l $282,000m $6,120 F Total sales-mix variance $235,000n $47,000 F Total sales-quantity variance $53,120 F Total sales-volume variance F = favorable effect on operating income; U = unfavorable effect on operating income. Actual Sales Mix: gWhite Chocolate jMacadamia Nut = 13,200 ÷ 120,000 = 11% = 21,600 ÷ 120,000 = 18% l$115,200 + $41,400 + $24,960 + $39,600 + $66,960 = $288,120 Budgeted Sales Mix: hWhite Chocolate kMacadamia Nut 15% = 5,000 ÷ 100,000 = = 15,000 ÷ 100,000 = 5% m$108,000 + $69,000 + $31,200 + $18,000 + $55,800 = $282,000 n$90,000 + $57,500 + $26,000 + $15,000 + $46,500 = $235,000 14-43 14-35 (15 min.) Market-share and market-size variances (continuation of 14-34). Chicago Market Debbie's Delight Market share Actual 960,000 120,000 0.125 Budgeted 1,000,000 100,000 0.100 The budgeted average contribution margin per unit (also called budgeted contribution margin per composite unit for budgeted mix) is $2.35: Chocolate chip Oatmeal raisin Coconut White chocolate Macadamia nut All cookies Budgeted average = contribution margin per unit Market-size variance in contribution margin Market-share variance in contribution margin Budgeted Contribution Margin per Pound $2.00 2.30 2.60 3.00 3.10 Budgeted Sales Volume in Pounds 45,000 25,000 10,000 5,000 15,000 100,000 Budgeted Contribution Margin $ 90,000 57,500 26,000 15,000 46,500 $235,000 $235,000 = $2.35 100,000 Budgeted Budgeted average = 错误!未指定开关参数。× market × contrib. margin share per unit = (960,000 – 1,000,000) × 0.100 × $2.35 = $9,400 U Budgeted Actual average = market size × 错误!未指定开关参数。× contrib. margin in units per unit = 960,000 × (0.125 – 0.100) × $2.35 = $56,400 F By increasing its actual market share from the 10% budgeted to the actual 12.50%, Debbie’s Delight has a favorable market-share variance of $56,400. There is a smaller offsetting unfavorable market-size variance of $9,400 due to the 40,000 unit decline in the Chicago market (from 1,000,000 budgeted to an actual of 960,000). 14-44 Solution Exhibit 14-35 presents the sales-quantity, market-share, and market-size variances for Debbie’s Delight, Inc., in August 2009. SOLUTION EXHIBIT 14-35 Market-Share and Market-Size Variance Analysis of Debbie’s Delight for August 2009 Debbie’ Actual Market Size Actual Market Share Budgeted Average Contribution Margin Per Unit 960,000 0.125a $2.35b $282,000 Actual Market Size Budgeted Market Share Budgeted Average Contribution Margin Per Unit 960,000 0.10c $2.35b $225,600 $56,400 F Static Budget: Budgeted Market Size Budgeted Market Share Budgeted Average Contribution Margin Per Unit 1,000,000 0.10c $2.35b $235,000 $9,400 U Market-share variance Market-size variance $47,000 F Sales-quantity variance F = favorable effect on operating income; U = unfavorable effect on operating income aActual market share: 120,000 units ÷ 960,000 units = 0.125, or 12.5% bBudgeted average contribution margin per unit: $235,000 ÷ 1,000,000 units = $2.35 per unit cBudgeted market share: 100,000 units ÷ 1,000,000 units = 0.10, or 10% An overview of Problems 14-34 and 14-35 is: Sales-Volume Variance $53,120 F Sales-Mix Variance $6,120 F Sales-Quantity Variance $47,000 F Market-Share Variance $56,400 F 14-45 Market-Size Variance $9,400 U 14-36 (35 min.) Direct materials efficiency, mix, and yield variances (Chapter Appendix). 1. Sugar ($1 × 7 cups) Flavoring ($3 × 2 cups) Coloring ($2 × 1 cup) Cost per batch Number of batches Budgeted Cost $ 7 6 2 $ 15 ×23 $345 2. Solution Exhibit 14-36A presents the total price variance ($0), the total efficiency variance ($5 U), and the total flexible-budget variance ($5 U). Total direct materials efficiency variance can also be computed as: Direct materials efficiency variance = for each input Budgeted quantity quantity Actualinput Budgetedfor actualof input × price of input of allowed output Sugar = (165 – 161) × $1 = $4 U Flavoring = (45 – 46) × $3 = 3F Coloring = (25 – 23) × $2 = 4U Total direct materials efficiency variance $5 U SOLUTION EXHIBIT 14-36A Columnar Presentation of Direct Materials Price and Efficiency Variances for Flavr-Wave Company. Sugar Flavoring Coloring Actual Costs Incurred (Actual Input Quantity × Actual Price) (1) 165× $1= $165 45 × $3 = 135 25 × $2 = 50 $350 Actual Input Quantity × Budgeted Price (2) 165 × $1 = $165 45 × $3 = 135 25 × $2 = 50 $350 $0 Total price variance Flexible Budget (Budgeted Input Quantity Allowed for Actual Output × Budgeted Price) (3) 23 × 7 × $1 = $161 23 × 2 × $3 = 138 23 × 1 × $2 = 46 $345 $5 U Total efficiency variance $5 U Total flexible-budget variance F = favorable effect on operating income; U = unfavorable effect on operating income 14-46 3. Actual price per cup: Sugar Flavoring Coloring $165 ÷ 165 cups = $1 per cup $135 ÷ 45 cups = $3 per cup $50 ÷ 25 cups = $2 per cup Total direct materials price variance can also be computed as: Direct materials Actual quantity Actual price variance = Budgeted × of input price of input price of input for each input Sugar = ($1 – $1) × 165 = $0 Flavoring = ($3 – $3) × 45 = 0 Coloring = ($2 – $2) × 25 = 0 Total direct materials price variance $0 The total direct materials price variance equals zero because for all three inputs, actual price per cup equals the budgeted price per cup. 4. Solution Exhibit 14-36B presents the total direct materials yield and mix variances. The total direct materials yield variance can also be computed as the sum of the direct materials yield variances for each input: Direct materials = yield variance for each input Budgeted Actual total Budgeted total quantity quantity of all of all direct materials inputs × direct materials input mix direct materials allowed for actual output inputs used percentage Budgeted price of × direct materials inputs Sugar = (235 – 230) × 0.70a × $1 = 5 × 0.70 × $1 = $3.50 Flavoring = (235 – 230) × 0.20b × $3 = 5 × 0.20 × $3 = 3.00 U Coloring = (235 – 230) × 0.10c × $2 = 5 × 0.10 × $2 = 1.00 U Total direct materials yield variance $7.50 U a7 10; b 2 10; c 1 10 The total direct materials mix variance can also be computed as the sum of the direct materials mix variances for each input: Direct materials = mix variance for each input Actual total Budgeted Actual Budgeted price of direct materials direct materials × quantity of all × direct materials direct materials input mix input mix percentage inputs used inputs percentage = (0.7021d – 0.7) × 235 × $1 = 0.0021 $0.50 U Flavoring = (0.1915e – 0.2) × 235 × $3 = – 0.0085 × 235 × $3 = Sugar = × 235 × $1 6.00 F Coloring = (0.1064f – 0.1) × 235 × $2 = 0.0064 × 235 × $2 = 3.00 U Total direct materials mix variance $2.50 F 14-47 d 165 235; e 45 235; f 25 235 14-48 SOLUTION EXHIBIT 14-36B Columnar Presentation of Direct Materials Yield and Mix Variances for Flavr-Wave Company. Sugar Flavoring Coloring Actual Total Quantity of All Inputs Used × Actual Input Mix × Budgeted Price (1) 235 × 0.7021 × $1 = $165 235 × 0.1915 × $3 = 135 235 × 0.1064 × $2 = 50 Actual Total Quantity of All Inputs Used × Budgeted Input Mix × Budgeted Price (2) 235 × 0.70 × $1 = $164.50 235 × 0.20 × $3 = 141.00 235 × 0.10 × $2 = 47.00 $350 Flexible Budget: Budgeted Total Quantity of All Inputs Allowed for Actual Output × Budgeted Input Mix × Budgeted Price (3) 230 × 0.70 × $1 = $161 230 × 0.20 × $3 = 138 230 × 0.10 × $2 = 46 $352.50 $2.50 F Total mix variance $345 $7.50 U Total yield variance $5 U Total efficiency variance F = favorable effect on operating income; U = unfavorable effect on operating income. The direct materials mix variance of $2.50 F indicates that actual product mix uses relatively more of less expensive ingredients than planned. In this case, the actual mix contains slightly more coloring and slightly less flavoring. The direct materials yield variance of $7.50 U occurs because the amount of total inputs needed (235 cups) exceeded the budgeted amount (230 cups) expected to produce 2,300 pops. The variances are very small relative to the budgeted cost to produce 2,300 pops. The company should not spend resources investigating them, especially since changing the standard mix slightly does not significantly affect product quality. 14-49 14-37 (35 min.) Materials variances: price, efficiency, mix and yield. 1. Oak ($6 × 8 b.f.) Pine ($2 × 12 b.f.) Cost per dresser Number of dressers Total budgeted cost $ 48 24 $ 72 ×3,000 units $216,000 2. Solution Exhibit 14-37A presents the total price variance ($5,246 F), the total efficiency variance ($1,280 F), and the total flexible-budget variance ($6,526 F). Total direct materials price variance can also be computed as: Direct materials Actual price variance = Budgeted × Actual quantity of input price of input price of input for each input Oak = ($6.10 – $6.00) × 23,180 = $2,318 U Pine = ($1.80 – $2.00) × 37,820 = 7,564 F Total direct materials price variance $5,246 F Total direct materials efficiency variance can also be computed as: Direct materials efficiency variance = for each input Budgeted quantity quantity Actualinput Budgetedfor actualof input × price of input of allowed output Oak = (23,180 – 24,000) × $6.00 = $4,920 F Pine = (37,820 – 36,000) × $2.00 = 3,640 U Total direct materials efficiency variance $1,280 F 14-50 SOLUTION EXHIBIT 14-37A Columnar Presentation of Direct Materials Price and Efficiency Variances for PDS Manufacturing Oak Pine Actual Costs Incurred (Actual Input Quantity × Actual Price) (1) 23,180 × $6.10 = $141,398 37,820 × $1.80 = 68,076 $209,474 Actual Input Quantity × Budgeted Price (2) 23,180 × $6.00 = $139,080 37,820 × $2.00 = 75,640 $214,720 $5,246 F Total price variance Flexible Budget (Budgeted Input Quantity Allowed for Actual Output × Budgeted Price) (3) 24,000 × $6.00 = $144,000 36,000 × $2.00 = 72,000 $216,000 $1,280 F Total efficiency variance $6,526 F Total flexible-budget variance F = favorable effect on operating income; U = unfavorable effect on operating income 3. Oak Pine Total Actual Quantity of Input 23,180 b.f. 37,820 b.f. 61,000 b.f. Actual Mix 38% 62% 100% Budgeted Quantity of Input for Actual Output 8 b.f. × 3,000 units = 24,000 b.f. 12 b.f. × 3,000 units = 36,000 b.f. 60,000 b.f. Budget ed Mix 40% 60% 100% 4. Solution Exhibit 14-37B presents the total direct materials yield and mix variances for PDS Manufacturing. The total direct materials yield variance can also be computed as the sum of the direct materials yield variances for each input: Direct materials = yield variance for each input Budgeted Actual total Budgeted total quantity quantity of all of all direct materials inputs × direct materials input mix direct materials allowed for actual output inputs used percentage Budgeted price of × direct materials inputs Oak = (61,000 – 60,000) × 0.40 × $6.00 = 1,000 × 0.40 × $6.00 = $2,400 U Pine = (61,000 – 60,000) × 0.60 × $2.00 = 1,000 × 0.60 × $2.00 = 1,200 U Total direct materials yield variance $3,600 U 14-51 The total direct materials mix variance can also be computed as the sum of the direct materials mix variances for each input: Direct materials = mix variance for each input Actual total Budgeted Actual Budgeted quantity of all price of direct materials direct materials × × direct materials direct materials input mix input mix percentage inputs used inputs percentage Oak = (0.38 – 0.40) × 61,000 × $6.00 = 0.02 × 61,000 × $6.00 = $7,320 F Pine = (0.62 – 0.60) × 61,000 × $2.00 = – 0.02 × 61,000 × $2.00 = 2,440 U Total direct materials mix variance $4,880 F The sum of the direct materials mix variance and the direct materials yield variance equals the direct materials efficiency variance. The favorable mix variance arises from using more of the cheaper pine (and less oak) than the budgeted mix. The yield variance indicates that the dressers required more total inputs (61,000 b.f.) than expected (60,000 b.f.) for the production of 3,000 dressers. Both variances are relatively small and probably within tolerable limits. PDS should investigate whether substituting the cheaper pine for the more expensive oak caused the unfavorable yield variance. It should also be careful that using more of the cheaper pine does not reduce the quality of the dresser or how customers perceive it. SOLUTION EXHIBIT 14-37B Columnar Presentation of Direct Materials Yield and Mix Variances for PDS Manufacturing Actual Total Quantity of All Inputs Used × Actual Input Mix × Budgeted Price (1) Oak Pine $214,720 61,000 × 0.38 × $6.00 = 61,000 × 0.62 × $2.00 = $139,080 75,640 Actual Total Quantity of All Inputs Used × Budgeted Input Mix × Budgeted Price (2) Flexible Budget: Budgeted Total Quantity of All Inputs Allowed for Actual Output × Budgeted Input Mix × Budgeted Price (3) 61,000 × 0.40 × $6.00 = $146,400 61,000 × 0.60 × $2.00 = 73,200 $219,600 60,000 × 0.40 × $6.00 = $144,000 60,000 × 0.60 × $2.00 = 72,000 $216,000 4,880 F Total mix variance $3,600 U Total yield variance $1,280 F Total efficiency variance F = favorable effect on operating income; U = unfavorable effect on operating income. 14-52 14-38 (40 min.) Customer profitability and ethics. 1. Customer-level operating income based on expected cost of orders: Customers IHoG Revenues at list price $40 × 200; 540; 300; 100; 400; 1,000 Price discounts GRU: 5% × $21,600; Gmart: 5% × $40,000 Revenues (actual price) Cost of good sold $30 × 200; 540; 300; 100; 400; 1,000 Gross margin Customer-level operating costs: Order taking $28 × 4; 12; 6; 4; 16; 20 Product handling $1 × 200; 540; 300; 100; 400; 1,000 Delivery $1 × 80; 120; 72; 28; 304; 100 Expedited delivery $300 × 0; 4; 0; 0; 1; 3 Sales commissions $20 × 4; 12; 6; 4; 16; 20) Total customer-level operating costs Customer-level operating income GRU GM GC GG Gmart $8,000 $21,600 $12,000 $4,000 $16,000 $40,000 0 8,000 1,080 20,520 0 12,000 0 4,000 0 16,000 2,000 38,000 6,000 2,000 16,200 4,320 9,000 3,000 3,000 1,000 12,000 4,000 30,000 8,000 112 336 168 112 448 560 200 540 300 100 400 1,000 80 120 72 28 304 100 0 1,200 0 0 300 900 80 472 $1,528 240 2,436 $ 1,884 120 660 $ 2,340 80 320 $ 680 320 1,772 $ 2,228 400 2,960 $ 5,040 2. Customer level operating income based on actual order costs: Customer IHoG Revenues at list price $40 × 200; 540; 300; 100; 400; 1,000 Price discounts GRU: 5% × $21,600; Gmart: 5% × $40,000 Revenues (actual price) Cost of good sold $30 × 200; 540; 300; 100; 400; 1,000 Gross margin Customer-level operating costs: Order taking $12 × 4; $28 × 12; $12 × 6; $12 × 4; $12 × 16; $12 × 20 Product handling $1 × 200; 540; 300; 100; 400; 1,000 Delivery $1 × 80; 120; 72; 28; 304; 100 Expedited delivery $300 × 0; 4; 0; 0; 1; 3 Sales commissions $20 × 4; 12; 6; 4; 16; 20 Total customer-level operating costs Customer-level operating income GRU GM GG Gmart $8,000 $21,600 $12,000 $4,000 $16,000 $40,000 0 8,000 1,080 20,520 0 12,000 0 4,000 0 16,000 2,000 38,000 6,000 2,000 16,200 4,320 9,000 3,000 3,000 1,000 12,000 4,000 30,000 8,000 48 336 72 48 192 240 200 540 300 100 400 1,000 80 120 72 28 304 100 0 1,200 0 0 300 900 80 408 $1,592 240 2,436 $ 1,884 120 564 $ 2,436 80 256 $ 744 320 1,516 $ 2,484 400 2,640 $ 5,360 14-53 GC Comparing the answers in requirements 1 and 2, it appears that operating income is higher than expected, so the management of Glat Corporation would be very pleased with the performance of the salespeople for reducing order costs. Except for GRU, all of the customers are more profitable than originally reported. 3. Customer-level operating Customer IHoG Revenues at list price $40 × 200; 540; 300; 100; 400; 1,000 Price discounts GRU: 5% × $21,600; Gmart: 5% × $40,000 Revenues (actual price) Cost of good sold $30 × 200; 540; 300; 100; 400; 1,000 Gross margin Customer-level operating costs: Order taking $28 × 2; 12; 2; 2; 4; 10 Product handling $1 × 200; 540; 300; 100; 400; 1,000 Delivery $1 × 80; 120; 72; 28; 304; 100 Expedited delivery $300 × 0; 4; 0; 0; 1; 3 Sales commissions $20 × 2; 12; 2; 2; 4; 10 Total customer-level operating costs Customer-level operating income GRU GM GC GG Gmart $8,000 $21,600 $12,000 $4,000 $16,000 $40,000 0 8,000 1,080 20,520 0 12,000 0 4,000 0 16,000 2,000 38,000 6,000 2,000 16,200 4,320 9,000 3,000 3,000 1,000 12,000 4,000 30,000 8,000 56 336 56 56 112 280 200 540 300 100 400 1,000 80 120 72 28 304 100 0 1,200 0 0 300 900 40 376 $1,624 240 2,436 $ 1,884 40 468 $ 2,532 40 224 $ 776 80 1,196 $ 2,804 200 2,480 $ 5,520 4. The behavior of the salespeople is costing Glat Corporation $640 in profit (the difference between the incomes in requirements 2 and 3.) Although management thinks the salespeople are saving money based on the budgeted order costs, in reality they are costing the firm money by increasing the costs of orders ($936 in requirement 2 versus $896 in requirement 3) and at the same time increasing their sales commissions ($1,240 in requirement 2 versus $640 in requirement 3). This is not ethical. Glat Corporation needs to change the structure of the sales commission, possibly linking commissions to the overall units sold rather than on number of orders. They could also base commissions on total revenues, which will discourage salespeople from offering discounts unless they are needed to close the sale. A negative consequence of greater reluctance to offer discounts is that salespeople will not seek larger orders but instead focus on smaller orders that do not require discounts to be offered. This behavior will, in turn, increase ordertaking costs. 14-54 14-39 (30 min.) Cost allocation and decision-making. 1. Arizona $7,800,000 Colorado $8,500,000 Delaware $6,200,000 Florida $5,500,000 Total $28,000,000 27.8571% $2,500,000 30.3571% $4,400,000 22.14285% $1,900,000 19.64285% $ 900,000 100% $ 9,700,000 1,560,000 1,700,000 1,240,000 1,100,000 5,600,000 $ 940,000 $2,700,000 $ 660,000 $(200,000) $ 4,100,000 6. Direct costs 7. % of direct costs $5,300,000; $4,100,000; $4,300,000; $4,600,000 ÷ $18,300,000 8. Segment margin 9. Allocated headquarter costs (Row 7 × $5,600,000) 10. Operating margin after allocating headquarter costs $5,300,000 $4,100,000 $4,300,000 $4,600,000 $18,300,000 28.96174% $2,500,000 22.40437% $4,400,000 23.49726% $1,900,000 25.13661% $ 900,000 100% $9,700,000 1,621,858 1,254,645 1,315,847 1,407,650 5,600,000 $ 878,142 $3,145,355 $ 584,153 $ (507,650) $4,100,000 11. Segment margin 12. %Segment margin $2,500,000; $4,400,000; $1,900,000; $900,000 ÷ $9,700,000 13. Segment margin 14. Allocated headquarter costs (Row 12 × $5,600,000) 15. Operating income after allocating headquarter costs $2,500,000 $4,400,000 $1,900,000 $ 900,000 $9,700,000 25.77319% $2,500,000 45.36082% $4,400,000 19.58762% $1,900,000 9.27835% $ 900,000 100% $9,700,000 1,443,299 2,540,206 1,096,907 519,588 5,600,000 $1,056,701 $1,859,794 $ 803,093 $ 380,412 $4,100,000 2,000 4,000 1,500 500 8,000 1. Division revenues 2. % revenues $7,800,000; $8,500,000; $6,200,000; $5,500,000 ÷ $28,000,000 3. Segment margin 4. Allocated headquarter costs (Row 2 × $5,600,000) 5. Operating margin after allocating headquarter costs 16. Number of employees 17. % Employees 2,000; 4,000; 1,500; 500 ÷ 8,000 18. Segment margin 19. Allocated headquarter costs (Row 17 × $5,600,000) 20. Operating income 25% $2,500,000 50% $4,400,000 18.75% $1,900,000 6.25% $ 900,000 100% $9,700,000 1,400,000 $1,100,000 2,800,000 $1,600,000 1,050,000 $ 850,000 350,000 $ 550,000 5,600,000 $4,100,000 2. The Florida Division manager will prefer the number of employees allocation base because it results in the highest operating margin for the division. 3. The Arizona Division and the Delaware Division receive roughly the same percentage allocation of headquarter costs regardless of the allocation base used (Arizona range = 25%-29%; Delaware range = 18.75%-23.5%). However, the Colorado Division and the Florida Division vary widely (Colorado range = 22.4%-50%; Florida range = 6.25%25.1%). All four methods are reasonable options, but none clearly meets the cause-andeffect criterion for selecting the allocation base. If larger divisions tend to consume more of headquarter’s resources, then using division revenues or number of employees seem to 14-55 be the best choices. Without compelling reason to change, Greenbold should stay with the division revenues as the allocation base. Another alternative is to use segment margin as the allocation base on the grounds that segment margin represents the ability of different divisions to bear corporate overhead costs. 4. If Greenbold elects to use direct costs as the allocation base, the Florida Division will appear to have a $507,650 operating loss. Even so, the Florida Division generates a $900,000 segment margin before allocating the cost of the corporate headquarters. As seen in the analysis in requirement 1, different allocation bases yield different operating incomes for the Florida Division, with the direct cost allocation base being the lowest. The Florida Division should not be closed because 1) the choice of allocation base is not based on a cause-and-effect relation (i.e., it is arbitrary), and 2) the division earns positive segment margin which contributes to covering the cost of the corporate headquarters. The Florida Division should only be closed if closing it will save more than $507,650 in corporate headquarter costs – a highly unlikely scenario. 14-56 CHAPTER 15 ALLOCATION OF SUPPORT-DEPARTMENT COSTS, COMMON COSTS, AND REVENUES 15-1 The single-rate (cost-allocation) method makes no distinction between fixed costs and variable costs in the cost pool. It allocates costs in each cost pool to cost objects using the same rate per unit of the single allocation base. The dual-rate (cost-allocation) method classifies costs in each cost pool into two pools—a variable-cost pool and a fixed-cost pool—with each pool using a different cost-allocation base. 15-2 The dual-rate method provides information to division managers about cost behavior. Knowing how fixed costs and variable costs behave differently is useful in decision making. 15-3 Budgeted cost rates motivate the manager of the supplier department to improve efficiency because the supplier department bears the risk of any unfavorable cost variances. 15-4 Examples of bases used to allocate support department cost pools to operating departments include the number of employees, square feet of space, number of hours, and machine-hours. 15-5 The use of budgeted indirect cost allocation rates rather than actual indirect rates has several attractive features to the manager of a user department: a. the user knows the costs in advance and can factor them into ongoing operating choices, b. the cost allocated to a particular user department does not depend on the amount of resources used by other user departments, and c. inefficiencies at the department providing the service do not affect the costs allocated to the user department. 15-6 Disagree. Allocating costs on “the basis of estimated long-run use by user department managers” means department managers can lower their cost allocations by deliberately underestimating their long-run use (assuming all other managers do not similarly underestimate their usage). 15-7 The three methods differ in how they recognize reciprocal services among support departments: a. The direct (allocation) method ignores any services rendered by one support department to another; it allocates each support department’s costs directly to the operating departments. b. The step-down (allocation) method allocates support-department costs to other support departments and to operating departments in a sequential manner that partially recognizes the mutual services provided among all support departments. c. The reciprocal (allocation) method allocates support-department costs to operating departments by fully recognizing the mutual services provided among all support departments. 15-1 15-8 The reciprocal method is theoretically the most defensible method because it fully recognizes the mutual services provided among all departments, irrespective of whether those departments are operating or support departments. 15-9 The stand-alone cost-allocation method uses information pertaining to each user of a cost object as a separate entity to determine the cost-allocation weights. The incremental cost-allocation method ranks the individual users of a cost object in the order of users most responsible for the common costs and then uses this ranking to allocate costs among those users. The first-ranked user of the cost object is the primary user and is allocated costs up to the costs of the primary user as a stand-alone user. The second-ranked user is the first incremental user and is allocated the additional cost that arises from two users instead of only the primary user. The third-ranked user is the second incremental user and is allocated the additional cost that arises from three users instead of two users, and so on. The Shapley Value method calculates an average cost based on the costs allocated to each user as first the primary user, the second-ranked user, the third-ranked user, and so on. 15-10 All contracts with U.S. government agencies must comply with cost accounting standards issued by the Cost Accounting Standards Board (CASB). 15-11 Areas of dispute between contracting parties can be reduced by making the “rules of the game” explicit and in writing at the time the contract is signed. 15-12 Companies increasingly are selling packages of products or services for a single price. Revenue allocation is required when managers in charge of developing or marketing individual products in a bundle are evaluated using product specific revenues. 15-13 The stand-alone revenue-allocation method uses product specific information on the products in the bundle as weights for allocating the bundled revenues to the individual products. The incremental revenue allocation method ranks individual products in a bundle according to criteria determined by management—such as the product in the bundle with the most sales—and then uses this ranking to allocate bundled revenues to the individual products. The first-ranked product is the primary product in the bundle. The second-ranked product is the first incremental product, the third-ranked product is the second incremental product, and so on. 15-14 Managers typically will argue that their individual product is the prime reason why consumers buy a bundle of products. Evidence on this argument could come from the sales of the products when sold as individual products. Other pieces of evidence include surveys of users of each product and surveys of people who purchase the bundle of products. 15-15 A dispute over allocation of revenues of a bundled product could be resolved by (a) having an agreement that outlines the preferred method in the case of a dispute, or (b) having a third party (such as the company president or an independent arbitrator) make a decision. 15-2 15-16 (20 min.) Single-rate versus dual-rate methods, support department. Bases available (kilowatt hours): Rockford Peoria Practical capacity 10,000 20,000 Expected monthly usage 8,000 9,000 1a. Single-rate method based on practical capacity: Total costs in pool = $6,000 + $9,000 = $15,000 Practical capacity = 50,000 kilowatt hours Allocation rate = $15,000 ÷ 50,000 = $0.30 per hour of capacity Practical capacity in hours Costs allocated at $0.30 per hour 1b. Rockford Peoria 10,000 20,000 $3,000 $6,000 Hammond Kankakee Total 12,000 8,000 50,000 $3,600 $2,400 $15,000 Single-rate method based on expected monthly usage: Total costs in pool = $6,000 + $9,000 = $15,000 Expected usage = 30,000 kilowatt hours Allocation rate = $15,000 ÷ 30,000 = $0.50 per hour of expected usage Expected monthly usage in hours Costs allocated at $0.50 per hour 2. Hammond Kankakee Total 12,000 8,000 50,000 7,000 6,000 30,000 Variable-Cost Pool: Total costs in pool Expected usage Allocation rate Fixed-Cost Pool: Total costs in pool Practical capacity Allocation rate Rockford Peoria 8,000 9,000 $4,000 $4,500 = = = $6,000 30,000 kilowatt hours $6,000 ÷ 30,000 = $0.20 per hour of expected usage = = = $9,000 50,000 kilowatt hours $9,000 ÷ 50,000 = $0.18 per hour of capacity Rockford Variable-cost pool $0.20 × 8,000; 9,000; 7,000, 6,000 Fixed-cost pool $0.18 × 10,000; 20,000; 12,000, 8,000 Total Hammond Kankakee Total 7,000 6,000 30,000 $3,500 $3,000 $15,000 Peoria Hammond Kankakee Total $1,600 $1,800 $1,400 $1,200 $ 6,000 1,800 $3,400 3,600 $5,400 2,160 $3,560 1,440 $2,640 9,000 $15,000 The dual-rate method permits a more refined allocation of the power department costs; it permits the use of different allocation bases for different cost pools. The fixed costs result from decisions most likely associated with the practical capacity level. The variable costs result from decisions most likely associated with monthly usage. 15-3 15-17 (20–25 min.) Single-rate method, budgeted versus actual costs and quantities. 1. a. Budgeted rate = Budgeted indirect costs Budgeted trips = $115,000/50 trips = $2,300 per round-trip Indirect costs allocated to Dark C. Division = $2,300 per round-trip 30 budgeted round trips = $69,000 Indirect costs allocated to Milk C. Division trips = $2,300 per round-trip 20 budgeted round = $46,000 b. Budgeted rate = $2,300 per round-trip Indirect costs allocated to Dark C. Division = $2,300 per round-trip 30 actual round trips = $69,000 Indirect costs allocated to Milk C. Division = $2,300 per round-trip 15 actual round trips = $34,500 c. Actual rate = Actual indirect costs = $96,750/ 45 trips = $2,150 per round-trip Actual trips Indirect costs allocated to Dark C. Division = $2,150 per round-trip 30 actual round trips = $64,500 Indirect costs allocated to Milk C. Division = $2,150 per round-trip 15 actual round trips = $32,250 2. When budgeted rates/budgeted quantities are used, the Dark Chocolate and Milk Chocolate Divisions know at the start of 2009 that they will be charged a total of $69,000 and $46,000 respectively for transportation. In effect, the fleet resource becomes a fixed cost for each division. Then, each may be motivated to over-use the trucking fleet, knowing that their 2009 transportation costs will not change. When budgeted rates/actual quantities are used, the Dark Chocolate and Milk Chocolate Divisions know at the start of 2009 that they will be charged a rate of $2,300 per round trip, i.e., they know the price per unit of this resource. This enables them to make operating decisions knowing the rate they will have to pay for transportation. Each can still control its total transportation costs by minimizing the number of round trips it uses. Assuming that the budgeted rate was based on honest estimates of their annual usage, this method will also provide an estimate of the excess trucking capacity (the portion of fleet costs not charged to either division). In contrast, when 15-4 actual costs/actual quantities are used, the two divisions must wait until year-end to know their transportation charges. The use of actual costs/actual quantities makes the costs allocated to one division a function of the actual demand of other users. In 2009, the actual usage was 45 trips, which is 5 trips below the 50 trips budgeted. The Dark Chocolate Division used all the 30 trips it had budgeted. The Milk Chocolate Division used only 15 of the 20 trips budgeted. When costs are allocated based on actual costs and actual quantities, the same fixed costs are spread over fewer trips resulting in a higher rate than if the Milk Chocolate Division had used its budgeted 20 trips. As a result, the Dark Chocolate Division bears a proportionately higher share of the fixed costs. Using actual costs/actual rates also means then any efficiencies or inefficiencies of the trucking fleet get passed along to the user divisions. In general, this will have the effect of making the truck fleet less careful about its costs, although in 2009, it appears to have managed its costs well, leading to a lower actual cost per roundtrip relative to the budgeted cost per round trip. For the reasons stated above, of the three single-rate methods suggested in this problem, the budgeted rate and actual quantity may be the best one to use. (The management of Chocolat, Inc. would have to ensure that the managers of the Dark Chocolate and Milk Chocolate divisions do not systematically overestimate their budgeted use of the fleet division in an effort to drive down the budgeted rate). 15-18 (20 min.) Dual-rate method, budgeted versus actual costs, and practical capacity versus actual quantities (continuation of 15-17). 1. Charges with dual rate method. Variable indirect cost rate = $1,500 per trip Fixed indirect cost rate = = $40,000 budgeted costs/ 50 round trips budgeted $800 per trip Dark Chocolate Division Variable indirect costs, $1,500 × 30 Fixed indirect costs, $800 × 30 Milk Chocolate Division Variable indirect costs, $1,500 × 15 Fixed indirect costs, $800 × 20 $45,000 24,000 $69,000 $22,500 16,000 $38,500 2. The dual rate changes how the fixed indirect cost component is treated. By using budgeted trips made, the Dark Chocolate Division is unaffected by changes from its own budgeted usage or that of other divisions. When budgeted rates and actual trips are used for allocation (see requirement 1.b. of problem 15-17), the Dark Chocolate Division is assigned the same $24,000 for fixed costs as under the dual-rate method because it made the same number of trips as budgeted. However, note that the Milk Chocolate Division is allocated $16,000 in fixed trucking costs under the dual-rate system, compared to $800 15 actual trips = $12,000 when actual trips are used for allocation. As such, the Dark Chocolate Division is not made to appear 15-5 disproportionately more expensive than the Milk Chocolate Division simply because the latter did not make the number of trips it budgeted at the start of the year. 15-6 15-19 (30 min.) Support department cost allocation; direct and step-down methods. 1. a. b. Direct method costs Alloc. of AS costs (40/75, 35/75) Alloc. of IS costs (30/90, 60/90) Step-down (AS first) costs Alloc. of AS costs (0.25, 0.40, 0.35) Alloc. of IS costs (30/90, 60/90) AS IS $600,000 $2,400,000 GOVT CORP (600,000) $ 320,000 $ 280,000 (2,400,000) $ 0 $ 0 $600,000 $2,400,000 800,000 $1,120,000 1,600,000 $1,880,000 (600,000) $ 240,000 $ 210,000 850,000 $1,090,000 1,700,000 $1,910,000 $ 720,000 $1,440,000 448,000 $1,168,000 392,000 $1,832,000 GOVT $1,120,000 1,090,000 1,168,000 CORP $1,880,000 1,910,000 1,832,000 $ c. Step-down (IS first) costs Alloc. of IS costs (0.10, 0.30, 0.60) Alloc. of AS costs (40/75, 35/75) 0 150,000 (2,550,000) $ 0 $600,000 $2,400,000 240,000 (2,400,000) (840,000) $ 0 $ 2. Direct method Step-down (AS first) Step-down (IS first) 0 The direct method ignores any services to other support departments. The step-down method partially recognizes services to other support departments. The information systems support group (with total budget of $2,400,000) provides 10% of its services to the AS group. The AS support group (with total budget of $600,000) provides 25% of its services to the information systems support group. When the AS group is allocated first, a total of $2,550,000 is then assigned out from the IS group. Given CORP’s disproportionate (2:1) usage of the services of IS, this method then results in the highest overall allocation of costs to CORP. By contrast, GOVT’s usage of the AS group exceeds that of CORP (by a ratio of 8:7), and so GOVT is assigned relatively more in support costs when AS costs are assigned second, after they have already been incremented by the AS share of IS costs as well. 15-7 3. Three criteria that could determine the sequence in the step-down method are: a. Allocate support departments on a ranking of the percentage of their total services provided to other support departments. 1. Administrative Services 25% 2. Information Systems 10% b. Allocate support departments on a ranking of the total dollar amount in the support departments. 1. Information Systems $2,400,000 2. Administrative Services $ 600,000 c. Allocate support departments on a ranking of the dollar amounts of service provided to other support departments 1. Information Systems (0.10 $2,400,000) = $240,000 2. Administrative Services (0.25 $600,000) = $150,000 The approach in (a) above typically better approximates the theoretically preferred reciprocal method. It results in a higher percentage of support-department costs provided to other support departments being incorporated into the step-down process than does (b) or (c), above. 15-20 (50 min.) Support-department cost allocation, reciprocal method (continuation of 15-19). 1a. Support Departments AS Corp. Costs $600,000 (861,538) 261,538 $ 0 Govt. $2,400,0 00 Alloc. of AS costs (0.25, 0.40, 0.35) Alloc. of IS costs (0.10, 0.30, 0.60) Operating Departments I S 215,385 (2,615,38 5) $ 0 Reciprocal Method Computation AS = $600,000 + IS = $2,400,000 IS = $2,400,000 = $2,400,000 0.975IS = $2,550,000 $ 344,615 $ 301,538 784,616 $1,129,231 1,569,231 $1,870,769 0.10 IS + 0.25AS + 0.25 ($600,000 + 0.10 IS) + $150,000 + 0.025 IS 15-8 IS = = AS = = = $2,550,000 ÷ 0.975 $2,615,385 $600,000 + 0.10 ($2,615,385) $600,000 + $261,538 $861,538 1b. Support Departments AS Corp. $600,000 $2,400,000 Govt. Costs 1st Allocation of AS (600,000) (0.25, 0.40, 0.35) 150,000 Operating Departments I S $ 240,000 $ 210,000 2,550,000 1st Allocation of IS (0.10, 0.30, 0.60) 2nd Allocation of AS (0.25, 0.40, 0.35) 2nd Allocation of IS (0.10, 0.30, 0.60) 3rd Allocation of AS (0.25, 0.40, 0.35) 3rd Allocation of IS (0.10, 0.30, 0.60) 4th Allocation of AS (0.25, 0.40, 0.35) 4th Allocation of IS (0.10, 0.30, 0.60) 5th Allocation of AS 255,000 (2,550,000) 765,000 1,530,000 63,750 102,000 89,250 6,375 (63,750) 19,125 38,250 (6,375) 1,594 2,550 2,231 160 (1,594) 478 956 (160) 40 64 56 4 (40) 12 24 (255,000) 15-9 (0.25, 0.40, 0.35) 5th Allocation of IS (0.10, 0.30, 0.60) Total allocation (4) 1 2 1 0 (1) 0 1 $ 0 $ 0 $1,129,231 $1,870,769 2. a. b. c. d. e. Govt. Consulting $1,120,000 1,090,000 1,168,000 1,129,231 1,129,231 Direct Step-Down (AS first) Step-Down (IS first) Reciprocal (linear equations) Reciprocal (repeated iterations) Corp. Consulting $1,880,000 1,910,000 1,832,080 1,870,769 1,870,769 The four methods differ in the level of support department cost allocation across support departments. The level of reciprocal service by support departments is material. Administrative Services supplies 25% of its services to Information Systems. Information Systems supplies 10% of its services to Administrative Services. The Information Department has a budget of $2,400,000 that is 400% higher than Administrative Services. The reciprocal method recognizes all the interactions and is thus the most accurate. This is especially clear from looking at the repeated iterations calculations. 15-21 (40 min.) Direct and step-down allocation. 1. Costs Incurred Alloc. of HR costs (42/70, 28/70) Alloc. of Info. Syst. costs (1,920/3,520, 1,600/3,520) Support Departments HR Info. Systems $72,700 $234,400 Operating Departments Corporate Consumer $ 998,270 $489,860 (72,700) 43,620 29,080 127,855 $1,169,745 106,545 $625,485 $ 2. 0 $ (234,400) 0 Rank on percentage of services rendered to other support departments. Step 1: HR provides 23.077% of its services to information systems: 21 21 = = 42 28 21 91 This 23.077% of $72,700 HR department costs is $16,777. 15-10 23.077% Total $1,795,230 $1,795,230 Step 2: Information systems provides 8.333% of its services to HR: 320 = 1,920 1,600 320 320 3,840 = 8.333% This 8.333% of $234,400 information systems department costs is $19,533. Costs Incurred Alloc. of HR costs (21/91, 42/91, 28/91) Alloc. of Info. Syst. costs (1,920/3,520, 1,600/3,520) Support Departments HR Info. Systems $72,700 $234,400 (72,700) $ 0 16,777 251,177 (251,177) $ 0 Operating Departments Corporate Consumer $ 998,270 $489,860 33,554 137,006 $1,168,830 Total $1,795,23 0 22,369 114,171 $626,400 $1,795,23 0 3. An alternative ranking is based on the dollar amount of services rendered to other support departments. Using numbers from requirement 2, this approach would use the following sequence: Step 1: Allocate Information Systems first ($19533 provided to HR). Step 2: Allocate HR second ($16777 provided to Information Systems). 15-11 15-22 (30 min.) Reciprocal cost allocation (continuation of 15-21). 1. The reciprocal allocation method explicitly includes the mutual services provided among all support departments. Interdepartmental relationships are fully incorporated into the support department cost allocations. 2. HR = $72,700 + .08333IS IS = $234,400 + .23077HR HR = $72,700 + [.08333($234,400 + .23077HR)] = $72,700 + [$19,532.55 + 0.01923HR] 0.98077HR = $92,232.55 HR = $92,232.55 0.98077 = $94,041 IS = $234,400 + (0.23077 $94,041) = $256,102 Support Depts. HR Info. Systems Costs Incurred Alloc. of HR costs (21/91, 42/91, 28/91) Alloc. of Info. Syst. costs (320/3,840, 1,920/3,840, 1,600/3,840) Operating Depts. Corporate Consumer $72,700 $234,400 $ 998,270 $489,860 (94,041) 21,702 43,404 Total $1,795,23 0 28,935 21,341 $ 0 (256,102) $ 0 128,051 $1,169,725 106,710 $625,505 Solution Exhibit 15-22 presents the reciprocal method using repeated iterations. 15-12 $1,795,23 0 SOLUTION EXHIBIT 15-22 Reciprocal Method of Allocating Support Department Costs for September 2009 at E-books Using Repeated Iterations Support Departments Operating Departments Information Corporate Consumer Human Resources Systems Sales Sales Budgeted manufacturing overhead costs before any interdepartmental cost allocation $234,400 $ 998,270 $489,860 (72,700) 16,777 251,177 33,554 22,369 1st Allocation of Information Systems (320/3,840, 1,920/3,840, 1,600/3,840)b 20,931 (251,177) 125,589 104,657 2nd Allocation of HR (21/91, 42/91, 28/91)a (20,931) 4,830 9,661 6,440 (4,830) 2,415 2,013 93 185 124 1st Allocation of HR (21/91, 42/91, 28/91)a $72,700 Total 2nd Allocation of Information Systems (320/3,840, 1,920/3,840, 1,600/3,840)b 402 3rd Allocation of HR (21/91, 42/91, 28/91)a (402) 3rd Allocation of Information Systems (320/3,840, 1,920/3,840, 1,600/3,840)b 8 (93) 46 39 4th Allocation of HR (21/91, 42/91, 28/91)a (8) 2 4 2 4th Allocation of Information Systems: (320/3,840, 1,920/3,840, 1,600/3,840)b 0 $1,795,230 Total budgeted manufacturing overhead of operating departments $ (2) 0 $ 0 1 $1,169,725 1 $625,505 $1,795,230 Total accounts allocated and reallocated (the numbers in parentheses in first two columns) HR $72,700 + $20,931 + $402 + $8 = $94,041 Information Systems $251,177 + $4,830 + $93 + $2 = $256,102 aBase bBase is (21 + 42 + 28) or 91 employees is (320 + 1,920 + 1,600) or 3,840 minutes 3. The reciprocal method is more accurate than the direct and step-down methods when there are reciprocal relationships among support departments. A summary of the alternatives is: Direct method Step-down method (HR first) Reciprocal method Corporate Sales $1,169,745 1,168,830 1,169,725 Consumer Sales $625,485 626,400 625,505 The reciprocal method is the preferred method, although for September 2009 the numbers do not appear materially different across the alternatives. 15-13 15-23 1. (2030 min.) Allocation of common costs. Three methods of allocating the $55 are: Mike $37 35 40 37.50 Stand-alone Incremental (Ed primary) Incremental (Mike primary) Shapley value Ed $18 20 15 17.50 a. Stand-alone cost allocation method. Mike: $40 $40 + $20 $55 = 2 3 $55 = $37 Ed: $20 $40 + $20 $55 = 1 3 $55 = $18 b. Incremental cost allocation method. Assume Ed (the owner) is the primary user and Mike is the incremental user: User Ed Mike Total Costs Allocated Cumulative Costs Allocated $20 $55 $20 35 ($55 – $20) $55 This method may generate some dispute over the ranking. Notice that Mike pays only $35 despite his prime interest in the more expensive Internet access package. Ed could make the argument that if Mike were ranked first he would have to pay $40 since he is the major Internet user. Then, Ed would only have to pay $15! Assume Mike is the primary user and Ed is the incremental user: User Mike Ed Total Costs Allocated $40 15 ($55 – $40) $55 Cumulative Costs Allocated $40 $55 c. Shapley value (average over costs allocated as the primary and incremental user). User Mike Ed Costs Allocated ($40 + $35) 2 = $37.50 ($20 + $15) 2 = $17.50 15-14 2. I would recommend the Shapley value. It is fairer than the incremental method because it avoids considering one user as the primary user and allocating more of the common costs to that user. It also avoids disputes about who is the primary user. It allocates costs in a manner that is close to the costs allocated under the stand-alone method but takes a more comprehensive view of the common cost allocation problem by considering primary and incremental users that the stand-alone method ignores. More generally, other criteria to guide common cost allocations include the following: a. Cause and effect. It is not possible to trace individual causes (either Internet access or phone services) to individual effects (uses by Mike or Ed). The $55 total package is a bundled product. b. Benefits received. There are various ways of operationalizing the benefits received: (i) Monthly service charge for their prime interest––Internet access for Mike ($40), and phone services for Ed ($20). This measure captures the services available to each person. (ii) Actual usage by each person. This would involve keeping a record of usage by each person and then allocating the $55 on a percent usage time basis. This measure captures the services actually used by each person, but it may prove burdensome and it would be subject to honest reporting by Ed and Mike. c. Ability to pay. This criterion requires that Mike and Ed agree upon their relative ability to pay. d. Fairness or equity. This criterion is relatively nebulous. A straightforward approach would be to split the $55 equally among the two users. 15-15 15-24 (20 min.) Allocation of common costs. 1. Alternative approaches for the allocation of the $1,800 airfare include the following: a. The stand-alone cost allocation method. This method would allocate the air fare on the basis of each client’s percentage of the total of the individual stand-alone costs. Baltimore client $1, 400 $1,800 = $1,008 $1, 400 $1,100 Chicago client $1,100 $1,800 = $1, 400 $1,100 792 $1,800 Advocates of this method often emphasize an equity or fairness rationale. b. The incremental cost allocation method. This requires the choice of a primary party and an incremental party. If the Baltimore client is the primary party, the allocation would be: Baltimore client Chicago client $1,400 400 $1,800 One rationale is that Gunn was planning to make the Baltimore trip, and the Chicago stop was added subsequently. Some students have suggested allocating as much as possible to the Baltimore client since Gunn had decided not to work for them. If the Chicago client is the primary party, the allocation would be: Chicago client Baltimore client $1,100 700 $1,800 One rationale is that the Chicago client is the one who is going to use Gunn’s services, and presumably receives more benefits from the travel expenditures. c. Gunn could calculate the Shapley value that considers each client in turn as the primary party: The Baltimore client is allocated $1,400 as the primary party and $700 as the incremental party for an average of ($1,400 + $700) ÷ 2 = $1,050. The Chicago client is allocated $1,100 as the primary party and $400 as the incremental party for an average of ($1,100 + 400) ÷ 2 = $750. The Shapley value approach would allocate $1,050 to the Baltimore client and $750 to the Chicago client. 15-16 2. I would recommend Gunn use the Shapley value. It is fairer than the incremental method because it avoids considering one party as the primary party and allocating more of the common costs to that party. It also avoids disputes about who is the primary party. It allocates costs in a manner that is close to the costs allocated under the stand-alone method but takes a more comprehensive view of the common cost allocation problem by considering primary and incremental users, which the stand-alone method ignores. The Shapley value (or the stand-alone cost allocation method) would be the preferred methods if Gunn was to send the travel expenses to the Baltimore and Chicago clients before deciding which engagement to accept. Other factors such as whether to charge the Chicago client more because Gunn is accepting the Chicago engagement or the Baltimore client more because Gunn is not going to work for them can be considered if Gunn sends in her travel expenses after making her decision. However, each company would not want to be considered as the primary party and so is likely to object to these arguments. 3. A simple approach is to split the $60 equally between the two clients. The limousine costs at the Sacramento end are not a function of distance traveled on the plane. An alternative approach is to add the $60 to the $1,800 and repeat requirement 1: a. Stand-alone cost allocation method. $1, 460 Baltimore client $1,860 = $1,036 $1, 460 $1,160 Chicago client $1,160 $1,860 = $ 824 $1, 460 $1,160 b. Incremental cost allocation method. With Baltimore client as the primary party: Baltimore client $1,460 Chicago client 400 $1,860 With Chicago client as the primary party: Chicago client $1,160 Baltimore client 700 $1,860 c. Shapley value. Baltimore client: Chicago client: ($1,460 + $700) ÷ 2 = $1,080 ($400 + $1,160) ÷ 2 = $ 780 As discussed in requirement 2, the Shapley value or the stand-alone cost allocation method would probably be the preferred approaches. Note: If any students in the class have faced this situation when visiting prospective employers, ask them how they handled it. 15-17 15-25 (20 min.) Revenue allocation, bundled products. 1a. Under the stand alone revenue-allocation method based on selling price, Monaco will be allocated 40% of all revenues, or $72 of the bundled selling price, and Innocence will be allocated 60% of all revenues, or $108 of the bundled selling price, as shown below. Stand-alone method, based on selling prices Selling price Selling price as a % of total ($80 $200; $120 $200) Allocation of $180 bundled selling price (40% $180; 60% $180) Monaco Innocence $80 $120 Total $200 40% 60% 100% $72 $108 $180 1b. Under the incremental revenue-allocation method, with Monaco ranked as the primary product, Monaco will be allocated $80 (its own stand-alone selling price) and Innocence will be allocated $100 of the $180 selling price, as shown below. Incremental Method (Monaco rank 1) Selling price Allocation of $180 bundled selling price ($80; $100 = $180 – $80) Monaco Innocence $80 $120 $80 $100 1c. Under the incremental revenue-allocation method, with Innocence ranked as the primary product, Innocence will be allocated $120 (its own stand-alone selling price) and Monaco will be allocated $60 of the $180 selling price, as shown below. Incremental Method (Innocence rank 1) Selling price Allocation of $180 bundled selling price ($60 = $180 – $120; $120) Monaco Innocence $80 $120 $60 $120 1d. Under the Shapley value method, each product will be allocated the average of its allocations in 1b and 1c, i.e., the average of its allocations when it is the primary product and when it is the secondary product, as shown below. Shapley Value Method Allocation when Monaco = Rank 1; Innocence = Rank 2 (from 1b.) Allocation when Innocence = Rank 1; Monaco = Rank 2 (from 1c.) Average of allocated selling price ($80 + $60) 2; ($100 + $120) 2 15-18 Monaco Innocence $80 $100 $60 $120 $70 $110 2. A summary of the allocations based on the four methods in requirement 1 is shown below. Stand-alone (Selling Prices) Monaco $ 72 Innocence 108 Total for L’Amour $180 Incremental (Monaco first) $ 80 100 $180 Incremental (Innocence first) $ 60 120 $180 Shapley $ 70 110 $180 If there is no clear indication of which product is the more “important” product, or, if it can be reasonably assumed that the two products are equally important to the company's strategy, the Shapley value method is the fairest of all the methods because it averages the effect of product rank. In this particular case, note that the allocations from the stand-alone method based on selling price are reasonably similar to the allocations from the Shapley value method, so the managers at Yves may well want to use the much simpler stand-alone method. The stand-alone method also does not require ranking the products in the suite, and so it is less likely to cause debates among product managers in the Men's and Women's Fragrance divisions. If, however, one of the products (Monaco or Innocence) is clearly the product that is driving sales of the bundled product, then that product should be considered as the primary product. 15-26 (10-15 min. ) Allocation of Common Costs 1. a. Stand-alone method (costs are in thousands): City Albany Troy Schenectady Separate Cost $2,100 1,400 3,500 $7,000 Percentage $2,100 ÷ $7,000=0.3 $1,400 ÷ $7,000=0.2 $3,500 ÷ $7,000=0.5 Joint Cost $5,000 5,000 5,000 Allocation $1,500 1,000 2,500 $5,000 1. b. Incremental method (cities ranked in order of most waste to least waste): Schenectady Albany Troy Allocated Cost $3,500 1,500 0 Cost Remaining to Allocate $1,500 ($5,000 ─ $3,500) 0 ($1,500 ─ $1,500) 0 2. In this situation, the stand-alone method is the better method because the weights it uses for allocation are based on the cost for each user as a separate entity. The citizens of Schenectady would not consider the incremental method fair because they would be subsidizing the other cities (especially Troy). Albany is indifferent across the two methods; its citizens save $600,000 over the stand-alone cost in either case. While the citizens of Troy would clearly prefer the incremental allocation method and might seek to justify it because they generate the least amount of waste, they should understand that citizens of the other cities would believe it is not fair. 15-19 15-27 (20 min.) Single-rate, dual-rate, and practical capacity allocation. Budgeted number of gifts wrapped = 6,750 Budgeted fixed costs = $6,750 Fixed cost per gift based on budgeted volume = $6,750 ÷ 6,750 = $1.00 Average budgeted variable cost per gift = 0.50 Total cost per gift wrapped $1.50 1.a. Allocation budgeted usage of gift-wrapping services: Women’s Face Wash (2,475 × $1.50) Men’s Face Wash (825 × $1.50) Fragrances (1,800 × $1.50) Body Wash (450 × $1.50) based on based on $ 3,712.50 1,237.50 2,700.00 675.00 1,800.00 $10,125.00 Hair Products (1,200 × $1.50) Total 1.b. Allocation actual usage of gift-wrapping services: Women’s Face Wash (2,100 × $1.50) Men’s Face Wash (750 × $1.50) Fragrances (1,575 × $1.50) Body Wash (525 × $1.50) Hair Products (1,050 × $1.50) Total $3,150.00 1,125.00 2,362.50 787.50 1,575.00 $9,000.00 1.c. Practical gift-wrapping capacity = 7,500 Budgeted fixed costs = $6,750 Fixed cost per gift based on practical capacity = $6,750 ÷ 7,500 = $0.90 Average budgeted variable cost per gift = 0.50 Total cost per gift wrapped $1.40 Allocation based on actual usage of gift-wrapping services: Women’s Face Wash (2,100 × $1.40) Men’s Face Wash (750 × $1.40) Fragrances (1,575 × $1.40) Body Wash (525 × $1.40) 735 Hair Products (1,050 × $1.40) 1,470 Total $8,400 15-20 $2,940 1,050 2,205 2. Budgeted rate for fixed costs = Budgeted fixed costs Practical capacity =$6,750 ÷ 7,500 gifts = $0.90 per gift Fixed costs allocated on budgeted usage. Rate for variable costs = $0.50 per item Variable costs based on actual usage. Allocation: Department Women’s Face Wash Men’s Face Wash Fragrances Body Wash Hair Products Total 3. Variable Costs 2,100 × $0.50 =$1,050.00 750 × $0.50 = 375.00 1,575 × $0.50 = 787.50 525 × $0.50 = 262.50 1,050 × $0.50 = 525.00 $3,000.00 Fixed Costs 2,475 × $0.90 = $2,227.50 825 × $0.90 = 742.50 1,800 × $0.90 = 1,620.00 450 × $0.90 = 405.00 1,200 × $0.90 = 1,080.00 $6,075.00 Total $3,277.50 1,117.50 2,407.50 667.50 1,605.00 $9,075.00 The dual-rate method has two major advantages over the single-rate method: a. Fixed costs and variable costs can be allocated differently—fixed costs based on rates calculated using practical capacity and budgeted usage and variable costs based on budgeted rates and actual usage. b. Fixed costs are allocated proportionately to the departments causing the incurrence of those costs based on the capacity of each department. c. The costs allocated to a department are not affected by the usage by other departments. Note: If capacity costs are the result of a long-term decision by top management, it may be desirable to allocate to each department the cost of capacity used based on actual usage. The users are then not allocated the costs of unused capacity. 15-21 15-28 (20 min.) Revenue allocation 1. a. Stand-alone method for the BegM + RCC package DVD BegM RCC Separate Revenue $ 60 40 $100 Joint Percentage Revenue $60 ÷ $100=0.6 $90 $40 ÷ $100=0.4 90 Allocation $54 36 $90 1. b. Incremental method BegM RCC Allocated Revenue (BegM first) $60 30 Revenue Remaining To Allocate $30 ($90 ─ $60) RCC BegM Allocated Revenue (RCC first) $40 50 Revenue Remaining To Allocate $50 ($90 ─ $40) i) ii) 1. c. Shapley method. (assuming each DVD is demanded in equal proportion) i) BegM ii) RCC ($60 + $50) ÷ 2 = $55 ($30 + $40) ÷ 2 = $35 2. a. Stand-alone method for the ConM + RCC package DVD ConM RCC Separate Revenue $50 40 $90 Joint Percentage Revenue $50 ÷ $90=0.556 $72 $40 ÷ $90=0.444 72 2. b. Incremental method ConM RCC Allocated Revenue (ConM first) $50 22 Revenue Remaining To Allocate $22 ($72 ─ $50) RCC ConM Allocated Revenue (RCC first) $40 32 Revenue Remaining To Allocate $32 ($72 ─ $40) i) ii) 15-22 Allocation $40 32 $72 2. c. Shapley method. (assuming each DVD is demanded in equal proportion) i) BegM ii) RCC 3. (50+32) ÷ 2 = 41 (22+40) ÷ 2 = 31 For each DVD package, the stand-alone method and the Shapley method give approximately the same allocation to each DVD. These methods are fair if the demand for the DVDs are approximately equal. The stand-alone method might be slightly preferable here since it is simpler and easier to explain. The incremental method would be appropriate if one DVD has a higher level of demand than the other DVD. In this situation, the dominant DVD would be sold anyway so it should receive its stand-alone revenue, and the other DVD should receive the remainder. 15-23 15-29 (20 min.) 1. Fixed cost allocation i) Allocation using actual usage. Restaurant A B C Total Actual Usage 1,500 1,400 1,300 4,200 Percentage of Total Usage 0.357 0.333 0.310 Allocation % × 10,000 $ 3,570 3,330 3,100 $10,000 ii) Allocation using planned usage. Restaurant A B C Total Planned Usage 1,600 1,300 1,100 4,000 Percentage of Total Planned Usage 0.400 0.325 0.275 Allocation % × 10,000 $ 4,000 3,250 2,750 $10,000 iii) Allocation using practical capacity. Restaurant A B C Total Practical Capacity 2,000 1,500 1,500 5,000 Percentage of Total Practical Capacity 0.400 0.300 0.300 Allocation % × 10,000 $ 4,000 3,000 3,000 $10,000 2. If the practical capacity refers to the number of parking spots that are earmarked or reserved for each of the restaurants, then it would appear to be the most appropriate basis for allocating the $10,000 common cost. This ratio is a stable benchmark and does not fluctuate based on variations in either the actual or planned monthly usage of spots for each of the restaurants, which is an issue with each of the other two methods. Moreover, the practical capacity taken by each restaurant presumably reflects the restaurant’s expectation of the long-run usage of the parking facility by its patrons. The cost of any unused capacity then highlights the extent to which these expectations are not met, and might lead to the restaurant settling for a smaller parking facility in the future. Of course, if it is ever the case that the expected or actual usage for any restaurant exceeds the practical capacity that it has “booked,” it would need to suitably compensate the other restaurants for the portion of their parking capacity it has appropriated. 15-24 15-30 (45 min.) Allocating costs of support departments; step-down and direct methods. 1. Step-down Method: (1) Building & grounds at $0.10/sq.ft. ($10,000 ÷ 100,000) (2) Personnel at $6/employee ($1,200 ÷ 200) (3) General plant administration at $1/labor-hour ($27,000 ÷ 27,000) (4) Cafeteria at $20/empoloyee ($3,100 ÷ 155) (5) Storeroom at $1.50/requisition ($4,500 ÷ 3,000) (6) Costs allocated to operating depts. (7) Divide (6) by dir. manuf. labor-hrs. (8) Overhead rate per direct manuf. labor-hour 2. Direct method: (1) Building & grounds, 30,000/80,000; 50,000/80,000 (2) Personnel, 50/150; 100/150 (3) General plant administration, 8,000/25,000; 17,000/25,000 (4) Cafeteria, 50/150; 100/150 (5) Storeroom: 2,000/3,000; 1,000/3,000 (6) Costs allocated to operating depts. (7) Divide (6) by direct manufacturing labor-hours (8) Overhead rate per direct manufacturing labor-hour Building & Grounds $ 10,000 $(10,000) Personnel $ 1,000 General Plant Admin. $ 26,090 200 Cafeteria Operating Loss $ 1,640 Storeroom $ 2,670 Machining $34,700 Assembly $48,900 700 700 3,000 5,000 210 60 30 300 600 1,000 1,000 8,000 17,000 100 1,000 2,000 3,000 $50,000 ÷ 5,000 1,500 $75,000 ÷15,000 $ $(1,200) 400 $ $(27,000) $(3,100) $(4,500) $10,000 $1,000 $26,090 $1,640 $2,670 10 5 (1,640) (2,670) 17,741 1,093 1,780 $49,459 890 $75,541 ÷ 5,000 (26,090) 6,250 667 8,349 547 (1,000) $48,900 3,750 333 (10,000) $34,700 ÷15,000 $ 9.892 15-25 $ 5.036 3. Comparison of Methods: Step-down method: Job 88: Job 89: Direct method: Job 88: Job 89: 18 × $10 2×$ 5 3 × $10 17 × $ 5 18 × $9.892 2 × $5.036 3 × $9.892 17 × $5.036 $180 10 $ 30 85 $178.06 10.07 $ 29.68 85.61 $190.00 115.00 $188.13 115.29 4. The manager of Machining Department would prefer the direct method. The direct method results in a lower amount of support departments’ costs being allocated to the Machining Department than the step-down method. This is clear from a comparison of the overhead rate, per direct manufacturing labor-hour, for the Machining Department under the two methods. 15-26 15-31 (40–60 min.) Support-department cost allocations; single-department cost pools; direct, step-down, and reciprocal methods. All the following computations are in dollars. 1. Direct method: To X A 250/400 $100,000 = $62,500 150/400 $100,000 =$37,500 B 100/500 $ 40,000 = 8,000 400/500 $ 40,000 = 32,000 Total $70,500 To Y $69,500 Step-down method, allocating A first: A $100,000 (100,000) — $ 0 X — $50,000 12,000 $62,000 Y — $30,000 48,000 $78,000 A B X Costs to be allocated $100,000$ 40,000 — Allocate B: (500; 100; 400 ÷ 1,000) 20,000 (40,000) $ 4,000 Allocate A: (250/400, 150/400) (120,000) — 75,000 Total $ 0 $ 0 $79,000 Y — $16,000 45,000 $61,000 Costs to be allocated Allocate A: (100; 250; 150 ÷ 500) Allocate B: (100; 400 ÷ 500) Total B $40,000 20,000 (60,000) $ 0 Step-down method, allocating B first: Note that these methods produce significantly different results, so the choice of method may frequently make a difference in the budgeted department overhead rates. Reciprocal method: Stage 1: Let (1) (2) A B A B = total costs of materials-handling department = total costs of power-generating department = $100,000 + 0.5B = $ 40,000 + 0.2A Stage 2: Substituting in (1): Substituting in (2): A A 0.9A A B B = = = = $100,000 + 0.5($40,000 + 0.2A) $100,000 + $20,000 + 0.1A $120,000 $133,333 = $40,000 + 0.2($133,333) = $66,666 Stage 3: Original amounts A $100,000 B $40,000 15-27 X — Y — Allocation of A Allocation of B 26,666(40%) Totals accounted for (133,333) $66,667(50%) 33,333(50%) 26,666(20%) $40,000(30%) (66,666) $ $ 0 15-28 0 6,667(10%) $73,334 $66,666 SOLUTION EXHIBIT 15-31 Reciprocal Method of Allocating Support Department Costs for Manes Company Using Repeated Iterations. Operating Departments X Y Support Departments A B Budgeted manufacturing overhead costs before any interdepartmental cost allocations 1st Allocation of Dept. A: (2/10, 5/10, 3/10)a 1st Allocation of Dept. B (5/10, 1/10, 4/10)b 2nd Allocation of Dept. A (2/10, 5/10, 3/10)a 2nd Allocation of Dept B: (5/10, 1/10, 4/10)b 3rd Allocation of Dept A: (2/10, 5/10, 3/10)a 3rd Allocation of Dept. B: (5/10, 1/10, 4/10)b 4th Allocation of Dept. A (2/10, 5/10, 3/10)a 4th Allocation of Dept. B (5/10, 1/10, 4/10)b 5th Allocation of Dept A (2/10, 5/10, 3/10) 5th Allocation of Dept B (5/10, 1/10, 4/10) 6th Allocation of Dept A (2/10, 5/10, 3/10) Total budgeted manufacturing overhead of operating departments $100,000 (100,000) $40,000 20 ,000 60 ,000 $50,000 $30,000 30,000 (60,000) 6,000 24,000 (30,000) 6,000 15,000 9,000 3,000 (6,000) 600 2,400 1,500 900 (3,000) 600 300 60 240 (300) 60 150 90 30 (60) 6 24 (30) 6 15 9 3 (6) 1 2 (3) $ (600) 0 2 1 0 $73,334 $66,666 0 $ Total accounts allocated and reallocated (the numbers in parentheses in first two columns) Dept A; Materials Handling: $100,000 + $30,000 + $3,000 + $300 + $30 + $3 = $133,333 Dept B; Power Generation: $60,000 + $6,000 + $600 + $60 + $6 = $66,666 aBase bBase is (100 + 250 +150) or 500 labor-hours; 100 ÷ 500 = 2/10, 250 ÷ 500 = 5/10, 150 ÷ 500 = 3/10. is (500 + 100 + 400) or 1,000 kWh ; 500 ÷ 1,000 = 5/10, 100 ÷ 1,000 = 1/10, 400 ÷ 1,000 = 4/10. Comparison of methods: Method of Allocation Direct method Step-down: A first Step-down: B first Reciprocal method X $70,500 62,000 79,000 73,334 Y $69,500 78,000 61,000 66,666 Note that in this case the direct method produces answers that are the closest to the “correct” answers (that is, those from the reciprocal method), step-down allocating B first is next, and stepdown allocating A first is least accurate. 15-29 2. At first glance, it appears that the cost of power is $40 per unit plus the material handling costs. If so, Manes would be better off by purchasing from the power company. However, the decision should be influenced by the effects of the interdependencies and the fixed costs. Note that the power needs would be less (students frequently miss this) if they were purchased from the outside: X Y A (500 units minus 20% of 500 units, because there is no need to service the nonexistent power department) Total units Outside Power Units Needed Needed 100 400 400 900 Total costs, 900 $40 = $36,000 In contrast, the total costs that would be saved by not producing the power inside would depend on the effects of the decision on various costs: Avoidable Costs of 1,000 Units of Power Produced Inside Variable indirect labor and indirect material costs Supervision in power department Materials handling, 20% of $70,000* Probable minimum cost savings Possible additional savings: a. Can any supervision in materials handling be saved because of overseeing less volume? Minimum savings is probably zero; the maximum is probably 20% of $10,000 or $2,000. b. Is any depreciation a truly variable, wear-and-tear type of cost? Total savings by not producing 1,000 units of power $10,000 10,000 14,000 $34,000 ? ? ______ $34,000 + ? * Materials handling costs are higher because the power department uses 20% of materials handling. Therefore, materials-handling costs will decrease by 20%. In the short run (at least until a capital investment in equipment is necessary), the data suggest continuing to produce internally because the costs eliminated would probably be less than the comparable purchase costs. 15-30 15-32 (25 min.) Common costs. 1. Stand-alone cost-allocation method. 2. (900 $40) (1,500 $32) (900 $40) (600 $40) $36, 000 $48, 000 = $28,800 ($36, 000 $24, 000) = (600 $40) (1,500 $32) (900 $40) (600 $40) = Brown, Inc. = = Wright, Inc. $24, 000 $48, 000 = $19,200 ($36, 000 $24, 000) With Wright, Inc. as the primary party: Party Wright Brown Total Costs Allocated $36,000 12,000 ($48,000 – $36,000) $48,000 Cumulative Costs Allocated $36,000 $48,000 With Brown, Inc. as the primary party: Party Brown Wright Total Costs Allocated $24,000 24,000 ($48,000 – $24,000) $48,000 15-31 Cumulative Costs Allocated $24,000 $48,000 3. To use the Shapley value method, consider each party as first the primary party and then the incremental party. Compute the average of the two to determine the allocation. Wright, Inc.: Allocation as the primary party Allocation as the incremental party Total Allocation ($60,000 ÷ 2) $36,000 24,000 $60,000 $30,000 Brown, Inc.: Allocation as the primary party Allocation as the incremental party Total Allocation ($36,000 ÷ 2) $24,000 12,000 $36,000 $18,000 Using this approach, Wright, Inc. is allocated $30,000 and Brown, Inc. is allocated $18,000 of the total costs of $48,000. 4. The results of the four cost-allocation methods are shown below. Stand-alone method Incremental (Wright primary) Incremental (Brown primary) Shapley value Wright, Inc. $28,800 36,000 24,000 30,000 Brown, Inc. $19,200 12,000 24,000 18,000 The allocations are very sensitive to the method used. The stand-alone method is simple and fair since it allocates the common cost of the dyeing machine in proportion to the individual costs of leasing the machine. The Shapley values are also fair. They result in very similar allocations and any one of them can be chosen. In this case, the stand-alone method is likely more acceptable. If they used the incremental cost-allocation method, Wright, Inc. and Brown, Inc. would probably have disputes over who is the primary party because the primary party gets allocated all of the primary party’s costs. 15-32 15-33 (20-25 mins.) Stand alone revenue allocation 1. Allocation using ticket sales price Park Water Superhero Theme Animal Total Ticket Price $ 40 60 20 $120 Percentage of Total Price 0.333 0.500 0.167 Allocation % × $90 $30 45 15 $90 2. Allocation using cost per entrant Park Water Superhero Theme Animal Total Cost Per Entrant $15 25 10 $50 Percentage of Total Cost 0.300 0.500 0.200 Allocation % × $90 $27 45 18 $90 3. Allocation using # of tickets received Park Water Superhero Theme Animal Total # of Tickets Received 1 1 1 3 Percentage of Total Price 0.333 0.333 0.333 Allocation % × $90 $30 30 30 $90 4. Sharing on the basis of revenue makes the most sense, especially if the ticket price is somewhat a surrogate for demand. One could argue that since each ticket gives the entrant one full day in each park, then an entrant’s willingness to pay more for a particular park reflects the additional value placed on that park. Also, it would be hard to justify the Animal park receiving almost its full ticket price using the cost basis and more than its ticket price using the # of tickets basis. 15-33 15-34 15-34 (10-15 min.) Effect of demand (continuation of 15-33) 15-33 33) 1. If the Water park receives its full ticket price of $40, then the remaining proceeds from the sale of the three day ticket, $90 – 40 = $50, would be divided between the two remaining parks. Using ticket price as the basis of allocation, each park would receive: Park Superhero Theme Animal Total Ticket Price $60 20 $80 Percentage of Total Price 0.750 0.250 Allocation % × $50 $37.50 12.50 $50.00 The same process would be used for the other two allocation bases. Under the cost basis, the 25 Superhero Theme park receives ×$50 = $35.71, while Animal park gets the other $14.29. 25+10 If revenue is assigned based on the number of tickets received, then the Superhero Theme and Animal Parks would each receive $25. 2. If the Superhero Theme park also demanded its full ticket price then it would want to receive $60. The two parks, Water and Superhero Theme, would then receive a combined amount of $40 + 60 = $100. Since the three-day ticket sells for only $90, this would not be possible. In addition, the Animal park director would not be pleased because he would incur a $10 cost for each entrant but receive no proceeds from the ticket. 3. If both the Water and the Superhero Theme parks are really operating at capacity then Funland is losing money by selling the three-day ticket for $90. Kent Clark should either raise the price or decide not to sell the three-day ticket. Alternatively, if he wishes to persist with the current arrangement, he should use a more sophisticated arrangement for allocating revenue, such as the Shapley method or even the weighted Shapley method. In the latter case, Kent could assign the number of months each park is considered the primary park as the weighting scheme. For example, while the Water Park may drive sales of the three-day ticket during summer months, customers may be more interested in one of the other parks during cooler periods. 15-34 Collaborative Learning Problem 15-35 (20–25 min.) Revenue allocation, bundled products. 1.a. The stand-alone revenues (using unit selling prices) of the three components of the $1,000 package are: Lodging $400.00 × 2 = $ 800 Recreation $187.50 × 2 = 375 Food $100.00 × 2 = 200 $1,375 Lodging $800 $1,000 0.582 $1,000 $582 $1,375 Recreation $375 $1,000 0.273 $1,000 $273 $1,375 Food $200 $1,000 0.145 $1,000 $145 $1,375 b. Product Recreation Lodging Food Revenue Allocated $ 375 625 ($1,000 – $375) 0 $1,000 15-35 Cumulative Revenue Allocated $ 375 $1,000 $1,000 2. The pros of the stand-alone-revenue-allocation method include the following: a. Each item in the bundle receives a positive weight, which means the resulting allocations are more likely to be accepted by all parties than a method allocating zero revenues to one or more products. b. It uses market-based evidence (unit selling prices) to decide the revenue allocations—unit prices are one indicator of benefits received . c. It is simple to implement. The cons of the stand-alone revenue-allocation method include: a. It ignores the relative importance of the individual components in attracting consumers to purchase the bundle. b. It ignores the opportunity cost of the individual components in the bundle. The golf course operates at 100% capacity. Getaway participants must reserve a golf booking one week in advance, or else they are not guaranteed playing time. A getaway participant who does not use the golf option may not displace anyone. Thus, under the stand-alone method, the golf course may be paid twice—once from the non-getaway person who does play and second from an allocation of the $1,000 package amount for the getaway person who does not play (either did not want to play or wanted to play but made a booking too late, or failed to show). c. The weight can be artificially inflated by individual product managers setting “high” list unit prices and then being willing to frequently discount these prices. The use of actual unit prices or actual revenues per product in the stand-alone formula will reduce this problem. d. The weights may change frequently if unit prices are constantly changing. This is not so much a criticism as a reflection that the marketplace may be highly competitive. The pros of the incremental method include: a. It has the potential to reflect that some products in the bundle are more highly valued than others. Not all products in the bundle have a similar “write-down” from unit list prices. Ensuring this “potential pro” becomes an “actual pro” requires that the choice of the primary product be guided by reliable evidence on consumer preferences. This is not an easy task. b. Once the sequence is chosen, it is straightforward to implement. The cons of the incremental method include: a. Obtaining the rankings can be highly contentious and place managers in a “no-win” acrimonious debate. The revenue allocations can be sensitive to the chosen rankings. b. Some products will have zero revenues assigned to them. Consider the Food division. It would incur the costs for the two dinners but receive no revenue. 15-36 CHAPTER 16 COST ALLOCATION: JOINT PRODUCTS AND BYPRODUCTS 16-1 Exhibit 16-1 presents many examples of joint products from four different general industries. These include: Industry Separable Products at the Splitoff Point Food Processing: • Lamb • Lamb cuts, tripe, hides, bones, fat • Turkey • Breasts, wings, thighs, poultry meal Extractive: • Petroleum • Crude oil, natural gas 16-2 A joint cost is a cost of a production process that yields multiple products simultaneously. A separable cost is a cost incurred beyond the splitoff point that is assignable to each of the specific products identified at the splitoff point. 16-3 The distinction between a joint product and a byproduct is based on relative sales value. A joint product is a product from a joint production process (a process that yields two or more products) that has a relatively high total sales value. A byproduct is a product that has a relatively low total sales value compared to the total sales value of the joint (or main) products. 16-4 A product is any output that has a positive sales value (or an output that enables a company to avoid incurring costs). In some joint-cost settings, outputs can occur that do not have a positive sales value. The offshore processing of hydrocarbons yields water that is recycled back into the ocean as well as yielding oil and gas. The processing of mineral ore to yield gold and silver also yields dirt as an output, which is recycled back into the ground. 16-5 1. 2. 3. 4. 5. 6. The chapter lists the following six reasons for allocating joint costs: Computation of inventoriable costs and cost of goods sold for financial accounting purposes and reports for income tax authorities. Computation of inventoriable costs and cost of goods sold for internal reporting purposes. Cost reimbursement under contracts when only a portion of a business's products or services is sold or delivered under cost-plus contracts. Insurance settlement computations for damage claims made on the basis of cost information of joint products or byproducts. Rate regulation when one or more of the jointly-produced products or services are subject to price regulation. Litigation in which costs of joint products are key inputs. 16-6 The joint production process yields individual products that are either sold this period or held as inventory to be sold in subsequent periods. Hence, the joint costs need to be allocated between total production rather than just those sold this period. 16-7 This situation can occur when a production process yields separable outputs at the splitoff point that do not have selling prices available until further processing. The result is that selling prices are not available at the splitoff point to use the sales value at splitoff method. Examples include processing in integrated pulp and paper companies and in petro-chemical operations. 16-1 16-8 Both methods use market selling-price data in allocating joint costs, but they differ in which sales-price data they use. The sales value at splitoff method allocates joint costs to joint products on the basis of the relative total sales value at the splitoff point of the total production of these products during the accounting period. The net realizable value method allocates joint costs to joint products on the basis of the relative net realizable value (the final sales value minus the separable costs of production and marketing) of the total production of the joint products during the accounting period. 16-9 Limitations of the physical measure method of joint-cost allocation include: a. The physical weights used for allocating joint costs may have no relationship to the revenue-producing power of the individual products. b. The joint products may not have a common physical denominator––for example, one may be a liquid while another a solid with no readily available conversion factor. 16-10 The NRV method can be simplified by assuming (a) a standard set of post-splitoff point processing steps, and (b) a standard set of selling prices. The use of (a) and (b) achieves the same benefits that the use of standard costs does in costing systems. 16-11 The constant gross-margin percentage NRV method takes account of the post-splitoff point “profit” contribution earned on individual products, as well as joint costs, when making cost assignments to joint products. In contrast, the sales value at splitoff point and the NRV methods allocate only the joint costs to the individual products. 16-12 No. Any method used to allocate joint costs to individual products that is applicable to the problem of joint product-cost allocation should not be used for management decisions regarding whether a product should be sold or processed further. When a product is an inherent result of a joint process, the decision to process further should not be influenced by either the size of the total joint costs or by the portion of the joint costs assigned to particular products. Joint costs are irrelevant for these decisions. The only relevant items for these decisions are the incremental revenue and the incremental costs beyond the splitoff point. 16-13 No. The only relevant items are incremental revenues and incremental costs when making decisions about selling products at the splitoff point or processing them further. Separable costs are not always identical to incremental costs. Separable costs are costs incurred beyond the splitoff point that are assignable to individual products. Some separable costs may not be incremental costs in a specific setting (e.g., allocated manufacturing overhead for postsplitoff processing that includes depreciation). 16-14 Two methods to account for byproducts are: a. Production method—recognizes byproducts in the financial statements at the time production is completed. b. Sales method—delays recognition of byproducts until the time of sale. 16-15 The sales byproduct method enables a manager to time the sale of byproducts to affect reported operating income. A manager who was below the targeted operating income could adopt a “fire-sale” approach to selling byproducts so that the reported operating income exceeds the target. This illustrates one dysfunctional aspect of the sales method for byproducts. 16-2 16-16 (20-30 min.) Joint-cost allocation, insurance settlement. 1. (a) Breasts Wings Thighs Bones Feathers Sales value at splitoff method: Pounds of Product 100 20 40 80 10 250 Wholesale Sales Selling Price Value per Pound at Splitoff $0.55 $55.00 0.20 4.00 0.35 14.00 0.10 8.00 0.05 0.50 $81.50 Weighting: Sales Value at Splitoff 0.675 0.049 0.172 0.098 0.006 1.000 Joint Costs Allocated $33.75 2.45 8.60 4.90 0.30 $50.00 Allocated Costs per Pound 0.3375 0.1225 0.2150 0.0613 0.0300 Costs of Destroyed Product Breasts: $0.3375 per pound 40 pounds = $13.50 Wings: $0.1225 per pound 15 pounds = 1.84 $15.34 b. Physical measure method: Pounds of Product Breasts Wings Thighs Bones Feathers 100 20 40 80 10 250 Weighting: Physical Measures 0.400 0.080 0.160 0.320 0.040 1.000 Joint Costs Allocated $20.00 4.00 8.00 16.00 2.00 $50.00 Costs of Destroyed Product Breast: $0.20 per pound 40 pounds Wings: $0.20 per pound 15 pounds = = Allocated Costs per Pound $0.200 0.200 0.200 0.200 0.200 $ 8 3 $11 Note: Although not required, it is useful to highlight the individual product profitability figures: Product Breasts Wings Thighs Bones Feathers Sales Value $55.00 4.00 14.00 8.00 0.50 Sales Value at Splitoff Method Joint Costs Gross Allocated Income $33.75 $21.25 2.45 1.55 8.60 5.40 4.90 3.10 0.30 0.20 16-3 Physical Measures Method Joint Costs Gross Allocated Income $20.00 $35.00 4.00 0.00 8.00 6.00 16.00 (8.00) 2.00 (1.50) 2. The sales-value at splitoff method captures the benefits-received criterion of cost allocation and is the preferred method. The costs of processing a chicken are allocated to products in proportion to the ability to contribute revenue. Quality Chicken’s decision to process chicken is heavily influenced by the revenues from breasts and thighs. The bones provide relatively few benefits to Quality Chicken despite their high physical volume. The physical measures method shows profits on breasts and thighs and losses on bones and feathers. Given that Quality Chicken has to jointly process all the chicken products, it is nonintuitive to single out individual products that are being processed simultaneously as making losses while the overall operations make a profit. Quality Chicken is processing chicken mainly for breasts and thighs and not for wings, bones, and feathers, while the physical measure method allocates a disproportionate amount of costs to wings, bones and feathers. 16-17 (10 min.) Joint products and byproducts (continuation of 16-16). 1. Ending inventory: Breasts 15 Wings 4 Thighs 6 Bones 5 Feathers 2 $0.3375 = 0.1225 = 0.2150 = 0.0613 = 0.0300 = $5.0625 0.4900 1.2900 0.3065 0.0600 $7.2090 2. Joint products Breasts Thighs Byproducts Net Realizable Values of byproducts: Wings $ 4.00 Bones 8.00 Feathers 0.50 $12.50 Wings Bones Feathers Joint costs to be allocated: Joint costs – Net Realizable Values of byproducts = $50 – $12.50 = $37.50 Pounds of Product Breast Thighs Wholesale Selling Price per Pound Sales Value at Splitoff Weighting: Sales Value at Splitoff Joint Costs Allocated Allocated Costs Per Pound 100 40 $0.55 0.35 $55 14 $69 55 ÷ 69 14 ÷ 69 $29.89 7.61 $37.50 $0.2989 0.1903 Ending inventory: Breasts 15 $0.2989 Thighs 6 0.1903 $4.4835 1.1418 $5.6253 3. Treating all products as joint products does not require judgments as to whether a product is a joint product or a byproduct. Joint costs are allocated in a consistent manner to all products for the purpose of costing and inventory valuation. In contrast, the approach in requirement 2 lowers the joint cost by the amount of byproduct net realizable values and results in inventory values being shown for only two of the five products, the ones (perhaps arbitrarily) designated as being joint products. 16-4 16-18 (10 min.) Net realizable value method. A diagram of the situation is in Solution Exhibit 16-18. Corn Syrup Final sales value of total production, 12,500 $50; 6,250 $25 Deduct separable costs Net realizable value at splitoff point Weighting, $250,000; $62,500 $312,500 Joint costs allocated, 0.8; 0.2 $325,000 $625,000 375,000 $250,000 0.8 $260,000 Corn Starch $156,250 93,750 $ 62,500 0.2 $ 65,000 Total $781,250 468,750 $312,500 $325,000 SOLUTION EXHIBIT 16-18 (all numbers are in thousands) Joint Costs Separable Costs Processing $375,000 Corn Syrup: 12,500 cases at $50 per case Processing $93,750 Corn Starch: 6,250 cases at $25 per case Processing $325000 Splitoff Point 16-5 16-19 (40 min.) Alternative joint-cost-allocation methods, further-process decision. A diagram of the situation is in Solution Exhibit 16-19. Physical measure of total production (gallons) Weighting, 2,500; 7,500 10,000 Joint costs allocated, 0.25; 0.75 $120,000 2. Final sales value of total production, 2,500 $21.00; 7,500 $14.00 Deduct separable costs, 2,500 $3.00; 7,500 $2.00 Net realizable value at splitoff point Turpentine 7,500 0.75 $ 90,000 Total 10,000 $120,000 Turpentine Total $ 52,500 $157,500 15,000 $ 90,000 22,500 $135,000 1/3 2/3 $ 40,000 $ 80,000 $120,000 Methanol $52,500 Turpentine $105,000 Total $157,500 30,000 7,500 37,500 $15,000 90,000 15,000 105,000 $ 0 120,000 22,500 142,500 $ 15,000 Methanol $52,500 Turpentine $105,000 40,000 7,500 47,500 $ 5,000 Joint costs allocated, 1/3; 2/3 $120,000 $105,000 7,500 $ 45,000 Weighting, $45,000; $90,000 $135,000 3. Methanol 2,500 0.25 $ 30,000 Methanol 1. 80,000 15,000 95,000 $ 10,000 a. Physical-measure (gallons) method: Revenues Cost of goods sold: Joint costs Separable costs Total cost of goods sold Gross margin b. Estimated net realizable value method: Revenues Cost of goods sold: Joint costs Separable costs Total cost of goods sold Gross margin 16-6 Total $157,500 120,000 22,500 142,500 $ 15,000 4. Alcohol Bev. Turpentine $150,000 $105,000 $255,000 60,000 $ 90,000 0.50 $ 60,000 15,000 $ 90,000 0.50 $ 60,000 75,000 $180,000 Final sales value of total production, 2,500 $60.00; 7,500 $14.00 Deduct separable costs, (2,500 $12.00) + (0.20 $150,000); 7,500 $2.00 Net realizable value at splitoff point Weighting, $90,000; $90,000 $180,000 Joint costs allocated, 0.5; 0.5 $120,000 Total $120,000 An incremental approach demonstrates that the company should use the new process: Incremental revenue, ($60.00 – $21.00) 2,500 $ 97,500 Incremental costs: Added processing, $9.00 2,500 $22,500 Taxes, (0.20 $60.00) 2,500 30,000 (52,500) Incremental operating income from further processing $ 45,000 Proof: Total sales of both products Joint costs Separable costs Cost of goods sold New gross margin Old gross margin Difference in gross margin $255,000 120,000 75,000 195,000 60,000 15,000 $ 45,000 SOLUTION EXHIBIT 16-19 Joint Costs Separable Costs 2500 gallons Processing $3 per gallon Methanol: 2500 gallons at $21 per gallon 7500 gallons Processing $2 per gallon Turpentine: 7500 gallons at $14 per gallon Processing $120000 for 10000 gallons Splitoff Point 16-7 16-20 (40 min.) Alternative methods of joint-cost allocation, ending inventories. Total production for the year was: X Y Z Ending Inventories 180 60 25 Sold 120 340 475 Total Production 300 400 500 A diagram of the situation is in Solution Exhibit 16-20. 1. a. Net realizable value (NRV) method: X Final sales value of total production, 300 $1,500; 400 $1,000; 500 $700 Deduct separable costs Net realizable value at splitoff point Weighting, $450; $400; $150 $1,000 Joint costs allocated, 0.45, 0.40, 0.15 $400,000 $450,000 –– $450,000 Y Z Total $400,000 –– $400,000 $350,000 200,000 $150,000 $1,200,000 200,000 $1,000,000 0.40 0.15 $160,000 $ 60,000 0.45 $180,000 $ 400,000 Ending Inventory Percentages: Z 25 500 X Ending inventory Total production Ending inventory percentage X Y 180 60 300 400 60% 15% 5% Z Income Statement Revenues, 120 $1,500; 340 $1,000; 475 $700 Cost of goods sold: Joint costs allocated Separable costs Production costs Deduct ending inventory, 60%; 15%; 5% of production costs Cost of goods sold Gross margin Gross-margin percentage Y Total $180,000 $340,000 $332,500 $852,500 180,000 –– 180,000 160,000 –– 160,000 60,000 200,000 260,000 400,000 200,000 600,000 108,000 72,000 $108,000 24,000 136,000 $204,000 13,000 247,000 $ 85,500 145,000 455,000 $397,500 60% 60% 25.71% 16-8 b. Constant gross-margin percentage NRV method: Step 1: Final sales value of prodn., (300 $1,500) + (400 $1,000) + (500 $700) Deduct joint and separable costs, $400,000 + $200,000 Gross margin Gross-margin percentage, $600,000 ÷ $1,200,000 $1,200,000 600,000 $ 600,000 50% Step 2: X Final sales value of total production, 300 $1,500; 400 $1,000; 500 $700 Deduct gross margin, using overall gross-margin percentage of sales, 50% Total production costs Step 3: Deduct separable costs Joint costs allocated Y Z Total $450,000 $400,000 $350,000 $1,200,000 225,000 225,000 200,000 200,000 175,000 175,000 600,000 600,000 — $225,000 — $200,000 200,000 200,000 $(25,000) $ 400,000 The negative joint-cost allocation to Product Z illustrates one “unusual” feature of the constant gross-margin percentage NRV method: some products may receive negative cost allocations so that all individual products have the same gross-margin percentage. Income Statement X Revenues, 120 $1,500; 340 $1,000; 475 $700 Cost of goods sold: Joint costs allocated Separable costs Production costs Deduct ending inventory, 60%; 15%; 5% of production costs Cost of goods sold Gross margin Gross-margin percentage Y Z Total $180,000 $340,000 $332,500 $852,500 225,000 225,000 200,000 200,000 (25,000) 200,000 175,000 400,000 200,000 600,000 135,000 90,000 $ 90,000 50% 30,000 170,000 $170,000 50% 8,750 166,250 $166,250 50% 173,750 426,250 $426,250 50% 16-9 Summary X a. NRV method: Inventories on balance sheet Cost of goods sold on income statement b. Z Total $108,000 72,000 $ 24,000 136,000 $ 13,000 247,000 $145,000 455,000 $600,000 $135,000 90,000 $ 30,000 170,000 $ $173,750 426,250 $600,000 Constant gross-margin percentage NRV method Inventories on balance sheet Cost of goods sold on income statement 2. Y 8,750 166,250 Gross-margin percentages: NRV method Constant gross-margin percentage NRV X 60% 50% Y 60% 50% Z 25.71% 50.00% SOLUTION EXHIBIT 16-20 Joint Costs Separable Costs Product X: 300 tons at $1,500 per ton Joint Processing Costs $400,000 Product Y: 400 tons at $1,000 per ton Processing $200000 Splitoff Point 16-10 Product Z: 500 tons at $700 per ton 16-21 (30 min.) Joint-cost allocation, process further. ICR8 (Non-Saleable) Crude Oil 150 bbls × $18 / bbl = $2700 ING4 (Non-Saleable) Processing $105 NGL 50 bbls × $15 / bbl = $750 XGE3 (Non-Saleable) Joint Costs = $1800 Processing $175 Processing $210 Splitoff Point 1a. Physical Measure Method 1. Physical measure of total prodn. 2. Weighting (150; 50; 800 ÷ 1,000) 3. Joint costs allocated (Weights $1,800) 1b. 1. 2. 3. 4. 5. Gas 800 eqvt bbls × $1.30 / eqvt bbl = $1040 Crude Oil 150 0.15 $270 NGL 50 0.05 $90 Crude Oil $2,700 175 $2,525 0.63125 $1,136.25 NGL $750 105 $645 0.16125 $290.25 Gas 800 0.80 $1,440 Total 1,000 1.00 $1,800 NRV Method Final sales value of total production Deduct separable costs NRV at splitoff Weighting (2,525; 645; 830 ÷ 4,000) Joint costs allocated (Weights $1,800) 16-11 Gas $1,040 210 $ 830 0.20750 $373.50 Total $4,490 490 $4,000 $1,800 2. The operating-income amounts for each product using each method is: (a) Physical Measure Method Revenues Cost of goods sold Joint costs Separable costs Total cost of goods sold Gross margin (b) Crude Oil $2,700 NGL $750 Gas $1,040 Total $4,490 270 175 445 $2,255 90 105 195 $555 1,440 210 1,650 $ (610) 1,800 490 2,290 $2,200 Crude Oil $2,700.00 NGL $750.00 Gas $1,040.00 Total $4,490.00 1,136.25 175.00 1,311.25 $1,388.75 290.25 105.00 395.25 $354.75 373.50 210.00 583.50 $ 456.50 1,800.00 490.00 2,290.00 $2,200.00 NRV Method Revenues Cost of goods sold Joint costs Separable costs Total cost of goods sold Gross margin 3. Neither method should be used for product emphasis decisions. It is inappropriate to use joint-cost-allocated data to make decisions regarding dropping individual products, or pushing individual products, as they are joint by definition. Product-emphasis decisions should be made based on relevant revenues and relevant costs. Each method can lead to product emphasis decisions that do not lead to maximization of operating income. 4. Since crude oil is the only product subject to taxation, it is clearly in Sinclair’s best interest to use the NRV method since it leads to a lower profit for crude oil and, consequently, a smaller tax burden. A letter to the taxation authorities could stress the conceptual superiority of the NRV method. Chapter 16 argues that, using a benefits-received cost allocation criterion, market-based joint cost allocation methods are preferable to physical-measure methods. A meaningful common denominator (revenues) is available when the sales value at splitoff point method or NRV method is used. The physical-measures method requires nonhomogeneous products (liquids and gases) to be converted to a common denominator. 16-12 16-22 (30 min.) Joint-cost allocation, sales value, physical measure, NRV methods. 1a. PANEL A: Allocation of Joint Costs using Sales Value at Splitoff Method Sales value of total production at splitoff point (10,000 tons $10 per ton; 20,000 $15 per ton) Weighting ($100,000; $300,000 ÷ $400,000) Joint costs allocated (0.25; 0.75 $240,000) PANEL B: Product-Line Income Statement for June 2009 2009 Revenues (12,000 tons $18 per ton; 24,000 $25 per ton) Deduct joint costs allocated (from Panel A) Deduct separable costs Gross margin Gross margin percentage Special B/ Beef Ramen Special S/ Shrimp Ramen $100,000 0.25 $60,000 $300,000 0.75 $180,000 Special B Special S $216,000 60,000 48,000 $108,000 50% $600,000 180,000 168,000 $252,000 42% $816,000 240,000 216,000 $360,000 44% Special B/ Beef Ramen 10,000 33% $80,000 Special S/ Shrimp Ramen 20,000 67% $160,000 Total 30,000 $240,000 Special B Special S Total Total $400,000 $240,000 Total 1b. PANEL A: Allocation of Joint Costs using Physical-Measure Method Physical measure of total production (tons) Weighting (10,000 tons; 20,000 tons ÷ 30,000 tons) Joint costs allocated (0.33; 0.67 $240,000) PANEL B: Product-Line Income Statement for June 2009 2009 Revenues (12,000 tons $18 per ton; 24,000 $25 per ton) Deduct joint costs allocated (from Panel A) Deduct separable costs Gross margin Gross margin percentage $216,000 80,000 48,000 $ 88,000 41% $600,000 160,000 168,000 $272,000 45% $816,000 240,000 216,000 $360,000 44% Special B Special S Total 1c. PANEL A: Allocation of Joint Costs using Net Realizable Value Method Final sales value of total production during accounting period (12,000 tons $18 per ton; 24,000 tons $25 per ton) Deduct separable costs Net realizable value at splitoff point Weighting ($168,000; $432,000 ÷ $600,000) Joint costs allocated (0.28; 0.72 $240,000) PANEL B: Product-Line Income Stateme